The Private Securities Litigation Reform Act of 1995 provides a safe harbor to encourage companies to provide prospective information so long as it is identified as forward-looking and is accompanied by meaningful cautions identifying important factors that could cause actual results to differ materially from the prospective information. The management of ALLIED Life Financial Corporation (ALFC or the Company) is adhering to these provisions. This report contains cautionary statements identifying important factors that could cause actual results to differ materially from those projected in forward-looking statements in the following discussion and elsewhere in this report.
ALLIED Life Financial Corporation is an insurance holding company formed by ALLIED Mutual Insurance Company (ALLIED Mutual) in July of 1993. The financial statements include the accounts of ALLIED Life Insurance Company (ALLIED Life), ALLIED Life Brokerage Agency, Inc. (ALBA), and ALLIED Group Merchant Banking Corporation (AGMB). ALLIED Life accounts for substantially all of the Company's operations and sells primarily life insurance and annuity products.
Total life insurance in force grew 10.4% to $9 billion at December 31, 1996 from $8.1 billion at December 31, 1995. The increase was due to policy retention and new term life insurance sales.
The face amount of new life insurance sold directly by agents in 1996 increased 2.9% to $1.9 billion from $1.8 billion in 1995. The face amount of new universal life insurance sold decreased 32.6% to $410.6 million from $609.7 million. Universal life account balances increased 8.3% at year-end 1996 from year-end 1995. Fee income increased 3% to $22.9 million from $22.2 million. The savings element of universal life products has become less attractive over the last several years due to generally lower interest rates and an increasing equity market.
The face amount of new term life insurance sold directly by agents increased 20.6% to $1.5 billion for 1996 from $1.2 billion for 1995. Sales of term insurance with 10- and 20-year guaranteed rates were strong.
Adjusted insurance revenues increased 5.3% to $44.9 million for 1996 from $42.7 million for 1995. The increase was primarily attributable to increased investment spread and other insurance income (due to term life insurance sales). The growth in life insurance in force and policyholder account balances permitted invested assets at cost to increase 12.2% to $714.1 million at December 31, 1996 from $636.7 million at December 31, 1995. Investment income increased by 6.5%. ALLIED Life's return on invested assets decreased to 7.4% in 1996 from 7.8% in 1995.
Death benefits net of reinsurance remained at $6.9 million. Other policyholder benefits decreased 5.1% to $6.4 million from $6.7 million as decreases in reserves for supplemental contracts and single premium immediate annuities with life contingencies more than offset the increase in reserves on new term life sales and policyholder bonus reserves on universal life products. Other insurance operating expenses increased 6.3% to $5.8 million from $5.5 million.
Primarily due to the additional charge of $2.8 million, operating income before taxes decreased to $11.7 million in 1996 from $14.8 million in 1995.
Income before income taxes and realized investment (losses) gains net of related amortization of deferred policy acquisition costs (operating income before taxes) for 1995 increased 13.4% to $14.9 million from $13.1 million reported for 1994. Net income totaled $9.7 million, up 13.5% from $8.6 million in 1994. Operating earnings per common share rose to $1.88 for 1995 from $1.66 for 1994; net income per common share was $1.78 for 1995 compared with $1.58 for 1994.
Death benefits net of reinsurance increased 20.3% to $6.9 million from $5.7 million. Other policyholder benefits increased 51.9% to $6.7 million from $4.4 million as a result of increased reserves on new term life sales and supplemental contracts and an increase in policyholder bonus reserves on universal life products.
As an insurance holding company, ALFC relies on dividends from ALLIED Life to make dividend payments to its preferred and common stockholders. The ability of ALLIED Life to pay dividends to the Company is limited by law to earned profits (unassigned surplus) as of the dates dividends are paid. Such ability is determined in accordance with accounting practices prescribed or permitted by insurance regulatory authorities of the State of Iowa.
The Iowa Insurance Holding Company Act precludes ALLIED Life's payment of an extraordinary dividend without prior notice to and approval of the Iowa Insurance Commissioner. An extraordinary dividend is defined as any dividend or distribution of cash or other property whose fair market value together with that of other dividends or distributions made within the preceding twelve months exceeds the greater of
During 1997, the maximum amount available for distribution to the Company from ALLIED Life without special regulatory approval of or notification to the Iowa Insurance Commissioner is approximately $5.2 million.
Annual dividends payable on the currently outstanding 6.75% Series preferred stock are approximately $1.5 million. In accordance with the terms of the 6.75% Series preferred stock, the Company may pay dividends thereon by issuing additional shares of such stock for any quarter ending on or prior to September 30, 1998. In 1996, the Company paid dividends in the form of 138,793 shares of 6.75% Series preferred stock.
Life insurance companies generally produce a positive cash flow from operations. Its adequacy is measured by liquidity. There should be sufficient cash to meet benefit obligations to policyholders and normal operating expenses as they are incurred and sufficient excess to help meet future policy benefit payments and to write new business. ALLIED Life's liquidity position continued to be favorable in 1996, with cash inflows at levels sufficient to provide the funds necessary to meet obligations.
Company operations provided cash inflows of $15.5 million in 1996, $11.5 million in 1995, and $8.2 million in 1994. Cash inflows from financing activities amounted to $62.5 million, $73.3 million, and $94.2 million during 1996, 1995, and 1994, respectively. These funds and the excess operating inflows were used primarily to increase the Company's fixed maturity investment portfolio.
The Company's fixed maturity portfolio includes collateralized mortgage obligations (CMOs). CMOs consist of pools of mortgages divided into tranches that provide sequential retirement of bonds. To provide call protection and more stable average lives, the Company invests primarily in planned amortization classes (PACs) and sequential-pay bonds that generally provide more predictable cash flows within a range of prepayment speeds by shifting some of the prepayment risks to support tranches.
Management anticipates that funds to meet the Company's short-term and long-term capital expenditures, cash dividends, and operating cash needs will come from existing capital and internally generated funds. As of December 31, 1996, the Company had no material commitments for capital expenditures. As additional capital needs arise, the Company will consider taking on additional debt or issuing equity. Specific methods for meeting such needs will depend upon financial market conditions at the time.
Interest rate changes and the slope of the yield curve may have temporary effects on the sale and profitability of the universal life and annuity products offered by ALLIED Life. For example, if interest rates rise, competing investments may become more attractive to potential purchasers until the interest rates credited to policyholder account balances are increased. If interest rates fall, profitability will be affected negatively until credited rates are adjusted to compensate for the decline in investment income. ALLIED Life sells universal life and annuity contracts that generally permit flexible responses to interest rates, which are monitored constantly.
In June 1996, the Company began interest rate hedging programs whereby certain derivative financial instruments including cash settle put swaptions (swaptions) and interest rate floors (floors) were purchased. Swaptions are being purchased to reduce the negative effect of increased withdrawal activity related to the Company's annuity liabilities that may result from extreme increases in interest rates. As of December 31, 1996, the Company was party to 44 agreements for these instruments. The agreements expire quarterly from June 1999 through March 2006. They entitle the Company to receive payments from the instrument's counter parties on future reset dates if the interest rate (which is directly tied to the 5-year constant maturity swap curve) on any expiration date is above a specified fixed rate (8.8% to 10.5% for instruments entered into as of December 31, 1996). The notional amounts range from $3 million to $9 million (total of $244 million).
Floors are being purchased to reduce the negative effect that may result from extreme decreases in interest rates to a level below the guaranteed interest rates provided for in the universal life insurance contracts. The 28 agreements for the floors outstanding as of December 31, 1996 expire quarterly from June 1999 through March 2006. They entitle the Company to receive payments from the instrument's counter parties on future reset dates if the interest rate (which is tied directly to the 10-year constant maturity treasury curve) on the expiration date is below a specified fixed rate (5.0% for instruments entered into as of December 31, 1996). The notional amounts for each quarter range from $140 million to $270 million.
At the beginning of the second quarter of 1996, the Company introduced an equity-indexed annuity product that guarantees customers the return of principal. Interest credited is based on a percentage of the gain of the S&P 500 Index(R). A portion of the premium from each customer is invested in investment grade fixed income securities to cover the minimum guaranteed value due the customer at the end of the term. A portion of the premium is used to purchase S&P 500 call options (call options) to hedge the growth in interest credited to the customer as a direct result of increases in the S&P 500 Index(R). The call options provide the Company the opportunity to participate in the increases of the S&P 500 Index(R) if the market advances. At December 31, 1996, the Company had purchased 40 call options with notional amounts between $65,000 and $900,000 (total of $11.2 million).
Premiums paid to purchase call options are capitalized and included in other assets. Through December 31, 1996, the Company had paid approximately $2.3 million in premiums. Premiums are amortized as an expense over the term of the instruments on a straight-line basis. Gains and losses on these instruments and related liabilities are not recorded in income until realized.
The Company is exposed to the risk of losses in the event of nonperformance of the counter parties of the above swaptions, floors, and call options. Losses recorded in the Company's financial statements in the event of non-performance will be limited to the unamortized premium paid to enter into the instruments. Economic losses will be measured by the net replacement cost of such instruments or by their fair value if the net fair value is in the Company's favor. The Company limits its exposure to such losses by diversification among reputable counter parties with appropriate credit ratings.
In 1996, the Company adopted SFAS 123, "Accounting for Stock-Based Compensation." This statement establishes a fair value-based method of accounting for stock-based compensation plans, but permits continued application of the provisions of Accounting Principles Board Opinion 25, "Accounting for Stock Issued to Employees," in determining compensation expense related to stock-based compensation. Companies that continue to apply Opinion 25 must nonetheless comply with the new disclosure requirements of SFAS 123. The Company elected to continue to account for stock-based compensation under the provisions of Opinion 25 and its related interpretations. This adoption had no impact on the Company's financial condition, results of operations, or liquidity.
We have audited the accompanying consolidated balance sheets of ALLIED Life Financial Corporation and subsidiaries as of December 31, 1996 and 1995 and the related consolidated statements of income, stockholders equity, and cash flows for each of the years in the three-year period ended December 31, 1996. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based upon our audits.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of ALLIED Life Financial Corporation and subsidiaries as of December 31, 1996 and 1995 and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1996, in conformity with generally accepted accounting principles.
Investments in fixed maturities the Company has the positive intent and ability to hold to maturity are classified as held to maturity and carried at cost adjusted for amortization of premium or discount. Except for declines that are other than temporary, changes in fair value are not reflected in the consolidated financial statements. Investments in fixed maturities that may be sold prior to maturity and are not bought and held principally for the purpose of selling in the near term are segregated into an available for sale portfolio and are carried at fair value. Unrealized appreciation and depreciation of available for sale securities are excluded from income and reported as a separate component of stock-holders' equity net of a valuation allowance for related deferred policy acquisition costs and deferred income taxes.
In November 1995, the Financial Accounting Standards Board (FASB) issued a Special Report entitled "A Guide to Implementation of Statement 115 on Accounting for Certain Investments in Debt and Equity Securities." The Special Report allowed companies to reassess the appropriateness of the classification of all securities and make any resulting transfers concurrent with the initial adoption of the implementation guide but no later than December 31, 1995. Effective November 30, 1995, the Company made such reassessment and reclassified $215,157,247 of held to maturity securities to available for sale. The net effect of such reclassification increased stockholders' equity by $4,446,692.
Deferred policy acquisition costs are reviewed at least annually to determine that the unamortized portion of such costs does not exceed recoverable amounts after anticipated investment income is taken into account. Expected gross profits used in determining the recoverability and amortization pattern of deferred policy acquisition costs are based on historical gross profits and management's estimates and assumptions regarding future investment spreads, maintenance expenses, and persistency of blocks of business. The accuracy of the estimates and assumptions are affected by several factors, including factors outside the control of management such as movements in interest rates and competition from other investment alternatives. It is reasonably possible that conditions affecting the estimates and assumptions will change and that such changes will result in future adjustments to deferred policy acquisition costs.
