The following management assessment of the financial condition and results of operations should be read in conjunction with the consolidated financial statements and related notes thereto. See Item 8, “Financial Statements and Supplementary Data.” Our consolidated financial statements and certain disclosures made in this Form 10-K have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and require us to make estimates and assumptions that affect reported amounts of assets and liabilities and contingent assets and contingent liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during each reporting period. The estimates most susceptible to material changes due to significant judgment are identified as critical accounting policies. The results of these estimates are critical because they affect our profitability and may affect key indicators used to measure the Company’s performance. Please refer to our discussion of such critical accounting policies under the heading “Critical Accounting Policies and Estimates.”
Economic Conditions. We are sensitive to changing interest rates and their effect on product pricing because premiums collected today must be invested to provide a return sufficient to meet the future claims of policyholders. For that reason, we closely monitor changes in interest rates and make changes to our pricing, as appropriate. When interest rates fall, we must raise our premium rates to compensate for the reduced investment income. Raising prices during difficult economic conditions may affect our ability to grow premiums as our customers also may face economic challenges and may be less inclined to offer their employees new benefits and may even reduce benefit offerings. Alternatively, in periods when interest rates are increasing, we can reduce premium rates, and therefore take pricing pressure off customers, and we have done so in the last two consecutive quarters. Interest rates also affect the discount rates we use to establish reserves. See “Consolidated Results of Operations-Benefits and Expenses-Benefits to Policyholders.”
As part of our commitment to high standards of customer service, we need to continually improve our systems and processes. Investment in technology is important for us to enhance our market position and achieve operating efficiencies in future years. As a result, we plan to increase our technology expense approximately 25% during 2004, resulting in a projected increase in pre-tax expenses of $13 million. In 2005, we estimate that operating efficiencies will approximate the on-going expenses.
our insurance subsidiaries (this equates to 530% to 550% of the authorized control level RBC by our states of domicile), plus an amount approximating 5% of consolidated equity excluding accumulated other comprehensive income. See “Statutory Financial Accounting” and “Capital Management-Risk-Based Capital.” The primary reason we maintain capital above targeted levels is to provide timing flexibility should we wish to access capital markets to finance growth or acquisitions. We will continue to maintain our three priorities, in the following order, for excess capital:
• fund acquisitions that are consistent with our mission and meet our return objectives, and
• provide a return to shareholders, via share repurchases and dividends.
Historically, it has been our objective to grow premiums in the range of 10% to 12% annually. For management purposes, we eliminate the effects of new assumed blocks of business and experience rated refunds (“ERRs”) (refunds on certain large group insurance contracts) from this calculation to determine our rate of premium growth. Economic conditions, including low interest rates and limited job growth, together with the rising cost of medical premiums faced by our customers, had an impact on our sales and premium growth in 2003. As a result, our premium growth for 2003 of 7.8%, as defined above, was below our target range of 10% to 12%. Our decline in premium growth is consistent with declines in the market growth rate. See discussion in “Consolidated Results of Operations-Revenues-Premiums” below. We believe continuing economic conditions will affect our results in 2004, and therefore have adjusted our expectation for 2004 premium growth to a range of 6.5% to 8%. We expect economic conditions for employers will improve, and therefore our premium growth will return to the 10% to 12% range in 2005 and beyond.
The following table sets forth premiums by segment for the years ended December 31:
The following table sets forth premiums in our Employee Benefits segment for our existing business and the block of business assumed from TIAA for the years ended December 31:
The following table sets forth premium growth as a percentage for our Employee Benefits segment for the years ended December 31:
Premium growth in the Employee Benefits segment (excluding the TIAA block of business assumed and ERRs) was 7.6% for 2003 compared to 2002, and 9.7% for 2002 compared to 2001. Based on industry statistics, the employee benefits market had been growing 8% to 9% annually as measured by average annual premiums. However, these same statistics indicate a growth rate in early 2003 of 5% to 6%. Growth in the employee benefits market comes primarily from employment and wage growth (as premiums are based in part on salaries of covered employees) and businesses adding new coverages.
• Premiums for this segment decreased $1.2 million, or 1.5%, in 2002 compared to 2001. This included a decrease in disability insurance premiums of $3.1 million for 2002 compared to 2001 primarily resulting from a $6.5 million reinsurance premium in 2002 related to the reinsurance agreement discussed above, and an increase in premiums for the life contingent annuities totaling $1.9 million. Sales of life contingent annuities can vary significantly from year to year.
• At December 31, 2003, assets under management for this segment totaled $2.58 billion, compared to $1.80 billion and $1.77 billion at December 31, 2002 and 2001, respectively. Asset growth was primarily due to higher market values of equity investments in the separate account, strong sales, continued deposit growth, and favorable customer retention. As a result, administration fees based on the market values of assets increased 23.0% in 2003 compared to 2002.
• Premiums for this segment decreased $2.0 million, or 9.5% in 2002 compared to 2001. The decrease was primarily due to a decrease in premiums for life contingent annuities, which resulted in a corresponding decrease in reserves and benefits to policyholders.
• Average invested assets were $6.56 billion for 2003, an increase of 18.2% compared to 2002. Average invested assets for 2002 increased 10% compared to 2001. Average invested assets increased in all segments. In the Employee Benefits segment, increased average invested assets in 2003 and 2002 included approximately $705 million in assets from the TIAA block of business and approximately $200 million to support payment of the $75 million ceding commission to TIAA to assume the block of business and to maintain targeted capital, both of which occurred in late 2002. See “-Liquidity and Capital Resources-Financing Cash Flows.” In the Individual Insurance segment, increased average invested assets resulted primarily from sales and retention of annuity deposits. In the Retirement Plans segment, increased average invested assets resulted primarily from higher market values of equity investments in the separate account, strong sales, continued deposit growth, and favorable customer retention.
