This "Management's Discussion and Analysis of Financial Condition and Results of Operations" reviews the consolidated financial condition of the Company as of December 31, 1999 and 1998, the consolidated results of operations for the three years ended December 31, 1999, and where appropriate, factors that may affect future financial performance.
On January 10, 2000 the Company announced that it had agreed to sell its Financial Services Division to Reassure America for $260 million subject to certain adjustments, and would accomplish such transaction through the filing of a voluntary petition for relief under Chapter 11 of the Bankruptcy Code.
Under the Recapitalization Plan, all existing shares of the Company's common stock will be cancelled for no value, and the Company's existing senior and subordinated debt, with principal currently aggregating approximately $180 million, will be paid in full in cash. Any and all other claims and liabilities of the Company will be paid in accordance with their terms.
The Company filed a plan of reorganization on April 5, 2000 and will seek confirmation of the Recapitalization Plan by the Bankruptcy Court on June 5, 2000, with consummation expected to occur promptly thereafter. For additional information, see Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations--Financial Condition, Liquidity and Capital Resources and Notes 9 and 23 of Notes to Consolidated Financial Statements.
During 1999 the Company used $267.0 million of the net proceeds from these sales to pay down the outstanding balance under the Bank Credit Facility. In addition, the Company repaid an additional $2.0 million of indebtedness as a result of liquidity at the parent company above the amounts prescribed in the Bank Credit Facility, as amended.
Acquisitions and Other Transactions. On January 2, 1998, the Company consummated the acquisition from KB Fund the SW Financial Controlling Interest for an aggregate purchase price of $73.7 million (not including acquisition expenses).
The 1999 plan provided for the termination of 50 employees consisting of divisional management and staff in Dallas over a nine month period. As of December 31, 1999, the Company had paid and charged $663,000 against the accrual for severance and related benefits for 32 terminated employees. Substantially all of the remaining terminations occurred by March 31, 2000.
The 1999 plan also provided for vacating additional floors of the Company's Dallas leased offices. The restructuring provision of $2.1 million represented the estimated net present value of the rent on the office space to be vacated net of the estimated sublease rental income to be received by the Company.
The Company anticipates realizing operating expense reductions and cash savings of approximately $3.9 million and $3.4 million per year, respectively, after implementing the 1999 restructuring plan.
On January 2, 1998, and January 5, 1998, respectively, the Company acquired the SW Financial Controlling Interest and the Fickes and Stone Knightsbridge Interest. The acquisition allowed the Company to complete its divisional restructuring which began in 1997. As a result, the Company incurred restructuring costs aggregating approximately $11.8 million for the year ended December 31, 1998, associated with the divisional restructuring.
The following reflects the impact of activity for the years ended December 31, 1999 and 1998 on the restructuring accrual balances under the 1st Quarter 1998 Plan (in thousands):
Approximately 120 and 39 people, respectively, were estimated to be terminated, as a result of the decision to transfer all operations of Union Bankers to Raleigh and transfer operations of United Life from Baton Rouge to Dallas. In addition, the Company also restructured certain of the operations in Raleigh. Certain employees in the areas of customer services, information technology, actuarial, legal, human resources and other policyholder service areas, totaling 54 people were considered for termination under the Raleigh portion of the restructuring plan. The Company recognized severance costs totaling $3.8 million. The Company charged $297,000 and $4.4 million against the severance accrual during 1999 and 1998, respectively, as the result of termination payments. In addition, during 1999 and 1998 the Company adjusted the severance accrual in the amount of $322,000 and $405,000, respectively, due to the Company paying less severance costs as a result of natural attrition and other factors such as inter-company transfers of employees. During 1998, the Company also increased the severance accrual by $1.6 million as a result of the decision to terminate all 54 of Security Life's Raleigh employees.
The 1997 plan provided for the termination of approximately 269 employees in the Company's Raleigh offices and certain foreign operations and substantially all of the employees of the Company's Waco operations, totaling 114. The 1997 plan anticipated a significant consolidation of operations into an affiliate's Dallas offices over a twelve month period. As of December 31, 1997, the Company had charged $2.4 million against the accrual for severance and related benefits. The Company adjusted the remaining severance accrual by $1.0 million during 1997 due to natural attrition thus reducing the level of severance required coupled with the decision to retain certain employees indefinitely. As of December 31, 1997, the severance accrual was $1.9 million which was adjusted during 1998 as a result of the decision not to merge the Company's Waco operations into Dallas.
In addition, the 1997 plan recognized the impairment of certain furniture, fixture and data processing equipment of $1.5 million as a result of the decision to abandon certain Company owned and leased facilities. During 1998 and 1997, the Company charged off furniture, fixtures and data processing equipment totaling $-- and $332,000, respectively, and adjusted the original impairment provision by $347,000 and $847,000, respectively.
Contract termination costs provided in the 1997 plan were adjusted to zero during 1998 as a result of the ultimate settlement of certain contracts without penalty.
For the years ended December 31, 1999 and 1998 the Company recorded an impairment provisions aggregating $58.5 million and $343.0 million, respectively. The Company recorded the impairment provisions in order to reflect the difference in the Company's accounting basis in the Businesses Held for Sale and the fair value of the consideration that the Company would likely receive for such businesses. The fair value of the consideration likely to be received has been primarily based upon the terms of definitive sales agreements. The impairment provision of $58.5 million in 1999 was related to the disposition of the Career Sales Division. The impairment provision recorded during 1998 aggregating $343.0 million reduced the Company's value of the Career Sales Division, Professional and the United Life Assets in the amounts of $328.6 million, $3.3 million and $11.1 million, respectively.
The Company evaluated the recoverability of all intangible assets of the Payroll Sales Division based upon the sales proceeds received from the disposition of the remaining Payroll Sales Division companies on February 4, 2000. As a result, an impairment provision for certain intangible assets aggregating $95.5 million was reflected in the Statement of Operations for the year ended December 31, 1999. All remaining costs in excess of net assets acquired in the Payroll Sales Division, totaling $19.3 million, were impaired. In addition, the Company impaired all remaining present value of insurance in force and a portion of deferred policy acquisition costs totaling $67.6 million and $49.7 million, respectively, net of deferred taxes of $41.0 million.
Many computer and software programs were designed to accommodate only two digit fields to represent a given year (e.g. "98" represents 1998). It was highly likely that such systems could not have been able to accurately process data containing date information for the year 2000 and beyond. The Company is highly reliant upon computer systems and software as are many of the businesses with which the Company interacts. The Company's ability to service its policyholders and agents is dependent upon accurate and timely transaction processing. Transaction processing in turn is dependent upon the Company's highly complex interdependent computer hardware, software, telecommunications and desktop applications. The inability of the Company or any of its integral business partners to continue processing transactions during 2000 could lead to a significant business interruption. Such an interruption could have resulted in a decline in current and long-term profitability and business franchise value.
The Company provided certain representations and warranties to each respective purchaser of the businesses sold with respect to each entity's ability to process date-sensitive information for the year 2000 and beyond. Although the Company believes that it is in compliance with, and is not aware of any breach of the year 2000 representations and warranties provided to the respective purchasers, there can be no assurances that the Company is in compliance with all such representations and warranties. A breach by the Company of such representations and warranties could result in indemnification obligations owed by the Company to the purchasers.
The following table shows the cash sources and uses of the parent company on a projected basis for 2000, assuming the consummation of the Recapitalization Plan, and on an actual basis for the period January 1, 2000 to February 7, 2000 (prior to the Petition Date) and years ended December 31, 1999, 1998 and 1997:
Cash from Subsidiaries. Cash generated by the Company's insurance subsidiaries is made available to PennCorp principally through periodic payments of principal and interest on surplus debentures issued by PLAIC, Constitution (sold July 30, 1999) and Pioneer Security (collectively, the "Surplus Note Companies"). The surplus debentures issued by PLAIC and Constitution were repaid in full in connection with the consummation of the sale of the Career Sales Division. As part of a subsidiary realignment, PLAIC issued a new surplus debenture to SW Financial in the amount of $150.0 million to acquire the common stock of Southwestern Life. With respect to Constitution, Pioneer Security and PLAIC (as to its surplus debenture issued as of July 30, 1999), the surplus debenture payments are made to non-insurance intermediate holding companies and paid to the Company in the form of dividends and tax sharing payments. The amounts outstanding under the surplus debentures totaled $258.3 million and $453.1 million as of December 31, 1999 and 1998, respectively. The surplus debentures generally require (subject to availability of statutory capital and surplus and in some instances, regulatory approval) principal and interest payments to be made periodically in amounts sufficient to allow PennCorp to meet its cash requirements.
For the years ended December 31, 1999, 1998 and 1997, the Company received surplus debenture interest and principal payments from PLAIC of $223.5 million, $26.2 million and $16.4 million, respectively, and received dividends and tax sharing payments from non-insurance intermediate holding companies of $126.4 million, $47.3 million and $ 18.4 million, respectively. Approximately $80.0 million of dividends and tax sharing payments from non-insurance intermediate holding companies during 1999 were the direct result of proceeds received from sales of Businesses Held for Sale. The Surplus Note Companies received $25.2 million, $69.5 million and $32.1 million in dividends and tax sharing payments from their respective insurance subsidiaries.
Sale of Directly Owned Subsidiaries. During the year ended December 31, 1999, the Company sold certain directly owned subsidiaries in connection with the disposition of the Businesses Held for Sale and received proceeds of $6.0 million.
Other Investment Income. During each of the years in the three year period ended December 31, 1999, the Company received other investment income from short-term invested assets.
Additional Borrowings. During 1998 and 1997 the Company borrowed under then existing bank credit facilities to primarily fund acquisitions or repay existing indebtedness. See "Cash Uses" below for the use of proceeds from the additional borrowings.
Interest Paid on Indebtedness. During the three year period, the Company utilized varying amounts of leverage in its capital structure. For the years ended December 31, 1999, 1998 and 1997, the average indebtedness outstanding aggregated $366.9 million, $452.6 million and $281.6 million, respectively. The Company's weighted average costs of borrowings increased significantly during 1999 and 1998 as a result of the Company's increased leverage ratio and projected weakness in future liquidity. For additional information regarding indebtedness, see Note 9 of Notes to Consolidated Financial Statements and Management's Discussion and Analysis of Financial Condition--Parent Company--General.
Purchase of Treasury Shares. During 1997 the Company utilized proceeds from its existing credit facility to repurchase approximately 819,000 shares of Common Stock for $28.8 million in accordance with an agreement with the former owner of United Life.
In conjunction with the Company's 1998 acquisition of the SW Financial Controlling interest, the Company borrowed under its existing $450 million Bank Credit Facility to repay indebtedness of SW Financial aggregating $115.0 million upon acquisition. In addition, during 1998 the Company used existing liquidity to repay $11.0 million of indebtedness under the company's Bank Credit Facility. During 1997, the Company utilized proceeds from the Bank Credit Facility to retire indebtedness aggregating $100.0 million outstanding under a prior bank credit agreement.
Purchase of Equity Securities. In conjunction with the acquisition of the Fickes and Stone Knightsbridge Interests, the Company acquired Fickes' and Stone's interest in the ACO Brokerage Common Stock for $5.0 million. During 1997, the Company invested $20.0 million in ACO Preferred Stock.
As part of series of restructuring transactions approved by the Texas Department of Insurance, Security Life became a wholly-owned subsidiary of PLAIC. In addition, PLAIC was permitted to prepay $20.4 million of principal and interest on its surplus debenture to SW Financial, which then paid these funds as a dividend to the Company. On February 4, 2000, AA Holdings sold the companies in the Payroll Sales Division for $103.3 million. The net proceeds to the parent company after repayment of intercompany borrowings to insurance company affiliates of PennCorp was $97.0 million. In addition, the Company received a $12.7 million dividend from AA Holdings. Of the proceeds, $100.0 million were used to repay a portion of the Company's Bank Credit Facility.
Management believes the Company will likely have sufficient financial flexibility and projected liquidity sources to meet all cash requirements until the maturity of the cash collateral agreement on May 31, 2000. The Company is in the process of proposing a plan of recapitalization to be filed with the Delaware Bankruptcy Court which will provide for the repayment of such indebtedness (see Note 23 of Notes to Consolidated Financial Statements). With respect to current liquidity projections, there can be no assurances actual liquidity sources will develop. In the event of a shortfall of actual liquidity sources, and as a result of the necessity of the Company to establish a new credit facility, the Company will explore options to generate any necessary liquidity, such as: (i) the sale of subsidiaries and (ii) obtaining regulatory approval for extraordinary dividends from its insurance subsidiaries (which is unlikely at the present time). If the Company is unable to obtain sufficient liquidity to meet its projected cash requirements, such failure could result in a default on one or more obligations and the holders thereof would be entitled to exercise certain remedies, including the acceleration of the maturity of the entire indebtedness and commencing legal proceedings to collect the indebtedness. In such event, the Company will examine and consider the range of available alternatives to the Company at that time.
Cash Flow from Investing Activities. During the years ended December 31, 1999, 1998 and 1997, the Company's subsidiaries sold $603.5 million, $1,019.9 million and $801.1 million of fixed maturity and equity securities, and purchased $814.2 million, $1,054.7 million and $1,021.5 million of fixed maturity and equity securities, respectively. Such sales and purchases were primarily effected in order to meet cash flow demands associated with policyholder surrenders that in the aggregate increasingly exceeded policyholder deposits as well as to improve the quality of the investment portfolio or avoid prepayment risks.
For the years ended December 31, 1999, 1998 and 1997, the Company has prepared the following unaudited selected pro forma financial information for the Company's remaining operating divisions, the Financial Services Division (Southwestern Life and Security Life) and the Payroll Sales Division (AA Life and OLIC) and Businesses Held for Sale (Career Sales Division, Professional, the United Life Assets and KIVEX). During the three months ended June 30, 1999, the Company concluded that it would retain, and shut down over time, certain remaining operations of Marketing One. Consequently, the results of operations of Marketing One have been reclassified out of "Businesses Held for Sale" to "Corporate" for all periods presented. The selected pro forma financial information by operating division is defined as pre-tax income (loss) excluding the impact of: (i) restructuring costs, (ii) gains or losses on the sale of investments and (iii) the impact of the Company's decision to dispose of the Businesses Held for Sale ((i), (ii) and (iii) collectively, "Operating Income (Loss)"). The Company considers operating income (loss) to reflect a division's "core earnings (loss)" and to be the most relevant and useful information to evaluate trends impacting each of the Company's divisions. This information is used by the Company's principal decision makers to evaluate the performance of each division as it eliminates the impact of transactions that the Company considers to be unrelated to the core operating results of the divisions. Other companies that operate primarily in the life insurance industry may or may not use similar measures. In addition, the 1997 unaudited selected pro forma financial information considers the impact of the: (i) acquisition of the SW Financial Controlling Interest, including the financing thereof, and (ii) the acquisition of the Fickes and Stone Knightsbridge Interests, including the financing thereof, as though each had occurred on January 1, 1997.
The following unaudited selected pro forma financial information has been prepared for comparative purposes only and does not purport to be indicative of what would have occurred had the acquisitions been made as of January 1, 1997, or the results which may occur in the future.
The Financial Services Division includes the operations of Southwestern Life and Security Life. Southwestern Life and Security Life market life insurance and, to a lesser extent annuity products, through independent general agents who sell directly to individuals primarily in the southwestern and southeastern United States.
Premiums, net of reinsurance, by major product line for the years ended December 31, 1999, 1998 and 1997 are as follows:
Universal life and traditional life renewal premiums declined $27.2 million and $4.1 million or 20.3% and 3.0% for the years ended December 31, 1999 and 1998, respectively. This reflects the impact of certain management actions instituted by Security Life and ratings downgrades. On January 1, 1999 Security Life instituted an exchange or refund program for holders of certain types of interest sensitive insurance contracts. This program resulted in a refund of premiums of $23.0 million during 1999 (see below). Universal life and traditional life renewal premiums declined $3.5 million and $653,000 for 3.5% and 1.8% respectively for the year ended December 31, 1998 compared to the year ended December 31, 1997. This reflects ratings downgrades and the impact of certain management actions instituted by Southwestern Life in the third quarter of 1997. Southwestern Life is implementing additional management actions during 2000 which may result in reduced renewal premiums in 2000 and subsequent years. See "Total Policyholder Benefits" included herein.
In January 1999, Security Life initiated management action in the form of an exchange program for certain policyholders of Security Life. The program was offered to all policyholders who had certain policy forms in force as of January 1, 1998. The program allowed the policyholder the following options in exchange for terminating his or her policy and executing a release: (i) refund of 115% of all premiums paid for the policy prior to January 1, 1999 and 100% of premiums paid thereafter; (ii) exchange the policy, without proof of insurability, for the same face amount in a universal life policy, or a new term universal life policy. The policyholder also had the choice of not accepting the exchange program and keeping the current policy in force. As of December 31, 1999, 66% of such policyholders completed the exchange. In November 1999, a lawsuit was filed against Security Life regarding the exchange program and products. (See Item 3. Legal Proceedings.)
Total Policyholder Benefits. The following table shows the components of total policyholder benefits for the year ended December 31, 1999, 1998 and 1997:
The Company is continually evaluating actuarial assumptions associated with interest sensitive life insurance contracts in which the determination of policy reserves is highly sensitive to assumptions such as withdrawal rates, investment earnings rates, mortality rates, and premium persistency. Currently reflected in the Company's financial statements are policy reserves and account values associated with such contracts, which aggregated approximately $527.1 million and $525.4 million as of December 31, 1999 and 1998, respectively. If developing trends were to continue, principally the less than expected level of the lapses currently associated with such interest sensitive blocks of business, the Company would be required to record additional reserves or reduce intangible assets, which could have a material impact on the Company's financial position and results of operations. A decrease of 1% in the assumed lapse rate would increase policy reserves associated with such contracts by $9.0 million. Management is also assessing the potential impact of future management actions, which might mitigate the financial impact of these trends. Types of management actions would likely include, but are not limited to, the redetermination of non-guaranteed charges and/or benefits under the contracts, asset segmentation, and reinsurance. There are risks associated with management action including potential sales disruption and the threat of litigation.
Insurance Related Expenses. During 1999, insurance related expenses (including non-deferrable commissions, amortization of deferred policy acquisition costs and amortization of present value of insurance in force) decreased $938,000 to $28.7 million or 3.2% from $29.6 million during 1998. Insurance related expenses decreased $3.3 million or 10.0% in 1998 compared to 1997. The small decrease in 1999 reflects reduced insurance expenses for Security Life as a result of declining production of new business for several years and a diminished block of in force business as a result of surrenders. The decrease in 1998 compared to 1997 also reflects this trend. Also during 1998 amortization of deferred policy acquisition costs increased approximately $3.2 million as a result of writing off certain deferred costs for Security Life which were unrecoverable from future profits as a result of shifts in the mix of products sold during the year. This was offset by a $3.2 million decrease in the amortization of present value of future profits at Southwestern Life in 1998 resulting from unlocking assumptions of future interest rates, lapses, expenses and mortality which affect the estimated future profitability of certain interest sensitive life insurance products.
