Domestic Operations. SMC leases approximately 31,000 square feet in an office building located at 9100 Keystone Crossing, Indianapolis, Indiana, under the terms of a lease, which expires on June 1, 2001. SMC entered into a lease on March 31, 1997, for approximately 16,000 square feet in a warehouse located at 2525 North Shadeland, Indianapolis, Indiana which expires on September 30, 2001.
SMC Selected Historical Financial Data (a) (Dollars in Thousands, Except Per Share Amounts and Shares Outstanding)
PER SHARE DATA: Operating income (b) .95	 .69	 .65 .49 .24 Operating income, assuming dilution (b) .89	 .65	 .58 .43	 .21 Net income	 .68 .69 .68 .54 .98 Net income, assuming dilution			 .66 .65 .62	 .48 .91 Weighted average common shares outstanding, assuming dilution 9,183,949 9,553,731 9,363,763 5,591,217 5,549,057 Book value per common share		$ 8.34	$ 6.85 $ 8.64 $ 8.88 $ 7.95 Book value per common share excluding unrealized gain (loss) on securities available for sale	$ 9.61	$ 8.89 $ 8.43 $ 8.44 $ 8.09 Common shares outstanding	 7,545,156 7,785,156 7,641,454 4,876,490 5,024,270 COVERAGE RATIO:
Ratio of earnings to total fixed charges (c) 2.9X 3.2X 3.1X 2.4X 5.4X
(e)	Includes recapture of premiums ceded and an increase in benefits due to an increase in reserves of $4.2 million due to the termination and recapture of a reinsurance agreement with National Mutual Life Insurance Company.
The following discussion highlights the principal factors affecting the results of operations and the significant changes in balance sheet items of SMC on a consolidated basis for the periods listed, as well as liquidity and capital resources. This discussion should be read in conjunction with the accompanying Consolidated Financial Statements, related Notes and selected historical financial data.
Changes in the federal income tax laws and regulation which may affect the relative tax advantages of some of the Company's products.
Product Profitability. Margins on life insurance and annuity products are affected by interest rate fluctuations. Rising interest rates would result in a decline in the market value of assets. However, as there are positive cash flows from renewal premiums, investment income and maturities of existing assets, the need for early disposition of investment assets to meet operating cash flow requirements would be unlikely. Rising interest rates would also result in available cash flows from maturities being invested at higher interest rates, which would help support a gradual increase in new business and renewal interest rates on interest-sensitive products. A sharp, sudden rise in the interest rate environment without a concurrent increase in crediting rates could result in higher surrenders, particularly for annuities. The effect of such surrenders would be to reduce earnings over the long term. Earnings in the period of the surrender could increase or decrease depending on whether surrender charges were applicable and whether such charges differed from the write-off of related deferred acquisition costs or present value of future profits.
The long-term profitability of insurance products depends on the accuracy of the actuarial assumptions that underlie the pricing of such products. Actuarial calculations for such insurance products, and the ultimate profitability of such products, are based on four major factors: i) persistency, ii) mortality, iii) return on cash invested by the insurer during the life of the policy, and iv) expenses of acquiring and administering the policies.
The average expected remaining life of Standard Life's traditional life and annuity business in force at December 31, 2000 was 6.9 years. This calculation was determined based upon SMC's actuarial models and assumptions as to expected persistency and mortality. Persistency is the extent to which insurance policies sold are maintained by the insured. The persistency of life insurance and annuity products is a critical element of their profitability. However, a surrender charge often applies in the early contract years and declines to zero over time.
Policyholders sometimes do not pay premiums, thus causing their policies to lapse. For the years 2000, 1999 and 1998 Standard Life experienced total policy lapses of 6.4%, 6.2% and 6.1% of total policies in force at December 31 of each year, respectively. The American Council of Life Insurance 2000 Fact Book reported industry life insurance voluntary termination rates in 1999 of 14.3% for policies in force less than two years, 4.3% for policies in force for two years or more and 5.8% for all policies in force.
Present Value of Future Profits. In accordance with industry practice, when SMC purchases additional insurance business, it assigns a portion of the purchase price, called the present value of future profits, to the right to receive future cash flows arising from existing insurance policies. This asset is recorded when the business is purchased at the value of projected future cash flows on existing policies, less a discount to present value. As future cash flows emerge, they are treated as a recovery of this asset. Therefore, if cash flows emerging from the purchased or recaptured business during a period exactly equal the projections, they are offset by that period's amortization of the cost of the policies purchased. In that event, the only income statement effect from the purchased business is the realization of the discount that was initially deducted from the asset to reflect its present value. Changes in the future annual amortization of this asset are not expected to have a significant effect on the results of operations, because the amount of amortization is expected to be equal to the profits emerging from the purchased policies, net of interest on the unrecovered present value of future profits balance. This asset is amortized over the expected life of the related policies purchased. Present value of future profits is increased for the estimated effect of realizing unrealized investment losses and decreased for the estimated effect of realizing unrealized investment gains.
The likelihood of changes in projected future cash flows that might occur if there are changes in insurance regulations and tax laws.
Deferred Acquisition Costs. Insurance products generate two types of profit streams: i) from the excess of investment income earned over that credited to the policyholder and ii) from the excess of premiums received over costs incurred for policy issuance, administration and mortality. Costs incurred in issuing new policies are deferred and recorded as deferred acquisition costs ("DAC"), which are amortized using present value techniques so that profits are realized in proportion to premium revenue for certain products and estimated gross profits for certain other products. Profits from all of these elements are recognized over the lives of the policies; no profits are recorded at the time the policies are issued.
Gross amortization $13,793	$13,387	$12,123	$10,736	$9,451 Interest accumulation 5,854	 4,765	 3,870	 3,180 2,612 Net amortization $ 7,939 $ 8,622	$ 8,253	$ 7,556	$6,839
The amounts included in the foregoing table do not include any amortization of DAC resulting from the sale of new products after December 31, 2000. Any changes in future annual amortization of this asset are not expected to have a significant effect on results of operations because the amount of amortization is expected to be proportionate to the profits from the produced policies, net of interest on DAC.
Costs relating to the acquisition of new business, primarily commissions paid to agents, which vary with and are directly related to the production of new business, are deferred to the extent that such costs are recoverable from future profit margins. At the time of issuance, the acquisition expenses, approximately 13% of initial annuity premium deposits and 55% of premiums from universal and interest-sensitive life products for SMC, are capitalized as DAC. In accordance with SFAS No. 97, DAC with interest is amortized over the lives of the policies in a constant relationship to the present value of estimated future gross profits.
Domestic operations		 $ 5,440 $ 6,054 $ 3,700 International operations	 3,128 1,266 2,258
SMC's 1999 operating earnings were $5.2 million, or 65 cents per diluted share, up 17% and 12%, respectively, compared to 1998. Operating earnings increased as a result of i) increased net spread revenue due to increases in weighted average insurance liabilities caused by increased sales in recent periods and the acquisition of Savers Life and Midwestern Life, ii) economies of scale achieved through the acquisitions of Savers Life and Midwestern Life, and iii) increased fees from separate accounts due to increases in weighted average separate account liabilities for the period. These increases were somewhat offset by i) the completion of negative goodwill amortization, a nonrecurring item, which contributed $1.4 million or 15 cents per diluted share in the 1998 period, ii) unfavorable mortality, and iii) increased amortization due to profit realization.
Subtotal - interest-sensitive and other financial products 	 196,489 165,676 81,858
Number of annuity contracts in force					 24,216 24,322 20,121 Interest-sensitive annuity and other financial products reserves, net of reinsurance ceded			 $ 695,475 $ 595,388 $506,749 Number of life policies in force	 55,533 61,573 66,412 Life insurance in force, net of reinsurance ceded	 $1,042,566 $1,367,533 $1,403,164
Premium deposits for 2000, received from the sale of FPDA's, equity-indexed annuities, interest sensitive annuities and other financial products, increased $30.8 million or 19%, to $196.5 million. The increase relates to i) a continued increase in the agency base achieved through the recruitment of high volume agents and larger managing general agencies, ii) the introduction of a SPIA product that contributed $18.3 million of deposits for the period, and iii) continued momentum of our equity-indexed products which contributed an additional $13.8 million for the period.
