The Company owns the building and annex housing its principal operations in Des Moines, Iowa, consisting of approximately 122,000 square feet of space. The land underlying the building is subject to a long-term lease expiring in 2016, at which time title to the building will pass to the lessor. The Company also owns another office building housing its operations in Birmingham, Alabama consisting of approximately 44,000 square feet.
The following discussion addresses the principal factors affecting earnings and financial condition including liquidity and capital resources and should be read in conjunction with the consolidated financial statements and notes thereto appearing elsewhere in this Form 10-K.
Year Ended December 31, 1995 Compared to 1994 Periods Combined (Three Months Ended December 31, 1994 and Nine Months Ended September 30, 1994)
Net investment income increased 21 percent to $415.6 million in 1995 from $343.6 million in the 1994 periods on a 7 percent increase in average invested assets (amortized cost basis) to $4.7 billion in 1995 compared to $4.4 billion in the 1994 periods. The percentage increase in net investment income was greater than the percentage increase in average invested assets because the yield earned on average invested assets increased to 8.78 percent in 1995 from 7.88 percent in the 1994 periods. The increase in yield primarily resulted from the application of purchase accounting on the Acquisition date as discussed above.
The increased level of investment activity in 1995 is the result of more active investment portfolio management by the Company's investment advisor since the Acquisition and planned changes in the fixed maturity investment portfolio to reduce the portfolio's duration and exposure to more volatile CMO investments (see "-Investment Portfolio"). The declining interest rate environment since the Acquisition date, which increased the market value of fixed maturity investments, contributed to the Company's ability to realize gains on investment sales in 1995.
Selling securities at a gain and reinvesting the proceeds at lower yields may, absent other management action, tend to decrease future investment yields. The Company believes, however, that certain factors would mitigate the adverse effect of such decreases as follows: (i) additional amortization of the cost of policies purchased and the cost of policies produced is recognized in the same period as the gain in order to reflect reduced future yields thereby reducing such amortization in future periods (see amortization related to realized gains below); (ii) interest rates credited to some products can be reduced thereby diminishing the effect of the yield decrease on the investment spread; and (iii) the investment portfolio grows as a result of reinvesting the realized gains.
Interest expense on notes payable increased to $33.8 million in 1995 from $15.5 million in the 1994 periods as a result of additional interest on debt incurred to finance the Acquisition, partially offset by reductions in interest expense resulting from: (i) the conversion and retirement of $9.2 million principal amount of the Convertible Debentures during 1995 and $44.8 million in the 1994 periods; and (ii) the repayment of subsidiary bank debt that had been outstanding prior to the Acquisition.
Interest expense on investment borrowings increased to $7.7 million in 1995 from $2.8 million in the 1994 periods as a result of increased investment borrowing activity and a higher cost of funds in 1995.
Amortization related to realized gains increased to $83.3 million in 1995 from $2.8 million in the 1994 periods as a result of the increase in realized gains discussed above.
Acquisition, merger and other nonrecurring expenses for 1995 include expenses related to: (i) the initial public offering of the Company's common stock that was withdrawn in the fourth quarter; (ii) payments made in conjunction with the discontinuation of employment of the Company's former president; and (iii) the termination of certain computer equipment leases. Such expenses for 1994 represent costs incurred by the Company related to the Acquisition, including legal, investment banking, accounting and actuarial fees and certain compensation expense. The aforementioned compensation expense represents amounts incurred to redeem certain unexercised options and stock appreciation rights in conjunction with the Acquisition.
Dividends on preferred stock increased to $7.7 million in 1995 from $3.0 million in the 1994 periods primarily due to the dividends on the 1994 Series Preferred Stock issued in connection with the Acquisition. This increase was partially offset by the elimination of the dividends on the other issues of preferred stock redeemed at the Acquisition date.
1994 Periods Combined (Three Months Ended December 31, 1994 and Nine Months Ended September 30, 1994)Compared to Year Ended December 31, 1993
Other income increased 16 percent to $6.4 million in the 1994 periods from $5.5 million in 1993. The increase was due to the greater interest earned on assets segregated for the future redemption of the redeemable preferred stock issued by a subsidiary in February 1993 and interest earned on cash segregated at the Acquisition date for the conversion of the Convertible Debentures. These increases were partially offset by decreased rental income and data processing fees received from nonaffiliated companies.
Insurance policy benefits (including change in future policy benefits) increased 12 percent to $35.5 million in the 1994 periods from $31.7 million in 1993 due to an increase in death benefits paid on annual renewable term policies during 1994 and the impact of certain non-recurring reserve adjustments recorded in 1993 which reduced benefits.
Interest expense on notes payable increased to $15.5 million in the 1994 periods from $6.1 million in 1993 as a result of additional interest on debt incurred to finance the Acquisition, partially offset by reductions in interest expense resulting from: (i) the conversion and retirement of $44.8 million of the Convertible Debentures; and (ii) the repayment of subsidiary bank debt that had been outstanding prior to the Acquisition.
Amortization related to operations increased 15 percent to $36.4 million in the 1994 periods from $31.7 million in 1993 due to an increase in the total costs subject to such amortization.
Amortization related to realized gains decreased 71 percent to $2.8 million in the 1994 periods from $9.8 million in 1993 primarily as a result of the decrease in realized gains. Amortization attributable to realized gains is a higher percentage of realized gains on sales of investments (excluding the loss on interest rate swaps) in the 1994 periods than 1993 because such amortization is based solely on net gains from fixed maturity securities.
Acquisition, merger and other nonrecurring expenses during the 1994 periods represent costs incurred by the Company related to the Acquisition. These expenses include legal, investment banking, accounting and actuarial fees and certain compensation expense. The aforementioned compensation expense represents amounts incurred to redeem certain unexercised stock options and stock appreciation rights in conjunction with the Acquisition.
The Company's investment strategy is to: (i) maintain a diversified predominantly investment grade fixed income portfolio; (ii) provide adequate liquidity to meet the cash flow requirements of policyholder and other obligations; and (iii) maximize current income and total investment return through active investment management. Consistent with this strategy, investments in fixed maturity securities, mortgage loans, policy loans and short-term debt investments collectively comprised 99 percent of the Company's investment portfolio at December 31, 1995. The remainder of the invested assets was in equity securities and other investments. To increase its return on investments, the Company from time to time lends securities in reverse repurchase agreements or dollar roll transactions.
On January 1, 1994, the Company adopted SFAS 115, which requires the Company to carry actively managed fixed maturity securities and equity securities at fair value and the unrealized gain or loss is recorded in shareholders' equity (see note 1 in the consolidated financial statements). Prior to adopting SFAS 115, actively managed fixed maturity securities were carried at the lower of amortized cost or fair value, in the aggregate. There was no effect on net income as a result of adopting SFAS 115. Since the Acquisition, all of the Company's fixed maturity securities have been classified as actively managed or trading account securities consistent with the intent of the new owner. Fixed maturity and equity investments are reported at their estimated fair value in the consolidated balance sheet at December 31, 1995 and 1994.
The Company's investment portfolio has been managed by CCM since the Acquisition. Prior to the Acquisition, the Company maintained a predominantly investment grade fixed maturity investment portfolio with the primary goal of avoiding credit risk. As a result, fixed maturity investments on the Acquisition date included approximately $2.0 billion of mortgage-backed securities which comprised 50 percent of the Company's fixed maturity investments. While these securities had minimal credit risk they were subject to greater interest rate risk (as discussed hereafter) than traditional fixed income securities. Since the Acquisition, the Company has reduced its overall exposure to interest rate risk by, in part, reducing mortgage-backed security investments to $1.5 billion at December 31, 1995, or 30 percent of fixed maturity securities, and investing proceeds from the sale of mortgage-backed securities and new cash flows in intermediate term investment grade corporate securities. The changes in the fixed maturity investment portfolio (including cash equivalents) since the Acquisition are summarized in the following portfolio statistics as of the respective dates indicated:
The Company believes that the changes made in its fixed maturity investment portfolio since the Acquisition date advance its investment goals of reducing interest rate risk (without materially adding to credit risk) and enhancing liquidity to meet the cash flow requirements of its policyholders and other creditors. The Company currently does not anticipate further material investment policy changes from those described above.
The amortized cost and estimated fair value of fixed maturities (all of which were actively managed) at December 31, 1995 were as follows:
Since the Acquisition, the level of below investment grade fixed maturities remained approximately the same, but may increase in future periods. The Company's senior credit facility limits the amount of below investment grade securities to 7 percent of invested assets. These securities generally have greater risks than other corporate debt investments, including risk of loss upon default by the borrower, and are often unsecured and subordinated to other creditors. Below investment grade issuers usually have high levels of indebtedness and are more sensitive to adverse economic conditions, such as recession or increasing interest rates, than are investment grade issuers. The Company is aware of these risks and monitors its below investment grade securities closely. At December 31, 1995, the Company's below investment grade corporate fixed maturities had an amortized cost of $162.7 million and an estimated fair value of $168.5 million.
The Company had no fixed maturity investments in technical or substantive default as of December 31, 1995. There were no fixed maturity investments about which the Company had serious doubts as to the ability of the issuers to comply with the contractual terms of their obligations on a timely basis.
The Company's policy is to discontinue the accrual of interest and eliminate all previous interest accruals for defaulted securities, if based on the Company's assessment such amounts will not be ultimately realized in full. Investment income forgone due to defaulted securities was $.5 million and $.7 million for the years ended December 31, 1995 and 1993, respectively. There was no forgone investment income in the 1994 periods.
Proceeds from the sales of investments (principally fixed maturities) were $2.8 billion for the year ended December 31, 1995. Such sales resulted in net realized gains of $154.9 million and trading gains of $1.5 million. Proceeds from the sales of investments (principally fixed maturities) were $.5 billion for the three months ended December 31, 1994. Such sales resulted in net realized gains of $1.7 million and trading losses of $.8 million. These sales were the result of a more active portfolio management by CCM and the implementation of strategies discussed above.
Proceeds from sales of fixed maturity securities during the first nine months of 1994 were $604 million, of which $596 million were from sales of securities classified as actively managed and $8 million were from the sale of securities classified as held-to- maturity as of January 1, 1994. These sales resulted in net realized gains of $5.8 million. The securities classified as held-to-maturity were sold subsequent to a debtor being placed on credit watch by a major independent rating agency. A loss of $1.6 million was recognized on such sale. The issuer's credit ratings were subsequently downgraded.