Year ended December 31, ----------------------------- 1999 1998 1997 ------- -------- -------- ($ in thousands) Revenues: Policy revenues .......................... $ 92,029 $ 89,990 $ 89,698 Net investment income .................... 36,771 38,252 38,161 Other income (loss) ...................... 2,085 (1,691) 4,454 -------- -------- -------- 130,885 126,551 132,313 -------- -------- -------- Benefits and expenses: Total policyholder benefits .............. 62,617 64,708 64,622 Insurance related expenses ............... 35,244 42,135 29,377 Other operating expenses ................. 16,924 23,209 14,354 -------- -------- -------- 114,785 130,052 108,353 -------- -------- -------- Pre-tax operating income (loss) ......... $ 16,100 $ 23,960 $ 23,960 ======== ======== ========
Policy Revenues. Premiums received, net of reinsurance, by major product line for the years ended December 31, 1999, 1998 and 1997 are as follows:
Year ended December 31, ------------------------------ 1999 1998 1997 --------- --------- --------- ($ in thousands)
Policyholder benefits decreased $2.1 million or 3.2% during 1999 compared with 1998. Death benefits decreased $1.3 million during 1999. Death benefits may vary significantly from period to period. Other insurance policy benefits and change in future policy benefits decreased $1.3 million during 1999 reflecting decreases in life and fixed benefit health reserves at OLIC as a result of reduced claims activity and a reduced inventory of open claims. Policyholder benefits totaled $64.7 million in 1998, which was little changed compared to 1997.
Other Operating Expenses. Other operating expenses (including general operating, overhead and policy maintenance) decreased $6.3 million during 1999 from 1998 and increased $8.9 million during 1998 from 1997. The decrease in 1999 operating expenses primarily reflects the consolidation of OLIC's operations into Waco which occurred in the fourth quarter of 1998. The increase in 1998 is attributable to several factors, including: (i) approximately $3.6 million of remediation costs associated with Year 2000 systems conversions and upgrades, (ii) approximately $2.0 million of acquisition costs at OLIC which were expensed in 1998 as unrecoverable from future profits and (iii) additional non-deferrable expenses such as consulting fees, appraisals and other costs associated with divisional realignment which are not considered restructuring costs.
Policy Revenues. Policy revenues declined 52.9% or $127.0 million in 1999 compared to 1998 and 9.0% or $23.8 million to $239.9 million in 1998 compared to 1997. The decline in 1999 is primarily attributable to the sale of Professional, the United Life Assets and the Career Sales Division on March 31, 1999, April 1999 and July 30, 1999, respectively. The decline in 1998 of $21.4 million is primarily attributable to Union Bankers which discontinued sales of major medical health products and its life insurance products and increased its utilization of reinsurance. The remainder of the decrease is attributable to Penn Life which experienced decreases in policy revenues of $3.8 million (2.6%) in 1998 compared to 1997 principally as a result of lower first year sales.
Total Policyholder Benefits. Policyholder benefits decreased $160.1 million (61.2%) in 1999 compared to 1998 and increased $30.8 million (13.4%) in 1998 compared to 1997. The decline in 1999 is primarily attributable to the sale of Professional, the United Life Assets and the Career Sales Division on March 31, 1999, April 1999 and July 30, 1999, respectively. The policyholder benefits of Penn life increased $43.0 million in 1998 compared to 1997. The increase was primarily the result of specific increases in reserve estimates associated with long term care products and certain claims reserves held by Penn Life. Policy reserves and claims reserves increases associated with the changes in estimates aggregated approximately $32.6 million.
The Company had been closely monitoring the development of its claim reserve experience associated with the Career Sales Division. The historical method of establishing claims reserves principally utilized claims lag factors. Based on results of independent calculations of the claim lag factors, performed annually, this methodology indicated a deterioration in the adequacy of claim reserves associated with Penn Life's disability income products underwritten prior to PennCorp's ownership of Penn Life. Disability claim adequacy analysis included statutory claim information, independent third-party review of claim lag method and factors and other claim tests. Previous results indicated no reason to consider a new methodology as results appeared consistent between periods and claim reserves appeared adequate. Once results of such analysis began to vary outside an acceptable tolerance, the Company reviewed its methods to determine the reasons for the variances.
Insurance Related Expenses. Insurance related expenses (including commissions, amortization of deferred policy acquisition costs and amortization of present value of insurance in force) decreased $62.5 million to $24.2 million in 1999 compared to 1998 and decreased $6.6 million to $86.7 million in 1998 compared to 1997. The decline in 1999 is primarily attributable to the sale of Professional, the United Life Assets and the Career Sales Division on March 31, 1999, April 1999 and July 30, 1999, respectively. Amortization of present value of insurance in force decreased $11.6 million in 1998 principally as a result of the Company recording an impairment provision associated with assets of Businesses Held for Sale resulting in the elimination of substantially all insurance assets subject to amortization. Specifically, Penn Life and Union Bankers wrote off $98.1 million of present value of insurance in force in 1998 which reduced amortization. This was partially offset by an increase in amortization of deferred policy acquisition costs of $5.3 million, which included (i) an increase at Professional of $1.8 million in 1998 compared to 1997 as a result of higher than expected lapses on fixed benefit products, (ii) an increase of $1.7 million for United Life as a result of unlocking future assumptions regarding the profitability of certain annuity products and (iii) an increase at Union Bankers of $1.9 million as a result of higher lapses. Non-deferrable commissions decreased approximately $1.0 million at Union Bankers principally due to the decision to stop writing new major medical and life business.
Other Operating Expenses. Other operating expenses (including general operating, overhead and policy maintenance) decreased $34.4 million (47.1%) in 1999 compared to 1998 and increased $6.2 million (9.3%) in 1998 compared to 1997. The decline in 1999 is primarily attributable to the sale of Professional, the United Life Assets and the Career Sales Division on March 31, 1999, April 1999 and July 30, 1999, respectively. In 1998, KIVEX's operating expenses increased $7.4 million reflecting costs associated with its expansion into new cities. In addition, the companies included in Businesses Held for Sale experienced increased costs as a result of additional non-deferrable expenses such as consulting, overhead and other costs associated with the divisional realignment, which are not considered restructuring costs. Offsetting the increases in operating expenses is reduced amortization of costs in excess of net assets acquired associated with the assets of the Businesses Held for Sale. During 1998, a total of $114.5 million of costs in excess of net assets acquired were written off as part of the impairment provision, which decreased amortization by approximately $2.8 million in 1998 compared to 1997.
In addition, during the year ended December 31, 1997, the Company incurred $7.6 million of one time pre-tax transaction costs associated with the termination of the Washington National merger agreement.
Income Taxes. For the years ended December 31, 1999 and 1998, the Company incurred income tax expense (benefit) of $28.7 million and ($3.4 million), on a pretax loss of $172.0 million and $424.6 million, respectively. The unusual effective tax rates for 1999 and 1998 are substantially due to the non-deductibility of the reduction in carrying value of the assets associated with the sale of the Payroll Sales Division and Businesses Held for Sale and an increase in the tax valuation allowance. The valuation allowance associated with tax assets is continually monitored by the Company in light of the dramatic changes in the operating structure and financial results of the Company. As a result of such analysis the Company increased the valuation allowances by $38.9 million and $23.5 million during 1999 and 1998, respectively. In each of the periods, the valuation allowance was incurred as the result of the increased likelihood that certain net operating losses and capital loss carryforwards would not be utilized and the impact or potential impact of a "change in control" as defined by the Internal Revenue Code Section 382. Change of control provisions of Section 382 could limit the Company's ability to utilize certain tax benefits including net operating loss carryforwards in future periods. For the year ended December 31, 1997, the effective rate of 39.5% is higher than the statutory rate of 35% primarily due to non-deductible amortization of costs in excess of net assets acquired and foreign taxes in excess of foreign taxes utilized.
The management of the Company is responsible for the preparation and fair presentation of the consolidated financial statements, financial data and other information in this annual report. They have been prepared in conformity with generally accepted accounting principles appropriate in the circumstances and include amounts based on the best estimates and judgment of management. The Company's management is also responsible for the accuracy and consistency of other financial information included in this annual report.
In recognition of its responsibility for the integrity and objectivity of data in the financial statements, the Company maintains a system of internal control over financial reporting which is designed to provide reasonable, but not absolute, assurance with respect to the reliability of the Company's financial statements. The concept of reasonable assurance is based on the notion that the cost of the internal control system should not exceed the benefits derived.
Keith A. Maib James P. McDermott President, Chief Executive Officer Executive Vice President and and Chief Operating Officer Chief Financial Officer
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of PennCorp Financial Group, Inc. and subsidiaries as of December 31, 1999 and 1998, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1999, in conformity with generally accepted accounting principles.
The accompanying 1999 consolidated financial statements have been prepared assuming that the Company will continue as a going concern. The Company suffered losses from operations in 1999 and 1998. As discussed in Note 23 to the consolidated financial statements, PennCorp Financial Group, Inc. filed a voluntary petition for relief under chapter 11 of title 11 of the United States Bankruptcy Code in the United States Bankruptcy Court for the District of Delaware. The Company has filed a plan of reorganization and will seek confirmation of the Recapitalization Plan by the Bankruptcy Court. Should the recapitalization plan not be approved by the Bankruptcy Court, be materially delayed or not be consummated, the Company may have to sell assets or otherwise realize assets and liquidate or settle liabilities for amounts other than those reflected in the consolidated financial statements or related notes. These factors raise substantial doubt about the Company's ability to continue as a going concern. The 1999 consolidated financial statements do not include any adjustments that might result from the outcome of these uncertainties.
PennCorp Financial Group, Inc. ("PennCorp," or the "Company") is an insurance holding company. Through its wholly-owned life insurance subsidiaries; Pennsylvania Life Insurance Company ("PLIC") and its wholly-owned subsidiary, PennCorp Life Insurance Company (collectively referred to as "Penn Life") (sold July 30, 1999); Peninsular Life Insurance Company ("Peninsular") (sold July 30, 1999); Professional Insurance Corporation ("Professional") (sold March 31, 1999); Pioneer Security Life Insurance Company ("Pioneer Security") and its wholly-owned subsidiaries American-Amicable Life Insurance Company of Texas and Pioneer American Insurance Company (Pioneer Security and its subsidiaries collectively referred to as "AA Life"); Southwestern Financial Corporation ("SW Financial") and its wholly-owned subsidiaries Southwestern Life Insurance Company ("Southwestern Life"), Constitution Life Insurance Company ("Constitution") (sold July 30, 1999), Union Bankers Insurance Company ("Union Bankers") (sold July 30, 1999), and Marquette National Life Insurance Company ("Marquette") (sold July 30, 1999); Security Life and Trust Insurance Company ("Security Life"); Occidental Life Insurance Company of North Carolina ("OLIC"); United Life & Annuity Insurance Company ("United Life") (sold April 30, 1999); and Pacific Life and Accident Insurance Company ("PLAIC"), the Company offers a broad range of accident and sickness, life, and accumulation insurance products to individuals through a sales force that is contractually exclusive to certain of the Company's subsidiaries and through general agents. Additionally, the Company owns KB Management, LLC ("KB Management"), which provides management and advisory services to the Company; Marketing One, Inc. ("Marketing One"), a third party marketing organization; KIVEX, Inc. ("KIVEX") (sold June 30, 1999), an internet service provider, UC Mortgage Corp. ("UC") (sold April 30, 1999) and Cyberlink Development, Inc. ("Cyberlink") (sold April 30, 1999). As part of a subsidiary realignment, Southwestern Life became a wholly-owned subsidiary of PLAIC as of July 30, 1999.
The Businesses Owned at December 31, 1999 includes the Payroll Sales Division (the Payroll Sales Division is comprised of AA Life and OLIC) and the Financial Services Division (the Financial Services Division is comprised of Southwestern Life and Security Life).
The accompanying consolidated financial statements include the accounts of the Company and its subsidiaries. All significant intercompany accounts and transactions have been eliminated. All dollar amounts presented hereafter, except share amounts, are stated in thousands.
The Company continually monitors the recoverability of the carrying value of intangible assets using the methodology prescribed in Statement of Financial Accounting Standards ("SFAS") No. 121 and Accounting Principles Board ("APB") No. 17 "Intangible Assets." The Company evaluates long-lived assets and the related intangible assets for impairment whenever events or changes in circumstances indicate the carrying amounts of these assets may not be recoverable. Recoverability of these assets is determined by comparing a forecast of the undiscounted net cash flows of the entity to the asset carrying amount. If the entity is determined to be unable to recover the carrying amount of its assets, intangible assets are written down initially, followed by the other long-lived assets of the operation, to fair value. Fair value is determined based upon discounted cash flows or appraised values, depending on the nature of the associated assets.
During 1999 and 1998, the Company recognized an aggregate $58,486 and $342,960, respectively, non-cash charges related to the fair value of consideration to be received upon disposition of certain operating companies which are aggregated for purposes of presentation of the Company's financial information as "assets and liabilities of Businesses Held for Sale."
In accordance with SFAS No. 121, the Company recorded the impairment provision in order to reflect the difference in the Company's accounting basis in the Businesses Held for Sale and the fair value of the consideration that the Company would likely receive for such businesses. The fair value of the consideration likely to be received has been primarily based upon the terms of definitive sales agreements.
The Company evaluated the recoverability of all intangible assets of the Payroll Sales Division based upon the sales proceeds received from the sale which was entered into on January 8, 2000 and consummated February 4, 2000 (see Notes 3 and 23). As a result, an impairment provision of $95,522 was reflected in the Statement of Operations for the year ended December 31, 1999.
For the year ended December 31, 1998, the Company made a valuation determination with respect to certain preacquisition contingencies. The Company reduced tax liabilities and associated costs in excess of net assets acquired associated with the SW Financial and United Life acquisitions by $6,407 and $647, respectively, as a result of the Company resolving certain acquisition date contingencies.
Accident and sickness insurance premiums are recognized as revenue ratably over the time period to which premiums relate. Revenues from traditional life insurance policies represent premiums which are recognized as earned when due. Benefits and expenses are associated with earned premiums so as to result in recognition of profits over the lives of the policies. This association is accomplished by means of the provision for liabilities for future policy benefits and the deferral and amortization of policy acquisition costs.
The Company utilized the requirements of SFAS No. 123, "Accounting for Stock-Based Compensation," when accounting for stock options and other stock based compensation. This statement provides a choice for the accounting of employee stock compensation plans. A company may elect to use a new fair-value methodology, under which compensation cost is measured and recognized in results of operations, or continue to account for these plans under APB No. 25, "Accounting for Stock Issued to Employees," and related Interpretations. Note 13 contains a summary of the pro forma effects to reported net income applicable to common stock and earnings per share for 1999, 1998 and 1997, as if the Company had elected to account for employee stock compensation plans utilizing the fair value methodology prescribed by SFAS No. 123.
Acquisitions of SW Financial Controlling Interest, Knightsbridge Interests and United Life
In addition, in February 1999, the Company engaged the firm of Wasserstein, Perella & Co. ("Wasserstein Perella") to review the Company's capital structure and develop recapitalization and restructuring alternatives. The Company, with Wasserstein Perella, has been exploring with interested parties, a sale of the Company or certain of its subsidiaries and, on a parallel track, a restructuring or recapitalization transaction (see Notes 3 and 23).
The Company used $267,000 of the net proceeds from these sales to pay down the outstanding balance under the bank credit facility (the "Bank Credit Facility"). In addition, the Company repaid an additional $2,000 of indebtedness as a result of liquidity at the parent company above the amounts prescribed in the Bank Credit Facility, as amended.
The amortized cost and fair value of fixed maturities available for sale as of December 31, 1999, by contractual maturity, are shown below:
As of December 31, 1999, there was no unrealized appreciation or loss in equity securities available for sale. As of December 31, 1998, net unrealized appreciation in equity securities available for sale consisted of gross unrealized gains of $27.
Investments with a carrying value of $216,629 and $146,385 were on deposit with certain regulatory authorities as of December 31, 1999 and 1998, respectively. Amounts on deposit are temporarily approximately $100,000 higher as a result of a change in custodians.
As a result of the Company's decision to exit the private placement bond sector, the Company transferred all of its remaining assets in the fixed maturities held for investment portfolio aggregating $49,384 to its fixed maturity available for sale as of April 1, 1997. In accordance with SFAS No. 115, the Company adjusted all transferred assets to fair value resulting in a net increase in shareholders' equity of $1,800, net of applicable income taxes.
Major categories of net investment income consisted of the following for the years ended December 31:
Preferred stock.............................. $ 6,656 $ 5,063 Other investments............................ 19,351 23,113 -------- ------- $ 26,007 $28,176 ======== =======
On December 14, 1995, SW Financial (see Note 18) purchased SW Life, Union Bankers and certain other related assets from I.C.H. Corporation for $260,000.
Through its initial direct investment of $120,000 in SW Financial (the "Southwestern Life Investment"), the Company beneficially owned, at December 31, 1997, 74.8% of SW Financial's outstanding common stock, including 100% of SW Financial's non-voting common stock, 14.3% of SW Financial's voting common stock, and 100% of SW Financial preferred stock. PennCorp is also a 16.3% limited partner in KB Fund. As a result, the Company had an economic interest in SW Financial aggregating 78.0 percent. Retained earnings of the Company included undistributed earnings of SW Financial aggregating $40,919 as of December 31, 1997.
Claims incurred ......................................... 201,385 Change in liability for future policy benefits and other policy benefits ................................. (35,103) Insurance and other operating expenses .................. 66,319 Interest and amortization of deferred debt issuance costs 13,773 --------- Total benefits and expenses .......................... 246,374 --------- Income before income taxes .............................. 43,751 Income taxes .......................................... 16,416 --------- Net income .............................................. 27,335 Preferred stock dividend requirements ................. 3,012 --------- Net income applicable to common stock ................... $ 24,323 =========
Information relating to deferred policy acquisition costs is as follows for the years ended December 31:
The methods used by the Company to value the fixed benefit, life, and accumulation products purchased are consistent with the valuation methods used most commonly to value blocks of insurance business. It is also consistent with the basic methodology generally used to value insurance assets. The method used by the Company includes identifying the future cash flows from the acquired business, the risks inherent in realizing those cash flows and the rate of return the Company believes it must earn in order to accept the risks inherent in realizing the cash flows, and determining the value of the insurance asset by discounting the expected future cash flows by the discount rate the Company requires.
Recoverability of the present value of insurance in force is evaluated annually and appropriate adjustments are then determined and reflected in the financial statements for the applicable period utilizing expected future cash flows. Expected future cash flows used in determining such values are based on actuarial determinations of future premium collection, mortality, morbidity, surrenders, operating expenses and yields on assets held to back policy liabilities as well as other factors. Variances from original projections, whether positive or negative, are included in income as they occur and will affect the present value of insurance in force amortization rates for insurance products accounted for under SFAS No. 97, "Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from Sales of Investments." To the extent that these variances indicate that future cash flows will differ from those included in the original scheduled amortization of the present value of insurance in force, future amortization may be adjusted.
Expected gross amortization of the present value of insurance in force, based upon current assumptions and accretion of interest at a policy liability or contract rate ranging from 3.5 to 14.5 percent, for the next five years is as follows:
2000 .............. $119,766 $ 19,743 $ 5,871 $ 13,872 2001 .............. 105,894 16,799 5,162 11,637 2002 .............. 94,257 14,583 4,519 10,064 2003 .............. 84,193 12,751 3,943 8,808 2004 .............. 75,385 11,031 3,441 7,590
The Company is continually evaluating actuarial assumptions associated with interest sensitive life insurance contracts in which the determination of policy reserves is highly sensitive to assumptions such as withdrawal rates, investment earnings rates, mortality rates, and premium persistency. Currently reflected in the Company's financial statements are policy reserves and account values associated with such contracts, which aggregated approximately $527.1 million and $525.4 million as of December 31, 1999 and 1998, respectively. If developing trends were to continue, principally the less than expected level of the lapses currently associated with such interest sensitive blocks of business, the Company would be required to record additional reserves or reduce intangible assets, which could have a material impact on the Company's financial position and results of operations. A decrease of 1% in the assumed lapse rate would increase policy reserves associated with such contracts by $9.0 million. Management is also assessing the potential impact of future management actions, which might mitigate the financial impact of these trends. Types of management actions would likely include, but are not limited to, the redetermination of non-guaranteed charges and/or benefits under the contracts, asset segmentation, and reinsurance. There are risks associated with management action including potential sales disruption and the threat of litigation. During 1999, the Company modified certain assumptions associated with the blocks of business including lowering the aggregate expected lapse rate. In addition, the Company is pursuing a plan to continue charging certain non-guaranteed expense loads associated with certain interest sensitive life insurance contracts. As a result of the actions, the Company increased the amount of reserves associated with these policies by approximately $6,200 during the fourth quarter of 1999.
1999 1998 ---------- ---------- Future policy benefits on traditional products: Traditional life insurance contracts ........ $ 736,931 $ 670,321 Health ...................................... 13,629 10,824 Unearned premiums ........................... 1,809 730 Other policyholder funds .................... 73,411 69,247 ---------- ---------- 825,780 751,122
Policy and contract claims: Health ...................................... 13,231 13,073 Life and other .............................. 36,538 25,245 ---------- ---------- Total future policy benefits ............... $2,756,957 $2,819,661 ========== ==========
As a result of changes in estimates of insured events in prior years and changes in methodology (described below), the liability for health policy and contract claims increased net of reinsurance by $1,217 in 1999, $31,545 in 1998 and $6,344 in 1997.
The lag factor method (an actuarial method to estimate aggregate claims reserves which utilizes the ratio of actual claims paid to what is ultimately paid as a function of time since the date incurred based upon historical experience) is one method which utilized Penn Life's experience considering its products and market. The Company believes that available industry data for establishing claim reserves was not appropriate for Penn Life's products and market. The utilization of a case reserve method (which estimates aggregate claims reserves based on the total estimates of all cases outstanding) for Penn Life required experience, in addition to that utilized by the lag factor method, to create case reserves based on Penn Life's experience. This experience was not sufficient until 1998. With system upgrades, Penn Life was able to obtain better benefit data distinguishing disability benefits from other benefits which may be payable under the same policy form. With the systems upgrades and more robust experience the Company was able to consider a more refined claims methodology such as seriatim case reserves (which estimates aggregate claims reserves based upon the sum of estimates for each individual unsettled case). During 1998, Penn Life implemented a method which substituted case reserves for most disability claims. The new method utilizes more detailed information by policy and by line of business resulting in a more refined estimate. As a result, the accident and health claim reserve for Penn Life increased by $25,691 during 1998. The effect of the change in methodology is inseparable from the effect of the change in accounting estimate and is accordingly reflected in operations for the year ended December 31, 1998.
-------------- (a) Interest costs under the Unsecured 9 1/4% Senior Subordinated Notes due 2003 (the "Notes") totaled $10,605, $10,622 and $11,461 during 1999, 1998 and 1997, respectively. As of December 31, 1999, the effective rate for the Notes was approximately 9 1/4%. (b) Interest costs under the $450,000 credit facility totaled $25,523, $30,680 and $9,188 during 1999, 1998 and 1997. The effective rate of interest as of December 31, 1999 was approximately 10.4%. In addition, the Company pays facility fees of $15 per month. During 1997, the Company had a $175,000 bank credit facility for which it incurred interest costs of $1,855.
The aggregate maturities of notes payable during each of the five years after December 31, 1999, are as follows: 2000, $165,000; and 2003, $114,646.
The required debt reduction of $40,000 was made on April 1, 1999, with proceeds from the sale of Professional, and the required debt reduction of $127,000 was made on April 30, 1999, with proceeds from the sale of the United Life Assets. Additional debt reduction of $22,000 was made on June 30, 1999, upon the completion of the sale of KIVEX. The Company repaid the final $78,000 of debt reduction requirements on July 30, 1999, upon the completion of the sale of the Career Sales Division. On September 23, 1999, the Company repaid an additional $2,000 of indebtedness as a result of liquidity at the parent company above amounts prescribed in the Bank Credit Facility, as amended.
Management believes the Company will likely have sufficient financial flexibility and projected liquidity sources to meet all cash requirements until the maturity of the cash collateral agreement on May 31, 2000. The Company is in the process of a plan of reorganization which was filed with the Delaware Bankruptcy Court on April 5, 2000 which provides for the repayment of such indebtedness (see Note 23). With respect to current liquidity projections, there can be no assurances actual liquidity sources will develop. In the event of a shortfall of actual liquidity sources, and as a result of the necessity of the Company to establish a new credit facility, the Company will explore options to generate any necessary liquidity, such as: (i) the sale of subsidiaries and (ii) obtaining regulatory approval for extraordinary dividends from its insurance subsidiaries (which is unlikely at the present time). If the Company is unable to obtain sufficient liquidity to meet its projected cash requirements, such failure could result in a default on one or more obligations and the holders thereof would be entitled to exercise certain remedies, including the acceleration of the maturity of the entire indebtedness and commencing legal proceedings to collect the indebtedness. In such event, the Company will examine and consider the range of available alternatives to the Company at that time (see Notes 3 and 23).
The Company and a number of its non-insurance subsidiaries file a consolidated federal income tax return. The life insurance subsidiaries file federal income tax returns with either PLAIC, or Pioneer Security, or Constitution (sold July 30, 1999) as the parent of the particular consolidated life insurance company tax group.
Current U.S. ................. $ (2,226) $(12,031) $ 3,775 Current foreign .............. 1,067 778 3,598 Deferred U.S. ................ 30,934 10,108 10,984 Deferred foreign ............. (1,066) (2,224) 2,018 -------- -------- -------- Income tax expense (benefit) $ 28,709 $ (3,369) $ 20,375 ======== ======== ========
Taxes (benefits) computed using the federal statutory rate of 35% are reconciled to the Company's actual income tax expense (benefit) attributable to income (loss) before extraordinary charge as follows for the years ended December 31:
The valuation allowance for deferred tax assets as of December 31, 1999 and 1998, was $83,674 and $44,784, respectively. The net change in the total valuation allowance for the years ended December 31, 1999 and 1998, was an increase of $38,890 and $23,492, respectively. The valuation allowance associated with tax assets is continually monitored by the Company in light of the dramatic changes in the operating structure and financial results of the Company. As a result of such analysis the Company increased the valuation allowances by $38,890 and $23,492 during 1999 and 1998, respectively. In each of the periods, the valuation allowance was incurred as the result of the increased likelihood that certain net operating losses and capital loss carryforwards would not be utilized and the impact or potential impact of a "change in control" as defined by the Internal Revenue Code Section 382. Change of control provisions of Section 382 could limit the Company's ability to utilize certain tax benefits including net operating loss carryforwards in future periods.
At December 31, 1999 the Company had 100,000,000 shares of $.01 par value common stock authorized and 30,143,416 shares issued and outstanding. The common stock has no preemptive or other subscription rights and there are no conversion rights, redemption or sinking fund provisions with respect to such shares.
During the year ended December 31, 1999, the Company issued 188,235 shares of treasury stock to the Chairman of the Board of Directors as a part of a special bonus award. The result was to decrease additional paid in capital and treasury shares by $1,447 and $1,562, respectively. In addition, the Company recorded compensation expense of $115.
During 1999, the Company issued 71,072 shares to certain members of the Board of Directors as compensation. During the year ended December 31, 1998, certain employees exercised stock options and warrants resulting in the issuance of 616,572 shares of the Company's Common Stock. The result of such exercises was to increase common stock and additional paid in capital by $2 and $2,014, respectively.
The Company has issued 2,875,000 shares of $50 redemption value (liquidation preference, $50 plus accrued and unpaid dividends) $3.50 Series II Convertible Preferred Stock (the "Series II Convertible Preferred Stock"). The Series II Convertible Preferred Stock is convertible at the option of the holder, unless previously redeemed, into 1.4327 shares of common stock for each share, subject to adjustment in certain events. As of December 31, 1999, the estimated fair value of the Series II Convertible Preferred Stock, based upon market-maker quotes, was $35,765 or $12.44 per share.
The Company has issued 2,300,000 shares of $50 redemption value (liquidation preference, $50 plus accrued and unpaid dividends) $3.375 Convertible Preferred Stock (the "Convertible Preferred Stock"). The Convertible Preferred Stock is convertible at the option of the holder, unless previously redeemed, into 2.2124 shares of common stock for each share, subject to adjustment in certain events. As of December 31, 1999, the estimated fair value of the Convertible Preferred Stock, based upon active market quotes, was $27,600 or $12 per share.
As of December 31, 1999 and 1998, the cumulative accrued and unpaid dividends on the $3.375 Convertible Preferred Stock amounted to $11,321 and $3,558, respectively. As of December 31, 1999 and 1998, the cumulative accrued and unpaid dividends on the $3.50 Convertible Preferred Stock amounted to $14,255 and $4,193, respectively.
On July 25, 1995, the Company issued 127,500 shares of 10% Series B Preferred Stock and 178,500 shares of 9% Series C Preferred Stock to fund a portion of the Security Life purchase price. The Series B Preferred Stock and the Series C Preferred Stock were mandatorily redeemable on or before June 30, 1997 and June 30, 1998, respectively. On March 15, 1997, the Company redeemed all of the previously outstanding Series B preferred stock at its stated redemption value of $14,705. Effective March 31, 1998, the Company redeemed all of the outstanding Series C Preferred Stock into 691,528 shares of the Company's Common Stock under provisions of the Series C Preferred Stock certificate of designation. The result of such redemption was to increase common stock and additional paid in capital by $7 and $22,220, respectively, as well as reduce retained earnings by $1,913 reflecting the difference between the reported and redemption amounts of the Series C Preferred Stock. Such difference is reflected in both the basic and diluted earnings per share calculation for the year ended December 31, 1998.
As part of agreements effective July 1998, the Company issued to the Chairman of the Board of Directors as well as the three senior officers of the Company, an aggregate of 1,550,000 stock appreciation rights at $3.88 per share. The stock appreciation rights provide compensation to each individual in an amount equal to the excess of the fair value of each stock appreciation right over the fair value of each stock appreciation right at the date of grant. Compensation, if any, is payable in either shares of common stock of the Company or cash, at the election of the recipient. As of December 31, 1999, there has been no compensation expense accrued associated with these stock appreciation rights.
The Company had established in 1995 a U.S. Sales Manager incentive stock option plan in which the senior sales manager of one of the Company's former insurance subsidiaries may earn stock options in the amount of 275,000 shares over a five-year period, subject to achieving certain performance goals, in addition to an initial grant of 100,000 options. Such options are vested immediately as earned, except for the initial 100,000 which vested in September 1999, and option prices range from $15 per share, for the initial 100,000 options, to the fair value of the common stock of the Company on the date of grant for those shares subject to performance goals and as such no compensation expense is recorded.
Cash generated by the Company's insurance subsidiaries is made available to PennCorp principally through periodic payments of principal and interest on surplus debentures issued by PLAIC, Constitution (sold July 30, 1999) and Pioneer Security (collectively, the "Surplus Note Companies"). The surplus debentures issued by PLAIC and Constitution were paid in full in connection with the consummation of the sale of the Career Sales Division. In connection with the acquisition of Southwestern Life from SW Financial which was part of a subsidiary realignment, PLAIC issued a new surplus debenture to SW Financial in the amount of $150,000. With respect to Constitution, Pioneer Security and PLAIC (as a result of its surplus debenture issued as of July 30, 1999), the surplus debenture payments have been made to non-insurance intermediate holding companies and paid to the Company in the form of dividends and tax sharing payments. The amounts outstanding under the surplus debentures totaled $258,335 and $453,118 as of December 31, 1999 and 1998, respectively. These surplus debentures generally require (subject to availability of statutory capital and surplus and in some instances, regulatory approval) principal and interest payments to be made quarterly.
In December 1992, the NAIC adopted the RBC for Life and/or Health Insurers Model Act (the "Model Act"). The main purpose of the Model Act is to provide a tool for insurance regulators to evaluate the capital of insurers with respect to the risks assumed by them and determine whether there is a need for possible corrective action with respect to them. To date, neither the Model Act or similar legislation or regulation has been adopted by Texas.
On October 1, 1990, the Company established the PennCorp Financial, Inc. Retirement and Savings Plan, a defined contribution retirement plan, for eligible employees. This plan and the Marketing One Incorporated 401(k) Profit Sharing Plan merged with the Southwestern Financial Services Corporation Savings Investment Plan effective January 1, 1998 and the name of the plan was changed to the PennCorp Financial Group, Inc. Retirement and Savings Plan ("the PennCorp Plan"). Employees are eligible to participate in the plan after six months of employment in which they are credited with 500 hours of service. Participants may contribute from 1 to 15% of pre-tax compensation and/or from 1 to 10% of after tax compensation. Each subsidiary participating in the plan matches each pay-period, 50% of pre-tax contributions up to 6% of compensation. If approved by the Board of Directors, each subsidiary may make a discretionary profit sharing contribution annually on behalf of employees eligible to participate in the plan based on their compensation for the prior plan year. Employee contributions are fully vested at all times. The employer matching contributions made for employees who participated in the PennCorp Plan prior to January 1, 1998 vest at the rate of 50% per calendar year of service. The employer matching contributions made for all other participants and the employer discretionary contribution vests at the rate of 20% per year of service. All participants are fully vested at death, disability or attainment of age 65. The assets of each account are invested at the direction of the participant. Eleven funds with various investment objectives are available to the participants. Distributions are normally made in a lump sum. Participants of the PennCorp Plan prior to January 1, 1998 may elect to receive an annuity in various forms of payment. Expenses related to this plan for years ended December 31, 1999, 1998 and 1997 amounted to $1,468, $3,341 and $1,483. During 1999 and 1998, the sales of Businesses Held for Sale and restructuring constituted a partial plan termination of the PennCorp Plan. As a result, terminated employees became fully vested.
1999 1998 ------ ------ Accumulated benefit obligation............... $18,622 $26,602 Unrecognized prior service cost.............. 108 162 Unrecognized transition obligation........... (2,029) (5,185) Unrecognized actuarial loss.................. 4,290 827 ------- ------- Benefit obligation at end of year........... $20,991 $22,406 ======= =======
"Assets of Businesses Held for Sale" and "Liabilities of Businesses Held for Sale" at December 31, 1998 in the accompanying consolidated balance sheet (see Note 3). The assets and liabilities of Businesses Held for Sale at December 31, 1998 were as follows:
Invested assets.............................. $1,842,749 Insurance assets............................. 329,950 Other assets................................. 244,884 ---------- Total assets............................... $2,417,583 ==========
Insurance liabilities........................ $1,853,163 Other liabilities............................ 210,149 ---------- Total liabilities.......................... $2,063,312 ==========
As of July 30, 1999, sales of all of the Businesses Held for Sale had been completed. During the three months ended June 30, 1999, the Company concluded that it would retain, and shut down over time, certain remaining operations of Marketing One. The related financial statement accounts of Marketing One which included assets and liabilities of $4,221 and $3,242, respectively, at December 31, 1998 have been reclassified out of Assets and Liabilities of Businesses Held for Sale.
The following unaudited selected pro forma financial information has been prepared to illustrate the pro forma effects of the sales of Payroll Sales Division (sold February 4, 2000) (see Notes 3 and 23), Career Sales Division (sold July 30, 1999), KIVEX (sold June 30, 1999), the United Life Assets (sold April 30, 1999) and Professional (sold March 31, 1999) . The pro forma statements of operations for the years ended December 31, 1999 and 1998 give effect to such sales as if they had occurred on January 1, 1998. The unaudited selected pro forma financial information has been prepared for comparative purposes only and does not purport to be indicative of what would have occurred had such purchases and sales been made as of January 1, 1998, or results which may occur in the future.
Total revenues................................. $ 879,995 $ 340,498 Income (loss) before extraordinary charge...... (421,259) (70,282) Income (loss) before extraordinary charge applicable to common stock................... (439,532) (88,555) Per share information: Net income (loss) before extraordinary charge applicable to common stock-basic.... $ (15.17) $ (3.04) Net income (loss) before extraordinary charge applicable to common stock-diluted......... (15.17) (3.04)
Southwestern Life owns 66,555 shares of redeemable preferred stock of Portsmouth Financial Group, Inc. ("Portsmouth") with a carrying value of $5,063 as of December 31, 1999 as of December 31, 1999. Portsmouth underwrites, acquires and ultimately receives the benefits payable under life insurance contacts covering individuals facing terminal illnesses. Portsmouth's common equity was owned by KB Fund and its affiliates and certain former and current executive officers of the Company.
As of December 31, 1999 and 1998, the Company had invested a total of $13,462 and $12,641, respectively, in transactions sponsored by Wand Partners L.L.C. ("Wand Partners") in which a director of the Company is a managing member. The Company has committed to invest up to an additional $7,038 in future transactions sponsored by Wand Partners.
During 1999, 1998 and 1997, the Company's insurance subsidiaries paid management and commitment fees aggregating $488, $718 and $444, respectively, to investment funds managed by a former member of the Board of Directors.
On September 1, 1997, the Company, through its insurance subsidiaries, purchased $25,000 of ACO Acquisition Corp. (subsequently re-named Acordia, Inc. ("Acordia") subordinated indebtedness and the Company purchased $20,000 of ACO Brokerage Holdings Corporation ("ACO"), an affiliate of Acordia, preferred stock. The Acordia subordinated notes pay interest on a current basis at 12.5%, per annum, payable in semi-annual installments. Acordia was 28.6% owned by KB Investment Fund I, LP (formerly Knightsbridge Capital Fund I, L.P.) (the "KB Fund"). PennCorp received fees aggregating $1,100 in 1997 from Acordia for its underwriting and participation in the subordinated notes and preferred stock offering. Knightsbridge Management, L.L.C. ("KM") received sponsor fees and other fees aggregating $1,714 in 1997 from Acordia for its role in consummating the Acordia acquisition. During 1998 the Company liquidated its common and preferred stock holdings in ACO. Total proceeds received from the sale of the
preferred and common stock aggregated $30,500. The Company had acquired the common stock interest in January 1998 for $5,000 as part of the Company's and the KB Fund investment in ACO.
During 1997, payments aggregating $250 were made for actuarial services provided in connection with the Company's acquisition activity to a company, whose chairman is a shareholder and director of the Company.
During the third quarter of 1998, the first of ten class-action complaints was filed in the United States District Court for the Southern District of New York ("District Court") against the Company and certain of its current or former directors and officers.
The Complaint alleges that defendants violated the Securities Exchange Act of 1934. Among other things, plaintiffs claim that defendants issued a series of materially false and misleading statements and omitted material facts regarding the Company's financial condition, including the value of certain of its assets, and failed to timely disclose that it was under investigation by the Securities and Exchange Commission (the "SEC").
The Company is a party to various other pending or threatened legal actions arising in the ordinary course of business, some of which include allegations of insufficient policy illustration and agent misrepresentations. Although the outcome of such actions is not presently determinable, management does not believe that such matters, individually or in the aggregate, would have a material adverse effect on the Company's financial position or results of operations if resolved against the Company.
The life insurance subsidiaries of the Company are required to be members of various state insurance guaranty associations in order to conduct business in those states. These associations have the authority to assess member companies in the event that an insurance company conducting business in that state is unable to meet its policyholder obligations. Assessments from guaranty associations, which have not been material, are recorded in accordance with Statement of Position 97-3 issued by the AICPA, "Accounting by Insurance and Other Enterprises for Insurance-Related Assessments." The Company periodically evaluates the accruals for future assessments net of future premium tax reductions at its life insurance subsidiaries. During 1999, the Company reduced the accrual approximately $3,500 as a result of completing its evaluation of third party guaranty fund assessment data on a corporate-wide basis, including the impact of the dispositions of the Businesses Held for Sale.
The Company engaged outside vendors and focused certain employees' full time efforts to help in the full array of its year 2000 initiative. This included systems assessment and monitoring advice, actual code remediation, communication and consultation with critical business partners and additional data center and testing resources. The Company originally projected to incur internal and external costs associated with such expertise ranging from $10,600 to $14,500, which were anticipated to be incurred primarily during 1998 and early 1999. The Company actually incurred internal and external costs of $8,000 million during 1999. The Company estimates it has incurred internal and external costs aggregating $13,400 and $1,900 million for the years ended December 31, 1998 and 1997, respectively.
As of December 31, 1999, the Company sold substantially all of the mortgages originally held by United Life but retained by the Company as a part of the Sale of the United Life Assets. The Company may be obligated to repurchase certain of the mortgages sold. The amount of mortgages the Company may be required to repurchase is not expected to exceed approximately $1,600. At December 31, 1999, the Company has established a $1,200 liability related to these contingencies.
At December 31, 1999, the Company had a contingent obligation for mortgage loans previously sold aggregating $4,884 as a result of the Company acting as a servicing conduit.
Fees incurred for financial reinsurance were approximately $372, $675, and $145 during 1999, 1998 and 1997, respectively.
The following reflects the impact of activity for the years ended December 31, 1999 on the restructuring accrual balances under the 4th Quarter 1998 Plan:
The fourth quarter 1998 plan provided for the termination of 43 employees including substantially all of the executive and administrative employees in the Company's Bethesda and New York offices, based on the Company's decision to shut down the Bethesda and New York offices by May 31, 1999. Substantially all of the severance has been paid with the exception of one former executive officer whose severance is to be paid monthly through April 2001. The Company had incurred costs of $1,396 and $3,985 which were charged against the accrual during 1999 and 1998, respectively, for terminated employees.
The following reflects the impact of activity for the years ended December 31, 1999 and 1998 on the restructuring accrual balances under the 1st Quarter 1998 Plan:
Approximately 120 and 39 people, respectively, were estimated to be terminated, as a result of the decision to transfer all operations of Union Bankers to Raleigh and transfer operations of United Life from Baton Rouge to Dallas. In addition, the Company also restructured certain of the operations in Raleigh. Certain employees in the areas of customer services, information technology, actuarial, legal, human resources and other policyholder service areas, totaling 54 people were considered for termination under the Raleigh portion of the restructuring plan. The Company recognized severance costs totaling $3,831. The Company charged $297 and $4,417 against the severance accrual during 1999 and 1998, respectively, as the result of termination payments. In addition, during 1999 and 1998 the Company adjusted the severance accrual in the amount of $322 and $405, respectively, due to the Company paying less severance costs as a result of natural attrition and other factors such as inter-company transfers of employees. During 1998, the Company also increased the severance accrual by $1,610 as a result of the decision to terminate all 54 of Security Life's Raleigh-based employees.
The first quarter 1998 plan also recognized impairment of certain furniture, fixture and data processing equipment totaling $1,131 which had been utilized in the office space to be vacated. The Company charged $831 of such assets against the accrual during 1998.
As a result, the Company began to realign its existing operating companies and incurred restructuring costs aggregating approximately $19,071 during the year ended December 31, 1997, directly and indirectly associated with the initial divisional restructuring which had no future economic benefit.
In addition, the 1997 plan recognized the impairment of certain furniture, fixture and data processing equipment of $1,526 as a result of the decision to abandon certain Company owned and leased facilities. During 1998 and 1997, the Company charged off furniture, fixtures and data processing equipment totaling $-- and $332, respectively, and adjusted the original impairment provision by $347 and $847, respectively.
Fixed Maturities Available for Sale and Equity Securities: The fair values for fixed maturities available for sale are based on quoted market prices, where available. For fixed maturities not actively traded, fair values are estimated using values obtained from independent pricing services or are estimated based on expected future cash flows using current market rate applicable to the yield, credit quality and maturity of the investments. The fair values for equity securities are based on quoted market prices.
The proposed Recapitalization Plan provides that the preferred stockholders will receive one share of common stock of the reorganized company for each share of outstanding preferred stock. In addition, the preferred stockholders will have an opportunity, pursuant to a rights offering, to purchase .3787 shares of common stock of the reorganized company for each share of outstanding preferred stock owned at a purchase price of $12.50 per share. Inverness and Vicuna have issued a standby commitment letter to the Company, committing $24,500 to fully underwrite the rights offering. In addition, Rapoport and Sharpe have committed to purchase equity in the recapitalized company amounting to $20,000 and $3,000, respectively. The standby commitment letter and the Rapoport and Sharpe investment are subject to certain conditions.
Consummation of the recapitalization transaction is subject to certain conditions including regulatory approvals, the consummation of a $95,000 credit facility, the consummation of a proposed transaction whereby Southwestern Life and Security Life will reinsure substantially all of their existing deferred annuity blocks of business, an order confirming the Company's plan of reorganization that incorporates the proposed recapitalization transaction shall have been entered by the Bankruptcy Court and such order shall be unstayed and in full force and effect, and the closing of the recapitalization shall occur no later than December 31, 2000. The definitive agreements for the credit facility and the reinsurance transaction will contain conditions to consummation including no material adverse change as defined in the proposed $95,000 credit agreement.
The Company has received irrevocable commitments from holders of approximately 71 percent of the Company's two outstanding series of preferred stock indicating that they will vote in favor of the Recapitalization Plan upon solicitation by the Company which, when such shares are voted, will satisfy the voting requirements for confirmation of a plan of reorganization. Inverness, Vicuna, Rapoport and Sharpe have deposited an aggregate of $47,500 into an escrow account, such that those funds will be used to make their respective committed equity investments in the recapitalized company once the Recapitalization Plan is consummated. A portion of such funds may be forfeited to the Company under certain circumstances.
The Company filed plan of reorganization on April 5, 2000 and will seek confirmation of the Recapitalization Plan by the Bankruptcy Court on June 5, 2000, with consummation expected to occur promptly thereafter.
Following the filing of PennCorp's Chapter 11 petition, the New York Stock Exchange ("NYSE") suspended all trading in the Company's listed securities and has applied to the Securities and Exchange Commission for the removal of the Company's common stock and $3.375 convertible preferred stock listing and registration on the NYSE.
In the first quarter of 2000, Portsmouth was reorganized and merged into ROP Financial Group, a wholly-owned subsidiary of Southwestern Life. The common equity was terminated with no value.
As part of a series of transactions approved by the Texas Department of Insurance, Security Life became a wholly-owed subsidiary of PLAIC. In addition, Southwestern Life and Security Life paid extraordinary dividends consisting of affiliate notes and securities aggregating $15,461 and $14,167, respectively.
As a result of the agreements to sell the Payroll Sales Division, Southwestern Life and Security Life, the three senior executives of the Company became entitled to terminate their existing employment agreements for "Good Reason" (as defined therein). In order to ensure the continued services of the executives, on January 28, 2000, the Company entered into an agreement with each executive, pursuant to which the Company and each executive terminated their existing employment agreements and entered into new executive employment agreements. As a result, the Company paid a total of $10,034 in employment contract obligations to the three senior executives of the Company.
The Company's fourth quarter 1999 reported loss primarily resulted from the impairment of intangibles totaling $95,522. The Company evaluated the intangible assets of the Payroll Sales Division based upon the proceeds received from the sale of the Payroll Sales Division on February 4, 2000 (see Notes 3 and 23). The Company increased the valuation allowances associated with tax assets by $17,900 as the result of the increased likelihood that certain operating losses and capital loss carryforwards would not be utilized and the impact or potential impact of a "change in control" as defined by the Internal Revenue Code Section 382.
We have audited the accompanying consolidated balance sheet of Southwestern Financial Corporation and subsidiaries as of December 31, 1997 and the related consolidated statements of income, shareholders' equity, and cash flows for the year then ended. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Southwestern Financial Corporation and subsidiaries as of December 31, 1997 and the results of their operations and their cash flows for the year then ended in conformity with generally accepted accounting principles.
Benefits and expenses: Policyholder benefits incurred ................................ 201,385 Change in liability for future policy benefits and other policy benefits ............................................. (35,103)
Fixed maturity and equity securities classified as available for sale are recorded at fair value, as they may be sold in response to changes in interest rates, prepayment risk, liquidity needs, the need or desire to increase income or capital and other economic factors. Changes in unrealized gains and losses related to securities available for sale are recorded as a separate component of shareholders' equity, net of applicable taxes and amount attributable to deferred policy acquisition costs and present value of insurance in force related to universal life and investment-type products. Mortgage-backed securities are amortized using the interest method including anticipated prepayments at the date of purchase. Significant changes in estimated cash flows from original assumptions are reflected in the period of such change. Mortgage loans on real estate are recorded at cost, adjusted for the provision for loan losses, if necessary. Policy loans are recorded at cost. Short-term investments purchased with maturities generally less than three months are recorded at cost, which approximates market. All short-term investments are considered to be cash equivalents.
Real estate, substantially all of which was acquired through foreclosure, is recorded at the lower of fair value, minus estimated costs to sell, or cost. If the fair value of the foreclosed real estate minus estimated costs to sell is less than cost, a valuation allowance is provided for the deficiency. Increases in the valuation allowance are charged to income.
Realized investment gains and losses and declines in value which are other than temporary, determined on the basis of specific identification, are included in the determination of net income.
Investments in a single entity, other than obligations of the U.S. Government or agencies thereof, totaling in excess of 10% of total shareholders equity at December 31, 1997 included Fund America Investors Corp., Ser. 93-C, Class B Certificates which had a carrying value of $19,271 (10%) of shareholders equity.
Amortized Fair Cost Value ---------- ---------- Available for sale: Due in one year or less......................... $ 28,929 $ 28,921 Due after one year through five years........... 234,776 236,677 Due after five years through ten years.......... 272,127 275,248 Due after ten years............................. 287,100 294,468 ---------- ---------- 822,932 835,314 Mortgage-backed securities...................... 820,837 842,194 ---------- ---------- $1,643,769 $1,677,508 ========== ==========
Included in fixed maturities available for sale at December 31, 1997, are below investment-grade securities with amortized costs of $71,467 and fair values of $74,227. Included in fixed maturities available for sale as of December 31, 1997, are unrated securities with an amortized cost and fair value of $11,811.
For the year ended December 31, 1997, net realized gains on sale of fixed maturities consisted of gross gains of $2,779 and gross losses of $2,226.
Following are changes in unrealized appreciation (depreciation) on investments for the year ended December 31, 1997:
Fixed maturities...................................... $ 48,976 Equity securities..................................... 221 Other investments..................................... (713) --------- 48,484
Texas....................................... $23,832 46.7 % Illinois.................................... 7,029 13.8 Oklahoma.................................... 4,915 9.6 Florida..................................... 3,180 6.2 Kansas...................................... 2,527 4.9 All other................................... 9,587 18.8 ------- ----- Balance, end of period...................... $51,070 100.0 % ======= =====
Policy and contract claims include provisions for reported claims in process of settlement, valued in accordance with the terms of the related policies and contracts, as well as provisions for claims incurred and unreported based on the Company's prior experience.
Future policy benefits on traditional products: Traditional life insurance contracts ............... $ 335,283 Traditional annuity products ....................... 105,663 Individual accident and health ..................... 87,152 Unearned premiums .................................. 26,900 ---------- Total future policy benefits ...................... 554,998 ----------
The following table presents information on changes in the liability for policy and contract claims for the year ended December 31, 1997:
Add claims incurred, net of reinsurance related to: Current year ............................................. 81,168 Prior years .............................................. (6,012) -------- 75,156
Deduct claims paid, net of reinsurance related to: Current year ............................................. 58,658 Prior years .............................................. 13,839 -------- 72,497
Revolving bank debt ........................................ $ 90,250 Bank debt with quarterly principal requirements ............ 24,500 7.0% convertible subordinated note ......................... 40,000 -------- $154,750 ========
Interest costs under the revolving bank debt totaled $7,860 for the year ended December 31, 1997. The interest rate of the debt is based on, at the Company's option, either a floating rate (based on the base rate of the First National Bank of Chicago) plus a margin of 1.75% or a Eurodollar rate (based on the London Interbank Offered Rate or LIBOR) plus a margin of 2.75%. At December 31, 1997, the effective rate of the revolving loan was approximately 9.13%. The revolving bank debt was repaid on January 2, 1998.
As part of the consideration for the acquisition of Southwestern Life, Union Bankers, Constitution and Marquette from ICH, the Company issued to ICH a $40,000 aggregate principal amount of SWF's 7.0% Convertible Subordinated Notes due 2005. The notes are convertible into an aggregate 3,200,000 shares of common stock of SWF, of which 800,000 will be Class B non-voting common stock. In the aggregate the shares upon conversion represent approximately 21.2% of SWF's fully diluted shares at closing before giving effect to certain warrants outstanding. During 1997, PennCorp acquired the notes from the liquidating trust for the creditors of ICH for $40,000 plus accrued interest. The Convertible Notes are unsecured obligations and are subordinate in right of payment to SWF's bank debt and all of the indebtedness of SWF. Interest costs
Total income taxes for the year ended December 31, 1997 are as follows:
The valuation allowance at December 31, 1997 is attributable to deferred tax assets principally arising from differences in the book and tax bases of invested assets subject to capital gains treatment that existed as of the date of acquisition of the company's insurance subsidiaries. To the extent that income tax benefits relative to such tax assets are ultimately realized, the reduction in the related valuation allowance would be allocated to reduce costs in excess of net assets acquired.
Deferred policy acquisition costs represent commissions and certain costs of policy issuance and underwriting. Information relating to these costs for the year ended December 31, 1997, is as follows:
Information related to the present value of insurance in force for the year ended December 31, 1997 is as follows:
Pursuant to the terms of the surplus debenture issued by Constitution to the benefit of SLC, a non-insurance subsidiary of SWF, Constitution may make principal and interest payments to the extent that Constitution's surplus, excluding the statutory carrying value of Southwestern Life and Union Bankers, exceeds $1,200. Constitution's surplus at December 31, 1997 was $174,715, of which $161,098 was attributable to its ownership of Southwestern Life and Union Bankers.
minimize its exposure to significant losses from reinsurer insolvencies. The effect of reinsurance on policy revenues earned and the related benefits incurred by such reinsurers for the year ended December 31, 1997 is as follows:
Effective July 1, 1996, Union Bankers entered into reinsurance agreements with Cologne Life Reinsurance Company ("Cologne") to coinsure 80% of its Medicare supplement business in force on July 1, 1996 and to coinsure 80% of its Medicare policies issued on or after July 1, 1996. The Company recorded a deferred gain on the transaction of $53,893 as of July 1, 1996, which is being amortized into income over the life of the business. For the year ended December 31, 1997 $14,222 of the deferred gain has been recognized and is included in other income. The Company is not subject to any negative experience adjustments if the ceded business is unprofitable; however, the Company may participate in a portion of future earnings from the ceded business after Cologne recovers its initial ceding commission plus interest at a specified rate. Union Bankers retained administration for the ceded block of business and is reimbursed by Cologne for administrative costs at the rate of 8.5% of ceded renewal premiums and 11.5% of ceded first year premiums.
Southwestern Life previously ceded a block of annuities under a reinsurance agreement with Employees Reassurance Corporation (ERC). Such reinsurance, accounted for as a financing arrangement, is not reflected in the accompanying financial statements except for the risk fees paid to ERC. The reinsurance agreement was terminated as of November 30, 1997. Risk fees paid to the reinsurer were 2% of the net amount of surplus provided, but not less than a minimum fee of $40 per quarter, and totaled $110 for the year ended December 31, 1997.
The Company has a defined contribution retirement plan (Defined Contribution Plan) for all employees who have attained age 21 and completed a year of service. Contributions to the Plan are made pursuant to salary deferral elections by participants in an amount equal to 1% to 15% of their annual compensation. In addition, the Company makes matching contributions in an amount equal to 50% of each participant's salary deferral to a maximum of 3% of annual compensation. The Defined Contribution Plan also provides for a discretionary employer profit sharing contribution, which is determined annually by the Board of Directors for the succeeding plan year. Profit sharing contributions are credited to participant's accounts on the basis of their respective compensation. Salary deferral contribution accounts are at all times fully vested, while matching contribution and profit sharing contribution accounts vest ratably from one to five years of service. All participant accounts are fully vested at death, disability or attainment of age 65. Payment of vested benefits under the Defined Contribution Plan may be elected by a participant in a variety of forms of payment. Expenses related to this plan for the year ended December 31, 1997 amounted to $936.
In addition, the Company has a bonus plan for certain key officers. The amount available to pay awards for any year is determined by a committee of senior executives of the Company and is subject to approval of the Board of Directors of the Company. Awards are based on the performance of the Company and the performance of eligible participants. The Company accrued or paid $1,350 under this plan during the year ended December 31, 1997.
Accrued postretirement benefits, beginning of year $ 12,686 Recognition of components of net periodic postretirement benefit cost:
Related party transactions described herein include those transactions not included elsewhere in the Notes to Consolidated Financial Statements.
The Company paid interest of $1,400 in 1997 in conjunction with PennCorp's acquisition of the Company's 7.0% convertible subordinated note.
The Company and its subsidiaries are obligated under operating leases, primarily for office space. Rent expense was $2,169 in 1997. There was no significant sublease income.
The life insurance companies are required to be members of various state insurance guaranty associations in order to conduct business in those states. These associations have the authority to assess member companies in the event that an insurance company conducting business in that state is unable to meet its policyholder obligations. In some states, these assessments can be partially recovered through a reduction in future premium taxes. The insurance subsidiaries paid assessments of $980 in 1997. Based on information currently available, the insurance subsidiaries have accrued $3,194 at December 31, 1997 for future assessments, net of future premium tax reductions.
Underwriting and other administrative expenses for the year ended December 31, 1997 are as follows:
Non-deferrable commission expense ..................... $ 19,746 Commission allowances on reinsurance ceded ............ (12,696) Taxes, licenses and fees .............................. 7,492 General and administrative expenses ................... 34,467 Expense allowance on reinsurance ceded ................ (8,409) -------- Underwriting and other administrative expenses ....... $ 40,600 ========
Mortgages: The fair values for mortgages are estimated using discounted cash flow analyses, based on interest rates currently being offered for similar loans to borrowers with similar credit ratings. Loans with similar characteristics are aggregated for purposes of the calculations.