Net income per diluted share was $3.30, $4.35 and $3.73 for the years 2008, 2007 and 2006, respectively. Net income for these same periods was $162.9 million, $227.5 million and $203.8 million, respectively. Results for 2008 reflected after-tax net capital losses of $83.4 million. In addition, declines in equity markets adversely affected the results from our asset management business in 2008. These effects on net income per diluted share were partially offset by premium growth, comparatively favorable claims experience for the group insurance businesses and a 3.1 million reduction in diluted weighted-average shares outstanding resulting primarily from share repurchases.
General economic conditions remain turbulent and reflect a disruption of credit markets and declining equity markets. As a result of current economic conditions, we have experienced a decline in revenues in our retirement plans business due to declines in equity markets and their impact on asset values, which is a key driver in administrative fee revenue. For our group insurance business we have experienced continuing price competition among insurers competing in a group insurance market where fewer large cases have come to market and declines in wage and employment growth have slowed the organic growth of our in force business. While we are not immune to the current economic turbulence, we will continue to focus on our long-term objectives and address challenges that arise with financial discipline and from a position of superior financial strength. We manage for profitability, focusing on good business diversification, disciplined product pricing, sound underwriting, effective claims management and high quality customer service. In 2009, our intent is to preserve the value of our business by continuing to provide excellent value to our customers, to preserve and enhance our financial strength by remaining disciplined in our approach, and to continue to build value for our shareholders despite facing the headwinds of a troubled economy.
For 2009, the Company has established the following expectations, which will affect our annual financial results:
Premiums from our Insurance Services segment are the primary driver of consolidated premium growth. The three primary factors that influence premium growth for our
Insurance Services segment are sales, customer retention, and organic growth that is derived from wage and employment growth. Premiums for the Insurance Services segment increased 2.2% to $2.11 billion for 2008 compared to 2007, and 7.1% to $2.06 billion for 2007 compared to 2006. The increase in premiums in 2007 and 2008 was due to strong sales in 2007 in our group insurance businesses. In 2008, sales were partially offset by three large case terminations. Premium growth in 2007 was also affected by a single premium in 2007 of $19.3 million related to a reserve buyout. In addition, premium growth was partially offset by higher experience rated refunds (“ERRs”), which increased by $7.4 million to $44.6 million in 2008. ERRs represent refunds to a limited number of groups with experience rated contracts where refunds are paid within contract terms for favorable claims experience. Premium growth for 2007 was partially offset due to an increase in ERRs of $14.6 million to $37.2 million, compared to $22.6 million for 2006. See “Business Segments-Insurance Services Segment.”
Premiums from our Asset Management segment are primarily generated from life-contingent annuities, which are a single-premium product. Premiums for the Asset Management segment increased 111.6% to $31.1 million for 2008 compared to 2007, and 93.4% to $14.7 million compared to 2006. The increase in premiums during 2008 was due to strong fixed annuity sales as a result of strong demand and higher relative return rates.
Administrative fee revenue from our Insurance Services segment is primarily from insurance products for which we provide only administrative services. Administrative fee revenue from our Insurance Services segment increased 9.5% to $9.2 million for 2008 compared to 2007, and decreased 3.4% to $8.4 million for 2007 compared to 2006.
Net investment income increased 4.8% to $541.0 million for 2008 compared to 2007, and 7.8% to $516.3 million for 2007 compared to 2006. Net investment income primarily is affected by changes in levels of invested assets, interest rates, the change in fair value of derivative assets and commercial mortgage loan prepayment fees.
of 2007. Premiums on called bonds were $2.0 million for 2007, compared to $0.5 million for 2006. The increase in net investment income was partially offset by decreases in the fair value of derivative assets and lower portfolio yield of commercial mortgage loans. The fair value adjustment to derivative assets was a decrease of $1.0 million for 2007, compared to an increase of $0.9 million for 2006. The portfolio yield for commercial mortgage loans decreased to 6.36% at the end of 2007 from 6.40% at the end of 2006. The portfolio yield for fixed maturity securities remained stable at 5.57% at the end of 2007 and 2006.
Commercial mortgage loan prepayment fees were $7.3 million, $9.7 million and $9.8 million for 2008, 2007 and 2006, respectively. Approximately 89% of our commercial mortgage loans contain a provision that requires the borrower to pay a prepayment fee. These prepayment fees assure us that expected cash flows from commercial mortgage loan investments would be protected in the event of prepayment. Since 2001, all new commercial mortgage loans originated by the Company contain this prepayment provision. Almost all of the remaining commercial mortgage loans contain fixed percentage prepayment fees that mitigate prepayments but may not fully protect the Company’s expected cash flow in the event of prepayment.
Benefits to policyholders are affected by four primary factors: reserves that are established in part based on premium levels, claims experience, assumptions used to establish related reserves and current and future benefits of life-contingent annuities. The predominant factors affecting claims experience are incidence measured by the
Consolidated interest credited increased by $1.9 million to $110.7 million for 2008, compared to $108.8 million for
2007. The increase reflects significant growth in individual fixed-rate annuity deposits of $760.7 million, or a 58.7% increase over balances at December 31, 2007.
In comparing 2007 to 2006, the increase in operating expenses was primarily due to the integration of Invesmart since 2007 included a full year of Invesmart expenses compared to a half year of expenses in 2006. The additional increase in operating expenses was also due to business growth as evidenced by growth in assets under administration and up-front costs related to the consolidation of some of our trust and insurance platforms. In addition, we acquired DPA, Inc. during the third quarter of 2007. DPA, Inc. is a retirement plan business based in Portland, Oregon. Operating expenses for DPA, Inc. during 2007 were approximately $1.9 million. There were also additional costs related to the installation of a large group life and long term disability policy that contributed approximately $8.5 million to the overall increase in operating expenses for 2007. The installation of the large policy included capitalized software and system costs that will be depreciated and amortized through 2012. The depreciation and amortization costs will add approximately $3.0 million per year to operating expenses for the next five years.
Operating expense growth is typically influenced by business growth as evidenced by premium and administrative fee growth. Premium and administrative fee growth for 2008 was 2.8% compared to 2007, and for 2007 was 9.0% compared to 2006. See “Business Segments-Insurance Services Segment and Asset Management Segment.”
Commissions and bonuses primarily represent sales-based compensation, which can vary depending on the product, the structure of the commission program and other factors such as customer retention, sales, growth in assets under administration and the profitability of business in each of our segments. Commissions and bonuses increased 14.9% to $227.6 million for 2008 compared to 2007, and 7.8% to $198.0 million for 2007 compared to 2006.
Net Change in Deferred Acquisition Costs (“DAC”), Value of Business Acquired (“VOBA”) and Intangibles
expired in September 2008. See Item 8, “Financial Statements and Supplementary Data-Notes to Consolidated Financial Statements-Note 10-Income Taxes” for more information on the change in the effective tax rate.
The following are key indicators that management uses to manage and assess the performance of the Insurance Services segment:
Sales. Sales of our group insurance products reported as annualized new premiums were $292.5 million, $408.8 million, and $317.8 million for 2008, 2007 and 2006, respectively. The group insurance market continues to reflect a price-competitive sales environment, and we are currently seeing fewer large cases come to market, which can have a substantial impact on premium growth. Sales activity for small and medium sized groups remains stable. Sales in 2007 included a few large accounts and a single premium sale of $19.3 million related to a reserve buyout. Excluding the single premium sale of $19.3 million in the 2007, sales declined 24.9% for 2008 compared to 2007.
respectively. ERRs, which are refunds to certain group contract holders based on claims experience, can fluctuate widely from quarter to quarter depending on the underlying experience of specific contracts.
Net investment income for the Insurance Services segment increased 3.6% to $337.5 million for 2008 compared to 2007, and 4.0% to $325.8 million for 2007 compared to 2006. The increase in net investment income for 2008 was primarily due to growth in average invested assets due to business growth, as evidenced by premium growth. The increase in net investment income for 2007 compared to 2006 was primarily affected by growth in average invested assets due to premium growth and by additional income related to premiums on called bonds for this segment of $1.2 million for 2007 compared to $0.3 million for 2006. See “Consolidated Results of Operations-Revenues-Net Investment Income.”
Three primary factors drive benefits to policyholders: reserves that are established in part based on premium level, claims experience and the assumptions used to establish related reserves. The predominant factors affecting claims experience are claims incidence, measured by the number of claims, and claims severity, measured as the length of time a disability claim is paid and the size of the claim. The assumptions used to establish the related reserves reflect claims incidence and claims severity, in addition to new-money investment interest rates and overall portfolio yield, as both affect the discount rate used to establish reserves.