• Commercial mortgage loan prepayment fees were $17.0 million, $9.0 million, and $3.4 million for 2003, 2002 and 2001, respectively. The level of commercial mortgage loan prepayment fees will vary depending on the overall interest rate environment. We anticipate that refinancing activity will slow in 2004. Currently, approximately half of the loans in our commercial mortgage loan portfolio have a provision that requires the borrower to pay a prepayment fee that assures that the Company’s expected cash flow from commercial mortgage loan investments will be fully protected in the event of prepayment. Since 2001, all new commercial mortgage loans contain the new prepayment provision. The remainder of our commercial mortgage loans contain fixed prepayment fees such that total cash flows may be more than or less than those originally expected at the time the loans were made.
Net capital gains and losses occur as a result of sale or impairment of the Company’s invested assets, neither of which is likely to occur in regular patterns. While impairments are generally not controllable, management does have significant discretion over the timing of sales of invested assets. Net capital gains and losses are reported in “Other.” Net capital gains were $9.3 million in 2003, compared to net capital losses of $19.7 million in 2002. Net capital gains for 2003 included gains on bond sales, which were driven in part by a higher than normal level of tender offers on bonds held in the Company’s portfolio. Net capital losses for 2002 were primarily related to impairments of our holdings of WorldCom, Lukens, Sprint, and AT&T bonds. Capital gains and losses in 2001 netted to zero.
Benefits to policyholders (including interest credited) increased $182.8 million, or 15.4% in 2003 compared to 2002, and $94.3 million, or 8.6% in 2002, compared to 2001. The increases in both comparative periods primarily related to increases in the size of our Employee Benefits segment. Benefits to policyholders in the Employee Benefits segment increased $185.8 million, or 18.0% in 2003 compared to 2002, and $102.2 million, or 11.0% in 2002, compared to
• Our assumption of the TIAA block of business, which was effective October 1, 2002, increased our premium levels by approximately 11%. This contributed to increased benefits to policyholders through both additional claims incurred and additional reserves established based on premium levels.
• During 2003, interest rates declined such that we decreased the discount rate for new long term disability reserves a net total of 0.05%. During 2002, interest rates declined such that we decreased the discount rate for new long term disability reserves a total of 1.0%. Corresponding changes in reserves were recorded as benefits to policyholders on the income statement. An increase in the discount rate will result in recording lower benefits to policyholders on the income statement while a decrease in the rate will result in recording higher benefits to policyholders on the income statement. Each quarter we determine a discount rate for new reserves established in the quarter based on the average new money investment rate for the quarter. When investment rates are increasing, the discount rate will also increase. Similarly, when investment rates are decreasing, the discount rate is comparably decreased. To offset this effect, we increase or decrease prices on our long term disability products. Because our long term disability contracts have one to three year rate guarantees, there is generally a time lag between the rate action and a corresponding increase or decrease in premium rates. Based upon our current size, a 0.25% change in the discount rate will result in a quarterly change of approximately $2 million in benefits to policyholders.
Operating expenses increased $32.3 million, or 13.0% in 2003 compared to 2002, and $42.8 million, or 20.9% in 2002, compared to 2001. The increases for both comparative periods primarily were to support business growth as evidenced by premium growth. In addition:
• In the first quarter of 2003, we began including the cost related to stock-based compensation in the determination of net income by adopting the fair value recognition provisions for all director and employee grants and awards after January 1, 2003. Total stock-based compensation expense in 2003 totaled $2.3 million.
The Individual Insurance segment operating expense ratio increased to 13.9% in 2003 from 12.8% and 12.6% in 2002 and 2001, respectively. The increase primarily resulted from two factors. First, annuity premiums (which are in the denominator of the ratio) decreased $2.9 million in 2003, compared to 2002. Annuity premiums consist of premiums on life contingent immediate annuities, which are a small part of our annuity sales and can vary significantly from year to year. Second, we incurred additional expense to support a 27.8% increase in sales of annuity deposits in 2003 compared to 2002. Sales of annuity deposits are not recorded as premiums. Annuity deposits are recorded as a liability. See “Business Segments-Individual Insurance Segment.”
In the Retirement Plans segment, the decrease in the operating expense ratio resulted from higher assets under
The following table sets forth commissions and bonuses by segment for the years ended December 31:
Interest expense (recorded in “Other”) was $17.5 million, $5.0 million, and $0.1 million for 2003, 2002, and 2001, respectively. Increases for the comparative periods were primarily due to interest expense on senior notes. Late in the third quarter of 2002, we completed an initial public debt offering of $250.0 million of 6.875%, 10-year senior notes. Prior to that, our debt consisted mainly of periodic short term borrowings. See “Liquidity and Capital Resources-Financing Cash Flows.”
We defer certain policy acquisition-related commissions and incentive payments, certain costs of policy issuance and underwriting, and certain printing costs related to obtaining new business and acquiring business through reinsurance agreements. See “Critical Accounting Policies and Estimates.” VOBA represents the discounted future profits of business assumed through reinsurance agreements.
The following table sets forth the balances at December 31, 2003 of DAC, VOBA, and the intangible asset related to our national marketing agreement with Minnesota Life. See “Business Segments-Individual Insurance Segment.”
Total income taxes may differ from the amount computed by applying the federal corporate tax rate of 35% because of the net result of permanent differences and the inclusion of state and local income taxes, net of the federal benefit. Income taxes also include estimated amounts provided for potential adjustments related to Internal Revenue Service examinations of open years, generally when the tax law is unclear. Although estimated amounts are adjusted when appropriate, amounts required to be provided upon the settlement of an examination may differ from amounts previously estimated. Years currently open for audit by the Internal Revenue Service are 1996 through 2003. The combined federal and state effective tax rates were 34.8%, 35.5%, and 35.6% for 2003, 2002, and 2001, respectively.
