Principal properties owned by Standard Insurance Company (“Standard”) and used by StanCorp Financial Group, Inc. or its subsidiaries consist of two office buildings in downtown Portland, Oregon: the Standard Insurance Center, with approximately 460,000 square feet; and the Standard Plaza, with approximately 220,000 square feet. Both of our business segments use the facilities described above. We also own two buildings in Hillsboro, Oregon, each with 72,000 square feet of office space. The Hillsboro offices are used by StanCorp Mortgage Investors, LLC and our group insurance claims operations. In addition, Standard leases approximately 160,000 square feet of office space located in downtown Portland, Oregon, for home office and claims operations. We lease 59 offices under commitments of varying terms to support our sales and regional processing offices throughout the United States. Management believes that the capacity and types of facilities are suitable and adequate for operations. See Part II, Item 8, “Financial Statements and Supplementary Data-Notes to Consolidated Financial Statements-Note 1-Summary of Significant Accounting Policies-Property and Equipment, Net.”
Includes operating expenses, commissions and bonuses, premium taxes, and the net increase in deferred acquisition costs, value of business acquired and other intangible assets.
Management believes that measuring net income per diluted share excluding AOCI is important to investors because the turnover of the Company’s portfolio of fixed maturity securities may not be such that unrealized gains and losses reflected in AOCI are ultimately realized. Furthermore, management believes exclusion of AOCI provides investors with a better measure of return.
This management’s discussion and analysis of financial condition and results of operations contain forward looking statements. See Part I, Item 1A, “Risk Factors-Forward-Looking Statements.”
The decrease in GAAP results for 2011 compared to 2010 was primarily due to a comparatively higher benefit ratio in our Insurance Services segment as a result of higher claims incidence in our group insurance business, partially offset by higher earnings in our Asset Management segment. Diluted earnings per common share for 2011 reflected the effect of a decrease in diluted weighted-average common shares outstanding, which was primarily due to share repurchases.
As we reflect on 2012, we were confronted with macro-economic factors that have challenged the growth of our business over the past few years. A persistent low interest rate environment has driven pricing changes in a very price sensitive group insurance marketplace. In addition, high levels of unemployment and its impact on the wage and employment growth of our customers, specifically in the state and local public and education sectors, has led to a lack of organic growth within our book of business. Despite these challenges we will continue to focus on our long-term objectives and address challenges that arise with financial discipline and from a position of financial strength. We manage for long-term profitability by focusing on business diversification, disciplined product pricing, sound underwriting, effective claims management and high-quality customer service.
Net income per diluted share, excluding after-tax net capital gains and losses, to be in the range of $3.40 to $3.80.
Return on average equity, excluding after-tax net capital gains and losses from net income and accumulated other comprehensive income and losses from equity, to be in the range of 8% to 9%.
Expectations and guidance for any specific year may vary due to short-term market trends, changes in the interest rate environment and other factors. More specifically, these expectations will be affected by the following items:
Premiums-In 2013, we will continue to implement pricing actions for both new and renewal long term disability business to address the impact of elevated claims incidence and the low interest rate environment. Given these pricing actions and the effect of the continued challenging economic environment on the employment and wage levels of our group insurance customers, we expect a low single digit decline in our group insurance premiums for 2013.
Effective income tax rate-We expect that the 2013 effective income tax rate will be in the range of 22% to 23%. The lower effective income tax rate for 2013 is primarily the result of our previous purchases of tax-advantaged investments.
Experience rated refunds (“ERRs”), which represent cost sharing arrangements with certain group contract holders that provide refunds to the contract holders when claims experience is more favorable than contractual benchmarks, and provide for additional premiums to be paid when claims experience is less favorable than contractual benchmarks. ERRs can fluctuate widely from quarter to quarter depending on the underlying experience of specific contracts.
The overall increase in premiums for 2012 compared to 2011 was primarily due to lower ERRs for 2012 in our Insurance Services segment. ERRs increased Insurance Services premiums by $4.0 million for 2012, and decreased Insurance Services premiums by $12.5 million for 2011. See “Business Segments-Insurance Services Segment.”
The overall increase in premiums for 2011 compared to 2010 was due to strong sales and customer retention levels, and comparatively lower ERRs for 2011 in our Insurance Services segment, partially offset by decreased premiums in our Asset Management segment related to a decrease in sales of life-contingent annuities. See “Business Segments-Insurance Services Segment” and “Business Segments-Asset Management Segment.”
The decrease in administrative fee revenues in our Asset Management segment for 2012 compared to 2011 was primarily related to a decrease in average retirement plan trust assets under administration.
The increase in net investment income for 2011 compared to 2010 was primarily due to an increase in average invested assets, which primarily resulted from individual annuity sales. Also contributing to the increase in net investment income for 2011 was higher commercial mortgage loan prepayment fee revenues and bond call premiums. Partially offsetting these increases was a decrease in the change in fair value of our S&P 500 Index options and a decrease in the portfolio yields for fixed maturity securities and commercial mortgage loans.
We seek investments containing call or prepayment protection to ensure our expected cash flow is not adversely affected by unexpected prepayments. Callable bonds, excluding bonds with make-whole provisions and bonds with provisions that allow the borrower to prepay near maturity, represented 4.1%, or $293.2 million, of our fixed maturity securities portfolio at December 31, 2012. We also originate commercial mortgage loans containing a make-whole prepayment provision
Net capital gains and losses are reported in the Other category and are not likely to occur in a stable pattern. Net capital gains and losses primarily occur as a result of sales of our assets for more or less than carrying value, other-than-temporary impairments (“OTTI”) of assets in our bond portfolio, provisions to our commercial mortgage loan loss allowance, losses recognized due to impairment of real estate and impairments of tax-advantaged investments.
Reserve assumptions-the assumptions used to establish the related reserves reflect expected incidence and severity, and the discount rate. The discount rate is affected by new money investment interest rates and the overall portfolio yield. See “Critical Accounting Policies and Estimates-Reserves for Future Policy Benefits and Claims.”
The following table sets forth interest credited and associated key components:
The increases in interest credited for both 2012 and 2011 primarily reflected growth in our average individual annuity assets under administration. The increase in interest credited for 2012 from 2011 was also due to the change in fair value of the index-based interest guarantees.
The decrease in operating expenses for 2012 compared to 2011 was due to $11.0 million of project costs for information technology service changes in 2011, which did not recur in 2012. The $11.0 million of project costs were recorded in our Other category. The decrease was partially offset by an increase in incentive compensation expenses for 2012 compared to 2011.
The increase in operating expenses for 2011 compared to 2010 was primarily related to business growth as evidenced by premium growth, and the project costs for information technology service changes in 2011. See “Business Segments.”
The following table sets forth the operating impact resulting from net increases to DAC, VOBA and other intangible assets:
The net increase in DAC, VOBA and other intangible assets was lower for 2011 compared to 2010 was primarily due to an increase in the amortization of DAC in our Asset Management segment which was driven by an increase in net investment income from bond call premiums and commercial mortgage loan prepayment fee revenues. This increase was partially offset by losses due to the change in fair value of our indexed-based guarantees and an increase in deferrals in our Insurance services segment resulting from higher sales.
