In connection with its credit insurance operations, Consumers Life maintained a branch office in leased facilities in Philadelphia, Pennsylvania until December 31, 1997. The branch office primarily provided supervision, sales and service for credit insurance agents doing business in the eastern Pennsylvania, Delaware and New Jersey areas. Annual rental for this office was approximately $27,000.
Investors Fidelity Life Assurance Corp. maintained an office in leased facilities in Columbus, Ohio until December 31, 1997. This office primarily provided sales support and supervision for credit insurance agents in the State of Ohio. Annual rental for this office was approximately $13,000 plus insurance, taxes and utilities.
A review of the significant factors which affected the Company's 1997 operating performance as well as its financial position at December 31, 1997 is presented below. Information relating to 1996 and 1995 is also presented for comparative purposes. This analysis should be read in conjunction with the Consolidated Financial Statements and the related Notes appearing elsewhere in this Form 10-K.
Since the Company had received no other viable offers to acquire the entire organization, the Board of Directors and management determined that selling the Company's remaining business operations, liquidating all of its assets and distributing cash to the Company's shareholders was necessary in order to fully provide for the Company's obligations to its preferred shareholders and to preserve some value for the common shareholders. Therefore, following the termination the Merger and the review and evaluation of new bids for the Company's credit insurance operations, the Company signed an Asset Purchase Agreement (the "Agreement") on December 30, 1997 to sell its credit insurance and fee income business as well as the stock of one of its insurance subsidiaries to Life of the South Corporation, a Georgia-based financial services holding company ("LOTS"). The Board of Directors also adopted a plan of liquidation and dissolution (the "Plan of Liquidation and Dissolution") pursuant to which the Company will be liquidated and dissolved in accordance with provisions of the Pennsylvania Business Corporation Law. The Plan of Liquidation and Dissolution was approved by the Company s shareholders on March 24, 1998.
Premium revenues from credit insurance, the Division's principal product, declined 13.1% in 1997 following a 9.5% decrease in 1996 compared to 1995. Credit insurance premiums in 1997 totaled $26.1 million in 1997 compared to premiums of $30 million and $33.1 million in 1996 and 1995, respectively. The decline in premium revenues in all periods is the result of the cancellation by the Company of unprofitable accounts in several states over the past few years, but it also reflects the loss of accounts and the Company's inability to attract new accounts because of its financial condition.
Effective January 1, 1998, the Company will reinsure its September 30, 1997 inforce block of credit insurance business and 100% of the credit insurance premiums written and processed in the fourth quarter of 1997 to American Republic Insurance Company ("American Republic"), which is acting as LOTS' financial partner in this transaction. LOTS and the Company have also agreed that, with respect to the Company's principal insurance subsidiary, new credit insurance business produced by that subsidiary's former customer accounts, which have now been transferred to LOTS, will continue to be written on the policy or certificate forms of the subsidiary until September 30, 1999, or an earlier date which may be agreed to by the parties. This premium and the related insurance risk will also be reinsured 100% to American Republic.
During 1997, the parties agreed to make certain adjustments to the recapture consideration which, together with a $123,000 loss on bonds sold in 1997 in order to close the transaction, resulted in an additional loss on disposal of $167,000, net of income tax benefits, which has been reported in 1997. In 1996, excluding the $914,000 write-off, the Division reported pre-tax income of $393,000 compared to restated pre-tax income of $83,000 in 1995. The Division's operating results for 1996 and 1995 reflect the elimination of any continuing overhead and indirect costs which had previously been allocated to this Division.
In November 1996, the Company sold the auto auction business and related operating assets (property and equipment and inventories) of Interstate Auto Auction to ADESA Pennsylvania, Inc. for cash of $4.85 million. The Division's pre-tax income for the first nine months of 1996, which excluded any continuing overhead, was $554,000 compared to income of $732,000, as restated to eliminate any continuing overhead, in 1995. The operating results of the auto auction after September 30, 1996, when the Company finalized its plan to dispose of the business, were included with the gain realized on the disposal of the auction business. The auction generated an $84,000 pre-tax loss ($57,000 after taxes) during this period. Approximately $1.7 million of the proceeds from the sale of the auto auction business was used to repay the remaining amount due on the Company's bank loans.