Pass-throughs and sequential and targeted amortization classes have similar prepayment variability. Pass-throughs have historically provided the best liquidity in the mortgage-backed securities market and provide the best price/performance ratio in a highly volatile interest rate environment. This type of security is also frequently used as collateral in the dollar roll market. Sequential classes pay in a strict sequence with all principal payments received by the CMO paid to the sequential tranches in order of priority. Targeted amortization classes provide a modest amount of prepayment protection when prepayments on the underlying collateral increase from those assumed at pricing and thus offer slightly better call protection than sequential classes and pass-throughs.
Growth in annuity deposits began to slow in 1994 and declined in 1995 as a result of several factors. The demand for individual fixed annuity products offered by all insurance companies decreased during 1995. Such decrease is believed to be attributable to increased competition from products such as mutual funds, traditional bank investments, variable annuities and other investment and retirement funding alternatives as a result of a flattened yield curve and rising equity markets. Additionally, new annuity sales have been negatively impacted by a reduction of American Life and Casualty's A.M. Best and Standard & Poor's claims-paying ratings to "A-" as a result of the Acquisition and related financing transactions. These rating declines have directly affected American Life and Casualty's competitive position in the financial institution marketplace where many financial institutions require an insurer's ratings to be at least "A" resulting in a loss of certain former customers and forgone opportunities for new sales.
Total withdrawals and surrenders were 14.2 percent, 11.2 percent and 9.6 percent of the average cash values outstanding during the years ended December 31, 1995, 1994 and 1993, respectively. Withdrawal and surrender payments accelerated in 1994 and 1995 primarily due to a certain policy form principally issued during 1988 through 1990 whose surrender charge declined from 4 percent at the fifth policy anniversary date to 0 percent at the sixth policy anniversary date. As these policies reached their sixth anniversary, surrenders occurred. The Company expects the trend of accelerated withdrawals and surrenders of this product to subside over the
The following table summarizes the Company's deferred annuity liabilities at December 31, 1995 and 1994, and sales for the years then ended, respectively, by surrender charge category.
The increase in deferred annuity liabilities that can be surrendered without penalty is principally attributable to the policy form discussed above where the surrender charge declines from 4 percent to 0 percent on the sixth policy anniversary.
The aggregate proceeds from the Acquisition financing of $422.9 million (excluding $30 million not yet borrowed to be used in connection with the Savings Bank Litigation) were used as follows (dollars in millions):
At December 31, 1995, American Life Holding had $150 million of senior subordinated notes outstanding and $125 million in outstanding indebtedness under the Senior Credit Facility. AGP and its subsidiaries may incur additional indebtedness in the future, subject to the limitations contained in the Senior Credit Facility and the indenture for the senior subordinated indebtedness. In addition, the Senior Credit Facility and the indenture contain limitations on the ability of American Life Holding to pay dividends on its capital stock (other than the two series of its redeemable preferred stock discussed in the following paragraph), which could impact AGP's access to funds to meet its obligations. Under the most restrictive covenants of the Senior Credit Facility, American Life Holding is limited to paying dividends of $.5 million per year to AGP. In the event that the Company is required to pay unpaid dividends on the 1988 Series Preferred Stock, limitations in the Senior Credit Facility would require the Company (absent a waiver from the lenders) to seek sources of funds other than dividends from American Life Holding or borrowing. The Company believes it will have sufficient resources to pay such preferred stock dividends if payment becomes necessary.
Statutory accounting practices prescribed or permitted for the Company's insurance subsidiaries differ in many respects from those governing the preparation of financial statements under GAAP. Accordingly, statutory operating results and statutory capital and surplus may differ substantially from amounts reported in the GAAP basis financial statements for comparable items. The Company's insurance subsidiaries follow certain permitted statutory accounting practices which are not specifically prescribed in state laws, regulations, general administrative rules or various NAIC publications. Such permitted practices do not enhance statutory surplus. Further, the Company's insurance subsidiaries do not have any reinsurance agreements generally known as "surplus relief reinsurance" which have the effect of increasing statutory surplus at inception and reducing statutory surplus in subsequent years as amounts are recaptured by reinsurers. Information as to statutory capital and surplus and statutory net income for the Company's insurance subsidiaries as of and for the years ended December 31, 1995 and 1994, is included in note 14 in the accompanying consolidated financial statements.
The annuity products marketed and issued by the Company enjoy certain income tax advantages as compared to certain other savings investments such as certificates of deposit and taxable bonds. One important tax advantage is the deferral of income taxation on any increases in the contract values during the accumulation phase of these annuity products as opposed to the current taxation of all earnings that is imposed on many other savings and investment products. In the event that the federal income tax laws are changed such that accumulated earnings on annuity products do not enjoy the tax deferral described above, or such that additional savings and investment products were to achieve similar tax deferral status, or such that tax rates were significantly lower so that the annuitant's ability to defer tax on annuity earnings was no longer a significant factor for the policyholder, consumer demand for the affected annuity products could decline materially or be eliminated. From time to time, Congress has considered proposals to revise or eliminate this tax deferral. There is no such proposal currently pending in Congress, nor has the current administration announced any consideration of such proposals. If legislation were enacted to eliminate the tax deferral for certain annuities, such a change would have an adverse effect on the ability of the Company to sell certain annuities.
Management of American Life Group, Inc. is responsible for the reliability of the financial information in this annual report. The financial statements are prepared in accordance with generally accepted accounting principles and the other financial information in this annual report is consistent with that of the financial statements (except for such information described as being in accordance with regulatory or statutory accounting requirements).
