Savers Marketing leases approximately 6,000 square feet in an office building located at 8064 North Point Boulevard, Winston-Salem, North Carolina, under the terms of a lease that expires on September 30, 2001.
(e)Includes Medicare supplement premiums of $6.0 million related to the Savers Life acquisition. This business was sold effective July 1, 1998.
In selecting the interest rate to calculate the discounted present value of the projected future profits, SMC uses the risk rate of return it needs to earn in order to invest in the business being acquired or recaptured.
In determining this required risk rate of return, SMC considers the following factors:
SMC used discount rates of 13% and 15% to calculate the present value of future profits of the Savers Life and Midwestern Life acquisitions, respectively. Each is being amortized over 20 years based on the mix of their respective annuity and life business.
DEFERRED ACQUISITION COSTS. Insurance products generate two types of profit streams: (i) from the excess of investment income earned over that credited to the policyholder and (ii) from the excess of premiums received over costs incurred for policy issuance, administration and mortality. Costs incurred in issuing new policies are deferred and recorded as deferred acquisition costs ("DAC"), which are amortized using present value techniques so that profits are realized in proportion to premium revenue for certain products and estimated gross profits for certain other products. Profits from all of these elements are recognized over the lives of the policies; no profits are recorded at the time the policies are issued.
Gross amortization$7,737 $7,872 $7,094 $6,127 $5,254 Interest accreted 2,576 2,047 1,575 1,233 986 Net amortization $5,161 $5,825 $5,519 $4,894 $4,268
The amounts included in the foregoing table do not include any amortization of DAC resulting from the sale of new products after December 31, 1999. Any changes in future annual amortization of this asset are not expected to have a significant effect on results of operations because the amount of amortization is expected to be proportionate to the profits from the produced policies, net of interest on DAC.
SMC's 1998 operating earnings were $4.4 million, or 58 cents per diluted share, up 87% and 35%, respectively compared to 1997. Operating earnings increased as a result of i) increased net spread revenue due to increases in weighted average insurance liabilities (primarily due to the inclusion of Savers Life and Midwestern Life operations), ii) favorable mortality experience, iii) fees from administration contracts and iv) increased fees from separate accounts. The percentage increase in operating earnings was greater than the percentage increase in operating earnings per diluted share primarily because of the 67% increase in weighted average diluted common shares or equivalents outstanding during the period. This increase in weighted average shares outstanding resulted primarily from issued shares in connection with the acquisitions of Savers Life and Midwestern Life.
PREMIUM DEPOSITS consist of FPDA's, equity indexed annuities, interest- sensitive annuities and other financial products that do not incorporate significant mortality features. For GAAP these premium deposits are not shown as premium income in the income statement. Furthermore, a change in premium deposits in a single period does not directly cause operating income to change, although continued increases or decreases in premiums may affect the growth rate of total assets on which investment spreads are earned.
Premium deposits for 1998, received from the sales of FPDA's, equity indexed annuities, interest sensitive annuities and other financial products increased $32.5 million or 66%, to $81.9 million. The increase relates to i) an increase in the agency base achieved through the recruitment of high volume agents and larger managing general agencies, ii) continued expansion of geographical concentration, iii) the introduction of an equity-indexed annuity product in May 1998, which contributed $16.9 million of deposits for the period and iv) deposits collected from Savers Life and Midwestern Life of $3.6 million.
POLICY INCOME represents i) mortality charges and administrative fees earned on universal life products and ii) surrender charges earned as a result of terminated universal life and annuity policies.
During 1998 policy income increased $1.0 million or 18%, to $6.5 million. The increase relates to $.8 million of surrender charges on certain FPDA products which is primarily the result of lowering credited rates on those products.
During 1999, net investment income increased $10.7 million or 32%, to $44.4 million. Average invested assets (at book value) increased by $166.2 million or 27% due to the growth in insurance liabilities from premium sales of recent periods and from the acquisitions of Savers Life and Midwestern Life. Net investment income also increased due to the impact from equity indexed products of $1.2 million.
FEE AND OTHER INCOME consists of fee income related to servicing blocks of business for unaffiliated companies, experience refunds, and commission income.
Fee and other income increased 37% in 1999, to $4.2 million and increased 181% in 1998, to $3.1 million. These increases are due to commission income that relates to the Savers Marketing administration agreement and the marketing efforts associated with the management of that business.
Benefits and claims in 1999 increased $1.2 million, to $14.5 million. This is due to $6.1 million of claims and benefits resulting from an increase in the average in force life insurance business for the periods due to the acquisition of Savers Life and Midwestern Life. This was somewhat offset by the inclusion of $4.9 million of benefits and claims in 1998 results related to the Medicare supplement business that was sold July, 1998.
