The Company's administrative offices are located in Raleigh, North Carolina. The Company owns and occupies a home office facility comprising approximately 165,000 rentable square feet, in Raleigh, North Carolina. The Company subleases a portion of its prior Raleigh home office facility which has a lease term expiring in 1999 and requires annual lease payments of approximately $1.1 million.
(1) Includes $21.1 million and $4.7 million of undistributed earnings in unconsolidated affiliates for the years ended 1996 and 1995, respectively.
PennCorp Financial Group, Inc. (the "Company", "PennCorp"), through its operating subsidiaries, is a low cost provider of accumulation, life, and fixed benefit accident and sickness insurance products throughout the United States and Canada. The Company's products are sold through several distribution channels, including exclusive agents, general agents, financial institutions, and payroll deduction programs, and are targeted primarily to lower and middle-income individuals in rural and suburban areas. These products are primarily small premium accident and sickness insurance policies with defined fixed benefit amounts, traditional whole life and universal life insurance with low face amounts and accumulation products such as single premium deferred annuities.
Strategic Review of Business Units. As a result of the tremendous growth the Company has experienced, the diversification of the underlying business units resulting from acquisitions over time, and the need for the Company to be able to rapidly integrate future acquisitions, the Company began a strategic business evaluation during the third quarter of 1996 which is now nearly complete.
The evaluation considered each of the current operating companies and, in anticipation of the consummation of the merger ("Washington National Merger") of the Company and Washington National Corporation ("Washington National") and the purchase of the Controlling Interest of Southwestern Financial Corporation ("SW Financial"), the impact of those operating companies on the Company's current and long-term profitability potential, the ability of the operating companies to absorb operations related to future acquisitions and the market focus of the operating companies.
The Company has begun to realign its existing operating companies in light of the strategic review and anticipates a charge related to costs directly associated with the initial divisional restructuring which will have no future economic benefit ("restructuring costs"), including the costs of employee termination benefits and relocation, early service contract termination, and facility abandonment. A charge for the restructuring costs will be included in the Company's results of operations during 1997. In addition, the Company may incur additional restructuring costs when integration plans are implemented for the pending Washington National and SW Financial transactions.
Acquisitions. The Company's growth strategy emphasizes the acquisition of complementary insurance operations and the utilization of the Company's several distribution channels to further penetrate its target markets. In making acquisitions, the Company seeks to broaden its distribution channels, increase its product offerings and expand its geographic presence. The Company also seeks benefits from expense reduction through the consolidation of facilities and staff and the conversion to common administrative systems.
Each of the operating considerations outlined above as well as the cost of capital to the Company, expected cash flows from the target acquisition and actuarial factors, such as future premium, mortality, morbidity, surrenders, operating expenses and yields on assets held to back policy liabilities are considered and weighted in determining the relative risk of financial rewards for taking on the acquisition target. On July 22, 1996, the Company acquired United Companies Life Insurance Company ("UC Life") from United Companies Financial Corporation. UC Life markets fixed and variable annuity products through independent agents and financial institution marketing channels.
On July 25, 1995, the Company consummated the acquisition of Integon Life Insurance Corporation ("Integon Life"). Integon Life's life and annuity products are marketed through a general agency sales force, primarily in the Southeastern United States.
The Company's liquidity requirements are funded primarily by its insurance subsidiaries. The insurance subsidiaries' principal sources of cash are premiums and investment income. The insurance subsidiaries' primary uses of cash are policy claims, commissions, operating expenses, income taxes and payments to the Company for principal and interest due under surplus debentures, tax sharing payments and dividends. Both sources and uses of cash are reasonably predictable.
Financings. On August 2, 1996, the Company issued 2,875,000 shares of $3.50 Series II Convertible Preferred Stock ("Series II Convertible Preferred Stock") for net proceeds of $139.2 million. The cash raised through this offering, along with borrowings under the Company's bank credit facility, were utilized (i) to fund the cash portion of the purchase price for UC Life, aggregating $100.4 million, (ii) to fund a capital contribution of $57.3 million to UC Life, and (iii) to pay related expenses of the acquisition of UC Life of $9.7 million. The Company accrued or paid dividends of $4.0 million during 1996, related to the Series II Convertible Preferred Stock.
In addition to the Series B and Series C Preferred Stock, the Company utilized $30.0 million in borrowings by Salem Holdings Corporation ("SHC"), the parent of Integon Life, from a syndicate of banks in order to fund a portion of the Integon Life acquisition. In March 1996, the Company utilized proceeds from the February Common Stock Offering to repay $30.0 million of indebtedness outstanding and cancel the SHC bank facility. For the years ended, December 31, 1996 and 1995, the Company incurred interest costs related to borrowings by SHC of $451,000 and $513,000, respectively.
In order to fund the AA Life acquisition, AAHC borrowed $55.0 million under the AAHC credit facility. The AAHC credit facility was repaid and cancelled in March 1996. During 1996, 1995 and 1994, AAHC made principal payments of $27.0 million, $23.0 million and $5.0 million, and had accumulated interest costs of $385,000, $3.3 million and $1.3 million under this facility, respectively.
Surplus Debentures, Dividend Restrictions and Cash Flows. Cash generated by the Company's insurance subsidiaries is made available to PennCorp principally through periodic payments of principal and interest on surplus debentures issued by Pacific Life and Accident Insurance Company ("PLAIC"), Salem Life Insurance Company ("Salem Life") and Pioneer Security Life Insurance Company ("Pioneer Security") (collectively, the "Surplus Note Companies"). The amounts outstanding under the surplus debentures totalled $367.9 million and $315.8 million as of December 31, 1996 and 1995, respectively. The surplus debentures generally require (subject to availability of statutory capital and surplus and in some instances, regulatory approval) principal and interest payments to be made periodically in amounts sufficient to allow PennCorp to meet its cash requirements.
For the years ended December 31, 1996, 1995 and 1994, the Company received net payments from the Surplus Note Companies of $31.9 million, $19.1 million and $11.5 million, respectively. The Surplus Note Companies received $25.8 million, $21.6 million and $900,000 in dividends and tax sharing payments from their respective insurance subsidiaries. During 1995, and 1994, the Company's downstream holding companies, SHC and AAHC, each had direct bank indebtedness outstanding which restricted the amount of payments which could be made by Salem Life and Pioneer Security for the benefit of the Company. As a result of the repayment of such indebtedness from proceeds of the Company's February Common Stock Offering, Salem Life and Pioneer Security may now make payments under their respective surplus debentures for the benefit of PennCorp.
The primary cash requirements of the Company are interest payments, preferred stock dividends and common stock dividends which aggregated $33.9 million, $24.5 million and $16.5 million for the years ended December 31, 1996, 1995 and 1994, respectively. For the year ended December 31, 1996, cash made available under the surplus debentures exceeded cash requirements by $21.2 million. For the years ended December 31, 1995 and 1994, cash requirements of the Company exceeded cash made available to the Company through payments under the surplus debentures by $5.4 million and $5.0 million, respectively. During each of these periods, the Company utilized a balance of dividends and surplus note payments from the insurance subsidiaries and borrowings under the Company's credit facilities to fund PennCorp's cash requirements. This balance resulted in what management believes to be, along with other factors, an appropriate retention of statutory capital and surplus to improve the insurance subsidiaries' A.M. Best Company ("A.M. Best") ratings without placing an undue debt burden upon the Company.
During 1997, the maximum dividends and corresponding surplus debenture payments, without prior regulatory approval, are anticipated to be approximately $27.2 million and the Company's cash requirements are anticipated to be approximately $35.3 million. The Company intends to utilize funds available under its revolving credit facility to fund the shortfall. For periods beginning in 1998, under current statutory limitations, the Company believes that it will receive sufficient cash flow from the Surplus Note Companies and their respective subsidiaries to satisfy its cash requirements. As a result of the Company's decision to retain capital and surplus at the insurance subsidiary level, and with the contemplated realignment of the insurance subsidiaries into operating divisions, the Company believes that as of December 31, 1996, its insurance subsidiaries have excess capital and surplus. The Company's own established targets for estimated risk-based capital requirements indicate that the insurance divisions could make available approximately $50.0 million to PennCorp, subject to applicable regulatory approvals.
Investments. The Company's investment portfolio is managed with the objectives of maintaining high credit quality and liquidity, maximizing current income within acceptable levels of risk, minimizing market and credit risk, and matching the anticipated maturities of investments to the Company's liabilities. The Company believes that a conservative investment strategy fits the nature of its insurance products which have little or no inflation risk and limited build-up of cash accumulation values in earlier years.
