Marketing and sales for all of the Company's insurance subsidiaries are directed by the Executive Vice President of Marketing and Sales. The Vice President for Investors Sales directs Regional Vice Presidents who are responsible for the recruitment and maintenance of the general agents and managing general agents for individual insurance sales.
As the provider of data processing for the Company and its subsidiaries and affiliates, FIC Computer Services, Inc. utilizes a centralized computer system to process policyholder records and financial information. In addition, the Company uses non- centralized computer terminals in connection with its operations. The software programs used by these systems will be affected by what is referred to as the "Year 2000 problem" or "Y2K problem". This refers to the limitations of the programming code in certain existing software programs to recognize date sensitive information as the year 2000 approaches. Unless modified prior to the year 2000, such systems may not properly recognize such information and could generate erroneous data or cause a system to fail to operate properly.
In response to the potential operations and policy administration problems caused by the computer calendar change on January 1, 2000, the management of the Company instructed FIC Computer Services, Inc. to analyze its system capabilities and the operational requirements of the Company and its respective subsidiaries and affiliates with respect to the Y2K problem. In 1996, FIC Computer Services, Inc. conducted the analysis of all of the Company's systems. After reviewing that analysis, the Company determined that a plan should be devised to prevent the data processing errors that may be encountered due to the Y2K problem. In November, 1996, a three-year plan outlining a proposed solution (the "Plan") was established and approved by the Company to ensure that all of the data processing systems would be Y2K compliant or converted onto Y2K compliant systems. The Company began the major work under this Plan in 1997 and it is scheduled to be completed by the Fall of 1999.
Additionally, the Company is developing a strategy for obtaining assurances from its various suppliers and service providers. In furtherance of this strategy, the Company is creating questionnaires which it will forward to its suppliers and service providers regarding the Y2K problem. The questionnaire will request information regarding that particular supplier's or service provider's awareness of the Y2K problem, its impact on their operations, and their plan for addressing any problems as they relate to that supplier's or service provider's performance of their contractual obligations to the Company and its subsidiaries.
In 1997, FIC Computer Services, Inc. purchased new mainframe hardware and accompanying operating software, which the vendor has represented to be Y2K compliant. FIC Computer Services, Inc. will be testing this hardware and software in 1998. The telephone system has been tested by the maintenance provider for that system and the Company has received assurances that the telephone system is Y2K compliant.
There are many life and health insurance companies in the United States. A significant number of casualty companies also market health insurance. Agents placing insurance business with ILCO's life insurance subsidiaries are compensated on a commission basis. However, some companies pay higher commissions and charge lower premium rates and many companies have more substantial resources.
In accordance with general practices in the insurance industry, the Company's insurance subsidiaries limit the maximum net losses that may arise from large risks by reinsuring with other carriers. Such reinsurance provides for a portion of the mortality risk to be retained (the "Retention") with the excess being ceded to a reinsurer at a premium set forth in a schedule based upon the age and risk classification of the insured. The reinsurance treaties provide for allowances that help the Company's insurance subsidiaries offset the expense of writing new business. Investors- IN generally retains the first $60,000 to $100,000 of risk on the life of any individual, depending upon the type of coverage being written. Investors-NA generally retains the first $100,000 to $250,000 of risk on the life of any individual, depending on the type of coverage being issued.
In 1988, Investors-NA entered into a bulk reinsurance treaty under which it reinsured all of its risks under accidental death benefit policies. Investors-IN had previously obtained similar bulk reinsurance for accidental death benefit policies. The treaty was renegotiated with a different reinsurer in January, 1997.