A discussion of the important elements affecting the Company's financial position at December 31, 1997 and 1996 is presented below.
During the fourth quarter of 1997, the Company sold a substantial portion of its bond portfolio in connection with the planned sale of its credit insurance business to LOTS. At the closing of the transaction, which is expected to occur in April 1998, the Company will deliver cash to cover the statutory reserve liabilities reinsured to American Republic, as LOTS' financial partner.
The bonds were sold in 1997 not only to provide the liquidity necessary to close the transaction but also to eliminate the market risk on the portfolio during the period prior to closing. The proceeds from the sale of the securities were reinvested in money market funds. As a result, 80% of the Company's total invested assets at the end of 1997 were short-term investments. The Company sold most of its remaining bonds in early 1998.
Prior to the sale of its various insurance operations, the Company s general investment policy emphasized fixed maturity securities (primarily bonds) with Moody's or Standard and Poor's ratings of A or better and mortgage loans with terms generally not more than seven years. The Company did not invest in non-investment grade securities because the greater returns on such investments did not justify the potentially greater risks.
During 1997, the Company increased its loan loss reserves for mortgage loans and investment and non-investment real estate by $229,000. Loan loss reserves were increased by $35,000 and $93,000 in 1996 and 1995, respectively. Management believes that its reserves at December 31, 1997 are adequate to cover any possible losses which may develop in its mortgage loan and real estate portfolios. The carrying value of these investments at December 31, 1997 was $2.9 million compared to $3.4 million at the end of 1996.
The principal sources of cash funds of the life insurance subsidiaries have historically been premiums and investment income, as well as proceeds from sales and maturities of investments. These companies used cash primarily to pay commissions, claims and operating expenses. Credit insurance was the Company s principal product line and credit insurance premiums were therefore the Company s principal source of premium revenues. Credit insurance premium levels during the past five years are substantially lower than the premium levels prior to the economic recession in the early 1990's. This continued reduction in cash funds has depleted most of the Company s short-term cash reserves and has caused a decline in its long-term investment base. The assessment by the Company s management and its Board of Directors that this decrease in revenues and the related decline in operating results could not be reversed within a reasonable period of time led to the decision in early 1996 to evaluate other alternatives to best serve the interests of its shareholders, which, in turn, led to the plan referred to above and discussed elsewhere in this Management s Discussion.
The Company s total equity decreased significantly in 1997 due primarily to the $6.3 million net loss. The decrease is also attributable to $409,000 in dividends paid to preferred shareholders. Total equity, including redeemable preferred stock, was $6.5 million at December 31, 1997 compared to $13.3 million at the end of 1996. Shareholders equity per common share also decreased from $3.31 at December 31, 1996 to $.78 at the end of 1997.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audits to ob- tain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and the significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Consumers Financial Corporation and subsidiaries as of December 31, 1997 and 1996, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted account- ing principles.
Consumers Financial Corporation is an insurance holding company which, until October 1, 1997, was a leading provider, through its subsidiaries, of credit life and credit disability insurance in the Middle Atlantic region of the United States. See Note 5 with respect to the sale of the Company s inforce credit insurance business and its credit insurance and fee income accounts.
The financial statements have been prepared on the basis of generally accepted accounting principles (GAAP) which, as to the life insurance company s u bsidiaries, vary from reporting practices prescribed or permitted by regulatory authorities. Certain prior year amounts have been reclassified to conform with classifications used for 1997.
Long-term debt: The carrying amount for long-term debt approximates its fair value.
Revenues for universal life-type policies and investment products consist of policy charges for the cost of insurance, policy administration, and surrenders assessed during the period, and expenses include interest credited to policy account balances and benefit claims incurred in excess of policy account balances. For credit insurance, premiums are earned over the terms of the policies, as discussed above. Policy and contract claims include provisions for claims reported and claims incurred but not reported. The Company believes that the liabilities for claims and related expenses are adequate. Anticipated investment income is considered in determining whether future earned premiums on existing credit insurance will be sufficient to cover the present value of future benefits and maintenance expenses and to recover the unamortized portion of deferred policy acquisition costs.