During the years ended December 31, 1996, 1995 and 1994, the Company sold $378.6 million, $106.6 million and $92.8 million of fixed maturity and equity securities, and purchased $955.8 million, $217.8 million and $183.6 million of fixed maturity and equity securities, respectively. Such sales and purchases were often effected to improve the quality of the investment portfolio or to avoid prepayment risks. In addition, during 1996 the Company sold one security in its held for investment portfolio aggregating $4.9 million as a result of a dramatic deterioration in its credit rating.
During 1995, the Company established a portfolio of "trading securities" to provide the Company with the opportunity to undertake interest rate hedging strategies, to participate in short-term relative value trades and to invest in special situations with the goal of generating short-term trading profits. As a result of trading activities, the Company recognized $1.3 million and $5.7 million of profits during 1996 and 1995, respectively.
Mortgage loans on real estate amounted to 7.0% and 1.6% of total invested assets as of December 31, 1996 and 1995, respectively. The substantial increase in mortgage loans was the result of the UC Life acquisition. UC Life invests in first mortgage loans and provides a mortgage loan warehousing facility for its former parent as a means of obtaining higher invested asset yields necessary to support competitively priced annuity products. The Company has established a reserve for loan loss which aggregated $11.9 million as of December 31, 1996. As of December 31, 1996 and 1995, the Company had non-performing loans amounting to $1.4 million and $3.5 million, respectively. The Company is in various stages of foreclosure or sales of such loans. The Company believes its current loan loss provision is adequate to cover any future losses related to currently performing and non-performing loans.
Inflation. The Company sells fixed benefit, life, and accumulation products. Approximately 48.6% of the Company's total policy revenues for the year ended December 31, 1996, were derived from fixed benefit products. These products typically provide a predetermined fixed payment that will be paid under specified conditions. Fixed benefit products are not designed to provide reimbursement for medical and related costs incurred as a result of accidents and sickness. Accordingly, payment amounts are not affected by the insured's actual cost of health care services. Because of the characteristics of its fixed benefit products, the Company believes that inflation does not have a material effect on its operations.
Pending Merger, Acquisition and Related Transactions. On January 22, 1997, the Company filed with the Securities and Exchange Commission ("SEC"), a preliminary PennCorp Financial Group, Inc. and Washington National Corporation Joint Proxy Statement and Prospectus ("Joint Proxy Statement") in which the Company, pending final review by the SEC, will be soliciting shareholder approval for the following transactions: (i) the Washington National Merger, (ii) the acquisition of the Controlling Interest in SW Financial, (iii) the acquisition of the Fickes and Stone Knightsbridge Interests, and (iv) other items (see Note 15 and 16 of Notes to Consolidated Financial Statements included elsewhere herein).
The following unaudited pro forma selected financial data represents the Company's consolidated results of operations, as if the Washington National Merger, SW Financial transaction, UC Life acquisition and other financial transactions occurred on January 1, 1996, and the pro forma financial position, as if such transactions occurred as of December 31, 1996. The unaudited selected financial data has been prepared for comparative purposes only and does not purport to be indicative of what would have occurred had the transactions been consummated as of January 1, 1996, or December 31, 1996, respectively, or the results of operations or financial position which may occur in the future.
The Company anticipates, pending regulatory and shareholder approval, consummating the Washington National Merger, the acquisition of the Controlling Interest in SW Financial, and the acquisition of the Fickes and Stone Knightsbridge Interests in late April 1997.
New Accounting Pronouncements. The Financial Accounting Standard Board ("FASB") has released for comment an Exposure Draft of a proposed Statement of Financial Accounting Standards, "Consolidated Financial Statements: Policy and Procedures" (the "Proposed Statement"). The Proposed Statement provides new guidelines with respect to the circumstances under which entities must report financial information on a consolidated basis. The Proposed Statement, if issued, would be effective for fiscal years beginning after December 15, 1996. Although the Company cannot predict if, and in what form, the Proposed Statement will be issued, the Company believes that the Proposed Statement could require consolidation of Southwestern Life and Union Bankers and certain other transactions of the Company and Knightsbridge.
The following analysis should be read in conjunction with the historical financial statements of the Company and related notes thereto contained elsewhere herein. Significant financial information, percentage changes and ratios (excluding realized gains and losses on sale of investments and equity in undistributed earnings of unconsolidated affiliates) are shown in the following table:
Insurance expenses dropped during 1996 to 15.4% of revenues from 19.1% and 20.7% during 1995 and 1994, respectively. The reduction in all periods resulted primarily from increased premium volume and persistency resulting in less amortization of insurance assets (primarily the present value of insurance in force) as a percentage of revenues. In addition, for the year ended December 31, 1996, certain interest sensitive blocks of business had significantly less amortization of deferred policy acquisition costs and present value of insurance in force, as compared to 1995 and 1994, due to reduced short-term profit margins from adverse mortality. The Company believes that the reduced profit margins will not impact the long-term profitability. However, should such mortality experience continue, the ultimate recoverability of deferred policy acquisition costs and present value of insurance in force could be adversely affected.