In 1995, Investors-NA entered into a reinsurance agreement with Family Life pertaining to universal life insurance written by Family Life. The reinsurance agreement is on a co-insurance basis and applies to all covered business with effective dates on and after January 1, 1995. The agreement applies to only that portion of the face amount of the policy which is less than $200,000; face amounts of $200,000 or more are reinsured by Family Life with a third party reinsurer. In 1996, Investors-NA entered into a reinsurance agreement with Family Life, pertaining to annuity contracts written by Family Life. The agreement applies to contracts written on or after January 1, 1996. These reinsurance arrangements reflect management's plan to develop universal life and annuity business at Investors-NA, with Family Life concentrating on the writing of term life insurance products.
The stock options were granted in 1986 to FIC by the Company principally in consideration for a $1,200,000 unsecured loan from FIC, FIC's agreement to guarantee up to $4,000,000 of Registrant's financial obligations and FIC's agreement to guarantee, upon demand, ILCO's performance under its lease on its headquarters building. In addition, FIC guaranteed a $15,000,000 term loan of ILCO. Under the terms of the option agreement, the options remain in effect so long as FIC guarantees any indebtedness of ILCO. As described under the heading "Senior Loan", the current Senior Loan of ILCO is scheduled to be fully repaid on October 1, 1998. Accordingly, unless ILCO s Senior Loan is extended, or ILCO otherwise incurs indebtedness which is guaranteed by FIC, FIC s rights under the 1986 option agreement would expire on October 1, 1998.
After FIC acquired control of ILCO, FIC's primary involvement in the insurance industry was its indirect investment, through ILCO, in ILCO's insurance subsidiaries. In June 1991, FIC acquired Family Life Insurance Company, ("Family Life"), based in Seattle, Washington, from Merrill Lynch Insurance Group, Inc.
The $114 million purchase price for Family Life and an additional $5 million for transaction costs, working capital and other related purposes were financed by: (a) a $50 million senior loan provided by a group of banks, (b) $44 million subordinated notes issued to the seller and its affiliates and (c) $25 million senior subordinated notes issued to Investors-CA and Investors-NA. In addition, FIC granted to Investors-CA and Investors-NA non- transferable options to purchase up to a total of 9.9% of FIC's common stock at a price of $10.50 per share, equivalent to the then current market price, subject to adjustment to prevent dilution. As a result of the five-for-one stock split implemented by FIC, effective in November, 1996, the exercise price of the options was changed to $2.10 per share. The initial terms of the option provided for their expiration on June 12, 1998, if not previously exercised. In connection with the 1996 amendments to the subordinated loans held by Investors-NA, the expiration date of the options was extended to September 12, 2006. For a discussion of the 1996 amendments, see Item 13, Certain Relationships and Related Transactions with Management, above. In July 1993, the subordinated notes held by the seller and its affiliates were prepaid. The primary source of the funds used to prepay the subordinated debt was a new subordinated loan of $34.5 million obtained from Investors-NA. See Item 13, above.
The Senior Loan prohibits the payment by the Company of cash dividends on the Common Stock and contains covenants, including restrictive covenants that impose limitations on the Company's and its subsidiaries' ability to, among other things: (i) make investments; (ii) create or incur additional debt; (iii) engage in businesses other than their present and related businesses; (iv) create or incur additional liens; (v) incur contingent obligations; (vi) dispose of assets, (vii) enter into transactions with affiliated companies; and (viii) make capital expenditures; and various financial covenants, including covenants requiring the maintenance of a minimum cash flow coverage ratio, minimum consolidated net worth and minimum statutory surplus of subsidiaries, and a minimum ratio (360%) of (i) the sum of the statutory capital and surplus, the asset valuation reserve and one-half of the dividend liability pertaining to participating policies of each insurance company subsidiary to (ii) its respective Authorized Control Level RBC (see "Regulation").
General. The Company's insurance subsidiaries are subject to regulation and supervision by the states in which they are licensed to do business. Such regulation is designed primarily to protect policy owners. Although the extent of regulation varies by state, the respective state insurance departments have broad administrative powers relating to the granting and revocation of licenses to transact business, licensing of agents, the regulation of trade practices and premium rates, the approval of form and content of financial statements and the type and character of investments.
