Standard Management International entered into a lease on March 15, 1996 for approximately 3,000 square feet in an office building located at 1, rue Emile Bian, L-1235 Luxembourg, Luxembourg, under the terms of a lease which expires on December 15, 1997.
Dixie National Life leases approximately 1,000 square feet in an office complex located at 855 South Pear Orchard Road, Suite 305, Ridgeland, Mississippi, under the terms of a lease which expires on December 31, 1997.
(c) Total capitalization is the sum of SMC's debt (long term debt, notes payable, capital lease obligations and redeemable preferred stock) and shareholders' equity.
(e) Does not reflect extraordinary gain of $502 ($.10 per share) on early redemption of Class S Preferred Stock.
(g) Excludes the effect of reporting securities available for sale at fair value and recording the unrealized gain or loss on such securities as a component of shareholders' equity, net of tax and other adjustments, which SMC began to do in 1994. Such adjustments are in accordance with Statement of Financial Accounting Standards No. 115 "Accounting for Certain Investments in Debt and Equity Securities" as described in the notes to the consolidated financial statements included in SMC's Consolidated Financial Statements, included elsewhere herein.
(h) Before deduction of extraordinary charge of $1,301 ($.32 per share) on early extinguishment on long-term debt and cumulative effect of change in accounting principle of $449 ($.11 per share) from applying the new method of accounting for income taxes.
SMC acquired First International on July 10, 1992, Standard Management International on December 15, 1993, Dixie National Life on October 2, 1995 and Shelby Life on November 8, 1996. These acquisitions are accounted for using the purchase method of accounting (effective June 30, 1992 for the First International acquisition, December 31, 1993 for the Standard Management International acquisition, October 2, 1995 for the Dixie National Life acquisition and November 1, 1996 for the Shelby Life acquisition. Therefore, these subsidiaries are included in the SMC Consolidated Financial Statements commencing with their respective acquisition effective dates. SMC acquired a block of insurance liabilities and assets from The Midwest Life Insurance Company in Liquidation (the "Midwest Block") effective June 30, 1992, and it is included in the SMC Consolidated Financial Statements commencing with that date. SMC disposed of First International on March 18, 1996 (effective March 1, 1996) and terminated the operations of Standard Reinsurance on March 1, 1996.
Product Profitability. Margins on life insurance and annuity products are affected by interest rate fluctuations. Rising interest rates would result in a decline in the market value of assets. However, as there are positive cash flows from renewal premiums, investment income and maturities of existing assets, the need for early disposition of investment assets to meet operating cash flow requirements would be unlikely. Rising interest rates would also result in available cash flows from maturities being invested at higher interest rates, which would help support a gradual increase in new business and renewal interest rates on interest-sensitive products. A sharp, sudden rise in the interest rate environment without a concurrent increase in crediting rates could result in higher surrenders, particularly for annuities. The effect of surrenders would be to reduce earnings over the long term but to increase or decrease earnings in the period of the surrender to the extent surrender charges were applicable and differed from the write-off of related deferred acquisition costs or present value of future profits.
In selecting the interest rate to calculate the discounted present value of the projected future profits, SMC used the risk rate of return it needs to earn in order to invest in the business being acquired or recaptured.
- The acquired company's compatibility with other SMC activities that may favorably affect future cash flows.
The discount rate used to determine the present value of the projected future profits is used to determine the subsequent amortization of the cost of the purchased policies for acquisitions prior to November 19, 1992. For acquisitions subsequent to November 19, 1992, the discount rate used to amortize the unamortized balance of the present value of future profits is the crediting rate of the underlying policies.
The discount rate selected may affect subsequent earnings in those instances where the purchase price of the policies exceeds the value of net assets acquired (including the value of future profits discounted at the selected interest rate). Selection of a lower (or higher) discount rate will increase (or decrease) the portion of the purchase price assigned to the present value of future cash flows and will result in an offsetting decrease (or increase) in the amount of the purchase price assigned to goodwill. The effect on subsequent earnings caused by this variation in purchase price allocation will depend on the characteristics of the policies purchased. For products where the profits emerge at relatively constant levels over an extended period of time (for example, most of SMC's immediate and deferred annuities), use of a lower rate may result in an increase in reported earnings in the early years after an acquisition followed by a decrease in earnings in later years. For products where profits emerge over a shorter period of time or in amounts that decrease over the life of the product (for example, ordinary and term life products), selection of a lower rate will generally result in a decrease in reported earnings in the early years after an acquisition followed by an increase in reported earnings in later years. For SMC, the majority of the cost of policies purchased relates to ordinary life products and the balance to deferred annuity products.
Acquisition of Blocks of Business. SMC's growth strategy includes the acquisition of in force blocks of business through assumption reinsurance agreements. The accounting recognition given these acquisitions is dependent upon the type of business acquired. FPDAs and payout annuities are recorded at full account value. Funds received are recorded as invested assets. The excess of the liabilities assumed over assets received is recorded as the present value of future profits and amortized in relation to expected gross profits.
The amounts included in the foregoing table do not include any amortization of DAC resulting from the sale of new products after December 31, 1996. Any changes in future annual amortization of this asset are not expected to have a significant effect on results of operations because the amount of amortization is expected to be proportionate to the profits from the produced policies, net of interest on DAC.
Accounting for Annuities and Universal and Interest-Sensitive Life Products. The Company primarily accounts for its annuity and universal and interest-sensitive life policy deposits in accordance with Statement
Premium Income. Premium income is composed of premiums, including renewal premiums, received on ordinary life insurance policies. As noted above, SMC's new product sales are composed primarily of annuity products. Under GAAP, deposits from interest-sensitive annuities and other financial products are not recorded as revenues. GAAP premium income for the 1996 was $10,468,000, an increase of $4,964,000 or 90% from $5,504,000 for 1995. This increase is mainly attributable to recapture of premiums ceded of $4,234,000 due to the termination and recapture of a reinsurance agreement with National Mutual and the inclusion of Dixie National Life and Shelby Life in the results of operations for periods after October 2, 1995 and November 1, 1996, respectively. These amounts offset the decline in premiums from the cession of a portion of First International's life insurance business and the regular policy lapses, surrenders and expiries in SMC's closed blocks of business.
products were $51,254,000 for the year ended December 31, 1996 compared to $37,614,000 for the year ended December 31, 1995. The increase is the result of an aggressive marketing campaign implemented by Standard Life with increased crediting interest rates. Also contributing to the increase in premiums is the continued development of SMC's distribution system. Since SMC's operating income is primarily a function of its investment spreads, mortality experience and operating expenses, a change in premium deposits in a single period does not directly cause operating income to change, although continued increases or decreases in premiums may affect the growth rate of total assets on which investment spreads are earned.
Net Realized Investment Gains. Net realized investment gains increased $614,000 or 89% to $1,302,000 from $688,000 for the years ended December 31, 1996 and 1995, respectively. The increase primarily resulted from active portfolio management by SMC. Net realized investment gains fluctuate from period to period and arise when securities are sold in response to changes in the investment environment which provide opportunities to maximize return on the investment portfolio without adversely affecting the quality and overall yield of the investment portfolio.
The combined effect of the pre-tax gain on the sale of First International and related contracts, and the Standard Reinsurance write-offs, was $886,000 pre-tax and $2,306,000 after tax ($.44 per share) in the first quarter of 1996.
Policy Charges. Policy charges, which represent the amounts assessed against policyholder account balances for the cost of insurance, policy administration and surrenders, increased $84,000 or 3% to $2,551,000 for the year ended December 31, 1996 compared to $2,467,000 for the year ended December 31, 1995. The increase in policy charges resulted from an increase in policy surrender charges on FPDAs and the inclusion of Dixie National Life and Shelby Life in operating results for periods after October 2, 1995 and November 1, 1996, respectively, which offset the absence of policy charges from SMC's closed blocks of universal life business which were sold to GIAC through a reinsurance contract effective January 1, 1996.
Administration Fee Income. Administration fee income includes administration fees of $316,000 and other income related to reinsurance and administration agreements with GIAC and administration fees of $375,000 collected in connection with the terminated and recaptured reinsurance agreement with National Mutual. The administration fee income from National Mutual primarily related to services provided in prior years; the income was not previously recorded due to uncertainty as to its collection. The National Mutual fee income will not recur in the future. Administration fee income was $691,000 for the year ended December 31, 1996; there was no such income for 1995.
Other Income. Other income increased $581,000 or 153% to $961,000 for the year ended December 31, 1996 compared to $380,000 for 1995. The increase resulted primarily from the reserve and experience refund adjustments in connection with the reinsurance agreements with GIAC and increased commissions received by Standard Marketing from the sale of unaffiliated products.
Benefits and Claims. Benefits and claims include life insurance and payout annuity benefits paid and changes in policy reserves. Benefits and claims increased $4,128,000 or 71% to $9,919,000 for the year ended December 31, 1996 from $5,791,000 for the year ended December 31, 1995. The increase resulted primarily from an increase in reserves of $4,234,000 related to the termination and recapture of a reinsurance agreement with National Mutual. Throughout SMC's history, it has experienced both periods of higher and lower benefit claims. Such volatility is not uncommon in the life insurance industry and, over extended periods of time, periods of higher claims experience tend to be offset by periods of lower claims experience.
Salaries and Wages. Salaries and wages were $5,053,000 for the year ended December 31, 1996, an increase of $352,000 or 7% from $4,701,000 for the comparable prior year period. This increase was caused primarily by an increase in the number and average wages of employees in the United States due to the acquisitions of Dixie National Life and Shelby Life and the increase in incentive compensation for the increase in income for the year ended December 31, 1996.
In the first quarter of 1997, the chief financial officer gave notice he will be terminating his employment at SMC as he has been named Commissioner of the Indiana Department of Insurance. The Company is currently discussing benefits that may or may not be due to the officer. The amount of such benefits cannot be determined at this time.
Amortization. Amortization expense includes charges to operations for the amortization of deferred policy acquisition costs, the present value of future profits, the excess of cost over net assets acquired and subsidiary organization costs. Amortization expense increased $548,000 or 27% to $2,592,000 for the year ended December 31, 1996 from $2,044,000 for the year ended December 31, 1995. The increase in current
Other Operating Expenses. Other operating expenses increased $789,000 or 12% to $7,122,000 for the year ended December 31, 1996 from $6,333,000 for the year ended December 31, 1995. The increase in other operating expenses resulted primarily from the expenses of Dixie National Life and Shelby Life included in the results for the periods after October 2, 1995 and November 1, 1996, respectively and the increased expenses related to potential acquisitions and advisory fees.
Class Action Litigation and Settlement Costs. Class action litigation and settlement costs were recorded to reflect the estimated costs of litigation and settlement of the shareholder class action lawsuit, based on the terms of the settlement agreement and assumptions as to the future estimated legal and other costs to settle the lawsuit, which was settled in March 1995, and to register the Class S Preferred Stock which was distributed to the class participants in February 1996. There were no class action litigation and settlement expenses in the years ended December 31, 1996 and 1995. However, with the signing of the Settlement Agreement with the 22 persons who previously excluded themselves from the class and the reevaluation of the future estimated legal and other costs to settle the lawsuit, SMC recorded a reduction of $314,000 in the second quarter of 1995 in the estimated future costs to settle the lawsuit and register the Class S Preferred Stock.
from operations from $1,013,000 in 1994 to a loss of $(22,000) in 1995 as the costs of resuming marketing were absorbed.
Premium Income. GAAP premium income for 1995 was $5,504,000, an increase of 21% from $4,565,000 for 1994. Increase in premium income resulted primarily from the inclusion of Dixie National Life in the results of operations effective October 2, 1995.
Net Investment Income. Net investment income increased 15% to $18,517,000 in 1995 from $16,057,000 in 1994. This increase primarily resulted from growth in SMC's total invested assets attributable to the increased sales of FPDAs in 1994 and the inclusion of Dixie National Life in the results of operations effective October 2, 1995. The amortized cost of total invested assets increased 12% to $274,148,000 in 1995 from $245,619,000 in 1994. These increased assets also benefited from a higher concentration of investments in fixed maturity securities. The average annualized yield of SMC's investment portfolio for the year ended December 31, 1995 increased to 7.32% from 7.26% for 1994.
Benefits and Claims. Benefits and claims increased 3% to $5,791,000 for 1995 from $5,603,000 for 1994. The increase in benefits and claims resulted primarily from an increase in death benefits in 1995 when compared to the favorable mortality experience in 1994. Mortality experience is volatile and these trends are not predictable from period to period.
Salaries and Wages. Salaries and wages were $4,701,000 for 1995, an increase of 20% from $3,910,000 for the prior year. This increase was caused by $185,000 of unusual charges due to the termination of certain international marketing programs and the subsequent reduction of SMC's staff in Luxembourg in 1995, the capitalization of certain salaries of $203,000 associated with the internal development of computer software in 1994, increased salaries for new marketing efforts for Standard Management International in 1995 and the inclusion of Dixie National Life in the results of operations for periods after October 2, 1995. Additionally, the average wages per employee increased in 1995.
Amortization. Amortization expense for 1995 was $2,044,000, an increase of $829,000, or 68%, from $1,215,000 for the prior year. The increase in current year amortization expense resulted primarily from increased amortization of deferred acquisition costs as gross profits from business sold in recent years began to emerge and from the amortization of present value of future profits for the acquisition of Dixie National Life, which more than offset reduced amortization of present value of future profits on previous acquisitions as persistency of the purchased business begins to improve.
Class Action Litigation and Settlement Costs. SMC recorded a reduction of $314,000 in 1995 in the estimated future costs to settle the lawsuit and list the Class S Preferred Stock.
Standard Management is an insurance holding company. The liquidity requirements of Standard Management are met primarily from management fees, equipment rental fees and payments for other charges and dividends and interest on Surplus Debentures received from Standard Management's subsidiaries as well
SMC reported on a consolidated GAAP basis net cash provided by operations of $1,726,000 and $6,331,000 for the years ended December 31, 1996 and 1995, respectively. Although deposits received on SMC's interest-sensitive annuities and other financial products are not included in cash flow from operations under GAAP, such funds are available for use by SMC. Cash provided by operations plus net deposits received, less net account balances returned to policyholders on interest sensitive annuities and other financial products, resulted in positive cash flow of $26,717,000 and $6,003,000 for the years ended December 31, 1996 and 1995, respectively. Cash generated on a consolidated basis is available to the parent company only to the extent that it is generated at the parent company level or is available to the parent company through dividends, management fees or other payments from subsidiaries.
In April 1993, Standard Management instituted a program to repurchase SMC Common Stock from time to time. The purpose of the stock repurchase program is to enhance shareholder value. Standard Management had repurchased 979,453 shares of SMC Common Stock for $4,747,000 as of December 31, 1996. The repurchases in 1996 have been paid for through additional borrowing under the Amended Credit Agreement. At December 31, 1996, Standard Management was authorized to purchase an additional 771,771 shares under this program. Standard Management implemented a policy to issue shares for the exercise of stock options from treasury stock. Standard Management has reissued 1,224 shares in 1996 under this program at a cost of $6,000.
Pursuant to the management services agreement with Standard Management, Standard Life paid Standard Management a monthly fee of $150,000 during 1996 and 1995 for certain management services related to the production of business, investment of assets and evaluation of acquisitions. Management service agreements between Standard Life and Dixie National Life have been approved by the Mississippi Department of Insurance which currently requires a monthly payment of $100,000 from Dixie National Life to Standard Life. Both of these agreements provide that they may be modified or terminated by the department of insurance in the event of financial hardship of Standard Life or Dixie National Life. The management service agreement between Standard Management and Standard Life for 1997 has been renegotiated to increase the monthly fee to $166,667 (annual fee of $2,000,000) in 1997. This amended management service agreement has been approved by the Commissioner of the Indiana Department of Insurance.
At April 1, 1995, Standard Management sold its property and equipment to an unaffiliated leasing/ financing company for $1,396,000 and subsequently entered into a capital lease obligation whereby Standard Management pays a monthly rental amount of $45,000. Standard Management charges a monthly equipment rental fee to its subsidiaries of $77,000 for this equipment and additional equipment purchased after April 1, 1995.
Assuming the continuation of current level of debt under the Amended Credit Agreement ($16,000,000) and current interest rates at December 31, 1996 (weighted average rate of 8.849%) and assuming Standard Management elects the non-cash interest payment option under the subordinated convertible debt, annual debt service in 1997 would be approximately $1,416,000 in interest paid on the Amended Credit Agreement. In addition, Standard Management has 1997 obligations under a capital lease of $539,000.
Standard Management anticipates the available cash from its existing working capital, plus anticipated 1997 dividends, management fees, rental income and interest payments on its Surplus Debentures receivable will be more than adequate to meet its anticipated "parent company only" cash requirements for 1997.
Statutory surplus is computed according to rules prescribed by the NAIC, as modified by the Indiana Department of Insurance, or the state in which the insurance subsidiaries do business. Statutory accounting rules are different from GAAP and are intended to reflect a more conservative perspective. With respect to new business, statutory accounting practices require that: (i) acquisition costs and (ii) reserves for future guaranteed principal payments and interest in excess of statutory rates, be expensed in the year the new business is written. These items cause a statutory loss ("surplus strain") from many insurance products in the year they are issued. SMC designs its products to minimize such first-year losses, but certain products
continue to cause a statutory loss in the year written. For each product, SMC controls the amount of net new premiums written to manage the effect of such statutory surplus strain. SMC's long-term growth goals contemplate continued growth in its insurance businesses. To achieve these growth goals, SMC's U.S. insurance subsidiaries will need to increase statutory surplus. Additional statutory surplus may be secured through various sources such as internally generated statutory earnings, equity sales, infusions by Standard Management with funds generated through debt or equity offerings or mergers with other life insurance companies. If additional capital is not available from one or more of these sources, SMC believes that it could reduce surplus strain through the use of reinsurance or through reduced issuance of new policies.