Interest costs fell to 3.3% of revenues during 1996, from 4.7% during 1995, and 6.1% during 1994. The Company's financings for each of its acquisitions have impacted these ratios. During 1996, the Company utilized common and preferred stock offerings to finance acquisition activities rather than debt. The weighted average interest cost for outstanding indebtedness dropped to 8.8% for the year ended December 31, 1996, from 9.0% and 9.3% for the years ended December 31, 1995, and 1994, respectively. The reduction in such interest costs was the result of the Company replacing subsidiary indebtedness with borrowings by the Company which carry substantially lower interest rates.
Net Investment Income. The effects of a larger invested asset base and improved average portfolio yields to 7.6% in 1996 from 7.3% during 1995 and 1994, have resulted in net investment income increasing 108.8%, 97.1% and 20.3% in 1996, 1995 and 1994, to $213.6 million, $102.3 million and $51.9 million, respectively. The acquisitions of UCLife, which added invested assets of $1,484.4 million in July 1996, Integon Life, which added invested assets of $1,336.9 million in July 1995, and AA Life, which added invested assets of $204.3 million in August 1994, contributed to the increase in investment income. During 1996, UCLife added $50.0 million of investment income and Integon Life incrementally added $59.7 million as a result of being included for the entire year. During 1995, Integon Life and AA Life incrementally added $40.1 million and $9.7 million to investment income, respectively. During 1994, AA Life and Professional provided additional investment income to the Company of $4.8 million and $2.5 million, respectively.
Claims Incurred. Claims incurred increased 33.0%, 25.9% and 18.3% during 1996, 1995 and 1994, to $188.7 million, $141.9 million and $112.7 million, respectively. The increase in claims during 1996 was due to the addition of UCLife, $3.3 million, the inclusion of Integon Life for the full year, $35.1 million, and adverse mortality experience at OLIC and Penn Life of $4.2 million and $2.6 million, respectively, when compared to the previously reported period.The Company believes that the modest increase in claims at OLIC and Penn Life are a statistical aboration and do not appear to be the result of poor underwriting or anti-selection. The Company is continuing to closely monitor the claims activity in each insurance subsidiary. During 1995, the increase in claims incurred attributable to Integon Life and AA Life, was $22.8 million and $10.3 million, respectively. During 1994, the impact of the AA Life acquisition and the inclusion of Professional for the entire year increased claims incurred by $18.2 million.
Income Taxes. The effective tax rates for the years ended December 31, 1996, 1995 and 1994, were 36.7%, 35.1% and 36.6%, respectively. The 1996 effective rate is higher than the statutory rate of 35% primarily due to non-deductible amortization of costs in excess of net assets acquired. The decline of the effective tax rate for 1995 as compared to 1996 and 1994 is due to previously non-deductible operating losses becoming available to reduce tax on operating earnings. Effective tax rates in 1994 are higher than the statutory rate principally due to foreign taxes and non-deductible amortization of costs in excess of net assets acquired.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of PennCorp Financial Group, Inc. and subsidiaries at 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. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
PennCorp Financial Group, Inc. (the "Company", "PennCorp") is an insurance holding company. The Company commenced operations with the acquisition of Pennsylvania Life Insurance Company ("PLIC") and Executive Fund Life Insurance Company (which was merged into PLIC effective July 1, 1996) and Pacific Life and Accident Insurance Company ("PLAIC") on August 23, 1990. Through its wholly-owned life insurance subsidiaries, PLIC and its wholly-owned subsidiary, Penncorp Life Insurance Company (collectively referred to herein as "Penn Life"), Peninsular Life Insurance Company ("Peninsular"), Professional Insurance Corporation ("Professional"), Pioneer Security Life Insurance Company ("Pioneer Security") and its wholly-owned subsidiaries American-Amicable Life Insurance Company of Texas and Pioneer American Insurance Company (Pioneer Security and its subsidiaries collectively referred to herein as "AA Life"), Salem Life Insurance Corporation ("Salem Life") and its wholly-owned subsidiaries Integon Life Insurance Corporation ("ILIC") and Georgia International Life Insurance Company and Occidental Life Insurance Company of North Carolina ("OLIC") (Salem Life and its wholly-owned subsidiaries collectively referred to herein as "Integon Life"), United Companies Life Insurance Company ("UC Life"), and PLAIC, the Company offers a broad range of accident and sickness, life, and accumulation insurance products to individuals through a sales force that is contractually exclusive to certain of the Company's subsidiaries and through general agents.