The RBC requirements provide for four different levels of regulatory attention in those states that adopt the NAIC regulations, depending on the ratio of the company's Total Adjusted Capital (which generally consist of its statutory capital, surplus and asset valuation reserve) to its Authorized Control Level RBC. A "Company Action Level Event" is triggered if a company's Total Adjusted Capital is less than 200% but greater than or equal to 150% of its Authorized Control Level RBC, or if a negative trend has occurred (as defined by the regulations) and Total Adjusted Capital is less than 250% but more than 200% of its Authorized Control Level RBC. When a Company Action Level Event occurs, the company must submit a comprehensive plan to the regulatory authority which discusses proposed corrective actions to improve its capital position. A "Regulatory Action Level Event" is triggered if a company's Total Adjusted Capital is less than 150% but greater than or equal to 100% of its Authorized Control Level RBC. When a Regulatory Action Level Event occurs, the regulatory authority will perform a special examination of the company and issue an order specifying corrective actions that must be followed. An "Authorized Control Level Event" is triggered if a company's Total Adjusted Capital is less than 100% but greater than or equal to 70% of its Authorized Control Level RBC, and the regulatory authority may take any action it deems necessary, including placing the company under regulatory control. A "Mandatory Control Level Event" is triggered if a company's total adjusted capital is less than 70% of its Authorized Control Level RBC, and the regulatory authority is mandated to place the company under its control.
Valuation Reserves. Commencing in 1992, the Mandatory Securities Valuation Reserve ("MSVR") required by the NAIC for life insurance companies was replaced by a mandatory Asset Valuation Reserve ("AVR") which is expanded to cover mortgage loans, real estate and other investments. During 1997, a change in the NAIC's AVR procedures resulted in a one-time reduction in the amount of the reserves held by ILCO's life insurance subsidiaries, with a corresponding one-time increase in the amount of surplus. For Investors-NA, the amount of the increase in surplus was $2,395,000; for Investors-IN, the amount of the increase in surplus was $590,000. A new mandatory Interest Maintenance Reserve ("IMR"), designed to defer realized capital gains and losses due to interest rate changes on fixed income investments and to amortize those gains and losses into future income, is also effective for 1992. Previously, realized capital gains attributable to interest rate changes were credited to the MSVR and had the effect of reducing the required MSVR contributions of ILCO's insurance subsidiaries. Effective in 1992, such realized capital gains are credited to the IMR. As a result of these changes, management believes that the Company's insurance subsidiaries are required to accrue greater aggregate asset valuation reserves. The combination of the AVR and IMR will affect statutory capital and surplus and may reduce the ability of the Company's insurance subsidiaries to pay dividends and make payments on the surplus debentures.
Insurance Holding Company Regulation. Investors-NA and Investors-IN are subject to regulation under the insurance and insurance holding company statutes of Washington and Indiana. The insurance holding company laws and regulations vary from jurisdiction to jurisdiction, but generally require insurance and reinsurance subsidiaries of insurance holding companies to register with the applicable state regulatory authorities and to file with those authorities certain reports describing, among other information, their capital structure, ownership, financial condition, certain intercompany transactions and general business operations. The insurance holding company statutes also require prior regulatory agency approval or, in certain circumstances, prior notice of certain material intercompany transfers of assets as well as certain transactions between insurance companies, their parent companies and affiliates.
Under the Washington and Indiana insurance holding company laws, unless (i) certain filings are made with the respective department of insurance, (ii) certain requirements are met, including a public hearing and (iii) approval or exemption is granted by the respective insurance commissioner, no person may acquire any voting security or security convertible into a voting security of an insurance holding company, such as the Company, which controls an insurance company domiciled in that state, or merge with such a holding company, if as a result of such transaction such person would "control" the insurance holding company. "Control" is presumed to exist if a person directly or indirectly owns or controls 10% or more or the voting securities of another person.
