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, under the terms of a lease which expires on September 30, 2001.
SMC SELECTED HISTORICAL FINANCIAL DATA (A) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS AND SHARES OUTSTANDING)
(a)Comparison of consolidated financial information is significantly affected by the acquisitions of Dixie Life on October 2, 1995, Shelby Life on November 8, 1996, Savers Life on March 12, 1998, Midwestern Life on October 30, 1998 and on the disposal of First International on March 18, 1996. Refer to the notes to the consolidated financial statements in this report for a description of business combinations.
(c)Total capitalization is the sum of SMC's debt (long term debt, notes payable and capital lease obligations), and redeemable preferred stock and shareholders' equity (excluding unrealized gains and losses.)
(d)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.
All statements, trend analyses, and other information contained in this Annual Report on Form 10-K or any document incorporated by reference herein relative to markets for the Company's products and trends in the Company's operations or financial results, as well as other statements including words such as "anticipate", "believe", "plan", "estimate", "expect", "intend" and other similar expressions, constitute forward-looking statements under the Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to known and unknown risks, uncertainties and other factors which may cause actual results to be materially different from those contemplated by the forward-looking statements. Such factors include, but are not limited to: (1) general economic conditions and other factors, including prevailing interest rate levels, stock market performance and health care inflation, which may affect the ability of the Company to sell its products, the market value of the Company's investments and the lapse rate and profitability of the Company's policies; (2) the Company's ability to achieve anticipated levels of operational efficiencies at recently acquired companies, as well as through other cost-saving initiatives; (3) customer response to new products, distribution channels and marketing initiatives; (4) mortality, morbidity, usage of health care services and other factors which may affect the profitability of the Company's insurance products; (5) changes in the Federal income tax laws and regulation which may affect the relative tax advantages of some of the Company's products; (6) increasing competition in the sale of the Company's products; (7) regulatory changes or actions, including those relating to regulation of financial services affecting bank sales and underwriting of insurance products, regulation of the sale, underwriting and pricing of insurance products; (8) the availability and terms of future acquisitions; and (9) the risk factors or uncertainties listed from time to time in any document incorporated by reference herein.
PRODUCT PROFITABILITY. Margins on life insurance and annuity products are affected by interest rate fluctuations. Rising interest rates would result in a decline in the market value of assets. However, as there are positive cash flows from renewal premiums, investment income and maturities of existing assets, the need for early disposition of investment assets to meet operating cash flow requirements would be unlikely. Rising interest rates would also result in available cash flows from maturities being invested at higher interest rates, which would help support a gradual increase in new business and renewal interest rates on interest-sensitive products. A sharp, sudden rise in the interest rate environment without a concurrent increase in crediting rates could result in higher surrenders, particularly for annuities. The effect of surrenders would be to reduce earnings over the long term. 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 acquired company's compatibility with other SMC activities that may favorably affect future cash flows.
The percentage of future expected net amortization of the beginning balance of the present value of future profits before the effect of net unrealized gains and losses, based on the present value of future profits at December 31, 1999 and current assumptions as to future events on all policies in force, will be between 8% and 10% in each of the years 2000 through 2004.
For more information related to Present Value of Future Profits refer to Note 4 to the Consolidated Financial Statements.
Amortization of DAC was $4.6 million, $3.3 million and $1.6 million for the years ended December 31, 1999, 1998 and 1997, respectively. The increase in current year amortization expense resulted primarily from increased amortization of DAC as gross profits from business sold in recent years began to emerge. DAC is generally amortized over the expected lives of the policies, a period of approximately 20 years, in a constant relationship to the present value of estimated future gross profits. Interest is being accreted at the projected crediting rate on the policies. DAC is increased for the estimated effect of realizing unrealized investment losses and decreased for the estimated effect of realizing unrealized investment gains. The offset to these amounts is recorded directly to shareholders' equity, net of taxes. Future expected amortization of DAC for the next five years before the effect of net realized and unrealized gains and losses, based on DAC at December 31, 1999 and current assumptions, is as follows (in thousands):
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 elimination 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.
GENERAL: This segment consists of revenues earned and expenses incurred from United States operations which includes deposits and/or income from annuity products (primarily FPDA's), equity indexed products, universal life products and traditional life products. This segment has been significantly impacted by the acquisitions of Savers Life, effective March 12, 1998, and Midwestern Life, effective October 30, 1998. The profitability for this segment is primarily a function of its investment spread earned (i.e. the excess of investment earnings over interest credited on annuity and universal life deposits), persistency of the in force business, mortality experience and management of operating expenses.
Premium deposits for 1999, received from the sales of FPDA's, equity indexed annuities, interest sensitive annuities and other financial products, increased $83.8 million or 102%, to $165.7 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) continued expansion of geographical concentration, iii) the full year impact of an equity-indexed product introduced in 1998, which contributed $46.6 million of deposits for the period and iv) the introduction of three equity-indexed annuity products in 1999, which contributed $12.7 million of deposits for the period.
PREMIUM INCOME consists of premiums earned from i) traditional life products, ii) annuity business that incorporates significant mortality features and iii) Medicare supplement premiums for the 1998 period.
Life premiums were up $1.4 million or 40% in 1998, to $8.4 million. Traditional life premiums of $1.1 million were earned from Savers Life and Midwestern Life in 1998. The remaining increase of $.3 million is due to premiums from existing blocks of traditional life business from Standard Life and Dixie Life.
NET INVESTMENT INCOME includes interest earned on invested assets and fluctuates with changes in i) the amount of average invested assets supporting insurance liabilities and ii) and the average yield earned on those invested assets.
The net investment yield earned on average invested assets was 7.15%, 7.48% and 7.77% for 1999, 1998 and 1997, respectively. Investment yields fluctuate from period to period primarily due to changes in the general interest rate environment.
INTEREST CREDITED TO INTEREST-SENSITIVE ANNUITIES AND OTHER FINANCIAL PRODUCTS represents interest credited to insurance liabilities of the FPDA's, equity- indexed annuities, interest sensitive and other financial products. This expense fluctuates with changes in i) average interest-sensitive insurance liabilities and ii) the average credited rate on those liabilities.
The weighted average credited rate was 4.89%, 5.25% and 5.71 % in 1999, 1998 and 1997, respectively.
AMORTIZATION includes i) amortization related to the present value of polices purchased from acquired insurance business, ii) amortization of deferred acquisitions costs related to capitalized costs of insurance business sold and iii) amortization of goodwill and organizational costs.
In 1999 other operating expenses declined $.8 million or 6%, to $12.4 million. The majority of this decrease relates to efficiencies achieved through the assimilation of the former insurance operations of Savers Life, Savers Marketing and Midwestern Life including the elimination of certain Medicare supplement expenses in connection with the sale of that business.
INTEREST EXPENSE AND FINANCING COSTS represent interest expense incurred and the amortization of related debt issuance costs.
NET REALIZED INVESTMENT GAINS fluctuate from period to period and arise when securities are sold in response to changes in the investment environment which provide opportunities to maximize return on the investment portfolio without adversely affecting the quality and overall yield.
GENERAL: International operations includes revenues earned and expenses incurred from abroad, primarily Europe, and includes fees collected on deposits from unit-linked products. The profitability for this segment primarily depends on the amount of separate account assets under management, the management fee charged on those assets and management of operating expenses.
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 a continuation of expanded marketing efforts, which have generated additional sales in Sweden and Belgium for the period.
NET INVESTMENT INCOME represents income earned on corporate assets such as cash, short-term investments and fixed securities.
Net investment income was $.4 million and $.5 million in 1999 and 1998 respectively, on average invested assets of approximately $11.0 million.
OTHER OPERATING EXPENSES consist of recurring general operating expenses and commission expenses, net of deferred amounts.
Standard Management is a financial services holding company whose liquidity requirements are met through payments received from its subsidiaries. These payments include i) interest on surplus debenture, 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.
Interest payments required in 2000 based on December 31, 1999 balances will be $2.1 million
$4.4 million due December 2003 and $5.6 million due July 2004.
Interest payments required in 2000 based on December 31, 1999 balances will be $1.0 million
DIVIDENDS from Standard Life to Standard Management are limited by laws applicable to insurance companies. As an Indiana domiciled insurance company, Standard Life may pay a dividend or distribution from its surplus profits, without the prior approval of the Commissioner of the Indiana Department of Insurance, if the dividend or distribution, together with all other dividends and distributions paid within the preceding twelve months, does not exceed the greater of (i) net gain from operations or (ii) 10% of surplus, in each case as shown in its preceding annual statutory financial statements. In 2000, Standard Life can pay dividends of approximately $4.4 million without regulatory approval.
Pursuant to the management services agreement, Premier Life (Luxembourg) paid Standard Management $.2 million during 1999 and $.1 million during 1998 for certain management, technical support and administrative services. The agreement provides that it may be modified or terminated by either Standard Management or Premier Life (Luxembourg).
U.S. INSURANCE OPERATIONS. The principal liquidity requirements of Standard Life are its contractual obligations to policyholders, dividend, rent, management fee and Surplus Debenture payments to Standard Management and other operating expenses. The primary source of funding for these obligations has been cash flow from premium income, net investment income, investment sales and maturities and sales of FPDA's and equity indexed products. These sources of liquidity for Standard Life significantly exceed scheduled uses. Liquidity is also affected by unscheduled benefit payments including death benefits and policy withdrawals and surrenders. The amount of withdrawals and surrenders is affected by a variety of factors such as renewal interest crediting rates, interest rates for competing products, general economic conditions, Standard Life's A.M. Best ratings (currently rated "B+") and events in the industry that affect policyholders' confidence.
The policies and annuities issued by Standard Life contain provisions that allow policyholders to withdraw or surrender their policies under defined circumstances. These policies and annuities generally contain provisions which apply penalties or otherwise restrict the ability of policyholders to make such withdrawals or surrenders. Standard Life closely monitors the surrender and policy loan activity of its insurance products and manages the composition of its investment portfolios, including liquidity, in light of such activity.
Management believes that the operational cash flow of Standard Life will be sufficient to meet its anticipated needs for 2000. As of December 31, 1999, Standard Life had statutory capital and surplus for regulatory purposes of $43.7 million compared to $43.6 million at December 31, 1998. As the life insurance and annuity business produced by Standard Life increases, Standard Life expects to continue to satisfy statutory capital and surplus requirements through statutory profits, through the continued reinsurance of a portion of its new business, and through additional capital contributions by Standard Management. Net cash flow from operations on a statutory basis of Standard Life, after payment of benefits and operating expenses, was $91.4 million and $15.8 million for 1999 and 1998, respectively. If the need arises for cash which is not readily available, additional liquidity could be obtained from the sale of invested assets.
FOREIGN CURRENCY RISK. SMI policyholders invest in assets denominated in a wide range of currencies. As policyholders are not permitted to invest directly in options, futures and derivatives, their investment and currency risk is limited to premiums they have paid. Although policyholders effectively bear the currency risk, SMI could be exposed to currency fluctuations if currencies within the conventional investment portfolio or certain actuarial reserves are mismatched. In order to minimize this risk, SMI continually matches the assets and liabilities of the portfolio and the reserves. In addition, Premier Life's (Luxembourg) shareholder's equity is denominated in Luxembourg francs. Premier Life (Luxembourg) does not hedge currency risk because its shareholder's equity will remain in Luxembourg francs for the foreseeable future, thus, no significant realized foreign exchange gains or losses are anticipated. At December 31, 1999, there was a $.9 million unrealized loss from foreign currency translation.
UNCERTAINTIES REGARDING INTANGIBLE ASSETS. Included in SMC's December 31, 1999 financial statements are certain assets that are primarily valued , for financial statement purposes, on the basis of management assumptions. These assets include items such as:
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.
FINANCIAL SERVICES DEREGULATION. The United States Congress is currently considering a number of legislative proposals intended to reduce or eliminate restrictions on affiliations among financial services organizations. The recently passed GLB Act would allow banks to own or affiliate with insurers and securities firms. An increased presence of banks in the life insurance and annuity businesses may increase competition in these markets. The Company cannot predict the impact of these proposals on the earnings of the Company.