Effective January 1, 1994, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity Securities," which was issued by the Financial Accounting Standards Board in May 1993. Since December 1991, the Company has utilized concepts considered in SFAS No. 115 regarding the classification of investments in debt securities. The implementation of SFAS No. 115 has resulted in the Company reflecting certain invested assets at fair value rather than lower of aggregate cost or market as was the previous accounting practice. As of January 1, 1994 the adoption of SFAS No. 115 resulted in an increase in the value reflected in the financial statements for the fixed maturity securities available for sale of approximately $14,351 and an increase in shareholders' equity of $9,328, net of deferred tax.
In November 1995, the Financial Accounting Standards Board ("FASB") announced that for the year ended December 31, 1995, companies that are subject to the reporting requirements of SFAS No. 115 would have a one-time opportunity to reclassify securities currently classified as held for investment without the risk of tainting the accounting for investments on a historical basis. The Company has evaluated the securities contained in this portfolio and has determined under which conditions it may dispose of such securities. In light of this review, the Company has reclassified approximately $61,410 of securities which were previously classified as held for investment to available for sale. The result of such reclassification was to increase shareholders' equity by $1,198, net of applicable deferred income taxes.
Policy and contract claims represent estimates of both reported claims and claims incurred but not reported based on experience.
Accounts and notes receivable consist primarily of agents' balances and premiums receivable from agents and policyholders in the United States and Canada. Agents' balances are partially secured by commissions due to agents in the future and premiums receivable are secured by policy liabilities. An allowance for doubtful accounts is established, based upon specific identification and general provision, for amounts which the Company estimates will not ultimately be collected.
Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
On July 22, 1996, the Company consummated the acquisition of UC Life for a total purchase price of $110,056 including expenses incurred of $9,706 and earnings through the date of consummation of the acquisition of $3,608. The fair value of net assets acquired amounted to $76,008 resulting in $34,048 costs in excess of net assets acquired.
On July 25, 1995, the Company consummated the acquisition of Integon Life for a total purchase price of $48,596 including acquisition expenses of approximately $3,200. The fair value of net assets acquired amounted to $2,974 resulting in $45,622 of costs in excess of net assets acquired.
The results of operations of the acquired companies are included in the accompanying financial statements since the respective acquisition dates.
The following investments, other than obligations of the U.S. Government or agencies thereof, individually exceeded 10% of total shareholders' equity as of December 31:
The amortized cost and fair value of investments in fixed maturities available for sale as of December 31 were as follows:
The amortized cost and fair value of fixed maturities held for investment as of December 31, 1996, by contractual maturity, are shown below:
Included in fixed maturities available for sale as of December 31, 1996 and 1995, are below investment-grade securities with an amortized cost of $91,590 and $30,556 and a fair value of $92,494 and $33,541, respectively. Included in fixed maturities available for sale as of December 31, 1996, are unrated securities with an amortized cost of $92,315 and a fair value of $92,752.
As of December 31, 1996, net unrealized appreciation in equity securities available for sale of $3,356 consisted of gross unrealized gains of $4,047, less gross unrealized losses of $691. As of December 31, 1995, net unrealized appreciation in equity securities available for sale of $1,465 consisted of gross unrealized gains of $2,031, less gross unrealized losses of $566.
The Company's commercial and residential mortgage portfolios had carrying values $256,998 and $36,563, respectively, and, fair values of approximately $261,408 and $37,190, respectively, as of December 31, 1996 and 1995. The fair values for mortgage loans on real estate are estimated using the quoted market prices for securities collateralized by similar mortgage loans, adjusted for the differences in loan characteristics. For mortgage loans on real estate where quoted market prices are not available, the fair values are estimated using discounted cash flow analysis and interest rates for loans with similar credit ratings.
Investments with a carrying value of $62,767 and $49,036 were on deposit with certain regulatory authorities as of December 31, 1996 and 1995, respectively.
Major categories of net investment income for the years ended December 31, consisted of the following:
The Company had non-income producing fixed maturity investments with an amortized cost of $17,115 and $10,184 as of December 31, 1996 and 1995, respectively.