Because premium growth is one of the primary factors that drive benefits to policyholders, the benefit ratio,
In 2007, we adopted a new group life waiver table, the Society of Actuaries Table 2005, to be used in the calculation of reserves for group life waiver claims incurred in 2007 and later. Adoption of this table resulted in a reduction of $26.7 million and $15.5 million in reserves established for new 2008 and 2007 group life waiver claims, respectively, compared to the reserves that would have been established using the prior table.
If investment rates prove to be lower than provided for in the margin between the new money investment rate and the reserve discount rate, we could be required to increase reserves, which could cause expense for benefits to policyholders to increase. The margin at December 31, 2008, in our overall block of business for group insurance between invested asset yield and weighted-average reserve discount rate was 45 basis points. See “Liquidity and Capital Resources.”
Efficiency projects that took place during 2008 are expected to help reduce our annual run rate for operating expenses beginning in the second half of 2009.
Income before income taxes for the Asset Management segment decreased 18.6% to $34.9 million for 2008 compared to 2007, and increased 11.7% to $42.9 million for 2007 compared to 2006. The decrease in 2008 compared to 2007 reflected the impact of declining equity markets on revenues in our retirement plans business. In addition, expense levels for the segment were higher due to integration and infrastructure work in the retirement plans business. The increase in 2007 compared to 2006 was primarily due to fees earned from higher assets under administration. Revenues grew 9.7% for 2008 compared to 2007, and 28.0% for 2007 compared to 2006. During the third quarter of 2007, the Company acquired DPA, Inc., a retirement business based in Portland, Oregon, which added $1.7 billion to the Company’s total assets under administration.
Following are key indicators that management uses to manage and assess the performance of the Asset Management segment:
Premiums for the Asset Management segment are generated from life-contingent annuities, which are a single-premium product. Premiums and benefits to policyholders reflect both the sale of immediate annuities by our individual annuity business and the conversion of retirement plan assets into life-contingent annuities, which can be selected by plan participants at the time of retirement. Premiums for the segment can vary significantly from quarter to quarter due to low sales volume of life-contingent annuities and the varying size of single premiums. Premiums for the Asset Management segment were $31.1 million, $14.7 million and $7.6 million for 2008, 2007 and 2006, respectively. The large increase in premiums in 2008 was due to strong life-contingent fixed annuity sales as a result of strong current demand and higher relative return rates.
StanCorp Mortgage Investors, LLC (“StanCorp Mortgage Investors”) originated $1.37 billion, $1.45 billion and $942.8 million of commercial mortgage loans for 2008, 2007 and 2006, respectively. The decrease in originations in 2008 was due to reduced demand in the fourth quarter of 2008 from borrowers because of higher interest rates. While originations decreased from 2007, originations in 2008 were still strong due to overall favorable interest rate conditions accompanied by increased demand for fixed-rate commercial mortgage loans. The strong originations also reflected a less competitive origination market, partially due to decreased competition from securitized lenders. Commercial mortgage loans managed for other investors increased 33.0% from December 31, 2007 to December 31, 2008, and 35.0% from December 31, 2006 to December 31, 2007.
Net investment income for the Asset Management segment increased 12.5% to $170.2 million for 2007 compared to 2006. The increase was primarily due to an increase of 9.8% to $1.41 billion in average general account assets under administration and an increase in
commercial mortgage loan commitment fees of $3.9 million for 2007 compared to 2006 as a result of the increase in commercial mortgage loan originations. Partially offsetting the increase in net investment income was a decrease in the fair value of derivative assets of $1.0 million, compared to an increase of $0.9 million for 2006 and lower yields on commercial mortgage loans.
Benefits to policyholders for the Asset Management segment represents current and future benefits on life-contingent annuities, which vary with life-contingent annuity sales. Benefits to policyholders for the Asset Management segment increased $17.3 million to $39.7 million for 2008 compared to 2007 and increased $6.4 million to $22.4 million for 2007 compared to 2006. Changes in the level of benefits to policyholders will correlate to changes in premium levels because these annuities primarily are single-premium life-contingent annuity products with a significant portion of all premium payments established as reserves. As evidence of this, Asset Management segment premiums increased to $31.1 million from $14.7 million for 2008 compared to 2007, and increased to $14.7 million from $7.6 million for 2007 compared to 2006.
Operating expenses for the Asset Management segment increased 52.9% to $120.2 million for 2007 compared to 2006. The increase in operating expenses for this segment was due to business growth as evidenced by growth in assets under administration, the integration of Invesmart, which included a full year of expenses in 2007 compared to a half year of expenses in 2006, up-front costs related to the consolidation of our trust product and group annuity platforms and $1.9 million of expenses in 2007 related to the operations of DPA, Inc.
The Other category reported a loss before income taxes of $160.2 million for 2008, compared to a loss before income taxes of $23.8 million for 2007 and a loss before income taxes of $11.1 million for 2006. The net capital losses in 2008 were primarily due to a decline in the market value of fixed maturity securities, which resulted in
Our financial instruments are exposed to financial market volatility and potential disruptions in the market that may result in certain financial instruments becoming less valuable. Financial market volatility includes interest rate risk. We have analyzed the estimated loss in fair value of certain market sensitive financial assets held at December 31, 2008 and 2007, using a hypothetical 10% increase in interest rates and related qualitative information on how we manage interest rate risk. The interest rate sensitivity analysis was based upon our fixed maturity securities and commercial mortgage loans held at December 31, 2008 and 2007. Interest rate sensitivity of our financial assets was measured assuming a parallel shift in interest rates. All security yields were increased by 10% of the year-end 10-year U.S. Government Treasury bond yield, or 0.23% and 0.40% for the 2008 and 2007 analyses, respectively. The change in fair value of each security was estimated as the change in the option adjusted value of each security. Option adjusted values were computed using our payment models and provisions for the effects of possible future changes in interest rates. The analyses did not explicitly provide for the possibility of non-parallel shifts in the yield curve, which would involve discount rates for different maturities being increased by different amounts. The actual change in fair value of our financial assets can be significantly different from that estimated by the model. The hypothetical reduction in the fair value of our financial assets that resulted from the model was estimated to be $78 million and $180 million at December 31, 2008 and 2007, respectively.
commercial mortgage loan investments would be protected in the event of prepayment. Approximately 89% of our commercial mortgage loan portfolio contains this prepayment provision. Almost all of the remaining commercial mortgage loans contain fixed percentage prepayment fees that mitigate prepayments but may not fully protect our expected cash flow in the event of prepayment.
Net cash provided by operations is net income adjusted for non-cash items and accruals and was $361.8 million, $485.7 million and $390.1 million for 2008, 2007 and 2006, respectively.
Net cash used in investing activities was $1.03 billion, $597.0 million and $749.3 million for 2008, 2007 and 2006, respectively. The increase in net cash used in investing activities from 2008 compared to 2007 was primarily due to increased investments from growth in the individual annuity business. The decrease in the net use of cash in investing activities from 2007 compared to 2006 was primarily due to the July 2006 purchase of Invesmart. Invesmart was a national retirement financial services company and is now part of our Asset Management
While the amount of impairments on our fixed maturity securities were much higher in 2008 than in recent years, the percent of the impairments compared to the total fixed maturity security portfolio at the beginning of the year was only 2.1%. In addition, sales in 2008 to remove holdings with potential liquidity concerns leave the portfolio in a better position for the future. Based upon our review, we
believe the remaining holdings in the portfolio are with companies that have good liquidity and manageable debt maturities. We also did not have any direct exposure to sub-prime or Alt-A mortgages in our fixed maturity securities portfolio at December 31, 2008. We expect our improved portfolio leaves us in a better position to weather an extended economic downturn.
At December 31, 2008, our fixed maturity securities portfolio had gross unrealized capital gains of $136.9 million and gross unrealized capital losses of $258.7 million. Unrealized gains and losses primarily result from holding fixed maturity securities with interest rates higher or lower, respectively, than those currently available at the reporting date.
Commercial mortgage loan originations for internal and external investors were $1.37 billion, $1.45 billion and $942.8 million for 2008, 2007 and 2006, respectively. The level of commercial mortgage loan originations in any year is influenced by market conditions as we respond to changes in interest rates, available spreads and borrower demand.
At December 31, 2008, StanCorp Mortgage Investors serviced $4.08 billion in commercial mortgage loans for subsidiaries of StanCorp and $2.53 billion for other institutional investors, compared to $3.66 billion serviced for subsidiaries of StanCorp and $1.90 billion for other institutional investors at December 31, 2007.