(3) Includes operating expenses, commissions and bonuses, premium taxes and the net increase in deferred acquisition costs and value of business acquired.
Following are key indicators that management uses to manage and assess the performance of the Employee Benefits segment at or for the years ended December 31:
(2) Pre-tax charges of $4.3 million incurred as a result of the terrorist events of September 11, 2001 were excluded from the computation of the benefit ratio for 2001.
For a discussion of premiums, persistency, and sales see “Consolidated Results of Operations.”
The duration of our invested assets is well matched to the duration of our liabilities in total and on a product segregated portfolio basis. Our investments are generally not callable or have prepayment penalties. Based on these factors, we believe the current margin in our overall block of business between invested assets yield and weighted average reserve discount rate of approximately 0.40% is adequate to cover potential reinvestment risk. The margin is lower than the 0.50% reported in prior periods due to the inclusion of the TIAA block of business, the reserves for which were established during the recent low interest rate environment, where, due to the decreased reinvestment risk, a lower interest rate margin is appropriate. See “Liquidity and Capital Resources.”
The following table sets forth key indicators that management uses to manage and assess the performance of the Individual Insurance segment at or for the years ended December 31:
For a discussion of sales and premiums, see “Consolidated Results of Operations.”
The primary sources of revenue for the Retirement Plans segment include plan administration fees, fees on separate account assets under management, and investment margin on general account assets under management (fixed-income investment option). In addition, premiums and benefits to policyholders reflect the conversion of retirement plan assets into life contingent annuities, which can be selected by plan participants at the time of retirement.
The Company manages interest rate risk, in part, through asset/liability duration analyses. As part of this strategy, detailed actuarial models of the cash flows associated with each type of insurance liability and the financial assets related to the liability are generated under various interest rate scenarios. Both interest rate risk and investment strategies are examined. The actuarial models include those used to support the statutory Statement of Actuarial Opinion required annually by insurance regulators. According to presently accepted actuarial standards of practice, statutory reserves of Standard and related items at December 31, 2003 made adequate provision for the anticipated cash flows required to meet contractual obligations and related expenses, in light of the assets actually held.
The low level of current interest rates resulted in a relatively small change when rates are increased 10%. An additional sensitivity analysis was therefore performed to look at the change in fair market value when rates were increased 1.0%. The resulting hypothetical reduction in fair value of the Company’s financial assets was estimated to be $363 million and $265 million at December 31, 2003 and 2002, respectively.
The duration of our invested assets was well matched to the duration of our liabilities, approximating 5.1 and 5.5, respectively, at December 31, 2003. Our investments are either generally not callable or have prepayment penalties. As a percentage of our fixed maturity investments, callable bonds were 1.85% at December 31, 2003.
Net cash provided by operations is net income adjusted for non cash items and accruals primarily related to net realized capital gains and losses, deferred income taxes, changes in reserves, and changes in other assets and liabilities. Net cash provided by operating activities was $337.4 million, $380.4 million, and $264.8 million for 2003, 2002, and 2001, respectively. Net cash provided by operations was comparatively higher in 2002. Adjustments to reconcile net income to net cash provided by operating activities in 2002 included the refund of $20.0 million in federal income taxes and changes in the related accruals.
The Company maintains a diversified investment portfolio consisting primarily of fixed maturity securities and fixed- rate commercial mortgage loans. Investing cash inflows consist primarily of the proceeds of investments sold, matured, or repaid. Investing cash outflows consist primarily of payments for investments acquired or originated.
At December 31, 2003, commercial mortgage loans in our investment portfolio totaled $2.32 billion. Collateralized properties in the commercial mortgage loan portfolio included the following at December 31, 2003:
The average loan to value ratio of the overall portfolio was 59% at December 31, 2003, and the average loan size was approximately $0.8 million. The Company receives personal recourse on almost all loans. At December 31, 2003, there were no loans more than sixty days delinquent or in the process of foreclosure. We had a net balance of restructured loans of $2.9 million at December 31, 2003, and a commercial mortgage loan loss reserve of $2.6 million. The delinquency and loss performance of our commercial mortgage loan portfolio have been consistently better than industry averages as reported by the American Council of Life Insurance. The performance of our commercial mortgage loan portfolio may fluctuate in the future. Should the delinquency rate or loss performance of our commercial mortgage loan portfolio increase, the increase could have a material adverse effect on the Company’s business, financial position, results of operations or cash flows.
At December 31, 2003, our commercial mortgage loan portfolio was collateralized regionally as follows:
cial mortgage loans, but do consider the potential for earthquake loss based upon seismic surveys and structural information specific to each property when new loans are underwritten.
To date, the delinquency rate of our California-based commercial mortgage loans has been substantially below the industry average and consistent with our experience in other states. However, if economic conditions in California worsen, we could experience a higher delinquency rate on the portion of our commercial mortgage loan portfolio located in California, which could have a material adverse effect on the Company’s business, financial position, results of operations or cash flows.
In the normal course of business, we commit to fund commercial mortgage loans generally up to 90 days in advance. At December 31, 2003, the Company had outstanding commitments to fund commercial mortgage loans with fixed interest rates ranging from 5.25% to 7.0%, totaling $102.8 million. These commitments generally have fixed expiration dates. A small percentage of commitments expire due to the borrower’s failure to deliver the requirements of the commitment by the expiration date. In these cases, we will retain the commitment fee and good faith deposit. Alternatively, if we terminate a commitment due to its disapproval of a commitment requirement, the commitment fee and deposit will be refunded to the borrower, less an administrative fee.
We currently have two unsecured credit agreements for $75 million each, with credit availability totaling $150 million. Both agreements expire on June 28, 2004. Under the credit agreements, we are subject to customary covenants, which take into consideration the impact of material transactions, changes to the business, compliance with legal requirements and financial performance. The financial covenants include limitations on indebtedness (funded debt to net worth less than or equal to 0.5 to 1.0), financial liquidity (fixed charge ratio greater or equal to 2.5 to 1.0 and statutory net income to total income percentage greater than or equal to 0), and risk-based capital (greater than or equal to 175% of the company action level).
We are not required to maintain compensating balances for the credit agreements, but pay commitment fees. Interest charged for use of the facilities is based on either the federal funds rate, the bank’s prime rate, or the London Interbank Offered Rate (“LIBOR”) at the time of borrowing. In addition, there is an incremental basis point charge, which varies by agreement, type of borrowing, and the amount outstanding on the lines. At December 31, 2003 and 2002, we were in compliance with all covenants under the credit agreements and have no outstanding balance on the lines of credit. Standard, our largest operating insurance subsidiary, is a guarantor for the total amount of both credit agreements. In addition, StanCorp Mortgage Investors also guarantees up to $25 million on the lines of credit. We currently have no commitments for standby letters of credit, standby repurchase obligations, or other related commercial commitments under the credit agreements.
Standard & Poor’s, Moody’s Investors Service, Inc., Fitch, Inc., and A.M. Best Company provide debt ratings on our senior debentures. As of December 2003, ratings from these agencies were BBB+, Baa1, A-, and bbb+, respectively.
Our current ratings allow up to a 25% debt to total capitalization ratio. We had a debt to total capitalization ratio of 19.3% and 20.0% at December 31, 2003 and 2002, respectively. Our ratio of earnings to fixed charges for the years ended December 31, 2003 and 2002 was 3.3x and 3.1x, respectively.
The National Association of Insurance Commissioners (“NAIC”) has implemented a tool to aid in the assessment of the statutory capital and surplus of life and health insurers. This tool, known as RBC, augments statutory minimum capital and surplus requirements. RBC employs a risk-based formula that applies prescribed factors to the various risk elements inherent in an insurer’s business to arrive at minimum capital requirements in proportion to the amount of risk assumed by the insurer.
The level of excess capital we generate varies in relation to our level of premium growth. At higher levels of premium growth we incur higher policy acquisition costs and therefore generate less excess capital (at very high levels of premium growth we generate the need for capital infusions). At lower levels of premium growth, we therefore generate more excess capital given lower policy acquisition costs.
Standard’s board of directors has approved distributions to StanCorp in 2004 to pay accrued interest and repayment of principal. The current amount approved by the board of directors, based on excess capital at December 31, 2003, is $155 million. We anticipate seeking approval of a distribution from the Oregon Department during 2004.
nection with StanCorp’s contribution to Standard in 2002 to fund the reinsurance agreement with TIAA to assume TIAA’s group disability and group life insurance business. The surplus note matures in August 2018 and bears an interest rate of 6.44% per annum. The form of the surplus note complies with the requirements of the NAIC with respect to surplus notes, including provisions requiring the approval of the Oregon Department for any payments of principal or interest and subordinating any payments with respect to the surplus note to Standard’s other obligations to policyholders, lenders and trade creditors.
In March 1998, the NAIC adopted the Codification of Statutory Accounting Principles (“Codification”), which became effective January 1, 2001. Codification standardized regulatory accounting and reporting among state insurance departments. However, statutory accounting principles also will continue to be established by individual state laws and permitted practices.
Statutory accounting practices differ in some respects from GAAP. The principal statutory practices which differ from GAAP are: a) bonds and commercial mortgage loans are reported principally at amortized cost; b) asset valuation and interest maintenance reserves are provided as prescribed by the NAIC; c) certain assets designated as non-admitted, principally deferred tax assets, furniture, equipment, and unsecured receivables, are not recognized as assets, resulting in a charge to statutory surplus; d) annuity considerations with life contingencies, or purchase rate guarantees, are recognized as income when received; e) reserves for life and disability policies and contracts are reported net of ceded reinsurance and calculated based on statutory requirements, including required discount rates; f) commissions, including initial commissions and expense allowance paid for reinsurance assumed, and other policy acquisition expenses are expensed as incurred; g) initial commissions and expense allowance received for a block of reinsurance ceded net of taxes are reported as deferred gains in surplus and recognized as income in subsequent periods; h) federal income tax expense includes current income taxes defined as current year estimates of federal income taxes and tax contingencies for current and all prior years and amounts incurred or received during the year relating to prior periods, to the extent not previously provided; i) deferred tax assets, net of deferred tax liabilities, are included in the regulatory financial statements, and represent the expected future tax
consequences of differences between the tax and the financial statement bases of assets and liabilities; and j) surplus notes are included in capital and surplus.
Statutory net gains from insurance operations before federal income taxes were $214.2 million and $111.9 million for 2003 and 2002, respectively. Capital and surplus, excluding asset valuation reserve, totaled $930.4 million and $853.4 million at December 31, 2003 and 2002, respectively.
In January 2004, Standard & Poor’s reaffirmed our debt and financial strength ratings, and raised its outlook on our ratings from stable to positive.
In July 2003, the Accounting Standards Executive Committee (“AcSEC”) of the American Institute of Certified Public Accountants (“AICPA”) issued Statement of Position (“SOP”) SOP 03-1, Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts. This SOP requires, among other things, an insurance enterprise to make various determinations, such as qualification for separate account treatment, classification of securities in separate account arrangements not meeting the criteria of the SOP, significance of mortality and morbidity risk, adjustments to contract holder liabilities, and adjustments to estimated gross profits or margins to determine the cumulative effect of a change in accounting principle from adopting this SOP. This SOP is effective for financial statements for fiscal years beginning after December 15, 2003. We are currently evaluating this guidance and do not expect this SOP to have a material impact on our financial statements.
In November 2003, the FASB Task Force reached a partial consensus under Emerging Issue Task Force (“EITF”) EITF 03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments. This EITF requires certain
The following table summarizes the Company’s contractual obligations as of December 31, 2003. The Company’s financing obligations generally include debts, lease payment obligations, commitments to fund commercial mortgage loans, and loan guarantees. The remaining obligations reflect purchase commitments for goods and services and the long-term liabilities portion of the Company’s Other Liabilities. This table does not reflect the Company’s obligations under our insurance and annuity product contracts.
Insolvency regulations exist in many of the jurisdictions in which subsidiaries of the Company do business. Such regulations may require insurance companies operating within the jurisdiction to participate in guaranty associations. The associations levy assessments against their members for the purpose of paying benefits due to policyholders of impaired or insolvent insurance companies. Association assessments levied against the Company from January 1, 2001, through
December 31, 2003, aggregated $0.3 million. At December 31, 2003, the Company maintained a reserve of $0.9 million for future assessments with respect to currently impaired, insolvent, or failed insurers.
Reserves represent amounts set aside today to pay future benefits and claims. Developing the estimates for reserves (and therefore the resulting impact on earnings) requires varying degrees of subjectivity and judgment, depending upon the nature of the reserve. For most of our reserves, the calculation methodology is prescribed by various accounting standards, although judgment is required in the determination of assumptions to use in the calculation. We also hold reserves that lack a prescribed methodology but instead are determined by a formula that we have developed based on our own experience. Because this type of reserve requires a higher level of subjective judgment, we closely monitor its adequacy. Finally, a small amount of reserves are held based entirely upon subjective judgment. These reserves are generally set up as a result of unique circumstances that are not expected to continue far into the future and are released according to pre-established conditions and timelines. Because this type of reserve requires the highest level of subjective judgment, formal documentation of reasoning is required. Currently, these reserves represent less than 1% of total reserves held.
For all of our product lines, we establish and carry as a liability actuarially determined reserves that are calculated to meet our obligations for future policy benefits and claims. These reserves do not represent an exact calculation of our future benefit liabilities, but are instead estimates based on assumptions and considerations concerning a number of factors, including:
• the amount of premiums that we will receive in the future;
• the rate of return on assets we purchase with premiums received;
• persistency, which is the measurement of the percentage of premiums remaining in force from year to year.
• discount rates used to value expected future claim payments and premiums;
• age and gender and, for individual policies, occupation class of the claimant;
VOBA represents the discounted future profits of business assumed through reinsurance agreements. VOBA is amortized in proportion to future premiums or future profitability, as appropriate. If actual premiums or future profitability are inconsistent with our assumptions, we could be required to make adjustments to VOBA and related amortization.
We have made in this Form 10-K, and from time to time may make in our public filings, news releases and oral presentations and discussions, certain statements which are not based on historical facts. These statements are “forward-looking” and, accordingly, involve risks and uncertainties that could cause actual results to differ materially from those discussed. Although such forward-looking statements have been made in good faith and are based on reasonable assumptions, there is no assurance that the expected results will be achieved. These statements include, without limitation, statements as to future expectations, beliefs, plans, strategies, objectives, events, conditions and financial performance, and are identified by words such as “believes,” “expects,” “intends,” “may,” “will,” “if,” “should,” “anticipates,” or the negative of those words or other comparable terminology.
• potential charges resulting from membership in a catastrophe reinsurance pool;
• changes in interest rates or the condition of the economy;
• adequacy of the diversification of risk by industry, geography and customer size;
• achievement of financial objectives, including growth of premiums, earnings, assets under management including performance of equities in the separate account, return on equity, or expense management objectives;
Consolidated Statements of Changes in Shareholders’ Equity for the years ended
The Standard Life Insurance Company of New York was organized in 2000, and is licensed to provide long term and short term disability, life, AD&D, and dental insurance for groups in New York.
StanCorp Mortgage Investors originates and services small commercial mortgage loans for investment portfolios of our insurance subsidiaries. It also generates additional fee income from the origination and servicing of commercial mortgage loans sold to institutional investors. As of December 31, 2003, StanCorp Mortgage Investors was servicing $2.32 billion in commercial mortgage loans for subsidiaries of StanCorp. Commercial mortgage loans serviced for other institutional investors and associated capitalized mortgage servicing rights totaled $677.1 million and $1.7 million, respectively, at December 31, 2003.
StanCorp Investment Advisers, Inc. is a Securities and Exchange Commission (“SEC”) registered investment adviser providing performance analysis, fund selection support, and model portfolios to our retirement plan clients and subsidiaries of StanCorp.
The consolidated financial statements include StanCorp and its subsidiaries. All significant intercompany balances and transactions have been eliminated. Certain 2002 and 2001 amounts have been reclassified to conform with the current presentation.
For all investments, capital gains and losses are recognized using the specific identification method. Net investment income and capital gains and losses related to separate account assets and liabilities are included in the separate account assets and liabilities. For all investments, we record impairments when it is determined that the decline in fair value of an investment below its amortized cost basis is other than temporary. We reflect impairment charges in net capital gains or losses and permanently adjust the cost basis of the investment to reflect the impairment. Factors considered in evaluating whether a decline in value of fixed maturity securities is other than temporary include the length of time and the extent to which the fair value has been less than amortized cost, the financial condition and near-term prospects of the issuer, our intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in market value, and the value of any security interest we may have collateralized in the investment. See “-Note 5, Investment Securities.”
For securities expected to be sold, an other than temporary impairment charge is recorded if we do not expect the realizable market value of a security to recover to amortized cost prior to the expected date of sale. Once an impairment charge has been recorded, we continue to review the other than temporarily impaired securities for further potential impairment on an on-going basis.
or decreases to other comprehensive income (loss), net of tax, on the consolidated statements of income and comprehensive income.
Real estate held for investment is stated at cost less accumulated depreciation. Depreciation generally is provided on the straight-line method, with property lives varying from 30 to 40 years. Accumulated depreciation totaled $29.6 million and $25.5 million at December 31, 2003 and 2002, respectively. Real estate acquired in satisfaction of debt is held for sale and is stated at the lower of cost or fair value less estimated costs to sell.
VOBA represents the discounted future profits of business assumed through reinsurance agreements. VOBA is amortized in proportion to future premiums or expected future profitability as appropriate. If actual premiums or future profitability are inconsistent with our assumptions, we could be required to make adjustments to VOBA and related amortization. For the VOBA associated with the Minnesota Life Insurance Company (“Minnesota Life”) block of business reinsured, the amortization period is up to 30 years. The VOBA associated with the Teachers Insurance and Annuity Association of America (“TIAA”) is comprised of two parts with differing amortization methods. The amortization periods are up to 10 years for VOBA that is amortized in proportion to premium and up to 20 years for VOBA that is amortized in proportion to expected gross profits, although approximately 75% is expected to be amortized by year 5. The revenues and expenses generated by the assumed business are included in the Company’s consolidated financial statements. The following table reconciles VOBA and the intangible related to a marketing agreement with Minnesota Life for the years ended December 31:
spectively. The Company reviews property and equipment for impairment when circumstances or events indicate the carrying amount of the asset may not be recoverable and recognizes a charge to earnings if an asset is impaired.
Capitalized leases totaling $0.4 million are included in property and equipment. Capital leases are amortized over the life of the leases.
Non-affiliated tenants leased approximately 41.8%, 44.1%, and 44.5% of the home office properties at December 31, 2003, 2002, and 2001, respectively. Income from the leases is included in net investment income.
The provision for income taxes includes amounts currently payable and deferred amounts that result from temporary differences between financial reporting and tax bases of assets and liabilities as measured by current tax rates. Income taxes also include estimated amounts provided for potential adjustments related to Internal Revenue Service examinations of open years, generally when the tax law is unclear. Although estimated amounts are adjusted when appropriate, amounts required to be provided upon the settlement of an examination may differ from amounts previously estimated. Years currently open for audit by the Internal Revenue Service are 1996 through 2003.
Awards under the Company’s plans vest over periods ranging from one to four years. Therefore, the cost related to stock-based employee compensation included in the determination of net income for 2003 and prior years is less than that which would have been recognized if the fair value based method had been applied to all awards since the first options were granted in 1999. The following table sets forth the effect on net income and earnings per share if the fair value based method had been applied to all outstanding and unvested awards for the years ended December 31:
In July 2003, the Accounting Standards Executive Committee (“Ac SEC”) of the American Institute of Certified Public Accountants (“AICPA”) issued Statement of Position (“SOP”) SOP 03-1, Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts. This SOP requires, among other things, an insurance enterprise to make various determinations, such as qualification for separate account treatment, classification of securities in separate account arrangements not meeting the criteria of the SOP, significance of mortality and morbidity risk, adjustments to contract holder liabilities, and adjustments to estimated gross profits or margins to determine the cumulative effect of a change in accounting principle from adopting this SOP. This SOP is effective for financial statements for fiscal years beginning after December 15, 2003. We are currently evaluating this guidance and do not expect this SOP to have a material impact on our financial statements.
In December 2003, the FASB released FASB 132R, Employers’ Disclosures about Pensions and Other Postretirement Benefits. This statement incorporates all of the disclosure requirements of FASB Statement No. 132, Employers’ Disclosure about Pensions and other Postretirement Benefits and replaces the disclosure requirements in FASB Statement No. 87, Employers’ Accounting for Pensions, No. 88, Employers’ Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits, and No. 106, Employers’ Accounting for Postretirement Benefits Other Than Pensions. The provisions of this statement shall be effective for fiscal years ending after December 15, 2003, while the interim-period disclosures required by this Statement shall be effective for interim periods beginning after December 15, 2003. Effective December 31, 2003, the required disclosures are included in the notes to consolidated financial statements.
Basic net income per common share was calculated based on the weighted-average number of common shares outstanding. Net income per diluted common share reflects the potential effects of restricted stock grants and exercises of outstanding options. The weighted-average common share and share equivalents outstanding used to compute the dilutive effect of common stock options outstanding were computed using the treasury stock method. The computation of dilutive weighted-average earnings per share does not include options with an option exercise price greater than the average market price because they are antidilutive (would increase earnings per share). For the years ended December 31, 2003, 2002, and 2001, antidilutive options were not material. Net income per diluted common share was calculated as follows, for the years ended December 31:
We operate through three segments: Employee Benefits, Individual Insurance, and Retirement Plans. Performance assessment and resource allocation are done at the segment level. The Employee Benefits segment sells group disability and life insurance, group dental insurance, and AD&D insurance. The Individual Insurance segment sells disability insurance and fixed-rate annuities, including life contingent annuities, to individuals. The Retirement Plans segment sells full- service 401(k), defined benefit, money purchase, profit sharing and deferred compensation plan products and services to small and medium-sized employers.
Amounts reported as “Other” primarily include net capital gains and losses on investments, return on capital not allocated to the product segments, other financial service businesses, holding company expenses, interest on senior notes and adjustments made in consolidation. Other financial service businesses are generally non-insurance related and include our commercial mortgage lending and other investment management subsidiaries.
The following table sets forth our investments’ gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2003:
A permanent impairment is recognized on a security if its market value falls below 80% of its book value for 6 months or longer, and/or it is determined that the value will not recover. During the 6 month period, or as long as the holding is valued below 80% of its book value, the holding is watched for potential permanent impairment. At December 31, 2003, we held two issues that had market values below 80% of their book values. One is secured by assets whose value exceeds the value of the debt issue and the other is newly acquired. These are both expected to fully recover, and therefore have not been permanently impaired.
The commercial mortgage loan valuation allowance is estimated based on evaluating known and inherent risks in the loan portfolio. The allowance is based on management’s analysis of factors including changes in the size and composition of the loan portfolio, actual loan loss experience, economic conditions, and individual loan analysis. A loan is considered impaired when it is probable that the Company will be unable to collect all amounts due, including principal and interest. Loan impairment is measured using discounted cash flows except when the current fair value, reduced by costs to sell, is determinable. Loans that are deemed uncollectible are written off against the allowance, and recoveries, if any, are credited to the allowance. Commercial mortgage loans foreclosed and transferred to real estate were $1.6 million for 2003. There was no charge against the valuation allowance for the foreclosure in 2003. There were no commercial mortgage loans foreclosed and transferred to real estate in 2002. There were no commercial mortgage loans more than 60 days delinquent or in the process of foreclosure at December 31, 2003 and 2002.
The Company has two non-contributory defined benefit pension plans: the Home Office Pension Plan and the Field Personnel Pension Plan. The defined benefit pension plans provide benefits based on years of service and final average pay. The accounting for the Home Office Pension Plan reflects several 2003 plan amendments, which include limiting future participation in the plan and reducing future benefit accruals by increasing the integration level, and no longer accruing cost of living adjustments for benefits.
A minimum pension liability adjustment is required when the actuarial present value of the accumulated benefit obligation exceeds plan assets. The plan assets of our plans exceed the accumulated benefit obligation. The following table summarizes the projected and accumulated benefit obligations and the fair value of assets for our plans for the years ended December 31:
The following table sets forth the Company’s weighted average asset allocations for defined benefit pension plans for the years ended December 31:
The following table sets forth net periodic benefit cost and obligation assumptions used in the measurement of the benefit obligations for the years ended December 31:
Substantially all full-time employees are covered by deferred compensation plans under which a portion of the employee contribution is matched. Contributions by Standard to the plans for 2003, 2002, and 2001 were $3.1 million, $2.8 million and $2.5 million, respectively.
The Company has a postretirement benefit plan, which includes medical, prescription drug benefits, and group term life insurance. Participants are required to contribute specified amounts, which are determined periodically, and are based on participants’ employment status and service. During 2003, the cost sharing between the Company and participants was changed for participants retiring after December 31, 2003.
The Company uses a December 31 measurement date for the postretirement benefit plan. The following table provides a reconciliation of the changes in the postretirement plan’s accumulated benefit obligations, fair value of assets and the funded status for the years ended December 31:
The projected discounted cash flow obligation for the postretirement plan at December 31, 2003 was $47.3 million.
(1) Year that the rate reaches the ultimate trend is 2009
The Company’s actual weighted average asset allocations for the postretirement benefit plans were the same as target allocation-100% debt securities at December 31, 2003 and 2002. These debt securities have long term maturities and fixed coupon rates. The coupon payments are normally paid quarterly and semiannually.
On December 8, 2003, the Medicare Prescription Drug, Improvement and Modernization Act (“the Act”) was enacted. The provisions of the Act will impact the Company’s postretirement benefit plan prescription drug benefits. However, the Company elects to defer the recognition of the effect of the Act until specific authoritative guidance on accounting for the federal subsidy has been issued by the FASB. Therefore, the current financial statements do not reflect any of the Act’s impact on the accumulated prescription benefit obligation or net periodic postretirement benefit. When specific authoritative guidance on the accounting for the federal subsidy provided by the Act is issued, the Company may change previously reported information. We do not expect this legislation to have a material impact on our financial statements.
The 1999 Omnibus Stock Incentive Plan authorizes the board of directors of StanCorp to grant eligible employees certain incentive or non-statutory stock options, bonuses and performance stock options, restricted and foreign stock awards, and stock appreciation and cash bonus rights related to StanCorp’s common stock. All options are granted at a stock price of not less than the market value at the date of the option grant and may be exercised for a period not exceeding ten years from the date of the grant. The maximum number of shares of common stock that may be issued under this plan is 1.7 million. By the end of 2003, 1.6 million shares, or options for shares, had been issued under this plan.
In 2002, we adopted the 2002 Stock Incentive Plan. This plan authorizes the board of directors to grant eligible employees and certain related parties incentive or non-statutory stock options and restricted stock. The maximum number of shares of common stock that may be issued under this plan is 1.5 million. By the end of 2003, options for 266,409 shares had been issued under the 2002 plan.
During 2003, options were granted under the 2002 Stock Incentive Plan to purchase 272,859 shares of common stock at prices ranging from $47.31 to $62.70 per share. These options were granted to members of StanCorp’s board of directors and employee groups consisting of officer and non-officer employees. Members of StanCorp’s board of directors received grants of options totaling 46,709 shares of common stock. Officers and other employees received grants of options totaling 226,150 shares of common stock. The employee options are subject to a four year annual step-vesting schedule beginning one year after the date of grant. Directors’ options are vested in one year.
We manage risk through diversification of products, industry, geography, and customers. Product diversification also yields risk-based capital synergies because of the varying capital requirements for different risks assumed. In addition, we manage risks by ceding exposure over certain limits.
To limit our exposure to large losses, we transfer insurance liability to others by entering into reinsurance agreements. Under these reinsurance agreements, the maximum liability retention limit per individual for group life and AD&D policies combined is $500,000. For group disability policies, the maximum retention limit is $10,000 gross monthly benefit per individual. Except for certain policies in the block of business we assumed from Minnesota Life in 2000, the maximum retention for individual disability policies is generally $3,500 monthly benefit per individual. On certain policies in the Minnesota Life block, Standard has a maximum retention limit of $6,000 monthly benefit per individual.
In addition to product-specific reinsurance arrangements, we have maintained reinsurance coverage in the past for certain catastrophe losses related to group life and AD&D. Subsequent to the terrorist events of September 11, 2001, the availability of reinsurance for catastrophe coverage became less certain and more expensive. Accordingly, we en -
tered into a catastrophe reinsurance pool with other insurance companies. This pool spreads catastrophe losses on group life and AD&D over approximately 35 participating members. The reinsurance pool exposes us to potential losses experienced by other participating members. However, through this pool, our catastrophe reinsurance coverage is increased to approximately $265 million per event. If the Company had been in the pool on September 11, 2001, the estimated pre-tax charges related to the terrorist events would have been approximately $15 million compared to pre-tax charges of $5 million actually incurred. An occurrence of a significant catastrophic event or a change in the on-going nature and availability of reinsurance and catastrophe reinsurance could have a material adverse effect on the Company’s business, financial position, results of operations or cash flows. The annual fees paid by the Company to participate in the pool and claims to date have been immaterial.
Effective October 1, 2000, Standard assumed through a reinsurance agreement, the individual disability insurance business of Minnesota Life. Standard paid a ceding commission of approximately $55 million and received approximately $500 million in assets and corresponding statutory liabilities. If Standard were to become unable to meet its obligations, Minnesota Life would retain the reinsured liabilities. Therefore, in accordance with the agreement with Minnesota Life, Standard established a trust for the benefit of Minnesota Life with the market value of assets in the trust equal to Minnesota Life’s reinsurance receivable from Stan -
dard. The trust is required to be trued up quarterly. The market value of assets required to be maintained in the trust at December 31, 2003 was $574 million. Accompanying the transaction was a national marketing agreement that provides access to Minnesota Life agents, some of whom now market Standard’s individual disability insurance products. We recently signed an extension of the national marketing agreement through 2007.
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 books and an equal amount is recorded as a recoverable from 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.
from GAAP are: a) bonds and commercial mortgage loans are reported principally at amortized cost; b) asset valuation and interest maintenance reserves are provided as prescribed by the NAIC; c) certain assets designated as non-admitted, principally deferred tax assets, furniture, equipment, and unsecured receivables, are not recognized as assets, resulting in a charge to statutory surplus; d) annuity considerations with life contingencies, or purchase rate guarantees, are recognized as income when received; e) reserves for life and disability policies and contracts are reported net of ceded reinsurance and calculated based on statutory requirements, including required discount rates; f) commissions, including initial commissions and expense allowance paid for reinsurance assumed, and other policy acquisition expenses are expensed as incurred; g) initial commissions and expense allowance received for a block of reinsurance ceded net of taxes are reported as deferred gains in surplus and recognized as income in subsequent periods; h) federal income tax expense includes current income taxes defined as current year estimates of federal income taxes and tax contingencies for current and all prior years and amounts incurred or received during the year relating to prior periods, to the extent not previously provided; i) deferred tax assets, net of deferred tax liabilities, are included in the regulatory financial statements, and represent the expected future tax consequences of differences between the tax and the financial statement bases of assets and liabilities; and j) surplus notes are included in capital and surplus.
The Company has certain software maintenance, licensing, and telecommunications commitments that expire in various years through 2008, with renewal options for a two-year period. Future minimum payments under these commitments are 2004, $1.3 million; 2005, $0.8 million; 2006, $0.2 million; 2007, $0.04 million; and 2008, $0.04 million. Total expense for these agreements was $0.9 million, $1.2 million and $1.7 million for the years ended December 31, 2003, 2002, and 2001, respectively.
In the normal course of business, the Company commits to fund commercial mortgage loans that generally have fixed expiration dates. At December 31, 2003, the Company had outstanding commitments to fund commercial mortgage loans with fixed interest rates ranging from 5.25% to 7.00%, totaling $102.8 million. These commitments generally have fixed expiration dates. A small percentage of commitments expire due to the borrower’s failure to deliver the requirements of the commitment by the expiration date. In these cases, the Company will retain the commitment fee and good faith deposit. Alternatively, if the Company terminates a commitment due to its disapproval of a commitment requirement, the commitment fee and deposit will be refunded to the borrower, less an administrative fee.
Other long-term liabilities reflected in the Company’s balance sheet at December 31, 2003 consisted of an $11.5 million tax reimbursement liability related to the block of life insurance business sold to Protective Life in 2001, $17.4 million in liabilities for deferred compensation and supplemental retirement plans, $9.3 million in capital commitments related to our joint venture businesses, and $0.9 million accrued guarantee association payments.
From time to time, the board of directors has authorized share repurchase programs. Share repurchases are to be effected in the open market or in negotiated transactions in compliance with the safe harbor provisions of Rule 10b-18 under regulations of the Securities Exchange Act of 1934. Execution of the share repurchase program is based upon management’s assessment of market conditions for its common stock and other potential growth opportunities. During 2003, we repurchased 185,700 shares of common stock at a total cost of $9.3 million, for a volume weighted-average price of $50.35 per common share.