The discount rate used to determine such values is the rate of return required in order to invest in the business being acquired. In selecting the rate of return, the Company considered the magnitude of the risks associated with the type of business acquired and actuarial factors described in the following paragraph, cost of capital available to the Company to fund the acquisition, compatibility with other Company activities that may favorably affect future profits, and the complexity of the acquired company.
(c) Interest costs under the $57,000 in bank debt totaled $836 and $3,839 in 1996 and 1995, respectively. The effective rate of interest charged on amounts outstanding during 1996 was 8.1 percent.
The Company realized an after-tax extraordinary charge of $2,372 for the year ended December 31, 1996. The charge represents (i) the write-off of $816 of deferred financing costs related to the retirement of certain indebtedness of the Company and its subsidiaries, and (ii) the write-off of $1,556 of deferred financing, swap cancellation and other costs related to the repurchase of approximately $35,354 in principal amount of the Senior Subordinated Notes.
The provisions for income tax expense (benefit) attributable to income before extraordinary charge for the years ended December 31, 1996, 1995 and 1994, are as follows:
Taxes computed using the federal statutory rate of 35% in 1996, 1995 and 1994, are reconciled to the Company's actual income tax expense attributable to income before extraordinary charge as follows:
Temporary differences between the financial statement carrying amounts and tax bases of assets and liabilities that give rise to the deferred tax liabilities at December 31, 1996 and 1995, relate to the following:
In assessing the realization of deferred taxes, management considers whether it is more likely than not that some portion or all of the deferred tax assets will be realized. The ultimate realization of deferred tax assets is dependent on the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment. Based upon those considerations, management believes it is more likely than not that the Company will realize the benefits of these deductible differences, net of the existing valuation allowance at December 31, 1996.
Under provisions of the Life Insurance Company Tax Act of 1959, certain special deductions were allowed to life insurance companies for federal income tax purposes. These special deductions were repealed by the Tax Reform Act of 1984, and the untaxed balances were frozen at their December 31, 1983 levels. These balances, aggregate approximately $42,301 for the Company's life insurance subsidiaries, and are subject to taxation if certain levels of premium income or life insurance reserves are not maintained, or if the life insurance companies make excess distributions to shareholders. It is not expected that a tax would become due on any such balance and no deferred income taxes have been provided. However, if such tax were to become payable, it would amount to approximately $14,805.
The Company issued 2,300,000 shares of $50 redemption value $3.375 Convertible Preferred Stock (the "Convertible Preferred Stock") on July 14, 1995. The Convertible Preferred Stock is convertible at the option of the holder, unless previously redeemed, into 2.2124 shares of common stock for each share, subject to adjustment in certain events. Dividends accrued and unpaid as of December 31, 1996 and 1995 were $1,660. The carrying value of the Convertible Preferred Stock approximates market due to the short-term nature of the instrument.
The Company has established two management stock option plans, the 1992 Stock Option Plan which set aside up to 475,635 shares for grant and the 1996 Stock Option Plan which set aside up to 2,800,000 shares for grant. Options granted under the 1992 Stock Option Plan are deemed to be in four equal units which are earned over four years from the
The Company has also established a senior management stock award plan ("Warrant Plan"). The Warrant Plan allows for grants to senior executive officers of PennCorp and Directors of PennCorp who are not executive officers of the Company. Grant prices are determined based on the average price of the shares traded on the date of grant. Warrants granted under the Warrant Plan are determined by the Compensation Committee and are exercisable at such times and in such amounts as the Compensation Committee shall determine, but no warrant granted under the Warrant Plan will be exercisable more than ten years after the date of grant. Upon change of control (as defined) of PennCorp, all outstanding warrants become immediately vested and exercisable, and any warrants that remain unexercised shall be canceled and replacement warrants shall be issued by the surviving entity.
The Company's cash flow is derived principally from dividends and principal and interest payments on the surplus debentures issued by the insurance subsidiaries.
Dividend payments of the Company's insurance subsidiaries are limited by, or subject to the approval of the insurance regulatory authority of each subsidiary's state of domicile. Such dividend requirements and approval processes vary significantly from state to state. In 1997, the insurance subsidiaries will be able to pay a maximum of $27,165 in dividends to the Company without prior regulatory approval. In 1997, the insurance subsidiaries, subject to availability of cash and statutory capital and surplus, could pay a maximum of $50,730 on surplus note payments to the Company.