The average loan to value ratio for the overall portfolio was approximately 59.2% at December 31, 2008. The loan to value ratio is calculated with stabilized net operating income and market capitalization rates after a thorough annual analysis by our underwriting and servicing staff of current rent rolls and operating history for each of the loans in the portfolio. The average loan size retained by the Company in the portfolio was approximately $0.8 million at December 31, 2008. We have the contractual ability to pursue personal recourse on most of the loans.
At December 31, 2008, our commercial mortgage loan portfolio was collateralized by properties with the following characteristics:
At December 31, 2008, our commercial mortgage loan portfolio was diversified regionally as follows:
Commercial mortgage loans in California accounted for 27.7% of our commercial mortgage loan portfolio at December 31, 2008. The next largest concentration by state is 10%. Through this concentration in California, we are exposed to potential losses from an economic downturn in California as well as to certain catastrophes, such as earthquakes and fires, which may affect certain areas of the state. We require borrowers to maintain fire insurance coverage to provide reimbursement for any losses due to fire. We diversify our commercial mortgage loan portfolio within California by both location and type of property in an effort to reduce certain catastrophe and economic exposure. However, diversification may not always eliminate the risk of such losses. Historically, the delinquency rate of our California-based commercial mortgage loans has been substantially below the industry average and consistent with our experience in other states. In addition, when new loans are underwritten, we do not require earthquake insurance for properties on which we make commercial mortgage loans but do consider the potential for earthquake loss based upon seismic surveys and structural information specific to each property. We do not expect a catastrophe or earthquake damage in California to have a material adverse effect on our business, financial position, results of operations or cash flows. Currently, our California exposure is largely in Los Angeles County, San Diego County and the Bay Area Counties. We have a smaller concentration of commercial mortgage loans on the Inland Empire and the San Joaquin Valley where there has been greater economic decline. If economic conditions in California continue to decline, we could experience a higher delinquency rate on the portion of our commercial mortgage loan portfolio located in California, which could have a material adverse effect on our business, financial position, results of operations or cash flows.
Under the laws of certain states, environmental contamination of a property may result in a lien on the property to secure recovery of the costs of cleanup. In some states, such a lien has priority over the lien of an existing mortgage against such property. As a commercial mortgage lender, we customarily conduct environmental assessments prior to making commercial mortgage loans secured by
In the normal course of business, we commit to fund commercial mortgage loans generally up to 90 days in advance. At December 31, 2008, the Company had outstanding commitments to fund commercial mortgage loans totaling $96.9 million, with fixed interest rates ranging from 6.50% to 7.25%. These commitments generally have fixed expiration dates. A small percentage of commitments expire due to the borrower’s failure to deliver the requirements of the commitment by the expiration date. In these cases, we will retain the commitment fee and good faith deposit. Alternatively, if we terminate a commitment due to the disapproval of a commitment requirement, the commitment fee and good faith deposit may be refunded to the borrower, less an administrative fee.
Financing cash flows primarily consist of policyholder fund deposits and withdrawals, borrowings and repayments on the line of credit, borrowings and repayments on long-term debt, repurchases of common stock and dividends paid on common stock. Net cash provided by financing activities was $741.9 million, $261.1 million and $362.0 million for 2008, 2007 and 2006, respectively.
On June 15, 2006, the Company established a five-year, $200 million senior unsecured revolving credit facility (“Facility”). On June 15, 2008, the Facility was amended to extend the expiration date by one year to June 15, 2013. The Facility will remain at $200 million through June 15, 2012, and will decrease to $165 million thereafter until final maturity on June 15, 2013. Borrowings under the Facility will continue to be used to provide for the working capital and general corporate purposes of the Company and its subsidiaries and the issuance of letters of credit.
State insurance departments require insurance enterprises to maintain minimum levels of capital and surplus. Our insurance subsidiaries’ target is generally to maintain capital at 300% of the company action level of Risk-based Capital (“RBC”) required by regulators, which is 600% of the authorized control level RBC required by our states of domicile. The insurance subsidiaries held capital at 314% of the company action level RBC at December 31, 2008. At December 31, 2008, statutory capital, adjusted to exclude asset valuation reserves, for our regulated insurance subsidiaries totaled $1.23 billion.
The levels of capital in excess of targeted RBC we generate vary inversely in relation to our levels of premium growth. As premium growth increases, capital is utilized to fund additional reserve requirements, meet increased regulatory capital requirements based on premium, and cover certain acquisition costs associated with policy issuance, leaving less available capital beyond our target levels. Higher levels of premium growth can result in increased utilization of capital beyond that which is
We will continue to maintain our three priorities, in the following order, for the use of this capital:
Standard may pay dividends only from the earned surplus arising from its business. If the proposed dividend exceeds certain statutory limitations, Standard must receive the prior approval of the Director of the Oregon Department of Consumer and Business Services-Insurance Division (“Oregon Insurance Division”). The current statutory limitations are the greater of (a) 10% of Standard’s combined capital and surplus as of December 31 of the preceding year, or (b) the net gain from operations after dividends to policyholders and federal income taxes before realized capital gains or losses for the 12-month period ended on the preceding December 31. In each case, the limitation must be determined under statutory accounting practices. Oregon law gives the Oregon Insurance Division broad discretion to decline requests for dividends in excess of these limits. There are no regulatory restrictions on dividends from non-insurance subsidiaries of StanCorp.
During 2008 and 2007, Standard paid dividends to StanCorp totaling $60.0 million and $155.0 million, respectively. The reduction in dividends paid to StanCorp from Standard for 2008 compared to 2007 reflected a decision to maintain capital in Standard at or above 300% of the company action level RBC. Prior to 2008, capital for Standard was targeted to be at or above 275% of the company action level RBC. At December 31, 2008, capital in the insurance subsidiaries was 314% of the company action level RBC.
On November 3, 2008, the board of directors of StanCorp declared an annual cash dividend of $0.75 per share, calculated and payable on a per share basis. The dividend was payable on December 5, 2008, to shareholders of record on November 14, 2008. The declaration and payment of dividends in the future is subject to the discretion of StanCorp’s board of directors. It is anticipated that annual dividends will be paid in December of each year depending on StanCorp’s financial condition, results of operations, cash requirements, future prospects, regulatory restrictions on distributions from the insurance subsidiaries, the ability of the insurance subsidiaries to maintain adequate capital and other factors deemed relevant by the board of directors. In addition, the declaration and payment of dividends would be restricted if StanCorp elects to defer interest payments on its Subordinated Debt. If elected, the restriction would be in place during the deferral period, which cannot exceed five years. StanCorp has paid dividends each year since its initial public offering in 1999.
From time to time, the board of directors has authorized share repurchase programs. Share repurchases will be made in the open market or in negotiated transactions in compliance with the safe harbor provisions of Rule 10b-18 under regulations of the Securities Exchange Act of 1934 (the “Exchange Act”). Execution of the share repurchase program is based upon management’s assessment of market conditions for its common stock and other potential growth opportunities.
financial strength and credit ratings. Despite the recent volatility in the economy, we do not currently anticipate financial strength ratings downgrades. We believe our well-managed underwriting and claims operations, our high quality invested asset portfolios and our strong capital position will continue to support our claims paying ability during the current recession. See “Liquidity and Capital Resources-Asset/Liability and Interest Rate Risk Management,” and “Capital Management.”
The estimated payments expected to be due by period for insurance obligations reflect future estimated cash payments, for pending and future potential claims, to be made to policyholders and others for future policy benefits, policyholders’ account balances, policyholders’ dividends, and reinsurance payables. These future estimated net cash payments are based on mortality, morbidity, lapse and other assumptions comparable with our experience, consider future premium receipts on current polices in force, and assume market growth and interest crediting consistent with assumptions used in amortizing deferred acquisition costs and value of business acquired. These net cash payments are undiscounted with respect to interest and, as a result, the sum of the net cash payments shown for all years in the table of $7.19 billion exceeds the corresponding liability amount of $5.29 billion included in the Consolidated Financial Statements as of December 31, 2008. We have made significant assumptions to determine the future estimated net cash payments related to the underlying policies and contracts. Due to the significance of the assumptions used, actual net cash payments will differ, possibly materially, from these estimates.
corresponding liability amount of $3.94 billion included in the Consolidated Financial Statements as of December 31, 2008. Due to the significance of the assumptions used, actual net cash payments will differ, possibly materially, from these estimates.