In 1999, interest credited increased $6.0 million or 30%, to $25.7 million. This increase was due to larger average interest-sensitive insurance liabilities of approximately $124.9 million or 33% for the period which includes increases of i) $44.1 million from the acquisitions of Savers Life and Midwestern Life and ii) $40.2 million from equity indexed products. The remaining increase primarily relates to FPDA products. These increases were somewhat offset by a decrease in the average credited rate for the period.
In 1998, interest credited on interest sensitive annuities and other financial products increased $3.5 million or 21%, to $19.8 million due to i) interest credited on the insurance liabilities of Savers Life and Midwestern Life of $2.4 million, ii) the impact from the new equity indexed product of $.6 million and iii) interest credited on the general growth of insurance liabilities from increased FPDA sales. These increases were somewhat offset by a decrease in the weighted average credited rate for the period.
Amortization in 1998 increased $1.5 million or 46%, to $4.8 million. The increase in amortization expense is primarily related to deferred policy acquisition costs and is a result of emerging gross profits from business sold in recent years, increased surrenders and a corresponding increase in the amortization of costs related to purchased insurance business. Amortization expense of $.5 million related to purchased insurance business of Savers Life and Midwestern Life.
OTHER OPERATING EXPENSES consist of general operating expenses, including salaries, and commission expenses, net of deferrable amounts.
In 1998, other operating expenses increased $2.9 million or 28%, to $13.2 million . This increase relates to normal operating expenses from Savers Life and Midwestern Life, including Medicare supplement insurance commissions of $.8 million incurred from March 12, 1998, the acquisition date of Savers Life, through July 1, 1998, the effective sale date of that business.
Interest expense and financing costs for 1998 increased $.6 million or 24%, to $3.0 million, due to increased average borrowings for the period of $6.4 million primarily related to the acquisitions of Savers Life and Midwestern Life. This increase was offset somewhat by a decreased interest rate on the revolving line of credit.
Net realized investment gains were $ .1 million for 1999 and $.4 for 1998.
During 1998, fees from separate accounts increased $.8 million or 38% to $2.9 million. This increase is primarily due to an increase in the average value of assets held in separate accounts of 22% for the period. Actual separate account assets increased $42.2 million or 28%, to $190.2 million. Net deposits from SMI's sales of unit-linked products increased $20.6 million or 94%, to $42.5 million. This increase is due to marketing efforts that were initiated in 1997.
AMORTIZATION OF NEGATIVE GOODWILL, which is the amortization of the excess cost of assets acquired over the purchase price paid for SMI in December, 1993 of $6.9 million has been amortized over 5 years at $1.4 million per year and was fully amortized at December 31, 1998.
AMORTIZATION includes the amortization of deferred acquisition costs, such as sales commissions and other costs, directly related to selling new business.
Amortization increased $.5 million in 1999, to $1.2 million and increased $.5 million in 1998, to $.7 million. These increases are due to amortizing deferred acquisition costs associated with increased sales of recent periods.
Other operating expenses for the periods presented have remained relatively stable. This is a result of effective expense management and due to the majority of additional expenses incurred for the periods being directly related to additional sales and are therefore capitalized and amortized. The number of separate account contracts administered increased 10%, to 3380 in 1999 and 32% to 3070 in 1998.
FOREIGN CURRENCY TRANSLATION: comparisons between 1999, 1998 and 1997 are impacted by the strengthening and destrengthening of the U.S. dollar relative to foreign currencies, primarily the Luxembourg franc. The impact of these translations have not been quantified on individual components.
GENERAL: On a consolidated GAAP basis SMC reported net cash provided by operations of $2.9 million and $.2 million for 1999 and 1998, respectively. Although deposits received on SMC's interest-sensitive annuities and other financial products are not included in cash flow from operations under GAAP, such funds are available for use by SMC. Cash provided by operations plus net deposits received, less net account balances returned to policyholders on interest sensitive annuities and other financial products, resulted in positive cash flow of $92.6 million and $29.2 million for 1999 and 1998, respectively. Cash generated on a consolidated basis is available to Standard Management only to the extent that it is generated at the Standard Management level or is available through dividends, interest, management fees or other payments from subsidiaries.
SMC instituted a program to repurchase its common stock in order to increase the market value of the stock. At December 31, 1999, Standard Management is authorized to repurchase 964,790 additional shares of SMC Common Stock under this program.
At February 29, 2000, Standard Management had "parent company only" cash and short-term investments of $.5 million. These funds are available to Standard Management for general corporate purposes. Standard Management's "parent company only" operating expenses (not including interest expense) were $4.7 million and $3.1 million for 1999 and 1998, respectively.