Policyholder account balances for universal life and annuity contracts consist of the deposits received plus accumulated credited interest less withdrawals and accumulated policy-holder assessments. Interest credited to policyholder account balances for universal life contracts averaged 5.4%, 5.9%, and 6.2% in 1996, 1995, and 1994, respectively. Interest credited to policyholder account balances for annuity contracts averaged 5.6%, 5.9%, and 5.8% in 1996, 1995, and 1994, respectively. Rates used to credit interest to policyholder account balances are subject to periodic adjustment. Certain universal life and annuity contracts offer persistency bonuses, which are accrued in the accompanying financial statements based on assumptions of investment yields, withdrawals, mortality, and other factors. For term life insurance policies, liabilities for future policy benefits are provided according to the net level premium method based on estimated investment yields, withdrawals, mortality, and other assumptions that were appropriate at the time the policies were issued.
The Company participates in a medical plan (the Plan) sponsored by an affiliate, ALLIED Group, Inc., which presently provides postretirement medical benefits. The Plan is subject to termination or modification by ALLIED Group, Inc. The Plan is contributory, with retiree contributions adjusted annually, and contains other cost-sharing features such as deductibles and coinsurance. ALLIED Group, Inc. collects a fee from the Company that represents its share of the Plan's current net periodic postretirement benefit cost. The accumulated postretirement benefit obligation and plan assets for the Company are combined with those of the ALLIED Group, Inc. plan covering other affiliates' employees and are not readily determinable on a separate basis.
Earnings per common share calculations are based on the weighted average number of shares of common stock outstanding for the period. Net income is reduced by dividends on preferred stock. The dilutive effect of the ESOP Series convertible preferred stock and stock options is not significant.
For purposes of reporting cash flows, all short-term investments are considered equivalent to cash since they have original maturities of three months or less.
(2) Investments The following is a schedule of amortized cost and estimated fair value of investments in fixed maturities and equity securities as of December 31, 1996 and 1995. The estimated fair value for fixed maturities and equity securities is based on quoted market prices where available or on values obtained from independent pricing services.
As of December 31, 1996 and 1995, there were no investments that were non-income producing for the previous twelve months.
For the years ended December 31, 1996, 1995, and 1994, the Company realized gross gains of $561,244, $2,076,132, and $442,911 and gross losses of $454,355, $2,822,054, and $372,087, respectively, from the call, prepayment, or sale of investments from the available for sale portfolio. Those same years, the Company also realized gross gains of $3,199, $24,142, and $488,910, respectively, from the call or prepayment of investments from the held to maturity portfolio. The Company realized no gross losses from the call or prepayment of investments from that portfolio in 1996 and gross losses of $450 and $34,345, respectively, in 1995 and 1994. There were no sales from the held to maturity portfolio in 1996, 1995, and 1994. During 1994, the Company was notified that a bond in its available for sale portfolio was rerated below investment grade. Though the bond was not in default, the Company chose to write down the bond to estimated realizable value and take the $1,250,000 loss through net income because the chance of recovery of the principal seemed unlikely. This bond was sold in 1995.
As required by law, fixed maturities and short-term investments were on deposit with or on behalf of various insurance regulatory authorities at December 31, 1996 and 1995, with carrying values of $681,101,979 and $623,600,240, respectively. As of December 31, 1996 and 1995, bonds with a carrying value of $30,284,338 and $32,871,190, respectively, were pledged as collateral for the Company's line of credit with the Federal Home Loan Bank.
Floors are being purchased to reduce the negative effect that may result from extreme decreases in interest rates to a level below the guaranteed interest rates provided for in the Company's universal life insurance contracts. The 28 agreements for the floors outstanding, as of December 31, 1996, expire quarterly from June 1999 through March 2006. The agreements entitle the Company to receive payments from the instrument's counter parties on future reset dates if the interest rate (which is tied directly to the 10-year constant maturity treasury curve) on the expiration date is below a specified fixed rate (5.0% for instruments entered into as of December 31, 1996). As of December 31, 1996, the notional amounts for each quarter range from $140 million to $270 million and have an amortized cost of $1.1 million.
The Company is exposed to the risk of losses in the event of nonperformance of the counter parties of the above swaptions, floors, and call options. Losses recorded in the Company's financial statements in the event of nonperformance will be limited to the unamortized premium paid to enter into the instruments. Any economic loss will be measured by the net replacement cost of such instruments or by their fair value if net fair value is in the Company's favor. The Company limits its exposure to economic loss by diversifying purchases among reputable counter parties with appropriate credit ratings.
The Company, ALLIED Life, and other affiliated companies are parties to the Management Information Services Agreement (the Services Agreement) with AMCO Insurance Company (AMCO), a subsidiary of ALLIED Group, Inc. Under the terms of the Services Agreement, AMCO provides certain computer services, printing, equipment leasing, and mail and communication services to ALLIED Life on a fee basis. The annual fee is subject to renegotiation throughout the term of the Services Agreement. The Services Agreement terminates on December 31, 2004 and has an extension provision similar to the Intercompany Operating Agreement's. Effective March 1, 1996, the Services Agreement was amended and certain personnel previously providing computer-related services to the Company and its subsidiaries were employed by ALLIED Life. As a result, fees paid for services provided by such employees prior to the amendment date are now paid directly by ALLIED Life. Expenses incurred under the Services Agreement were approximately $863,000, $1,400,000, and $1,575,000 for the years ended December 31, 1996, 1995, and 1994, respectively.
ALLIED Life received premium income from ALLIED Group, Inc. for term life insurance on its employee group in the amounts of approximately $452,000, $418,000, and $430,000 for the years ended December 31, 1996, 1995, and 1994, respectively.
The Company and its subsidiaries have from time to time borrowed funds from affiliates as needed on an arms length basis. During 1996, the Company entered into a note payable agreement with ALLIED Mutual. At December 31, 1996, the outstanding balance of the note payable was approximately $1,617,000. At December 31, 1995, there were no borrowings outstanding with affiliates. The Company incurred interest expense to affiliates of $61,165, $51,181, and $7,123 in 1996, 1995, and 1994, respectively.
Management believes the costs incurred by its affiliates and allocated to the Company would not be materially different than if they had been incurred from an unrelated third party. The transactions discussed herein result in intercompany balances that are created during the normal course of business and are settled on a monthly basis unless otherwise indicated.
such reinsurers were unable to pay their portion of the claims. The Company evaluates the financial condition of its reinsurers and monitors concentrations of credit risk arising from similar geographic regions, activities, or economic characteristics of the reinsurers to minimize its exposure to significant losses from reinsurer insolvencies.
Assumed premiums and related benefits are not material to the Company's consolidated financial position and results of operations.
(7) Preferred Stock The Company is authorized to issue 7,500,000 shares of preferred stock without par value. The preferred stock may be issued from time to time by the Board of Directors in one or more series with such dividend rights, conversion rights, voting rights, redemption provisions, liquidation preferences, and other rights and restrictions as the Board of Directors may determine.
The Company paid dividends to ALLIED Mutual on its outstanding 6.75% Series through the issuance of 138,793, 129,808, and 121,402 shares of such stock in 1996, 1995, and 1994, respectively.
On October 27, 1994, in conjunction with the establishment of the ESOP, the Company sold 74,137 shares of Series A ESOP Convertible Preferred Stock (ESOP Series) to the ESOP Trust for $15 per share. In 1996 and 1995, the ESOP Trust purchased 14,787 and 14,650 shares of ESOP Series for $18.13 and $15 per share, respectively. At December 31, 1996, a commercial bank, acting on behalf of the ESOP participants as the trustee for the ESOP, was the holder of 93,982 shares of the ESOP Series. The ESOP Trust purchased an additional 19,143 shares on January 2, 1997 for $17.50 per share funded by a $238,000 employer contribution from ALLIED Life and ESOP Series dividends.
(8) Common Stock The Company and ALLIED Mutual have entered into a Stock Rights Agreement (Agreement) which expires in 2008. Under the Agreement, ALLIED Mutual is entitled to nominate and the Company is required to use its best efforts to cause the election or retention of a number of members of the Company's Board of Directors in proportion to ALLIED Mutual's percentage ownership of the total number of shares of the Company's voting stock outstanding at the time of nomination. In addition, the Company is required to elect to its Executive Committee at least one Company director who has been nominated by ALLIED Mutual. The Agreement restricts the ability of ALLIED Mutual to grant proxies to other than affiliated individuals and to solicit other shareholders of the Company. ALLIED Mutual also is prohibited from initiating or accepting a tender offer for shares of the common stock except under certain conditions. The Company has a right of first refusal with respect to any sale by ALLIED Mutual of the common stock, subject to certain exceptions. ALLIED Mutual has incidental registration rights and three-demand registration rights with respect to all stock of the Company owned by ALLIED Mutual. The Company has reserved 350,000 shares of common stock for issuance under the ALLIED Life Financial Corporation Employee Stock Purchase Plan (ESPP). The Company receives 85% of the fair market value of the shares issued under the ESPP. During 1996, 1,934 shares were issued at prices ranging from $13.18 to $17.37. During 1995 and 1994, 6,963 and 9,239 shares, respectively, were issued at prices ranging from $12.33 to $19.13 for 1995 and $10 to $12.22 for 1994. At December 31, 1996, 328,530 shares were available for issuance.
participants pay 85% of the fair value of the shares issued. The 15% discount is recognized as expense on the date of issue. During 1996, 2,677 shares were issued at prices ranging from $17.37 to $17.38. During 1995 and 1994, 4,737 and 4,415 shares were issued at prices ranging from $17.06 to $17.13 and $11.75 to $14.38. At December 31, 1996, 338,171 shares were available for issuance.
During 1995 the Company reserved 350,000 shares of common stock for issuance under the ALLIED Life Financial Corporation Dividend Reinvestment and Stock Purchase Plan. Any stockholder of record may participate in the plan and have cash dividends reinvested in additional shares of Company common stock. The plan also allows for optional cash payments. Shares of common stock purchased under the plan may be either original issue shares or open market shares. The Company has determined the purchased shares will be original shares until it determines otherwise. The number of shares purchased by the plan participants is based upon fair market value on a predetermined date. During 1996, 628 shares were issued at prices ranging from $15.88 to $21. During 1995, 312 shares were issued at prices ranging from $16.81 to $19.13. At December 31, 1996, 349,060 shares were available for issuance.
During 1996, pursuant to rule 10b-18 under the Securities Exchange Act of 1934, the Company repurchased on the open market and cancelled 150,000 shares of Company common stock at an average cost of $16.94 per share.
Statutory capital and surplus for ALLIED Life was $46,543,735 and $45,503,922 at December 31 1996 and 1995, respectively. Statutory net income for ALLIED Life was $5,291,433, $6,696,577, and $6,658,813 for the years ended December 31, 1996, 1995, and 1994, respectively.
The Company has a line of credit agreement with the Federal Home Loan Bank to make available borrowings of up to $25,000,000. The line expires March 13, 1997. Interest is payable at either an adjustable interest rate with the interest rate set daily on the outstanding advance amount or at a fixed rate with the interest rate set at issuance. As of December 31, 1996 and 1995, borrowings on this line of credit agreement were $20,470,000 and $16,605,000 at an interest rate of 5.7% and 5.92% per annum, respectively. The Company incurred interest expense to nonaffiliates of $689,786, $656,385, and $501,897 in 1996, 1995, and 1994, respectively.
(13) Federal Income Taxes Total income taxes for the years ended December 31, 1996, 1995, and 1994 were allocated as follows:
For the years ended December 31, 1996, 1995, and 1994, the actual income tax expense differed from the expected income tax expense based on the statutory federal income tax rate of 35%, primarily as a result of a reduction of income taxes related to prior years. The Company paid federal and state income taxes of $3,929,001 $4,134,364, and $4,761,664 in 1996, 1995, and 1994, respectively.
(14) Contingencies The Company is required to comply with the regulations of every state in which it operates. Every state administers a guaranty fund, which exists for the protection of policyholders in the event of insurance company insolvencies. A number of insurance companies are under supervision, resulting in large assessments to cover losses to policyholders of such companies. Potential future assessments, if any, are not reasonably determinable by the Company and have not been accrued.
Caution should be exercised in comparing the results of consecutive quarters. Due to the relatively small size of ALLIED Life, the Company's operating results may be significantly affected in any reporting period by the level of death and other policyholder benefits incurred.