In the normal course of business, the Company commits to fund commercial mortgage loans generally up to 90 days in advance. At December 31, 2008, the Company had outstanding commitments to fund commercial mortgage loans totaling $96.9 million, with fixed interest rates ranging from 6.50% to 7.25%. These commitments generally have fixed expiration dates. A small percentage of commitments expire due to the borrower’s failure to deliver the requirements of the commitment by the expiration date. In these cases, the Company will retain the commitment fee and good faith deposit. Alternatively, if we terminate a commitment due to the disapproval of a commitment requirement, the commitment fee and deposit may be refunded to the borrower, less an administrative fee.
Other long-term obligations reflected in the Company’s balance sheet at December 31, 2008, consisted of a $14.8 million tax reimbursement liability related to the block of life insurance business sold to Protective Life in 2001, $9.7 million in capital commitments related to our low-income housing investments, $293.5 million in expected benefit payments for supplemental, home office, and field office retirement plans, $177.5 million in expected benefit payments for the postretirement benefit plan, $8.9 million liability for deferred compensation plan and $0.7 million of accrued guarantee association payments.
Federal income tax expense includes current income taxes defined as current year estimates of federal income taxes and tax contingencies for current and
Effective December 31, 2006, the NAIC adopted changes to the RBC calculation that required us to perform additional testing to determine the risk based capital requirement for annuities. The adopted change did not have a material impact on our RBC requirements.
The length of time and the extent to which the fair value has been below adjusted carrying value.
Our investment portfolio includes fixed maturity securities and commercial mortgage loans. At December 31, 2008, issues on our fixed maturity securities impairment watch list totaled approximately $329.5 million in market value and $439.0 million in book value after other-than-temporary impairments had been taken. The Company recorded other-than-temporary impairments of $104.9 million during 2008, primarily due to a decline in the market value of holdings of issuers the Company believed would face difficulties in the deteriorating economic environment. In 2008, the Company sold bond holdings of companies with potential liquidity concerns in order to solidify the condition of the Company’s bond portfolio. The Company will continue to evaluate its holdings but currently expects the fair values of its investments to recover as the securities approach their maturity dates. Should the credit quality of our fixed maturity securities continue to decline, there could be a material adverse effect on our business, financial position, results of operations or cash flows. We did not have any direct exposure to sub-prime or Alt-A mortgages in our fixed maturity securities portfolio at December 31, 2008. Investment securities include fixed maturity securities. Fixed maturity securities are classified as available-for-sale and are carried at fair value on the consolidated balance sheets. See Item 8, “Financial Statements and Supplementary Data-Notes to Consolidated Financial Statements-Note 4-Fair Value of Financial Instruments,” for a detailed explanation of the valuation methods the Company uses to calculate the fair value of the Company’s financial instruments. Investment securities also include derivative investments, which are carried at fair value. See Item 8, “Financial Statements and Supplementary Data-Notes to Consolidated Financial Statements-Note 7-Derivative Financial Instruments.” Valuation adjustments for fixed maturity securities that are not accounted for as other-than-temporary impairments are reported as net increases or decreases to other comprehensive income (loss), net of tax, on the consolidated statements of income
and comprehensive income. Valuation adjustments for derivatives are reported as a component of net investment income.
DAC, VOBA and other intangible assets are considered intangible assets. These intangible assets are generally originated through the issuance of new business or the purchase of existing business either by purchasing blocks of insurance policies from other insurers or by the outright purchase of other companies. The Company’s intangible assets are subject to impairment tests on an annual basis or
more frequently if circumstances indicate that carrying values may not be recoverable.
Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments. For the Company’s individual deferred annuities, DAC is generally amortized over 30 years with approximately 50% and 90% expected to be amortized by years 5 and 15, respectively. DAC for group annuity products is amortized over 10 years with approximately 30% expected to be amortized by year five.
VOBA primarily represents the discounted future profits of business assumed through reinsurance agreements. We have established VOBA for a block of individual disability business assumed from the Minnesota Life and a block of group disability and group life business assumed from Teachers Insurance and Annuity Association of America (“TIAA”). VOBA is generally amortized in proportion to future premiums for group and individual disability insurance products and group life products. However, a portion of the VOBA related to the TIAA transaction associated with an in force block of group long term disability claims for which no ongoing premium is received is amortized in proportion to expected gross profits. If actual premiums or future profitability are inconsistent with our assumptions, the Company could be required to make adjustments to VOBA and related amortization. For the VOBA associated with the Minnesota Life block of business reinsured, the amortization period is up to 30 years and is amortized in proportion to future premiums. The amortization period of the intangible asset for the marketing agreement with Minnesota Life is up to 25 years. The VOBA associated with the TIAA transaction is comprised of two parts with differing amortization methods. The amortization period was up to 10 years for VOBA that was amortized in proportion to premiums and up to 20 years for VOBA that is amortized in proportion to expected gross profits. VOBA totaled $31.1 million and $34.4 million at December 31, 2008 and 2007, respectively. Upon adoption of SOP 05-1 in 2007, the premium portion of the VOBA related to TIAA was recorded as a $10.0 million reduction to retained earnings.
The Company’s other intangible assets are subject to amortization and consist of certain customer lists and a marketing agreement. Customer lists were acquired primarily in connection with the purchase of Invesmart during the third quarter of 2006. Additional customer lists were acquired with the purchase of DPA, Inc. and with the acquisition of small investment advisory firms. Customer lists have a combined estimated weighted-average remaining life of approximately 9.3 years. A marketing agreement accompanied the Minnesota Life transaction and provides access to Minnesota Life agents, some of whom now market Standard’s individual disability insurance products. The amortization period for the Minnesota Life marketing agreement is up to 25 years. Other intangible assets totaled $54.2 million and $52.1 million at December 31, 2008 and 2007, respectively.
to determine whether any input factor or combination of factors moving moderately in either direction would change the results of these tests. Through the performance of these tests, we concluded that goodwill was not impaired as of December 31, 2008.
Reserves represent amounts to pay future benefits and claims. Developing the estimates for reserves (and therefore the resulting impact on earnings) requires varying degrees of subjectivity and judgment, depending upon the nature of the reserve. For most of our reserves, the calculation methodology is prescribed by various accounting and actuarial standards, although judgment is required in the determination of assumptions to use in the calculation. At December 31, 2008, these reserves represented approximately 87% of total reserves held or $4.62 billion. We also hold reserves that lack a prescribed methodology but instead are determined by a formula that we have developed based on our own experience. Because this type of reserve requires a higher level of subjective judgment, we closely monitor its adequacy. These reserves, which are primarily incurred but not reported reserves associated with our disability products, represented approximately 13% of total reserves held at December 31, 2008, or $661.4 million. Finally, a small amount of reserves is held based entirely upon subjective judgment. These reserves are generally set up as a result of unique circumstances that are not expected to continue far into the future and are released according to pre-established conditions and timelines. These reserves represented less than 1% of total reserves held at December 31, 2008, or $8.1 million.
Reserves include policy reserves for claims not yet incurred, policy reserve liabilities for our individual and group immediate annuity business and claim reserve liabilities for unpaid claims and claim adjustment expenses for claims that have been incurred or are estimated to have been incurred but not yet reported to us. These reserves totaled $5.12 billion, $5.02 billion and $4.78 billion at December 31, 2008, 2007 and 2006, respectively.
Policy reserves totaled $945.4 million, $908.3 million and $887.4 million at December 31, 2008, 2007 and 2006, respectively. Policy reserves include reserves established for individual life and individual disability businesses.
Policy reserves for our individual disability block of business are established at the time of policy issuance using
the net level premium method as prescribed by GAAP and represent the current value of projected future benefits including expenses less projected future premium. These reserves, related specifically to our individual disability block of business, totaled $177.2 million, $164.4 million and $153.8 million at December 31, 2008, 2007 and 2006, respectively.
Policy reserves for our individual and group immediate annuity blocks of business totaled $162.1 million, $141.8 million and $136.8 million at December 31, 2008, 2007 and 2006, respectively. These reserves are established at the time of policy issue and represent the present value of future payments due under the annuity contracts. The contracts are single premium contracts, and, therefore, there is no projected future premium.
Claim reserves are established when a claim is incurred or is estimated to have been incurred but not yet reported to us and, as prescribed by GAAP, equal our best estimate of the present value of the liability of future unpaid claims and claim adjustment expenses. Reserves for incurred but not reported claims (“IBNR”) are determined using company experience and consider actual historical incidence rates, claim-reporting patterns, and the average cost of claims. The IBNR reserves are calculated using a company derived formula based primarily upon premium, which is validated through a close examination of reserve run-out experience.