Standard Management anticipates the available cash from its existing working capital, plus anticipated 2000 dividends, management fees, rental income and interest payments on its surplus debentures receivable will be more than adequate to meet its anticipated "parent company only" cash requirements for 2000.
The following are characteristics of the Amended Credit Agreement at December 31, 1999:
Principal payments: $2.8 million due March 2000, $4.3 million thereafter through March 2005
The following are characteristics of the subordinated convertible debt agreement at December 31, 1999:
From the funds borrowed by Standard Management pursuant to the Amended Credit Agreement and the subordinated convertible debt agreement, $27.0 million was loaned to Standard Life pursuant to Unsecured Surplus Debenture Agreements ("Surplus Debenture") which requires Standard Life to make quarterly interest payments to Standard Management at a variable corporate base rate plus 2% per annum, and annual principal payments of $1.0 million per year beginning in 2007 and concluding in 2033. The interest and principal payments are subject to quarterly approval by the Indiana Department of Insurance, depending upon satisfaction of certain financial tests relating to levels of Standard Life's capital and surplus and general approval of the Commissioner of the Indiana Department of Insurance. Standard Management currently anticipates these quarterly approvals will be granted. Assuming the approvals are granted and the December 31, 1999 interest rate of 10.50% continues, Standard Management will receive interest income of $2.8 million from the Surplus Debenture in 2000.
MANAGEMENT FEES. Pursuant to a management services agreement, Standard Life paid Standard Management $3.4 million during 1999 and $2.0 million during 1998 for certain management services related to the production of business, investment of assets and evaluation of acquisitions. Prior to its merger into Standard Life, Savers Life paid Standard Management $.8 million during 1998 for certain management services pursuant to a management services agreement. In addition, Dixie Life paid Standard Life $.9 million during 1999 and $1.0 million during 1998 for certain management services provided. Both of these agreements provide that they may be modified or terminated by the Indiana and Mississippi Departments of Insurance in the event of financial hardship of Standard Life or Dixie Life.
EQUIPMENT RENTAL FEES. In 1999 and 1998, Standard Management charged subsidiaries $1.0 million and $.9 million, respectively, for the use of equipment owned by Standard Management.
INTERNATIONAL OPERATIONS. SMI dividends are limited to its accumulated earnings without regulatory approval. SMI and Premier Life (Luxembourg) were not permitted to pay dividends in 1999 and 1998 due to accumulated losses. Premier Life (Bermuda) paid a dividend of $.8 million to SMI in 1999 and no dividends in 1998. SMC does not anticipate dividends from SMI in 2000.
EURO CURRENCY. Effective January 1, 1999, eleven participating European member union countries established fixed conversion rates between their legal currencies and the Euro. The legal currencies in those countries will continue to be used as legal tender through June 30, 2002. Subsequent to this date, the legal currencies will be canceled and Euro bills and coins will be used for cash transactions in the participating countries. During this three year dual- currency environment, conversion rates between the legal currencies will no longer be computed directly between one another. Instead, a special "triangulation" procedure must be followed by first converting one legal currency into its euro equivalent and then converting the Euro equivalent into the other legal currency. Although the Company has not initiated an analysis plan for the Euro conversion, SMC does not expect it to have a material impact on its operations or financial condition.
POSSIBILITY OF FUTURE DILUTION OF OWNERSHIP AND VOTING POWER. The SMC Board of Directors has the authority to issue up to .9 million additional shares of preferred stock and 11.0 million additional shares of common stock. The board's authority under SMC's charter typically does not require stockholder approval unless it is otherwise required for a particular transaction. Although SMC is not currently involved in any life insurance acquisitions, the Company regularly investigates such opportunities and could issue additional shares of SMC common or preferred stock in connection with an acquisition.
The value of these assets reflected in the December 31, 1999 balance sheet total $104.1 million or 9.1% of SMC's assets. SMC has established procedures to periodically review the assumptions used to value these assets and determine the need to make adjustments of such values in SMC's consolidated financial statements. SMC has determined that the assumptions used in the initial valuation of the assets are consistent with the current operations of SMC as of December 31, 1999.
IMPACT OF YEAR 2000. In prior years, the Company discussed the nature and progress of its plans to become Year 2000 ready. In late 1999, the Company completed its remediation and testing of systems. As a result of those planning and implementation efforts, the Company experienced no significant disruptions in mission critical information technology and non-information technology systems and believes those systems successfully responded to the Year 2000 date change. The company is not aware of any material problems resulting from Year 2000 issues, either with its products, its internal systems, or the products and services of third parties. The Company will continue to monitor its mission critical computer applications and those of its suppliers and vendors throughout the year 2000 to ensure that any latent Year 2000 matters that may arise are addressed promptly.
The financial statements and supplementary data required with respect to this Item 8 are listed in Item 14(a)(1) and included in a separate section of this report.