Potential Federal Regulation. Although the federal government generally does not directly regulate the insurance industry, federal initiatives often have an impact on the business. Congress and certain federal agencies are investigating the current condition of the insurance industry (encompassing both life and health and property and casualty insurance) in the United States in order to decide whether some form of federal role in the regulation of insurance companies would be appropriate. Congress is currently conducting a variety of hearings relating in general to the solvency of insurers. It is not possible to predict the outcome of any such congressional activity nor the potential effects thereof on the Company's insurance subsidiaries.
The principal operations of the Company's insurance subsidiaries are the underwriting of life insurance and annuities. Accordingly, no separate segment information is required to be provided by the Registrant for the three-year period ending December 31, 1997.
Following the sale of the Austin Centre, the Company and its affiliates continued to occupy three floors of the office space, under a lease arrangement. The current lease, which was entered into in May, 1997, is for a five (5) year term ending in October, 2002, with options to renew for three successive five (5) year terms thereafter.
On May 3, 1996, Family Life Insurance Company, an indirect, 100% owned subsidiary of FIC, purchased a tract of land adjoining the Bridgepoint Office Square tract for a cash purchase price of $1.3 million. The property consists of 7.1 acres of land with one office building site and one parking structure site. Family Life began construction of the fifth building (known as "Bridgepoint Five") on the new site in January 1997. In May, 1997, the entire rentable space (approximately 76,793 rentable square feet) contained in the building was leased to a major tenant in the technology business. Construction of the parking garage and the building shell was completed in October, 1997.
ILCO leases a building located at 40 Parker Road, Elizabeth, New Jersey. This building, which was formerly the Company's headquarters building, contains approximately 41,000 square feet of office space. The remaining term of the lease is 8 years, and the lease calls for a minimum base rental of $450,000 per annum. The lease provides that all costs including, but not limited to, those for maintenance, repairs, insurance and taxes be borne by ILCO. The Company has sub-leased the space in the property to third parties.
Net Income before extra- ordinary item and cumulative effect of change in accounting principle 20,540 26,938 10,714 9,917 12,200
Common Stock and Common Stock Equivalents 4,369 4,441 4,342 4,473 4,538
Net Income per share before extraordinary item and cumulative effect of change in accounting principle Basic $ 4.75 $ 6.36 $ 2.57 $ 2.41 $ 2.97 Diluted $ 4.70 $ 6.07 $ 2.47 $ 2.22 $ 2.69
Net income per share before cumulative effect of change in accounting principle Basic 4.75 6.36 2.57 2.41 1.45 Diluted 4.70 6.07 2.47 2.22 1.31
Basic $4.75 $6.36 $2.57 $2.41 $0.82 Diluted $4.70 $6.07 $2.47 $2.22 $0.74
Net Income per share for the year 1993 to 1996 has been restated to reflect the effect of FAS 128.
Net income from continuing operations (excluding the gain resulting from the sale of Bridgepoint Square Offices in 1997 and the sale of the Austin Centre in 1996, as described below) was $11,443,000 ($2.62 per common share) for the year ended December 31, 1997, $11,650,000 ($2.62 per common share) for the year ended December 31, 1996 and $10,714,000 ($2.47 per common share) for the year ended December 31, 1995.
Net income for 1997 includes $9.1 million resulting from the sale of the Bridgepoint Square Offices, an office complex located in Austin, Texas. The selling price was $78 million, which was allocated approximately 78.5% to Investors-NA ($61.3 million). The sale closed on December 5, 1997. As part of the decision to sell the Bridgepoint properties, the Company cancelled its plans to move its headquarters to one of the Bridgepoint buildings and entered into a new lease at the Austin Centre. Under the provisions of the lease, Investors-NA received a payment from the owner of the Austin Centre in the amount of $1.7 million. That amount is included in net income for the year ended December 31, 1997.
