The principal executive offices of the Company are located in Schaumburg, Illinois in a building purchased by the Company in January 1994. The Company, through a subsidiary, owns three buildings in Rockford, Illinois and, through another subsidiary, also owns a building in the Dallas, Texas metropolitan area which currently serves as the main administrative office for the Group Medical Division. The Company leases the offices of its other regional service centers. The executive and administrative offices of Manhattan National Life are located in Cincinnati, Ohio, in leased space. The Company believes these facilities will adequately serve its needs for the foreseeable future and could accommodate expansion of the Company's business.
PFS has three business segments: Group Medical, Senior Health, and Life Insurance. The segments are based on PFS' main Divisions. Allocations of investment income and certain general expenses are based on various assumptions and estimates, and reported operating results by segment would change if different methods were applied. Investment income is allocated based primarily on the policy liabilities and capital supporting the segment. General expenses are determined based on cost center and functional expense analysis prepared in conjunction with the monthly budgeting process. Assets are not individually identifiable by segment and have been allocated based on the amount of policy liabilities by segment and by other formulas. Depreciation expense and capital expenditures are not considered material. Realized investment gains and losses are allocated to the appropriate segment.
General corporate expenses are not allocated to the individual segments. Revenues, income or loss before income taxes, and identifiable assets by business segment are as follows:
Net investment income increased $1.7 million, or 21%, from $7.7 million to $9.4 million due to the increase in invested assets associated with the WNIC block of business.
Other income decreased $3.7 million, or 21%, from $18.9 million to $15.2 million due to a reduction in commission overrides at the Company's marketing subsidiaries.
Benefits. The following table sets forth the earned premium, benefits, and loss ratios for products issued by the Group Medical Division:
The increase in loss ratio is due to the assumed block of WNIC business which has a higher ultimate loss ratio and a shift to a low commission and higher benefit product structure due to small group reform. The loss ratio on the assumed block of WNIC business was 77.2% for 1996.
Insurance and General Expenses. Insurance and general expenses decreased $11.4 million, or 10%, from $119.5 million to $108.1 million. The expense decreased in 1996 primarily due to lower average commission rates resulting from non-commissionable rate increases and a marginal improvement in administration efficiencies. The remaining decrease was due to the reduction in new business from historical distribution channels.
Benefits. The following table sets forth the earned premium, benefits, and loss ratios for senior health products:
Insurance and General Expenses. The expense ratio remained relatively unchanged. The decline in administrative expense levels was offset by a continued increase in marketing expenses associated with new marketing initiatives.
Net investment income decreased $3.6 million, or 7%, from $54.4 million to $50.8 million. This decrease was primarily due to a decrease in the investment income allocated to the senior life product line.
Insurance and General Expenses. Insurance and general expenses decreased $4.2 million, or 19%, from $22.0 million to $17.8 million. The decrease was due primarily to $1.6 million associated with a reinsurance litigation settlement included in the 1995 amount, an overall reduction in commissions associated with the senior life products, and a 14% reduction in the maintenance unit cost per policy.
The amortization of DAC increased $3.8 million, or 40%, from $9.6 million to $13.4 million with the increased life insurance in force.
Corporate expenses increased $3.7 million, or 132% during 1996 due to executive officer bonuses of $1.5 million, increased outside consulting expenses of $0.9 million, and a general increase in other corporate expenses. Interest expense increased $1.6 million or 34% due primarily to the March 1996 issuance of the convertible subordinated notes. The operations of the managed care division included in the corporate segment did not have a material effect on operating income in 1996 or 1995.
Premiums and policy charges. Total premiums and policy charges increased $83.9 million, or 12%, from $687.0 million to $770.9 million. Accident and health premiums increased $60.9 million, or 10% due to the acquisition of UFLIC and the small group and individual health reinsurance agreement with WNIC. Life and annuity premiums increased $22.9 million or 38% due to the significant growth in new business during 1996.
Net investment income. Net investment income increased $3.8 million, or 5%, from $71.0 million to $74.8 million. Invested assets increased 15% to $1,196 million and annualized investment yields decreased slightly from 7.0% to 6.9%.
Insurance and general expenses. Insurance and general expenses (which include non-deferred commission compensation to agents) decreased $6.1 million, or 3%, from $218.4 million to $212.3 million. The commission compensation is expected to continue to decline on the Company's small group major medical products.
Amortization of DAC. Amortization of DAC decreased $3.7 million, or 5%, from $69.2 million to $65.5 million. The decrease was primarily due to a lower level of group major medical new business and improved persistency on Medicare supplement business.
Other. Investments, premiums and other receivables, amounts on deposit and due from reinsurers, accrued investment income and other assets increased principally due to the acquisitions of SLIC, UFLIC and the WNIC block of business. DAC increased as a result of the significant increase in life and long-term care production. The decrease in short-term notes payable resulted from the use of proceeds from the Company's public offering in the first quarter of 1996. General expenses and other liabilities, and amounts due to reinsurers increased due primarily to the acquisition of SLIC and the WNIC block of business. The remaining balance sheet amounts remained relatively consistent with the amounts at December 31, 1995.
Income tax rate. The effective federal income tax rate was 34% due to the increased investment in tax-exempt securities included in the Company's portfolio.
Under generally accepted accounting principles, a DAC asset is established to match properly the costs of writing new business against the expected future revenues or gross profits from the policies. The costs which are capitalized and amortized consist of first-year commissions in excess of renewal commissions and certain home office expenses related to selling, policy issue, and underwriting.
The Company's consolidated liquidity requirements are created and met primarily by operations of its subsidiaries. The insurance subsidiaries' primary sources of cash are premiums, investment income, and investment sales and maturities. The insurance subsidiaries' primary uses of cash are operating costs, policy acquisition costs, payments to policyholders and investment purchases. In addition, liquidity requirements of the holding company are created by dividends, interest payments on the 6.5% Notes and other debt service requirements.
Notwithstanding the foregoing, if insurance regulators otherwise determine that payment of a dividend or any other payment to an affiliate would be detrimental to an insurance subsidiary's policyholders or creditors because of the financial condition of the insurance subsidiary or otherwise, the regulators may block dividends or other payments to affiliates that would otherwise be permitted without prior approval.
The Company's insurance subsidiaries require capital to fund acquisition costs incurred in the initial year of policy issuance and to maintain adequate surplus levels for regulatory purposes. These capital requirements have been met principally from internally generated funds, including premiums and investment income, and capital contributions from the holding company.
In July 1993 the Company issued $57.5 million of its 8% Debentures. Net proceeds from the offering totaled approximately $54.0 million. The 8% Debentures were convertible into the Company's Common Stock at any time prior to maturity, unless previously redeemed, at a conversion price of $11.75 per share. In August 1995, the Company accepted the conversion of $46.9 million of the outstanding 8% Debentures. The effect of the conversion was an increase in stockholders' equity of $45.3 million and a charge to income of $3.5 million, net of taxes, for payments to converting bondholders and other expenses relating to the conversion. In August 1996, the Company completed the redemption of the remaining outstanding debentures. The effect of the conversion was an increase in stockholders' equity of $9.0 million.
In September 1995, a non-insurance subsidiary of the Company borrowed $3.3 million from a finance company to finance the purchase of certain equipment. The note, which is secured by the equipment purchased, bears interest at a fixed rate of 7.81% and has principal and interest payments of $40,000 payable monthly through August 2005.
The Company has a line of credit arrangement for short-term borrowings with six banks amounting to $30.0 million through July 1999, all of which was unused at December 31, 1996 (the "Credit Facility"). Amounts borrowed under the Credit Facility accrue interest at a rate per annum based upon either a corporate base rate, LIBOR, or a prime rate plus a margin. The line of credit arrangement can be terminated, in accordance with the agreement, at the Company's option.
In March, June, September and December 1996, the Company's Board of Directors announced a quarterly Common Stock dividend of $.055 per share, for a total of 22 cents per share in 1996.
In March 1997 the Board of Directors announced a quarterly stock dividend of $.055 per share to be paid in April, 1997.
Management believes that the diversity of the Company's investment portfolio and the liquidity attributable to the large concentration of investments in highly liquid United States government agency securities provide sufficient liquidity to meet foreseeable cash requirements. See "Business- Investments." Because the Company's insurance subsidiaries experience strong positive cash flows, including monthly cash flows from mortgage-backed securities, the Company does not expect its insurance subsidiaries to be forced to sell the held-to-maturity investments prior to their maturities and realize material losses or gains. Although the Company has the ability and intent to hold those securities to maturity, there could occur infrequent and unusual conditions under which it would sell certain of these securities. Those conditions would include a significant deterioration of the issuer's creditworthiness, significant changes in tax law affecting the taxation of securities, a significant business acquisition or disposition, and changes in regulatory capital requirements or permissible investments.
Since investment income is an important component of revenue and profitability for the Company; significant focus is placed on the analysis of both asset and liability characteristics in the investment process. Profitability is impacted by spreads between yields earned on investments and rates credited on annuities, interest sensitive and life insurance liabilities. Although substantially all credited rates on these liabilities can be changed annually, changes in interest rates credited may not be sufficient to maintain targeted investment spreads in all economic and market environments. In addition, other factors including competition, the impact of the level of surrenders and withdrawals may limit the Company's ability to adjust or to maintain crediting rates at levels necessary to avoid narrowing of spreads under certain market conditions.
The Company, in recognizing this importance of interest rate management, seeks to balance the duration of its invested assets with the expected duration of benefit payments arising from insurance liabilities. At December 31, 1996, the duration of the Company's fixed maturity portfolio is 4.5 years and the duration of the Company's insurance liabilities is 4.1 years. The Company meets at least monthly to review the asset and liability position in order to make necessary adjustments including adjustments to investment activity or crediting rates or both.
For a discussion of a new accounting standard relating to transfers and servicing of financial assets and extinguishments of liabilities and a new stock-based employee compensation accounting standard and the impact of these standards on the financial statements of the Company, see Note 2 of Notes to Consolidated Financial Statements.