At December 31, 2012, the years open for audit by the Internal Revenue Service (“IRS”) were 2009 through 2012. The years 2009 through 2012 were also open for audit by state authorities. See Item 8, “Financial Statements and Supplementary Data-Notes to the Consolidated Financial Statements-Note 7-Income Taxes” for more information on the change in the effective tax rate.
Income before income taxes decreased for 2012 compared to 2011 primarily due to a comparatively higher group insurance benefit ratio as a result of a 95 basis point lower average discount rate used for newly established long term disability claim reserves, partially offset by higher premiums for the Insurance Services segment and a lower individual disability benefit ratio. In addition, bond call premiums and commercial mortgage loan prepayment fee revenues added $13.1 million of income before income taxes for 2012, compared to $4.9 million for 2011, offsetting the effects of lower yields on invested assets.
Income before income taxes decreased for 2011 compared to 2010 primarily due to less favorable claims experience in the group insurance business as a result of higher group long term disability claims incidence.
Customer Retention. Customer retention, also referred to as persistency, decreased to 86.7% for 2012, compared to 88.8% for 2011. This decrease was primarily due to our pricing actions on our long term disability business. Persistency in our individual disability products remained above 90%.
We continue to make progress with the implementation of our pricing actions related to the low interest rate environment and pricing actions that began in 2011 related to higher claims incidence. Our pricing reflects our long-term expectations of claims experience, demographic changes, return objectives and interest rates. By the end of the first quarter of 2013 we will have had the opportunity to re-price about three-fourths of our long term disability business. Our sales force is communicating and selling our unique value proposition, while the rest of our employees are delivering the quality service on which we have based our reputation in the employee benefits marketplace.
The increase in Insurance Services benefits to policyholders (including interest credited) for 2012 compared to 2011 was primarily due to a 95 basis point decrease in the average discount rate used for newly established long term disability claim reserves. In addition, we recorded a net increase in group long term disability reserves of $3.7 million, and a net increase in individual disability reserves of $3.8 million as part of our regular annual assessments of the adequacy of reserves for 2012. We recorded a net increase in individual disability claims reserves of $3.6 million and made no similar adjustments to group long term disability reserves for 2011.
The reserve releases related to our group long term disability insurance business for 2010 were primarily due to favorable claims experience compared to reserving assumptions for certain reserve items. Claims experience is one of the factors we use in estimating our reserves. However, the favorable claims experience seen in 2010 did not result in a significant change in our underlying assumptions or methods used to determine the estimated reserves, primarily due to the long-term nature of our group long term disability insurance business and the materiality of other factors, including the potential impact of the economic uncertainty during 2010. We carefully monitor trends in reserve assumptions and when these trends become credible and are expected to persist, we incorporate these factors into our reserves to ensure the best estimates are established. For a complete discussion of our reserve methodology, see “Critical Accounting Policies and Estimates-Reserves for Future Policy Benefits and Claims.”
The group insurance benefit ratio for 2012 was outside of our 2012 annual guidance range of 80% to 82%. We expect the benefit ratio to remain elevated during continuing uncertainty in the economy and while the effects of our pricing actions take hold. Claims experience can fluctuate widely from quarter to quarter and tends to be more stable when measured over a longer period of time.
The benefit ratio for individual disability insurance decreased for 2012 compared to 2011. We generally expect the individual disability benefit ratio to trend down over the long term to reflect growth in the business outside of the large block of individual disability business assumed in 2000 from Minnesota Life, and we expect there to be a corresponding shift in revenues from net investment income to premiums. The anticipated general increase or decrease in the expected benefit ratio does not necessarily indicate a corresponding shift in profitability; rather it reflects a change in the mix of revenues from the business from investment income to premiums.
In 2006, we adjusted the claim termination rate assumptions for the reserves on a small block of individual disability claims based on an industry table. These assumptions were further refined in 2012, 2011 and 2010 resulting in increases in reserves of $4.9 million, $5.5 million and $12.5 million, respectively. Our block of business is relatively small, and, as a result, we view a blend of the released industry table and our own experience as a more appropriate method for establishing reserve levels compared solely to our own experience. We will continue to monitor the credibility of our developing experience and, if necessary, will adjust reserves accordingly.
We refined our reserve calculation for certain other individual disability claims in 2012, 2011 and 2010 which resulted in a decrease in our individual disability reserves of $1.1 million, $1.9 million and $4.7 million, respectively.
The discount rate is based on the average rate we receive on newly invested assets during the previous 12 months, less a margin. We also consider our average investment yield and average discount rate on our entire block of claims when deciding whether to increase or decrease the discount rate. The lower average discount rate for 2012 compared to 2011 and 2010 was primarily the result of the continued low interest rate environment. A 25 basis point increase or decrease in the discount rate results in a corresponding increase or decrease in pre-tax income of $1.8 million per quarter. Any offsetting adjustments of group insurance premium rates due to sustained changes in investment yields can take from one to three years given that most contracts have rate guarantees in place.
The increase in Insurance Services operating expenses for 2012 compared to 2011 was primarily related to increased compensation related costs. The increase in Insurance Services operating expenses for 2011 compared to 2010 was primarily related to business growth as evidenced by premium growth.
Revenues for the Asset Management segment include retirement plan administration fees, private client wealth management assets under administration, and investment income on general account assets under administration. Premiums and benefits to policyholders reflect both the sale of life-contingent annuities by our individual annuity business and the conversion of retirement plan assets into life-contingent annuities. Most of the sales for this segment are recorded as deposits and are therefore not reflected as premiums. Individual fixed-rate annuity deposits earn investment income, a portion of which is credited to policyholders.
The increase in revenue for 2012 compared to 2011 was primarily due to an increase in net investment income due to higher commercial mortgage loan prepayment fee revenues and bond call premiums, and the contribution from the change in fair value of our S&P 500 Index options. See “Business Segments-Asset Management Segment-Net Investment Income.”
Premiums for the Asset Management segment are generated from the sale of life-contingent annuities, which are primarily a single-premium product. Premiums and benefits to policyholders reflect both the sale of immediate annuities by our individual annuity business and the conversion of retirement plan assets into life-contingent annuities, which can be selected by plan participants at the time of retirement. Premiums for the segment can vary significantly from quarter to quarter due to low sales volume of life-contingent annuities and the varying size of single premiums. Increases or decreases in premiums for life-contingent annuities generally correlate with corresponding increases or decreases in benefits to policyholders.
Administrative fee revenues for the Asset Management segment include asset-based and plan-based fees related to our retirement plans and private client wealth management businesses, and fees related to the origination and servicing of commercial mortgage loans. The primary driver for administrative fee revenues is the level of assets under administration for retirement plans, which is driven by equity market performance and net customer deposits. Assets under administration that produce administrative fee revenues include retirement plan group annuity products, retirement plan trust products, private client wealth management and commercial mortgage loans under administration for other investors.
The decrease in administrative fee revenues for 2012 compared to 2011 was primarily related to a decrease in average retirement plan trust assets under administration. The decrease in administrative fee revenues for 2011 compared to 2010 was primarily due to a few large plan terminations in the our retirement plan trust assets under administration in the first quarter and the fourth quarter of 2011, and a decline in assets under administration in our private client wealth management assets due to attrition associated with the loss of two advisers.
The increase in net investment income for 2011 compared to 2010 was primarily due to increases in our average individual annuity assets under administration and our average retirement plan general account assets under administration. Also contributing to the increase in net investment income for 2011 compared to 2010 were increases in bond call premiums received on certain fixed maturity securities, and in prepayment fees received on commercial
mortgage loans. These increases were partially offset by the change in fair value of our S&P 500 Index options and a decline in the portfolio yield of our fixed maturity securities and commercial mortgage loans. See Item 8, “Financial Statements and Supplementary Data-Notes to Consolidated Financial Statements-Note 11-Derivative Financial Instruments” for further derivatives disclosure.
Benefits to policyholders for the Asset Management segment primarily represent current and future benefits on life-contingent annuities. Changes in the level of benefits to policyholders will generally correlate to changes in premium levels because these annuities are primarily single-premium life-contingent annuity products with a significant portion of all premium payments established as reserves.
The following table sets forth benefits to policyholders for the Asset Management segment:
The increase in Asset Management operating expenses for 2012 compared to 2011 was primarily due to increased business related service and administrative costs.
In addition to our two segments, we report our holding company and corporate activities in the Other category. This category includes return on capital not allocated to the product segments, holding company expenses, operations of certain unallocated subsidiaries, interest on debt, unallocated expenses, net capital gains and losses and adjustments made in consolidation.
The decrease in losses before income taxes for 2011 compared to 2010 was primarily due to a decrease in net capital losses, partially offset by a decrease in net investment income and an increase in operating expenses related to project costs for information technology service changes. The project costs related to information technology service changes were primarily severance and outsourcing transition costs, which were reported in our Other category since these costs were not representative of our segment operations.
Net capital gains and losses are reported in the Other category and are not likely to occur in a stable pattern. Net capital gains and losses primarily occur as a result of sales of our assets for more or less than carrying value, OTTI of assets in our bond portfolio, provisions to our commercial mortgage loan loss allowance, losses recognized due to impairment of real estate and impairments of tax-advantaged investments.
Our interest rate risk analysis reflects the influence of call and prepayment rights present in our fixed maturity securities and commercial mortgage loans. The majority of these investments have contractual provisions that require the borrower to compensate us in part or in full for reinvestment losses if the security or loan is retired before maturity. Callable bonds, excluding bonds with make-whole provisions and bonds with provisions that allow the borrower to prepay near maturity, represented 4.1%, or $293.2 million, of our fixed maturity securities portfolio at December 31, 2012. We also originate commercial mortgage loans containing a make-whole prepayment provision requiring the borrower to pay a prepayment fee. As interest rates decrease, potential prepayment fees increase. These larger prepayment fees deter borrowers from refinancing during a low interest rate environment. Approximately 97% of the commercial mortgage loan portfolio contains this prepayment provision. Approximately 2% of the commercial mortgage loan portfolio, without a make-whole prepayment provision, contains fixed percentage prepayment fees that mitigate prepayments but may not fully protect our expected cash flows in the event of prepayment.
support the obligations of our insurance products and required capital supporting these products. Our cash flows from operating activities are affected by the timing of premiums, fees, and investment income received and expenses paid.
Net cash used in investing activities was $763.0 million, $595.4 million and $493.1 million for 2012, 2011 and 2010, respectively. The increase in net cash used in investing activities for 2012 compared to 2011 was primarily due to an increase in net purchases of fixed maturity securities and lower proceeds from sales of real estate for 2012. The increase in net cash used in investing activities for 2011 compared to 2010 was primarily due to higher commercial mortgage loan originations for 2011, in addition to higher net purchases of fixed maturity securities and other invested assets, resulting from higher policyholder fund net deposits.
Our target investment portfolio allocation is approximately 60% fixed maturity securities and 40% commercial mortgage loans with a maximum allocation of 45% to commercial mortgage loans. At December 31, 2012, our portfolio consisted of 56.5% fixed maturity securities, 41.4% commercial mortgage loans, 1.3% other invested assets and 0.8% real estate.
Our fixed maturity securities portfolio generates unrealized gains or losses primarily resulting from market interest rates that are lower or higher relative to our book yield at the reporting date. In addition, changes in the spread between the risk-free rate and market rates for any given issuer can fluctuate based on the demand for the instrument, the near-term prospects of the issuer and the overall economic climate.
We recorded OTTI of $3.2 million and $1.8 million for 2012 and 2011, respectively. See “Critical Accounting Policies and Estimates-Investment Valuations-Fixed Maturity Securities.” We did not have any direct exposure to sub-prime or Alt-A mortgages in our fixed maturity securities portfolio at December 31, 2012. At December 31, 2012, we did not have any direct exposure to euro zone government issued debt or debt issued by investment and commercial banks headquartered in Portugal, Ireland, Italy, Greece or Spain. At December 31, 2012, fixed maturity securities issued by investment and commercial banks headquartered in other euro zone countries represented 0.8%, or $55.2 million, of our fixed maturity securities portfolio. There were no impairments on fixed maturity securities related to euro zone exposure for 2012.
Geographic regions obtained from the American Council of Life Insurers Mortgage Loan Portfolio Profile.
At December 31, 2012, our ten largest borrowers represented less than 7% of our total commercial mortgage loan portfolio balance. Our largest borrower concentrations within our commercial mortgage loan portfolio consisted of one borrower that comprised less than 2% of our total commercial mortgage loan portfolio balance. The second largest borrower comprised less than 1% of our total commercial mortgage loan portfolio balance.
Through our concentration of commercial mortgage loans in California, we are exposed to potential losses from an economic downturn in California as well as to certain catastrophes, such as earthquakes and fires that may affect certain areas of the western region. We require borrowers to maintain fire insurance coverage. We diversify our commercial mortgage loan portfolio within California by both location and type of property in an effort to reduce certain catastrophe and economic exposure. However, diversification may not always eliminate the risk of such losses. Historically, the delinquency rate of our California-based commercial mortgage loans has been consistent with our experience in other states. We do not require earthquake insurance for the properties when we underwrite new loans. However, we consider
The performance of our commercial mortgage loan portfolio may fluctuate in the future. However, based on our business approach of diligently underwriting high-quality loans, we believe our delinquency rate will remain contained. We have steadfastly avoided the types of structured products that do not meet an adequate level of transparency for good decision making.
The lower provision and net charge-offs for the commercial mortgage loan loss allowance for 2012 compared to 2011 were primarily due lower losses associated with foreclosures, accepted deeds in lieu of foreclosure on commercial mortgage loans and other related charges associated with commercial mortgage loans leaving the portfolio for 2012. The decreases in the specific and general loan loss allowances at December 31, 2012 compared to December 31, 2011 were primarily due to a decrease in impaired commercial mortgage loans and the composition of the commercial mortgage loan portfolio at December 31, 2012. The lower provision for the commercial mortgage loan loss allowance for 2011 compared to 2010 was primarily due to a prior year provision related to a single borrower, which is no longer in the commercial mortgage loan portfolio. The lower charge-offs for 2011 compared to 2010 were primarily related to the prior year acceptance of deeds in lieu of foreclosure associated with a single borrower in the second quarter of 2010, which did not recur in 2011.
An impaired commercial mortgage loan is a loan where we do not expect to receive contractual principal and interest in accordance with the terms of the original loan agreement. A specific allowance for losses is recorded when a loan is considered to be impaired and it is probable that all amounts due will not be collected. We also hold specific allowances for losses on certain performing loans that we continue to monitor and evaluate. Impaired commercial mortgage loans without specific allowances for losses are those for which we have determined that it remains probable that we will collect all amounts due. The decrease in the impaired commercial mortgage loans at December 31, 2012 compared to 2011 was primarily due to an increase in loan repayments and foreclosures of impaired commercial mortgage loans for 2012.
The amount of interest income recognized on impaired commercial mortgage loans was $4.1 million, $3.8 million and $2.8 million for 2012, 2011 and 2010, respectively. The cash received by us in payment of interest on impaired commercial mortgage loans was $4.0 million, $3.1 million and $3.3 million for 2012, 2011 and 2010, respectively.
Financing cash flows primarily consist of policyholder fund deposits and withdrawals, borrowings and repayments on the line of credit, borrowings and repayments on long-term debt, repurchases of common stock and dividends paid on common stock. Net cash provided by financing activities was $409.6 million, $327.7 million and $181.7 million for 2012, 2011 and 2010, respectively. The increase in funds provided by financing cash flows for 2012 compared to 2011 was primarily due to a decrease in cash used to repurchase shares of common stock. See “Capital Management-Share Repurchases” for further discussion on share repurchases.
the Subordinated Debt is payable at final maturity. Interest is payable semi-annually at 6.90% in June and December for the first 10 years up to June 1, 2017, and quarterly thereafter at a floating rate equal to three-month LIBOR plus 2.51%. We have the option to defer interest payments for up to five years. We have not deferred interest on the Subordinated Debt.
The insurance laws of the states of domicile and other states in which the insurance subsidiaries conduct business regulate the investment portfolios of the insurance subsidiaries. Relevant laws and regulations generally limit the admissibility of investments to bonds and other fixed maturity securities, commercial mortgage loans, common and preferred stock and real estate. Decisions to acquire and dispose of investments are made in accordance with guidelines adopted and modified from time to time by the Boards of Directors of our insurance subsidiaries. Each investment transaction requires the approval of one or more members of senior investment staff, with increasingly higher approval authorities required for transactions that are more significant. Transactions are reported quarterly to the Audit Committee of the Board of Directors for Standard Insurance Company (“Standard”) and to the Board of Directors for The Standard Life Insurance Company of New York.
As of December 31, 2012, Standard’s net gain from operations after dividends to policyholders and federal income taxes and before capital gains or losses for the 12-month period then ended was $132.7 million and capital and surplus was $1.19 billion. Based upon Standard’s results for 2012, the amount of ordinary dividends and other distributions available in 2013, without prior approval from the Oregon Insurance Division is $132.7 million. As of December 31, 2011, Standard’s net gain from operations after dividends to policyholders and federal income taxes and before capital gains or losses for the 12-month period then ended was $144.0 million and capital and surplus was $1.14 billion. Based upon Standard’s results for 2011, the amount of ordinary dividends and other distributions available in 2012, without prior approval from the Oregon Insurance Division was $144.0 million. As of December 31, 2012 Standard had issued, upon approval of the Oregon Insurance Division, dividends in excess of $144.0 million.
Dividends paid from Standard to StanCorp will be based on levels of available capital and needs at the holding company, which are driven by the financial results of Standard and the Company as a whole. Standard paid ordinary cash dividends to StanCorp of $10.0 million and extraordinary cash dividends to StanCorp of $310.0 million during 2012. Standard paid ordinary cash dividends to StanCorp of $87.8 million and $244.0 million for 2011 and 2010, respectively.
On November 13, 2012, our Board of Directors declared an annual cash dividend of $0.93 per share. The dividend was paid on December 7, 2012 to shareholders of record on November 23, 2012. In 2011 and 2010, we paid an annual cash dividend of $0.89 and $0.86 per share, respectively. The Board of Directors has increased the annual dividend per share to shareholders each year for the past 13 consecutive years. The declaration and payment of dividends to shareholders in the future is subject to the discretion of our Board of Directors. It is anticipated that annual dividends to shareholders will be paid in December of each year depending on our financial condition, results of operations, cash requirements, future prospects, regulatory restrictions on distributions from the insurance subsidiaries, the ability of the insurance subsidiaries to maintain adequate capital and other factors deemed relevant by the Board of Directors. In addition, the declaration and payment of dividends to shareholders would be restricted if we elect to defer interest payments on our Subordinated Debt issued May 7, 2007. If elected, the restriction would be in place during the interest deferral period, which cannot exceed five years. We have not deferred interest on the Subordinated Debt, and have paid dividends each year since our initial public offering in 1999.
Our debt obligations consisted primarily of the $250 million 5.00% 2022 Senior Notes and the $300 million 6.90% Subordinated Debt. See Item 8, “Financial Statements and Supplementary Data-Notes to Consolidated Financial Statements-Note 18-Long-Term Debt” for additional information.
In the normal course of business, we commit to fund commercial mortgage loans generally up to 90 days in advance. At December 31, 2012, we had outstanding commitments to fund commercial mortgage loans totaling $144.8 million, with fixed interest rates ranging from 4.50% to 5.50%. These commitments generally have fixed expiration dates. A small percentage of commitments expire due to the borrower’s failure to deliver the requirements of the commitment by the expiration date. In these cases, we will retain the commitment fee and good faith deposit. Alternatively, if we terminate a commitment due to the disapproval of a commitment requirement, the commitment fee and deposit may be refunded to the borrower, less an administrative fee.
Certain assets designated as non-admitted, principally deferred tax assets, furniture, equipment, and unsecured receivables, are not recognized as assets, resulting in a charge to statutory surplus.
The decrease in Statutory Results for 2012 compared to 2011 was primarily due to an increase in group long term disability reserves due to higher claims experience. The decrease in Statutory Results for 2011 compared to 2010 was primarily due to an increase in group long term disability reserves.
The fluctuations in the difference between the Statutory Results and Adjusted GAAP Results for 2012 compared to 2011 and 2011 compared to 2010 were primarily due to differences in the prescribed accounting treatments between GAAP and Statutory Accounting Requirements for the changes in the fair value of our S&P 500 Index options, reinsurance ceding commission, the discount rate used for newly established long term disability claim reserves, net income or loss from the holding company and noninsurance subsidiaries, and DAC.
If it is determined an OTTI exists, we separate the OTTI of debt securities into an OTTI related to credit loss and an OTTI related to noncredit loss. The OTTI related to credit loss represents the portion of losses equal to the difference between the present value of expected cash flows, discounted using the pre-impairment yields, and the amortized cost basis. All other changes in value represent the OTTI related to noncredit loss. The OTTI related to credit loss is recognized in earnings in the current period, while the OTTI related to noncredit loss is deemed recoverable and is recognized in other comprehensive income. The cost basis of the fixed maturity security is permanently adjusted to reflect the credit related impairment. Once an impairment charge has been recorded, we continue to review the OTTI securities for further potential impairment.
The carrying value of commercial mortgage loans represents the outstanding principal balance less a loan loss allowance for probable uncollectible amounts. The commercial mortgage loan loss allowance is estimated based on evaluating known and inherent risks in the loan portfolio and consists of a general loan loss allowance and a specific loan loss allowance. The general loan loss allowance is based on our analysis of factors including changes in the size and composition of the loan portfolio, debt coverage ratios, loan to value ratios, actual loan loss experience and individual loan analysis. An impaired commercial mortgage loan is a loan where we do not expect to receive contractual principal and interest in accordance with the terms of the loan agreement. A specific allowance for losses is recorded when a loan is considered to be impaired. We also hold specific allowances for losses on certain performing loans that we continue to monitor and evaluate. Impaired commercial mortgage loans without specific allowances for losses are those for which we have determined that it remains probable that we will collect all amounts due. In addition, for impaired commercial mortgage loans, we evaluate the loss to dispose of the underlying collateral, any significant out of pocket expenses the loan may incur, the loan-to-value ratio and other quantitative information we have concerning the loan. Portions of loans that are deemed uncollectible are generally written off against the allowance, and recoveries, if any, are credited to the allowance. See “Liquidity and Capital Resources-Investing Cash Flows-Commercial Mortgage Loans.”
We record impairments when it is determined that the decline in fair value of an investment below its carrying value is other than temporary. The impairment loss is charged to net capital losses, and the cost basis of the investment is permanently adjusted to reflect the impairment.
Real estate owned is initially recorded at the lower of cost or net realizable value, which includes an estimate for disposal costs. This amount may be adjusted in a subsequent period as additional information is received. Our real estate owned is initially considered an investment held for sale and is expected to be sold within one year from acquisition. For any real estate expected to be sold, an impairment charge is recorded if we do not expect the investment to recover its carrying value prior to the expected date of sale. Once an impairment charge has been recorded, we continue to review the investment for further potential impairment.
Total real estate was $95.5 million at December 31, 2012, compared to $92.7 million at December 31, 2011. The $2.8 million increase in total real estate during 2012 was primarily due to a $3.8 million net increase in real estate owned that was acquired in satisfaction of debt through foreclosure or the acceptance of deeds in lieu of foreclosure on commercial mortgage loans.
In October 2010, the Financial Accounting Standard Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2010-26, Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts. ASU No. 2010-26 amends the
codification guidance for insurance entities to eliminate the diversity of accounting treatment related to deferred acquisition costs. We have adopted this standard retrospectively as of January 1, 2012, and comparative financial statements of prior periods have been adjusted.
Our other intangible assets are subject to amortization and consist of certain customer lists from an Asset Management business acquired and an individual disability marketing agreement. Customer lists have a combined estimated weighted-average remaining life of approximately 7.4 years. The marketing agreement accompanied the Minnesota Life transaction and provides access to Minnesota Life agents, some of whom now market Standard’s individual disability insurance products. The Minnesota Life marketing agreement will be fully amortized by the end of 2023. The accumulated amortization of other intangible assets was $36.5 million and $30.6 million at December 31, 2012 and 2011, respectively.
The following table sets forth total reserve balances by calculation methodology:
Individual disability policy reserves are sensitive to assumptions and considerations regarding:
Claim reserves for our disability products are sensitive to assumptions and considerations regarding:
The claim incidence rate for policy reserves and IBNR claim reserves.
Reserve discount rates for newly incurred claims are reviewed quarterly and, if necessary, are adjusted to reflect our current and expected new investment yields. The discount rate is based on the average rate we received on newly invested assets during the previous 12 months, less a margin. We also consider our average investment yield and average discount rate on our entire block of claims when deciding whether to increase or decrease the discount rate. The decrease in the average discount rate from 2012 to 2011 was primarily the result of a continued low interest rate environment. A 25 basis point decrease in the discount rate for newly incurred claims results in a corresponding decrease in quarterly pre-tax income of $1.8 million. We do not adjust group insurance premium rates based on short-term fluctuations in investment yields. Any offsetting adjustments of group insurance premium rates due to sustained changes in investment yields can take from one to three years given that most contracts have rate guarantees in place.
Claim termination rates can vary widely from quarter to quarter. The claim termination assumptions used in determining our reserves represent our expectation for claim terminations over the life of our block of business and will vary from actual experience in any one quarter. While we have experienced some variation in our claim termination experience, we did not see any prolonged or systemic change in the 2012 that would indicate a sustained underlying trend that would affect the claim termination rates used in the calculation of reserves.
As a result of studies of our long-term trends compared to reserving assumptions for our group long term disability insurance, we increased IBNR claim reserves $3.7 million in 2012, while we did not increase any IBNR claim reserves in 2011. We released IBNR claim reserves totaling $11.7 million and claim reserves totaling $2.9 million in 2010.
We refined the claim termination rate assumptions for the reserves on a small block of individual disability claims based on a blend of our experience and industry data in 2012, 2011 and 2010 which resulted in an increase in reserves of $4.9 million, $5.5 million and $12.5 million, respectively. Our block of business is relatively small, and as a result, we view a blend of established industry tables and our own experience as a more appropriate method for establishing reserve levels compared solely to our own experience. We will continue to monitor the credibility of our developing experience and the use of available industry tables, and if necessary, will adjust reserves accordingly.
We refined our reserve calculation for certain other individual disability claims in 2012, 2011 and 2010, which resulted in decreases in our individual disability reserves of $1.1 million, $1.9 million and $4.7 million, respectively.
We monitor the adequacy of our reserves relative to our key assumptions. In our estimation, scenarios based on reasonably possible variations in claim termination assumptions could produce a percentage change in reserves for our group insurance lines of business of approximately +/-0.2% or $8.0 million. However, given that claims experience can fluctuate widely from quarter to quarter, significant unanticipated changes in claim termination rates over time could produce a change in reserves for our group insurance lines outside of this range.
We have two non-contributory defined benefit pension plans: the employee pension plan and the agent pension plan. The employee pension plan is for all eligible employees and the agent pension plan is for former field employees and agents. The defined benefit pension plans provide benefits based on years of service and final average pay. Participation in the defined benefit pension plans is generally limited to eligible employees whose date of employment began before 2003. The employee pension plan is sponsored by StanCorp and the agent pension plan is sponsored by Standard. Both plans are administered by Standard Retirement Services, Inc. and are closed for new participants. In addition, eligible executive officers are covered by a non-qualified supplemental retirement plan.
We also have a postretirement benefit plan that includes medical, prescription drug benefits and group term life insurance. Eligible retirees are required to contribute specified amounts for medical and prescription drug benefits that are determined periodically and are based on retirees’ length of service and age at retirement. Participation in the postretirement benefit plan is limited to employees who had reached the age of 40 or whose combined age and length of service was equal to or greater than 45 years as of January 1, 2006. This plan is sponsored and administered by Standard and is closed for new participants. In 2012, the postretirement benefit plan was amended to reduce future benefits to plan participants that are either not eligible to or choose not to retire by July 2, 2013. The 2012 amendment will not affect future benefits for employees who retire prior to July 2, 2013. In addition, as of December 31, 2011, the group term life insurance benefit was curtailed for plan participants who were not retired at December 31, 2011.
Intent and ability to hold investments consistent with our investment strategy.
Competition from other insurers and financial services companies, including the ability to competitively price its products.
The condition of the economy and expectations for interest rate changes.
The effect of changing levels of bond call premiums, commercial mortgage loan prepayment fees and commercial mortgage loan participation levels on cash flows.
Consolidated Statements of Income for the years ended December 31, 2012, 2011 and
StanCorp has the following wholly-owned operating subsidiaries: Standard Insurance Company (“Standard”), The Standard Life Insurance Company of New York, Standard Retirement Services, Inc. (“Standard Retirement Services”), StanCorp Equities, Inc. (“StanCorp Equities”), StanCorp Mortgage Investors, LLC (“StanCorp Mortgage Investors”), StanCorp Investment Advisers, Inc. (“StanCorp Investment Advisers”), StanCorp Real Estate, LLC (“StanCorp Real Estate”) and Standard Management, Inc. (“Standard Management”).
StanCorp Equities is a limited broker-dealer and member of the Financial Industry Regulatory Authority. As a wholesaler, StanCorp Equities activities are limited to soliciting and supporting third-party broker-dealers and investment advisers that offer or advise their retirement plan clients on using an unregistered group annuity contract or a mutual fund trust platform.
StanCorp Real Estate is a property management company that owns and manages the Hillsboro, Oregon home office properties and other properties held for investment and held for sale.
Real estate investment properties are stated at cost less accumulated depreciation. Generally, the Company depreciates this real estate using the straight-line depreciation method with useful lives varying from 30 to 40 years. Accumulated
Significant, unanticipated changes in key assumptions, which affect the determination of expected gross profits, may result in a large unlocking event that could have a material adverse effect on our financial position or results of operations.
The Company’s other intangible assets are subject to amortization and consist of certain customer lists from Asset Management business acquired and an individual disability marketing agreement. Customer lists have a combined
Non-affiliated tenants leased 33.3%, 35.3% and 34.3% of the corporate headquarters in Portland, Oregon at December 31, 2012, 2011 and 2010, respectively. Income from the leases is included in net investment income.
Other policyholder funds are liabilities for investment-type contracts and are based on the policy account balances including accumulated interest. Other policyholder funds also include amounts related to advanced premiums, premiums on deposit and experience rated liabilities totaling $402.8 million and $419.4 million at December 31, 2012 and 2011, respectively.
In December 2011, the FASB issued ASU No. 2011-11, Disclosures about Offsetting Assets and Liabilities. The main objective of ASU No. 2011-11 is to enhance disclosures for financial instruments and derivative instruments which have right of setoff conditions. Under the guidance provided in this ASU, entities will be required to disclose the amount of both the recognized asset and the recognized liability subject to set-off under the same arrangement.
ASU No. 2011-11 is effective for interim and annual periods beginning on or after January 1, 2013. The Company does not currently have exposure to hedges, derivatives or master netting arrangements that would be subjected to these additional disclosures. Therefore, the Company does not expect this ASU to have a material effect on its asset and liability disclosures in the financial statements.
In February 2013, the FASB issued ASU No. 2013-02, Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income. The main objective of ASU No. 2013-02 is to enhance disclosures for reclassification adjustments including changes in accumulated other comprehensive income (“AOCI”) balances by component and significant items reclassified out of AOCI. The ASU would not change the current requirements for reporting net income or other comprehensive income in financial statements. However, the proposed amendments would require an entity to provide enhanced disclosures to present separately by component reclassifications out of AOCI. In addition, an entity would be required to provide a tabular disclosure of the effect of items reclassified out of AOCI on the respective line items of net income but only if the item reclassified is required under GAAP to be reclassified to net income in its entirety. For other reclassification items that are not required under GAAP to be reclassified directly to net income in their entirety, the new tabular disclosure would only require a cross-reference to other disclosures currently required under GAAP for those items.
ASU No. 2013-02 is effective for interim and annual periods beginning after December 15, 2012. The Company currently does not have items that are reclassified in their entirety directly to net income, which would have required new tabular disclosures while the reclassifications that the Company does currently have would require cross-referencing to other disclosures. Therefore, the Company does not expect this ASU to have a material effect on our disclosures around reclassifications out of AOCI.
The Company has two active share-based compensation plans: the 2002 Stock Incentive Plan (“2002 Plan”) and the 1999 Employee Share Purchase Plan (“ESPP”). The 2002 Plan authorizes the Board of Directors to grant incentive or non-statutory stock options and stock awards to eligible employees and certain related parties. Of the 4.8 million shares of common stock authorized for the 2002 Plan, 0.9 million shares or options for shares remain available for grant at December 31, 2012. The Company’s ESPP allows eligible employees to purchase StanCorp common stock at a discount. During the year amendments were made to the ESPP. See “Employee Share Purchase Plan” for additional details. Of the 3.5 million shares authorized for the ESPP, 1.5 million shares remain available for issuance at December 31, 2012.
The Company has provided three types of share-based compensation pursuant to the 2002 Plan: option grants, stock award grants and director stock award grants.
The weighted-average grant date fair value of options granted was $13.73, $16.87 and $16.16 for 2012, 2011 and 2010, respectively.
Performance Share grants represent the maximum number of shares issuable to the designated senior officers and are generally granted two years before the beginning of the performance period. The actual number of shares issued at the end of the performance period is based on satisfaction of employment and Company financial performance conditions, with a portion of the shares withheld to cover required tax withholding.
The compensation cost that the Company will ultimately recognize as a result of these stock awards is dependent on the Company’s financial performance. Assuming that the maximum performance is achieved for each performance goal, $12.8 million in additional compensation cost would be recognized through 2014. The target or expected payout is 50% of the maximum Performance Shares for the 2013 and 2014 performance periods. A target payout for these periods would result in approximately $6.4 million of additional compensation cost through 2014. This cost is expected to be recognized over a weighted-average period of 1.6 years.
On May 7, 2012 shareholders approved an amendment to the ESPP which increased the number of shares authorized for the ESPP to 3.5 million.
The Company has two non-contributory defined benefit pension plans: the employee pension plan and the agent pension plan. The employee pension plan is for all eligible employees of the Company, and the agent pension plan is for
As a result of inputs used during the current period to estimate the fair value of stable asset fund, Plan management has categorized the stable asset fund as having Level 2 inputs at December 31, 2012. The valuation methods may produce fair value calculations that may not be indicative of net realizable values or reflective of future fair values. See “Note 9-Fair Value” for further disclosure on valuation methods. Furthermore, although the Plan believes its valuation methods are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different fair value measurement at the reporting date.
Assumption for rate of compensation increase was not applicable in determining benefit obligations for 2012 and 2011 or net periodic benefit cost in 2012 due to curtailment of group term life insurance benefit as of December 31, 2011.
Resources are allocated and performance is evaluated at the segment level. The Insurance Services segment offers group and individual disability insurance, group life and AD&D insurance, group dental and group vision insurance, and absence management services. The Asset Management segment offers full-service 401(k) plans, 403(b) plans, 457 plans, defined benefit plans, money purchase pension plans, profit sharing plans and non-qualified deferred compensation products and services. This segment also offers investment advisory and management services, financial planning services, origination and servicing of fixed-rate commercial mortgage loans, individual fixed-rate annuity products, group annuity contracts and retirement plan trust products. The Other category includes return on capital not allocated to the product segments, holding company expenses, operations of certain unallocated subsidiaries, interest on debt, unallocated expenses, net capital gains and losses related to the impairment or the disposition of the Company’s invested assets and adjustments made in consolidation. The accounting policies of the segments are the same as those described in the summary of significant accounting policies. See “Note 1-Summary of Significant Accounting Policies.”
The following table sets forth StanCorp’s condensed statements of cash flows:
As of December 31, 2012, the Company is subject to examination by the IRS for the years 2009 through 2012.
The Company did not have any material unrecognized tax benefits at December 31, 2012 and 2011. It is the Company’s accounting policy to record income tax interest and penalties in the income tax provision. See “Note 1-Summary of Significant Accounting Policies-Income Taxes.”
Goodwill is related to the Asset Management segment and totaled $36.0 million at both December 31, 2012 and 2011. Goodwill is not amortized and is tested at least annually for impairment. If indicators of impairment appear throughout the year, or in the event of material changes in circumstances, the test will be more frequent. The Company performs a step-one test and compares the carrying value of the tested assets with the fair value of the assets. Fair value is measured using a combination of the income approach and the market approach. The income approach consists of utilizing the discounted cash flow method that incorporates the Company’s estimates of future revenues and costs, discounted using a market participant weighted-average cost of capital. The estimates the Company uses in the income approach are consistent with the plans and estimates that the Company uses to manage its operations. The market approach utilizes multiples of profit measures in order to estimate the fair value of the assets. As the income approach more closely aligns with how the Company internally evaluates and manages its business, the Company weights the income approach more heavily than the market approach in determining the fair value of the assets. However, the Company performs testing to ensure that both models are providing reasonably consistent results. Additionally, the Company performs sensitivity analysis on the key input factors in these models to determine whether any input factor or combination of factors moving moderately in either direction would change the results of these tests. Through the performance of these tests, the Company determined the fair value of goodwill substantially exceeded the carrying value, and concluded that it was not impaired as of December 31, 2012.
The Company did not elect to measure and record commercial mortgage loans, policy loans, other policyholders funds that are investment-type contracts, short-term debt, or long-term debt at fair value on the consolidated balance sheets.
The Company performs control procedures over the external valuations at least quarterly through a combination of procedures that include an evaluation of methodologies used by the pricing service, analytical reviews and performance analysis of the prices against statistics and trends, back testing of sales activity and maintenance of a securities watch list. As necessary, the Company compares prices received from the pricing service to prices independently estimated by the Company utilizing discounted cash flow models or through performing independent valuations of inputs and assumptions similar to those used by the pricing service in order to ensure prices represent a reasonable estimate of fair value. Although the Company does identify differences from time to time as a result of these validation procedures, the Company did not make any significant adjustments as of December 31, 2012 or December 31, 2011.
The Company calculates the fair value for its S&P 500 Index options using the Black-Scholes option pricing model and parameters derived from market sources. The Company’s valuations maximize the use of observable inputs, which include direct price quotes from the Chicago Board Options Exchange (“CBOE”) and values for on-the-run treasury securities and London Interbank Offered Rate (“LIBOR”) as reported by Bloomberg. Unobservable inputs are estimated from the best sources available to the Company and include estimates of future gross dividends to be paid on the stocks underlying the S&P 500 Index, estimates of bid-ask spreads, and estimates of implied volatilities on options. Valuation parameters are calibrated to replicate the actual end-of-day market quotes for options trading on the CBOE. The Company performs
additional validation procedures such as the daily observation of market activity and conditions and the tracking and analyzing of actual quotes provided by banking counterparties each time the Company purchases options from them. Additionally, in order to help validate the values derived through the procedures noted above, the Company obtains indicators of value from representative investment banks.
Valuations for the index-based interest guarantees are sensitive to a number of variables, but are most sensitive to the S&P 500 Index value, the implied volatilities of this index, and LIBOR as reported by Bloomberg. Generally, a significant increase or decrease used in the assumption for the implied volatilities and in the S&P 500 Index value would result in a directionally similar change, while an increase or decrease in LIBOR would result in a directionally opposite change in the fair value of the liability.
Quantitative information regarding significant unobservable inputs used in Level 3 valuation of assets and liabilities measured and recorded at fair value is as follows:
Capitalization rates are used as an internal analysis in converting the underlying property’s income to an estimated property value.
For all periods disclosed above, fixed maturity securities transferred into Level 3 from Level 2 are the result of the Company being unable to obtain observable assumptions for these investments in the market. Fixed maturity securities transferred out of Level 3 into Level 2 are the result of the Company being able to obtain observable assumptions for these investments in the market. There were no transfers between Level 1 and Level 2 for 2012 and 2011.
The following table sets forth the assets measured at fair value on a nonrecurring basis as of December 31, 2011 that the Company continued to hold:
The decrease in the impaired commercial mortgage loans at December 31, 2012 compared to December 31, 2011 was primarily due to loan repayments and foreclosures of previously impaired loans during 2012. As of December 31, 2012 and December 31, 2011 the Company did not have any commercial mortgage loans greater than 90 days delinquent that were accruing interest. See “Note 1-Summary of Significant Accounting Policies-Investment Valuations-Commercial Mortgage Loans” for the policies regarding interest income for delinquent commercial mortgage loans.
A modification is considered to be a troubled debt restructuring when the debtor is experiencing financial difficulties and the restructured terms constitute a concession. The Company evaluates all restructured commercial mortgage loans for indications of troubled debt restructurings and the potential losses related to these restructurings. If a loan is considered a troubled debt restructuring, the Company impairs the loan and records a specific allowance for estimated losses. In some cases, the recorded investment in the loan may increase post-restructuring. As a result of adopting the amendments in ASU No. 2011-02, A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring, the Company assessed all restructurings that occurred during the period to determine if they were troubled debt restructurings. The Company did not identify any troubled debt restructurings that were not already considered impaired.
The following table sets forth information related to the troubled debt restructurings identified in the previous 12 months that subsequently defaulted during the periods presented:
Securities deposited for the benefit of policyholders in various states, in accordance with state regulations, amounted to $7.9 million and $6.7 million at December 31, 2012 and 2011, respectively.
The notional amount of the Company’s S&P 500 Index options at December 31, 2012 and 2011 was $315.2 million and $303.1 million, respectively. Option premiums paid for the Company’s S&P 500 Index option contracts were $9.5 million and $9.6 million for 2012 and 2011, respectively. The Company received $13.2 million and $15.5 million for options exercised in 2012 and 2011, respectively.
The Company recognizes all derivative instruments as assets or liabilities on the balance sheet at fair value. The Company does not currently designate its derivatives as hedging instruments and thus does not use hedge accounting. As such, any change in the fair value of the derivative assets and derivative liabilities is recognized as income or loss in the period of change. See “Note 9-Fair Value” for additional information regarding the fair value of the Company’s derivative assets and liabilities.
Changes in the fair value of the S&P 500 Index options and index-based interest guarantees are primarily the result of fluctuations in the S&P 500 Index and are recorded to net investment income and interest credited, respectively. As a result of the Company’s annual update of the key assumptions used to value index-based interest guarantees, a process known as “unlocking”, interest credited decreased $3.3 million and $1.9 million for 2012 and 2011, respectively.