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated results of operations and cash flows of American Life Group, Inc. and subsidiaries for the year ended December 31, 1993, in conformity with generally accepted accounting principles.
American Life Group, Inc. (the "Company") (formerly The Statesman Group, Inc. prior to its name change in August 1995) is an insurance holding company engaged primarily in the development, marketing, issuance and administration of annuity and life insurance products through its insurance subsidiaries, American Life and Casualty Insurance Company ("American Life and Casualty") and Vulcan Life Insurance Company ("Vulcan Life"). The Company markets its annuity and life insurance products primarily to middle-income individuals, ages 45 and over, through a general agency and insurance brokerage distribution system. The Company, through its wholly owned subsidiary, American Life Holding Company ("American Life Holding"), owns 100 percent of American Life and Casualty, which owns 98 percent of Vulcan Life.
The Acquisition is accounted for using the purchase method of accounting. Under purchase accounting, the total purchase cost was allocated to the assets and liabilities acquired based on their fair values, with the excess of the total purchase cost over the fair value of the net assets acquired recorded as goodwill. The consolidated balance sheet as of December 31, 1995 and 1994, and consolidated statements of operations, shareholders' equity and cash flows for the year ended December 31, 1995, and the three months ended December 31, 1994, are reported based on such purchase values.
The values of the assets and liabilities acquired were as follows (dollars in millions):
Assuming the Acquisition and related transactions had occurred as of January 1, 1994, revenues, income before extraordinary charge and loss before extraordinary charge per common share were $397.6 million, $7.3 million and $.01, respectively, for the year ended December 31, 1994. All such pro forma amounts are unaudited.
Fixed maturity investments are securities that mature more than one year after they are issued and include bonds, notes receivable and preferred stocks with mandatory redemption features. Equity securities include investments in common stocks and non-redeemable preferred stock. Effective January 1, 1994, the Company adopted Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities" ("SFAS 115"), and, accordingly, classifies its fixed maturity and equity securities into the following three categories:
o Trading account securities are fixed maturity and equity securities that are bought and held principally for the purpose of selling them in the near term. Trading account securities are carried at estimated fair value and the unrealized gain or loss is included as a component of net trading income. No trading securities were held at December 31, 1995 or 1994.
o All other fixed maturity securities are those securities which the Company has the ability and positive intent to hold to maturity, and are carried at amortized cost. The Company may dispose of such securities under certain unforeseen circumstances, such as issuer credit deterioration or regulatory requirements. In conjunction with the Acquisition, all fixed maturity securities previously classified as held to maturity were transferred to actively managed to reflect the intent of the current management. The Company has not held any securities in this classification since the Acquisition.
Unrealized gains and losses and the related adjustments described in the preceding paragraph have no effect on earnings, but are recorded, net of tax, as a component of shareholders' equity. The following table summarizes the effect of these adjustments as of December 31, 1995:
o For transfers to the trading category, the unrealized gain or loss is recognized in earnings;
Other invested assets principally consist of debt instruments, which are generally recorded at amortized cost, and limited partnership investments which are reported under the equity method.
o Identify the risks inherent in realizing those cash flows (i.e., the probability that the cash flows will be realized).
Expected future cash flows used in determining such value are based on actuarially determined projections of future premium collections, mortality, surrenders, operating expenses, changes in insurance liabilities, investment yields on the assets held to back the policy liabilities and other factors. These projections take into account all factors known or expected at the valuation date based on the collective judgment of the management of the Company. Actual experience on purchased business may vary from projections due to differences in renewal premiums collected, investment spread, investment gains or losses, mortality and morbidity costs and other factors.
The discount rate of 19.5 percent used to determine the value of the cost of policies purchased is the rate of return required by Partnership II to invest in the business being acquired. The following factors have been considered in determining this rate:
To the extent that past or future experience on purchased business varies from projections due to differences in renewal premiums collected, investment spread, investment gains or losses, mortality and morbidity costs and other factors, it may be necessary to adjust the amortization of the cost of policies purchased. For example, sales of fixed maturity investments that result in a gain (or loss), but also reduce (or increase) the future investment spread because the sale proceeds are reinvested at a lower (or higher) earnings rate, may cause amortization to increase (or decrease) reflecting the change in the incidence of cash flows. For universal life-type contracts and investment-type contracts, the accumulated amortization is adjusted (whether an increase or a decrease) whenever there is a material change in the estimated gross profits expected over the life of a block of business in order to maintain a constant relationship between cumulative amortization and the present value (discounted at the rate of interest that accrues to the policies) of expected gross profits. For most other contracts, the unamortized asset balance is reduced by a charge to income only when the present value of future cash flows, net of the policy liabilities, is not sufficient to cover such asset balance.
The excess of the cost of acquiring the Company's net assets over their estimated fair values on the Acquisition date is recorded as goodwill and is being amortized on the straight-line basis over a 40 year period. The Company periodically assesses the recoverability of goodwill through projections of future earnings of the related subsidiaries. Such assessment is made based on whether goodwill is fully recoverable from projected undiscounted net cash flows from earnings of the subsidiaries over the remaining amortization period. If future evaluations of goodwill indicate a material change in the factors supporting recoverability over the remaining amortization period, all or a portion of goodwill may need to be written off or the amortization period shortened.
Property and equipment are reported at cost, less accumulated depreciation and amortization. Provisions for depreciation and amortization are computed using the straight-line method over the estimated useful lives of the assets.
Reserves for universal life-type and investment-type contracts (principally deferred annuities) are based on the contract account balance, if future benefit payments in excess of the account balance are not guaranteed, or on the present value of future benefit payments when such payments are guaranteed. Additions to insurance liabilities are made if future cash flows including investment income are insufficient to cover future benefits and expenses.
Reserves for traditional life insurance policy benefits are generally calculated using the net level premium method and assumptions made at the time the contract is issued (or in the case of policies acquired by purchase, at purchase date) as to investment yields, mortality, withdrawals and other assumptions based on projections of past experience modified as necessary to reflect anticipated trends and include provisions for possible unfavorable deviation. Policy benefit claims are charged to expense in the period that claims are incurred.
Liabilities for incurred claims are determined using historical experience and published tables for disabled lives and represent an estimate of the present value of the remaining ultimate net cost of all reported and unreported claims. Management believes these estimates are adequate. Such estimates are reviewed continually and any adjustments are reflected in current operations.
Assets and liabilities related to insurance contracts are reported before the effects of reinsurance. Reinsurance receivables and prepaid reinsurance premiums (including amounts related to insurance liabilities) are reported as assets. Estimated reinsurance receivables are recognized in a manner consistent with the liabilities related to the underlying reinsured contracts.
Effective January 1, 1993, the Company changed its method of accounting for income taxes from the deferred method to the liability method required by Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes" ("SFAS 109"). The cumulative effect of adopting SFAS 109 as of January 1, 1993, and the effect of the change on federal income tax expense for the year ended December 31, 1993, were not material.
For periods prior to October 1, 1994, fully diluted earnings per common share assume that the Series Preferred Stock $1 Par and the 6-1/4% Convertible Subordinated Debentures were converted into common stock as of the date of issuance and that the related dividend and interest requirements were eliminated. In addition, net income has been reduced by the additional contribution to the employee stock ownership plan ("ESOP"), less applicable income tax benefits, that would have been required to service the ESOP debt, if the shares of 1987 Series II Preferred Stock were converted into common stock. For the year ended December 31, 1995, and the three month period ended December 31, 1994, there were no dilutive securities.
Net interest received or paid on interest rate swap contracts that reduce the Company's exposure to interest rate risk and qualify as hedges is recognized as an adjustment to net investment income over the term of the contract. To qualify as a hedge, it must be probable that a high correlation will exist between: (i) changes in the estimated fair value of the interest rate swap contract; and (ii) changes in the estimated fair value of the related financial instrument exposed to interest rate risk. If conditions change so that the contracts no longer effectively hedge the interest exposure, the contracts are recorded at fair value with the appropriate charge or credit to income. The Company had no material interest rate swap contracts outstanding at December 31, 1995.
The Company operates in the single business segment of providing individual life insurance and annuity coverage within the United States.
Credit-tenant loans, mortgage loans and policy loans: The estimated fair values of these loans are determined by discounting future expected cash flows using interest rates currently being offered for similar loans to borrowers with similar credit ratings. Loans with similar characteristics are aggregated for purposes of the calculations.
Securities segregated for the future redemption of redeemable preferred stock of a subsidiary: Estimated fair values of the U.S. Treasury securities held in escrow for the future redemption of redeemable preferred stock of American Life Holding are based on quoted market prices.
Redeemable preferred stock of a subsidiary: The estimated fair value of the publicly-traded redeemable preferred stock issued by American Life Holding is based on quoted market prices. The estimated fair value of the privately placed redeemable preferred stock issued by American Life Holding is determined by discounting expected future cash flows using assumed incremental dividend rates for similar duration securities.
Interest rate swaps: Estimated fair values of interest rate swap contracts are based on estimates of fair value from dealers which represent the net value or the cost of terminating the contracts at the balance sheet date.
At December 31, 1995, the amortized cost and estimated fair value of actively managed fixed maturity investments were as follows:
At December 31, 1994, the amortized cost and estimated fair value of actively managed fixed maturity investments were as follows:
The following table sets forth fixed maturity investments at December 31, 1995, classified by rating categories. The category assigned is the highest rating by a nationally recognized statistical rating organization or, as to $130.1 million fair value of fixed maturities not rated by such firms, the rating assigned by the National Association of Insurance Commissioners ("NAIC"). For the purposes of this table, NAIC Class 1 is included in the "A" rating; Class 2, "BBB-"; and Class 3, "BB-".
At December 31, 1995, the Company's below investment grade corporate fixed maturities had an amortized cost of $162.7 million and an estimated fair value of $168.5 million. For substantially all of these securities, the amortized cost exceeded the fair value by less than 5 percent or the fair value of the securities exceeded amortized cost. During the year ended December 31, 1995 and the nine months ended September 30, 1994, the Company recorded realized losses for investment writedowns of $7.1 million and $1.2 million, respectively, as a result of changes in the financial condition of an issuer and changes in the value of underlying collateral, which caused the Company to conclude that a decline in fair value of such investments was other than temporary. There were no such realized losses in the three months ended December 31, 1994, and the year ended December 31, 1993. The Company had no fixed maturity investments in technical or substantive default as of December 31, 1995. As of December 31, 1995, there were no fixed maturity investments about which the Company had serious doubts as to the ability of the issuer to comply with the contractual terms of their obligations on a timely basis.
