(2) Operating earnings (loss) excluding income taxes, minority interest, interest expense, amortization of goodwill, realized gains (losses), and related amortization represents the base earnings from the Company's business, similar to the measurement "Earnings before Interest, Taxes, Depreciation and Amortization (EBITDA)" used by many noninsurance companies. To the extent that realized gains (losses) relate to interest sensitive policies which have unamortized deferred policy acquisition costs, the realized gains may cause additional amortization and the realized losses negative amortization of the deferred policy acquisition costs. See Note 4 of Notes to Consolidated Financial Statements.
(3) In July 1992, Common Stock was issued in connection with certain warrants which were previously mandatorily repurchaseable. In accordance with Financial Accounting Standards Board Emerging Issues Task Force Issue No. 88-9, "Put Warrants", net earnings (loss) reflects the reduction by $15.0 million in 1991 and $9.3 million in 1992, in each case attributable to the increase in the fair value of the warrants during such periods. See Notes 1 and 9 of Notes to Consolidated Financial Statements.
The Company consummated the acquisition of Lamar Life and certain affiliates effective April 28, 1995. In accordance with applicable financial reporting rules, the Company accounted for the acquisition as a purchase. Under purchase accounting, the Company recorded all assets and liabilities acquired at their fair values on the purchase date. As a practical matter, the consolidated operations of the Company include the gross revenues and expenses of Lamar Life for the nine months ended December 31, 1995, with an offsetting net change recorded as interest expense of $0.5 million relating to the net earnings of Lamar Life from April 1, 1995 through April 28, 1995, the date of closing. As a result of the purchase, the financial condition and results of operations for 1995 may not be directly comparable to 1994. See Notes 1 and 2 to Notes to Consolidated Financial Statements.
The following table reflects, for the Company's individual life insurance and annuity lines of business, the growth in the Company's annualized premiums on new life insurance and annuity sales, and in the approximate number of applications received, and policies issued.
Universal life revenues consist of the monthly mortality charges and administrative fees earned by the Company on its in force universal life insurance, excluding net surrender charges on terminating policies. Such revenues increased 26.8% from $199.5 million in 1994 to $252.9 million in 1995. The increase in revenues is a result of continued sales of universal life policies and reflects revenues of Lamar Life since their acquisition totaling $30.1 million. The Company's net annualized premiums on new life insurance sales for individual life insurance increased 16.8% from $86.2 million in 1994 to $100.7 million in 1995, with Lamar Life contributing $13.5 million during 1995.
The Company's growth in sales of its life insurance products will translate into future increases in the Company's universal life revenues as the premiums received on most of the Company's insurance
products are accounted for as deposit liabilities. With respect to products that are accounted for as deposit liabilities, revenues are recognized over time in the form of investment income on policyholder account balances, surrender charges and mortality and other charges deducted from the policyholders' account balances.
Reinsurance premiums ceded represent coinsured traditional premiums as well as yearly renewal term reinsurance premiums on traditional and universal life policies for risks in excess of the Company's maximum retention. The Company does not retain the mortality risk for any policy to the extent the risk exceeds the Company's stated retention, which currently ranges from $100,000 to $500,000. The reinsurance premiums increased by 43.8% from $28.1 million in 1994 to $40.4 million in 1995, relating primarily to reinsurance premiums on Lamar business of $10.5 million, combined with continued growth of life insurance in force.
Accident and health insurance premiums represent premiums earned over the applicable period on individual and group accident and health policies. Such revenues increased from $5.5 million in 1994 to $24.2 million in 1995. The increase relates entirely to the acquisition in 1995 of Lamar Life, which added considerably to the Company's accident and health business. Lamar Life underwrites the business and cedes said business to its reinsurers, while retaining only a small portion of the risk. As such, this business principally represents a servicing fee to the Company.
sales of certain fixed income securities during a period of rising market interest rates, write-downs of $7.1 million related to other than temporary declines in the market value of certain invested assets, and $6.8 million of other realized losses. A substantial portion of the 1995 gain related to the sale of one equity investment during 1995, offset by $9.2 million of write-downs for other than temporary declines in market value. In accordance with applicable financial reporting rules, the net amortization of deferred policy acquisition costs and deferred policy fees was decelerated by $8.0 million during 1995 and accelerated by $12,000 during 1994 in conjunction with the recognition of these gains (losses).
Total policyholder benefits increased $42.4 million, or 38.2%, from $110.9 million in 1994 to $153.3 million in 1995, due primarily to an increase in death benefits, which occurred as a result of the growth in the Company's universal life in-force block of business and the in-force block of business acquired from Lamar Life. In addition, the Company experienced adverse mortality of approximately $11.9 million in excess of actuarial expectations in the second quarter of 1995.
Interest credited to policyholders includes interest credited to universal life and annuity account balances, and the interest accretion inherent in reserve increases on traditional life insurance policies determined based on standard actuarial valuation rates. Interest credited increased 20.9% from $136.8 million in 1994 to $165.4 million in 1995 primarily as a result of increased policyholder account balances acquired with Lamar Life.
Other operating expenses consist of general, administrative, and other operating costs. These costs were $94.8 million in 1995 and $52.7 million in 1994. Included in the 1995 amount were approximately $14.2 million of one-time litigation charges related to the settlement of a class action lawsuit, $2.2 million related to the write off of certain agent debit balances and $1.9 million related to an increase in the Company's estimate of its guarantee fund assessment liability. Included in the 1994 amount are charges of $2.4 million related to guarantee fund assessments and $3.5 million related to litigation provisions.