The results for 1997, 1996 and for that portion of 1995 beginning on February 14th, include the operations of Investors Life Insurance Company of Indiana (formerly known as Meridian Life Insurance Company and referred to herein as "Pre-Merger Investors-IN" for purposes of identifying the entity prior to the December 1997 merger transaction described below). Pre-Merger Investors-IN was purchased by ILCO and Investors Life Insurance Company of North America ("Investors-NA") for an adjusted purchase price of $17.1 million; the transaction was completed on February 14, 1995. The name change was completed in May, 1995.
In December, 1997, ILIC, an indirect subsidiary of the Company, transferred its domicile from New Jersey to Indiana. Following completion of the redomestication, ILIC merged with Pre-Merger Investors-IN, with ILIC as the surviving entity in the merger process. Immediately after the merger, ILIC changed its name to Investors Life Insurance Company of Indiana. As used hereinafter, the phrase "Investors-IN" shall be used to refer to the merged entities. As a result of the merger, Investors-IN is licensed in 44 states. As of December 31, 1997, it had assets of $153.8 million and capital and surplus of $23.1 million.
The statutory earnings of the Company's insurance subsidiaries, as required to be reported to insurance regulatory authorities, before interest expense, capital gains and losses, and federal income taxes were $19,681,000 at December 31, 1997, as compared to $21,965,000 at December 31, 1996, and $24,511,342 at December 31, 1995. These statutory earnings are the source to provide for the repayment of ILCO's indebtedness.
Interest expense was $1.7 million for the year 1997, as compared to $2.8 million for the year 1996, and $5.7 million for the year 1995. The decrease is attributable to a reduction in the average principal balance of the Senior Loan from $64.4 million for the year ending December 31, 1995 to $33.7 million for the year ending December 31, 1996 and $18.5 million for the year ending December 31, 1997, as well as a decrease in the average rate of interest paid on the senior loan - 7.68% for the year 1997, as compared to 7.76% for the year 1996 and 8.63% for the year 1995.
For the year ended December 31, 1997, the Company's income from operation before Federal income taxes was $31,602,000 on revenues of $127,683,000, as compared to $41,443,000 on revenues of $138,244,000 for the year 1996, and $16,483,000 on revenues of $122,390,000 in 1995.
During 1997, the lapse rate with respect to universal life insurance policies decreased slightly from the lapse rate experienced in 1996. The rate in 1997 was 8.9%, as compared to 9.0% in 1996. The lapse rate with respect to traditional (non-universal) life insurance policies increased slightly from the levels experienced in 1996. The rate in 1997 was 8.9% as compared to 8.0% in 1996. The lapse rates experienced during the 1997 period were within the ranges anticipated by management.
ILCO's principal source of liquidity consists of the periodic payment of principal and interest by Investors-NA, pursuant to the terms of the Surplus Debentures. The Surplus Debentures were originally issued by Standard Life Insurance Company and their terms were previously approved by the Mississippi Insurance Commissioner. Upon the merger of Standard Life into Investors-NA, the obligations of the Surplus Debentures were assumed by Investors-NA. As of December 31, 1997, the outstanding principal balance of the Surplus Debentures was $5.2 million and $22.6 million, respectively. Since Investors-NA is domiciled in the State of Washington, the provisions of Washington insurance law apply to the Surplus Debentures. Under the provisions of the Surplus Debentures and current law, no prior approval of the Washington Insurance Commissioner is required for Investors-NA to pay interest or principal on the Surplus Debentures; provided that, after giving effect to such payments, the statutory surplus of Investors-NA is in excess of $10 million (the "surplus floor"). However, Investors-NA has voluntarily agreed with the Washington Insurance Commissioner that it will provide at least five days advance notice of payments which it will make under the surplus debenture. As of December 31, 1997, the statutory surplus of Investors-NA was $71.5 million, an amount substantially in excess of the surplus floor. The funds required by Investors-NA to meet its obligations to the Company under the terms of the Surplus Debentures are generated from operating income generated from insurance and investment operations.
