* Includes operating expenses, commissions and bonuses, premium taxes, and the net increase in deferred acquisition costs, value of business acquired and other intangible assets.
Financial measures that exclude after-tax net capital gains and losses and accumulated other comprehensive income (“AOCI”) are non-GAAP measures. To provide investors with a broader understanding of earnings, we provide net income per diluted share excluding after-tax net capital gains and losses, along with the GAAP measure of net income per diluted share, because capital gains and losses are not likely to occur in a stable pattern.
Management believes that measuring return on average equity excluding after-tax net capital gains and losses from net income and AOCI from equity is important to investors because the turnover of our portfolio of fixed maturity securities may not be such that unrealized gains and losses reflected in AOCI are ultimately realized. Furthermore, management believes exclusion of AOCI provides investors with a better measure of return.
Net income excluding after-tax net capital losses was $5.34 per diluted share for 2013, compared to $3.24 per diluted share for 2012. The increase was primarily due to more favorable claims experience in Employee Benefits, lower operating expenses as a result of expense management actions, and higher earnings in the Asset Management and Individual Disability segments for 2013. Operating expenses were reduced by $20.6 million or $0.30 per diluted share for the first half of 2013 due to the amendment of the postretirement medical plan.
Net income excluding after-tax net capital losses was $3.24 per diluted share for 2012, compared to $3.14 per diluted share for 2011. The increase was primarily due to higher net investment income from bond call premiums and commercial mortgage loan prepayment fee revenues, higher premiums for Employee Benefits and Individual Disability, a lower effective income tax rate and higher earnings in
We reported higher earnings in all of our businesses in 2013 compared to 2012. The primary drivers of our results for 2013 were the favorable claims experience in Employee Benefits, lower operating expenses as a result of expense management actions and higher earnings in our Asset Management and Individual Disability segments. We returned over $130 million of capital to shareholders through dividends and share repurchases.
We are seeing the benefits of a slowly improving economy as well as actions within our Employee Benefits businesses now that we are nearly complete with our re-pricing efforts related to higher long term disability claims incidence.
If it is determined other-than-temporary impairments (“OTTI”) exists, we separate the OTTI of fixed maturity securities into an OTTI related to credit loss and an OTTI related to noncredit loss. The OTTI related to credit loss represents the portion of losses equal to the difference between the present value of expected cash flows, discounted using the pre-impairment yields, and the amortized cost basis. All other changes in value represent the OTTI related to noncredit loss. The OTTI related to credit loss is recognized in earnings in the current period, while the OTTI related to noncredit loss is deemed recoverable and is recognized in other comprehensive income. The cost basis of the fixed maturity security is permanently adjusted to reflect the credit related impairment. Once an impairment charge has been recorded, we continue to review the OTTI securities for further potential impairment.
The carrying value of commercial mortgage loans represents the outstanding principal balance less a loan loss allowance for probable uncollectible amounts. The commercial mortgage loan loss allowance is estimated based on evaluating known and inherent risks in the loan portfolio and consists of a general loan loss allowance and a specific loan loss allowance. The general loan loss allowance is based on our analysis of factors including changes in the size and composition of the loan portfolio, debt coverage ratios, loan to value ratios, actual loan loss experience and individual loan analysis. An impaired commercial mortgage loan is a loan where we do not expect to receive contractual principal and interest in accordance with the terms of the original loan agreement. A specific allowance for losses is recorded when a loan is considered to be impaired. We also hold specific allowances for losses on certain performing loans that we continue to monitor and evaluate. Impaired commercial mortgage loans without specific allowances for losses are those for which we have determined that it remains probable that we will collect all amounts due. In addition, for impaired commercial mortgage loans, we evaluate the loss to dispose of the underlying collateral, any significant out of pocket expenses the loan may incur, the loan-to-value ratio and other quantitative information we have concerning the loan. Portions of loans that are deemed uncollectible are generally written off against the allowance, and recoveries, if any, are credited to the allowance. See “Liquidity and Capital Resources-Investing Cash Flows-Commercial Mortgage Loans.”
We record impairments when it is determined that the decline in fair value of an investment below its carrying value is other than temporary. The impairment loss is charged to capital losses, and the cost basis of the investment is permanently adjusted to reflect the impairment.
Real Estate Owned is initially recorded at the lower of cost or net realizable value, which includes an estimate for disposal costs. This amount may be adjusted in a subsequent period as additional information is received. Our Real Estate Owned is initially considered an investment held for sale and is expected to be sold within one year from acquisition. For any real estate expected to be sold, an impairment charge is recorded if we do not expect the investment to recover its carrying value prior to the expected date of sale. Once an impairment charge has been recorded, we continue to review the investment for further potential impairment.
The following table sets forth the net balances of DAC, VOBA and other intangible assets:
VOBA primarily represents the discounted future profits of business assumed through reinsurance agreements. We have established VOBA for a block of individual disability business assumed from Minnesota Life Insurance Company (“Minnesota Life”) and a block of group disability and group life business assumed from Teachers Insurance and Annuity Association of America (“TIAA”). VOBA is generally amortized in proportion to future premiums for group and individual disability insurance products and group life products. However, the VOBA related to the TIAA transaction associated with an in force block of group long term disability claims for which no ongoing premium is received is amortized in proportion to expected gross profits. If actual premiums or future profitability are inconsistent with our assumptions, we could be required to make adjustments to VOBA and related amortization. The VOBA associated with the TIAA transaction is amortized in proportion to expected gross profits with an amortization period of up to 20 years. For the VOBA associated with the Minnesota Life block of business assumed, the amortization period is up to 30 years and is amortized in proportion to future premiums. The accumulated amortization of VOBA was $68.7 million and $65.4 million at December 31, 2013 and 2012, respectively.
These assumptions are modified to reflect actual experience when appropriate. Although a change in a single assumption may have an impact on the calculated amortization of DAC or VOBA for balances associated with investment contracts, it is the relationship of that change to the changes in other key assumptions that determines the ultimate impact on DAC or VOBA amortization. Because actual results and trends related to these assumptions vary from those assumed, we revise these assumptions annually to reflect our current best estimate of expected gross profits. As a result of this process, known as “unlocking,” the cumulative balances of DAC and VOBA are adjusted with an offsetting benefit or charge to income to reflect changes in the period of the revision. An unlocking event generally occurs as a result of actual experience or future expectations differing from previous estimates. We recorded a reduction to VOBA of $1.0 million in 2013 and $0.8 million in 2012 due to changes in expected gross profits related to a block of claims assumed. We did not record a similar impairment for 2011. As a result of unlocking, the amortization schedule for future periods is also adjusted.
Developing the estimates for reserves, and thus the resulting impact on earnings, requires varying degrees of subjectivity and judgment, depending upon the nature of the reserve. For most of our reserves, the reserve calculation methodology is prescribed by various accounting and actuarial standards, although judgment is required in the determination of assumptions used in the calculation. We also hold reserves that lack a prescribed methodology but instead are determined by a formula that we have developed based on our own experience. Because this type of reserve requires a higher level of subjective judgment, we closely monitor its adequacy.
Claim reserves are established when a claim is incurred or is estimated to have been incurred but not yet reported to us and, as prescribed by GAAP, equal our best estimate of the present value of the liability of future unpaid claims and claim adjustment expenses. Reserves for IBNR claims are determined using our experience and consider actual historical incidence rates, claim-reporting patterns and the average cost of claims. The IBNR claim reserves are calculated using a company derived formula based primarily upon premiums, which is validated through a close examination of reserve run-out experience. The claim reserves are related to group and individual disability insurance and group life insurance products offered by our Employee Benefits and Individual Disability segments.
Claim reserves are subject to revision based on credible changes in claim experience and expectations of future factors that may influence claim experience. During each quarter, we monitor our emerging claim experience to ensure that the claim reserves remain appropriate. We make adjustments to our assumptions based on emerging trends that are credible and are expected to persist, and expectations of future factors that may influence our claim experience. Assumptions used to calculate claim reserves may vary by the age, gender and occupation class of the claimant, the year the claim was incurred, time elapsed since disablement, and specific contract provisions and limitations.
As a result of studies of our long-term trends compared to reserving assumptions for our group long term disability insurance, we did not adjust our IBNR claim reserves 2013. We increased IBNR claim reserves totaling $3.7 million in 2012 while we did not adjust IBNR claim reserves in 2011.
We refined the claim termination rate assumptions for the reserves on a small block of individual disability claims based on a blend of our experience and industry data in 2013, 2012 and 2011, which resulted in an increase in reserves of $2.1 million, $4.9 million and $5.5 million, respectively. Our block of business is relatively small, and as a result, we view a blend of established industry tables and our own experience as a more appropriate method for establishing reserve levels compared solely to our own experience. We will continue to monitor the credibility of our developing experience and the use of available industry tables, and if necessary, will adjust reserves accordingly. We also refined our reserve calculation for certain other individual disability reserves, which resulted in a net increase in our individual disability reserves of $5.1 million in 2013 and a net decrease in our individual disability reserves of $1.1 million and $1.9 million in 2012 and 2011, respectively. The combination of these adjustments resulted in an overall net increase to individual disability reserves of $7.2 million, $3.8 million and $3.6 million in 2013, 2012 and 2011, respectively.
We have two non-contributory defined benefit pension plans: the employee pension plan and the agent pension plan. The employee pension plan is for all eligible employees and the agent pension plan is for former field employees and agents. The defined benefit pension plans provide benefits based on years of service and final average pay. Participation in the defined benefit pension plans is generally limited to eligible employees whose date of employment began before 2003. The employee pension plan is sponsored by StanCorp and the agent pension plan is sponsored by Standard. Both plans are administered by Standard Retirement Services and are closed for new participants. In addition, eligible executive officers are covered by a non-qualified supplemental retirement plan.
The weighted-average discount rate is an interest assumption used to convert the benefit payment stream to present value. The discount rate is selected based on the yield of a portfolio of high-quality corporate bonds with durations that are similar to the expected distributions from the employee benefit plan.
We file a U.S. consolidated income tax return that includes all subsidiaries. Our U.S. income tax is calculated using regular corporate income tax rates on a tax base determined by laws and regulations administered by the Internal Revenue Service. We also file corporate income tax returns in various states. The provision for income taxes includes amounts currently payable and deferred amounts that result from temporary differences between financial reporting and tax bases of assets and liabilities. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply when the temporary differences are expected to reverse.
Management is required to determine whether tax return positions are more likely than not to be sustained upon audit by taxing authorities. Tax benefits of uncertain tax positions, as determined and measured by this interpretation, cannot be recognized in our financial statements.
Revenues consist of premiums, administrative fees, net investment income and net capital gains and losses. Historically, premium growth in Insurance Services and administrative fee and net investment income growth in Asset Management have been the primary drivers of consolidated revenue growth.
The discount rate for newly established claim reserves is reviewed quarterly and, if necessary, is adjusted to reflect our current and expected new investment yields. The discount rate is based on the average rate we received on newly invested assets during the previous 12 months, less a margin. We also consider our average investment yield and average discount rate on our entire block of claims when deciding whether to increase or decrease the discount rate. A 25 basis point increase or decrease in the discount rate for newly established claim reserves results in a corresponding increase or decrease in quarterly pre-tax income of approximately $2 million. See “Critical Accounting Policies and Estimates-Reserves for Future Policy Benefits and Claims.”
Interest credited represents interest paid to policyholders on retirement plan general account assets, individual fixed-rate annuity deposits and index-based interest guarantees embedded in indexed annuities (“index-based interest guarantees”) in Asset Management and interest paid on life insurance proceeds on deposit in Insurance Services. Interest credited is primarily affected by the following factors:
Changes in the fair value of the index-based interest guarantees. The changes may fluctuate from quarter to quarter due to changes in interest rates and equity market volatility.
Commissions and bonuses primarily represent sales-based compensation, which can vary depending on the product, the structure of the commission program and other factors such as customer retention, sales, in force premium, growth in assets under administration and the profitability of business in each of our segments.
The increase in revenues for 2012 compared to 2011 was primarily due to an increase in net investment income, which was primarily due to higher bond call premiums and commercial mortgage loan prepayment fee revenues, and an increase in premiums from Employee Benefits. Bond call premiums increased to $8.0 million for 2012, compared to $7.1 million for 2011. Commercial mortgage loan prepayment fees increased to $13.2 million for 2012, compared to $7.5 million for 2011.
The increase in net investment income for 2012 compared to 2011 was primarily due to favorable changes in the fair value of our S&P 500 Index options and increases in bond call premiums and commercial mortgage loan prepayment fee revenues. Also contributing to the increase in net investment income for 2012 was an increase in average retirement plan general account assets under administration. Partially offsetting the increase to net investment income was lower average portfolio yields for both fixed maturity securities and commercial mortgage loans and higher operating losses on our tax-advantaged investments. The benefits from these investments are recorded as either a reduction to income taxes or a reduction of state premium taxes. See “Business Segments-Asset Management.”
The increase in interest credited for 2012 compared to 2011 was primarily due to growth in our average individual annuity assets under administration. Also contributing to the increase in interest credited for 2012 was a $5.1 million increase in the change in fair value of the index-based interest guarantees. See “Business Segments-Asset Management.”
The decrease in commissions and bonuses for 2012 compared to 2011 was primarily due to lower Employee Benefits sales for 2012.
The net decrease in DAC, VOBA and other intangible assets for 2012 compared to 2011 was primarily due to a decrease in deferral of acquisition costs and an increase in amortization of DAC, VOBA and other intangible assets. Deferrals of acquisition costs decreased to $71.4 million in 2012, compared to $81.7 million in 2011 primarily due to lower Employee Benefits sales for 2012. Amortization of DAC, VOBA and other intangible assets increased to $70.5 million for 2012, compared to $67.2 million for 2011 primarily due to higher Asset Management earnings, as amortization fluctuates with changes in estimated gross profit.
Income before income taxes for Insurance Services was $272.4 million for 2013, compared to $179.8 million for 2012. The increase in income before income taxes was primarily due to more favorable claims experience in Employee Benefits, partially offset by lower Employee Benefits premiums and lower net investment income.
The benefit ratio for Employee Benefits was 78.9% for 2013 compared to 83.9% for 2012. The decrease was partially offset by a 43 basis point lower average discount rate for 2013 compared to 2012 used for newly established long term disability claims reserves. Claims experience can fluctuate widely from quarter to quarter and tends to be more stable when measured over a longer period of time.
