**Statutory data represents Standard Insurance Company and The Standard Life Insurance Company of New York.
Management believes that measuring net income return on average equity excluding after-tax net capital gains and losses from net income and AOCI from equity is important to investors because the low turnover of our portfolio of fixed maturity securities-available-for-sale (“fixed maturity securities”) may not be such that unrealized gains and losses reflected in AOCI are ultimately realized. Furthermore, management believes exclusion of AOCI provides investors with a better measure of return.
StanCorp Financial Group, Inc., through its subsidiaries marketed as The Standard-Standard Insurance Company (“Standard”), The Standard Life Insurance Company of New York, Standard Retirement Services, Inc. (“Standard Retirement Services”), StanCorp Mortgage Investors, LLC (“StanCorp Mortgage Investors”), StanCorp Investment Advisers, Inc., StanCorp Real Estate, LLC and StanCorp Equities, Inc. (“StanCorp Equities”)-is a leading provider of financial products and services. StanCorp’s subsidiaries offer group and individual disability insurance, group life and accidental death and dismemberment (“AD&D”) insurance, group dental and group vision insurance, absence management services, retirement plans products and services, individual annuities, origination and servicing of fixed-rate commercial mortgage loans and investment advice.
expenses were reduced by $20.6 million or $0.30 per diluted share for the first half of 2013 due to the amendment of our postretirement medical plan.
Asset Management reported income before income taxes of $77.9 million for 2014, compared to $79.3 million for 2013. Assets under administration, which include assets related to retirement plans, individual fixed annuities, private client wealth management and commercial mortgage loans managed for third-party investors, increased 7.4% to $26.53 billion at December 31, 2014 from $24.70 billion at December 31, 2013. The increase primarily reflected higher equity values and positive cash flows for retirement plan assets under administration. Commercial mortgage loan originations were $1.18 billion for 2014, compared to $1.30 billion for 2013. The decrease reflected increased competition in the commercial mortgage origination market.
We deployed $248.8 million of capital through our annual cash dividend to shareholders and the repurchase of shares and debt for 2014, while maintaining a strong balance sheet and growing book value per share, excluding AOCI, by 6.9% over the past 12 months.
These results show our commitment to our strategy of obtaining and retaining profitable business.
Capital gains and losses for fixed maturity securities are recognized using the specific identification method. If the fair value of a fixed maturity security declines below its amortized cost, we assess whether the decline is other than temporary.
The duration and extent the fair value has been below amortized cost.
If we determine an other-than-temporary impairment (“OTTI”) exists, we separate the OTTI of fixed maturity securities into an OTTI related to credit loss and an OTTI related to noncredit loss. The OTTI related to credit loss represents the portion of losses equal to the difference between the present value of expected cash flows, discounted using the pre-impairment yields, and the amortized cost basis. All other changes in value represent the OTTI related to noncredit loss. The OTTI related to credit loss is recognized in earnings in the current period, while the OTTI related to noncredit loss is deemed recoverable and is recognized in other comprehensive income (loss). The cost basis of the fixed maturity security is permanently adjusted to reflect the credit loss. Once an impairment has been recorded, we continue to review the OTTI securities for further potential impairment.
We maintain an internally identified list of fixed maturity securities with characteristics that could indicate potential impairment (“watch list”). At December 31, 2014, our fixed maturity securities watch list totaled $12.7 million at fair value and $15.2 million at amortized cost after OTTI. We recorded $1.2 million of OTTI related to credit loss due to impairments for 2014, compared to $1.1 million for 2013. We recorded no OTTI related to noncredit loss for 2014 and 2013. See Item 8, “Financial Statements and Supplementary Data-Notes to Consolidated Financial Statements-Note 1-Summary of Significant Accounting Policies-Investment Valuations-Fixed Maturity Securities-Available-for-Sale” for further disclosures.
We will continue to evaluate our holdings; however, we currently expect the fair values of our investments to recover either prior to their maturity dates or upon maturity. Should the credit quality of our fixed maturity securities significantly decline, there could be a material adverse effect on our business, financial position, results of operations or cash flows.
Fixed maturity securities are classified as available-for-sale and are carried at fair value on the consolidated balance sheets. See Item 8, “Financial Statements and Supplementary Data-Notes to Consolidated Financial Statements-Note 9-Fair Value” for a detailed explanation of the valuation methods we use to calculate the fair value of our financial instruments. Valuation adjustments for fixed maturity securities not accounted for as OTTI are reported as net increases or decreases to other comprehensive income (loss), net of tax, on the consolidated statements of comprehensive income.
Our real estate investments are recorded at the lower of cost or net realizable value. We generally depreciate real estate investments using the straight-line depreciation method with property lives varying from 30 to 40 years.
Real Estate Owned is initially recorded at net realizable value, which includes an estimate for disposal costs. This amount may be adjusted in a subsequent period as additional information is received. Our Real Estate Owned is initially considered an investment held for sale and is expected to be sold within one year from acquisition. For any real estate expected to be sold, an impairment is recorded if we do not expect the investment to recover its carrying value prior to the expected date of sale. Once an impairment has been recorded, we continue to review the investment for further potential impairment.
Our tax-advantaged investments are structured as limited partnerships and are accounted for under the equity method of accounting. We have purchased tax-advantaged investments opportunistically due to the higher risk-adjusted returns. The primary sources of investment return are tax credits and the tax benefits derived from operating losses, both of which may exhibit variability over the life of the investment. Tax credits received from these investments are reported in our consolidated statements of income as either a reduction of state premium taxes, or a reduction of income taxes based on the nature of the credit. Our share of the operating losses of the limited partnerships decreases the carrying value of the investments and is reported as a component of net investment income. If the net present value of expected future cash flows of the tax-advantaged investments is less than the current book value of the investments, we evaluate whether a decline in value is other than temporary. If it is determined an OTTI exists, the investment is written down to the net present value of expected future cash flows and the OTTI is recognized as a capital loss.
Interest rate swaps are recognized as either other invested assets or other liabilities in our consolidated balance sheets and are reported at fair value. The accounting for an interest rate swap depends on whether it has been designated and qualifies as part of a hedging relationship and on the type of hedging relationship. To qualify for hedge accounting, we document the risk management objective and strategy for undertaking the hedging transaction and the designation of the hedge as either a fair value hedge or a cash flow hedge at the inception of the hedging transaction. The documentation includes a description of how the interest rate swap is expected to hedge the designated risk related to specific assets or liabilities on our balance sheets, the method that will be used to prospectively and retrospectively assess the hedge effectiveness, the method that will be used to measure ineffectiveness and how this ineffectiveness will be recorded.
Changes in the fair value of an interest rate swap designated as a fair value hedge, including amounts measured as ineffective, and changes in the fair value of the hedged item, are recognized in the consolidated statements of income as a component of net capital gains and losses. The gain or loss on the termination of a fair value hedge is recognized in the consolidated statements of income as a component of net capital gains and losses during the period in which the termination occurs. When interest rate swaps are used in hedge accounting relationships, periodic settlements are recorded in net investment income.
We purchase S&P 500 Index options for our interest crediting strategy used in our indexed annuity product. The S&P 500 Index options are purchased from investment banks and are selected in a manner that supports the amount of interest that is expected to be credited in the current year to annuity policyholder accounts that are dependent on the performance of the S&P 500 Index. The purchase of S&P 500 Index options is a pivotal part of our risk management strategy for indexed annuity products. The S&P 500 Index options are exclusively used for risk management. Changes in the fair value of S&P 500 Index options are recorded in net investment income.
Cash settlement activity of derivative contracts is reported in the consolidated statements of cash flows as a component of proceeds from or acquisition of other invested assets. See Item 8, “Financial Statements and Supplementary Data-Notes to Consolidated Financial Statements-Note 11-Derivative Financial Instruments.”
Effective January 1, 2001, substantially all of our individual life insurance policies and the associated reserves were ceded to Protective Life Insurance Company (“Protective Life”) under a reinsurance agreement. Effective February 1, 2015, Protective Life was acquired by The Dai-ichi Life Insurance Company, Limited (“Dai-ichi Life”) and is a wholly-owned subsidiary of Dai-ichi Life. If Protective Life were to become unable to meet its obligations, Standard would retain the reinsured liabilities. Therefore, the associated reserves remain on Standard’s consolidated balance sheets and an equal amount is recorded as recoverable from the reinsurer. We also retain a small number of individual policies arising out of individual conversions from our group life policies.
The following table sets forth the average discount rate used for newly established long term disability insurance claim reserves and life waiver reserves:
The reserve discount rate is reviewed quarterly and reflects our current and expected new investment yields. The discount rate is based on the average rate we received on newly invested assets attributable to the corresponding line of business during the previous 12 months, less a margin. We also consider our average investment yield and average discount rate on our entire block of claims when deciding whether to increase or decrease the discount rate. A 25 basis point increase or decrease in the discount rate currently results in a corresponding increase or decrease in quarterly pre-tax income of approximately $2 million. We do not adjust Employee Benefits premium rates based on short-term fluctuations in investment yields. Any offsetting adjustments of Employee Benefits premium rates due to sustained changes in investment yields can take from one to three years given that most contracts have rate guarantees in place.
Claim termination rates can vary widely from quarter to quarter. The claim termination assumptions used in determining our reserves represent our expectation for claim terminations over the life of our block of business and will vary from actual experience in any one quarter. While we have experienced some variation in our claim termination experience, we did not see any prolonged or systemic change in 2014 that would indicate a sustained underlying trend that would affect the claim termination rates used in the calculation of reserves.
We evaluate the claim termination rate assumptions for the reserves on a small Minnesota Life Insurance Company (“Minnesota Life”) block of individual disability insurance claims annually. These assumptions were refined in 2014, 2013 and 2012, which resulted in an increase in reserves of $2.7 million, $2.1 million and $4.9 million, respectively. Our block of business is relatively small, and as a result, we view a blend of established industry tables and our own experience as a more appropriate method for establishing reserve levels compared solely to our own experience. We will continue to monitor the credibility of our developing experience and the use of available industry tables, and if necessary, will adjust reserves accordingly. We also refined our reserve calculation for certain other individual disability insurance reserves, which resulted in a net increase in our individual disability insurance reserves of $2.0 million and $5.1 million in 2014 and 2013, respectively and a net decrease of $1.1 million in 2012. The combination of these adjustments resulted in an overall net increase to individual disability reserves of $4.7 million, $7.2 million and $3.8 million in 2014, 2013 and 2012, respectively.
The following table sets forth the balances of DAC, VOBA and other intangible assets:
Our individual deferred annuities and group annuity products are classified as investment contracts. DAC related to these products is amortized over the life of related policies in proportion to expected gross profits. For our individual deferred annuities, DAC is generally amortized over 30 years with approximately 54% and 93% expected to be amortized by years 5 and 15, respectively. DAC for group annuity products is amortized over 10 years with approximately 76% expected to be amortized by year five.
These assumptions are modified to reflect actual experience when appropriate. Although a change in a single assumption may have an impact on the calculated amortization of DAC or VOBA for balances associated with investment contracts, it is the relationship of that change to the changes in other key assumptions that determines the ultimate impact on DAC or VOBA amortization. Because actual results and trends related to these assumptions vary from those assumed, we review, and if necessary, revise these assumptions annually to reflect our current best estimate of expected gross profits. As a result of this process, known as “unlocking”, the cumulative balances of DAC and VOBA are adjusted with an offsetting increase or decrease to income to reflect changes in the period of the revision. An unlocking event generally occurs as a result of actual experience or future expectations differing from previous estimates. We recorded a decrease to VOBA of $1.0 million in 2013 and $0.8 million in 2012 due to changes in expected gross profits related to a block of claims assumed. We did not record an adjustment to VOBA as a result of unlocking in 2014. As a result of unlocking, the amortization schedule for future periods is also adjusted.
We are required to recognize the funded status of our pension and postretirement benefit plans as an asset or liability on our consolidated balance sheets. For pension plans, this is measured as the difference between the plan assets at fair value and the projected benefit obligation as of the year-end balance sheet date. For our postretirement plan, this is measured as the difference between the plan assets at fair value and the accumulated benefit obligation as of the year-end balance sheet date. Unrecognized actuarial gains or losses, prior service costs or credits, and transition assets are amortized, net of tax, out of accumulated other comprehensive income or loss as components of net periodic benefit cost.
GAAP requires management to use a more likely than not standard to evaluate whether, based on available evidence, each deferred tax asset will be realized. A valuation allowance is recorded to reduce a deferred tax asset to the amount expected to be realized. We have recorded a deferred tax asset for loss carryforwards. Realization is dependent on generating sufficient taxable income prior to expiration of the loss carryforwards. Although realization is not assured, management believes it is more likely than not that the deferred tax asset for federal loss carryforwards will be realized. The amount of the deferred tax asset considered realizable, however, could be reduced in the near term if estimates of future taxable income during the carryforward period are reduced. Management has established a valuation allowance on some state and local loss carryforwards which it believes are not likely to be realized.
Income tax expense may differ from the amount computed by applying the federal corporate tax rate of 35% to pre-tax income because of the net results of permanent differences between book and taxable income, tax credits and the inclusion of state and local income taxes, net of the federal tax benefit. In addition, tax credits received due to the purchases of tax-advantaged investments also impact our federal tax rate. See Item 8, “Financial Statements and Supplementary Data-Notes to Consolidated Financial Statements-Note 7-Income Taxes.”
Premiums for Asset Management are generated from sales of life-contingent annuities, which are a single-premium product. Due to the competitive nature of single-premium products, premiums received by Asset Management can fluctuate widely from quarter to quarter due to low sales volume of life-contingent annuities and the varying size of single premiums. Increases or decreases in premiums for life-contingent annuities generally correlate with corresponding increases or decreases in benefits to policyholders.
Reserve assumptions-the assumptions used to establish the related reserves reflect expected incidence and severity, and the discount rate. The discount rate is affected by new money investment rates attributable to the corresponding line of business and the overall portfolio yield. See “Critical Accounting Policies and Estimates-Reserves for Future Policy Benefits and Claims.”
Benefits to policyholders for Asset Management primarily represent current benefits and the change in reserves for future benefits on life-contingent annuities. Changes in the level of benefits to policyholders will generally correlate to changes in premium levels because these annuities are primarily single-premium life-contingent annuity products with a significant portion of all premium payments established as reserves.
The benefit ratio for Employee Benefits is calculated as benefits to policyholders and interest credited as a percentage of premiums and is used to provide a measurement of claims normalized for growth in our in-force block. The benefit ratio for Employee Benefits can fluctuate widely from quarter to quarter and has historically been higher in the first half of the year. The benefit ratio for Individual Disability is calculated as benefits to policyholders as a percentage of premiums. Due to the relatively small size of the Individual Disability business, the benefit ratio for Individual Disability generally fluctuates more than Employee Benefits. See “Critical Accounting Policies and Estimates-Reserves for Future Policy Benefits and Claims” for more information.
The discount rate used for newly established long term disability insurance claim reserves and life waiver reserves is reviewed quarterly and reflects our current and expected new investment yields. The discount rate is based on the average rate we received on newly invested assets attributable to the corresponding line of business during the previous 12 months, less a margin. We also consider our average investment yield and average discount rate on our entire block of claims when deciding whether to increase or decrease the discount rate. A 25 basis point increase or decrease in the discount rate currently results in a corresponding increase or decrease in the quarterly pre-tax income of approximately $2 million or approximately $8 million for the full year. See “Critical Accounting Policies and Estimates-Reserves for Future Policy Benefits and Claims-Claim Reserves.”
Income taxes may differ from the amount computed by applying the federal corporate tax rate of 35% to pre-tax income because of the net result of permanent differences between book and taxable income, tax credits and the inclusion of state and local income taxes, net of the federal tax benefit.
Net income for 2014 was $219.3 million, compared to $228.5 million for 2013. The decrease in net income was primarily due to lower operating expenses for 2013, which included savings of $20.6 million due to the amendment of our postretirement medical plan, which did not recur in 2014.
The decrease in revenues for 2014 compared to 2013 was primarily due to a decrease in Employee Benefits premiums and net investment income. The decrease was partially offset by an increase in Individual Disability premiums and an increase in administrative fees from Asset Management. See “Business Segments-Insurance Services” and “Business Segments-Asset Management.”
The decrease in net investment income for 2014 compared to 2013 was primarily due to lower average portfolio yields for both fixed maturity securities and commercial mortgage loans as shown in the table above, in addition to the change in fair value of our S&P 500 Index options related to our equity-indexed annuity product and higher operating losses on tax-advantage investments for 2014, compared to 2013. The change in fair value of our S&P 500 Index options increased net investment income by $8.6 million for 2014, compared to an increase of $14.4 million for 2013. Operating losses on tax-advantage investments increased to $19.4 million for 2014, compared to $13.9 million for 2013. See “Business Segments-Insurance Services” and “Business Segments-Asset Management.”
The decrease in benefits to policyholders for 2014 compared to 2013 was primarily due to more favorable claims experience in Employee Benefits. See “Business Segments-Insurance Services.”
The decrease in the effective income tax rate for 2014 compared to 2013 was primarily due to the utilization of tax credits from tax-advantaged investments. See Item 8, “Financial Statements and Supplementary Data-Notes to the Consolidated Financial Statements-Note 7-Income Taxes” for more information.
The increase in administrative fees for 2013 compared to 2012 was primarily due to the increase in administrative fees from Asset Management as a result of an increase in assets under administration related to higher equity values for retirement plan assets under administration. See “Business Segments-Asset Management.”
The decrease in operating expenses for 2013 compared to 2012 was primarily due to expense management actions. Operating expenses were reduced by $20.6 million for the first half of 2013 due to the amendment of our postretirement medical plan. See “Business Segments-Other.”
The increase in the effective income tax rate for 2013 compared to 2012 was primarily due to higher taxable income relative to permanent book-to-tax differences for 2013. The increase was partially offset by the utilization of tax credits from tax-advantaged investments. See Item 8, “Financial Statements and Supplementary Data-Notes to the Consolidated Financial Statements-Note 7-Income Taxes” for more information.
Insurance Services is comprised of our Employee Benefits and Individual Disability segments.
Income before income taxes for Insurance Services was $254.7 million for 2014, compared to $272.4 million for 2013. The decrease in income before income taxes was primarily due to lower Employee Benefits premiums and lower net investment income, partially offset by more favorable claims experience in Employee Benefits.
The decrease in premiums for Employee Benefits for 2014 compared to 2013 was primarily due to lower sales during the first half of 2014 compared to prior periods. The decrease in new sales reflected our pricing discipline in a competitive group insurance market. See “Basis of Presentation-Premiums.”
The decrease in benefits to policyholders (including interest credited) for Insurance Services for 2013 compared to 2012 was primarily due to comparatively favorable claims experience in the Employee Benefits segment. The benefit ratio for Employee Benefits was 78.9% for 2013 compared to 83.9% for 2012. The decrease in the annual benefit ratio was primarily due to pricing actions implemented on our long term disability insurance business and an improvement in long term disability insurance claims incidence.
The benefit ratio for Individual Disability decreased to 63.9% for 2013, compared to 65.8% for 2012. Due to the relatively small size of the Individual Disability business, the benefit ratio generally fluctuates more than Employee Benefits. See “Critical Accounting Policies and Estimates-Investment Valuations-Claim Reserves” for more information.
The following tables set forth our Asset Management results of operations and key indicators:
The increase in operating expenses for Asset Management for 2014 compared to 2013 was primarily to support business growth, consistent with growth in assets under administration.
The Other category reported a loss before income taxes of $45.7 million for 2014, compared to a loss before income taxes of $38.7 million for 2013. Net capital losses were $14.0 million for 2014, compared to $15.7 million for 2013. The loss before income taxes excluding net capital losses was $31.7 million for 2014, compared to $23.0 million for 2013. The increase in the loss before income taxes for 2014 was primarily due to the amendment of our postretirement medical plan that resulted in a $20.6 million decrease in operating expenses for the first half of 2013, which did not recur in 2014.
The Other category reported a loss before income taxes of $38.7 million for 2013, compared to a loss before income taxes of $60.4 million for 2012. Net capital losses were $15.7 million for 2013, compared to $8.7 million for 2012. The loss before income taxes excluding net capital losses was $23.0 million for 2013, compared to $51.7 million for 2012. The loss before income taxes for 2013 included lower operating expenses, higher net investment income and lower interest expense.
The increase in net investment income for the Other category for 2013 compared to 2012 was primarily due to interest income from fixed maturity securities of $11.0 million for 2013, compared to $9.0 million for 2012, which was primarily due to a larger amount of invested assets allocated to the Other category. In addition, operating losses related to our tax-advantaged investments decreased to $2.0 million for 2013, compared to $3.8 million for 2012.
The increase in net capital losses for the Other category for 2013 compared to 2012 was primarily due to the provision for our commercial mortgage loan losses and capital losses on real estate. These capital losses were partially offset by net capital gains related to the sale of certain fixed maturity securities.
On August 10, 2012, we issued $250 million of 5.00%, 10-year senior notes (“2022 Senior Notes”). On September 28, 2012, we used the net proceeds from the issuance to repay our $250 million of 6.875%, 10-year senior notes (“2012 Senior Notes”) due October 1, 2012. The decrease in interest expense for the Other category for 2013 compared to 2012 was primarily due to the overlap of the outstanding 2022 Senior Notes in 2012 and the higher interest rate on the repaid 2012 Senior Notes resulting in higher interest expense for 2012 of approximately $5 million.
Asset-liability management is a part of our risk management structure. The risks we assume related to asset-liability mismatches vary with economic conditions. The primary sources of economic risk are interest rate related and include changes in interest rate term risk, credit risk and liquidity risk. It is generally management’s objective to align the characteristics of assets and liabilities to meet our financial obligations under a wide variety of economic conditions. From time to time, management may choose to liquidate certain investments and reinvest in different investments to increase the likelihood of meeting our financial obligations is increased. See “-Investing Cash Flows.”
Interest rate risk management, along with asset-liability analysis informs us of an appropriate allocation of invested assets to mitigate our interest rate risk exposure. We also use interest rate swaps, whereby we agree with another party to exchange, at specified intervals, the difference between fixed-rate and floating rate interest amounts as calculated by reference to an agreed notional amount, in fair value hedging relationships to reduce interest rate exposure arising from asset and liability duration mismatches. In accordance with presently accepted actuarial standards, we have made adequate provisions for the anticipated cash flows required to meet contractual obligations and related expenses through the use of statutory reserves and related items in light of the assets held at December 31, 2014.
Net cash provided by operating activities is net income adjusted for non-cash items and accruals, and was $238.2 million, $279.6 million and $375.7 million for 2014, 2013 and 2012, respectively. These changes were mainly due to fluctuations in future policy benefits and claims due to changes in reserve requirements in Employee Benefits and other assets and other liabilities, mainly attributable to timing differences. We typically generate positive cash flows from operating activities, as premiums collected from our insurance products and income received from our investments exceed policy acquisition costs, benefits paid, redemptions and operating expenses. These positive cash flows are then invested to support the obligations of our insurance products and required capital supporting these products. Our cash flows provided by operating activities are affected by the timing of premiums, administrative fees and investment income received and expenses paid.
Net cash used in investing activities was $616.8 million, $504.3 million and $763.0 million for 2014, 2013 and 2012, respectively. The increase in net cash used in investing activities for 2014 compared to 2013 was primarily due to lower proceeds from the sale, maturity or repayment of fixed maturity securities and higher acquisitions of fixed maturity securities and other invested assets. These increases were partially offset by an increase in proceeds from the sale or repayment of commercial mortgage loans. Our target investment portfolio allocation is approximately 60% fixed maturity securities and 40% commercial mortgage loans with a maximum allocation of 45% in commercial mortgage loans. At December 31, 2014, total cash and investments consisted of 56.8% fixed maturity securities, 38.8% commercial mortgage loans, 2.3% other invested assets, 1.8% cash and cash equivalents and 0.3% real estate.
The decrease in commercial mortgage loan originations for 2014 compared to 2013 was primarily due to an increase in competition in the commercial real estate market. The increase in 2013 compared to 2012 was primarily due to an increase in commercial real estate market activity.
At December 31, 2014, we did not have any direct exposure to sub-prime or Alt-A mortgages in our commercial mortgage loan portfolio. When we undertake mortgage risk, we do so directly through loans that we originate ourselves rather than in packaged products such as commercial mortgage-backed securities. Given that we service the vast majority of loans in our portfolios, we are prepared to deal with them promptly and proactively. Should the delinquency rate or loss performance of our commercial mortgage loan portfolio increase significantly, the increase could have a material adverse effect on our business, financial position, results of operations or cash flows.
The performance of our commercial mortgage loan portfolio may fluctuate in the future. However, based on our business approach of diligently underwriting high-quality loans, we believe our delinquency rate will remain low. The increase in restructured commercial mortgage loans of $8.0 million during 2014 was primarily due to a net increase in the number of restructured commercial mortgage loans, which was partially offset by commercial mortgage loans that were paid off or became delinquent during the period.
The decrease in the commercial mortgage loan loss allowance for 2014 compared to 2013 was primarily due to fewer loans with a general loan loss allowance and specific loan loss allowance. The decrease in net charge-offs was primarily due to lower losses related to foreclosures, accepted deeds in lieu of foreclosure on commercial mortgage loans and other related charges associated with commercial mortgage loans leaving the portfolio for 2014. The higher provision and net charge-offs for the commercial mortgage loan loss allowance for 2013 compared to 2012 were primarily due to higher losses associated with foreclosures, accepted deeds in lieu of foreclosure on commercial mortgage loans and other related charges associated with commercial mortgage loans leaving the portfolio for 2013. The decrease in the commercial mortgage loan loss allowances for 2013 compared to 2012 was primarily due to the decrease in the general loan loss allowance, which was driven by improvement in the composition factors of the commercial mortgage loan portfolio that impacts the general loan loss allowance.
A commercial mortgage loan is impaired when we do not expect to receive contractual principal and interest in accordance with the terms of the original loan agreement. A specific allowance for losses is recorded when a loan is considered to be impaired and it is probable that all amounts due will not be collected based on the terms of the original note. We also hold specific loan loss allowances on certain performing commercial mortgage loans that we continue to monitor and evaluate. Impaired commercial mortgage loans without specific allowances for losses are those for which we have determined that it remains probable that all amounts due will be collected although the timing or nature may be outside the original contractual terms. The decrease to the net carrying value of impaired commercial mortgage loans at December 31, 2014 compared to 2013 was primarily due to a decrease in impaired commercial mortgage loans with a specific allowance in our industrial and retail segments for 2014 associated with a small number of borrowers.
Financing cash flows primarily consist of policyholder fund deposits and withdrawals, borrowings and repayments on the line of credit, borrowings and repayments on long-term debt, issuances and repurchases of common stock and dividends paid on common stock. Net cash provided by financing activities was $250.4 million, $443.3 million and $409.6 million for 2014, 2013 and 2012, respectively. The decrease in funds provided by financing cash flows for 2014 compared to 2013 was primarily due to a $64.7 million increase in share repurchases, a $47.1 million repurchase of debt, and a $34.3 million decrease in policyholder fund deposits, net of withdrawals. See “Capital Management-Share Repurchases” for further discussion on share repurchases.
We have $250 million of 5.00%, 10-year senior notes (“Senior Notes”), which mature on August 15, 2022. Interest is paid semi-annually on February 15 and August 15.
and cover certain acquisition costs associated with policy issuance, leaving less available capital beyond our target level. Higher levels of premium growth can result in increased utilization of capital and surplus beyond that which is generated by the business, and at very high levels of premium growth, we could generate the need for capital infusions. At lower levels of premium growth, additional capital and surplus produced by the business exceeds the capital and surplus utilized to meet these requirements, which can result in additional capital and surplus above our targeted RBC level. In assessing our capital and surplus position, we also consider cash and capital at the holding company and non-insurance subsidiaries.
As of December 31, 2014, Standard’s net gain from operations after dividends to policyholders and federal income taxes and before capital gains or losses for the 12-month period then ended was $208.5 million and capital and surplus was $1.15 billion. Based upon Standard’s results for 2014, the amount of ordinary dividends and other distributions available in 2015, without prior approval from the Oregon Insurance Division is $208.5 million. As of December 31, 2013, Standard’s net gain from operations after dividends to policyholders and federal income taxes and before capital gains or losses for the 12-month period then ended was $195.1 million and capital and surplus was $1.29 billion. Based upon Standard’s results for 2013, the amount of ordinary dividends and other distributions available in 2014, without prior approval from the Oregon Insurance Division was $195.1 million.
In August 2012, Standard paid an extraordinary cash distribution of $250.0 million to StanCorp from its paid-in and contributed surplus. Concurrently with the distribution, Standard issued a $250.0 million subordinated surplus note (“Surplus Note”), payable to StanCorp. The Surplus Note matures in 2042 and bears an interest rate of 5.25%, with interest payments due March 31, June 30, September 30 and December 31 of each year. Standard has the right to prepay the principal balance of the Surplus Note, in whole or in part, at any time or from time to time, without penalty. In accordance with the requirements of the National Association of Insurance Commissioners (“NAIC”), the Surplus Note provides that no interest or principal payments may be made by Standard without the prior approval of the Oregon Insurance Division, interest will not be represented as an addition to the instrument, interest will not accrue additional interest and any payments with respect to the Surplus Note will be subordinate to Standard’s other obligations to policyholders, lenders and creditors. As a result of the extraordinary distribution in August 2012, dividends through August 14, 2013 were considered extraordinary.
During 2014 and 2013, Standard made distributions to StanCorp totaling $390.0 million and $130.0 million, respectively. The 2014 distribution included a $240.0 million extraordinary distribution to StanCorp that was used to capitalize StanCap Insurance Company. Effective September 30, 2014, StanCap Insurance Company entered into a reinsurance agreement with Standard to reinsure Standard’s group life and AD&D business. This reinsurance agreement between StanCap Insurance Company and Standard replaced the yearly renewable term group life reinsurance agreement with Canada Life Assurance Company, which was terminated effective September 30, 2014. As a result of the extraordinary distribution in September 2014, future dividends will require approval from the Oregon Insurance Division through September 2015 and will be considered extraordinary.
Dividends received from our non-insurance subsidiaries were $33.0 million and $17.0 million for 2014 and 2013, respectively.
On November 11, 2014, our Board of Directors declared an annual cash dividend of $1.30 per common share. The dividend was paid on December 8, 2014 to shareholders of record on November 24, 2014. In 2013 and 2012, we paid an annual cash dividend of $1.10 and $0.93 per common share, respectively. The Board of Directors has increased the annual dividend per common share to shareholders each year for the past 15 consecutive years. The declaration and payment of dividends to shareholders in the future is subject to the discretion of our Board of Directors. It is anticipated that an annual dividend to shareholders will be paid in December of each year depending on our financial condition, results of operations, cash requirements, future prospects, regulatory restrictions on distributions from the insurance subsidiaries, the ability of the insurance subsidiaries to maintain adequate capital and other factors deemed relevant by the Board of Directors. In addition, the declaration and payment of dividends to shareholders would be restricted if we elect to defer interest payments on our Subordinated Debt issued May 7, 2007. If elected, the restriction would be in place during the interest deferral period, which cannot exceed five years. We have not deferred interest on the Subordinated Debt, and have paid dividends each year since our initial public offering in 1999.
The following table summarizes our contractual obligations by period in which payments are due:
Our debt obligations consisted primarily of the $250 million of 5.00% Senior Notes and the $252.9 million of 6.90% Subordinated Debt. See Item 8, “Financial Statements and Supplementary Data-Notes to Consolidated Financial Statements-Note 18-Long-Term Debt”.
The insurance obligations in the table are actuarial estimates of the cash required to meet our obligations for future policy benefits and claims. These estimates do not represent an exact calculation of our future benefit liabilities, but are instead based on assumptions, which involve a number of factors, including mortality, morbidity, recovery, the consumer price index, reinsurance arrangements and other sources of income for people on claim. Assumptions may vary by age and gender and, for individual policies occupation class of the claimant, time elapsed since disablement, and contract provisions and limitations. Certain of these factors could be materially affected by changes in social perceptions about work ethics, emerging medical perceptions and legal interpretations regarding physiological or psychological causes of disability, emerging or changing health issues and changes in industry regulation. Changes in one or more of these factors or incorrect assumptions could cause actual results to be materially different from the information presented in the table.
Policyholder fund obligations include payments based on currently scheduled withdrawals and annuity benefit payments stemming from liabilities shown on the consolidated balance sheets as policyholder funds.
At December 31, 2014, we had $139.0 million outstanding under funding agreements with the FHLB of Seattle, with fixed interest rates ranging from 0.38% to 3.79% that mature in 1 to 15 years. The funding agreements with the FHLB of Seattle are recorded as other policyholder funds on the consolidated balance sheets. The FHLB of Des Moines and the FHLB of Seattle have
Bonds and commercial mortgage loans are reported principally at amortized cost and adjusted carrying value, respectively.
Asset valuation and the interest maintenance reserves are provided as prescribed by the NAIC.
The decrease in Statutory Results for 2014 compared to 2013 was primarily due to lower net investment income and the adoption of new statutory accounting guidance for share based compensation, partially offset by more favorable claims experience in Employee Benefits. The increase in Statutory Results for 2013 compared to 2012 was primarily due to more favorable claims experience in Employee Benefits.
The change in asset valuation reserve is primarily due to the reduction in reserve factors prescribed by the NAIC in 2014 for commercial mortgage loans.
Changes in liquidity needs and the liquidity of assets in our investment portfolios, including the ability to pledge collateral as required.
Competition from other insurers and financial services companies, including the ability to competitively price our products.
Availability, adequacy and pricing of reinsurance and catastrophe reinsurance coverage and potential charges incurred.
Consolidated Statements of Cash Flows for the years ended December 31, 2014, 2013 and
(1) Net of tax expense of $24.6 million, tax benefit of $111.1 million and tax expense of $38.3 million for 2014, 2013 and 2012, respectively.
(3) Net of tax benefit of $37.9 million and tax expenses of $22.2 million and $0.2 million for 2014, 2013 and 2012, respectively.
StanCorp Investment Advisers is a Securities and Exchange Commission registered investment adviser providing performance analysis, fund selection support, model portfolios and other investment advisory and investment management services.
Standard Management manages certain real estate properties held for sale from time to time in conjunction with our real estate business.
Standard holds interests in tax-advantaged investments. These interests are accounted for under the equity method of accounting. The carrying value of these interests was $296.3 million and $192.4 million at December 31, 2014 and 2013, respectively.
The Company’s intent to sell or whether it is more likely than not it will be required to sell a fixed maturity security before recovery of the security’s cost basis through the evaluation of facts and circumstances including, but not limited to, decisions to rebalance the Company’s portfolio, current cash flow needs and sales of securities to capitalize on favorable pricing.
If it is determined an other-than-temporary impairment (“OTTI”) exists, the Company separates the OTTI of fixed maturity securities into an OTTI related to credit loss and an OTTI related to noncredit loss. The OTTI related to credit loss represents the portion of losses equal to the difference between the present value of expected cash flows, discounted using the pre-impairment yields, and the amortized cost basis. All other changes in value represent the OTTI related to noncredit loss. The OTTI related to credit loss is recognized in earnings in the current period, while the OTTI related to noncredit loss is deemed recoverable and is recognized in other comprehensive income (loss). The cost basis of the fixed maturity security is permanently adjusted to reflect the credit loss. Once an impairment has been recorded, the Company continues to review the OTTI securities for further potential impairment.
In conjunction with determining the extent of credit losses associated with fixed maturity securities, the Company utilizes certain information in order to determine the present value of expected cash flows discounted using pre-impairment yields. The information includes, but is not limited to, original scheduled contractual cash flows, current market spread information, risk-free rates, fundamentals of the industry and sector in which the issuer operates, and general market information.
Fixed maturity securities are classified as available-for-sale and are carried at fair value on the consolidated balance sheets. See “Note 9-Fair Value” for a detailed explanation of the valuation methods the Company uses to calculate the fair value of its financial instruments. Valuation adjustments for fixed maturity securities not accounted for as OTTI are reported as net increases or decreases to other comprehensive income (loss), net of tax, on the consolidated statements of comprehensive income.
Real estate investments are recorded at the lower of cost or net realizable value. The Company depreciates real estate investments using the straight-line depreciation method with useful lives varying from 30 to 40 years. The Company records impairments when it is determined that the decline in fair value of an investment below its carrying value is other than temporary. The impairment is recorded to net capital losses, and the carrying value of the investment is adjusted to reflect the impairment. There were no impairments recorded on real estate investments for 2014, 2013 or 2012.
Real Estate Owned is initially recorded at net realizable value, which includes an estimate for disposal costs. This amount may be adjusted in a subsequent period as additional information is received. Real Estate Owned is initially considered an investment held for sale and is expected to be sold within one year from acquisition. For any real estate expected to be sold, an impairment is recorded if the Company does not expect the investment to recover its carrying value prior to the expected date of sale. Once an impairment has been recorded, the Company continues to review the investment for further potential impairment. Impairments recorded on Real Estate Owned were $5.2 million, $8.7 million and $3.0 million for 2014, 2013 and 2012 respectively.
Other invested assets include tax-advantaged investments, derivative financial instruments, policy loans and common stock. Valuation adjustments for these investments are recognized using the specific identification method.
The Company’s tax-advantaged investments are structured as limited partnerships and are accounted for under the equity method of accounting. The Company has purchased tax-advantaged investments opportunistically due to the higher risk-adjusted returns. The primary sources of investment return are tax credits and the tax benefits derived from operating losses, both of which may exhibit variability over the life of the investment. Tax credits received from these investments are reported in the Company’s consolidated statements of income as either a reduction of state premium taxes, or a reduction of income taxes, based on the nature of the credits. The Company’s share of the operating losses of the limited partnerships decreases the carrying value of the investments and is reported as a component of net investment income. If the net present value of expected future cash flows of a tax-advantaged investment is less than the current book value of the investment, the Company evaluates whether a decline in value is other than temporary. If it is determined an OTTI exists, the investment is written down to the net present value of expected future cash flows and the OTTI is recognized as a capital loss in the period in which it was determined to be impaired.
Cash settlement activity of derivative contracts is reported in the consolidated statements of cash flows as a component of proceeds from or acquisition of other invested assets. See “Note 11-Derivative Financial Instruments.”
In 2013, Standard became a member of the Federal Home Loan Bank of Seattle (“FHLB of Seattle”) and purchased the required common stock for membership and activity. The FHLB of Seattle common stock is carried at par value and accounted for under the cost method. The Company periodically evaluates the FHLB of Seattle common stock for OTTI. The Company’s determination of whether this investment is impaired is based on its assessment of the ultimate recoverability of cost rather than by recognizing temporary declines in value. There were no impairments recorded on the common stock of FHLB of Seattle in 2014 or 2013. The Federal Home Loan Bank of Des Moines (“FHLB of Des Moines”) and the FHLB of Seattle have announced that they have entered into a definitive agreement to merge the two banks. The merger agreement has been unanimously approved by the boards of directors of both banks and by the Federal Housing Finance Agency (“FHFA”). The potential merger must be approved by the members of both banks through a voting process that is expected to take place in the first half of 2015. The Company does not expect the merger to have a material effect on its business, financial position, results of operations, or cash flows.
The Company’s individual deferred annuities and group annuity products are classified as investment contracts. DAC related to these products is amortized over the life of related policies in proportion to expected gross profits. For the Company’s individual deferred annuities, DAC is generally amortized over 30 years with approximately 54% and 93% expected to be amortized by years 5 and 15, respectively. DAC for group annuity products is amortized over 10 years with approximately 76% expected to be amortized by year five.
Significant, unanticipated changes in key assumptions, which affect the determination of expected gross profits, may result in a large unlocking event that could have a material adverse effect on the Company’s financial position or results of operations.
Non-affiliated tenants leased 34.2%, 33.8% and 33.3% of the corporate headquarters in Portland, Oregon at December 31, 2014, 2013 and 2012, respectively. Income from the leases is included in net investment income.
Accounting Standards Update (“ASU”) No. 2014-01, Accounting for Investments in Qualified Affordable Housing Projects
of approximately $13 million for 2015. The adoption of this ASU will change the timing of the benefit realized in net income but will not change the cumulative total benefit to net income over the life of the investments.
In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers. The main objective of ASU No. 2014-09 is to provide a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. This ASU does not apply to insurance contracts, financial instruments, and various other topics within the FASB Accounting Standards Codification. The core principle of the revenue model is that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled to in exchange for those goods or services.
The following table sets forth the total compensation cost and related income tax benefit under the Company’s share-based compensation plans:
The Company has provided two types of share-based compensation pursuant to the 2002 Plan: option grants and stock award grants.
Options are granted to officers and certain non-officer employees. Executive officers typically receive annual grants in amounts determined by the Organization & Compensation Committee of the Board of Directors. Non-executive officers typically receive annual grants as determined by management. Officers may also receive options when hired or promoted to an officer position. In addition, the Chief Executive Officer has authority to award a limited number of options at his discretion to non-executive officers and other employees. Options are granted with an exercise price per share equal to the closing market price of StanCorp common stock on the grant date. Options typically vest in four equal installments on the first four anniversaries of the vesting reference date. Option awards to certain officers vest if the officer’s employment is terminated by the Company without cause or the officer terminates for good reason within 24 months after a change of control of the Company as defined in the Company’s change of control agreement. Options generally expire 10 years from the grant date.
The following table sets forth a summary of the activity of RSU and Performance Shares outstanding:
The Company issued 8,846 and 9,899 shares of StanCorp common stock for 2014 and 2012, respectively. Due to timing of when performance shares vested, the Company did not issue shares for 2013.
The Company’s ESPP allows eligible employees to purchase StanCorp common stock at a 5% discount of the lesser of the closing market price of StanCorp common stock on either the commencement date or the final date of each six-month offering period. Under the terms of the plan, each eligible employee may elect to have the lesser of up to 5% of the employee’s gross total cash compensation or $5,000 per offering period withheld to purchase StanCorp common stock. No employee may purchase StanCorp common stock having a fair market value in excess of $25,000 in any calendar year.
The Company recognizes as a component of accumulated other comprehensive (income) loss, net of tax, the actuarial gains or losses, prior service costs or credits, and transition assets that have not yet been recognized as components of net periodic benefit cost.
The Company made contributions to the employee pension plan of $15.0 million and $10.0 million in 2014 and 2012, respectively. The Company did not make any contributions to the employee pension plan in 2013. The Company is not obligated to make any contributions to its pension plans for 2015. In addition, no plan assets are expected to be returned to the Company in 2015.
The investment goal of the employee pension plan is to produce long-run portfolio returns that are consistent with reasonable contribution rates and a well-funded plan. To manage the overall risk of the portfolio, the portfolio is reviewed quarterly and rebalanced as necessary to keep the allocation of debt and equity securities within target allocation tolerance levels. The equity securities include pooled separate account funds comprised of large cap growth, large cap blend, large cap value, mid cap blend and foreign mutual funds and are diversified across investment strategies. The employee pension plan held no StanCorp equity securities as plan assets at December 31, 2014 and 2013. The plan invests in a stable asset fund comprised of debt securities included in the general account represented by a Deposit Administration Contract with Standard. Standard maintains the contributions in an unallocated fund, whose assets are invested with other assets in the general account of Standard. The account is credited with earnings on the underlying investments and charged for plan withdrawals and administrative expenses charged by Standard Retirement Services. The stable asset fund contract may subject the plan to concentrations of risk as its contract value is dependent on the ability of Standard to honor its contractual commitments. There are no reserves against the contract value for credit risk of Standard or otherwise.
Eligible employees are covered by a qualified deferred compensation plan sponsored by Standard under which a portion of the employee contribution is matched. Employees not eligible for the employee pension plan are eligible for an additional non-elective employer contribution. Contributions to the plan for 2014, 2013 and 2012 were $10.7 million, $9.9 million and $9.9 million, respectively.
Eligible executive officers, directors, agents and group producers may participate in one of several non-qualified deferred compensation plans under which a portion of the deferred compensation for participating executive officers, agents and group producers is matched. The liability for the plans was $12.6 million and $11.6 million at December 31, 2014 and 2013, respectively.
determined periodically and are based on retirees’ length of service and age at retirement. As of 2006, participation in the postretirement benefit plan was closed to new participants. An amendment announced in 2012 reduced future benefits for plan participants that did not retire by July 1, 2013.
The Company contributed $0.5 million, $0.4 million and $0.3 million to fund the postretirement benefit plan in 2014, 2013 and 2012, respectively. The Company expects to make contributions of $0.8 million to its postretirement benefit plan in 2015. No plan assets are expected to be returned to the Company in 2015.
The Company collectively views and operates its businesses as Insurance Services and Asset Management. Insurance Services contains two reportable product segments, Employee Benefits and Individual Disability. Insurance Services offers group and individual disability insurance, group life and AD&D insurance, group dental and group vision insurance, and absence management services. Asset Management is a separate reportable segment. Asset Management provides investment and asset management products and services. Asset Management offers full-service 401(k) plans, 403(b) plans, 457 plans, defined benefit plans, money purchase pension plans, profit sharing plans and non-qualified deferred compensation products and services. Asset Management also offers investment advisory and management services, origination and servicing of fixed-rate commercial mortgage loans, individual fixed and indexed annuity products, group annuity contracts and retirement plan trust products. The Other category includes return on capital not allocated to the product segments, holding company expenses, operations of certain unallocated subsidiaries, interest on debt, unallocated expenses, net capital gains and losses primarily related to the impairment or the disposition of the Company’s invested assets and adjustments made in consolidation. Resources are allocated and performance is evaluated at the segment level. The accounting policies of the segments are the same as those described in the summary of significant accounting policies. See “Note 1-Summary of Significant Accounting Policies.”
The Company is carrying forward net operating losses (“NOLs”) of $54 million that originated in StanCorp and certain subsidiaries. The losses will be used in future years to offset taxable income from those entities to the degree allowed by the Internal Revenue Code. If unutilized, these losses would expire between the years 2024 to 2034. In addition, the Company is carrying forward a $46 million federal NOLs from a business acquisition. This carryforward is subject to limitations under IRS Section 382, which potentially reduces the annual amount that may be utilized. This NOLs carryforward will expire between 2020 and 2025.
Realization of the Company’s NOLs carryforwards is dependent upon generating sufficient taxable income of the appropriate character before expiration of the losses. Although realization is not assured, management believes it is more likely than not that all of
the deferred tax asset relating to the federal loss carryforwards will be realized. The amount of the deferred tax asset considered realizable could be reduced in the future if estimates of expected taxable income during the carryforward period are reduced.
The Company is carrying forward a deferred tax asset of $13.2 million related to losses attributable to various states and municipalities. In some instances, state and local loss carryforwards are subject to a shorter expiration period than the 20-year federal period. Further, some losses originated in a subsidiary which has reduced its operations in the state where the loss was incurred. The Company believes that the benefit from certain state and local NOLs carryforwards will not be realized. As such, the Company has provided a valuation allowance of $8.4 million at December 31, 2014 on the deferred tax assets relating to these assets. The Company also has an additional $1.1 million in valuation allowances for other assets that are not state and local NOLs. If the Company’s assumptions change, the Company may be able to realize these NOLs. The state and local loss carryforwards expire at various dates through 2034.
Adjustments in interest rate spread based on an aggregate portfolio loan-to-value ratio, estimated from historical differential yields with respect to loan-to-value ratios.
The fair value for long-term debt was predominantly based on quoted market prices as of December 31, 2014 and December 31, 2013, and trades occurring close to December 31, 2014 and December 31, 2013.
Fixed maturity securities, S&P 500 Index options, interest rate swaps and index-based interest guarantees are recorded at fair value on a recurring basis. In the Company’s consolidated statements of comprehensive income, unrealized gains and losses are reported in other comprehensive income (loss) for fixed maturity securities. In the Company’s consolidated statements of income, the change in fair value for S&P 500 Index options is reported in net investment income. For interest rate swaps that are designated as a fair value hedge, the change in the fair values of the interest rate swap and the hedged item are reported in net capital gains and losses. The fair value of interest rate swaps is determined through Level 2 inputs using quoted prices from an independent pricing service. The change in fair value for index-based interest guarantees is reported in interest credited.
The significant unobservable inputs used in the fair value measurement of the reporting entity’s bonds are valuations and quotes received from the secondary pricing service, analytical reviews and broker quotes. Significant increases or decreases in any of those inputs in isolation would result in a significantly lower or higher fair value measurement. Generally, a change in the assumption used for the pricing evaluation is accompanied by a directionally similar change in the assumption used for the methodologies.
Valuations for the index-based interest guarantees are sensitive to a number of variables, but are most sensitive to the S&P 500 Index value, the implied volatilities of this index, and the interest rate environment. Generally, a significant increase or decrease used in the assumption for the implied volatilities and in the S&P 500 Index value would result in a directionally similar change, while an increase or decrease in interest rate environment would result in a directionally opposite change in the fair value of the liability.
Valuations for Real Estate Owned are measured at fair value on a nonrecurring basis using significant unobservable Level 3 inputs and are sensitive to a number of variables. Real Estate Owned is most sensitive to the reductions taken on appraisals obtained, which may result in a fair value and carrying value below the appraised value. Generally, an increase in the reductions taken on appraisals obtained would result in a reduction in the fair value of the asset.
For all periods disclosed above, fixed maturity securities transferred into Level 3 from Level 2 are the result of the Company being unable to obtain observable assumptions for these investments in the market. Fixed maturity securities transferred from Level 3 into Level 2 are the result of the Company being able to obtain observable assumptions for these investments in the market. There were no transfers between Level 1 and Level 2 for 2014 and 2013.
The following table sets forth the assets measured at fair value on a nonrecurring basis as of December 31, 2014 that the Company continued to hold:
The following table sets forth the recorded investment in commercial mortgage loans:
The Company assesses the credit quality of its commercial mortgage loan portfolio quarterly by reviewing the performance of its portfolio, which includes evaluating its performing and nonperforming commercial mortgage loans. Nonperforming commercial mortgage loans include all commercial mortgage loans that are 60 days or more past due and commercial mortgage loans that are not 60 days past due but are not substantially performing to other original contractual terms.
The following tables set forth impaired commercial mortgage loans identified in management’s specific review of probable loan losses and the related allowance:
There were no troubled debt restructurings identified in the previous 12 months that subsequently defaulted during 2014.
The Company closely monitors all past due commercial mortgage loans. Additional attention is given to those loans at least 60 days past due. Commercial mortgage loans that have been granted forbearance are not considered to be past due and totaled $5.2 million and $40.1 million at December 31, 2014 and 2013, respectively. Commercial mortgage loans that were at least 60 days past due totaled $8.6 million and $15.2 million at December 31, 2014 and 2013, respectively. The Company’s current level of past due commercial mortgage loans is lower than its historical levels due to an improving commercial real estate market. Commercial mortgage loans that were at least 60 days past due were 0.16% of the commercial mortgage loan portfolio at December 31, 2014, compared to 0.28% at December 31, 2013.
The following table sets forth net investment income summarized by investment type:
Securities deposited for the benefit of policyholders in various states, in accordance with state regulations, amounted to $7.2 million and $7.4 million at December 31, 2014 and 2013, respectively.
Standard is a member of the FHLB of Seattle. Standard issues collateralized funding agreements to the FHLB of Seattle and invests the cash received from advances to support various spread-based businesses and enhance its asset-liability management. Membership also provides an additional funding source and access to financial services that can be used as an alternative source of liquidity. At December 31, 2014, Standard had $139.0 million outstanding under funding agreements with the FHLB of Seattle and pledged $174.4 million of commercial mortgage loans as collateral for its outstanding advances. Standard had no outstanding funding agreements or pledged collateral with the FHLB of Seattle at December 31, 2013. The FHLB of Des Moines and the FHLB of Seattle have announced that they have entered into a definitive agreement to merge the two banks. The merger agreement has been
unanimously approved by the boards of directors of both banks and by the FHFA. The potential merger must be approved by the members of both banks through a voting process that is expected to take place in the first half of 2015. The Company does not expect the merger to have a material effect on our business, financial position, results of operations or cash flows.
The Company uses derivative financial instruments to mitigate business risks including interest rate risk exposure. The Company has the following derivatives on its consolidated balance sheets: interest rate swaps, index-based guarantees and S&P 500 Index options.
Interest rate swaps are recognized as either other invested assets or other liabilities in the consolidated balance sheets and are reported at fair value. To qualify for hedge accounting, the Company formally documents the risk management objective and strategy for undertaking the hedging transaction and the designation of the hedge as either a fair value hedge or a cash flow hedge at the inception of the hedging transaction. Included in this documentation is how the interest rate swap is expected to hedge the designated risk related to specific assets or liabilities on the balance sheet as well as a description of the method that will be used to retrospectively and prospectively assess the hedge effectiveness, the method that will be used to measure ineffectiveness and how this ineffectiveness will be recorded.
A derivative instrument designated as part of a hedging relationship must be assessed as being highly effective in offsetting the designated risk of the hedged item. Hedge effectiveness is formally assessed at inception and periodically throughout the life of the designated hedging relationship, using qualitative and quantitative methods. Qualitative methods include comparison of critical terms of the derivative to the hedged item. Quantitative methods include regression or other statistical analysis of changes in the fair value or cash flows associated with the hedge relationship.
In the event a hedged item is disposed, the Company will terminate the related interest rate swap and recognize the gain or loss on termination in the consolidated statements of income.
The Company sells indexed annuities, which permit the holder to elect a fixed interest rate return or an indexed return, where interest credited to the contracts is based on the performance of the S&P 500 Index, subject to an upper limit or cap and minimum guarantees. The index-based interest guarantees do not qualify for hedge accounting. Policyholders may elect to rebalance between interest crediting options at renewal dates annually. At each renewal date, the Company has the opportunity to re-price the indexed component by changing the cap, subject to minimum guarantees. The Company estimates the fair value of the index-based interest guarantees for the current period and for all future reset periods until contract maturity. Changes in the fair value of the index-based interest guarantees are recorded to interest credited. The liability represents an estimate of the cost of the options to be purchased in the future to manage the risk related to the index-based interest guarantees. The liability for index-based interest guarantees is the present value of future cash flows attributable to the projected index growth that is in excess of cash flows attributable to fixed interest rates guarantees. The excess cash flows are discounted back to the date of the balance sheet using current market indicators for future interest rates and option costs. Cash flows depend on actuarial estimates for policyholder lapse behavior and management’s discretion in setting renewal index-based interest guarantees.
The Company purchases S&P 500 Index options for its interest crediting strategy used in its indexed annuity product. The S&P 500 Index options do not qualify for hedge accounting. The S&P 500 Index options are purchased from investment banks and are selected in a manner that supports the amount of interest that is expected to be credited in the current year to annuity policyholder accounts that are dependent on the performance of the S&P 500 Index. The purchase of S&P 500 Index options is a pivotal part of the Company’s risk management strategy for indexed annuity products. The S&P 500 Index options are exclusively used for risk management. While valuations of the S&P 500 Index options are sensitive to a number of variables, valuations for S&P 500 Index options purchased are most sensitive to changes in the S&P 500 Index value and the implied volatilities of this index. Changes in the fair value of the S&P 500 Index options are recorded to net investment income. The Company generally purchases two S&P 500 Index option contracts per month, which have expiry dates of one year from the date of purchase.
Fluctuations in the fair value of the interest rate swaps are driven by changes in the interest rate environment. Fluctuations in the fair value of the S&P 500 Index options are related to the volatility of the S&P 500 Index. Changes in fair value of the index-based interest guarantees are sensitive to a number of variables, but are most sensitive to changes in the interest rate environment.
As the Company uses a central counterparty (“CCP”) to clear all of its interest rate swaps, the Company is only exposed to the default of the CCP. Transactions with the CCP require the Company to pledge initial and variation margin collateral. At December 31, 2014, the Company pledged $12.2 million of cash and cash equivalents on its consolidated balance sheets as collateral to the CCP.
The following table sets forth the fair value of the Company’s S&P 500 Index options and its maximum credit risk exposure related to these instruments:
DAC, VOBA and other acquisition related intangible assets are generally originated through the issuance of new business or the purchase of existing business, either by purchasing blocks of insurance policies from other insurers or by the outright purchase of other companies. The Company’s other intangible assets consist of certain customer lists from Asset Management business acquired and an individual disability marketing agreement. See “Note 1-Summary of Significant Accounting Policies-DAC, VOBA and Other Intangible Assets” for additional information.
The value of DAC and VOBA is dependent on key assumptions. See “Note 1-Summary of Significant Accounting Policies-DAC, VOBA and Other Intangible Assets” for a discussion of the key assumptions used to determine the values of DAC and VOBA. These assumptions are modified to reflect actual experience when appropriate. Although a change in a single assumption may have an impact on the calculated amortization of DAC or VOBA for balances associated with investment contracts, it is the relationship of that change to the changes in other key assumptions that determines the ultimate impact on DAC or VOBA amortization. Because actual results and trends related to these assumptions vary from those assumed, the Company revises these assumptions annually to reflect its current best estimate of expected gross profits. As a result of this process, known as “unlocking”, the cumulative balances of DAC and VOBA are adjusted with an offsetting increase or decrease to income to reflect changes in the period of the revision. An unlocking event generally occurs as a result of actual experience or future expectations differing from previous estimates. The Company recorded a decrease to VOBA of $1.0 million in 2013 and $0.8 million in 2012 due to changes in expected gross profits related to the block of claims assumed. The Company did not record an adjustment to VOBA as a result of unlocking in 2014. As a result of unlocking, the amortization schedule for future periods is also adjusted.
The following table sets forth the impact of unlocking on DAC and VOBA balances:
13. LIABILITY FOR UNPAID CLAIMS, CLAIM ADJUSTMENT EXPENSES AND OTHER POLICYHOLDER FUNDS
The liability for unpaid claims, claim adjustment expenses and other policyholder funds includes liabilities for insurance offered on products such as group long term and short term disability, individual disability, group dental and group vision, and group AD&D. The liability for unpaid claims and claim adjustment expenses is established when a claim is incurred or is estimated to have been incurred but not yet reported to the Company and, as prescribed by GAAP, equals the Company’s best estimate of the present value of the liability of future unpaid claims and claim adjustment expenses. This liability is included in future policy benefits and claims on the consolidated balance sheets.
Standard participates in a reinsurance and third-party administration arrangement with Northwestern Mutual Life Insurance Company (“Northwestern Mutual”) under which Northwestern Mutual group long term and short term disability products are sold using Northwestern Mutual’s agency distribution system. Generally, Standard assumes 60% of the risk and receives 60% of the premiums for the policies issued. If Standard were to become unable to meet its obligations, Northwestern Mutual would retain the reinsured liabilities. Therefore, in accordance with an agreement with Northwestern Mutual, Standard established a trust for the benefit of Northwestern Mutual with the market value of assets in the trust equal to Northwestern Mutual’s reinsurance receivable from Standard. The market value of assets required to be maintained in the trust at December 31, 2014, was $241.1 million. Premiums assumed by Standard for the Northwestern Mutual business accounted for approximately 3% of the Standard’s total premiums for each of the three years 2014, 2013 and 2012. In addition to assuming risk, Standard provides product design, pricing, underwriting, legal support, claims management and other administrative services under the arrangement.
The Company also maintains reinsurance coverage for certain catastrophe losses related to group life and AD&D with partial coverage of nuclear, biological and chemical acts of terrorism and is part of a catastrophe reinsurance pool with other insurance companies.
This pool spreads catastrophe losses from group life and AD&D over 18 participating members. The annual fee paid by the Company to participate in the pool was less than $30,000 for 2014. As a member of the pool, the Company is exposed to maximum potential losses experienced by other participating members of up to $104.6 million for a single event for losses submitted by a single company and a maximum of $261.5 million for a single event for losses submitted by multiple companies. The Company’s percentage share of losses experienced by pool members will change over time as it is a function of the Company’s group life and AD&D in-force relative to the total group life and AD&D in-force for all pool participants. The catastrophe reinsurance pool does not exclude war or nuclear, biological and chemical acts of terrorism. Through a combination of reinsurance and its participation in the catastrophe reinsurance pool, the Company has coverage of up to $484.7 million per catastrophic event. In February 2015, the Company was notified of the termination of the catastrophe reinsurance pool effective June 2015. The Company is exploring its options in the market for catastrophe reinsurance coverage.
Effective January 1, 2001, Standard ceded to Protective Life, through a reinsurance agreement, Standard’s individual life insurance product line. Standard received a ceding commission of approximately $90 million and transferred to Protective Life approximately $790 million in assets and corresponding statutory liabilities. If Protective Life were to become unable to meet its obligations, Standard would retain the reinsured liabilities. Therefore, the liabilities remain on Standard’s consolidated balance sheets, and an equal amount is recorded as a recoverable from the reinsurer. In accordance with the agreement, Protective Life established a trust for the benefit of Standard with assets in the trust required to be equal to Standard’s reinsurance receivable from Protective Life. The Company evaluates the collectability of the amounts recoverable from reinsurers by monitoring the value of assets held in trust and the credit quality of Protective Life. Effective February 1, 2015, Protective Life was acquired by Dai-ichi Life and is a wholly-owned subsidiary of Dai-ichi Life. The amount of assets required to be maintained in the trust is determined quarterly.
Effective October 1, 2002, Standard entered into a reinsurance agreement with TIAA to assume TIAA’s group disability and group life insurance business. This business included approximately 1,800 group insurance contracts, representing 650,000 insured individuals. Standard paid a ceding commission of approximately $75 million and received approximately $705 million in assets and corresponding statutory liabilities. If Standard were to become unable to meet its obligations, TIAA would retain the reinsured liabilities. Therefore, in accordance with the agreement with TIAA, Standard established a trust for the benefit of TIAA with the market value of assets in the trust equal to TIAA’s reinsurance receivable from Standard. The market value of assets required to be maintained in the trust is determined quarterly. The market value of assets required to be maintained in the trust at December 31, 2014, was $190.1 million. Approximately $60.0 million in VOBA was recorded related to the reinsurance agreement.
Surplus notes are classified as a component of surplus for statutory reporting and are classified as a liability for GAAP reporting.
During 2014 and 2013, Standard made distributions to StanCorp totaling $390.0 million and $130.0 million, respectively. The 2014 distributions included a $240 million extraordinary distribution that was used to capitalize StanCap Insurance Company. Effective September 30, 2014, StanCap Insurance Company entered into a reinsurance agreement with Standard to reinsure Standard’s group life and AD&D business. This reinsurance agreement between StanCap Insurance Company and Standard replaced the yearly renewable term group life reinsurance agreement with Canada Life Assurance Company, which was terminated effective September 30, 2014. As a result of the extraordinary distribution in 2014, future dividends will require approval from the Oregon Insurance Division through September 2015 and will be considered extraordinary.
The following table reconciles statutory net income based on statutory filings with applicable insurance regulatory authorities to the Company’s GAAP net income:
On August 10, 2012, the Company issued $250 million of 5.00%, 10-year senior notes (“Senior Notes’’), which mature on August 15, 2022. Interest is payable semi-annually on February 15 and August 15.
The Company has $252.9 million of 6.90%, junior subordinated debentures (“Subordinated Debt”), which matures on June 1, 2067 and is non-callable prior to June 1, 2017. In the first quarter of 2014, the Company repurchased $47.1 million in principal amount of Subordinated Debt. The remaining principal amount of the Subordinated Debt is payable at final maturity. Interest is payable semi-annually on June 1 and December 1 for the first 10 years up to June 1, 2017, and quarterly thereafter at a floating rate equal to three-month LIBOR plus 2.51%. StanCorp has the option to defer interest payments for up to five years. The declaration and payment of dividends to shareholders would be restricted if the Company elected to defer interest payments on its Subordinated Debt. If elected, the restriction would be in place during the interest deferral period. StanCorp is currently not deferring interest on the Subordinated Debt.
The Company maintains a $250 million Facility. Upon the request of StanCorp and with the consent of the lenders under the Facility, the Facility can be increased to $350 million. The termination date of the Facility is June 22, 2018. The Company expects to use the Facility for working capital, general corporate purposes and for the issuance of letters of credit.
At December 31, 2014, the Company had $139.0 million outstanding under funding agreements with the FHLB of Seattle, with fixed interest rates ranging from 0.38% to 3.79% that mature in 1 to 15 years. The funding agreements with the FHLB of Seattle are recorded as other policyholder funds on the Company’s consolidated balance sheets. The FHLB of Des Moines and the FHLB of Seattle have announced that they have entered into a definitive agreement to merge the two banks. The merger agreement has been unanimously approved by the boards of directors of both banks and by the FHFA. The potential merger must be approved by the members of both banks through a voting process that is expected to take place in the first half of 2015. The Company does not expect the merger to have a material effect on our business, financial position, results of operations or cash flows.
(1) Net of tax benefit of $111.1 million for net unrealized losses on fixed maturity securities and net of tax expense of $22.2 million for employee benefits.
(2) Net of tax benefits of $3.1 million for net unrealized gains on fixed maturity securities and $3.2 million for employee benefits, respectively.
(3) Net of tax expense of $24.6 million for net unrealized gains on fixed maturity securities and net of tax benefit of $37.9 million for employee benefits.
(4) Net of tax benefit of $1.1 million for net unrealized gains on fixed maturity securities and net of tax expense of $0.9 million for employee benefits.
During 2013, the Company implemented expense management initiatives to offset the negative effects of the continued low interest rate environment and lower Employee Benefits premiums compared to prior periods. In addition to severance, transition costs and lease terminations, the Company incurred $2.3 million in other project initiatives in 2013.
(1) Amounts relate to restructuring charges implemented by the Company during 2011.
In January 2015, StanCorp reached an agreement to sell certain assets of its private client wealth management business within StanCorp Investment Advisers to a third party. StanCorp expects the sale to be completed during the first half of 2015. StanCorp Investment Advisers will remain a wholly-owned subsidiary of StanCorp and will continue to provide performance analysis, fund selection support, model portfolios and investment management services to its retirement plan clients and subsidiaries of StanCorp. The assets under administration associated with the private client wealth management business totaled $884.4 million at December 31, 2014, which represents 3.3% of the Company’s total assets under administration. As a result of this sale, the Company does not expect a material gain or loss, nor a material impact to net income.
The following tables set forth select unaudited financial information by calendar quarter: