The following table sets forth for the indicated periods selected historical financial information for SLC and its consolidated subsidiaries. Such information should be read in conjunction with the consolidated financial statements of SLC, and the related notes and schedules, included elsewhere herein. Factors affecting the comparability of certain
Following is an analysis of these various events and factors, including management's assessment of their impact on the financial position and liquidity of SLC, as well as management's future expectations.
In February 1994, SLC purchased all of its Class B Common Stock from CNC and immediately cancelled and retired such stock. In June 1994, certain transactions were consummated with CFLIC, a subsidiary of CNC, pursuant to which SLC acquired from CFLIC all of its outstanding shares of 1984-A Preferred Stock and 1987-B Preferred Stock and 620,423 shares of its Common Stock, all of which shares were retired in 1994. See "Business-Business Strategy" and Note 4 of Notes to Financial Statements. As a result of these transactions, CNC's ownership in SLC was reduced to less than one million shares, or 2%, of SLC's outstanding Common Stock. Management believes these transactions are significant for various reasons. Most importantly, management believes that SLC's access to both debt and equity capital markets had been limited because of the control position held by CNC through the Class B Stock, and that the retirement of the Class B Stock and simultaneous, considerable reduction in CNC's holdings of SLC Common Stock through sales to Stephens and Torchmark could ultimately enhance SLC's ability to refinance its currently outstanding debt. Further, the redemption and retirement of the SLC preferred stocks and the cancellation of senior debt of the Company that had been held by CFLIC reduced SLC's interest and preferred dividend requirements by approximately $5.4 million annually.
The principal requirement for liquidity of SLC's insurance subsidiaries is their contractual obligations to policyholders, including policy loans, payments of benefits and claims, and general operating expenses. Further, policy loans of SLC's subsidiaries have represented 7% of SLC's consolidated investment assets during the past three years.
In each of 1992, 1993 and 1994 and in January 1995, the claims-paying ratings assigned to certain of SLC's subsidiaries by various nationally recognized statistical ratings organizations were lowered. See "Business-Ratings" for information regarding ratings. Prior to 1995 and except for withdrawals made by certain GIC holders, management believes SLC's subsidiaries had not experienced more than normal policy surrenders and withdrawals as a result of these ratings downgrades. For the years ended December 31, 1994 and 1993, policyholder contract withdrawals, principally GICs, exceeded policyholder contract deposits by approximately $11.2 million and $207.4 million, respectively. Withdrawals by GIC holders totaled $76.1 million during 1994 and $329.0 million in 1993. Approximately $59.0 million of such withdrawals in 1994 and $184.3 million in 1993 represented scheduled maturities of GICs which were not reinvested with an SLC subsidiary. In addition, as a result of the restructuring of SLC's holding company system completed in 1993, the surplus of the subsidiary was significantly reduced and, as a consequence, some policyholders became entitled to an early withdrawal of their GICs. The subsidiary also voluntarily offered certain other GIC holders the right of early withdrawal. Unscheduled and early GIC withdrawals totaled $17.1 million in 1994 and $144.7 million during 1993. Because of its available liquidity and readily marketable securities, the subsidiary has not encountered, and management does not anticipate that the subsidiary will encounter, any difficulty in meeting its obligations relative to such withdrawals.
outstanding debt and fixed charges. Management believes that primarily as a result of these announcements, subsequent downgrades in credit and claim paying ratings, and the similarity between the holding company's name and that of its largest insurance subsidiary, Southwestern Life, surrender activity relative to the life insurance and annuity business of Southwestern Life and, to a lesser extent, its other insurance subsidiaries has increased over comparable levels in 1994. Surrenders of life insurance and annuity policies have averaged approximately $8.8 million during each of the first two months of 1995, as compared to $5.3 million per month in the comparable 1994 period. Because of their available liquidity, SLC's insurance subsidiaries have not encountered any difficulty in meeting their obligations relative to these surrenders. SLC's subsidiaries maintain significant levels of cash and short-term investments and approximately two-thirds of their investment portfolios are comprised of readily marketable investment-grade fixed maturity investments. In management's estimate, substantially all of the net surrender values of the Company's insurance policies in force at December 31, 1994, could be met through the liquidation of such investments, if required. Accordingly, management is confident that SLC's insurance subsidiaries have the capacity to meet all of their policyholder obligations as they become due.
Certain of SLC's insurance subsidiaries have ceded blocks of insurance to unaffiliated reinsurers to provide funds for financing acquisitions and other purposes. Net statutory surplus provided by such treaties before tax effects totaled $57.8 million at December 31, 1994. For further information, see "Business-Reinsurance."
The unpaid principal balance of surplus debentures issued to SLC by its insurance subsidiaries totaled $247.6 million at December 31, 1992. Of this amount, surplus debentures in the aggregate unpaid principal amount of $141.8 million were payable by Southwestern Life and $105.8 million were payable by Modern American. In 1993, Southwestern Life repaid the remaining balance on its surplus debenture utilizing proceeds from its 1992 sale of Bankers. In the restructuring of SLC's insurance holding company system in 1993, the surplus debenture from Modern American was retired and added to SLC's investment in its subsidiaries. Since September 30, 1993, there have been no surplus debentures due SLC by its subsidiaries.
Prior to 1992, SLC had issued demand and collateralized notes to certain of its subsidiaries in order to meet short-term liquidity requirements. During 1993 and 1992 SLC repaid all of such obligations to its subsidiaries and does not intend to utilize such borrowings in future periods.
SLC's principal needs for liquidity are debt service and, to a lesser extent, preferred dividend requirements. SLC's consolidated indebtedness totaled $369.4 million at December 31, 1994, as compared to $418.0 million at December 31, 1993, and $543.3 million at December 31, 1992. Substantially all indebtedness of SLC was incurred in connection with acquisitions of subsidiaries in periods prior to 1987, including collateralized senior debt and unsecured subordinated debt, a portion of which was exchanged for new debt in 1993. See Note 3 of Notes to Financial Statements for additional information regarding SLC's consolidated indebtedness, including annual maturities.
SLC reduced its reported indebtedness by $162.8 million in 1992, $125.3 million in 1993, and $48.6 million in 1994. Such reductions totaling $336.7 were effected primarily through SLC's prepayment of $45.0 million of senior secured debt in 1992, the prepayment of $168.4 million of senior secured debt and subordinated debt with proceeds form the sale of Bankers in 1992 and BLHC in 1993, a purchase in an open-market transaction of $10.0 million of senior subordinated debt in 1994, and $83.3 million of scheduled subordinated debt sinking fund and principal installments during the three-year period. In connection with the CFLIC transactions in 1994, SLC retired the remaining $30.0 million principal balance outstanding on its senior secured debt.
SLC's actual cash sources in 1994 exceed the previously projected 1994 cash sources, as reflected in SLC's 1993 Annual Report on Form 10-K, by approximately $13.1 million. Included in the increase in such cash sources is a $5.0 million prepayment on a note receivable, $6.5 million in income tax reimbursements for utilization of SLC's
In 1993, SLC realized significant gains on the sale of its investment in BLHC, the sale of other invested assets, and the termination of a reinsurance arrangement with Bankers, and realized a benefit from the change in corporate income tax rates. In addition, significant writedowns of certain capitalized costs and operating facilities were taken in connection with the continuation of an operational consolidation and provisions were made for the costs associated with agreements entered into with SLC's former controlling stockholders and certain other contingencies.
In 1992, SLC realized a gain on the sale of an effective 60% interest in Bankers, which was offset by charges for significant losses on the portfolio of derivative CMOs, a litigation settlement, costs incurred to modify a data processing services arrangement, and costs incurred or accrued relative to an operational consolidation.
The following table reflects the results of SLC's basic operations from 1992 through 1994, the contribution to operating results of Bankers through October 1992, and the effects that the above described charges and credits had on SLC's operating results for each of the three years.
The increase in the pretax operating loss from $6.6 million in 1993 to a pretax operating loss of $23.3 million in 1994 reflects in part the effects of SLC's sale of its investment in BLHC effective September 30, 1993, and the subsequent utilization of the proceeds from such sale. In 1993, SLC had reflected its equity in the operating results of BLHC totaling $29.1 million through the date of such sale, and in 1994 SLC had no similar equity earnings included in its operating results. SLC utilized $100 million of the proceeds from such sale to redeem preferred stocks with annual dividend requirements totaling $13.5 million. Although such use of funds to redeem preferred stock had an effect on earnings available to common stockholders, it had no effect on SLC's pretax operating results. SLC utilized approximately $63.2 million of such proceeds for the redemption of a portion of its outstanding indebtedness in 1993 and 1994, which reduced annual interest requirements on long-term indebtedness by approximately $9.4 million. The
Pretax earnings from existing operating companies improved by $4.4 million in 1994 as compared to 1993, primarily as a result of general and administrative expense savings realized in 1994. General and administrative expenses totaled $92.2 million in 1994, as compared to $111.2 million in 1993, primarily reflecting the results of operational consolidations and other cost saving measures. The expense savings in 1994 were offset in large measure by higher than expected benefit costs, primarily in the individual life insurance and individual health insurance segments.
The decline in pretax operating earnings of $47.7 million in 1992 to a pretax operating loss of $6.6 million in 1993 reflects primarily the exclusion of Bankers' results for all of 1993, offset in part by a reduction in interest expense on long-term indebtedness of $16.5 million (See "-Interest Expense and Preferred Dividend Requirements"). Through October 1992, Bankers was included in SLC's consolidated results and contributed approximately $94.3 million to SLC's 1992 pretax earnings. For the last two months of 1992, SLC reflected its equity in the operating results of BLHC totaling $3.3 million. The combined Bankers contribution to pretax earnings and equity in operating results of BLHC totaling $97.6 million in 1992 compares to SLC's equity in the operating earnings of BLHC totaling $29.1 million in 1993. Except for the interest expense savings on long-term debt realized in 1993, SLC was unable to effectively redeploy the proceeds from the sale of Bankers during the last two months of 1992 and during 1993 to fully replace the reduction in pretax earnings resulting from the sale of Bankers. In addition, SLC incurred losses of $12.9 million in its group insurance operations in 1993.
previously discussed under "-Liquidity and Capital Resources-Insurance Operations"), could result in reduced profitability in this segment in future periods.
Exclusive of Bankers, sales of individual health products increased from $60.3 million in 1992 to $63.6 million in 1993, but declined to $49.4 million in 1994. Premiums earned (exclusive of Bankers) increased from $216.2 million in 1992 to $220.3 million in 1993, but declined to $215.8 million in 1994. The ratio of policy benefits to premiums earned (exclusive of Bankers) declined from 68.4% in 1992 to 62.3% in 1993, but increased to 67.6% in 1994. The significant decline in the benefit ratio in 1993 resulted in an approximate $15.0 million improvement in the gross operating margins (the excess of premiums earned over benefits incurred) of the Company's individual health insurance segment. Correspondingly, the significant increase in the benefit ratio in 1994 resulted in an approximate $13.3 million deterioration in gross operating margins. Substantially all of the increase in the individual health benefit ratio in 1994 was attributable to the Medicare supplement line of business, reflecting a deficiency in premiums charged for certain Medicare supplement products. Congressional mandates have imposed a minimum 65% benefit ratio for Medicare supplement products and, as a result, the benefit ratio for Medicare supplement products is generally higher than for other individual health insurance products. The benefit ratio applicable to the Company's Medicare supplement business decreased from 69.5% in 1992 to 65.8% in 1993, resulting in a substantial portion of the improvement in the individual health benefit ratio in 1993, but increased to 73.3% in 1994. The Company received rate increases for these products in 1994, which subsequently proved to be insufficient, and in mid and late 1994 and early 1995 filed requests for significant additional rate increases, a majority of which have been approved as requested and implemented, and the remainder of which are still pending.
Management expects to continue to emphasize growth in the individual health insurance segment, principally through the sale of a new comprehensive product introduced in January 1995. Management believes that the recent consolidation of the marketing operations of Southwestern Life and Union Bankers and the Company's reputation for quality service and support are important factors that will enable the Company to compete more effectively in the market for Medicare supplement products.
attributable to PALICO's TPA business. PALICO's success with ASO contracts prior to 1993 led it to greatly expand its involvement in TPA operations during 1993. Primarily because of problems in adequately pricing for the services to be rendered under these contracts, the TPA operations were unprofitable in both 1993 and 1994. As a consequence, PALICO terminated all of its TPA contracts during 1994.
CORPORATE. The corporate segment includes those elements of the Company's operations other than its insurance operations. Revenues allocated to the corporate segment include investment income on the interest-bearing assets of the holding company and on the capital and surplus of SLC's insurance subsidiaries in excess of amounts necessary to support their insurance operations. In addition, such revenues also include the $11.1 million gain realized on the CFLIC recapture in 1994, which was offset in part by the $4.2 million estimated loss to be incurred on the sale of Bankers New York; the $297.0 million gain on the sale of SLC's investment in BLHC in 1993; and the $110.7 million gain on SLC's sale of its investment in Bankers in 1992.
SLC's consolidated interest expense totaled $48.3 million in 1994, $66.2 million in 1993, and $79.0 million in 1992. The reductions in interest expense were primarily as a result of the principal reductions in SLC's long-term indebtedness made during the periods as previously discussed under "-Liquidity and Capital Resources of Parent Company." The reductions in interest expense in 1993 and 1992 were offset, in part, by the interest expense incurred relative to collateralized mortgage note obligations totaling $6.0 million in 1993 and $2.3 million in 1992. The collateralized mortgage note obligations were initially incurred in conjunction with the sale of Bankers in 1992. As a result of the transactions entered into in July 1993 intended to reduce SLC's exposure to prepayment risks on certain
In 1993, income tax expense represented approximately 31% of consolidated operating earnings before income taxes, or 4% less than the expected corporate income tax rate. During 1993, the corporate income tax rate was increased from 34% to 35%, retroactive to January 1, 1993. The effect of such rate increase on SLC's deferred income tax asset as of the beginning of 1993, a benefit totaling $3.5 million, has been included in the 1993 income tax provision. Other significant items affecting the 1993 effective income tax rate included a reduction in the valuation allowance for SLC's deferred income tax asset based on the utilization of available loss carryforwards to offset income taxes otherwise payable as a result of the BLHC sale and other investment gains and the utilization of capital loss carryforwards which had previously not been reflected for financial reporting purposes. In 1992, SLC reported an income tax credit totaling $69.2 million on a consolidated operating loss before income taxes of $18.4 million. This unusual relationship was primarily attributable to the significant tax basis gain on the sale of Bankers and a reduction in the Company's valuation allowance for its deferred tax asset as a result of utilizing available capital loss carryforwards to reduce taxes otherwise payable as a result of such gain. See Note 13 of Notes to Financial Statements for an analysis of the various components affecting SLC's income tax provisions.
At December 31, 1994 and 1993, SLC reported deferred income tax assets totaling $84.9 million and $53.0 million, respectively. The substantial increase in the deferred income tax asset between the periods is primarily as a result of the tax effect associated with realized losses incurred in 1994 on certain invested assets and the tax effect associated with net unrealized losses that arose in 1994. The tax assets were comprised of the tax benefit (cost) associated with the following types of temporary differences based on the 35% tax rate in effect at the end of 1994 and 1993:
Operating and capital loss carryforwards have significantly different characteristics as to expiration dates and their usability. For federal income tax purposes, operating losses may be carried forward for a maximum of fifteen years from the year they are incurred; capital losses may be carried forward for a maximum of five years. In addition, ordinary loss carryforwards may be utilized to offset ordinary income or capital gains, whereas capital loss carryforwards can only be utilized to offset capital gains. As a consequence, taxpayers have substantially more flexibility in being able to utilize operating loss carryforwards than capital loss carryforwards. For federal income tax purposes, at December 31, 1994, SLC and its insurance subsidiaries had $43.5 million of ordinary loss carryforwards expiring in 2009.
Alternative minimum tax ("AMT") credit carryforwards result from the acceleration of income taxes under certain circumstances and can be carried forward for an indefinite period. The $8.6 million and $13.9 million component of SLC's deferred income tax assets at December 31, 1994 and 1993, respectively, represents taxes incurred under AMT provisions which are expected to be recovered through reduced income tax payments over the next several years.
See Note 13 of Notes to Financial Statements for a summary of management's assessment regarding the recoverability of the Company's deferred income tax assets and the valuation allowances provided against such deferred income tax assets at December 31, 1994 and 1993.
Effective January 1, 1993, SLC adopted SFAS No. 106, "Employers' Accounting for Postretirement Benefits Other than Pensions," and incurred a charge for the cumulative effect of the adoption of the accounting change as of that date totaling $1.8 million, after tax effects. In addition, effective December 31, 1993, SLC adopted SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities," and incurred a charge for the cumulative effect of the adoption of the accounting change as of that date totaling $4.9 million, after tax effects.
See Note 12 of Notes to Financial Statement for a discussion of potential income tax audit issues.
We have audited the consolidated financial statements and financial statement schedules of Southwestern Life Corporation and Subsidiaries as listed in the index on page 45 of this Form 10-K. These financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits.
As discussed in Note 3 to the consolidated financial statements, the Company has significant debt requirements in 1995 and 1996. Management has stated they have several alternatives which they believe will result in full satisfaction of the 1995 requirements. However, at the present time, it appears that to satisfy the requirements for both 1995 and 1996, a significant restructuring of these debt obligations or a more comprehensive recapitalization plan will be required. Such restructuring or recapitalization would likely result in a substantial dilution of existing stockholders, especially common stockholders, and could possibly result in a change in control of the Company.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Southwestern Life Corporation and Subsidiaries as of December 31, 1994 and 1993, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles. In addition, in our opinion, the financial statement schedules referred to above, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information required to be included therein.
SOUTHWESTERN LIFE CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF EARNINGS (LOSS) For the Years Ended December 31, 1994, 1993 and 1992 (In Thousands, Except Per Share Data)
SOUTHWESTERN LIFE CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS For the Years Ended December 31, 1994, 1993 and 1992 (In Thousands)
Fixed maturity investments and related futures contracts which are denominated in or linked to foreign currencies are revalued to reflect changes in the exchange rate as of the balance sheet date. Anticipated prepayments on mortgage-backed securities are taken into consideration in determining estimated future yields on such securities.
Mortgage loans are stated at the aggregate unpaid principal balances, less unamortized discount and valuation allowances. Fees received and costs incurred with origination of mortgage loans are deferred and amortized as yield adjustments over the remaining lives of the mortgages. Real estate, substantially all of which was acquired through foreclosure, is recorded at the lower of fair value, minus estimated costs, to sell or cost. If the fair value of the foreclosed real estate minus estimated costs to sell is less than cost, a valuation allowance is provided for the deficiency. Increases or decreases in the valuation allowance are charged or credited to income.
Investments in limited partnerships and 20% to 50% interests in the common stocks of other entities, whose affairs are not controlled by the Company (equity investees), are reflected on the equity method, or at cost, adjusted for the Company's share, after allowance for possible dilution, of the undistributed earnings and losses (both realized and unrealized) since acquisition.
The Company regularly evaluates investments based on current economic conditions, past credit loss experience and other circumstances. A decline in net realizable value that is other than temporary is recognized as a realized investment loss and a reduction in the cost basis of the investment. The Company discounts expected cash flow in the computation of net realizable value of its investments, other than certain mortgage-backed securities. In those circumstances where the expected cash flows of residual interest and interest-only mortgage-backed securities, discounted at a risk-free rate of return, result in an amount less than the carrying value, a realized loss is reflected in an amount sufficient to adjust the carrying value of a given security to its fair value.
Excess cost of investments in subsidiaries over net assets acquired, or "goodwill," is amortized on the straight-line basis over a 40-year period. The Company periodically assesses the recoverability of excess cost through an actuarial projection of future earnings of the applicable insurance subsidiaries (excluding excess cost amortization) over the remaining life of such excess cost. Such projections include various interest rate scenarios, with anticipated levels of new business production for only a five-year period. Prior to 1994, projected future earnings were undiscounted. At December 31, 1994, the Company adopted a change in accounting for assessing the recoverability of excess cost by discounting projected future earnings of the Company's insurance subsidiaries, using an economic rate of return (13%). (See Note 7.)
Anticipated returns, including realized and unrealized gains and losses, from the investment of policyholder balances are considered in determining the amortization of deferred policy acquisition costs. When fixed maturities are stated at their fair value, an adjustment is made to deferred policy acquisition costs and unearned revenue reserves equal to the changes in amortization that would have been recorded if those fixed maturities had been sold at their fair value and the proceeds reinvested at current yields. Furthermore, if future yields expected to be earned on fixed maturities decline, it may be necessary to increase certain insurance liabilities. Adjustments to such liabilities are required when their balances, in addition to future net cash flows including investment income, are insufficient to cover future benefits and expenses.
Benefit reserves for universal life, interest-sensitive and investment products are determined following the retrospective deposit method and consist principally of policy account values before any surrender charges, plus certain deferred policy fees which are amortized using the same assumptions and factors used to amortize deferred policy acquisition costs.
CASH AND SHORT-TERM INVESTMENTS: The carrying amounts reported in the balance sheet for these instruments approximate their fair values.
INVESTMENTS IN LIMITED PARTNERSHIPS: Fair values for the Company's investments in limited partnerships are based on the estimated fair values of the partnership assets and liabilities, assuming a liquidation of the partnership and distribution of proceeds to the partners. (See Note 6.)
OFF-BALANCE-SHEET INSTRUMENTS: Fair values for the Company's off-balance-sheet interest rate swaps are based on formulas using current assumptions. (See Note 5.)
On November 9, 1992, the Company completed the sale of its wholly-owned subsidiary, Bankers Life and Casualty Company (Bankers), and Bankers' subsidiary, Certified Life Insurance Company (Certified), to an affiliate of Conseco, Inc. (Conseco) for $600 million cash, subject to final adjustment. Prior to the closing, Bankers transferred its ownership in all of its other subsidiaries to the Company, and the Company and its subsidiaries purchased certain other assets from Bankers, including primarily a residual interest in certain mortgage-backed securities, Bankers' home office real estate, and certain equity investments. The Company provided financing for the acquisition totaling $101.4 million and, in return, retained an approximate 29.7% interest in Bankers. The financing consisted of a $16.7 million common equity investment in Bankers Life Holding Corporation (BLHC), the Conseco entity formed for the purpose of making the acquisition, and the purchase of $34.7 million of BLHC 11% Junior Subordinated Debentures due 2003 and $50.0 million of a BLHC preferred stock yielding an 11% annual return. In addition, Conseco Capital Partners, L.P. (CCP) acquired a 52.6% interest in BLHC, and the Company, through one of its subsidiaries, made an additional $9.6 million investment to acquire a 19.3% ownership interest in CCP. As a result of the 29.7% interest in BLHC and the indirect investment through CCP the Company retained a residual interest in Bankers totaling approximately 39.9%. The results of operations of Bankers and Certified were included in the Company's consolidated results of operations through October 31, 1992, the effective date of the sale for financial reporting purposes. Subsequent to that date, the Company reflected its proportionate share of the operating results of CCP and BLHC based on the equity method. Because of the significant ownership interest in Bankers retained by the Company, the sale of Bankers was accounted for as a step transaction in accordance with GAAP. Accordingly, the Company reflected its residual interest in Bankers on its historical accounting basis and reflected a gain on the approximate 60.1% interest in Bankers deemed to have been sold totaling $110,734,000 in the Company's consolidated statement of earnings for the year ended December 31, 1992. In conjunction with the sale of Bankers, the Company indemnified the purchasers against certain contingencies relating to taxes and other matters associated with Bankers and Certified in periods prior to the closing date. The Company believes its liability, if any, will not be material.
On September 30, 1993, the Company sold its investment in BLHC to Conseco and one of Conseco's subsidiaries for $287,639,000 cash. The Company utilized $50 million of the proceeds to redeem $50 million stated value of the Series 1987-A Preferred Stock of the Company from a Conseco subsidiary. The sale of the BLHC shares resulted in a gain totaling $197,665,000. The gains resulting from BLHC's Offering and the sale of the Company's interest in BLHC totaling $297,041,000 have been reflected as a single line item in the consolidated statement of earnings for the year ended December 31, 1993. The Company continued to reflect its equity in the earnings of BLHC through the date of sale.
On January 12, 1995, the Company sold its wholly-owned subsidiary, Southeast Title and Insurance Company (Southeast) for cash in the amount of $2,071,000. The sales price approximated the GAAP book value of the Company's investment in Southeast.
On January 20, 1995, the Company entered into a letter of intent to sell to an unaffiliated party its wholly-owned subsidiary, Bankers Life Insurance Company of New York (Bankers New York) for $35,000,000 cash, subject to certain closing adjustments. At December 31, 1994, the Company reflected a loss on the anticipated sale of Bankers New York totaling $4.2 million. The transaction is subject to, among other conditions, completion of a definitive agreement and receipt of required regulatory approvals.
On March 24, 1995, the Company entered into a definitive agreement to sell to an unaffiliated party its ownership interest in its 98.8% owned subsidiary, Integrity National Life Insurance Company (Integrity National), for $9,578,000 cash, subject to closing adjustments. The transaction is subject to, among other conditions, receipt of required regulatory approvals and reinsurance of certain of Integrity National's business.
The carrying and fair values of notes payable at December 31, 1994 and 1993 are summarized as follows:
At December 31, 1994 and 1993, the Company had notes receivable totaling $27,000,000 and $26,500,000, respectively, which were collateralized by the Company's note payable in the amount of $21,000,000 and $20,340,000, respectively. The Company has the right to set off its obligation against the notes receivable. In the accompanying balance sheets, the Company's notes receivables have been reflected net of amounts due under the notes payable.
On June 15, 1993, the Company, the Company's then-controlling shareholder, CNC, and CNC's subsidiary, CFLIC, entered into an agreement (the 1993 Agreement) under which (i) the Company was authorized, and undertook the obligation, to negotiate the termination of reinsurance agreements pursuant to which CFLIC reinsured certain annuity business written by Southwestern Life Insurance Company (Southwestern Life), a subsidiary of the Company, and Bankers, and (ii) the Company transferred assets, consisting of a limited partnership interest at market value, which exceeded book value by $13,002,000 (that has since been liquidated) and 83% of the outstanding common stock of I.C.H. Funding Corporation (ICH Funding), to CFLIC to acquire preferred stock of CFLIC, with a stated value of $63,000,000. Under the terms of the 1993 Agreement, the CFLIC preferred stock was to be repurchased by CFLIC immediately following the termination of the CFLIC reinsurance agreements. Therefore, for financial reporting purposes, the recognition of the unrealized gain on the limited partnership interest transferred and subject to repurchase was deferred. The reinsurance agreements had been entered into in 1990 in conjunction with the Company's sale of Marquette to CNC and its stockholders. Under the reinsurance agreements, Employers Reassurance Corporation (ERC), an independent third party insurer, retroceded to CFLIC certain annuity business which was reinsured with ERC by each of Southwestern Life and Bankers.
Upon termination of the CFLIC reinsurance agreement relating to the business written by Southwestern Life, CFLIC transferred cash and invested assets to ERC with a fair value equal to the reserve liabilities being recaptured, net of the ceding fees payable. Due primarily to a requirement by insurance regulatory authorities to transfer such investments upon termination of the reinsurance agreements at their fair value, the Company increased its basis in the CFLIC preferred stock by investing an additional $26,212,000 (including $21,078,000 cash and a $5,134,000 receivable) immediately prior to the terminations to enable CFLIC to have sufficient assets (other than the Company's securities being transferred to the Company upon redemption of the CFLIC preferred stock) to complete the terminations. A substantial portion of such amount was attributable to a decline in the fair value of the 83% interest in ICH Funding subsequent to the Company's transfer of such investment to CFLIC in June 1993.
Pursuant to the 1993 Agreement, the Company agreed to bear the federal income tax consequences resulting from the termination of the CFLIC reinsurance agreements. Upon closing of the CFLIC termination, the Company agreed to indemnify CNC and CFLIC for tax liabilities of CFLIC and Marquette arising through June 30, 1994, and deposited into an escrow account $8,825,000 of cash which the Company was to have received upon CFLIC's repurchase of its preferred stock as a source of funds for the payment of taxes for which the Company is responsible. With the payment of such tax liabilities, the Company became entitled to all tax refunds to which CFLIC is entitled through the carryback of capital losses resulting from the termination of the CFLIC reinsurance agreements or as a result of any redetermination of CFLIC's tax liabilities through the first taxable period of CFLIC and Marquette ending after such termination. The amount deposited into escrow along with the proceeds from CFLIC's tax refunds exceeded what was required to pay CFLIC's tax liabilities and the $5,134,000 liability to ERC by $5,426,000. These excess
For financial reporting purposes, the Company recorded the redemption of its preferred stocks received from CFLIC at their stated value which, in management's opinion, approximated the fair value of such securities as of the date the 1993 Agreement was entered into. The 620,423 shares of the Company's Common Stock received from CFLIC were recorded at their market value, or $5.25 per share, as of the date of closing. The termination of the CFLIC reinsurance agreements, the receipt of a payment-in-kind dividend from CFLIC representing dividends on such preferred stock from the date of issuance through the date of redemption, and the redemption of the Company's securities resulted in a pretax gain totaling approximately $11,133,000, which included recognition of the $13,002,000 deferred unrealized gain on the limited partnership interest that had been liquidated while held by CFLIC.
Bankers was a party to a service agreement with Marquette and CFLIC whereby it provided investment management, administrative, data processing, and general supervisory and management services related to business reinsured with CFLIC, in exchange for annual fees equal to .45% of reserves on the reinsured policies. Fees earned from providing such services totaled $1,593,000 for the ten months ended October 31, 1992. Such fees were taken into consideration in the determination of profitability of the reinsured business. In addition, a subsidiary entered into a service agreement effective January 1992, whereby the subsidiary provided administrative services for Marquette. Fees earned from providing such services totaled $449,000 and $2,016,000 for the years ended December 31, 1993 and 1992, respectively.
During 1994, the Company continued to evaluate its Fund America Investment and the SIST Residual in accordance with SFAS No. 115 and Emerging Issues Task Force (EITF) Issue No. 93-18, "Impairment Recognition for a Purchased Investment in a Collateralized Mortgage Obligation Investment or in a Mortgage- Backed Interest Only Certificate." Due primarily to the rising interest rate environment experienced in 1994 and its effect on the projected future cash flows of the Fund America Investment and the SIST Residual, realized investment losses were triggered under the provisions of EITF No. 93-18 on two occasions during 1994. For the three months ended March 31, 1994, the Company reflected a charge to earnings for the writedown of these investments from their GAAP book value of $96,384,000 to their then fair value totaling $49,936,000, or a total charge of $46,448,000. For the three months ended December 31, 1994, the Company recorded an additional charge to earnings for the writedown of the Fund America Investment from its GAAP book value totaling $48,352,000 to its estimated fair value of $8,613,000, or a total charge of $39,739,000. At December 31, 1994, the combined GAAP book value and carrying value of these investments totaled $15,000,000 and $12,253,000, respectively.
Excluding scheduled maturities and sales related to reinsurance transactions, proceeds from sales of investments in debt securities during 1994, 1993 and 1992 and the related gross gains and gross losses realized on such sales were as follows:
The Company has a diversified investment portfolio that includes securities of over 750 issuers. Excluding investments in bonds or notes of the United States Government or Government agencies or authorities, the carrying value and fair values of investments by issuer which exceeded 10% of stockholders' equity at December 31, 1994 were as follows (in thousands):
At December 31, 1994 and 1993, the Company held unrated or noninvestment-grade fixed maturities with carrying values of $100,493,000 and $107,012,000, respectively, and aggregate fair values of $100,233,000 and $106,197,000, respectively. These holdings amounted to 6.1% of the Company's fixed maturity investments and 4.2% of total cash and invested assets at December 31, 1994. The holdings of noninvestment-grade securities are widely diversified and include securities of 63 issuers.
At December 31, 1994 and 1993, the Company held mortgage loans principally involving commercial real estate with carrying values of $127,047,000 and $138,504,000, respectively, and estimated fair values of $119,065,000 and $142,998,000, respectively. Approximately 62% of such mortgages involved property located in Texas, consisting of first mortgage liens on completed income-producing properties. No individual mortgage exceeds $8 million.
The Company's life insurance subsidiaries are required to maintain certain amounts of assets on deposit with state regulatory authorities. Such assets had an aggregate carrying value of $185,250,000 at December 31, 1994, including securities of the Company with an estimated fair value of $3,640,000, which have been eliminated in consolidation in the accompanying balance sheet.
Certain of the Company's subsidiaries have entered into interest rate swap arrangements to convert the interest rate characteristics of certain investments to match those of related insurance liabilities. The agreements expire from 1995 to 1997 and exchange fixed-rate payments ranging from 6.0% to 8.44% for three month LIBOR-based interest payments on notional amounts of $23.3 million. The interest rate differential to be received or paid is recognized over the lives of the agreements as an adjustment to interest expense. The subsidiaries are exposed to credit risk in the event of default by counterparties to the extent of any amounts that have been recorded in the balance sheet and market risk as a result of potential future increases in LIBOR. The fair value of interest rate swap arrangements at December 31, 1994, approximated $336,000.
Following is an analysis of the Company's investment in limited partnerships (excluding the Company's investment in CCP at December 31, 1992, which was reflected as an investment in equity investees):
The fair value of the Company's investments in limited partnerships approximated their carrying value of $42,027,000 and $43,640,000 at December 31, 1994 and 1993, respectively.
Included in limited partnerships at December 31, 1994, was a $21,100,000 investment, representing a 49% limited partnership interest, in a partnership formed to acquire through auction for resale certain mortgage loans and real estate formerly held by failed savings and loan associations. During 1994, this limited partnership distributed $7,891,000 of mortgages to the Company.
At December 31, 1992, the Company owned a 39.9% indirect equity interest in Bankers, consisting of a 29.7% equity interest in BLHC and 10.2% equity interest through its limited partnership investment in CCP. In addition, the Company owned $34.7 million principal amount of BLHC 11% Junior Subordinated Debentures due 2003 and $50.0 million of a BLHC 11% preferred stock. The 1992 sale of Bankers was accounted for as a "step transaction" in accordance with GAAP. Accordingly, gain recognition was limited to the 60.1% interest deemed to have been sold. The excess of the sales price over the Company's basis in Bankers on the 39.9% portion of the investment deemed to have been retained by the Company (excess of sales price over basis in retained interest) was reflected as a reduction in the carrying value of the Company's investments in BLHC and CCP. Effective March 31, 1993, the Company's ownership interest in BLHC was reduced to 24.4% as a result of BLHC's offering and on September 30, 1993, the Company sold its investment in BLHC (see Note 2).
At December 31, 1992, CCP had no assets or liabilities, other than its investment in BLHC. Financial information of BLHC and the Company's carrying value and equity in earnings of BLHC as of and for the two months ended December 31, 1992, and the Company's equity in the earnings of BLHC for the nine months ended September 30, 1993, is as follows (in thousands):
SLC's accounting policy is to amortize goodwill on a straight-line basis over a 40-year period. Historically, the Company periodically assessed the recoverability of its goodwill through an actuarial projection of the undiscounted future earnings of the Company's insurance subsidiaries (excluding excess cost amortization) over the remaining life of such goodwill. Such projections assumed anticipated levels of new production over a succeeding five-year period.
Under its historical accounting practices, approximately $288,333,000 of SLC's total $298,017,000 of unamortized goodwill at year-end 1994 was attributable to SLC's acquisition of Southwestern Life in 1986. The Company tested the recoverability of the Southwestern Life goodwill and, based on the historical methodology utilized, management concluded that such goodwill appeared to be fully recoverable.
an estimate, such reduction was reflected as a charge to operating earnings, as opposed to being reflected as the cumulative effect of a change in an accounting principle.
In addition to the reduction in goodwill related to Southwestern Life, SLC evaluated the recoverability of its remaining goodwill totaling approximately $9,683,000 and determined that $6,834,000 of such goodwill, substantially all of which was related to the 1986 acquisition of Philadelphia American Life Insurance Company (PALICO), was not recoverable through projected future earnings. PALICO is the Company's principal provider of group health insurance products and incurred substantial losses relative to such business over the past two years. Accordingly, an additional charge to operating earnings of $6,834,000 was reflected at year-end 1994 and included in amortization of excess cost in the consolidated statement of earnings.
The above reconciliation shows a consistent redundancy in the Company's claims reserve due to the Company's conservative reserving methodology which has been applied on a consistent basis from year to year.
At the request of the Illinois Department of Insurance, BML has informed the Illinois Department in writing that it currently has no intention to declare or pay any dividends in 1995 and that it will give the Illinois Department advance notice if there is a change in the company's intention.
The Company's insurance subsidiaries prepare their statutory financial statements in accordance with accounting practices prescribed or permitted by their respective state insurance departments. Prescribed statutory accounting practices include state laws, regulations, and general administrative rules, as well as a variety of publications of the National Association of Insurance Commissioners (NAIC). Permitted statutory accounting practices encompass all accounting practices that are not prescribed; such practices differ from state to state, and may differ from company to company within a state, and may change in the future. Furthermore, the NAIC has a project to codify statutory accounting practices, the result of which is expected to constitute the only source of "prescribed" statutory accounting practices. Accordingly, that project, which is expected to be completed in 1996, will likely change to some extent prescribed statutory accounting practices, and may result in changes to the accounting practices that insurance enterprises use to prepare their statutory financial statements.
During 1992, certain employees who had previously purchased shares of the Company's Common Stock under a Restricted Stock Purchase Agreement pledged the shares of Common Stock to collateralize notes receivable which had been issued to a former affiliate in 1982, but which were subsequently acquired by the Company in 1985. The notes and accrued interest totaling $1,537,000 and $1,471,000 at December 31, 1994 and 1993, respectively, bear interest at 9%, mature in 1996 and were collateralized by 375,564 shares of the Company's Common Stock at each of the respective dates. In addition, the Company has other notes receivable with a carrying value of $258,000 at December 31, 1994 and 1993, respectively, which are collateralized by 51,534 shares of the Company's Common Stock. In the accompanying balance sheets, such notes and accrued interest have been reflected as reductions in stockholders' equity.
At December 31, 1994, the Company had two classes of capital stock, Series Preferred Stock (no par value), and Common Stock ($1.00 par value). The only Preferred Stock outstanding at December 31, 1994 was the Series 1986-A (Series 1986-A Preferred Stock).
In connection with the sale of the Company's investment in BLHC on September 30, 1993 (see Note 2), the Company redeemed all of the outstanding shares of its Series 1987-A Preferred Stock at their $50 per share stated value. On December 2, 1993, the Company redeemed for cash all of the outstanding shares of its Series 1987-C Preferred Stock at their $50 per share stated value. Annual dividend requirements on the redeemed shares totaled $5.50 per share and $8.00 per share, respectively.
Capital stock activity for the three years ended December 31, 1994, was as follows:
accompanying financial statements except for the risk fees paid to reinsurers. Statutory surplus provided by such treaties totaled $57.8 million and $51.5 million at December 31, 1994 and 1993, respectively. Risk fees paid to reinsurers generally range from 2% to 4% of the net amount of surplus provided.
At December 31, 1994, the Company had made investments during the year of $1.8 million associated with an outstanding commitment to make limited partnership investments of up to $25 million in Conseco Capital Partners II, L.P. The partnership was formed to make corporate acquisitions of specialized annuity, life and health insurance companies and related businesses.
See Note 2 for a discussion regarding indemnifications made by the Company with respect to the sale of Bankers.
The Company, its non-life insurance subsidiaries and its life insurance subsidiaries file a single consolidated tax return. ICH Funding filed a separate income tax return subsequent to the Company's transfer of an 83% ownership interest to CFLIC in June 1993 (see Note 4) and continued to do so until the Company's reacquisition of such interest in June 1994. As an indirect wholly-owned subsidiary of the Company, ICH Funding will request permission from the IRS to rejoin the consolidated tax group for the period subsequent to June 1994. Marquette, which was also acquired in June 1994, is not eligible to join the Company's consolidated tax return for 60 months and, therefore, will file a separate income tax return until such time has passed.
The Company's deferred federal income tax asset at December 31, 1994 and 1993, is comprised of the tax benefit (cost) associated with the following items based on 35% tax rates in effect:
The components of the provision (credit) for income taxes on operating earnings (loss) are as follows:
At December 31, 1994, the Company and its subsidiaries had the following income tax carryforwards available (in thousands):
The IRS is examining federal income tax returns of the Company and certain insurance subsidiaries through 1992. See Note 12 for a discussion of certain proposed deficiencies.
The weighted-average discount rate and rate of increase in future compensation levels used in determining the actuarial present value of the projected benefit obligation were 8% and 5%, respectively.
For measurement purposes, an 8% annual rate of increase in the health care cost trend rate was assumed for 1994; the rate was assumed to decrease gradually to 4.5% by the year 2015 and remain at that level thereafter. The health care cost trend rate assumption has a significant effect on the amounts reported. To illustrate, increasing the assumed health care cost trend rates by 1 percentage point in each year would increase the accumulated postretirement health care benefit obligation as of December 31, 1994 by $2,078,000 and the aggregate of the service and interest components of net periodic postretirement health care benefit cost for 1994 by $355,000. The weighted average discount rate used in determining the accumulated postretirement benefit obligation was 8.5%.
Under provisions of the 1990 Stock Option Incentive Plan the Company is authorized to grant options to certain key employees for the purchase of up to 2.9 million shares of the Company's Common Stock at a price not less than fair market value at date of grant. The options are exercisable for up to ten years from date of grant and become exercisable at various times ranging from six months to three years. Stock options granted are summarized as follows:
For the years 1993 and 1992, the Company incurred extraordinary losses, all related to early extinguishment of debt, as follows:
Exclusive of scheduled sinking fund obligations, in 1993, the Company redeemed $83,379,000 of its 16 1/2% Debentures utilizing proceeds from the sales of Bankers and BLHC. In 1992, the Company prepaid $130 million of
its senior secured loan utilizing proceeds from the sale of Bankers totaling $85 million and internally-generated funds totaling $45 million.
Pretax charges to operations in the 1994 fourth quarter included writedowns related to certain investments totaling $58,216,000, a provision for the loss on the anticipated sale of Bankers New York totaling $4,200,000, and a provision for litigation costs and other contingencies totaling $7,830,000. The investment writedowns included an other than temporary writedown of the Company's Fund America Investment totaling $39,739,000 (see Note 5). Other investment writedowns reflected in the 1994 fourth quarter included other than temporary impairments in the values of certain other derivative CMOs, real estate and mortgage loans totaling $10,800,000, and provisions for losses on CMO investments expected to be disposed of in order to meet liquidity needs totaling $7,677,000. The Company has entered into a letter of intent with respect to the sale of Bankers New York and, accordingly, reflected a charge to operating earnings during the 1994 fourth quarter for the difference between the proceeds anticipated to be received
from such sale and the Company's carrying value of its investment in Bankers New York (see Note 2). The net after-tax effect of the investment writedowns, the estimated loss on the sale of Bankers New York and the provision for litigation costs and other contingencies totaled $45,660,000, or $0.97 per common share.
Exclusive of the above-described excess cost adjustments, other charges and income tax provisions, the Company reported a net loss for the 1994 fourth quarter totaling $9,120,000. After preferred dividend requirements, the net loss attributable to common stock totaled $11,453,000, or $0.24 per common share. Such 1994 fourth quarter operating results were effected by, among other things, pretax losses in the Company's group insurance segment totaling approximately $6,985,000, provisions for anticipated future guaranty fund assessments and other miscellaneous taxes totaling approximately $3,700,000, and provisions for the doubtful collectibility of certain receivables totaling $2,000,000.
The Company and its subsidiaries are principally engaged in the sale and underwriting of individual life and health insurance, group insurance and accumulation products. Total revenues by segment reflect sales to unaffiliated customers. Operating earnings (loss) equal total revenues less operating expenses.
Fixed maturity investments held to maturity at amortized cost decreased from $26,149,000 at December 31, 1993 to $15,915,000 at December 31, 1994. The decrease was principally due to the redemption during 1994 of one security with a book value of $10,000,000. No gain or loss was recorded on the redemption. No purchases, sales or transfers of securities occurred in this category during 1994.
For the years ended December 31, 1993, and 1992, the Company reflected consolidation and reorganization expenses totaling $23,870,000 and $10,885,000, respectively. The expenses were associated with the operational consolidation of three of the Company's Texas-based insurance subsidiaries. The 1993 expenses include a $10,757,000 writedown of certain home office real estate, a $9,760,000 writeoff of certain capitalized data processing costs and $3,353,000 in writeoffs of other property and equipment. The 1992 expense included an accrual for the expenses anticipated to be incurred relative to such consolidation and an $8,000,000 writedown of certain home office real estate. In addition, during 1994 and 1993, the Company assessed its exposure to the costs associated with pending litigation and certain other contingencies and provided reserves totaling $7,830,000 and $9,320,000, respectively, for the costs anticipated to be incurred relative to such matters. The litigation settlement expense in 1992 related to a class action suit which had been filed by certain policyholders and which was settled in that year.
Based on current conditions and assumptions as to future events on all policies in force, approximately 10% and 9% of the present value of future profits of acquired business as of December 31, 1994, are expected to be amortized in each of the next two years, respectively, and 8% in each of the succeeding three years. The interest accrual rate for the present value of future profits of acquired business ranged from 8% to 10% during each of the three years in the period ended December 31, 1994.
SOUTHWESTERN LIFE CORPORATION CONDENSED FINANCIAL INFORMATION OF REGISTRANT BALANCE SHEETS December 31, 1994 and 1993 (In Thousands)
SOUTHWESTERN LIFE CORPORATION CONDENSED FINANCIAL INFORMATION OF REGISTRANT (Continued) STATEMENTS OF EARNINGS For the Years Ended December 31, 1994, 1993 and 1992 (In Thousands)
The accompanying condensed financial statements should be read in conjunction with the consolidated financial statements and notes thereto of Southwestern Life Corporation and Subsidiaries. Notes payable at December 31, 1994 and 1993, are summarized as follows:
The parent company had a $955,000 extraordinary gain from the repurchase of Senior Subordinated Notes from a subsidiary which has been eliminated in the consolidated financial statements.