In addition to the payments under the terms of the Surplus Debentures, ILCO has received dividends from Standard Life (now, from Investors-NA). Washington's insurance code includes the "greater of" standard for payment of dividends to shareholders, but has a requirement that prior notification of a proposed dividend be given to the Washington Insurance Commissioner and that cash dividends may be paid only from earned surplus. As of December 31, 1997, Investors-NA had earned surplus of $32.9 million. Since the law applies only to dividend payments, the ability of Investors-NA to make principal and interest payments under the Surplus Debentures is not affected. ILCO does not anticipate that Investors-NA will have any difficulty in making principal and interest payments on the Surplus Debentures in the amounts necessary to enable ILCO to service the Senior Loan for the foreseeable future.
The level of short-term investments at the end of 1997 was $164.6 million, as compared to $91.6 million at the end of 1996.
The Company's fixed maturities portfolio (including short-term investments), as of December 31, 1997, included a non-material amount (0.9% of total fixed maturities and short-term investments) of debt securities which, in the annual statements of the companies as filed with state insurance departments, were designated under the National Association of Insurance Commissioners ("NAIC") rating system as "3" (medium quality) or below. For the year ended December 31, 1996, the comparable percentage was 1.1%. The majority of these non-investment grade investments are concentrated in the medium quality (or "3") category, with only 0.7% receiving an NAIC rating of "4" (low quality) or below as of December 31, 1997, as compared to 0.7% as of December 31, 1996.
As of June 12, 1996, the provisions of the notes from Investors-NA to FIC, FLC and FLIIC were modified as follows: (a) the $22.5 million note was amended to provide for twenty quarterly principal payments, in the amount of $1,125,000 each, to commence on December 12, 1996; the final quarterly principal payment is due on September 12, 2001; the interest rate on the note remains at 11%, (b) the $30 million note was amended to provide for forty quarterly principal payments, in the amount of $163,540 each for the period December 12, 1996 to September 12, 2001; beginning with the principal payment due on December 12, 2001, the amount of the principal payment increases to $1,336,458; the final quarterly principal payment is due on September 12, 2006; the interest rate on the note remains at 9%, (c) the $4.5 million note was amended to provide for forty quarterly principal payments, in the amount of $24,531 each for the period December 12, 1996 to September 12, 2001; beginning with the principal payment due on December 12, 2001, the amount of the principal payment increases to $200,469; the final quarterly principal payment is due on September 12, 2006; the interest rate on the note remains at 9%, (d) the $2.5 million note was amended to provide that the principal balance of the note is to be repaid in twenty quarterly installments of $125,000 each, commencing December 12, 1996 with the final payment due on September 12, 2001; the rate of interest remains at 12%, (e) the Master PIK note, which was issued to provide for the payment in kind of interest due under the terms of the $2.5 million note prior to June 12, 1996, was amended to provide that the principal balance of the note ($1,977,119) is to be paid in twenty quarterly principal payments, in the amount of $98,855.95 each, to commence December 12, 1996 with the final payment due on September 12, 2001; the interest rate on the note remains at 12%.
The Company has evaluated its centralized computer systems and has developed a plan to reach year 2000 compliance. A central feature of the Plan is to convert most of the centralized systems to a common system which is already in compliance with year 2000 requirements. The Company is in the process of this systems conversion and anticipates that the project will be completed in advance of the year 2000.
In 1997, FIC Computer Services purchased new mainframe hardware and accompanying operating software, which the vendor has represented to be Y2K compliant. This hardware and software will be tested in 1998. The telephone system has been tested by the maintenance provider for that system and the Company has received assurances that the telephone system is Y2K compliant.
With respect to non-centralized systems(i.e., desktop computers), the Company anticipates that updated software releases will be commercially available well in advance of the year 2000. Accordingly, to the extent that such systems rely on date sensitive information, the Company expects that the effort needed to correct for year 2000 problems will be less time intensive than the effort needed to achieve compliance for its centralized systems.