Amortization of deferred policy acquisition costs, cost of insurance acquired and deferred policy fees increased from $46.2 million in 1994 to $148.7 million in 1995. The amortization related to realized gains, included therein, decreased from $12,000 in 1994 to $(8.0) million in 1995. The amortization of the cost of insurance acquired is higher in 1995 due to the acquisition of Lamar Life, which added $14.5 million of amortization in 1995. Also, deferred policy acquisition costs on universal life type products are amortized with interest in relation to the present value of expected gross profits on the products. As such estimates of expected gross profits are revised, retrospective adjustments are reflected in current operations, causing amortization of deferred policy acquisition costs to vary from period to period.
As of December 31, 1995, the Company revised its assumptions relating to expected gross profits on the in-force block of business. These assumptions included investment yields, interest rates credited to policyholders, expense levels, and mortality and persistency levels. Such assumptions were revised based upon standard actuarial and accounting practices, and such revisions were made specifically to separate products or homogeneous groups of products. This unlocking of assumptions resulted in increased amortization of deferred policy acquisition costs and deferred policy fees of $66.6 million in 1995, and will serve to shorten the amortization period for the remaining deferred costs and fees.
The estimation of future gross profits and losses with respect to cost of insurance acquired is subject to the same estimation process and is impacted by the same factors as discussed above regarding deferred policy acquisition costs. Due to changes in estimates of future gross profits and losses, the estimated future amortization is expected to increase as compared to prior year estimates.
Deferred policy fees represent front-end loads assessed against policyholder account balances on universal life insurance contracts. Under applicable financial reporting rules, such fees are deferred and amortized with interest in relation to the present value of expected gross profits on the product. Such amortization is in direct proportion to amortization of deferred policy acquisition costs for a given group of policies and is included in the statement of operations as a reduction in amortization of deferred policy acquisition costs.
The Company's growth in sales of its life insurance products will translate into future increases in the Company's universal life revenues as the premiums received on most of the Company's insurance products are accounted for as deposit liabilities. With respect to products that are accounted for as deposit liabilities, revenues are recognized over time in the form of investment income on policyholder account balances, surrender charges and mortality and other charges deducted from the policyholders' account balances.
Accident and health premiums represent premiums earned over the applicable period on individual or group accident and health policies. Such revenues decreased from $6.1 million to $5.5 million, from the years ended 1993 to 1994. Prior to the acquisition of Lamar Life in 1995, such accident and health business was not a significant line of business for the Company.
Net investment income increased $4.3 million, or 1.9%, from $221.1 million in 1993 to $225.4 million in 1994. This moderate change reflected an increase in the amount of invested assets, which was partially offset by a lower effective portfolio yield on investments made during 1994. Average invested assets, excluding assets subject to reverse repurchase financing arrangements, were $2.9 billion during 1994, compared to $2.8 billion during 1993, and increased due primarily to deposits to annuities and universal life policies. The effective yield on invested assets was 7.7% for the year ended December 31, 1994, compared to 7.9% for the year ended December 31, 1993. During 1993 the Company experienced significant calls, redemptions, and pay-downs of fixed maturity investments. The Company continually assesses investment yields, and when necessary takes action to reduce credited interest rates on its insurance products to preserve targeted spreads.
Interest credited to policyholders decreased 1.9% from $139.4 million in 1993 to $136.8 million in 1994. This change was the result of decreases in interest rates as determined on a periodic basis by the Company for each product. Such decreases were in response to continued deterioration in the Company's investment yield resulting from generally declining market interest rates. The reduction in rates was partially offset by growth in policyholder account balances as a result of new life insurance sales.
AMORTIZATION OF DEFERRED POLICY ACQUISITION COSTS, COST OF INSURANCE ACQUIRED AND DEFERRED POLICY FEES
The Company's interest expense decreased by approximately $5.3 million between the 1993 and 1994 periods as a result of principal repayments made on the Company's senior indebtedness in 1993 and the first 3 months of 1994 (which aggregated $105.7 million) and the refinancing of the Company's senior indebtedness in June of 1993, which allowed LIBOR interest option. In addition, the senior indebtedness was also refinanced in August 1994 resulting in a .25% reduction in the margin attached to the LIBOR interest option. The decrease in interest expense due to principal paydowns
and refinancings was partially offset by an increase in the Company's borrowing rates (on which such interest expense was based) from an average prime/LIBOR of 4.5% in 1993 to an average LIBOR rate of 6.0% in 1994.
(2) Represents the closing sales price of marketable debt securities. Market values for privately placed securities and senior secured loans are estimated by the Company.
At December 31, 1995, of the fixed maturity securities in the Company's investment portfolio, 93.7% were in the highest two NAIC designations representing investment grade debt securities.
Non-investment grade debt securities generally provide higher yields and involve greater risks than investment grade debt securities because their issuers typically are more highly leveraged and more vulnerable to adverse economic conditions than investment grade issuers. In addition, the trading market for these securities is usually more limited than for investment grade debt securities. The Company continually reviews the percentage of its portfolio which is invested in non-investment grade debt securities (NAIC designations 3 through 6) and intends to maintain the percentage holdings of such securities at or below the current level. Pursuant to the terms of the Senior Credit Facility, the Company's investments in non-investment grade debt securities are restricted. At December 31, 1995, the Company's investments in non-investment grade debt securities were 4.2% of total assets, which was substantially less than allowed by the Senior Credit Facility.
At December 31, 1995, $110.2 million in book value of the Company's investment portfolio consisted of mortgage loans. As of December 31, 1995, mortgage loans delinquent by more than 90 days constituted $1.5 million, which was less than 1% of cash and invested assets at such date. The book value of the Company's real estate investments constituted less than 1% of the book value of the Company's total investment portfolio at December 31, 1995. The Company intends to maintain its real estate exposure at or below such percentage.
During 1994 the Company entered into certain reverse repurchase financing agreements related to the purchase of certain mortgage-backed securities acquired as a component of the Company's asset management strategy. Such financings were extinguished during 1995. In addition, the Company acquired certain investment borrowings in the Lamar acquisition. These borrowings consist primarily of a leverage program with the Federal Home Loan Bank of Dallas (FHLB). In this program, Lamar Life purchased $3.3 million of FHLB Preferred Stock and is entitled, as provided within FHLB
Life Partners' principal need for liquidity consists of its debt service obligations under its senior indebtedness ("Senior Loan") and subordinated indebtedness ("Notes"). The unpaid principal of the Senior Loan totaled $156.2 million at December 31, 1995 and $121.2 million at December 31, 1994, and the unpaid principal of Life Partners' subordinated indebtedness equaled $95.1 million at December 31, 1995 and December 31, 1994. Life Partners' senior and subordinated indebtedness are reported at $155.6 million and $90.5 million, respectively, in the Company's financial statements at December 31, 1995. Such amounts are net of issuance costs which are being amortized over their remaining terms in accordance with applicable accounting principles.
Life Partners' principal source of liquidity consists of the periodic payments of principal and interest made by Wabash on the two surplus debentures issued by Wabash to Life Partners in connection with the Acquisition. Because the surplus debentures were issued at the time of the Acquisition, and because payments on the surplus debentures were intended to be used to make the respective principal and interest payments due under the Senior Loan and the subordinated Acquisition indebtedness, the financial terms of the surplus debentures were designed to correspond, in all material respects, to the financial terms of the Senior Loan and Life Partners' subordinated Acquisition indebtedness. Life Partners did not amend the surplus debentures as a result of the issuance of the Notes in July of 1992, prepayment of a portion of the Senior Loan to General Electric Capital ("GE Capital") with proceeds from the initial public offering in March of 1993, or refinancing of the Senior Loan with Chase Manhattan Bank ("Chase") in June of 1993 and August of 1994. Accordingly, at December 31, 1995, the subordinated surplus debenture is in the principal amount of $90.0 million (which is $10.0 million less than the principal amount of the Notes) and bears interest at 15 1/2% (which is 2 3/4% higher than the interest rate on the Notes). As a result of this additional 2 3/4% interest, and notwithstanding the additional $10.0 million of Notes outstanding, Life Partners' total interest income on the subordinated surplus debentures is scheduled to exceed its total interest expense on the Notes by $1.2 million per year. In addition, the unpaid principal of the surplus debenture corresponding to the Senior Loan totaled $179.2 million at December 31, 1995, or $23.0 million in excess of the Senior Loan at December 31, 1995. Such differences on the senior indebtedness could create additional excess cash flow to Life Partners of more than $1.5 million annually. This excess interest income is available to meet Life Partners' liquidity requirements. The Company revised the interest rates, terms and provisions of the senior surplus debenture in 1995 to more closely match the enhanced credit quality of Life Partners' insurance subsidiaries.
Wabash may make payments of principal on the surplus debentures only with the prior approval of the Kentucky Department of Insurance. Because all surplus debenture payments made by Wabash
through December 31, 1995 have been approved, without objection, by the Kentucky Department of Insurance, the Company currently does not believe that it will have any difficulty in obtaining payment approvals for the foreseeable future.
Under the terms of the surplus debentures, payments of principal and interest may be made only to the extent that Wabash's statutory capital and surplus exceeds 25% of its total statutory liabilities, exclusive of the surplus debentures. Wabash's capital and surplus totaled $153.6 million at December 31, 1995, which exceeded the minimum required capital and surplus by $60.9 million. Also, financial covenants under the Senior Credit Facility require that Massachusetts General and Philadelphia Life maintain combined year-end capital and surplus minimums (including an asset contingency reserve) of $195 million in 1995 and 1996, and $200 million in 1997 and later years. At December 31, 1995, the combined capital and surplus of Massachusetts General and Philadelphia Life, including such reserve, exceeded the loan covenant requirement by $31.8 million. As a result of Wabash's operating cash flows, its existing cash and short-term investments, and such excess capital and surplus of Wabash and subsidiaries, the Company does not anticipate that Wabash will encounter any difficulty in making its scheduled payments of principal and interest on the surplus debentures for the foreseeable future.
The principal requirement for liquidity in connection with the Company's insurance operations is its contractual obligations to policyholders and annuitants, including payments of surrender benefits, contract withdrawals, claims under outstanding insurance policies and annuities, and policy loans. Although the contractual terms of substantially all of the Company's in force life insurance policies and annuities give the holders the right to surrender the policies and annuities, the Company imposes significant penalties for early surrenders. At December 31, 1995, the Company held reserves that exceeded the underlying cash surrender values of its in-force life insurance and annuities by more than $456 million. Contract withdrawals and surrender benefits totaled $284.8 million during 1995, $224.0 million during 1994, and $226.1 million during 1993, which in each case represented less than 8.3%, on an annual basis, of the average related liabilities for the respective year. As a result, the Company believes that it maintains adequate liquidity to pay anticipated benefits and claims to policyholders and annuitants.
Massachusetts General is a party to a financial reinsurance agreement under which it received statutory surplus of $1.3 million at December 31, 1995, $2.9 million at December 31, 1994, and $4.6 million at December 31, 1993. The surplus provided by this agreement will be recaptured over the next few years. In addition, Lamar Life is party to a financial reinsurance agreement under which it received $8.2 million of statutory surplus at December 31, 1995. Such financial reinsurance was reduced by $3.3 million from the date of acquisition of Lamar Life, and is scheduled to be recaptured ratably over the next two years. See Note 10 of the Notes to Consolidated Financial Statements.
Also, interest rate changes may have temporary effects on the sale and profitability of the universal life and annuity products offered by the Company. For example, if interest rates rise, competing investments (such as certificates of deposit, mutual funds, and similar instruments) may become more attractive to potential purchasers of the Company's products until the Company increases the rate credited to holders of its universal life and annuity products. In contrast, as interest rates fall, the Company attempts to adjust its credited rates to compensate for the corresponding declines in its net investment income. The Company constantly monitors interest rates with respect to a spectrum of durations and sells policies and annuities that permit flexible responses to interest rate changes as part of the Company's management of interest spreads.
Also during 1995, the FASB issued Statement of Financial Accounting Standard No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION ("SFAS 123"), which is effective for transactions entered into in fiscal years beginning after December 15, 1995. The Company does have certain stock-based compensation plans which may fall under the scope of SFAS 123; however, the Company is unable to determine whether the adoption of the provisions of SFAS 123 will have a material impact on its financial position or results of operations.
In 1994, the FASB issued Statement of Financial Accounting Standards No. 120, ACCOUNTING AND REPORTING BY MUTUAL LIFE INSURANCE ENTERPRISES AND BY INSURANCE ENTERPRISES FOR CERTAIN LONG-DURATION PARTICIPATING CONTRACTS ("SFAS 120"), which is effective for fiscal years beginning after December 15, 1995. The Company does not believe that the application of the provisions of SFAS 120 will have a material effect on its financial condition or results of operations.
Management of Life Partners Group, Inc. is responsible for the reliability of the financial information in this annual report. The financial statements are prepared in accordance with generally accepted accounting principles and the other financial information in this annual report is consistent with that of the financial statements.
The Company engages independent accountants to audit its financial statements and express their opinion thereon. They have full access to each member of management in conducting their audits. Such audits are conducted in accordance with generally accepted auditing standards and include a review of internal controls, tests of the accounting records, and such other auditing procedures as they consider necessary to express an opinion on the Company's financial statements.
To the Board of Directors and Stockholders Life Partners Group, Inc.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Life Partners Group, Inc. and Subsidiaries as of December 31, 1995 and 1994, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles.
LIFE PARTNERS GROUP, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (IN THOUSANDS)
The effect of the adoption of SFAS 115 was to decrease stockholders' equity by approximately $0.8 million. This net decrease consisted of an increase of approximately $6.6 million from securities which were previously classified as held-to-maturity and transferred to available-for-sale, and a decrease of approximately $7.4 million for securities which were previously classified as actively
In November 1995, the Company transferred certain securities between the available-for-sale and held-to-maturity classifications as permitted by an implementation guide issued by the Financial Accounting Standards Board (See Note 4).
Premiums and discounts on fixed maturity investments are amortized over the term of the security, or in the case of mortgage-backed securities, over the estimated life of the security. Such amortization is included in net investment income.
Principal prepayments affect the cash flow pattern and yield of mortgage-backed securities. The amortization of discounts and premiums takes into consideration actual and future estimated principal prepayments. The Company utilizes estimated prepayment speed information obtained from published sources or from estimates developed by its investment advisors. The effects on the yield of a security from changes in principal prepayments are recognized retrospectively, except for interest only or residual interest structured securities which are recognized prospectively. The degree to which a security is susceptible to yield adjustments is influenced by the difference between its carrying value and par, the relative sensitivity of the underlying mortgages backing the assets to prepayment in a changing interest rate environment, and the repayment priority for structured securities such as collateralized mortgage obligations.
Mortgage loans are stated at the aggregate unpaid principal balances, less unamortized discount and less allowance for possible losses. Real estate held for investment is stated at cost, less allowances for depreciation and, as appropriate, provisions for possible losses. Real estate acquired through foreclosure is stated at lower of cost or market.
Policy and collateral loans are stated at the aggregate unpaid principal balances.
Other invested assets consist primarily of limited partnerships acquired prior to 1995, which are accounted for under the cost method. Certain of these limited partnership investments are related party transactions (see Note 14).
During 1994 the Company entered into certain reverse repurchase finance agreements related to the purchase of certain mortgage-backed securities. These financings were collateralized by mortgage-backed securities with fair market values in excess of the loan value. Such transactions are accounted for as short-term collateralized borrowings and generally terminate within 120 days.
Net realized investment gains and losses are included in the determination of net earnings (loss). Unrealized investment gains and losses on marketable equity securities and fixed maturity investments available-for-sale, net of amortization of deferred policy acquisition costs, deferred policy fees and related deferred tax effect, if any, are charged or credited directly to stockholders' equity and do
Costs which vary with and are primarily related to the acquisition of new business have been deferred to the extent that such costs are deemed recoverable through future revenues. These costs include commissions, certain costs of policy issuance and underwriting, and certain variable agency selling expenses. For traditional life products, deferred costs are amortized with interest over the premium paying period in proportion to the ratio of annual premium revenue to the anticipated total premium revenue. Deferred policy acquisition costs related to universal life, interest-sensitive life, and annuity products are amortized with interest in relation to the present value, using the assumed crediting rate, of expected positive gross profits on the products, with a provision during earlier profitable periods for losses occurring in latter periods. Retrospective adjustments of these amounts are made when the Company revises its estimates of current or future gross profits and losses, including investment gains and losses related to changes in market interest rates to be realized from a group of policies. Anticipated investment income is considered in the determination of recoverability of deferred policy acquisition costs.
A portion of the purchase price paid for the Company's insurance subsidiaries was allocated to the cost of insurance acquired based on the actuarially determined future profits from policies acquired with the purchase of the insurance subsidiaries. The portion of the asset relating to the acquisition of subsidiaries in 1990 is amortized without interest in relation to expected future gross profits, adjusted prospectively for changes in assumptions, including direct charge-offs for any excess of the unamortized asset over the present value of projected future profits.
The estimation of future gross profits and losses with respect to cost of insurance acquired is subject to the same estimation process and is impacted by the same factors as discussed above under deferred policy acquisition costs.
Changes in the cost of insurance acquired are as follows (in thousands):
Future amortization is estimated at $47.8 million, $41.3 million, $36.4 million, $30.9 million, and $26.5 million for the years 1996, 1997, 1998, 1999, and 2000, respectively. Due to changes in estimates of future gross profits and losses, the estimated future amortization is expected to increase as compared to prior year estimates.
The liability for future policy benefits of traditional life products has been computed by the net level premium method based on estimated future investment yield, mortality, and withdrawal experience. Reserve interest assumptions are graded to rates between 7.25% and 8.5%. Mortality assumptions are based on the 1965-70 Basic Experience Table. Withdrawal assumptions vary by year of issue, age of the insured, and type of insurance. Mortality and withdrawal assumptions are based on actual experience, modified as necessary to reflect anticipated trends and to include provisions for possible unfavorable deviations. The assumptions vary by plan, year of issue, and duration. Substantially all of the traditional life products were issued prior to 1984. The future policy benefit reserves include a provision for policyholder dividends based upon dividend scales assumed at the date of purchase of acquired companies or as presently contemplated.
Future policy benefits and claims are calculated using numerous assumptions and estimates including interest rates, mortality and persistency, which are intended to estimate the timing of payment of policyholder benefits and claims. Actual results could differ from these estimates.
Benefit reserves for universal life, including both variable and fixed premium products, and annuity products are determined using the "retrospective deposit" method and consist of policy account values before any surrender charges.
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) (k) LIABILITY FOR GUARANTY FUND ASSESSMENTS
The acquisition was accounted for using the purchase method, and the results of operations of Lamar were included in the consolidated statement of operations from the date of acquisition. Also included in the results of operations is a one time charge of $0.5 million for interest expense on the acquisition purchase price. The fair value of assets and liabilities of Lamar were reflected in the Company's consolidated balance sheet as of April 28, 1995, and goodwill recorded as a result of the acquisition was increased by approximately $4.8 million due to further evaluation of the fair values of
2. ACQUISITION (CONTINUED) the acquired assets and liabilities. Evaluation of fair values for acquired assets and liabilities, including investments, cost of insurance purchased, and insurance and annuity liabilities is continuing and allocation of the purchase price may be further adjusted.
The above unaudited pro forma information is intended for informational purposes only and may not necessarily be indicative of the Company's future results of operations.
3. NOTES PAYABLE Notes payable at December 31, 1995, and December 31, 1994, are summarized below (in thousands):
3. NOTES PAYABLE (CONTINUED) Group, Inc. (See Note 2). On December 28, 1995, the Company utilized the remaining $14 million of the facility. According to the amended agreement, the $50 million outstanding principal will convert to a term loan effective January 1, 1997, payable in quarterly installments through September 30, 1999. The outstanding principal under the existing term loan is payable in quarterly installments through September 30, 1999. Both the outstanding term loan principal and outstanding revolving loan principal may be designated as a "base rate loan", a "eurodollar loan", or a combination of both at the Company's option on a periodic basis.
Interest expense for the year ended December 31, 1995, as reported in the consolidated statement of operations, also includes interest paid or accrued to the Internal Revenue Service relating to assessments on prior tax years of $4.2 million (See Note 12), and interest expense of $0.5 million associated with purchase accounting of Lamar (See Note 2).
To the extent that loans were payable to GE Capital, which owned approximately 40% of the outstanding common stock of Life Partners at January 1, 1993, under the Senior Loan Agreement, they were classified as "Indebtedness to related party." To the extent that loans are payable to unaffiliated third parties, they are classified as "Notes payable" (see Note 9).
Realized investment gains (losses) resulted in (decelerated) accelerated net amortization expense for deferred policy acquisition and deferred policy fees of $(8,039,000), $12,000 and $4,773,000 during the years ended December 31, 1995, 1994 and 1993, respectively.
4. INVESTMENTS (CONTINUED) During 1995, the Company sold $35.1 million of fixed maturity investments which were previously classified as held-to-maturity. Such sales were primarily the result of significant deterioration of creditworthiness of the issuers. Based upon available information, the Company concluded that, in all probability, substantial amounts due would not be collected or there would be delay in collection, causing the Company to sell these securities. As a result of such sales, the Company realized net losses of $1.6 million in 1995.
The cost and estimated fair values of equity securities are as follows (in thousands):
The amortized cost and estimated fair values of debt securities classified as fixed maturity investments held-to-maturity are as follows (in thousands):
4. INVESTMENTS (CONTINUED) The amortized cost and estimated fair value of debt securities at December 31, 1995, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
In November 1995, the Financial Accounting Standards Board issued "A GUIDE TO IMPLEMENTATION OF STATEMENT 115 ON ACCOUNTING FOR CERTAIN INVESTMENTS IN DEBT AND EQUITY SECURITIES" which permitted a one-time reassessment of the appropriateness of the classifications of all securities. Based on such reassessment, the Company transferred certain securities from the held-to-maturity portfolio to the available-for-sale portfolio in November 1995. The transferred securities had an amortized cost of approximately $1,201.4 million and net unrealized gains of approximately $52.1 million. The transfer resulted in an increase of approximately $26.4 million to shareholders' equity. Such reassessment does not change management's intent to hold other debt securities to maturity.
4. INVESTMENTS (CONTINUED) At December 31, 1994, the carrying amount, fair value and effective yield of high-risk collateralized mortgage obligations included in fixed maturities were $11.6 million, $10.7 million and 14.8%, respectively. At December 31, 1995, the Company did not hold any collateralized mortgage obligations which would be considered high-risk.
Following is an analysis of the components of net unrealized gains (losses), net of tax on investments (in thousands):
5. CONCENTRATIONS OF CREDIT RISK (CONTINUED) Additionally, the Company held investments in non-investment grade senior secured debt securities and mezzanine financing securities as follows (in millions):
6. DISCLOSURES ABOUT FAIR VALUES OF FINANCIAL INSTRUMENTS The following methods and assumptions were used to estimate the fair value of each class of financial instrument required to be valued by SFAS 107 for which it is practicable to estimate that value. None of the financial instruments are held for trading purposes.
For those securities held-to-maturity and available-for-sale, fair value equals quoted market price, if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities or discounted future cash flows.
For equity securities, fair value equals quoted market price, if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities.
Fair value is estimated by grouping mortgage loans into homogeneous categories and using quoted market prices for securities backed by similar loans, adjusted for differences in loan characteristics.
For short-term instruments, the carrying amount is a reasonable estimate of fair value.
The fair value of interest rate swaps is the estimated amount that the Company would receive or pay to terminate the swap agreements at the reporting date, taking into account current interest rates and the current creditworthiness of the swap counterparties.
6. DISCLOSURES ABOUT FAIR VALUES OF FINANCIAL INSTRUMENTS (CONTINUED) (h) NOTES AND ACCOUNTS RECEIVABLE AND UNCOLLECTED PREMIUMS
Notes and accounts receivable and uncollected premiums are primarily insurance contract related receivables which are determined based upon the underlying insurance liabilities and related reinsurance amounts, and thus are excluded for the purpose of fair value disclosure by paragraph 8(c) of SFAS 107.
The estimated fair values of the Company's financial instruments required to be valued by SFAS 107 are as follows as of December 31 (in thousands):
(C) The amount shown under "carrying amount" represents accrued interest on the unrecognized notional amounts of interest rate swaps.
7. STOCKHOLDERS' EQUITY AND RESTRICTIONS At December 31, 1995 and 1994, substantially all of consolidated stockholders' equity represented net assets of insurance subsidiaries that cannot be transferred to Life Partners in the form of dividends, loans, or advances without prior regulatory approval. Funds are transferred from Wabash to Life Partners in the form of interest and principal payments on the surplus debentures (see Note 3).
8. PREFERRED STOCK At December 31, 1995 and 1994, Life Partners has 10,000,000 authorized shares of Series Life Partners Series Preferred Stock with $.01 par value and $1,000 per share stated value, 250,000 shares of which are designated as 15% Series A Exchangeable Preferred Stock.
9. COMMON STOCK On March 23, 1993, the Company amended its certificate of incorporation to, among other things, change its authorized Class A Common Stock and Class B Common Stock into one class of stock of the Company designated as Common Stock. Upon the effectiveness of such amendment, each of the 13,150,749 issued and outstanding shares of Class A Common Stock and 1,234,675 issued and outstanding shares of Class B Common Stock were automatically converted into one share of Common Stock. During 1995 and 1994 the Company paid approximately $3,018,192, or $0.11 per share, and $2,035,000, or $0.08 per share, in cash dividends on the Common Stock, respectively.
On March 31, 1993, the Company issued 11,000,000 shares of $.001 par value Common Stock through an initial public offering at a price of $17 per share. Also included in the offering were 5,806,440 shares of Common Stock previously owned by GE Capital. The Company did not receive any proceeds from the sale of the GE Capital shares. The net proceeds to the Company from the offering were used to redeem all outstanding shares of Series A Exchangeable Preferred Stock and accrued PIK Dividends for $122.0 million and to prepay $51.7 million on the notes payable.
At December 31, 1993, there were 37,719 shares of Common Stock reserved for issuance to three directors pursuant to warrants issued during 1991 and 1992. During 1994, two of the directors exercised their warrants and were each issued 12,573 shares of Common stock at an exercise price of $3.98 per share. The remaining warrant has an exercise price of $3.98 per share, is currently exercisable by the holder, and, if unexercised, will expire on November 12, 1996. The option price was determined by the Compensation Committee of the Board of Directors in February 1991 and represented a 25% premium over the previous sale of stock in March 1990. In August 1993, the Board of Directors formally granted options to a director to purchase 10,000 shares of Common Stock at an exercise price of $21.00 per share. The options vest in equal amounts in 1994, 1995, and 1996, and expire in 2003.
At December 31, 1995, and 1994, there were 352,941 shares of Common Stock reserved for issuance pursuant to an option which was granted to an officer in 1991 at an exercise price of $5.31 per share. The option vested in October 1992 and expires on November 1, 2001. Upon issuance the shares will be subject to transfer and voting restrictions imposed under an agreement among Life Partners
9. COMMON STOCK (CONTINUED) Capital stock activity for the years 1995, 1994, and 1993 was as follows:
In October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION ("SFAS 123"). SFAS 123 establishes fair value based accounting and reporting standards for all transactions in which a company acquires goods or services by issuing equity securities, including stock-based compensation plans. Under SFAS 123, compensation cost is measured at the grant date based on the value of the award and is recognized over the service period, which is usually the vesting period. The fair value of
10. REINSURANCE The life insurance subsidiaries have retention limits for acceptance of risk on life insurance policies at various levels up to $1 million, for business issued prior to 1987. Effective January 1, 1987, the retention limit for new policy issues has been set at various levels up to $500,000. There are reinsurance agreements with various companies whereby insurance in excess of the respective subsidiaries' retention limits is reinsured. To the extent that reinsuring companies become unable to meet their obligations under these agreements, the subsidiaries remain contingently liable. Insurance in force ceded at December 31, 1995 and 1994 under risk sharing arrangements totaled approximately $16.4 billion and $11.0 billion, respectively. The liability for future policy benefits is stated exclusive of amounts applicable to such risk sharing reinsurance ceded as of December 31, 1995, and 1994 of $86.5 million and $75.2 million, respectively. Policyholder benefits reflects the reduction of death and accident and health claims by amounts recovered from reinsurers of $114.3 million, $42.9 million and $41.4 million for the years ended December 31, 1995, 1994, and 1993, respectively.
Accident and health premiums are net of assumed premiums of $41.4 million and ceded premiums of $71.4 million for the year ended December 31, 1995. The Company did not have material reinsurance for accident and health business prior to the Lamar acquisition in 1995.
11. COMMITMENTS, LITIGATION AND CONTINGENT LIABILITIES IPS leases office facilities in Englewood, Colorado. In July, 1994 the Company renegotiated certain provisions of the master lease agreement. The minimum rental commitment under the revised noncancelable lease is $1.1 million per year through June, 2014 and $2.6 million per year through the lease expiration date in July, 2016. The Company has no other significant long-term leases. Rental expense for the years 1995, 1994, and 1993 was approximately $1.9 million, $2.0 million, and $2.7 million, respectively.
At December 31, 1994, Philadelphia Life and Massachusetts General were defendants in a class action originally instituted by a former agent and policyholder of Philadelphia Life. In the case, the plaintiff alleged that these companies breached the terms of certain universal life policies by increasing the cost of insurance rates to pass on a portion of their increased tax liability resulting from the passage of the Revenue Reconciliation Act in 1990, which act contained provisions requiring the recognition of taxable income by the insurer on a percentage of actual premium received on existing, as well as subsequently written, individual life policies (the so called "DAC tax"). On July 31, 1995 the Federal District Court in California approved a settlement of this action following notice to members of the class. The recording of the liability associated with this settlement and other related litigation resulted in a pre-tax expense of $14.2 million for the year ended December 31, 1995.
In addition, various other lawsuits and claims are pending against the Company. The Company has established a liability of approximately $1 million in its financial statements, as of December 31, 1995, for litigation contingencies. While this provision was established based upon management's judgment as to the probable exposure associated with the disposition of these lawsuits, there can be no assurance that the Company's ultimate liability, if any, in connection with such lawsuits will not exceed the provisions established therefor.
On October 10, 1995, I.C.H. filed under Chapter 11 for bankruptcy protection. I.C.H., in publicly released documents, has stated that it has reached a tentative agreement with the IRS for tax years through 1989 whereby I.C.H.'s insurance subsidiaries would be subject to approximately $68 million of federal income tax liability and interest for years in which certain of the Company's insurance subsidiaries were members of the consolidated federal tax group to which such tax liability related. All members of a consolidated group of companies may be, under federal law, jointly and severally liable for tax deficiencies related to such group. The Company has been informed that I.C.H. has made payment to the IRS for the tax liability and interest. I.C.H. has orally advised the Company of an intention to file suit against certain subsidiaries of the Company for contribution of their respective shares of such tax deficiency. Based upon the indemnification provisions and other relevant documents, the Company does not believe that it will be responsible for an allocable share of said taxes.
11. COMMITMENTS, LITIGATION AND CONTINGENT LIABILITIES (CONTINUED) The Company has received a determination from an IRS examination of certain agent compensation practices in certain of its life insurance subsidiaries. The Company has protested and appealed the assessment. It is possible that the ultimate resolution of this examination could result in additional employment taxes, interest and penalties for the period under examination, as well as future periods which are subject to examination. The Company believes that it has made adequate provision for the potential outcome of the appeal.
Included in interest expense in the consolidated statement of operations for the year ended December 31, 1995, is a provision for interest of $4.2 million on federal income tax deficiencies relating to prior year taxes. I.C.H. has reached a settlement agreement with the IRS whereby certain of the Company's tax deductions which relate to amortization of purchased intangibles have been disallowed. The provision for interest includes the interest cost related to these lost deductions. As a result of the IRS settlement, the tax basis of certain assets of Philadelphia Life was increased. The effect of this increase will result in a refund of federal income taxes paid in years these assets were sold with a corresponding receipt of interest. No receivable has been established for the interest attributable to the refund of taxes since the amount and timing are uncertain at this time.
The IRS has examined federal income tax returns of certain Life Partners companies through the 1991 tax year. An examination was also performed on certain Lamar Financial Group subsidiary returns through the 1994 preacquisition tax years. In addition, the Company has been informed that the IRS intends to begin an examination of certain Life Partners' insurance subsidiaries income tax returns for 1992, 1993, and 1994 tax years. The Company does not anticipate any significant adjustments which would materially affect the financial position or results of operations of the Company.
Under previous life insurance company tax laws, a portion of the Company's gain from operations which was not subject to current income taxation was accumulated for tax purposes as Policyholders' Surplus Accounts. The aggregate accumulation in this account was approximately $7.6 million at December 31, 1995. Should the accumulation in the Policyholders' Surplus Accounts exceed certain stated maximums, or if certain other events occur, all or a portion of the amount may be subject to federal income taxes at rates then in effect. Deferred taxes have not been established for such amounts since the Company does not anticipate paying taxes on the Policyholders' Surplus Accounts.
13.PERMITTED STATUTORY ACCOUNTING PRACTICES AND SUPPLEMENTAL STATUTORY FINANCIAL INFORMATION Life Partners' insurance subsidiaries prepare their statutory financial statements in accordance with accounting practices prescribed or permitted by their respective state insurance departments. Prescribed statutory accounting practices include a variety of publications of the National Association of Insurance Commissioners (NAIC), as well as state laws, regulations, and general administrative rules. Permitted statutory accounting practices encompass all accounting practices not so prescribed.
Combined statutory surplus for Life Partner's insurance subsidiaries at December 31, 1995 and 1994 was $153.6 million and $127.9 million, respectively, and combined statutory net income for the years ended December 31, 1995, 1994 and 1993 was $36.7 million, $15.4 million and $38.5 million, respectively. Combined statutory operating earnings, excluding income tax and interest expense, was $78.1 million, $75.8 million, and $83.5 million for the years ended December 31, 1995, 1994 and 1993, respectively.
In August 1990, the Company committed to invest $10 million, as a limited partner, in acquisition transactions in which an affiliate of a stockholder is the ultimate managing partner. In 1993, the Company increased its commitment in these transactions by an additional $10 million. As of December 31, 1994 and 1995, the Company had invested approximately $17.4 million and $23.4 million as a limited partner in twelve acquisitions. During 1995, the Company committed to invest an aggregate of $4.5 million in two limited partnerships in which this affiliate is also the ultimate managing partner. Of this commitment, $1.4 million is on a standby basis and is subject to increase by $0.8 million upon the occurrence of certain contingencies. As of December 31, 1995, the Company had invested $1.2 million in these limited partnerships. In 1993, a senior term loan and approximately $5 million of senior subordinated notes the Company had previously loaned to certain of the companies acquired were repaid. During 1993, the remaining senior subordinated notes were written off.
In June 1990, the Company committed to invest $10 million, as a limited partner, in acquisition transactions in which another stockholder serves as the ultimate general partner. During 1992, the Company's previous investment as a limited partner in three acquisitions totaling $7.1 million was converted to common stock of the acquired companies. All of the stock was sold during 1993 and 1994.
During 1992 and 1993, the Company committed to invest an aggregate of $10 million, as a limited partner, in real estate transactions in which an affiliate of a stockholder is the ultimate managing partner. As of December 31, 1994 and 1995, the Company had invested $9.1 million and $13.9 million, respectively, in this limited partnership. As of December 31, 1993, the Company had invested $2.5 million in another limited partnership controlled by an affiliate of this stockholder. During 1994, the Company committed to invest an additional $5.0 million in the limited partnership. As of December 31, 1995, the Company's investment in this limited partnership totaled $6.5 million.
As of December 31, 1995 and 1994, the Company had invested $2 million, as a limited partner in an acquisition in which an affiliate of a stockholder is the managing partner. In addition, as of December 31, 1993, the Company had invested $7.1 million, in a Senior Loan of the company acquired. The loan was paid off in March 1994. During 1994, the Company committed to invest $1.0 million in another acquisition sponsored by an affiliate of this stockholder. As of December 31, 1995, no investment had been made in this acquisition.
During 1993, the Company invested $4.0 million as a limited partner in an investment transaction in which another stockholder serves as the ultimate general partner.
15. LINES OF BUSINESS The Company operates principally in the individual life insurance, annuity and accident and health lines of business. Assets and related investment income are allocated to the lines of business on their respective liabilities and to corporate based on the total capital structure. Information as to the Company's lines of business is as follows (in thousands):
Earnings on the individual life and annuity lines include net charges of $58.5 million and $8.1 million, respectively, relating to the revision of estimated future gross profits used to amortize deferred policy acquisition costs and deferred policy fees (See Note 1).
Purchases of fixed maturities available-for-sale and held-to-maturity in 1995, totaled $376.0 million and $13.3 million, respectively. Purchases of fixed maturities available-for-sale and held-to-maturity in 1994 totaled $853.2 million and $988.8 million, respectively.
17. EXTRAORDINARY LOSS In 1993, the Company realized extraordinary losses in the aggregate of $7.3 million resulting from the extinguishment of debt. The extraordinary losses are reflected net of the estimated tax effect of $2.5 million.
18. QUARTERLY FINANCIAL DATA (UNAUDITED) (CONTINUED) policy acquisition costs and deferred policy fees, resulting in a $66.6 million net reduction in such balances (See Note 1). Also during the fourth quarter of 1995, the Company revised its liability for guarantee fund assessments, resulting in a $1.9 million increase in the liability (See Note 1).
19. SUBSEQUENT EVENT On March 11, 1996, the Company and Conseco, Inc. ("Conseco") jointly entered into a definitive merger agreement providing for all shareholders of the Company to receive Conseco stock for each of their shares through a share exchange based upon a value of $21.00 per share for Life Partners stockholders. The total value of the transaction would be approximately $840 million, including $600 million to purchase the Company's outstanding common stock and $240 million of existing debt to be assumed by Conseco. Under the merger agreement, Life Partners would become a wholly owned subsidiary of Conseco. Consummation of the merger is subject to customary terms and conditions, including approval by both the stockholders of the Company and Conseco and regulatory authorities. A termination fee of $20 million is payable under certain circumstances by either party if its shareholders do not approve the transaction.