Proceeds from sales of fixed maturity investments were $2,822.1 million, $502.0 million, $603.8 million and $2,166.2 million for the year ended December 31, 1995, the three months ended December 31, 1994, the nine months ended September 30, 1994, and the year ended December 31, 1993, respectively.
At December 31, 1995, net unrealized appreciation of equity securities (before income taxes) was $2.3 million, consisting of $2.3 million of gross appreciation and no depreciation.
At December 31, 1995, the mortgage loan balance was comprised of 99 percent commercial loans (including multifamily residential) and 1 percent single family residential loans. Approximately 16 percent, 16 percent, 12 percent and 11 percent of the mortgage loan balance was on properties located in Florida, Minnesota, Iowa and Nevada, respectively. No other state comprised greater than 9 percent of the mortgage loan balance. Less than 2 percent of the mortgage loan balance was noncurrent at December 31, 1995. The Company had a loan loss reserve of $1.4 million at December 31, 1995.
Mortgage-backed securities issued by a single entity in excess of ten percent of shareholders' equity at December 31, 1995, other than mortgage-backed securities issued or guaranteed by the United States Government or a United States Government agency, were as follows. Mortgage-backed securities issued by non-government entities are aggregated by the issuing entity with the number of individual securities (if greater than one) identified parenthetically following the issuer's name. The creditworthiness of such mortgage-backed securities is based solely on the underlying segregated pools of mortgage loan collateral and related credit enhancements rather than the general creditworthiness of the issuing entity.
The Company files a consolidated federal income tax return including all subsidiaries. At December 31, 1995, the Company has net operating loss carryforwards of $51.0 million which expire in 1999 through 2010. These loss carryforwards relate to the operations of the non-life consolidated group. Utilization of the operating loss carryforwards to offset taxable income of the life insurance subsidiaries is limited under existing federal income tax rules and regulations. In connection with the adoption of SFAS 109 on January 1, 1993, a $4.1 million valuation allowance was established relating to the uncertainty of realizing the benefit of loss carryforwards. Of the allowance, $2.6 million was reversed prior to the Acquisition date and the remaining $1.5 million was eliminated in the purchase accounting adjustments at the Acquisition date.
The Senior Credit Facility provides for $225 million of senior secured credit facilities comprised of: (i) a Tranche A Facility ("Tranche A") in the amount of $105 million; (ii) a Tranche B Facility ("Tranche B") in the amount of $20 million; and (iii) a Revolving Credit Facility (the "Revolver") in an amount of up to $100 million. The Senior Credit Facility was recorded net of debt issuance costs of $1.6 million. At December 31, 1995, the Company had borrowed $105 million and $20 million under Tranche A and Tranche B, respectively. There were no outstanding borrowings under the Revolver at December 31, 1995.
Unless otherwise extended, the Revolver will mature, and all principal and interest thereunder will become due and payable, in October 1998. The Revolver may be extended in one year increments through October 2001, subject to defined conditions. Tranche A and Tranche B mature in April 2002 and April 2003, respectively.
The Senior Credit Facility bears interest based on defined rates as selected by the Company plus an applicable margin which varies based on American Life Holding's long-term senior debt rating. At December 31, 1995, borrowings under Tranche A and Tranche B bear interest at 7.32 percent and 7.82 percent, respectively. The Company pays a per annum non-use fee on the unused portion of the Revolver of .2 percent to .5 percent depending on the long-term senior debt rating of American Life Holding.
In connection with the financing of the Acquisition, American Life Holding issued $150 million of senior subordinated notes in a public offering. The senior subordinated notes bear interest at 11.25 percent, payable semiannually and will mature on September 15, 2004. Such notes are unsecured and are subordinated in right of payment to the prior payment in full of all senior indebtedness (as defined in the indenture for the subordinated notes), including American Life Holding's obligations under the Senior Credit Facility. The notes are redeemable at the Company's option, in whole or in part, at any time on or after September 15, 1999, initially at 105.625 percent of their principal amount, plus accrued interest, declining to 100 percent of their principal amount, plus accrued interest, on or after September 15, 2001. At the date of Acquisition, the senior subordinated notes were recorded net of $6.6 million of debt issuance costs (including $2.4 million paid to Conseco).
The Senior Credit Facility and the indenture governing the senior subordinated notes contain a waiver of any rights, claims or interests in the securities held in escrow for the benefit of the holders of the redeemable preferred stock issued by American Life Holding and contain certain covenants, which among other things: (i) require the maintenance of specified statutory capital and surplus, ratings, and financial and other ratios by the Company's subsidiaries; (ii) limit the incurrence of additional indebtedness, the payment of dividends by the Company's subsidiaries and investments in certain types of investments including non-investment grade securities and certain classes of collateralized mortgage obligations; and (iii) restrict transfers of funds from the Company's principal subsidiaries to the Company. In addition, the occurrence of a change of control (as defined) would accelerate the repayment of the Senior Credit Facility and senior subordinated notes at the holders' option.
In August 1992 and February 1993, American Life Holding issued 2.8 million shares and 1.2 million shares, respectively, of non-convertible redeemable preferred stock. The 2.8 million shares were issued in a public offering at a price of $25 per share (aggregate $69.0 million) and the 1.2 million shares were issued at a price of $25 per share (aggregate $30.0 million) in exchange for all of American Life Holding's then outstanding 11.5 percent subordinated debentures which were retired.
Preferred stock outstanding at December 31, 1995 and 1994, was as follows:
The Savings Bank Litigation seeks monetary damages from the government including recovery of: (i) the Company's investment in the Savings Bank of 143,640 shares of the 1988 Series Preferred Stock and $8.4 million of cash; and (ii) compensation for costs incurred and the value of benefits conferred on the defendant through the Company's purchase, operation and management of the Savings Bank. Total restitution sought by the Company exceeds $30 million.
On July 24, 1992, the Court of Federal Claims granted the Company's motion for summary judgment as to the defendant's liability for breach of contract in the Savings Bank Litigation. The court also consolidated this case with two others and certified these cases for interlocutory appeal to the United States Court of Appeals for the Federal Circuit (the "Court of Appeals"). Subsequently, the Court of Appeals entered a judgment reversing the order of the Court of Federal Claims by a decision of two to one and the Company filed a Petition for Rehearing with Suggestion for Rehearing in Banc (the "Rehearing Petition") with the Court of Appeals. On August 18, 1993, the Court of Appeals accepted the Rehearing Petition, vacated the judgment which was entered in favor of the defendant and withdrew its opinion accompanying the judgment. On August 30, 1995, the Court of Appeals, in banc, affirmed the summary judgment of the Court of Federal Claims in the Company's favor by a decision of nine to two. Subsequently, the United States of America filed a petition for certiorari to the United States Supreme Court which was granted. The Supreme Court scheduled
oral arguments for April 1996. In the event the Supreme Court affirms the summary judgment of the Court of Federal Claims, a trial will be held in the Court of Federal Claims to determine damages related to the breach of contract by the United States.
In conjunction with the Acquisition, each common or equivalent share of the Company outstanding immediately prior to the Acquisition received a Contingent Payment Right, designed to provide holders with certain financial benefits that the Company may receive from a favorable determination of the Savings Bank Litigation. If the rights of the holder of the 1988 Series Preferred Stock were not an issue in the Savings Bank Litigation, the 1988 Series Preferred Stock was convertible into approximately $30.1 million in conjunction with the Acquisition.
Under the terms of a stock option plan adopted in 1994, options to purchase 15,000 shares of the Company's common stock were granted to the Company's non-employee directors in 1994. Pursuant to the terms of the merger agreement between the Company and Partnership II, these options were redeemed for cash on September 29, 1994, and the consolidated statement of operations for the nine months ended September 30, 1994, includes an insignificant charge for the redemption of these options. Subsequent to the Acquisition, this plan was terminated.
Total rental expense for all leases is as follows: year ended December 31, 1995 - $1.4 million; three months ended December 31, 1994 - $.3 million; nine months ended September 30, 1994 - $1.0 million; and year ended December 31, 1993 - $1.2 million. Future minimum rental commitments for operating leases having initial or remaining noncancelable lease terms in excess of one year are not material.
The Company and its subsidiaries participate in the Statesman Savings Plan 401(k) (the "401(k) plan"), a qualified salary deferral retirement plan covering all eligible employees of the Company and its subsidiaries. Employees may contribute a portion of their annual salary, subject to limitation, to the 401(k) plan. The Company and its subsidiaries contribute an additional amount, subject to limitation but not to exceed a certain percent of eligible compensation (5 percent in 1995 and 2 percent in 1994), based on the voluntary contributions of the employees. Prior to 1994, all employer matching contributions were invested in shares of the Company's common stock. Plan contributions charged to expense were $.3 million, $.1 million and $.1 million for 1995, the 1994 periods and 1993, respectively.
The Company and its subsidiaries participate in a qualified trusteed plan, The Statesman Group, Inc. Employee Stock Ownership Plan and Trust ("Plan"), which provides for a uniform noncontributory retirement program covering all eligible employees of the Company and its subsidiaries. The Plan was frozen effective December 16, 1994, and no contributions will accrue after that date. Prior to December 16, 1994, contributions to the Plan were equal to 10 percent of eligible compensation of all participants plus such additional amounts (2.9 percent for the year ended December 31, 1993) as may be determined annually by the Board of Directors. Total plan expense for the three months ended December 31, 1994, the nine months ended September 30, 1994, and the year ended December 31, 1993, amounted to $.2 million, $.6 million and $.9 million, respectively.
The Company has entered into employment continuation agreements with certain officers of the Company and its subsidiaries that provide for payments if there is a change in control of the Company (as defined) and a termination of their employment. The agreements do not constitute employment contracts and apply only in circumstances following a change in control. The Acquisition constituted a change of control under the agreements. Nonrecurring expenses in 1995 include a payment of $3.3 million under one of these agreements. The maximum contingent liability under these agreements at December 31, 1995 is $.6 million.
The Company, Conseco, Partnership II and certain of the persons formerly serving as directors on the Board of Directors of the Company have been named as defendants in a purported class action commenced on May 3, 1994, entitled Nitti v. Statesman Group, Inc., et al., No. 13501 (Delaware Chancery Court, New Castle County) (the "Nitti Action"). The complaint in the Nitti Action alleges that in authorizing the Company to enter into the merger agreement, the members of the board of directors failed to maximize the value received by the Company's stockholders in a sale of the Company and accordingly breached their fiduciary duties. On September 21, 1994, an amended class action complaint adding a second plaintiff and additional allegations were filed. On October 5, 1994, a motion to dismiss for failure to state a claim was filed on behalf of the Company. The Company believes that this complaint is without merit and intends to defend it vigorously.
The Company, Vulcan Life and certain of its independent agents have been named as defendants in litigation in the state of Alabama concerning life insurance products sold to school teachers in the late 1980's. The cases are: (i) Sentell, et al. v. Vulcan Life Insurance Company et al., filed in the Circuit Court for Pickens County, Alabama, on August 22, 1994; (ii) Rembert, et al. v. Vulcan Life Insurance Company et al., filed on June 29, 1995, and pending in the Circuit Court of Marengo County,
Alabama; (iii) Baldwin et al, v. Vulcan Life Insurance Company et al., filed on July 6, 1995, and pending in the Circuit Court of Marengo County, Alabama; (iv) Thomas, et al., v. Charley, et al., filed in the Circuit Court of Wilcox County, Alabama on or about December 20, 1994; and (v) Wheeler v. Vulcan Life Insurance Company, et al., filed in the Circuit Court in Lamar County, Alabama on May 18, 1995 (all cases are referred to herein as the "Vulcan Life Litigation"). The plaintiffs in the Vulcan Life Litigation allege, among other things, that the agent defendants misrepresented that the life products were part of an employee benefit plan and that such plan would pay the premiums for their policies although, under the Code, life insurance products may not be purchased through such a plan. The plaintiffs allege that they purchased the life insurance products because of such alleged misrepresentations. The plaintiffs have requested an award of compensatory and punitive damages of unspecified amounts. The defendants have denied any liability and have raised numerous defenses including the statute of limitations.
From time to time, mandatory assessments are levied on the Company's insurance subsidiaries by life and health guaranty associations of most states in which these subsidiaries are licensed to cover losses to policyholders of insolvent or rehabilitated insurance companies. The associations levy assessments (up to prescribed limits) on all insurers in a particular state in order to pay claims on the basis of the proportionate share of premiums written by insurers in the lines of business in which the insolvent or rehabilitated insurer are engaged. These assessments may be deferred or forgiven in certain states if they would threaten an insurer's financial strength and, in some states, these assessments can be partially recovered through a reduction in future premium taxes. Assessments levied against the Company's insurance subsidiaries and charged to expense in the year ended December 31, 1995, the three month period ended December 31, 1994, the nine month period ended September 30, 1994 and the year ended December 31, 1993 were $.2 million, $.6 million, $1.4 million and $2.6 million, respectively. The balance sheet at December 31, 1995, includes a liability of $7.2 million representing the Company's estimate of all known assessments that will be levied against the Company's insurance subsidiaries by various state guaranty associations on premiums that have been written through December 31, 1995. Such estimate is subject to change as the associations determine more precisely the losses due to all failures that have occurred and how such losses will be allocated to insurance companies.
Prior to the Acquisition, the Company entered into certain interest rate swap agreements primarily to: (i) match the interest rate characteristics of investments and related insurance liabilities for a portion of its single premium annuity liabilities; (ii) offset a portion of the cost of interest rate swaps used as hedges; and (iii) convert a portion of its floating rate bank debt to fixed rate debt. Prior to the Acquisition, several contracts ceased to effectively hedge risks and the Company began reporting them at their estimated fair value with changes in fair value reflected in income as they occurred. Realized losses on interest rate swap contracts of $13.8 million, net of income taxes of $7.5 million were recognized in the nine months ended September 30, 1994. All swap agreements were recorded at their estimated fair values at the Acquisition date pursuant to purchase accounting and all material agreements were terminated during 1995 and 1994. No significant gain or loss was recognized on the swap contracts during the year ended December 31, 1995, and the three months ended December 31, 1994.
In accordance with its partnership agreement: (i) Partnership II paid acquisition fees of $.9 million in 1994 to a subsidiary of Conseco for services related to the Acquisition; and (ii) the Company paid $4.0 million in 1994 to a subsidiary of Conseco for services provided in connection with the financings related to the Acquisition.
Anticipated returns from the investment of policyholder balances are considered in determining the amortization of the cost of policies purchased and cost of policies produced. Sales of fixed maturity investments change the incidence of profits on such policies because capital gains (losses) are recognized currently and the expected future yields on the investment of policyholder balances are reduced (increased). Accordingly, amortization of the cost of policies produced and the cost of policies purchased was increased by $83.3 million, $2.8 million and $9.8 million for the year ended December 31, 1995, the nine months ended September 30, 1994, and the year ended December 31, 1993, respectively.
Supplemental disclosures and non-cash items that are not reflected in the consolidated statement of cash flows were as follows:
Combined statutory net income of the Company's life insurance subsidiaries was $27.1 million, $39.7 million and $31.9 million in 1995, 1994 and 1993, respectively, after appropriate eliminations of intercompany accounts between such subsidiaries. The Company's insurance subsidiaries follow certain permitted accounting practices which are not specifically prescribed in state laws, regulations, general administrative rules and various NAIC publications. Such permitted accounting practices do not enhance statutory surplus.
Included in statutory capital and surplus at December 31, 1995, is $3.9 million related to 463,649 shares of the Company's common stock held by Vulcan Life. Such amount is eliminated in the consolidated financial statements.
Earnings per common share for each quarter are calculated independently of earnings per share for the year. The sum of the quarterly earnings per share may not equal the earnings per share for the year because of: (i) transactions affecting the weighted average number of shares outstanding in each quarter; and (ii) the uneven distribution of earnings during the year.