Statutory capital and surplus of the Company's life insurance subsidiaries as reported to regulatory authorities at December 31, 1996 and 1995, totaled $305,126 and $167,753, respectively. Shareholders' equity of the Company's life insurance subsidiaries included in the consolidated balance sheet totaled $592,304 and $410,228 at December 31, 1996 and 1995, respectively. Statutory net income (loss) of the Company's life insurance subsidiaries as reported to regulatory authorities totaled $(21,330), $18,581 and $20,156 for the years ended December 31, 1996, 1995 and 1994, respectively. Surplus note interest expense of $51,254, $24,170 and $11,527 for the years ended December 31, 1996, 1995, and 1994, respectively, is included in statutory net income (loss).
Remittances to PLIC from the Canadian operations totaled $-, $2,485 and $5,761 for the years ended December 31, 1996, 1995 and 1994, respectively.
On October 1, 1990, the Company established a defined contribution retirement plan (the "Defined Contribution Plan") for all employees of the Company who have attained age 21, and for certain agents whose commission earnings represent more than 50% of their income from the Company. Contributions to the Defined Contribution Plan are made pursuant to salary deferral elections by participants in an amount equal to 1% to 15% of their annual compensation. In addition, the Company makes matching contributions in an amount equal to 50% of each participant's salary deferral to a maximum of 3% of annual compensation. The Defined Contribution Plan also provides for a discretionary employer profit sharing contribution, which is determined annually by the Board of Directors for the succeeding plan year. Profit sharing contributions are credited to participant's accounts on the basis of their respective compensation in accordance with a formula that provides a higher percentage contribution for compensation in excess of the federal Social Security wage base. Salary deferral contribution accounts are at all times fully vested, while matching contribution accounts vest ratably from one to two years of service, and profit sharing contribution accounts vest ratably from one to five years of service. All participant accounts are fully vested at death, disability or attainment of age 65. Payment of vested benefits under the Defined Contribution Plan may be elected by a participant in a variety of forms of payment. The Company's funding policy is to contribute annually an amount that can be deducted for federal income tax purposes. Expenses related to this plan for the years ended December 31, 1996, 1995 and 1994, amounted to $1,520, $1,335 and $1,105, respectively.
The Company has an established bonus plan for insurance subsidiary officers. The amount available to pay awards for any year is determined by a committee of senior executives of the Company and is subject to the review and recommendation of the Compensation Committee and approval of the Board of Directors of the Company. Awards are based primarily on the income growth of the Company and the performance of eligible participants. The Company accrued or paid $1,144, $691 and $180 under this plan during the years ended December 31, 1996, 1995 and 1994, respectively.
Prior to its acquisition by the Company, Integon provided postretirement life and health benefits for employees who retired at age 55 or later and agents who retired at age 65 or later with 10 or more years of service. A closed group of agent retirees under age 65 was also eligible for benefits. Spouses, surviving spouses and dependent children were eligible for life and health benefits. Retired employees under age 65 are covered by a health maintenance organization under which benefits are generally paid at 100% after various copayments. Retired agents or employees outside the service area are covered by a self-funded indemnity plan which has a deductible with 20%-30% coinsurance. Retirees contribute toward their own benefits and contributions are required for spouses and dependent children. Under the plan, health benefits for retirees are the same as before retirement, except amounts paid by Medicare are excluded from consideration. The plan was terminated as of the date of acquisition.
During 1995, two of the Company's officers and directors, Messrs. Stone and Fickes, formed a fund, Knightsbridge Capital Fund I, L.P., ("Knightsbridge") for the purpose of making equity and equity linked investments in companies engaged primarily in the life insurance industry. Knightsbridge has received subscriptions for approximately $92,000 in limited partnership interests, including a $15,000 subscription from the Company.
In the second half of 1995, the Company and Knightsbridge determined that a joint venture strategy was in the best interest of both parties. As part of that joint venture, Knightsbridge provides PennCorp with a right of first refusal with respect to all insurance transactions considered by Knightsbridge. The joint venture entity formed for this purpose is Knightsbridge Management, L.L.C. ("KM"). PennCorp participates in 45% of the net distributable income of KM.
In February 1996, the PennCorp Board of Directors (the "PennCorp Board") and the principals of Knightsbridge began discussions on consolidating Messrs. Stone's and Fickes' outside interests under PennCorp. Such discussions culminated in a restructuring of the Knightsbridge relationship including the following completed and pending transactions (see Note 16) (i) Messrs. Stone and Fickes entered into five-year employment agreements, (ii) the proposed acquisition of the Fickes and Stone Knightsbridge Interests, (iii) the proposed acquisition of the Fickes and Stone interests in SW Financial, subject to certain contingencies, and (iv) the purchase by the Company, from the limited partners of Knightsbridge, the right to acquire UC Life for $7,500.
As required by the joint venture agreement, all bonuses paid to officers of KM who are also officers of PennCorp must be approved by the Compensation Committee of the Board of Directors of PennCorp. During 1995, the Company paid or accrued for KM incentive bonuses to certain individuals who are officers of PennCorp and KM of approximately $2,400.
In August 1995, the Company sold its preferred and common stock position in a company which has historically provided investment management services to the PennCorp insurance subsidiaries and for which a senior executive officer of the investment management firm is a member of the PennCorp Board of Directors. Fees paid for such investment management services amounted to $895, $738 and $789 during 1996, 1995 and 1994, respectively.
Under the terms of the amended and restated Washington National Merger agreement, Washington National shareholders will receive the right to receive $29.50 per share of consideration in the form of cash, PennCorp Common Stock, or a combination of cash and PennCorp Common Stock. The aggregate consideration to be received by the Washington National shareholders will be approximately $377,000, of which no more than $100,000 will be payable in cash.
In addition, PennCorp has proposed to acquire the Fickes and Stone Knightsbridge Interests for total consideration estimated to be $10,000. Fickes and Stone will each receive consideration in the form of estimated annual payments of $330 due April 15, 1997, each year through 2001 and the by issuance by PennCorp of 169,491 shares of PennCorp Common Stock to each of Fickes and Stone on April 15, 2001.
In January 1996, stockholder derivative lawsuits styled Tozour Energy Systems Retirement Plan v. David J. Stone et al, and PennCorp Financial Group, Inc., C.A. No. 14775 (the "Tozour Case") and Lois Miller v. David J. Stone et al, and PennCorp Financial Group, Inc., C.A. No. 14795 (the "Miller Complaint") were filed against PennCorp and each of its directors, individually, in the Delaware Court of Chancery. The suits allege that the SW Financial Investment involved the usurpation of a corporate opportunity and a waste of PennCorp's assets by Messrs. Stone and Fickes, and that the directors of PennCorp in approving that transaction, failed to act in good faith and breached their fiduciary duties, including the duty of loyalty to PennCorp and its stockholders, having favored the interests of Messrs. Stone and Fickes over PennCorp and its stockholders. These lawsuits seek judgments against each of the defendants for the amount of damages sustained, or to be sustained, by the Company as a result of the breaches of fiduciary duty alleged in the complaint, the imposition of a constructive trust for the benefit of the Company on profits or benefits obtained by any defendant through the alleged breaches of fiduciary duty, attorney's fees and costs, and such other relief as the court determines to be just, proper or equitable.
The defendants and the plaintiff's counsel are negotiating a stipulation of settlement (the "Proposed Settlement") of the shareholder derivative actions. The Proposed Settlement consists of the following principal elements: (i) Messrs. Stone and Fickes will cancel the 335,564 SW Financial common stock warrants they hold for no consideration enabling PennCorp to purchase the SW Financial Controlling Interest for $67.5 million, reducing the price to be paid by PennCorp for the SW Financial Controlling Interest by approximately $2.0 million, (ii) that the PennCorp Board will proceed with the purchase of The Fickes and Stone Knightsbridge Interests, having received a fairness opinion of a nationally recognized investment banking firm with respect to the price to be paid for The Fickes and Stone Knightsbridge Interests, (iii) the PennCorp Board will proceed with the acquisition of the SW Financial Controlling Interest, having received a fairness opinion of a nationally recognized investment banking firm with respect to the price to be paid for the SW Financial Controlling Interest; (iv) the PennCorp Board will submit the purchase of The Fickes and Stone Knightsbridge Interests and the SW Financial Controlling Interest to a vote of a majority of the PennCorp stockholders present at the Stockholders Meeting and entitled to vote, and stockholders must approve both transactions, (v) Messrs. Stone and Fickes will abstain from voting on the proposals to approve the purchase of The Fickes and Stone Knightsbridge Interests and the SW Financial Controlling Interest, and (vi) the plaintiff's counsel will be entitled to conduct confirmatory discovery.
The Company has agreed to provide guarantees of indebtedness of certain officers and directors up to a maximum of $10,000.