In 1997, the Company adopted Statement of Financial Accounting Standards No. 128, Earnings Per Share (SFAS 128). Under SFAS 128, the calculation of primary and fully diluted earnings per share has been replaced with basic and diluted earnings per share. The basic earnings per share calculation differs from primary earnings per share in that it excludes the dilutive effects of options, warrants and convertible securities, while the calculation of diluted earnings per share is about the same as the previous fully diluted earnings per share calculation. Adoption of SFAS 128 had no effect on the per share amounts previously reported for 1996 and 1995 because the Company s stock options and convertible securities are anti-dilutive for those periods.
The more significant GAAP applied in the preparation of the financial statements that differ from life insurance statutory accounting practices prescribed or permitted by regulatory authorities (which are primarily designed to demonstrate solvency) are as follows:
(a) Investments in securities of unaffiliated companies are reported as described in Note 2, rather than in accordance with valuations established by the National Association of Insurance Commissioners (NAIC). Pursuant to NAIC valuations, bonds eligible for amortization are reported at amortized value; other securities are carried at values prescribed by or deemed acceptable to the NAIC, including common stocks, other than stocks of affiliates, at market value.
(b) Costs of acquiring new business are deferred and amortized rather than being charged to operations as incurred.
(h) Loan origination fees are deferred and recognized over the life of the applicable mortgage as an adjustment of yield rather than being reported in income as received.
Insurance laws require that certain amounts be deposited with various state insurance departments for the benefit and protection of policyholders. The approximate carrying amounts of such deposits at December 31, 1997 and 1996 were $1.9 million and $5.3 million, respectively.
For statutory reporting purposes, the Company utilizes an accelerated method of reserving disability unearned premiums which allows the Company to recognize revenue in a manner which more appropriately matches its incidence of claims. In addition to the use of this unearned premium method, which was approved by the Delaware Insurance Department, the insurance subsidiaries have also received approval from their respective domiciliary states to carry as an admitted asset a receivable for certain credit insurance premiums, net of commissions, which have been collected by the companies agents but have not yet been remitted to the companies. At December 31, 1997 and 1996, the premiums in process of collection receivable totaled $1.5 million and $1.8 million, respectively.
On October 30, 1996, the Company entered into an Agreement and Plan of Merger (the Merger Agreement) with LaSalle Group, Inc. (LaSalle) and an affiliate of LaSalle whereby the Company would have become a wholly-owned subsidiary of LaSalle (the Merger). The Merger was subject to, among other things, the approval of insurance regulators in the four states in which the Company s insurance subsidiaries were domiciled and the approval of the Company s common shareholders. Although the shareholders voted to approve the Merger at a meeting held on March 25, 1997, LaSalle disclosed to the Company on May 15, 1997 that its original source of funding for the Merger was not likely to be available within a reasonable period of time and that it was in the process of securing alternate funding. At that time, the Company exercised its right to renew its search for another acquiror to protect the Company in the event LaSalle s funding would not be available.
The operating losses incurred by the Company over the past five years have significantly reduced the Company s net worth and its liquidity position. Consequently, in March 1996, the Company announced its plans to explore various alternatives for selling or merging its remaining business operations, which included credit insurance and related products, the auto auction business conducted through Interstate and a closed block of assumed universal life business. The Company had previously sold its traditional whole life, term and annuity business in 1992 and the majority of its universal life business in 1994, both of which were part of the individual life insurance division.
In March 1997, the Company completed a reinsurance transaction with World, in which World recaptured the individual life insurance business previously assumed by the Company from World through a joint venture agreement. World initially paid the Company a recapture consideration equal to $1.05 million in exchange for the transfer to World of assets supporting the net statutory basis policy reserves for this business. The recapture transaction resulted in an after-tax loss of approximately $900,000 which was reported by the Company in the fourth quarter of 1996. During 1997, the parties agreed to make certain adjustments to the recapture consideration which, together with a $123,000 loss on bonds sold in 1997 in order to close the transaction, resulted in an additional loss on disposal of $167,000, net of income tax benefits. As indicated above, the Company had previously sold all of its other individual life insurance business. Accordingly, in the accompanying financial statements, the operating results of the Company s individual life insurance division have been reported as discontinued operations for all periods presented.
In addition to the above transactions, the Asset Purchase Agreement also provides for (i) the sale, effective January 1, 1998, of the Company s September 30, 1997 inforce block of credit insurance business to American Republic Insurance Company, an Iowa-domiciled insurance company (American Republic), which is acting as LOTS financial partner in this transaction and (ii) the sale of one of the Company s wholly-owned reinsurance subsidiaries to LOTS as of January 1, 1998. The sale of the inforce business referred to in (i) above required the approval of the Company s preferred and common shareholders and the approval of insurance regulators in Delaware and Ohio, the domiciliary states of the two insurance subsidiaries which produced the credit insurance business. The Company s shareholders approved the transaction at a special meeting held on March 24, 1998 (the Special Meeting). The Delaware and Ohio insurance departments approved the reinsurance agreements which provide for the transfer of the insurance business on February 17, 1998 and March 30, 1998, respectively. The sale of the subsidiary referred to in ( ii) above requires the approval of the insurance regulators in the state of Arizona, the subsidiary s state of domicile, which approval has not yet been received.
Based upon the reinsurance consideration to be received for the sale in 1998 of the inforce credit insurance business, the transaction will result in an after-tax loss of approximately $3.9 million, which has been reflected in the Company s 1997 financial statements through a write-down of deferred policy acquisition costs. The estimated loss on disposal includes a loss from operations of approximately $800,000 from September 30, 1997 (the measurement date) to December 31, 1997, net of an income tax benefit of $363,000.
At the Special Meeting, the Company s preferred and common shareholders also approved the Plan of Liquidation and Dissolution, pursuant to which the Company intends to liquidate its remaining assets, provide for all of its liabilities, redeem its preferred stock at par value ($10 per share) and distribute all remaining cash to its common shareholders. Pursuant to the terms of the Asset Purchase Agreement, the Company will receive payments from LOTS over a five-year period based on the amount of credit insurance premiums produced by the customer accounts sold by the Company to LOTS. The Company may also receive a payment from a contingency fund established by the parties based on the claims experience on the inforce credit insurance business from October 1, 1997 to September 30, 2002. As a result, the final distribution to the Company s common shareholders will not be made until late in 2002 when the amounts due from LOTS have been received. The Company has made substantial reductions in its number of employees during the past several years as a result of the events described above. As of March 31, 1998, eight people are employed by the Company. During the liquidation period, the Company intends to outsource most of the functions which will continue to be required.
A summary of the results of operations of the discontinued segments is presented below:
If the Company had reinsured all of its credit insurance business to American Republic as of December 31, 1997, the Company s remaining assets and liabilities would consist principally of $5.8 million in cash and invested assets (primarily bonds, mortgage loans and short-term investments), $1.4 million in receivables, $2.6 million in property and equipment, non-investment real estate and other assets, $1.2 million in policy liabilities on a closed block of extended service contract business and $2.1 million in other liabilities.
A portion of the Company's invested funds is restricted as to use. Deposits are required with various state insurance departments for the benefit and protection of policyholders (see Note 3).
At December 31, 1997 and 1996, no mortgage loans or other loans were considered to be non-performing loans.
The amortized cost and estimated fair values of investments in debt securities at December 31, 1997 and 1996 are as follows:
Proceeds from the sales of investments in debt securities during 1997 were $48 million. Gross gains of $446,000 and gross losses of $247,000 were realized on those sales. Proceeds from such sales in 1996 were $4.1 million. Gross gains of $6,000 and gross losses of $20,000 were realized on those sales. Proceeds from sales in 1995 were $4.1 million. Gross gains of $3,000 and gross losses of $29,000 were realized on those sales.
The composition of future policy benefits and unearned premiums at December 31, 1997 and the assumptions pertinent thereto are as follows:
The withdrawal assumptions for individual life insurance are predominantly Linton B and Linton C.
Transactions affecting the Company s credit disability claim liabilities and reserves, net of reinsurance, are summarized as follows:
The life insurance companies routinely cede and, in certain instances, assume reinsurance. Ceded insurance is treated as a risk and liability of the assuming companies. Net premium income, benefits, and expenses are presented net of non-financing reinsurance ceded and include non-financing reinsurance assumed.
The life insurance companies have entered into various financing-type reinsurance agreements with unaffiliated insurance companies. Such agreements are primarily designed to minimize the reduction of statutory capital and surplus arising at the time premiums are written. In connection with these agreements, the insurance subsidiaries have received and reported, in the aggregate, approximately $22.8 million at December 31, 1997 as an advance of future statutory profits on the blocks of business reinsured under these agreements. The life insurance subsidiaries are obligated to repay the advances from future statutory profits. The effects of these agreements have been removed from the financial statements except for the cost of this financing, which amounted to $660,000, $608,000 and $603,000 in 1997, 1996 and 1995, respectively. All of these financing-type reinsurance agreements were termina- ted effective January 1, 1998 when the Company s credit insurance business was reinsured to American Republic (see Note 5).
Excluding premiums reinsured under financing-type agreements, credit insurance premiums ceded to other companies were $3.4 million, $10.4 million and $12 million in 1997, 1996 and 1995, respectively.
In 1990, the Company obtained financing in the form of a $10 million term loan. In 1993, the terms of this loan were restructured, resulting in the elimination or modification of several financial covenants, a reduction in the Company s required debt service payments and the transfer of a portion of the remaining balance to Interstate pursuant to a separate loan agreement. In 1995, the Company further restructured the new loans. These restructuring changes included an extension of the maturity date of the loans, the removal of several additional financial covenants and the transfer of an additional portion of the remaining loan balance directly to Interstate. A balloon payment was due at the end of the term. The interest rate on these loans was one percentage point above the bank s prime rate. The Company assigned all of the outstanding common stock of Consumers Life, Interstate and Consumers Car Care Corporation as security for its loan, while Interstate s property and equipment and its inventories were separately pledged for Interstate s loan. The security for each loan was cross- collateralized to the other loan. Both of these loans were repaid in full in 1996 in connection with the sale of the Company s auto auction business, resulting in a release of the liens on Interstate s property and equipment and the release of the stock of the subsidiaries (see Note 5).
Interest costs incurred on long-term debt were $230,000 in 1996 and $286,000 in 1995.
The Company has a defined benefit pension plan and two profit sharing plans which cover substantially all full-time employees. Contributions under the pension plan are based upon length of service and annual compensation of each employee. The assets of the pension plan include principally debt securities and mortgages. Effective July 31, 1996, the Company froze the benefits payable to participants under the pension plan. As a result, contributions to the plan, which have approximated $200,000 per year in recent years, were approximately $100,000 in 1997 and will decrease further in future years.
Rental expense in 1997, 1996 and 1995 was approximately $345,000, $351,000 and $355,000, respectively.
In connection with the cancellation of a joint venture agreement in 1996, the Company had agreed to pay $500,000 in cash to its former joint venture partner at the time the planned Merger with LaSalle was consummated. As a result of the termination of the Merger Agreement, as discussed in Note 5, the $500,000 payment will not be made. The Agreement with the joint venture partner provided that in the event the Merger with LaSalle was not completed, any payment to the joint venture partner would be determined under a separate calculation as follows: (a) if the Company entered into a transaction similar to the LaSalle transaction in which it was acquired by or merged with another entity, the parties agreed to negotiate a mutually acceptable termination price; (b) if the Company entered into a transaction whereby, as part of a plan to terminate its insurance operations and sell all of its assets, it sold its credit insurance marketing organization to an unrelated third party, the Company agreed to pay its former partner a pro rata share of the proceeds, if any, it receives from the sale of the marketing organization. The Company agreed to make such payments to the joint venture partner as consideration for terminating the venture, which will allow the purchaser of the Company s credit insurance business to retain the profits or losses on credit insurance premiums previously reinsured to the partner. The transaction with LOTS meets the criteria described in (b) above, and the Company therefore will pay approximately 19% of the gross fee revenues received from LOTS to the former partner.
In connection with the sale of Interstate s business, as discussed in Note 5, the Company provided the buyer with limited indemnifications with respect to certain potential environmental liabilities asserted within two years from the closing date. The Company does not believe that these limited indemnifications will have a materially adverse effect on the Company's financial position or results of operations.
Annual dividends at the rate of $.85 per share are cumulative from the date of original issue and are payable quarterly on the first day of January, April, July and October. Except in certain limited instances, the holders of the Preferred Stock have no voting rights. Beginning July 1, 1998, a sinking fund will be established requiring annual payments sufficient to redeem 10% of the number of shares of Preferred Stock initially issued, calculated to redeem all of the Preferred Stock by July 1, 2007.
The difference between the fair value of the Preferred Stock at the date of issue and the mandatory redemption value is being recorded through periodic accretions, using the interest method, with the related charge to retained earnings ($36,000 in 1997, 1996 and 1995).
At December 31, 1997 and 1996, 713,275 shares of common stock were reserved for the conversion of the Preferred Stock. 16. STOCK OPTIONS
In May 1982, the shareholders of the Company approved a Stock Option Plan which permitted the granting of incentive stock options (as defined in the Internal Revenue Code). The Plan provided for the granting of stock options to purchase shares of the Company's common stock at at price not less than its fair market value on the date of grant. Options granted under the Plan expire not later than six years from the date of grant. The Plan authorized 300,000 shares for purchase upon the exercise of such options, which were made available from either authorized but unissued shares or shares issued and reacquired by the Company.
The grant price with respect to a freestanding SAR or an SAR granted in tandem with an option is the fair market value of the Stock on the date of the grant. Upon exercise of an SAR, the participant is entitled to receive up to, but no more than, an amount in cash or Stock equal to the excess of the fair market value of the shares with respect to which the SAR is exercised (calculated as of the exercise date) over the grant price of the SAR. Payment by the Company upon a participant's exercise could be in cash or Stock, as the Committee may determine. With respect to SARs granted together with options, any related option will no longer be exercisable to the extent the SAR is exercised and the exercise of any option will cancel the related SAR to the extent of such exercise.
The Company and all but one of its subsidiaries file a consolidated Federal income tax return. One insurance company subsidiary files a separate return. At December 31, 1997 the life insurance companies have available approximately $5.9 millon of Federal net operating losses. These losses will be carried forward to future years, and may only be used to offset the taxable income of the life insurance companies. Approximately $3.6 million of these net operating losses are subject to limitations on their use under Internal Revenue Code Section 382 and the consolidated return regulations. This operating loss will expire in 2004. The remaining $2.3 million of net operating losses will expire in 2009 and 2012.
The following table sets forth the computation of basic and diluted per share data.
In June 1997, the Company redomesticated its North Carolina insurance subsidiary to the state of Texas in connection with the sale of the subsidiary in August 1997 to Safeguard Health Enterprises, Inc. located in Anaheim, California. The redomestication was required by the North Carolina Insurance Department in order to sell the subsidiary, since that department no longer permits North Carolina domestic companies to have their principal administra- tive offices located outside the state. The sale of the stock of the subsidiary resulted in a gain to the Company of approximately $234,000.
The Company has received correspondence from and conducted discussions w i th various state insurance departments concerning the surplus relief reinsurance agreements, capital levels and unprofitable operations of certain of the Company s insurance subsidiaries. These insurance departments have indicated their expectation that the insurance subsidiaries would be sold or merged or otherwise raise additional capital. Failure to complete the reinsurance and related transactions with American Republic and LOTS could subject the Company's insurance subsidiaries to possible sanctions which may include, among other things, restrictions on operations, mandatory asset dispositions and other forms of regulatory intervention. The financial statement impact, if any, of such regulatory actions cannot presently be determined.
On March 24, 1998, the Company s preferred and common shareholders, each voting separately as a class, approved the sale of the Company s September 30, 1997 inforce block of credit insurance to LOTS and also approved the Company s Plan of Liquidation and Dissolution. The sale of the insurance business will be accomplished through reinsurance agreements which were entered into in January 1998 between American Republic, LOTS financial partner, and each of the Company s two credit insurance subsidiaries. The reinsurance transactions are expected to be settled in April 1998, although the Company has included the estimated loss from these transactions in its 1997 financial statements (see Note 5). Under the Plan of Liquidation and Dissolution, the Company will ultimately be dissolved after distributing all of its remaining assets to its shareholders, as discussed in Note 5.