The benefit ratio for Individual Disability decreased to 63.9% for 2013, compared to 65.8% for 2012. Due to the relatively small size of the Individual Disability business, the benefit ratio generally fluctuates more on a quarterly basis and tends to be more stable when measured on an annual basis. See “Critical Accounting Policies and Estimates-Investment Valuations-Claim Reserves” for more information.
The decrease in operating expenses for Insurance Services for 2013 compared to 2012 was primarily due to expense management actions, which reduced headcount and other non-compensation related expenses to align operating expenses with lower anticipated premium levels.
The increase in operating expenses for Insurance Services for 2012 compared to 2011 was primarily related to increased compensation related costs.
The following tables sets forth our Asset Management results of operations and key indicators:
Income before income taxes for Asset Management was $79.3 million for 2013, compared to $64.0 million for 2012. The increase was primarily due to higher administrative fee revenues as a result of the increase in assets under administration and lower benefits to policyholders as a result of favorable mortality experience in the individual annuity business. In addition, bond call premiums and commercial mortgage loan prepayment fees and their related affect on DAC amortization added $8.6 million of income before income taxes for 2013, compared to $6.6 million for 2012. Income before income taxes also increased $2.6 million for 2013 and $0.2 million for 2012 as a result of the change in fair values of the hedging assets and liabilities related to our equity-indexed annuity product.
The increase in interest credited for Asset Management for 2013 compared to 2012 was primarily due to growth in our retirement plan general account assets under administration and individual fixed-rate annuity assets under administration, partially offset by a decrease in the average interest-crediting rate for our annuity products.
The decrease in operating expenses for Asset Management for 2013 compared to 2012 was primarily due to expense management actions, which reduced headcount and other non-compensation related expenses.
Income before income taxes for Asset Management was $64.0 million for 2012, compared to $61.3 million for 2011. The increase was primarily a result of the change in fair values of the hedging assets and liabilities related to our equity indexed annuity product. The net change in the hedging assets and liabilities related to our equity indexed annuity product was $0.2 million for 2012 and negative $1.0 million for 2011. See Item 8, “Financial Statements and Supplementary Data-Notes to Consolidated Financial Statements-Derivative Financial Instruments.”
The increase in net investment income for Asset Management for 2012 compared to 2011 was primarily due to an increase in individual annuity assets under administration and an increase in retirement plan general account assets under administration. Net investment income also increased due to a higher contribution from the change in fair value of our S&P 500 Index options related to our indexed annuity product and an increase in commercial mortgage loan prepayment fees. The change in fair value of our S&P 500 Index options in 2012 was an increase of $7.8 million compared to a decrease of $0.2 million for 2011. Commercial mortgage loan prepayment fees were $5.4 million for 2012, compared to $3.5 million for 2011. These increases were partially offset by lower portfolio yields for fixed maturity securities and commercial mortgage loans in addition to a decrease in bond call premiums received on fixed maturity securities. Consolidated portfolio yields for fixed maturity securities and commercial mortgage loans were 4.66% and 6.09% for 2012, respectively, and 5.08% and 6.34% for 2011, respectively. Bond call premiums were $2.6 million for 2012 compared to $6.3 million for 2011.
We report our holding company and corporate activities in the Other category. This category includes return on capital not allocated to the product segments, holding company expenses, operations of certain unallocated subsidiaries, interest on debt, unallocated expenses, net capital gains and losses and adjustments made in consolidation.
The increase in net investment income for Other for 2013 compared to 2012 was primarily due to interest income from fixed maturity securities of $11.0 million for 2013, compared to $9.0 million for 2012, which was primarily due to a larger amount of invested assets allocated to the Other category. In addition, operating losses related to our tax-advantaged investments decreased to $2.0 million for 2013, compared to $3.8 million for 2012.
The decrease in the loss before income taxes for Other for 2012 compared to 2011 was primarily due to higher operating expenses for 2011 related to project costs for information technology service changes, which did not recur in 2012.
Our interest rate risk analysis reflects the influence of call and prepayment rights present in our fixed maturity securities and commercial mortgage loans. The majority of these investments have contractual provisions that require the borrower to compensate us in part or in full for reinvestment losses if the security or loan is retired before maturity. Callable bonds, excluding bonds with make-whole provisions and bonds with provisions that allow the borrower to prepay near maturity, represented 4.25%, or $302.8 million, of our fixed maturity securities portfolio at December 31, 2013. We also originate commercial mortgage loans containing a make-whole prepayment provision requiring the borrower to pay a prepayment fee. As interest rates decrease, potential prepayment fees increase. These larger prepayment fees deter borrowers from refinancing during a low interest rate environment. Approximately 97% of the commercial mortgage loan portfolio contains this prepayment provision. Approximately 1% of the commercial mortgage loan portfolio, without a make-whole prepayment provision, contains fixed percentage prepayment fees that mitigate prepayments but may not fully protect our expected cash flows in the event of prepayment.
Our financial instruments are exposed to financial market volatility and potential disruptions in the market that may result in certain financial instruments becoming less valuable. Financial market volatility includes interest rate risk. We have analyzed the estimated loss in fair value of certain market sensitive financial assets held at December 31, 2013 and 2012, using a hypothetical 10% increase in interest rates and related qualitative information on how we manage interest rate risk. The interest rate sensitivity analysis was based upon our fixed maturity securities and commercial mortgage loans held at December 31, 2013 and 2012. Interest rate sensitivity of our financial assets was measured assuming a parallel shift in interest rates. All security yields were increased by 10% of the year-end 10-year U.S. Government Treasury bond yield, or 0.30% and 0.18% for the 2013 and 2012 analyses, respectively. The change in fair value of each security was estimated as the change in the option adjusted value of each security. Option adjusted values were computed using our payment models and provisions for the effects of possible future changes in interest rates. The analyses did not explicitly provide for the possibility of non-parallel shifts in the yield curve, which would involve discount rates for different maturities being increased by different amounts. The actual change in fair value of our financial assets can be significantly different from that estimated by the model. The hypothetical reduction in the fair value of our financial assets that resulted from the model was estimated to be $164 million and $99 million at December 31, 2013 and 2012, respectively.
We maintain prudent diversification across industries, issuers and maturities. We have avoided the types of structured products that we believe are not adequately transparent to allow for good decision making. Our corporate bond industry diversification targets are based on the Bank of America Merrill Lynch U.S. Corporate Index, which we believe reasonably reflects the mix of issuers broadly available in the market. Our fixed maturity securities rated below investment grade are primarily managed by a third party.
The increases in commercial mortgage loan originations for 2013 compared to 2012, and 2012 compared to 2011 were primarily due to increased commercial real estate market activity.
The estimated average loan to value ratio for the overall portfolio was less than 70% at December 31, 2013. The average loan balance of our commercial mortgage loan portfolio was approximately $0.8 million at December 31, 2013. We have the contractual ability to pursue personal recourse on approximately 74% of our loans and partial personal recourse on a majority of the remaining loans. The weighted-average capitalization rate for the portfolio at December 31, 2013 was approximately 9%. Capitalization rates, which vary by property type and geographic region, are used as part of our annual internal analysis of our commercial mortgage loan portfolio. The rate is used in converting the property’s income to an estimated property value.
Our largest concentration of commercial mortgage loan property type was retail properties and primarily consisted of convenience related properties in strip malls, convenience stores and restaurants. Our exposure to retail properties is diversified among various borrowers, properties and geographic regions. In addition, retail commercial lending represents an area of experience and expertise, where careful underwriting and consistent surveillance mitigate risks surrounding our commercial mortgage lending in this area. See Item 8, “Financial Statements and Supplementary Data-Notes to Consolidated Financial Statements-Note 10-Investments-Commercial Mortgage Loans.”
At December 31, 2013, our ten largest borrowers represented less than 7% of our total commercial mortgage loan portfolio balance. Our largest borrower concentrations within our commercial mortgage loan portfolio consisted of one borrower that comprised less than 2% of our total commercial mortgage loan portfolio balance. The second largest borrower comprised less than 1% of our total commercial mortgage loan portfolio balance.
The performance of our commercial mortgage loan portfolio may fluctuate in the future. However, based on our business approach of diligently underwriting high-quality loans, we believe our delinquency rate will remain low. We have avoided structured products that do not meet an adequate level of transparency for good decision making. The increase in restructured commercial mortgage loans of $23.2 million during 2013 was associated with a small number of borrowers.
Commercial mortgage loan foreclosures may result in the sale of the property to a third party at the time of foreclosure, resulting in fewer properties transferred to Real Estate Owned than the number of loans foreclosed during the period. Commercial mortgage loans may have multiple properties as collateral, resulting in more properties transferred to Real Estate Owned than the number of loans foreclosed during the period. Real Estate Owned is initially recorded at estimated net realizable value, which includes an estimate for disposal costs. These amounts may be adjusted in a subsequent period as additional market information regarding fair value is received, however, these adjustments would not result in a carrying value greater than the initial recorded amount. The book value of real estate acquired during 2013 decreased compared to 2012 primarily due to fewer properties being foreclosed and because those that were foreclosed and transferred to Real Estate Owned had lower average book values in 2013. See “Critical Accounting Policies and Estimates-Investment Valuations-Commercial Mortgage Loans” for our commercial mortgage loan loss allowance policy.
A commercial mortgage loan is impaired when we do not expect to receive contractual principal and interest in accordance with the terms of the original loan agreement. A specific allowance for losses is recorded when a loan is considered to be impaired and it is probable that all amounts due will not be collected based on the terms of the original note. We also hold specific loan loss allowances on certain performing commercial mortgage loans that we continue to monitor and evaluate. Impaired commercial mortgage loans without specific allowances for losses are those for which we have determined that it remains probable that all amounts due will be collected although the timing or nature may be outside the original contractual terms. The increase to the net carrying value of impaired commercial mortgage loans at December 31, 2013 compared to 2012 was primarily due to an increase in impaired commercial mortgage loans with a specific allowance in our retail segment associated with a small number of borrowers, partially offset by a decrease in our commercial segment during 2013.
Under the agreement, we are subject to customary covenants that take into consideration the impact of material transactions, changes to the business, compliance with legal requirements and financial performance. The two financial covenants are based on our total debt to total capitalization ratio and consolidated net worth. Under the two financial covenants, we are required to maintain a total debt to capitalization ratio that does not exceed 35% and a consolidated net worth that is equal to at least $1.37 billion. The financial covenants exclude the unrealized gains and losses related to fixed maturity securities that are held in accumulated other comprehensive income (loss). At December 31, 2013, we had a total debt to total capitalization ratio of 21.85% and consolidated net worth of $1.98 billion as defined by the financial covenants. The Facility is subject to pricing levels based upon our publicly announced debt ratings and includes an interest rate option at the election of the borrower of a base rate plus the applicable margin or the London Interbank Offered Rate (“LIBOR”) plus the applicable margin, plus facility and utilization fees. At December 31, 2013,
In November 2013, we became a member of the Federal Home Loan Bank (“FHLB”) of Seattle and purchased the required common stock for membership. Membership in the FHLB provides an attractive funding source and access to financial services that can be used as an alternative source of liquidity. At December 31, 2013, we had no outstanding balances with the FHLB.
State insurance departments require insurance enterprises to maintain minimum levels of capital and surplus. Our target for the insurance subsidiaries is generally to maintain statutory capital at 300% of the Company Action Level of Risk-based capital (“RBC”) required by regulators, which is 600% of the Authorized Control Level RBC required by our states of domicile. The insurance subsidiaries held statutory capital of approximately 398% of the Company Action Level RBC as of December 31, 2013. At December 31, 2013, statutory capital, adjusted to exclude asset valuation reserves, for our regulated insurance subsidiaries totaled $1.49 billion.
Statutory capital growth from our insurance subsidiaries is generally a result of generated income, less a charge for business growth, measured by insurance premium growth, which includes individual annuity sales. The level of capital in excess of targeted RBC we generate varies inversely in relation to the level of our premium growth. As premium growth increases, capital is utilized to fund additional reserve requirements, meet increased regulatory capital requirements based on premium and cover certain acquisition costs associated with policy issuance, leaving less available capital beyond our target level. Higher levels of premium growth can result in increased utilization of capital beyond that which is generated by the business, and at very high levels of premium growth, we could generate the need for capital infusions. At lower levels of premium growth, additional capital produced by the business exceeds the capital utilized to meet these requirements, which can result in additional capital above our targeted RBC level. In assessing our capital position, we also consider cash and capital at the holding company and non-insurance subsidiaries.
Our ability to pay dividends to shareholders, repurchase shares and meet obligations substantially depends upon the receipt of distributions from Standard. Standard’s ability to pay dividends to StanCorp is affected by factors deemed relevant by Standard’s Board of Directors and by Oregon law, which limits Standard’s dividend payments and other distributions to the earned surplus arising from its business. If the proposed dividend or other distribution exceeds certain statutory limitations, Standard must receive prior approval of the Director of the Oregon Department of Consumer and Business Services-Insurance Division (“Oregon Insurance Division”). The current statutory dividend limitations are the greater of (a) 10% of Standard’s combined capital and surplus as of December 31 of the preceding year, or (b) the net gain from operations after dividends to policyholders and federal income taxes and before realized capital gains or losses for the 12-month period ended on the preceding December 31. In each case, the limitation must be determined under statutory accounting practices. Oregon law gives the Oregon Insurance Division broad discretion to approve or decline requests for dividends and other distributions in excess of these limits. With the exception of StanCorp Equities, a limited broker-dealer and member of the Financial Industry Regulatory Authority, there are no regulatory restrictions on dividends from our non-insurance subsidiaries.
As of December 31, 2013, Standard’s net gain from operations after dividends to policyholders and federal income taxes and before capital gains or losses for the 12-month period then ended was $195.1 million and capital and surplus was $1.29 billion. Based upon Standard’s results for 2013, the amount of ordinary dividends and other distributions available in 2014, without prior approval
On November 12, 2013, our Board of Directors declared an annual cash dividend of $1.10 per share. The dividend was paid on December 9, 2013 to shareholders of record on November 25, 2013. In 2012 and 2011, we paid an annual cash dividend of $0.93 and $0.89 per share, respectively. The Board of Directors has increased the annual dividend per share to shareholders each year for the past 14 consecutive years. The declaration and payment of dividends to shareholders in the future is subject to the discretion of our Board of Directors. It is anticipated that an annual dividend to shareholders will be paid in December of each year depending on our financial condition, results of operations, cash requirements, future prospects, regulatory restrictions on distributions from the insurance subsidiaries, the ability of the insurance subsidiaries to maintain adequate capital and other factors deemed relevant by the Board of Directors. In addition, the declaration and payment of dividends to shareholders would be restricted if we elect to defer interest payments on our Subordinated Debt issued May 7, 2007. If elected, the restriction would be in place during the interest deferral period, which cannot exceed five years. We have not deferred interest on the Subordinated Debt, and have paid dividends each year since our initial public offering in 1999.
On November 13, 2012, our Board of Directors authorized the repurchase of 3.0 million shares of StanCorp common stock through December 31, 2014. As of December 31, 2013, there were 1.4 million shares remaining under the November 2012 authorization. On February 11, 2014, our Board of Directors authorized the repurchase of an additional 3.0 million shares of StanCorp common stock through December 31, 2015. The February 2014 authorization takes effect on the earlier of the expiration or completion of the November 2012 authorization. Share repurchases under the repurchase program are made in the open market or in negotiated transactions in compliance with the safe harbor provisions of Rule 10b-18 under regulations of the Securities Exchange Act of 1934 (“Exchange Act”). Execution of the share repurchase program is based upon management’s assessment of market conditions for its common stock, capital levels, our assessment of the overall economy and other potential growth opportunities or priorities for capital use. Repurchases are made at market prices on the transaction date. We will evaluate share repurchases opportunistically based on our capital levels and our assessment of the direction of the overall economy and equity market valuations.
(2) While historical withdrawal patterns indicate withdrawal primarily occurs in periods in excess of one year, policyholder fund obligations in the amount of $4.61 billion have been included in the less than one year column of the table as they may be withdrawn upon request. These net cash payments are undiscounted with respect to interest but reflect an offsetting effect due to reinsurance receivables and, as a result, the sum of the net cash payments shown for all years in the table of $5.77 billion differs from the corresponding liability amount of $6.05 billion included in the Consolidated Financial Statements as of December 31, 2013. Due to the significance of the assumptions used, actual net cash payments will differ, possibly materially, from these estimates.
In the normal course of business, we commit to fund commercial mortgage loans generally up to 90 days in advance. At December 31, 2013, we had outstanding commitments to fund commercial mortgage loans totaling $197.6 million, with fixed interest rates ranging from 4.25% to 5.75%. These commitments generally have fixed expiration dates. A small percentage of commitments expire due to the borrower’s failure to deliver the requirements of the commitment by the expiration date. In these cases, we will retain the commitment fee and good faith deposit. Alternatively, if we terminate a commitment due to the disapproval of a commitment requirement, the commitment fee and deposit may be refunded to the borrower, less an administrative fee.
Statutory accounting practices differ in some respects from GAAP. The principal statutory practices that differ from GAAP are:
Reserves for life and disability policies and contracts are reported net of ceded reinsurance and calculated based on statutory requirements, including required discount rates.
The fluctuations in the difference between the Statutory Results and Adjusted GAAP Results for 2013 compared to 2012 and 2012 compared to 2011 were primarily due to differences in the prescribed accounting treatments between GAAP and Statutory accounting practices for net investment income, reserves for our individual annuity products, net income or loss from the holding company and noninsurance subsidiaries and lower operating expenses as a result of expense management actions. The expense management actions included an amendment to the postretirement medical plan which reduced operating expenses by $20.6 million during 2013, which were included in the Adjusted GAAP Results and not included in the Statutory Results.
From time to time StanCorp or its representatives make written or oral statements, including some of the statements contained or incorporated by reference in this Annual Report on Form 10-K and in other reports, filings with the Securities and Exchange Commission, press releases, conferences or otherwise, that are other than purely historical information. These statements, including estimates, projections, statements related to business plans, strategies, objectives and expected operating results and the assumptions upon which those statements are based, are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and Section 21E of the Exchange Act. Forward-looking statements also include, without limitation, any statement that includes words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “estimates,” “seeks,” “will be,” “will continue,” “will likely result” and similar expressions that are predictive in nature or that depend on or refer to future events or conditions. Our forward-looking statements are not guarantees of future performance and involve uncertainties that are difficult to predict. They involve risks and uncertainties which may cause actual results to differ materially from the forward-looking statements and include, but are not limited to, the following:
Availability of capital required to support business growth and the effective use of capital, including the ability to achieve financing through debt or equity.
Changes in liquidity needs and the liquidity of assets in our investment portfolios.
Adequacy of diversification of risk within our commercial mortgage loan portfolio by borrower, property type and geographic region.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of StanCorp Financial Group, Inc. and subsidiaries as of December 31, 2013 and 2012, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2013, in conformity with accounting principles generally accepted in the United States of America.
(2) Net of tax benefits of $3.1 million, $2.2 million and $3.2 million for 2013, 2012 and 2011, respectively.
(4) Net of tax benefit of $3.2 million and tax expenses of $3.4 million and $1.7 million for 2013, 2012 and 2011, respectively.
Standard holds interests in tax-advantaged investments. These interests do not meet the requirements for consolidation under existing accounting standards, and thus the Company’s interests in the tax-advantaged investments are accounted for under the equity method of accounting. The total investment in these interests was $192.4 million and $173.0 million at December 31, 2013 and 2012 respectively.
Company’s profitability and may affect key indicators used to measure the Company’s performance. These estimates have a material effect on our results of operations and financial condition.
An impaired commercial mortgage loan is a loan where the Company does not expect to receive contractual principal and interest in accordance with the terms of the original loan agreement. A specific allowance for losses is recorded when a loan is considered to be impaired and it is probable that all amounts due will not be collected based on the terms of the original note. The Company also holds specific loan loss allowances on certain performing commercial mortgage loans that it continues to monitor and evaluate. Impaired commercial mortgage loans without specific allowances for losses are those for which the Company has determined that it remains probable that all amounts due will be collected although the timing or nature may be outside the original contractual terms. In addition, for impaired commercial mortgage loans, the Company evaluates the cost to dispose of the underlying collateral, any significant out of pocket expenses the loan may incur and other quantitative information management has concerning the loan. Portions of loans that are deemed uncollectible are charged-off against the allowance, and recoveries, if any, are credited to the allowance. See “Note 10-Investments-Commercial Mortgage Loans.”
Real estate investment properties are stated at cost less accumulated depreciation. Generally, the Company depreciates this real estate using the straight-line depreciation method with useful lives varying from 30 to 40 years. Accumulated depreciation for real estate totaled $13.4 million and $12.4 million at December 31, 2013 and 2012, respectively. The Company records impairments when it is determined that the decline in fair value of an investment below its carrying value is other than temporary. The impairment loss is charged to net capital losses, and the cost basis of the investment is permanently adjusted to reflect the impairment. There were no impairment losses recorded on real estate investment properties during 2013 or 2012.
The Company’s individual deferred annuities and group annuity products are classified as investment contracts. DAC related to these products is amortized over the life of related policies in proportion to expected gross profits. For the Company’s individual deferred annuities, DAC is generally amortized over 30 years with approximately 50% and 95% expected to be amortized by years 5 and 15, respectively. DAC for group annuity products is amortized over 10 years with approximately 80% expected to be amortized by year five.
Key assumptions, which will affect the determination of expected gross profits for determining DAC and VOBA balances, include:
These assumptions are modified to reflect actual experience when appropriate. Although a change in a single assumption may have an impact on the calculated amortization of DAC or VOBA for balances associated with investment contracts, it is the relationship of that change to the changes in other key assumptions that determines the ultimate impact on DAC or VOBA amortization. Because actual results and trends related to these assumptions vary from those assumed, we revise these assumptions annually to reflect our current best estimate of expected gross profits. As a result of this process, known as “unlocking,” the cumulative balances of DAC and VOBA are adjusted with an offsetting benefit or charge to income to reflect changes in the period of the revision. An unlocking event generally occurs as a result of actual experience or future expectations differing from previous estimates. As a result of unlocking, the amortization schedule for future periods is also adjusted.
Benefits and expenses are matched with recognized premiums to result in recognition of profits over the life of the contracts. The match is accomplished by recording a provision for future policy benefits and unpaid claims and claim adjustment expenses. For most of the Company’s product lines, management establishes and carries as a liability actuarially determined reserves that are calculated to meet the Company’s obligations for future policy benefits and claims. These reserves do not represent an exact calculation of the
Premiums from group life and group and individual disability contracts are recognized as revenue when due. Investment-type contract fee revenues consist of charges for policy administration and surrender charges assessed during the period. Charges related to services to be performed are deferred until earned. The amounts received in excess of premiums and fees are unearned and included in other policyholder funds in the consolidated balance sheets. Experience rated refunds are computed in accordance with the terms of the contracts with certain group policyholders and are accounted for as an adjustment to premiums.
The Company files a U.S. consolidated income tax return that includes all subsidiaries. The Company’s U.S. income tax is calculated using regular corporate income tax rates on a tax base determined by laws and regulations administered by the Internal Revenue Service (“IRS”). The Company also files corporate income tax returns in various states. The provision for income taxes includes amounts currently payable and deferred amounts that result from temporary differences between financial reporting and tax bases of assets and liabilities. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply when the temporary differences are expected to reverse.
Accounting Standards Update (“ASU”) No. 2013-11, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists
Net income per basic common share was calculated by dividing net income by the weighted-average number of common shares outstanding. Net income per diluted common share, as calculated using the treasury stock method, reflects the potential dilutive effects of stock award grants and exercises of dilutive outstanding stock options. The computation of diluted weighted-average earnings per share does not include stock options with an option exercise price greater than the average market price because they are antidilutive and inclusion would increase earnings per share.
On May 13, 2013, shareholders approved an amendment to the 2002 Plan that increased the number of shares authorized for the 2002 Plan to 7,000,000 shares and increased the number of shares authorized to be allocated to stock awards to 1,700,000 shares.
Of the 7,000,000 shares of common stock authorized for the 2002 Plan, 2,856,251 shares or options for shares remain available for grant at December 31, 2013. Of the 3,500,000 shares authorized for the ESPP, 1,425,002 shares remain available for issuance at December 31, 2013.
Options are granted to officers and certain non-officer employees. Executive officers typically receive annual grants in amounts determined by the Organization & Compensation Committee of the Board of Directors. Non-executive officers typically receive annual grants as determined by management. Officers may also receive options when hired or promoted to an officer position. In addition, the Chief Executive Officer has authority to award a limited number of options at his discretion to non-executive officers and other employees. Options are granted with an exercise price equal to the closing market price of StanCorp common stock on the grant date. Options typically vest in four equal installments on the first four anniversaries of the vesting reference date. Option awards to certain officers vest if the officer’s employment is terminated by the Company without cause or the officer terminates for good reason within 24 months after a change of control of the Company as defined in the Company’s change of control agreement. Options generally expire 10 years from the grant date.
The compensation cost of stock options is recognized over the vesting period, which is also the period over which the grantee must provide services to the Company. At December 31, 2013, the total cost related to unvested option awards that had not yet been recognized in the financial statements was $5.4 million. This cost will be recognized over a weighted-average period of 2.4 years.
The Company grants three types of stock awards: restricted stock unit awards (“RSUs”), performance-based stock awards (“Performance Shares”) and non-employee director stock awards (“Director Stock Grants”). Under the 2002 Plan, the Company had 1,074,257 shares available for issuance as stock award grants at December 31, 2013.
The fair value of the RSUs is determined based on the closing market price of StanCorp common stock on the grant date.
The compensation cost of RSUs is recognized over the vesting period, which is the period over which the grantee must provide services to the Company. At December 31, 2013, the total cost related to unvested RSUs that had not yet been recognized in the financial statements was $1.4 million. This cost will be recognized over a weighted-average remaining period of 2.0 years.
The Company issued 20,099, 9,489 and 10,399 shares of StanCorp common stock for 2013, 2012 and 2011, respectively, related to the vesting of the annual Director stock grant for 2012, 2011 and 2010. The weighted-average fair value per share for the shares issued was $44.12, $36.40 and $43.00 for the same periods, respectively.
Purchases prior to February 2, 2013 allowed for a purchase discount of 15% and contributions of up to 10% of the employee’s gross total cash compensation.
The estimated net loss and prior service cost for the pension plans that will be amortized from accumulated other comprehensive (income) loss into net periodic benefit cost in 2014 are $0.2 million and $0.4 million net of tax, respectively.
The following table sets forth the components of net periodic benefit cost, other changes in plan assets and benefit obligations recognized in other comprehensive (income) loss, and assumptions used in the measurement of the net periodic benefit cost and the benefit obligations:
The long-run rate of return for the employee pension plan portfolio is derived by calculating the average return for the portfolio monthly, from 1971 to the present, using the average mutual fund manager returns in each asset category, weighted by the target allocation to each category.
The company did not make any contributions to the employee pension plan in 2013. The Company made contributions of $10.0 million and $58.0 million to the employee pension plan in 2012 and 2011, respectively. The Company is not obligated to make any contributions to its pension plans for 2014. In addition, no plan assets are expected to be returned to the Company in 2014.
There were no transfers into or out of Level 3 for 2013 and 2012.
As a result of inputs used during the current period to estimate the fair value of stable asset fund, Plan management has categorized the stable asset fund as having Level 2 inputs at December 31, 2013. The valuation methods may produce fair value calculations that may not be indicative of net realizable values or reflective of future fair values. See “Note 9-Fair Value” for further disclosure on valuation methods. Furthermore, although the Plan believes its valuation methods are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different fair value measurement at the reporting date.
Eligible executive officers, directors, agents and group producers may participate in one of several non-qualified deferred compensation plans under which a portion of the deferred compensation for participating executive officers, agents and group producers is matched. The liability for the plans was $11.6 million and $10.5 million at December 31, 2013 and 2012, respectively.
Standard sponsors and administers a postretirement benefit plan that includes medical, prescription drug benefits and group term life insurance. Eligible retirees are required to contribute specified amounts for medical and prescription drug benefits that are determined periodically and are based on retirees’ length of service and age at retirement. As of January 1, 2006, participation in the postretirement benefit plan was closed to new participants. At the end of 2012, the postretirement benefit plan was amended to reduce future benefits to plan participants that were either not eligible to or chose not to retire on or before July 1, 2013. The 2012 amendment did not affect future benefits for employees who were retired as of July 1, 2013. In addition, as of December 31, 2011, the group term life insurance benefit was curtailed for plan participants who were not retired at December 31, 2011.
The Company recognizes the funded status of the postretirement benefit plan as an asset or liability on the balance sheet. The funded status is measured as the difference between the fair value of the plan assets and the accumulated benefit obligation.
The gains and losses, and prior service costs or credits excluded from the projected benefit obligation are recognized as a component of accumulated other comprehensive (income) loss, net of tax.
In 2014, there is no estimated prior service credit or net (gain) loss for the postretirement benefit plan that will be amortized from accumulated other comprehensive (income) loss into net periodic benefit cost. The projected discounted cash flow obligation for the postretirement benefit plan was $17.6 million and $24.0 million at December 31, 2013 and 2012, respectively.
* Year that the rate reaches the ultimate trend is 2027.
The following table sets forth the components of net periodic benefit cost, other changes in plan assets and benefit obligations recognized in other comprehensive (income) loss, and assumptions used in the measurement of the postretirement net periodic benefit cost and the postretirement benefit obligations:
For the postretirement benefit plan, the expected long-term rate of return on assets was developed by considering the historical returns and the future expectations for returns, as well as the target asset allocation.
The Company contributed $0.4 million, $0.3 million and $0.3 million to fund the postretirement benefit plan in 2013, 2012 and 2011, respectively. The Company expects to make contributions of $0.6 million to its postretirement benefit plan in 2014. No plan assets are expected to be returned to the Company in 2014.
Postretirement benefit plan assets are recorded at fair value and are disclosed below using a three-level hierarchy. See “Note 9-Fair Value” for additional fair value information. As there was not an active market for the Company’s municipal bond holdings at December 31, 2013, the municipal bonds were valued using Level 2 measurements.
The following table sets forth the reconciliation between taxes calculated as if the federal corporate tax rate of 35% was applied to income before income taxes and the recorded income tax provision:
Realization of the Company’s NOL carryforwards is dependent upon generating sufficient taxable income of the appropriate character before expiration of the losses. Although realization is not assured, management believes it is more likely than not that all of
The Company is carrying forward a deferred tax asset of $11 million related to losses attributable to various states and municipalities. In some instances, state and local loss carryforwards are subject to a shorter expiration period than the 20-year federal period. Further, some losses originated in a subsidiary which has reduced its operations in the state where the loss was incurred. The Company believes that the benefit from certain state and local NOL carryforwards will not be realized. As such, the Company has provided a valuation allowance of $9.5 million at December 31, 2013 on the deferred tax assets relating to these assets. If the Company’s assumptions change, the Company may be able to realize these NOLs. The state and local loss carryforwards expire at various dates through 2032.
Goodwill is related to the Asset Management segment and totaled $36.0 million at both December 31, 2013 and 2012. Goodwill is not amortized and is tested at least annually for impairment. If indicators of impairment appear throughout the year, or in the event of material changes in circumstances, the test will be more frequent. The Company performs a step-one test and compares the carrying value of the tested assets with the fair value of the assets. Fair value is measured using a combination of the income approach and the market approach. The income approach consists of utilizing the discounted cash flow method that incorporates the Company’s estimates of future revenues and costs, discounted using a market participant weighted-average cost of capital. The estimates the Company uses in the income approach are consistent with the plans and estimates that the Company uses to manage its operations. The market approach utilizes multiples of profit measures in order to estimate the fair value of the assets. As the income approach more closely aligns with how the Company internally evaluates and manages its business, the Company weights the income approach more heavily than the market approach in determining the fair value of the assets. However, the Company performs testing to ensure that both models are providing reasonably consistent results. Additionally, the Company performs sensitivity analysis on the key input factors in these models to determine whether any input factor or combination of factors moving moderately in either direction would change the results of these tests. Through the performance of these tests, the Company determined the fair value of goodwill substantially exceeded the carrying value, and concluded that it was not impaired as of December 31, 2013.
The following tables set forth the estimated fair value and the carrying value of each financial instrument:
The fixed maturity securities are diversified across industries, issuers and maturities. The Company calculates fair values for all classes of fixed maturity securities using valuation techniques described below. They are placed into three levels depending on the valuation technique used to determine the fair value of the securities.
Valuations for the index-based interest guarantees are sensitive to a number of variables, but are most sensitive to the S&P 500 Index value, the implied volatilities of this index, and the interest rate environment. Generally, a significant increase or decrease used in the assumption for the implied volatilities and in the S&P 500 Index value would result in a directionally similar change, while an increase or decrease in the interest rate environment would result in a directionally opposite change in the fair value of the liability.
(c) Capitalization rates are used as an internal analysis in converting the underlying property’s income to an estimated property value.
Changes to the fair value of fixed maturity securities, excluding S&P 500 Index options, were recorded in other comprehensive income. Changes to the fair value of the S&P 500 Index options were recorded to net investment income. Changes to the fair value of the index-based interest guarantees were recorded to interest credited and are sensitive to a number of variables and assumptions. The increase in unrealized losses for the index-based guarantee liability for 2013 was due to a change in the interest rate environment. The interest credited amount for 2013 and 2012 included negative interest on policyholder funds of $4.1 million and $3.3 million, respectively, due to changes in the Level 3 actuarial assumptions.
The unrealized losses on the investment securities set forth above were partly due to increases in market interest rates subsequent to their purchase by the Company and have also been affected by overall economic factors. The Company expects the fair value of
these investment securities to recover as the investment securities approach their maturity dates or sooner if market yields for such investment securities decline. The Company does not believe that any of the investment securities are impaired due to credit quality or due to any company or industry specific event. Based on management’s evaluation of the securities and the Company’s intent to hold the securities, and as it is unlikely that the Company will be required to sell the securities, none of the unrealized losses summarized in this table are considered other-than-temporary. See “Note 1-Summary of Significant Accounting Policies-Investment Valuations-Fixed Maturity Securities” for a discussion regarding fixed maturity securities’ OTTI.
The following tables set forth information related to the troubled debt restructurings of financing receivables:
The amount of interest income recognized on impaired commercial mortgage loans was $4.2 million, $4.1 million and $3.8 million for 2013, 2012 and 2011, respectively. The cash received by the Company in payment of interest on impaired commercial mortgage loans was $3.8 million, $4.0 million and $3.1 million for 2013, 2012 and 2011, respectively. See “Note 1-Summary of Significant Accounting Policies-Investment Valuations-Commercial Mortgage Loans” for policies regarding interest income for delinquent commercial mortgage loans.
The Company closely monitors all past due commercial mortgage loans. Additional attention is given to those loans at least 60 days past due. Commercial mortgage loans that have been granted forbearance are not considered to be past due. Commercial mortgage loans that were at least 60 days past due totaled $15.2 million and $21.3 million at December 31, 2013 and 2012, respectively. The Company’s current level of past due commercial mortgage loans is lower than its historical levels due to an improving commercial real estate market. Commercial mortgage loans that were at least 60 days past due were 0.28% of the commercial mortgage loan portfolio at December 31, 2013, compared to 0.40% at December 31, 2012.
The Company purchases S&P 500 Index options for its interest crediting strategy used in its indexed annuity product. The S&P 500 Index options are purchased from investment banks and are selected in a manner that supports the amount of interest that is expected to be credited in the current year to annuity policyholder accounts that are dependent on the performance of the S&P 500 Index. The purchase of S&P 500 Index options is a pivotal part of the Company’s risk management strategy for indexed annuity products. The S&P 500 Index options are exclusively used for risk management. While valuations of the S&P 500 Index options are sensitive to a number of variables, valuations for S&P 500 Index options purchased are most sensitive to changes in the S&P 500 Index value and the implied volatilities of this index. The Company generally purchases one S&P 500 Index option contract per month, which has an expiry date of one year from the date of purchase.
The following table sets forth the amount of DAC and VOBA balances amortized in proportion to expected gross profits and the percentage of the total balance of DAC and VOBA amortized in proportion to expected gross profits:
The accumulated amortization of VOBA was $68.7 million and $65.4 million at December 31, 2013 and 2012, respectively. The accumulated amortization of other intangible assets was $42.6 million and $36.5 million at December 31, 2013 and 2012, respectively. See “Note 1-Summary of Significant Accounting Policies-DAC, VOBA and Other Intangible Assets” for a discussion on the amortization policies for VOBA and other intangible assets.
The majority of the net liability balances are related to long term disability claims on which interest earned on assets backing the reserves is a key component of reserving and pricing. The year-to-year development of incurred claims related to prior years is therefore broken out into an interest portion and remaining incurred portion.
The changes in amounts incurred related to prior years are not the result of a significant change in an underlying assumption or method used to determine the estimate. Instead the Company expects these amounts to change over time as a result of the growth in the size of the Company’s in force insurance business and the actual claims experience with respect to that business during the time periods captured for claims with an incurred date in years prior to the year of valuation. Interest is also a key component in the year-to-year development of the reserves and therefore the positive changes in amounts incurred related to prior years should not be taken as an indicator of the adequacy or inadequacy of the reserves held. In each of the years captured, there was a decrease in incurred amounts associated with prior years after the effect of interest is taken into account, indicating that claim experience was favorable compared to the assumptions used to establish the associated reserves. Significant changes to assumptions regarding unpaid claims and claims adjustment expenses for prior periods in the group long term disability reserves were not made in 2013, 2012 and 2011 primarily due to the long-term nature of this product and the materiality of other factors including the potential impact of the
The Company also maintains reinsurance coverage for certain catastrophe losses related to group life and AD&D with partial coverage of nuclear, biological and chemical acts of terrorism. Through a combination of this agreement and its participation in a catastrophe reinsurance pool discussed below, the Company has coverage of up to $520.0 million per event.
The Company is part of a catastrophe reinsurance pool with other insurance companies. This pool spreads catastrophe losses from group life and AD&D over 21 participating members. The annual fee paid by the Company in 2013 to participate in the pool was less than $30,000. As a member of the pool, the Company is exposed to maximum potential losses experienced by other participating members of up to $112.6 million for a single event for losses submitted by a single company and a maximum of $281.8 million for a single event for losses submitted by multiple companies. The Company’s percentage share of losses experienced by pool members will change over time as it is a function of the Company’s group life and AD&D in force relative to the total group life and AD&D in force for all pool participants. The catastrophe reinsurance pool does not exclude war or nuclear, biological and chemical acts of terrorism.
Recoveries recognized under reinsurance agreements were $79.8 million, $74.0 million and $75.9 million for 2013, 2012 and 2011, respectively. Amounts recoverable from reinsurers were $988.1 million and $972.4 million at December 31, 2013 and 2012, respectively. Of these amounts, $791.0 million and $793.0 million for 2013 and 2012, respectively, were from the reinsurance transaction with Protective Life Insurance Company (“Protective Life”) effective January 1, 2001. See “Note 15-Reinsurance of Blocks of Business.”
Effective October 1, 2000, Standard assumed, through a reinsurance agreement, the individual disability insurance business of Minnesota Life. Standard paid a ceding commission of approximately $55 million and received approximately $500 million in assets and corresponding statutory liabilities. If Standard were to become unable to meet its obligations, Minnesota Life would retain the reinsured liabilities. Therefore, in accordance with the agreement with Minnesota Life, Standard established a trust for the benefit of Minnesota Life with the market value of assets in the trust equal to Minnesota Life’s reinsurance receivable from Standard. The market value of assets required to be maintained in the trust is determined quarterly. The market value of assets required to be maintained in the trust at December 31, 2013, was $569.2 million. Accompanying the transaction was a national marketing agreement that provides access to Minnesota Life agents, some of whom now market Standard’s individual disability insurance products. The national marketing agreement is renewed annually.
(2) Other operating expenses include operating expenses, commissions and bonuses, premium taxes, interest expense and the net increase in DAC, VOBA and other intangible assets.
Standard and The Standard Life Insurance Company of New York prepare their statutory financial statements in accordance with accounting practices prescribed or permitted by their states of domicile. Prescribed statutory accounting practices include state laws, regulations, and general administrative rules, as well as the Statements of Statutory Accounting Principles (“SSAP”) set forth in publications of the National Association of Insurance Commissioners (“NAIC”). Standard and the Standard Life Insurance Company of New York did not use any prescribed or permitted statutory accounting practices that are different than the statutory accounting practices promulgated by the NAIC for the years ended 2013, 2012 or 2011.
Federal income tax expense includes current income taxes defined as current year estimates of federal income taxes and tax contingencies for current and all prior years and amounts incurred or received during the year relating to prior periods, to the extent not previously provided.
During 2013 and 2012, Standard made distributions to StanCorp totaling $130.0 million and $320.0 million, respectively.
On August 10, 2012, the Company issued $250 million of 5.00%, 10-year senior notes (“2022 Senior Notes”), which mature on August 15, 2022. Interest is payable semi-annually on February 15 and August 15. The Company used the net proceeds from the issuance of the 2022 Senior Notes to repay the $250 million of 6.875%, 10-year senior notes (“2012 Senior Notes”), on September 28, 2012.
In the normal course of business, the Company is involved in various legal actions and other state and federal proceedings. A number of actions or proceedings were pending at December 31, 2013. In some instances, lawsuits include claims for punitive damages and similar types of relief in unspecified or substantial amounts, in addition to amounts for alleged contractual liability or other compensatory damages. In the opinion of management, the ultimate liability, if any, arising from the actions or proceedings is not expected to have a material effect on the Company’s business, financial position, results of operations or cash flows.
The Company maintains a $250 million Facility. Upon the request of StanCorp and with the consent of the lenders under the Facility, the Facility can be increased to $350 million. The termination date of the Facility is June 22, 2017, though, at the option of StanCorp and with the consent of the lenders under the Facility, the termination date can be extended one additional year to June 22, 2018. The Company expects to use the Facility for working capital, general corporate purposes and for the issuance of letters of credit.
Under the agreement, the Company is subject to two financial covenants that are based on the Company’s ratio of total debt to total capitalization and consolidated net worth. The Company is also subject to covenants that limit subsidiary indebtedness. The Facility is subject to pricing levels based upon the Company’s publicly announced debt ratings and includes an interest rate option at the election of the borrower of a base rate plus the applicable margin or LIBOR plus the applicable margin, plus facility and utilization fees. At December 31, 2013, the Company was in compliance with all financial covenants under the Facility and had no outstanding balance on the Facility.
The following table sets forth the changes in accumulated other comprehensive income (loss) by component:
(3) Net of tax benefit of $111.1 million for unrealized losses on fixed maturity securities and net of tax expense of $22.2 million for employee benefits.
During 2013, the Company implemented expense management initiatives to offset the negative effects of the continued low interest rate environment and lower Employee Benefits premiums compared to 2012. In addition to severance, transition costs and lease terminations, the Company incurred $2.3 million in other project initiatives.
The following tables set forth expenses incurred related to the expense management initiatives: