- --------------- (1) The balance sheet data presented as of December 31, 1996 and 1995 and the income statement data for December 31, 1995 were derived from unaudited financial information not included elsewhere herein.
The following discussion addresses financial condition and results of operations of the Company for the periods indicated. The discussion and analysis of the Company's financial condition and results presented below should be read in conjunction with the "Selected Financial Information" and the Financial Statements and related footnotes and other financial information included elsewhere herein.
The Company's profitability depends in large part upon (i) the amount of its assets, (ii) the adequacy of its product pricing (which is primarily a function of competitive conditions, management's ability to assess and manage trends in mortality and morbidity experience as compared to the level of benefit payments, and its ability to maintain expenses within pricing assumptions), (iii) the maintenance of the Company's target spreads between credited rates on policyholders' account balances and the rate of earnings on its investments, (iv) the persistency of its policies (which affects the ability of the Company to recover the costs incurred to sell a policy) and (v) its ability to manage the market
and credit risks associated with its invested assets. External factors, such as legislation and regulation of the insurance marketplace and products, may also affect the Company's profitability.
UL product fees were $50.9 million for 1999, a decrease of $2.4 million, from $53.3 million reported in the comparable prior year period. The decrease is primarily due to reduced loading and surrender charges of $2.0 million and lower unearned revenue (amount assigned to the policyholders for future services) of $0.5 million.
Net investment income was $94.7 million for 1999, an increase of $0.1 million, or 0.1%, from $94.6 million reported in the comparable prior year period. The increase is primarily related to an increase in the average balances of invested assets of $6.5 million between the periods, which was partially offset by a 7 basis point decrease in portfolio yields.
Net realized losses on investments were $0.3 million for 1999, a change of $7.4 million, or 104.2%, from net realized gains of $7.1 million reported in the comparable prior year period. The decrease is primarily due to lower sales/ prepayment gains on fixed maturities of $3.2 million, lower sales gains on real estate and real estate partnerships of $2.0 million, higher losses on provisions for allowances on mortgage loans and real estate of $1.2 million and lower mortgage sales gains of $1.0 million.
Benefits to policyholders were $43.6 million for 1999, an increase of $8.7 million, or 24.9%, from $34.9 million reported in the comparable prior year period. The increase is primarily a result of higher UL death claims of $5.1 million to $30.8 million in 1999 from $25.7 million in 1998. Corporate-owned life insurance ("COLI"), a new product introduced in 1998, death claims (before reinsurance) increased to $2.9 million in 1999 from $0.0 million in 1998.
traditional life products and an increase of $1.4 million due to higher expected gross profits in the FPVA business offset by the effect of the FPVA exchange program.
Other operating costs and expenses were $73.8 million for 1999, a decrease of $1.8 million, or 2.4%, from $75.6 million reported in the comparable prior year period. The decrease is due to higher capitalized DAC slightly offset by higher general expenses and commissions.
VUL and CSVUL product fees were $20.7 million for 1998, an increase of $3.5 million, from $17.2 million reported in the comparable prior year period. The increase relating to the Company's VUL and CSVUL business was $1.8 million and $1.7 million, respectively. The Company began offering CSVUL during the fourth quarter of 1997. For 1998, the Company reported total fees from its VUL business of $18.9 million, as compared to $17.1 million reported from 1997. The increase in VUL fees is primarily due to higher charges for the cost of insurance, administration, and loading of approximately $5.0 million, $0.7 million and $1.6 million, respectively.
Net realized gains on investments were $7.1 million for 1998, an increase of $4.4 million, or 163.0%, from $2.7 million reported for 1997. The increase is primarily due to $2.7 million in gains on sales and prepayments of fixed maturity securities, higher gains on sales of real estate of $1.1 million, and higher gains on sales of farm mortgages of $0.5 million.
Benefits to policyholders were $34.9 million for 1998, an increase of $4.3 million, or 14.1%, from $30.6 million reported for 1997. The increase is primarily due to higher death claims, net of reinsurance, and higher transfers to supplementary contracts.
Interest credited to policyholders' account balances was $65.1 million for 1998, a decrease of $7.4 million, or 10.2%, from $72.5 million reported for 1997. The decrease was primarily due to lower interest crediting of approximately $3.9 million relating to the Company's SPDA business in conjunction with lower interest crediting on all other products. During 1998, SPDA account value decreased $62.2 million to $303.7 million at December 31, 1998 from $365.9 million at December 31, 1997. The decrease in account value was due to continued withdrawals in 1998, as compared to 1997, which management believes reflected consumer preferences for separate account products. Average interest crediting rates on the Company SPDA's were approximately 5.5% in both 1998 and 1997, respectively.
The events most likely to cause an adjustment in the Company's investment policies are: (i) a significant change in its product mix, (ii) a significant change in the outlook for either the economy in general or for interest rates in particular and (iii) a significant reevaluation of the prospective risks and returns of various asset classes.
The following table sets forth the withdrawal characteristics and the surrender and withdrawal experience of the Company's total annuity reserves and deposit liabilities at December 31, 1999 and 1998.
Annuity surrenders have increased for the year ended December 31, 1999 as compared to the comparable prior year period primarily due to the aging of the block of business and consequent decrease in surrender charge rates and due to an increase in competition. In July 1999, the Company has responded to this trend by enhancing its variable annuity products by offering new investment fund choices.
During 1999, the Company reported cash used in operations of $64.6 million, as compared to $13.0 million during 1998, an increase of $51.6 million between the periods. The decrease in net cash flow from operations resulted primarily from higher operating expense of $29.2 million, higher benefits payment of $15.7 million and lower cash net investment income of $4.8 million. In 1999, net cash flow provided by financing activities was $70.4 million, an increase of $56.2 million from $14.2 million in the prior year. This increase is primarily due to the receipt of cash on the issuance of a note payable to MBMC in the amount of $50.5 million (see Note 3 of the Financial Statements.) The Company's liquid assets include U.S. Treasury holdings, short-term money market investments and marketable long-term fixed maturity securities. As of December 31, 1999, the Company had readily marketable fixed maturity securities with a carrying value of $1,048.8 million, which were comprised of $539.6 million public and $509.2 million private fixed maturity securities. At that date, approximately 94.8% of the Company's fixed maturity securities were designated in NAIC rating categories 1 and 2 (considered investment grade, with a rating of "Baa" or higher by Moody's or "BBB" or higher by S&P). In addition, at December 31, 1999, the Company had cash and cash equivalents of $28.9 million. Management believes that the Company's sources of liquidity are adequate to meet its anticipated needs.
At December 31, 1999, the Company had commitments to issue $3.7 million of fixed rate agricultural loans with periodic interest rate reset dates. The initial interest rates on such loans range from 7.90% to 8.44%. The Company had no commitments outstanding for private fixed maturity securities as of December 31, 1999. In addition, at that date the Company had no outstanding commitments to issue any fixed rate commercial mortgage loans.
Of the $52.8 million of currently outstanding commercial mortgage loans in the Company's investment portfolio at December 31, 1999, $2.2 million, $4.6 million and $8.7 million are scheduled to mature in 2000, 2001 and 2002, respectively. See "Investments -- Mortgage Loans -- Commercial Mortgage Loans".
Aggregate contractual debt service payments on the Company's debt at December 31, 1999, for 2000 and the succeeding four years are $5.4 million each year and $49.8 million thereafter.
The total cost of the Project was $2.4 million. The Company does not expect to incur any material future costs on the Project.
The Company has not experienced any material (or significant) Year 2000 related problems post-December 31, 1999 with its operations or with any external parties with which business is conducted. Based on this experience and the amount of work and testing the Company has previously performed, the Company believes the likelihood of a Year 2000 issue that would have a material effect on the Company's financial position and results of its operations continues to be remote as the Company performs month-end, leap year, quarter-end, and year-end processing. However, there is still the possibility that future Year 2000 related failures in the Company's systems or equipment and/or failure of external parties to achieve Year 2000 compliance could have a material adverse effect on the Company's financial position and results of its operations.
General account assets are managed to support all of the Company's life insurance and annuity lines of business. With respect to the general account, the Company seeks to protect policyholders' benefits through asset/liability matching, emphasizing safety of principal, maintaining sufficient liquidity and avoiding undue asset concentrations through diversification. At the same time, the Company seeks to produce an investment return that supports competitive product pricing and which contributes to achieving the required risk adjusted return on surplus. The Company's general account consists of a diversified portfolio of investments. Although all the assets of the general account support all the Company's liabilities, the Company has developed separate investment portfolios for specific classes of product liabilities within the general account. The investment area works closely with the business lines to develop investment guidelines,
- --------------- (1) Real estate to be disposed of was $1.6 million and $0.0 million for 1999 and 1998, respectively. Real estate held for investment was $5.3 million and $8.3 million for 1999 and 1998, respectively.