Life premiums were up $2.4 million or 19% in 2000, to $15.4 million, which is primarily the result of $2.4 million of traditional life premiums and other deposits that incorporate mortality features.
Health premiums for 1998 include $6.0 million of Medicare supplement premiums that were earned from March 12, 1998, the acquisition date of Savers Life, through July 1, 1998, the effective sale date of the Medicare supplement block of business.
During 2000 policy income increased $1.4 million or 20%, to $8.2 million. The increase primarily relates to $1.6 million of surrender income received as a result of i) reducing crediting rates on certain FPDA products and ii) general market conditions.
During 1999, net investment income increased $10.7 million or 32%, to $44.4 million. Average invested assets, at book value, increased by $166.2 million or 27% due to the growth in insurance liabilities from premium sales of recent periods and from the acquisitions of Savers Life and Midwestern Life. Net investment income was favorably impacted by $1.2 million due to the change in the market value of call options hedging equity-indexed products.
Fee and other income consist of fee income related to servicing blocks of business for unaffiliated companies, experience refunds, and commission income.
Benefits and claims in 1999 increased $1.2 million, to $14.5 million. This is due to $6.1 million of claims and benefits resulting from an increase in the average in force life business for the periods due to the acquisitions of Savers Life and Midwestern Life. This was somewhat offset by the inclusion of $4.9 million of benefits and claims in 1998 results related to the Medicare supplement business that was sold July, 1998.
In 1999, interest credited increased $6.0 million or 30%, to $25.7 million. This increase was due to larger average interest-sensitive insurance liabilities of approximately $124.9 million or 33% for the period, which includes increases of i) $44.1 million from the acquisitions of Savers Life and Midwestern Life, and ii) $40.2 million from equity indexed products. The remaining increase primarily relates to FPDA products. These increases were somewhat offset by a decrease in the average credited rate for the period.
Amortization in 2000 increased $3.4 million or 54%, to $9.7 million. This increase relates to i) additional amortization of deferred acquisition costs, ii) increased business in force, and iii) the recognition of additional profits for the period. Additional profits were recognized from i) the realization of profits from increased sales of annuity products in recent periods and ii) the realization of profits from surrender income of deferred annuities.
Amortization in 1999 increased $1.6 million or 33%, to $6.3 million. This increase relates to additional amortization of deferred acquisition costs, due to increased business in force, and the recognition of additional profits for the period. Additional profits were recognized from i) the realization of profits from increased sales of annuity products in recent periods, and ii) the realization of profits from the purchased insurance business of Savers Life and Midwestern Life.
In 2000 other operating expenses increased $.2 million or 2%, to $12.6 million.
In 1999 interest expense and financing costs increased $.4 million or 15%, to $3.4 million primarily due to increased average borrowings for the period of approximately $5.3 million and an increase in the average interest rate for the period on the revolving line of credit.
Net realized investment gains (losses), net of related amortization fluctuate from period to period and generally arise when securities are sold in response to changes in the investment environment which provide opportunities to maximize return on the investment portfolio without adversely affecting the quality and overall yield. Realized investment gains (losses) can affect the timing of the amortization of deferred acquisition costs and the amortization of the present value of future profits.
Benefits and claims			 35 (140) (40) Amortization			 2,061 1,158 658 Other operating expenses	 3,043 2,202 2,344
Net investment income was $.5 million and $.4 million in 2000 and 1999, respectively, on average invested assets of $11.7 million and $11.0 million, respectively.
The net yield was 4.24%, 4.06% and 4.74% for 2000, 1999 and 1998, respectively.
Fees from separate accounts fluctuate in relationship to total separate account assets and the fees earned on such assets.
During 2000, fees from separate accounts increased $3.8 million or 96%, to $7.7 million. This increase is primarily due to an increase in the average value of assets held in separate accounts of 82% for the period. Actual separate account assets increased $200.5 million or 63%, to $520.4 million. Net deposits from SMI's sales of unit-linked products increased $115.3 million or 209%, to $170.5 million for the period. The increase in deposits is primarily due to i) strengthening of SMI's distribution system by engaging more, highly productive agents, ii) concentrated marketing efforts in certain European countries, primarily Sweden, Belgium and Italy, and iii) favorable demand, in general, for investment based products.
During 1999, fees from separate accounts increased $1.1 million or 37%, to $3.9 million. This increase is primarily due to an increase in the average value of assets held in separate accounts of 36% for the period. Actual separate account assets increased $129.7 million or 68%, to $320.0 million. Net deposits from SMI's sales of unit-linked products increased $12.6 million or 30%, to $55.2 million for the period. This increase is due to expanded marketing efforts, which have generated additional sales in Sweden and Belgium for the period.
Amortization of negative goodwill, which is the amortization of the excess cost of assets acquired over the purchase price paid for SMI in December 1993 of $6.9 million, has been amortized over 5 years at $1.4 million per year and was fully amortized at December 31, 1998.
Amortization includes the amortization of deferred acquisition costs, such as sales commissions and other costs, directly related to selling new business.
Other operating expenses consist of recurring general operating expenses and commission expenses, net of deferred amounts.
Other operating expenses declined $.1 million or 6% in 1999 to $2.2 million.
Foreign currency translation comparisons between 2000, 1999 and 1998 are impacted by the strengthening and weakening of the U.S. dollar relative to foreign currencies, primarily the Luxembourg franc. The impact of these translations has not been quantified on individual income statement components.
Standard Management is a financial services holding company whose liquidity requirements are met through payments received from its subsidiaries. These payments include i) surplus debenture interest, ii) dividends, iii) management fees and iv) rental income, which are subject to restrictions under applicable insurance laws and are used to pay operating expenses and meet debt service obligations. These internal sources of liquidity have been supplemented in the past by external sources such as revolving credit agreements and long-term debt and equity financing in the capital markets.
General: On a consolidated GAAP basis SMC reported net cash provided by operations of $.9 million and $2.9 million for 2000 and 1999, respectively. Although deposits received on SMC's interest-sensitive annuities and other financial products are not included in cash flow from operations under GAAP, these funds are available for use by SMC. Cash provided by operations plus net deposits received, less net account balances returned to policyholders on interest sensitive annuities and other financial products, resulted in positive cash flow of $108.2 million and $92.6 million for 2000 and 1999, respectively. Cash generated on a consolidated basis is available to Standard Management only to the extent that it is generated at the Standard Management level or is available through dividends, interest, management fees or other payments from subsidiaries.
In 1998, the Company issued convertible redeemable preferred stock with a stated value of $6.5 million. Proceeds were used to reduce the borrowings from the Amended Credit Agreement. Holders are entitled to receive annual dividends of $7.75 per share. Refer to Notes 7 and 10, respectively, to the consolidated financial statements for additional information.
Standard Management is in the process of constructing a new domestic home office which is projected to be completed in May 2001. The transition to this new facility is not expected to be material to the liquidity and capital resources of the Company.
Standard Management anticipates the available cash from its existing working capital, plus anticipated 2001 dividends, management fees, rental income and interest payments on its surplus debentures receivable will be more than adequate to meet its anticipated "parent company only" cash requirements for 2001.
Principal payments: $3.2 million due March 2001, $4.3 million due annually thereafter through March 2005
Interest payments required in 2001 based on December 31, 2000 balances will be $1.8 million
Statutory surplus is computed according to rules prescribed by the NAIC, as modified by the IDOI, or the state in which the insurance subsidiaries do business. Statutory accounting rules are different from GAAP and are intended to reflect a more conservative perspective. With respect to new business, statutory accounting practices require that: i) acquisition costs (primarily commissions and policy issue costs) and ii) reserves for future guaranteed principal payments and interest in excess of statutory rates, be expensed in the year the new business is written. These items cause a reduction in statutory surplus ("surplus strain") in the year written for many insurance products. SMC designs its products to minimize such first-year losses, but certain products continue to cause a statutory loss in the year written. For each product, SMC controls the amount of net new premiums written to manage the effect of such surplus strain. SMC's long-term growth goals contemplate continued growth in its insurance businesses. To achieve these growth goals, SMC's U.S. insurance subsidiaries will need to increase statutory surplus. Additional statutory surplus may be secured through various sources such as internally generated statutory earnings, infusions by Standard Management with funds generated through debt or equity offerings or mergers with other life insurance companies. If additional capital is not available from one or more of these sources, SMC believes that it could reduce surplus strain through the use of reinsurance or through reduced writing of new business.
SMC's operating results are affected by many factors, including, competition, lapse rates, interest rates, maintenance of insurance ratings, governmental regulation and general business conditions, many of which are outside its control.
Financial results could suffer if our A.M. Best ratings are downgraded. Insurers compete with other insurance companies, financial intermediaries and other institutions on the basis of a number of factors, including the ratings assigned by A.M. Best. Standard Life and Dixie Life have a rating of "B+" and "B," respectively, by A.M. Best. A rating of "B+" is assigned by A.M. Best to companies that, in their opinion, have achieved very good overall performance when compared to the standards established by A.M. Best, and have a good ability to meet their obligations to policyholders over a long period of time. A rating of "B" is assigned by A.M. Best to companies that, in their opinion, have achieved good overall performance when compared to the standards established by A.M. Best. According to A.M. Best, these companies generally have an adequate ability to meet their obligations to policyholders, but their financial strength is vulnerable to unfavorable changes in underwriting or economic conditions. In evaluating a company's financial and operating performance, A.M. Best reviews the company's profitability, leverage and liquidity as well as the company's book of business, the adequacy and soundness of its reinsurance, the quality and estimated market value of its assets, the adequacy of its reserves, and the experience and competence of its management. A.M. Best reviews its ratings of insurance companies from time to time. If the A.M. Best ratings were downgraded, sales of annuity products and life insurance policies could be significantly impacted and the financial condition and results of operations could be materially adversely affected. See "Business of SMC- Competition."
A tax law change could adversely affect SMC's ability to compete with non-insurance products. Under the United States Internal Revenue Code, income tax payable by policyholders on investment earnings is deferred during the accumulation period of certain life insurance and annuity products. This favorable tax treatment may give certain products a competitive advantage over other non-insurance products. To the extent that the Internal Revenue Code is revised to reduce the tax-deferred status of life insurance and annuity products, or to increase the tax-deferred status of competing products, all life insurance companies, including SMC, would be adversely affected with respect to their ability to sell these products, and, depending on grandfathering provisions, the surrenders of existing annuity contracts and life insurance policies. In addition, life insurance products are often used to fund estate tax obligations. If the estate tax were eliminated or significantly reduced, the demand for certain life insurance products could be adversely affected. SMC cannot predict what tax initiatives may be enacted which could have an adverse affect on its business.
Interest-rate fluctuations could negatively affect spread income. Significant changes in interest rates expose insurance companies to the risk of not earning anticipated spreads between the interest rate earned on investments and the credited interest rates paid on outstanding policies. Both rising and declining interest rates can negatively affect spread income. Although SMC develops and maintains asset/liability management programs and procedures designed to preserve spread income in rising or falling interest rate environments, changes in interest rates could adversely affect these spreads.
SMC's reinsurance program is subject to the financial failure of the reinsurer and to market conditions which affect the amount and cost of reinsurance. If a large number of SMC's reinsurers fail or market conditions make it more difficult to reinsure profitably, SMC financial results could suffer. SMC is able to assume insurance risks beyond the level which capital and surplus would support by transferring substantial portions of risks to other, larger insurers through reinsurance contracts. These reinsurance arrangements, which are the usual practice in the insurance industry, leave exposure to credit risk which exists because reinsurance does not fully relieve SMC of liability to insureds for the portion of the risks ceded to reinsurers. Although SMC places reinsurance with reinsurers it believes to be financially stable, a reinsurer's subsequent insolvency or inability to make payments under the terms of a reinsurance treaty could have a materially adverse effect on SMC's financial condition.
Policy claims fluctuate from year to year, and future benefit payments may exceed reserves, which may cause financial results to suffer.	 Financial results may fluctuate from year to year due to fluctuations in policy claims received by subsidiaries. Reserves are established for claims and future policy benefits based on accepted actuarial practices. By care in underwriting new policies and sharing risk with reinsurance companies, SMC has attempted to limit the risk that actual payments for death and other benefits will exceed its reserves. The reserves are, however, only actuarial estimates and it is possible that SMC's claims experience could be worse than anticipated, so that reserves may prove to be insufficient. If this were to happen, it could result in a decline in operating earnings.
A stock price decline may limit the ability to raise capital or consummate acquisitions. During 1999 and 2000, many financial services companies, including SMC, experienced a decrease in the market price of their common stock. Although management believes that SMC has sufficient, internally generated cash flow to fund its day-to-day operations, a lower stock price may limit the ability to raise capital to fund other growth opportunities and acquisitions.
SMC's business strategy has in the past and might in the future include the acquisition of other businesses. SMC may not be able to identify appropriate acquisition candidates or properly integrate their businesses. From time to time, acquisitions of other businesses may be considered. Competition for acquisition candidates, which may limit the number of acquisition opportunities, may lead to higher acquisition prices. Also, SMC may not be able to identify, acquire or manage additional businesses profitably or to successfully integrate the acquired businesses. Businesses acquired may have liabilities that SMC underestimated or did not discover during pre-acquisition investigations. Some of the liabilities of the businesses acquired, even if not expressly assumed, may be imposed on SMC as the successor to the business. Further, each acquisition involves a number of other special risks that could cause the acquired business to fail to meet expectations. For example:
substantial, unanticipated costs, delays or other operational financial problems may be incurred when the business is integrated with SMC;
Mergers, Acquisitions and Consolidations. The U.S. insurance industry is experiencing an increasing number of mergers, acquisitions, consolidations and sales of certain business lines. These consolidations are largely the result of the following:
Euro Currency. Effective January 1, 1999, eleven participating European member union countries established fixed conversion rates between their legal currencies and the Euro. The legal currencies in those countries will continue to be used as legal tender through June 30, 2002. Subsequent to this date, the legal currencies will be canceled and Euro bills and coins will be used for cash transactions in the participating countries. During this three-year dual-currency environment, conversion rates between the legal currencies will no longer be computed directly between one another. Instead, a special "triangulation" procedure must be followed by first converting one legal currency into its euro equivalent and then converting the Euro equivalent into the other legal currency. Although the Company has not initiated an analysis plan for the Euro conversion, SMC does not expect it to have a material impact on its operations or financial condition.
Regulatory Environment. Currently, prescribed or permitted statutory accounting principles ("SAP") may vary between states and between companies. The NAIC has completed the process of codifying SAP to promote standardization of methods utilized throughout the industry. Completion of this project might result in changes in statutory accounting practices for SMC's insurance subsidiaries; however, it is not expected that such changes would materially affect SMC's insurance subsidiaries' statutory capital requirements. There can be no assurance that existing insurance- related laws and regulations will not become more restrictive in the future and, therefore, it is not possible to predict the potential effects that any proposed or future legislation may have on the financial condition or operations of the company. See "Business of SMC-Regulatory Factors."
The financial statements and supplementary data required with respect to this Item 8 are listed in Item 14(a)(1) and included in a separate section of this report.