Certain of these factors could be materially affected by changes in social perceptions about work ethics, emerging medical perceptions and legal interpretations regarding physiological or psychological causes of disability, emerging or changing health issues and changes in industry regulation. If there are changes in one or more of these factors or if actual claims experience is materially inconsistent with our assumptions, we could be required to change our reserves.
Claim reserves for our group life and AD&D products are established for death claims reported but not yet paid, IBNR for death and waiver claims and waiver of premium benefits. The death claim reserve is based on the actual amount to be paid. The IBNR reserve is calculated using historical information, and the waiver of premium benefit is calculated using a tabular reserve method that takes into account company experience and published industry tables.
claim termination experience, we have not seen any prolonged or systemic change that would indicate a sustained underlying trend that would affect the claim termination rates used in the calculation of reserves.
We adjusted the calculation of the incurred but not reported reserves related to pending group life waiver claims in 2007 as a result of continued redundancy in the reserve. This resulted in a decrease in reserves of $6.0 million. There were no similar reserve changes in 2008 or 2006.
Claim incidence rates, which affect our policy reserves and IBNR claim reserves, can also vary widely from quarter to quarter. Overall, we have not seen any prolonged or systemic change that would indicate a sustained underlying trend that would affect the claim incidence rates used in the calculation of policy reserves or IBNR claim reserves.
recognize as a component of accumulated other comprehensive income or loss, net of tax, the actuarial gains or losses, prior service costs or credits, and transition assets that have not yet been recognized as components of net periodic benefit cost.
In accordance with the accounting principles related to the Company’s pension and other postretirement plans, the Company is required to make a significant number of assumptions in order to calculate the related liabilities and expenses each period. The major assumptions that affect net periodic benefit cost and the funded status of the plans include the weighted-average discount rate, expected return on plans assets, and rate of compensation increase.
We file a U.S. consolidated income tax return that includes all subsidiaries. Our U.S. income tax is calculated using regular corporate income tax rates on a tax base determined by laws and regulations administered by the IRS. We also file corporate income tax returns in various states. The provision for income taxes includes amounts currently payable and deferred amounts that result from temporary differences between financial reporting and tax bases of assets and liabilities. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply when the temporary differences are expected to reverse.
FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, requires management to determine whether tax return positions are more likely than not to be sustained upon audit by taxing authorities. Tax benefits of uncertain tax positions, as determined and measured by this interpretation, cannot be recognized in our financial statements.
Currently, years open for audit by the IRS are 2005 through 2008. See Item 8, “Financial Statements and Supplementary Data-Notes to Consolidated Financial Statements-Note 10-Income Taxes.”
Our actual results and financial condition may differ, perhaps materially, from the anticipated results and financial condition in any such forward-looking statements. Given these uncertainties or circumstances, readers are cautioned not to place undue reliance on such statements. We assume no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
Growth of sales, premiums, and annuity deposits, cash flows, gross profits and profitability.
Availability of capital required to support business growth and the effective utilization of capital.
The impact of rising benefit costs on employer budgets for employee benefits.
Consolidated Statements of Income and Comprehensive Income (Loss) for the years ended December 31, 2008, 2007 and 2006
As discussed in Note 1 to the consolidated financial statements, on January 1, 2007, the Company changed its method of accounting for deferred acquisition costs upon the adoption of Statement of Position 05-1, Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection with Modifications or Exchanges of Insurance Contracts. As also discussed in Notes 1 and 11 to the consolidated financial statements, on December 31, 2006, the Company changed its method of accounting for defined benefit and other postretirement plans upon the adoption of Statement of Financial Accounting Standards No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans.
StanCorp Mortgage Investors originates, underwrites and services small, fixed-rate commercial mortgage loans for the investment portfolios of the Company’s insurance subsidiaries. StanCorp Mortgage Investors also generates additional fee income from the origination and servicing of commercial mortgage loans participated to institutional investors.
pursuant to the definition of Financial Accounting Standards Board (“FASB”) Interpretation No. 46(R), Consolidation of Variable Interest Entities, (revised December 2003)-an interpretation of ARB No. 51, nor do they meet the requirements for consolidation. The total investment in these interests was $18.8 million and $17.8 million at December 31, 2008 and 2007, respectively.
For all investments, capital gains and losses are recognized using the specific identification method. Net investment income and capital gains and losses related to separate account assets and liabilities are included in the separate account assets and liabilities. For all investments, we record impairments when it is determined that the decline in fair value of an investment below its adjusted carrying value or amortized cost basis is other than temporary. The impairment loss is charged to net capital
No. 157 beginning January 1, 2008. See “Note 4-Fair Value of Financial Instruments.”
Acquisition costs that the Company has deferred as DAC are those costs that vary with and are primarily related to the acquisition and, in some instances, the renewal of insurance products. These costs are typically one-time expenses that represent the cost of originating new business and placing that business in force. Certain costs related to obtaining new business and acquiring business through reinsurance agreements have been deferred and will be amortized to accomplish matching against related future premiums or gross profits as appropriate. The Company normally defers certain acquisition-related commissions and incentive payments, certain costs of policy issuance and underwriting, and certain printing costs. Assumptions used in developing DAC and amortization amounts each period include the amount of business in force, expected future persistency, withdrawals, interest rates and profitability. These assumptions are modified to reflect actual experience when appropriate. Additional amortization of DAC is charged to current earnings to the extent it is determined that future premiums or gross profits are not adequate to cover the remaining amounts deferred. DAC totaled $249.2 million and $202.3 million at December 31, 2008 and 2007, respectively. Changes in actual persistency are reflected in the calculated DAC balance. Costs that do not vary with the production of new business are not deferred as DAC and are charged to expense as incurred. Annual commissions are considered expenses and are not deferred.
DAC for group and individual disability insurance products and group life insurance products is amortized over the life of related policies in proportion to future premiums in accordance with SFAS No. 60, Accounting and Reporting by Insurance Enterprises. Beginning with the adoption of Statement of Position (“SOP”) 05-1, Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection With Modifications or Exchanges of Insurance Contracts. On January 1, 2007, the Company began amortizing DAC for group disability and life insurance products over the initial premium rate guarantee period, which averages 2.5 years. DAC for individual disability insurance products is amortized in proportion to future premiums over the life of the contract, averaging 20 to 25 years with approximately 50% and 75% expected to be amortized by years 10 and 15, respectively.
VOBA primarily represents the discounted future profits of business assumed through reinsurance agreements. We have established VOBA for a block of individual disability business assumed from the Minnesota Life Insurance Company (“Minnesota Life”) and a block of group disability and group life business assumed from Teachers Insurance and Annuity Association of America (“TIAA”). VOBA is generally amortized in proportion to future premiums for group and individual disability insurance products and group life products. However, a portion of the VOBA related to the TIAA transaction associated with an in force block of group long term disability claims for which no ongoing premium is received is amortized in proportion to expected gross profits. If actual premiums or future profitability are inconsistent with our assumptions, the Company could be required to make adjustments to VOBA and related amortization. For the VOBA associated with the Minnesota Life block of business reinsured, the amortization period is up to 30 years and is amortized in
proportion to future premiums. The amortization period of the intangible asset for the marketing agreement with Minnesota Life is up to 25 years. The VOBA associated with the TIAA transaction is comprised of two parts with differing amortization methods. The amortization period was up to 10 years for VOBA that was amortized in proportion to premiums and up to 20 years for VOBA that is amortized in proportion to expected gross profits. VOBA totaled $31.1 million and $34.4 million at December 31, 2008 and 2007, respectively. Upon adoption of SOP 05-1 in 2007, the premium portion of the VOBA related to TIAA was recorded as a $10.0 million reduction to retained earnings.
compared to previous estimates. An unlocking event that results in an after-tax charge generally occurs as a result of actual experience or future expectations being unfavorable compared to previous estimates. As a result of unlocking, the amortization schedule for future periods is also adjusted. Due to unlocking, DAC and VOBA balances decreased $0.4 million for 2008 and decreased $0.4 million for 2007. Based on past experience, future changes in DAC and VOBA balances due to changes in underlying assumptions are not expected to be material. However, significant, unanticipated changes in key assumptions, which affect the determination of expected gross profits, may result in a large unlocking event that could have a material adverse effect on the Company’s financial position or results of operations.