The following tables present the Company's private, public and total fixed maturities by NAIC designation and the equivalent ratings of the Nationally Recognized Securities Rating Organizations as of December 31, 1999 and 1998, as well as the percentage, based on fair value, that each designation comprises.
The Company defines potential problem securities in the fixed maturity category as securities of companies that are deemed to be experiencing significant operating problems or difficult industry conditions. Typically these securities are experiencing or anticipating liquidity constraints, having difficulty meeting projections/budgets and would most likely be considered a below investment grade risk. The fair value of potential problem fixed maturities was $6.4 million and $16.4 million at December 31, 1999 and 1998, respectively.
CMOs are purchased to diversify the portfolio risk characteristics from primarily corporate credit risk to a mix of credit and cash flow risk. The majority of the CMOs in the Company's investment portfolio have relatively low cash flow variability. In addition, approximately 70.4% of the CMOs in the portfolio have minimal credit risk because the underlying collateral is backed by the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation, or the Government National Mortgage Association. These CMOs offer greater liquidity and higher yields than corporate debt securities of similar credit quality and expected average lives.
Asset-backed securities ("ABS") are purchased both to diversify the overall credit risks of the fixed maturity portfolio and to provide attractive returns. The ABS portfolio is diversified both by type of asset and by issuer. The largest asset class exposure in the ABS portfolio is to credit card receivables. These are comprised of pools of both general purpose credit card receivables such as Visa and Mastercard and private label credit card receivable pools. Excluding the exposures to home equity loans (which represented 6.3% and 10.8%, of the ABS portfolio as of December 31, 1999 and 1998, respectively), the ABS portfolio is in general insensitive to changes in interest rates. As of December 31, 1999 and 1998, respectively, the ABS portfolio did not contain any pools of assets outside of the United States.
Following is a summary of the Company's commercial mortgage loans by geographic area and property type as of December 31, 1999 and 1998.
The carrying value of commercial mortgage loans at December 31, 1999 was $52.8 million, which amount is net of valuation allowances aggregating $1.1 million which represents management's best estimate of cumulative impairments at such date. However, there can be no assurance that increases in valuation allowances will not be necessary. Any such increases may have a material adverse effect on the Company's financial position and results of operations.
Gross interest income on restructured commercial mortgage loan balances that would have been recorded in accordance with the loans' original terms was approximately $1.1 million and $1.4 million at December 31, 1999 and 1998. As a result of the restructurings, the gross interest income recognized in net income at December 31, 1999 and 1998 was $0.9 million and $1.0 million.
The carrying value of the Company's agricultural mortgage loans was $112.2 million and $92.5 million at December 31, 1999 and 1998, respectively, representing 68.0% and 77.0% of total mortgage assets. The agricultural mortgage portfolio is diversified both geographically and by type of product. The security for these loans includes row crops, permanent plantings, dairies, ranches and timber tracts. Due to strong agricultural markets and advantageous yields, the Company expects to continue to invest in agricultural mortgage investments. Less than 1.0% and 0.0% of total agricultural loans outstanding at December 31, 1999 and 1998, respectively, were delinquent or in process of foreclosure.
(2) As of December 31, 1999 and 1998, there were $0.1 million and $0.0 million valuation allowances/writedowns relating to problem, potential problem and restructured agricultural mortgages.
Equity real estate is categorized as either "Real estate held for investment" or "Real estate to be disposed of". Real estate to be disposed of consists of properties for which the Company has commenced marketing efforts. The carrying value of real estate held for investment totaled $5.3 million and $8.3 million as of December 31, 1999 and 1998, respectively. The carrying value of real estate to be disposed of aggregated $1.6 million and $0.0 million as of December 31, 1999 and 1998, respectively.
All of the Company's fixed maturity securities are classified as available for sale and, accordingly, are marked to market, with unrealized gains and losses excluded from earnings and reported as a separate component of accumulated other comprehensive income. Securities whose value is deemed other than temporarily impaired are written down to fair value. The writedowns are recorded as realized losses and included in earnings. The cost basis of such securities is adjusted to fair value. The new cost basis is not changed for subsequent recoveries in value. For the years ended December 31, 1999, 1998 and 1997 such writedowns aggregated $0.0 million, $0.4 million and $0.9 million, respectively.