Management believes that operational cash flow of Standard Life will be sufficient to meet its anticipated needs for 1997. As of December 31, 1996, Standard Life had statutory capital and surplus for regulatory purposes of $22,969,666 compared to $12,876,960 at December 31, 1995. As the life insurance and annuity business produced by Standard Life and Dixie National Life increases, Standard Life expects to continue to satisfy statutory capital and surplus requirements through statutory profits, through the continued reinsurance of a portion of its new business, and through additional capital contributions by Standard Management. During 1996, Standard Management did not make any capital contributions to Standard Life, other than the Common Stock associated with the Shelby Merger. Net cash flow from operations on a statutory basis of Standard Life, after payment of benefits and operating expenses, was $17,921,422 and $4,263,011 for the years ended December 31, 1996 and December 31, 1995, respectively. If the need arises for cash which is not readily available, additional liquidity could be obtained from the sale of invested assets.
Standard Life's acquisition of Shelby Life, and merger of Shelby Life into Standard Life, effective November 1, 1996 is anticipated to have a positive effect on Standard Life's liquidity and cash flows. Shelby Life ceased writing new business effective November 1, 1996, thus reducing the statutory surplus strain normally associated with the issuance of new policies. The anticipated profits from Shelby Life's book of business are expected to exceed the related interest expense connected with the $13,000,000 of Surplus Debentures issued by Standard Life in connection with the acquisition of Shelby Life. The statutory net
Standard Management International dividends are limited to its accumulated earnings without regulatory approval. Standard Management International and Premier Life (Luxembourg) were not permitted to pay dividends in 1996 and 1995 due to accumulated losses. Premier Life (Bermuda) did not pay dividends in 1996 and 1995. SMC does not anticipate any dividends from these companies in 1997.
Due to the nature of unit-linked products issued by Standard Management International, which represent over 90% of the Standard Management International portfolio, the investment risk rests with the policyholder. Investment risk for Standard Management International exists where Standard Management International makes investment decisions with respect to the remaining traditional business and for the assets backing certain actuarial and regulatory reserves. The investments underlying these liabilities mostly represent short-term investments and fixed maturity securities. These short-term investments and fixed maturity securities are normally only bought and/or disposed of on the advice of independent consulting actuaries who perform an annual analysis comparing anticipated cash flows on the insurance portfolio with the cash flows from the fixed maturity securities. Any resulting material mis-matches are then covered by adjusting the securities in the investment portfolio as appropriate.
Mergers, Acquisitions and Consolidations. The U.S. insurance industry has experienced an increasing number of mergers, acquisitions, consolidations and sales of certain business lines. These consolidations have been driven by a need to reduce costs of distribution and overhead and maintain business in force. Additionally, increased competition, regulatory capital requirements and technology costs have also contributed to the level of consolidation in the industry. These forces are expected to continue as is the level of industry consolidation.
assets and determine the need to make any adjustments in such values in SMC's consolidated financial statements. SMC has determined that the assumptions utilized in the initial valuation of these assets are consistent with the current operations of SMC as of December 31, 1996.
Regulatory Environment. Currently, prescribed or permitted statutory accounting principles ("SAP") may vary between states and between companies. The NAIC is in the process of codifying SAP to promote standardization of methods utilized throughout the industry. Completion of this project might result in changes in statutory accounting practices for SMC's insurance subsidiaries; however, it is not expected that such changes would materially affect SMC's insurance subsidiaries' statutory capital requirements.
Safe Harbor Provisions. Forward-looking statements in this Annual Report on Form 10-K are made pursuant to the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995. There are certain important factors that could cause results to differ materially from those anticipated by some of the statements made above. Investors are cautioned that all forward-looking statements involve risks and uncertainty. In addition to the factors discussed above, among the other factors that could cause actual results to differ materially are the following: economic environment, interest rate changes, product development, regulatory changes, the results of financing efforts, SMC's accounting policies, competition, the reinsurance agreement with GIAC and the acquisitions of Shelby Life and Savers Life.