Goodwill of $33.5 million was acquired by the Company during the third quarter of 2006, primarily in connection with the purchase of Invesmart, and is related to the Asset Management segment. Goodwill totaled $36.0 million at both December 31, 2008 and 2007. In accordance with SFAS No. 142, Goodwill and other Intangible Assets, goodwill is not amortized and is tested at least annually for impairment. If indicators of impairment appear, or in the
event of material changes in circumstances, the test will be more frequent. Per SFAS No. 142, we performed a step one test, as of December 31, 2008, in which the carrying value of tested assets was compared to the assets’ fair values. Fair value is measured using a combination of the income approach and the market approach. The income approach consists of utilizing the discounted cash flow method that incorporates our estimates of future revenues and costs of our business, discounted using a market participant weighted-average cost of capital. The estimates we use in the income approach are consistent with the plans and estimates that we use to manage our operations. The market approach utilizes multiples of profit measures in order to estimate the fair value of the assets. As a result of the consistency of the income approach with how we internally evaluate and manage our business, we weight the income approach more heavily than the market approach in determining the fair value of the assets. However, we do perform testing to ensure that both models are providing reasonably consistent results. Additionally, we perform sensitivity analysis on the key input factors in these models to determine whether any input factor or combination of factors moving moderately in either direction would change the results of these tests. Through the performance of these tests, we concluded that goodwill was not impaired as of December 31, 2008.
The Company reviews property and equipment for impairment when circumstances or events indicate the carrying amount of the asset may not be recoverable and recognizes a charge to earnings if an asset is impaired.
Premiums from group life and group and individual disability contracts are recognized as revenue when due. Investment-type contract fee revenues consist of charges for policy administration and surrender charges assessed during the period. Charges related to services to be performed are deferred until earned. The amounts received in excess of premiums and fees are included in other policyholder funds in the consolidated balance sheets. Experience rated refunds (“ERRs”) are computed in accordance with the terms of the contracts with certain group policyholders and are accounted for as an adjustment to premiums.
The provision for income taxes includes amounts currently payable and deferred amounts that result from temporary differences between financial reporting and tax bases of assets and liabilities as measured by current tax rates. Currently, years open for audit by the Internal Revenue Service (“IRS”) are 2005 through 2008. See “Note 10-Income Taxes.”
The following table sets forth the adjustment to initially apply SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106 and 132(R) in 2006:
In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities-an Amendment of FASB Statement 133. SFAS No. 161 expands the disclosure requirements for derivative instruments and hedging activities. The enhanced disclosures required by SFAS No. 161 include how and why an entity uses derivative instruments, how derivative instruments and related hedged items are accounted for under SFAS No. 133 and its related interpretations, and how derivative instruments and related hedged items affect an entity’s financial position, financial performance and cash flows. The guidance in SFAS No. 161 is effective for fiscal years and interim periods beginning after November 15, 2008. The Company will adopt the new standard as of January 1, 2009 and the enhanced disclosures will be reflected in the Company’s first quarter Form 10-Q.
and Other Intangible Assets. The intent of this FSP is to improve the consistency between the useful life of a recognized asset under SFAS No. 142 and the period of expected cash flows used to measure the fair value of the asset under SFAS No. 141R, Business Combinations, and other U.S. generally accepted accounting principles. In addition, this FSP requires additional disclosures concerning recognized intangible assets. These additional disclosures would enable users of financial statements to assess the extent to which the expected future cash flows associated with the asset are affected by the entity’s intent and/or ability to renew or extend the arrangement. FSP FAS No. 142-3 is effective for fiscal years beginning after December 15, 2008, and interim periods within those years. Earlier adoption is prohibited; therefore, the Company will adopt FSP FAS No. 142-3 as of January 1, 2009. The Company does not expect the adoption to have a material effect on our financial statements.
In May 2008, the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted Accounting Principles. SFAS No. 162 identifies the sources of accounting principles and provides a consistent framework, or hierarchy, for selecting the accounting principles to be used in preparing financial statements that are presented in conformity with U.S. generally accepted accounting principles for nongovernmental entities. The hierarchy of accounting principles within SFAS No. 162 is consistent with that previously defined in the AICPA Statement on Auditing Standards (SAS) No. 69, The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles. SFAS No. 162 became effective November 15, 2008. The Company had previously utilized the guidance within SAS No. 69, and, therefore, we do not expect the adoption of SFAS No. 162 to have a material effect on our financial statements.
In December 2008, the FASB issued FSP FAS No. 132(R)-1, Employer’s Disclosures about Postretirement Benefit Plan Assets. This FSP amends FAS No. 132(R), Employers’ Disclosures about Pensions and Other Postretirement Benefits, to provide guidance on an employer’s disclosures about plan assets of a defined benefit pension or postretirement plan. The objectives of the disclosures about plan assets are to provide users of financial statements with an understanding of:
How investment allocation decisions are made, including the factors that are pertinent to an understanding of investment policies and strategies.
The inputs and valuation techniques used to measure fair value of plan assets.
The effect of fair value measurements using significant unobservable inputs (Level 3) on changes in plan assets for the period.
In September 2006, the FASB issued SFAS No. 157, which is intended to increase consistency and comparability in fair value measurements by defining fair value, establishing a framework for measuring fair value and expanding disclosures about fair value measurements. SFAS No. 157 applies to other accounting pronouncements that require or permit fair value measurements. SFAS No. 157 became effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. StanCorp adopted the provisions of SFAS No. 157 beginning January 1, 2008.
SFAS No. 157 establishes a three-level hierarchy for disclosure of assets and liabilities recorded at fair value. The classification of assets and liabilities within the
hierarchy is based on whether the inputs to the valuation methodology used for measurement are observable or unobservable. Observable inputs reflect market-derived or market-based information obtained from independent sources while unobservable inputs reflect our estimates about market data.
There are three types of valuation techniques described in SFAS No. 157: (1) the market approach, which uses prices or other relevant information generated by market transactions involving identical or comparable assets or liabilities; (2) the income approach, which uses the present value of cash flows or earnings; and (3) the cost approach, which uses replacement costs more readily adaptable for valuing physical assets.
The fair value of each financial instrument in the table below was measured using SFAS No. 157 input guidance and valuation techniques. The following table sets forth carrying amounts and estimated fair values for financial instruments at December 31:
For policy loans, the carrying values represent historical cost but approximate fair values. While potentially financial instruments, policy loans are an integral component of the insurance contract and have no maturity date.
Fixed maturity securities-available-for-sale, S&P 500 index options and index-based interest guarantees are recorded at fair value on a recurring basis. The Company currently has no assets or liabilities measured at fair value on a nonrecurring basis. In the Company’s consolidated statements of income and comprehensive income, unrealized gains and losses are reported in other comprehensive income for fixed maturity securities-available-for-sale, in net investment income for S&P 500 index options and in interest credited for index-based interest guarantees.
case-by-case basis, the Company may obtain further quotes or prices from additional parties as needed.
The pricing service provides quoted market prices when available. Quoted prices are not always available due to bond market inactivity. The pricing service obtains a broker quote when sufficient information, such as security structure or other market information, is not available to produce an evaluation. Valuations and quotes obtained from third party commercial pricing services are non-binding and do not represent quotes on which one may execute the disposition of the assets.
S&P 500 index options were valued using the market approach and Level 3 measurement. The valuations for the Company’s S&P 500 index options are provided to us as non-binding courtesy indications of value by the banking counterparties that have written each option. The valuations are estimates of the mid-market values of the positions, based on proprietary valuation models that use information derived from estimated or actual bids and offers for similar positions. In addition, the Company produces its own valuations based on its derivations of
Black-Scholes pricing parameters. The Company’s valuations maximize the use of observable inputs, which include direct price quotes from the Chicago Board Options Exchange and values for on-the-run treasury securities and LIBOR rates as reported by Bloomberg. Where observable inputs are not available, we use unobservable inputs such as estimates of future gross dividends to be paid on the stocks underlying the S&P 500 index, estimates of bid-ask spreads, and estimates of implied volatilities on options. In order to assure that the Company’s valuations are consistent with SFAS No. 157, we perform additional validation procedures such as the daily observation of market activity and conditions and the tracking and analyzing of actual quotes provided to us by banking counterparties each time the Company purchases options from them. At December 31, 2008, the Company utilized valuations of the S&P 500 index options that were provided by the banking counterparties.
The following table sets forth the changes in Level 3 assets and liabilities measured at fair value on a recurring basis for the year ended December 31, 2008:
Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations. Callable bonds represented 2.43%, or $126.2 million, of our investment securities at December 31, 2008.
Includes increases to the loan valuation allowance of $3.8 million and $0.6 million for 2008 and 2007, respectively, and a decrease to the loan loss allowance of $0.1 million in 2006.
Securities deposited for the benefit of policyholders in various states, in accordance with state regulations, amounted to $7.0 million and $6.4 million at December 31, 2008 and 2007, respectively.
The following table sets forth our investments’ gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2008. The Company expects the fair value of these investment securities to recover as the investment securities approach their maturity dates or sooner if market yields for such investment securities decline. The Company reviews the fixed maturity securities portfolio at least quarterly and, given the increase in issuer credit quality concerns and the movement in credit spreads and general interest rates, has recorded other-than-temporary impairments when appropriate. Based on management’s evaluation and intent, none of the unrealized losses summarized in this table are considered other-than-temporary. In comparing December 31, 2008, to December 31, 2007, the significant increase in the number and amount of securities with an unrealized loss position was primarily due to an overall economic decline in the securities markets that affected multiple economic sectors.
The following table sets forth our investments’ gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2007:
Although the Company underwrites commercial mortgage loans throughout the United States, commercial mortgage loans in California represent a concentration of credit risk at 27.7% and 30.0% of our commercial mortgage loan portfolio at December 31, 2008 and 2007, respectively. Through this concentration in California, we are exposed to potential losses from an economic downturn in California as well as to certain catastrophes, such as earthquakes and fires, which may affect certain areas of the state. We diversify our commercial mortgage loan portfolio within California by both location and type of property in an effort to reduce certain catastrophe and economic exposure. However, diversification may not always eliminate the risk of such losses. We require borrowers to maintain fire insurance coverage to provide reimbursement for any losses due to fire. Historically, the delinquency rate of our California-based commercial mortgage loans has been substantially below the industry average and consistent with our experience in other states. In addition, when new loans are underwritten, we do not require earthquake insurance for properties on which we make commercial mortgage loans but do consider the potential for earthquake loss based upon seismic surveys and structural information specific to each property.
Commercial mortgage loans foreclosed were $6.8 million and $0.5 million for 2008 and 2007, respectively. Assets transferred to real estate were $6.2 million and $0.5 million for 2008 and 2007, respectively, after charges against the reserve. At December 31, 2008 and 2007, we had commercial mortgage loans totaling $7.8 million and $1.9 million, respectively, that were more than sixty days delinquent and of these amounts, $3.9 million and $0.7 million, respectively, were in the process of foreclosure.
The following table sets forth commercial mortgage loan valuation and allowance provisions at December 31:
The following table sets forth non-performing commercial mortgage loans identified in management’s specific review of probable loan losses and the related allowance at December 31, are as follows:
There were no non-performing commercial mortgage loans with no allowance for losses for the years 2008, 2007 and 2006. Non-performing commercial mortgage loans with no allowance for losses are those for which we have determined that it remains probable that the Company will collect all amounts due. The average recorded investment in non-performing mortgages before allowance for losses was $3.2 million, $2.2 million and $2.1 million for 2008, 2007 and 2006, respectively. Net investment income recognized on these non-performing mortgages was $0.1 million, $0.1 million and less than $0.1 million for the 2008, 2007 and 2006, respectively. The Company continues to recognize interest income on delinquent loans until the loans are more than 90 days delinquent.
policyholders relating to the change in the fair value of the index-based interest guarantees decreased $9.2 million for 2008, compared to an increase of $1.6 million for 2007. The decrease for 2008 was primarily due to the decline, on average, of the S&P 500 Index during 2008 compared to 2007.
The liability for unpaid claims, claims adjustment expenses and other policyholder funds includes liabilities for insurance offered on products such as group long term and short term disability, individual disability, group dental and group AD&D. The liability for unpaid claims and claim adjustment expenses is established when a claim is incurred or is estimated to have been incurred but not yet reported to us and, as prescribed by GAAP, equals our best estimate of the present value of the liability of future unpaid claims and claim adjustment expenses. This liability is included in future policy benefits and claims in the consolidated balance sheets. The following table sets forth the change in the liabilities for unpaid claims and claim adjustment expenses for the years ended December 31:
Classified as future policyholder benefits and claims, but excluded from the table above are amounts recorded for group and individual life reserves, group and individual annuity reserves, and individual disability active life reserves. Below is a table that reconciles amounts above to future policyholder benefits and claims as presented on the consolidated balance sheet:
The changes in amounts incurred related to prior years for the years 2008, 2007, and 2006 are not the result of a significant change in an underlying assumption or method used to determine the estimate. Instead we expect these amounts to change over time as a result of the growth in the size of our in force insurance business and the actual claims experience with respect to that business during the time periods captured for claims with an incurral date in years prior to the year of valuation. Interest is also a key component in the year-to-year development of the reserves and therefore the positive changes in amounts incurred related to prior years for the years 2008, 2007 and 2006 should not be taken as an indicator of the adequacy or inadequacy of the reserves held. In each of the years captured there was a decrease in incurred amounts associated with prior years after the effect of interest is taken into account, indicating claim experience was favorable when compared to the assumptions used to establish the associated reserves.
On May 29, 2007, the Company completed a public debt offering of $300 million of 6.90%, junior subordinated debentures (“Subordinated Debt”). The Subordinated Debt has a final maturity on June 1, 2067, is non-callable at par for the first 10 years and is subject to a replacement capital covenant. The covenant limits replacement of the Subordinated Debt for the first 40 years to be redeemable after year 10 and only with securities that carry equity-like characteristics that are the same as or more equity-like than the Subordinated Debt. The principal amount of the Subordinated Debt is payable at final maturity. Interest is payable semi-annually at 6.90% in June and December for the first 10 years and quarterly thereafter at a floating rate equal to three-month LIBOR plus 2.51%. StanCorp has the option to defer interest payments for up to five years. StanCorp is currently not deferring interest on the subordinated debt.
The Company is carrying forward net operating losses of $31.9 million that originated in StanCorp and certain subsidiaries. The losses will be used in future years to offset taxable income from those entities to the degree allowed by the Internal Revenue Code. If unutilized, these losses would expire between the years 2023 to 2028. In addition, the Company is carrying forward a $55.4 million federal net operating loss from the acquisition of Invesmart. This carryforward is subject to limitations under IRS Section 382, which potentially reduces the annual amount that may be utilized. This carryforward will expire between 2019 and 2024. In addition, as a result of the Invesmart
Upon adoption of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, on January 1, 2007, and throughout 2007 and 2008, the Company did not have any material unrecognized tax benefits. It is the Company’s accounting policy to record income tax interest and penalties in the income tax provision. See “Note 1-Summary of Significant Accounting Policies-Income Taxes.”
The following table summarizes the projected and accumulated benefit obligations and the fair value of assets for our plans at December 31:
The estimated net loss and prior service cost for the defined benefit pension plans that will be amortized from accumulated other comprehensive loss into net periodic benefit cost in 2009 are $7.4 million and $0.6 million, respectively.
The long-run rate of return for the employee pension plan portfolio is derived by calculating the average return for the portfolio monthly, from 1971 to the present, using the average mutual fund manager returns in each asset category, weighted by the target allocation to each category. Because the average equity market value returns over the last 30 years generally have been higher than the long run expected rate of return, the historical average return used to determine the expected return on plan assets was reduced by 20% to reflect the expected long run rate of return more effectively.
Equity securities in the employee pension plan portfolio totaled $112.5 million and $114.9 million at December 31, 2008 and 2007, respectively. The plan held no StanCorp securities as plan assets at December 31, 2008 and 2007.
The funded or underfunded status of the postretirement benefit plan, reflected as an asset or liability, is measured as the difference between the fair value of plan assets and the accumulated benefit obligation. At December 31, 2008, a liability of $8.0 million was reflected on the balance sheet for this plan.
Components of net periodic benefit cost, other changes in plan assets and benefit obligations recognized in other comprehensive loss, and obligation assumptions used in the measurement of the postretirement benefit obligations were as follows for the years ended December 31:
Options are granted to directors, officers and certain non-officer employees. Directors and executive officers receive annual grants in amounts determined by the organization and compensation committee of the board of directors. Officers may also receive options when hired or promoted to an officer position. In addition, the chief executive officer has authority to award a limited number of options at his discretion to non-executive officers and other employees. Options are granted with an exercise price equal to the market closing price of the stock on the date of grant. Directors’ options vest in one year with all
The expense of stock options is amortized over the vesting period, which is also the period over which the grantee must provide services to the Company. At December 31, 2008, the total compensation cost related to unvested option awards that had not yet been recognized in the financial statements was $6.2 million. This cost will be recognized over the next four years.
On December 8, 2006, the organization and compensation committee of the board of directors of StanCorp approved a revised form of long-term incentive award agreement to be used in connection with future grants of performance-based awards to executives (“Stock Performance Units”). Under the new agreement, Stock Performance Units granted represent the maximum number of shares to be issued and Units are generally granted two years before the performance period. Stock is issued at the end of the performance period based on satisfaction of employment and financial performance conditions, with a portion of the shares withheld to cover required tax withholding. The new agreement replaced the restricted stock and cash performance unit arrangement previously used.
The compensation cost of these awards was measured using an estimate of the number of shares of StanCorp stock that will vest at the end of the performance period, multiplied by the fair market value. For shares, the fair market value was measured at the grant date. For cash units, the value was measured as of the date of the financial statements.
A summary of the activity for Stock Performance Units outstanding is presented below:
The compensation cost that the Company will ultimately recognize as a result of these awards is dependent on the Company’s financial performance and (for cash units) the price of the Company’s stock on the vesting dates. Assuming that the maximum is achieved for each performance goal, and valuing cash units at the price of StanCorp stock on December 31, 2008, $4.8 million in additional compensation cost would be recognized through 2012. The target or expected payout is 70% of the total or approximately $3.9 million in additional compensation cost through 2012. This cost is expected to be recognized over a weighted-average period of 1.8 years.
A summary of the retention-based restricted stock activity and its characteristics are presented below:
Prior to May 7, 2007, the Company used StanCorp common stock pursuant to the 1999 Omnibus Stock Incentive Plan and the 2002 Stock Incentive Plan to pay a portion of the retainer fees to members of the Company’s board of directors each quarter. Total retainer fees were fixed in dollars. Directors received one-third of the retainer fees in stock and received the remainder in cash. The number of shares issued varied according to the market value of the stock on the date of the issue. The shares were fully vested when issued.
The number of director shares issued was 9,820, 1,292, and 3,617 during 2008, 2007 and 2006, respectively. The weighted-average fair value per share for the shares issued was $53.22, $46.36 and $49.83 for the same periods, respectively.
The Company’s ESPP allows eligible employees to purchase StanCorp common stock at a 15% discount off the lesser of the fair market value of the stock on either the
commencement date of each six-month offering period or the end-of-the-period purchase date. Under the terms of the plan, each eligible employee may elect to have up to 10% of the employee’s gross total cash compensation for the period withheld to purchase StanCorp common stock. No employee may purchase StanCorp common stock having a fair market value in excess of $25,000 in any calendar year. Of the 2.0 million shares authorized for this plan, 0.7 million remain available at December 31, 2008.
The weighted-average per-share fair value for the Company’s ESPP offerings was $12.18, $10.27 and $10.68 during 2008, 2007 and 2006, respectively. The Company’s compensation cost resulting from the ESPP was $1.8 million, $1.2 million and $1.2 million for 2008, 2007 and 2006, respectively. The related tax benefit was $0.6 million, $0.4 million and $0.4 million for the same periods, respectively.
During 2002, Standard formed a strategic marketing alliance with Ameritas Life Insurance Corp. (“Ameritas”) that offers Standard’s policyholders new and more flexible dental coverage options and access to Ameritas’ nationwide preferred provider organization panel of dentists. As part of this alliance, Standard and Ameritas entered into a reinsurance agreement. In 2008, the agreement provided for 21% of the net dental premiums written by Standard and the risk associated with this premium to be ceded to Ameritas.
Subsequent to the terrorist events of September 11, 2001, the Company entered into a catastrophe reinsurance pool with other insurance companies. This pool spreads catastrophe losses on group life and AD&D over approximately 27 participating members. The annual fee paid by the Company in 2008 to participate in the pool was less than $30 thousand. As a member of the pool, the Company is exposed to maximum potential losses experienced by other participating members of up to $105.2 million for a single event for losses submitted by a single company and a maximum of $263.5 million for a single event for losses submitted by multiple companies. The Company’s percentage share of losses experienced by pool members will change over time as it is a function of our group life and AD&D in force relative to the total
group life and AD&D in force for all pool participants. The reinsurance pool does not exclude war or nuclear, biological and chemical acts of terrorism.
Effective October 1, 2000, Standard assumed, through a reinsurance agreement, the individual disability insurance business of Minnesota Life. Standard paid a ceding commission of approximately $55 million and received approximately $500 million in assets and corresponding statutory liabilities. If Standard were to become unable to meet its obligations, Minnesota Life would retain the reinsured liabilities. Therefore, in accordance with the
Statutory accounting practices differ in some respects from GAAP. The principal statutory practices that differ from GAAP are: a) bonds and commercial mortgage loans are reported principally at adjusted carrying value; b) asset valuation and the interest maintenance reserve are provided as prescribed by the NAIC; c) certain assets designated as non-admitted, principally deferred tax assets, furniture, equipment, and unsecured receivables are not recognized as assets, resulting in a charge to statutory surplus; d) annuity considerations with life contingencies, or purchase rate guarantees, are recognized as revenue when received; e) reserves for life and disability policies and contracts are reported net of ceded reinsurance and calculated based on statutory requirements, including required discount rates; f) commissions, including initial commissions and expense allowance paid for reinsurance assumed, and other policy acquisition expenses are expensed as incurred; g) initial commissions and expense allowance received for a block of reinsurance ceded net of taxes are reported as deferred gains in surplus and recognized as income in subsequent periods; h) federal income tax expense includes current income taxes defined as current year estimates of federal income taxes and tax contingencies for current and all prior years and amounts incurred or received during the year relating to prior periods, to the extent not previously provided; and i) deferred tax assets, net of deferred tax liabilities, are included in the regulatory financial statements, but are limited to those deferred tax assets that will be realized within one year that are considered admitted assets. Standard and The Standard Life Insurance Company of New York are subject to statutory restrictions that limit the maximum amount of dividends and distributions that they could declare and pay to StanCorp without prior approval of the states in which the subsidiaries are domiciled.
State insurance departments require insurance enterprises to adhere to minimum Risk-based Capital (“RBC”) requirements promulgated by the NAIC. At December 31, 2008 and 2007, the insurance subsidiaries’ capital levels were significantly in excess of that which would require corrective action by the insurance subsidiaries or regulatory agencies. The authorized control level RBC was $196.1 million and $191.3 million at December 31, 2008 and 2007, respectively.
The following table sets forth StanCorp’s condensed statements of cash flows for the years ended December 31:
In the normal course of business, the Company is involved in various legal actions and other state and federal proceedings. A number of actions or proceedings were pending at December 31, 2008. In some instances, lawsuits include claims for punitive damages and similar types of relief in unspecified or substantial amounts, in addition to amounts for alleged contractual liability or other compensatory damages. In the opinion of management,
the ultimate liability, if any, arising from the actions or proceedings is not expected to have a material adverse effect on the Company’s business, financial position, results of operations or cash flows.
The Company leases certain buildings and equipment under non-cancelable operating leases that expire in various years through 2014, with renewal options for periods ranging from one to five years. Future minimum payments under the leases are 2009, $14.7 million; 2010, $13.2 million; 2011, $10.4 million; 2012, $8.2 million; and thereafter, $5.4 million. Total rent expense was $16.0 million, $15.8 million and $9.6 million for the years ended December 31, 2008, 2007 and 2006, respectively.
The purchase obligations were 2009, $1.4 million; 2010, $0.6 million; 2011, $0.6 million; and 2012, $0.2 million. Purchase obligations were related to non-cancelable telecommunication obligations, software maintenance agreements and other contractual obligations.
From time to time, the board of directors has authorized share repurchase programs. Share repurchases are to be effected in the open market or in negotiated transactions in compliance with the safe harbor provisions of Rule 10b-18 under regulations of the Securities Exchange Act of 1934. Execution of the share repurchase program is based upon management’s assessment of market conditions for its common stock, other potential growth opportunities or other priorities for capital use. On May 7, 2007, the board of directors authorized a share repurchase program of up to 6.0 million shares of StanCorp common stock. The share repurchase program replaced our previous share repurchase program, which had 1.2 million shares remaining that were canceled upon authorization of the new program. On November 3, 2008, the board of directors extended the expiration date of the Company’s share repurchase program to December 31, 2009.
During 2008, the Company repurchased approximately 0.5 million shares of common stock at a total cost of $24.9 million for a volume weighted-average price of $47.31 per common share. At December 31, 2008, there were 0.9 million shares remaining under the current share repurchase program. In addition, during 2008, the Company acquired 5,245 shares of common stock from executive officers and directors to cover tax liabilities of these officers and directors resulting from the release of
performance-based shares and retention-based shares at a total cost of $0.3 million for a volume weighted-average price of $51.33 per common share, which reflects the market price on the transaction dates.