The value of DAC and VOBA is dependent on key assumptions. See “Note 1-Summary of Significant Accounting Policies-DAC, VOBA and Other Intangible Assets” for a discussion of the key assumptions used to determine the values of DAC and VOBA. These assumptions are modified to reflect actual experience when appropriate. Although a change in a single assumption may have an impact on the calculated amortization of DAC or VOBA for balances associated with investment contracts, it is the relationship of that change to the changes in other key assumptions that determines the ultimate impact on DAC or VOBA amortization. Because actual results and trends related to these assumptions vary from those assumed, the Company revises these assumptions annually to reflect its current best estimate of expected gross profits. As a result of this process, known as “unlocking,” the cumulative balances of DAC and VOBA are adjusted with an offsetting benefit or charge to income to reflect changes in the period of the revision. An unlocking event generally occurs as a result of actual experience or future expectations differing from previous estimates. During 2012, the Company recorded a $0.8 million impairment to VOBA due to experience related to the block of claims assumed. The Company did not record a similar impairment for 2011. As a result of unlocking, the amortization schedule for future periods is also adjusted.
The liability for unpaid claims, claim adjustment expenses and other policyholder funds includes liabilities for insurance offered on products such as group long term and short term disability, individual disability, group dental and group vision,
and group AD&D. The liability for unpaid claims and claim adjustment expenses is established when a claim is incurred or is estimated to have been incurred but not yet reported to the Company and, as prescribed by GAAP, equals the Company’s best estimate of the present value of the liability of future unpaid claims and claim adjustment expenses. This liability is included in future policy benefits and claims in the consolidated balance sheets.
the reserves held. In each of the years captured, there was a decrease in incurred amounts associated with prior years after the effect of interest is taken into account, indicating that in spite of the increase in long term disability claims incidence in 2012 and 2011, claim experience was favorable when compared to the assumptions used to establish the associated reserves. However, significant changes to assumptions regarding unpaid claims and claims adjustment expenses for prior periods in the group long term disability reserves were not made in 2012, 2011 and 2010 primarily due to the long-term nature of this product and the materiality of other factors including the potential impact of the economic uncertainty in 2012, 2011 and 2010. The Company carefully monitors trends in reserve assumptions and when these trends become credible and are expected to persist, the Company incorporates these factors into its reserves to ensure best estimates are established.
The primary components of other policyholder funds are employer-sponsored defined contribution and benefit plan funds, individual fixed-rate annuity funds and indexed annuity funds. The remaining balance is comprised primarily of premiums on deposits, advanced premiums and experience related liabilities.
Standard maintains a strategic marketing alliance with Ameritas Life Insurance Corp. (“Ameritas”) that offers Standard’s policyholders more flexible dental coverage options and access to Ameritas’ nationwide preferred provider organization panel of dentists. As part of this alliance, Standard and Ameritas entered into a reinsurance agreement. In 2012, the agreement provided for 24.9% of the net dental premiums written by Standard and the risk associated with this premium to be ceded to Ameritas.
Effective October 1, 2000, Standard assumed, through a reinsurance agreement, the individual disability insurance business of Minnesota Life. Standard paid a ceding commission of approximately $55 million and received approximately $500 million in assets and corresponding statutory liabilities. If Standard were to become unable to meet its obligations, Minnesota Life would retain the reinsured liabilities. Therefore, in accordance with the agreement with Minnesota Life, Standard established a trust for the benefit of Minnesota Life with the market value of assets in the trust equal to Minnesota Life’s reinsurance receivable from Standard. The market value of assets required to be maintained in the trust is determined quarterly. The market value of assets required to be maintained in the trust at December 31, 2012, was $573.1 million. Accompanying the transaction was a national marketing agreement that provides access to Minnesota Life agents, some of whom now market Standard’s individual disability insurance products. The national marketing agreement remains in effect through 2013.
Other operating expenses include operating expenses, commissions and bonuses, premium taxes, interest expense and the net increase in DAC, VOBA and other intangible assets.
Standard and The Standard Life Insurance Company of New York are subject to statutory restrictions that limit the maximum amount of dividends and distributions that they could declare and pay to StanCorp without prior approval of the states in which the subsidiaries are domiciled. As of December 31, 2012, Standard’s net gain from operations after dividends to policyholders and federal income taxes and before capital gains or losses for the 12-month period then ended was $132.7 million and capital and surplus was $1.19 billion. Based upon Standard’s results for 2012, the amount of ordinary dividends and other distributions available in 2013, without prior approval from the Oregon Insurance Division is $132.7 million. As of December 31, 2011, Standard’s net gain from operations after dividends to policyholders and federal income taxes and before capital gains or losses for the 12-month period then ended was $144.0 million and capital and surplus was $1.14 billion. Based upon Standard’s results for 2011, the amount of ordinary dividends and other distributions available in 2012, without prior approval from the Oregon Insurance Division was $144.0 million. As of December 31, 2012 Standard had issued, upon approval of the Oregon Insurance Division, dividends in excess of $144.0 million.
During 2012 and 2011, Standard made distributions to StanCorp totaling $320.0 million and $87.8 million, respectively.
During 2012, StanCorp made a capital infusion of $10.0 million to The Standard Life Insurance Company of New York. In 2011, there was not a capital infusion between StanCorp and The Standard Life Insurance Company of New York.
Company’s states of domicile. At December 31, 2011, the capital of the Company’s insurance subsidiaries was approximately 327% of the Company Action Level RBC required by regulators, which was approximately 654% of the Authorized Control Level RBC required by the Company’s states of domicile.
On August 10, 2012, the Company issued $250 million of 5.00%, 10-year senior notes (“2022 Senior Notes’’), which mature on August 15, 2022. Interest will be paid semi-annually on February 15 and August 15, beginning on February 15, 2013. The Company used the net proceeds from the issuance of the 2022 Senior Notes to repay the $250 million of 6.875%, 10-year senior notes (“2012 Senior Notes”), on September 28, 2012.
The Company has $300 million of 6.90%, junior subordinated debentures (“Subordinated Debt”), which matures on June 1, 2067, is non-callable for the first 10 years (prior to June 1, 2017). The principal amount of the Subordinated Debt is
In the normal course of business, the Company is involved in various legal actions and other state and federal proceedings. A number of actions or proceedings were pending at December 31, 2012. In some instances, lawsuits include claims for punitive damages and similar types of relief in unspecified or substantial amounts, in addition to amounts for alleged contractual liability or other compensatory damages. In the opinion of management, the ultimate liability, if any, arising from the actions or proceedings is not expected to have a material effect on the Company’s business, financial position, results of operations or cash flows.
On June 22, 2012, StanCorp entered into an agreement for a four-year, $250 million Facility. Additionally, upon the request of StanCorp and with the consent of the lenders under the Facility, the Facility can be increased to $350 million. The termination date of the Facility is June 22, 2016, though, at the option of StanCorp and with the consent of the lenders under the Facility, the termination date can be extended for two additional one year periods. Borrowings from the Facility will be used to provide for the working capital and general corporate purposes of the Company and its subsidiaries and for the issuance of letters of credit.
The following table sets forth the minimum future rental receivables on non-cancelable leases of retail and office space with initial terms of one year or more:
The following table sets forth the expenses incurred for 2011 by major category: