The Company does not own any real estate. The Company's principal operations are conducted from leased office space pursuant to a leasing arrangement with ALLIED Mutual. See "Certain Transactions and Relationships" in the 1997 Proxy Statement for additional information. Management considers the leased space to be adequate for its needs.
Selected Financial Data At or for the year ended December 31,
The risks and uncertainties that may affect the operations, performance, development, and results of the Company's business include the following: (1) heightened competition, particularly intensified price competition, the entry of new competitors from the financial services sector, and the creation of new products by competitors; (2) adverse state and federal legislation and regulations, including federal tax laws affecting individuals, changes in the taxation of insurance companies, federal legislation allowing the entry of new competitors from the financial services sector, and the regulation of product design and marketing of those products; (3) changes in interest rates causing a reduction of investment income; (4) general economic and business conditions that are less favorable than expected; (5) unanticipated changes in industry trends; and (6) inaccuracies in assumptions regarding future morbidity, persistency, mortality, and interest rates.
The following analysis of the consolidated results of operations and financial condition of the Company should be read in conjunction with the Selected Financial Data and Financial Statements and related footnotes included elsewhere herein.
Annuity contracts are products which provide for fixed or variable periodic benefit payments that commence according to contract terms and permit interest income to accumulate on a tax-deferred basis. Considerations paid by policyholders are credited to their accounts and earn interest at rates determined by ALLIED Life. To encourage policy persistency, surrender charges are imposed against account balances for early termination of annuity contracts.
Annuity considerations received and surrender benefits paid are shown as increases and decreases to liabilities for policyholder account balances and are not shown as revenues or expenses. Revenues reported for annuity products consist of surrender charges deducted from policyholder accounts. Expenses consist of interest credited to account balances.
Another source of revenues for ALLIED Life is investment income earned from the funds deposited to accounts by universal life and annuity policyholders, a portion of which is passed through to these policyholders in the form of interest credited.
Profitability is primarily affected by investment spread (the excess of investment income earned over the amounts credited as interest to policyholder accounts), mortality experience (difference between actual and expected death and other policyholder benefits), and the ability to control policy acquisition costs and other operating expenses. Because of ALLIED Life's relatively small size, its operating results may be affected significantly by the level of death and other policyholder benefits incurred in any one reporting period.
The tables on pages 24 and 25 reflects ALLIED Life's production information and pretax operating results excluding realized investment gains (losses) and related amortization of deferred policy acquisition costs for the years indicated. The following analysis of life insurance operations should be read with reference to the table.
Consolidated revenues for the year ended December 31, 1996 were $80.7 million, a 7.2% increase over the $75.3 million reported for 1995. The increase was attributable to life insurance premiums and other insurance income net of reinsurance premiums ceded that rose 9.9% due to increased sales of term life insurance. In 1996 the Company had realized gains on investments of $122,000 as compared with realized losses of $722,000 in 1995. Consolidated revenues have grown at a slower rate over the last several quarters due to lower sales of universal life and annuity products. Investment income and policyholder assessments on universal life have shown decreases in growth primarily because of lower increases in invested assets and universal life account balances.
First-year annuity premiums decreased 10.4% to $68.1 million from $75.9 million for 1995. The decrease was due to lower sales in the first and second quarter. The lower sales were caused by a flat interest yield curve, which allowed banks and other financial institutions to offer short-term certificates of deposit at more competitive interest rates. Interest rates rose during the middle of the year, and sales reached expected levels in the third and fourth quarters. The total annuity account balance increased 13.4% to $467.5 million at year-end 1996 from $412.2 million at year-end 1995.
Investment spread grew to $13.6 million from $12.7 million. Annual average interest-credited rates on universal life contracts decreased to 5.4% from 5.9% and on annuities decreased to 5.6% from 5.9%. The ratio of investment spread to investment income decreased only slightly to 28% from 28.2% despite the volatile interest rate environment during 1996. This is evidence of ALLIED Life's ability to adjust interest credited to policyholder accounts to reflect trends in investment earnings.
Amortization of deferred policy acquisition costs (DPAC) was $10.7 million in 1996. Included in that amount was an additional charge taken by the Company of $2.8 million as the result of its annual DPAC study that suggested refinements in assumptions concerning future annuity policy persistency and interest rate spreads were necessary. Annuity DPAC reflects the deferred costs (primarily commissions) associated with sales. These expenses are amortized in proportion to the actual profits and estimated future profits of a given block of annuity policies. Estimated future profits and amortization of costs are reviewed annually for universal life insurance and annuity products and may be reviewed more frequently if circumstances dictate. GAAP requires that the estimated future profits and future amortization be recomputed based on actual experience and updated expectations of future experience (unlocking). This unlocking may result in both adjustments related to prior amortization as well as changes to ongoing amortization rates.
While the Company will continue to re-evaluate the DPAC assumptions, it does not anticipate making additional material adjustments to DPAC amortization schedules in the foreseeable future. Further adjustments would be necessary only if actual experience should differ significantly from the assumptions used in the DPAC study models. DPAC amortization was $6 million in 1995.
Consolidated revenues for the year ended December 31, 1995 were $75.3 million, an 18.7% increase over the $63.5 million reported for 1994. The increase was primarily attributable to higher investment income, which rose 19.1% to $45.4 million from $38.1 million, and policyholder assessments on universal life contracts, which increased 15% to $20 million from $17.4 million. These increases resulted from the growth in invested assets and policyholder account balances during the year. Policyholder account balances increased 16.4% primarily as a result of policy retention and premiums and considerations received from universal life and annuity products.
Total life insurance in force grew 12% to $8.1 billion at December 31, 1995 from $7.2 billion at December 31, 1994. The increase was due to policy retention and insurance sales.
The face amount of new life insurance sold directly by agents in 1995 decreased 8.4% to $1.8 billion from $2 billion in 1994. The primary factor was a 30.7% decrease in the face amount of new universal life insurance sold to $609.7 million from $879.3 million. This decrease was partially due to the discontinuance of the Champion product on January 1, 1995. Lower market interest rate levels also affected sales. Policyholder account balances, however, were up 8.2%, and fee income increased 16% to $22.2 million from $19.2 million.
The face amount of new term life insurance sold directly by agents increased 8.8% to $1.2 billion for 1995 from $1.1 billion for 1994. ALLIED Life introduced a 10-year term life insurance product at the beginning of 1994, and sales remained strong in 1995.
Adjusted insurance revenues increased 17.9% to $42.7 million for 1995 from $36.2 million for 1994. The increase was primarily attributable to increased investment spread, greater fee income, and other insurance income. The growth in life insurance in force and policyholder account balances permitted invested assets at cost to increase 15.4% to $636.7 million at December 31, 1995, from $551.6 million at December 31, 1994, allowing investment income to increase by 18.9%. ALLIED Life's return on invested assets in 1995 remained unchanged from 1994 at 7.8%.
Investment spread grew to $12.7 million from $10.8 million. Annual average interest-credited rates on universal life contracts decreased to 5.9% from 6.2% and on annuities increased to 5.9% from 5.8%. The ratio of investment spread to investment income decreased only slightly to 28.2% from 28.4% despite the volatile interest rate environment during 1995.
ALLIED Life's operating income before taxes was up 13.9% to $14.8 million from$13 million in 1994. The increase occurred because the improved investment spread and increased fee income more than offset the higher expenses and policyholder benefits.
(i) 10% of statutory policyholders' surplus (total capital stock and surplus) as of December 31 of the preceding year or
(ii) the net gain from operations on a statutory basis for the twelve-month period ending December 31 of the preceding year.
A source of cash flows for ALFC is dividend payments from ALLIED Life. During 1996, the Company paid cash dividends of $1.1 million to common and preferred stockholders. ALLIED Life paid to the Company dividends of $1.4 million primarily to fund the Company's dividend requirement.
Effective August 6, 1996, the Board of Directors approved a stock repurchase program to acquire shares of the Company common stock on the open market. The Company completed the program during the third quarter of 1996, repurchasing and cancelling 150,000 shares at an average cost of $16.94 per share.
The Company's cash inflows consist primarily of deposits to policyholder account balances, proceeds from sales, maturities and calls of investments, and repayments of investment principal. The Company's cash outflows primarily are related to policyholder account withdrawals, investment purchases, policy acquisition costs, policyholder benefits, and current operating expenses. These outflows are typically met from normal annual premium and net investment cash inflows.
As part of this monitoring process, the Company performs cash-flow testing of its assets and liabilities under various scenarios to evaluate the adequacy of reserves. In developing its investment strategy, the Company establishes a level of cash and securities that when combined with expected net cash inflows from operations, maturities of fixed maturity investments, principal payments on amortizing securities, and its insurance products is believed to be adequate to meet anticipated short-term and long-term benefit and expense payment obligations.
As of December 31, 1996, 96.8% of the Company's investments were in fixed maturities. The investment policy for ALLIED Life requires that the fixed maturity portfolio be invested primarily in debt obligations rated "BBB" or higher when they are acquired. Of the Company's fixed maturity investments held at year-end 1996, 89% were rated "A" or better; 1% were rated below investment grade (below "BBB").
The carrying values of all the Company's investments in fixed maturities are reviewed on an ongoing basis for credit deterioration. If review indicates a decline in fair value below cost that is other than temporary, the Company's carrying value in the investment is reduced to its estimated realizable value and a corresponding write-down is taken. Such reductions in carrying value are recognized as realized losses and charged to income. No reductions in carrying value were recognized for the year ended December 31, 1996.
As a rule, the fair value of the Company's fixed maturity portfolio increases or decreases in inverse relationship with fluctuations in interest rates while investment income moves in direct relationship with interest rate changes. For example, if interest rates decrease, the Company's fixed maturity investments generally will increase in value. Investment income, on the other hand, will decrease as fixed maturity investments mature or are sold and the proceeds are reinvested at the lower interest rates.
The costs of the interest rate hedging programs are not expected to have a material impact on the interest rate margin. For both swaptions and floors, the Company pays only the original premium and is not at risk of further payments regardless of market conditions. The Company does not anticipate making any further purchases of interest rate hedges in the near future.
Premiums paid to purchase these instruments are capitalized and included in other invested assets. Through December 31, 1996, the Company had paid approximately $4.1 million in premiums. Premiums are amortized into income over the term of the instruments on a straight-line basis. Gains and losses on these instruments and related assets are not recorded in income until realized.
The Financial Accounting Standards Board (FASB) and the Securities and Exchange Commission (SEC) are evaluating the accounting and disclosure requirements for hedging activities and derivative financial instruments. As a result of these deliberations, the Company's accounting treatment may change in the future. The Company is actively monitoring the proposals that are in various stages of discussion; the impact of the final standards cannot be clearly projected at this time.
The Company's insurance subsidiary is subject to regulation and supervision by the states in which it is admitted to transact business. State insurance laws generally establish supervisory agencies with broad administrative and supervisory powers related to granting and revoking licenses to transact business, establishing guaranty fund associations, licensing agents, approving policy forms, regulating premium rates
for some lines of business, establishing reserve requirements, prescribing the form and content of required financial statements and reports, determining the reasonableness and adequacy of statutory capital and surplus, and regulating the type and amount of investments permitted.
Recently, the insurance regulatory framework has received increased scrutiny from various states, the federal government, and the National Association of Insurance Commissioners (NAIC). The NAIC has recommended to the states for adoption and implementation several regulatory initiatives.
Iowa as well as three other states have adopted the NAIC regulation for life insurance policy sales illustrations. Additional states are expected to adopt the new regulation in 1997. The effect of any adoption by individual states is not expected to have a significant effect on the Company's insurance production.
In 1996 the Company adopted SFAS 121, "Accounting for Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." This statement requires that long-lived assets and certain identifiable intangibles be reviewed for impairment whenever events or changes in circumstances indicate the carrying amount of such assets may not be recoverable. Management determined the adoption had no impact on the Company's financial condition, results of operations, or liquidity.
In June of 1996, the FASB issued SFAS 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." This statement provides consistent standards for distinguishing transfers of financial assets that are sales from transfers that are secured borrowings. SFAS 125 is effective for fiscal years beginning after December 31, 1996. Earlier or retroactive application of this statement is not permitted. The Company will adopt SFAS 125 on January 1, 1997. Management has determined that the implementation will not have a material effect on its financial condition, results of operations, or liquidity.
The Company maintains a system of internal accounting controls designed to provide reasonable assurance that assets are safeguarded and transactions are properly authorized and recorded. Management continually monitors these internal accounting controls, modifying and improving them as business conditions and operations change. An internal audit department also evaluates the adequacy and effectiveness of internal accounting controls and measures adherence to established policies and procedures. The management of ALLIED Life Financial Corporation believes that as of December 31, 1996, the Company's system of internal accounting controls was adequate to accomplish the objectives discussed herein.
(1) Summary of Significant Accounting Policies Principles of Consolidation and Basis of Presentation
The accompanying consolidated financial statements include the accounts of ALLIED Life Financial Corporation (the Company), an insurance holding company, and its wholly owned subsidiaries, that as of December 31, 1996 consisted of ALLIED Life Insurance Company (ALLIED Life), ALLIED Life Brokerage Agency, Inc. (ALBA), and ALLIED Group Merchant Banking Corporation (AGMB). At December 31, 1996, ALLIED Mutual Insurance Company (ALLIED Mutual) owned 54% of the outstanding voting stock of the Company and the ALLIED Life Employee Stock Ownership Trust (ESOP Trust) owned 1%. The remainder was owned by public stockholders.
The Company's operations consist primarily of those of ALLIED Life. ALLIED Life underwrites, markets, and distributes a portfolio of life insurance and annuity products to individuals who live primarily in rural and suburban areas of the midwestern and western United States. ALLIED Life's products are sold through two distribution systems: the independent agencies representing affiliated property-casualty insurance companies (ALLIED Agencies) and a traditional life insurance distribution system that includes financial institutions and a number of independent life insurance marketing organizations. In 1996 the ALLIED Agencies generated 75% of life insurance face amount sold and 43% of annuity premiums collected.
Equity securities are carried at fair value with their unrealized appreciation or depreciation reported as a net amount in a separate component of stockholders' equity. Mortgage loans on real estate and policy loans are recorded at the unpaid principal balance of such loans, which approximated fair value as of December 31, 1996 and 1995. A majority of the Company's mortgage loans are on residential real estate located in Iowa. All short-term investments are recorded at cost which approximates fair value.
Cash settle put swaptions (swaptions), interest rate floors (floors), and call options the Company uses for hedging purposes are carried at cost that is amortized over the term of the instruments on a straight-line basis (see note 3 for a discussion of hedging activities). Swaptions and floors are included in other invested assets; call options are included in other assets. The amortization of the swaptions and floors is included as a reduction of investment income; the amortization of the call options is included with annuity interest credited. Gains and losses on these instruments and related assets and liabilities will not be recorded as income until realized. The FASB and the Securities and Exchange Commission are evaluating the accounting and disclosure requirements for these instruments, and, as a result, this accounting treatment may change in the future. The Company is actively monitoring the proposals that are in various stages of discussion. The impact of the final standards can not be clearly projected at this time.
Costs deferred amounted to $17,709,977, $17,239,118, and $18,704,281 for the years ended December 31, 1996, 1995, and 1994, respectively. Amortization of deferred policy acquisition costs, net of interest accretion, included in the consolidated statements of income were $10,594,828, $5,940,996, and $5,136,195 for the years ended December 31, 1996, 1995, and 1994, respectively. In 1996 the amortization included an additional charge of approximately $2,800,000 the Company took in response to its annual deferred policy acquisition costs study. The study suggested refinements in certain assumptions used to estimate future gross profits to be realized from blocks of annuity business. The Company will continue to re-evaluate all applicable assumptions but does not anticipate making any further material adjustments in the foreseeable future. At December 31, 1996 unamortized deferred policy acquisition costs were decreased by approximately $3,993,000 (decreased by $9,578,000 in 1995 and increased by $1,315,000 in 1994) to recognize the impact of unrealized appreciation or depreciation of investments on such deferred costs. The decreases and increase net of deferred income taxes were charged and credited, respectively, to stockholders' equity.
Revenues from universal life contracts include policy fees for administration expenses, mortality charges, and surrender charges assessed against policyholder account balances during the period; revenues from annuity contracts include only surrender charges. Benefits and expenses relating to these contracts include interest credited as well as benefits incurred in excess of policyholder
account balances during the period. Premiums and considerations received and surrender benefits paid on these contracts are reported as deposits to and withdrawals from policyholder account balances.
Term life insurance premium revenues are recognized over the premium-paying period. Benefits and expenses, taking into account the provisions for liabilities for future policy benefits and the amortization of deferred policy acquisition costs, are associated with earned premiums that result in the recognition of profits over the life of the policy contracts.
Prior to January 1, 1996, the Company accounted for its stock option plans in accordance with the provisions of Accounting Principles Board (APB) Opinion 25, "Accounting for Stock Issued to Employees," and related interpretations. Under these provisions, compensation expense was recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price. On January 1, 1996, the Company adopted SFAS 123, "Accounting for Stock-Based Compensation," which permits entities to recognize as expense over the vesting period the fair value of all stock-based awards on the date of grant. Alternatively, SFAS 123 allows entities to continue applying the provisions of APB Opinion 25 and to provide pro forma net income and pro forma earnings per share disclosures for employee stock option grants made in 1995 and future years as if the fair-value method defined in SFAS 123 had been applied. The Company has elected to continue applying the provisions of APB Opinion 25 and to comply with the pro forma disclosure provisions of SFAS 123.
The table below presents the amortized cost and estimated fair value of investments in fixed maturities at December 31, 1996 by contractual maturity. Expected maturities at December 31, 1996 can differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
(3) Hedging Activities In June 1996, the Company began interest rate hedging programs whereby certain derivative financial instruments including swaptions and floors were purchased. The Company also began to purchase S&P 500 call options as a result of an equity indexed annuity product it introduced at the start of the second quarter.
Swaptions are being purchased to reduce the negative effect on the Company's fixed maturity investments and annuity liabilities of increased withdrawal activity resulting from extreme rises in interest rates. As of December 31, 1996, the Company was party to 44 agreements that expire quarterly from June 1999 through March 2006. The agreements entitle the Company to receive payments from the instrument's counter parties on future reset dates if the interest rate (which is tied directly to the 5-year constant maturity swap curve) on any expiration date is above a specified fixed rate (8.8% to 10.5% for instruments entered into as of December 31, 1996). As of December 31, 1996, the notional amounts range from $3 million to $9 million (total of $244 million) and have an amortized cost of $2.6 million.
The costs of the interest rate hedging programs are not expected to have a material impact on the interest rate margin. For both swaptions and floors, the Company pays only the original premium and is not at risk of further payments regardless of market conditions.
The Company has introduced an equity-indexed annuity product that guarantees the return of principal to the customer and credits interest based on a percentage of the gain in the S&P 500 Index(R). A portion of the premium from each customer is invested in investment grade fixed income securities to cover the minimum guaranteed value due the customer at the end of the term. A portion of the premium is used to purchase S&P 500 call options (call options) to hedge the growth in interest credited to the customer as a direct result of increases in the S&P 500 Index(R).
The call options provide the Company the opportunity to participate in the increases of the S&P 500 Index(R) if the market advances. As of December 31, 1996, the Company had purchased 40 call options with notional amounts ranging from $65,000 to $900,000 (total of $11.2 million) and have an amortized cost of $2.2 million.
The Company and its subsidiaries are parties to the Intercompany Operating Agreement (the Agreement) with ALLIED Group, Inc., ALLIED Mutual, and each of their respective subsidiaries. ALLIED Mutual controls 18.3% of the voting stock of ALLIED Group, Inc. The Agreement provides for the continued availability of office space, marketing services, agency forces, and computer and other facilities generally in the manner they had been provided to affiliates in the past. The Agreement extends through December 31, 2004, after which it may be terminated on two years' notice given after December 31, 2002 by any party. Expenses are charged to the Company based on specific identification or, if undeterminable, the expenses are allocated on the basis of cost and time studies that are updated annually. Rental expense incurred for office space allocated to the Company by ALLIED Mutual amounted to approximately $253,000, $234,000, and $189,000 for the years ended December 31, 1996, 1995, and 1994, respectively. ALLIED Life receives certain services from the Human Resources Department of ALLIED Group, Inc. that include, but are not limited to, maintaining employment documents, administering payroll and employee benefits, keeping related records, placing employees, and providing termination counseling and processing. For such services, ALLIED Life pays a fee to ALLIED Group, Inc. based on a percentage of the Company's gross payroll. Also included in this fee is an amount that represents the Company's share of the current net periodic postretirement benefit cost for the ALLIED Group, Inc. medical plan. Amounts incurred were approximately $156,000, $132,000, and $130,000 for the years ended December 31, 1996, 1995, and 1994 respectively.
ALLIED Life, ALLIED Mutual, and the property-casualty subsidiaries of ALLIED Group, Inc. are parties to the ALLIED Group Joint Marketing Agreement (JMA). The JMA requires ALLIED Mutual and the property-casualty affiliates to promote to their customers and agents the sale of the products of ALLIED Life. The JMA provides for payment by ALLIED Life of an annual access fee of $100,000 plus an annual new-production incentive fee. The JMA also provides for joint systems development, including joint databases of customers and agents, multiple-account billing systems, marketing plans and promotions, and other systems to be developed. Development costs are to be allocated on a mutually agreeable basis reflecting projected and actual utilization of the systems. The JMA continues to the year 2008 and continues thereafter subject to termination on two years' notice given by any party. The JMA contains noncompete provisions applicable during its term and for a period of ten years thereafter. Fees and expenses incurred under this agreement for the years ended December 31, 1996, 1995, and 1994 were approximately $165,000, $121,000, and $222,000, respectively.
The Company invests excess cash in a short-term investment fund with other affiliated companies. AID Finance Services, Inc., a wholly owned subsidiary of ALLIED Mutual, is the administrator of the fund. The fund was established to concentrate short-term cash in a single account to maximize yield. At December 31, 1996 and 1995, the Company had $794,687 and $596,729, respectively, invested in the fund, which is carried as a short-term investment. Interest earned from the fund during 1996, 1995, and 1994 was $74,058, $77,356, and $109,991, respectively.
(5) Fair Value of Financial Instruments The following table presents the carrying value and estimated fair value of the Company's significant financial instruments at December 31, 1996, and 1995:
(6) Reinsurance In the normal course of business, the Company seeks to limit its exposure to loss on any single insured and to recover a portion of benefits paid by ceding reinsurance to other insurance enterprises or reinsurers under excess coverage and coinsurance contracts. In 1996, the Company followed the policy of reinsuring that portion of the risk in excess of $150,000 on each life ($250,000 for insureds aged 59 and under). The Company's long-term care and medicare supplement insurance coverage is 100% ceded. Reinsurance contracts do not relieve the Company of its obligations to policyholders. The Company is contingently liable for these amounts and would become actually liable in the event
The 6.75% Series Preferred Stock (6.75% Series) issued to ALLIED Mutual is perpetual, nonconvertible, voting, and cumulative with respect to dividends. The annual dividend rate is 6.75% of the liquidation preference of $10.85 ($0.7324 per share) and is payable quarterly. The Company, at its option, may pay the dividend in additional shares of 6.75% Series for any quarter ending on or prior to September 30, 1998. The 6.75% Series has no preemptive rights and is not registered or traded. Upon any transfer by ALLIED Mutual, the 6.75% Series becomes nonvoting and is callable under certain conditions.
As holder of the outstanding ESOP Series, the ESOP Trust is entitled to vote the ESOP Series on all matters submitted to a vote of the holders of the common stock of the Company, voting together with the holders of common stock and 6.75% Series as one class. The ESOP generally provides that each ESOP participant is entitled to direct the trustee how to vote (or whether to tender or exchange) the shares of the ESOP Series allocated to the participant's account. Each share of the ESOP Series is convertible into one share of common stock and has one vote, subject to antidilution adjustments. During 1996, 1995, and 1994, 2,834, 5,263, and 338 shares of the ESOP Series were converted to common stock.
The ESOP Series can be redeemed at the option of the Company, in whole or part, at any time after three years from the date the shares are issued or, under certain circumstances, in the third year or before. For redemptions in the year 2004 and beyond, the redemption price is $15 per share plus accrued and unpaid dividends, and in years prior to 2004, there is a premium above the $15 per share price as set forth in the Certificate of Designations for the ESOP Series. The Company, at its option, may make payment of the redemption price in cash, in shares of common stock, or a combination thereof. Upon receipt of a redemption notice from the Company, the trustee, acting in its fiduciary capacity, may elect to convert the ESOP Series to common stock prior to redemption. If necessary to provide for distributions to participants or for other special circumstances, the trustee may request the Company redeem shares at $15 per share. In accordance with the foregoing, the Company redeemed 438 shares of the ESOP Series at $15 per share in 1995.
The Company has reserved 350,000 shares of common stock for issuance under the ALLIED Life Financial Corporation Outside Director Stock Purchase Plan (DSPP). Under the DSPP,
The dividend per common share for 1996, 1995, and 1994 was $0.21, $0.17, and $0.13, respectively.
(9) Stock Option Plans At December 31, 1996, the Company had four stock-based compensation plans, two described in note 8 (the ESPP and DSPP) and two described below. The Company applies APB Opinion 25 and related interpretations in accounting for its plans. Accordingly, no compensation cost has been recognized for its stock option plans described below or for the ESPP. Had compensation cost for these items been determined consistent with SFAS 123, the Company's net income and earnings per share would have been reduced to the pro forma amounts indicated below:
Pro forma net income reflects only options granted in 1996 and 1995. Therefore, the full impact of calculating compen-sation cost for stock options under SFAS 123 is not reflected in the pro forma net income amounts presented above because compensation cost is reflected over the options' vesting period and compensation cost for options granted prior to January 1, 1995 is not considered.
The fair value of each stock option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions used for grants in 1996 and 1995: dividend yield of 1.25%, expected volatility of 45%, risk free interest rate of 7%, and expected life of 6 years.
During 1994, the Company reserved 186,800 shares of common stock for issuance to key employees of the Company and its affiliates under the ALLIED Life Financial Corporation Long-Term Management Incentive Plan (Incentive Plan). Under the Incentive Plan, shares of common stock are available for grant until December 31, 2003 as incentive and nonqualified stock options (collectively, Options), stock appreciation rights (SARs), and restricted stock. The Options, SARs, and restricted stock were issued to vest beginning two years after the grant date at a rate of 25% per year and expire ten years after the date of grant. Options, SARs, and restricted stock prices are based on the fair market value as of the date of grant. As of December 31, 1996, the 41,372 outstanding Options and SARs had exercise prices ranging from $12.88 to $17.63 and had a weighted-average remaining contractual life of 8.4 years. At December 31, 1996, 139,717 shares were available for award under the Incentive Plan.
The Company has reserved 213,000 shares of common stock for issuance to key employees of the Company and its affiliates under the ALLIED Life Financial Corporation Executive Stock Option Plan (Option Plan) until September 1, 2003. The Option Plan is a nonqualified stock option plan. Options are granted subject to a vesting schedule whereby 33.3% of the options vest three years from the date of grant, 66.7% of the options vest four years from the date of grant, and 100% of the options vest five years from the date of grant. The option price is equal to the fair market value of the common stock at the time the option is granted. Options granted under the Option Plan expire ten years from the date of grant. As of December 31, 1996, the 168,709 outstanding options had exercise prices ranging from $12 to $17.63 and had a weighted-average remaining contractual life of 7.1 years. At December 31, 1996, 13,400 shares were available for award under the Option Plan.
A summary of the status of the Company's stock option plans as of December 31, 1996 and 1995 and changes during the years ending on those dates is presented below:
The issuance of SARs and restricted stock under the Incentive Plan reduces the number of Options available for future issuance. During 1996 and 1995, 1,355 and 3,428 shares of restricted stock were awarded at $17.25 and $15.50 per share, respectively. At December 31, 1996, 4,157 restricted shares were outstanding. The following table shows SAR activity for the years ended December 31, 1996 and 1995:
(10) Retained Earnings Retained earnings of ALLIED Life available for distribution as dividends to ALLIED Life Financial Corporation are limited by law. Under the Iowa Insurance Code, dividends may be paid by ALLIED Life only from statutory earned surplus, which as of December 31, 1996 was $16,553,944. In addition, ALLIED Life may not pay an extraordinary dividend without prior notice to and approval of the Iowa Insurance Commissioner. An extraordinary dividend is defined as any dividend or distribution of cash or other property whose fair market value together with that of other dividends or distributions made within the preceding twelve months exceeds the greater of (i) 10% of statutory policyholders' surplus (total capital stock plus surplus) as of December 31 of the preceding year or (ii) the statutory net gain from operations of the insurer for the twelve-month period ending December 31 of the preceding year. During 1996, 1995, and 1994 the Company paid cash dividends on common stock of $957,915, $785,239, and $595,164, respectively. During 1996, 1995, and 1994 the Company paid cash dividends of $95,185, $84,833, and $13,280, respectively, on preferred stock. ALLIED Life paid to the Company dividends of $1,375,000, $800,000, and $747,500 during 1996, 1995, and 1994 primarily to fund the Company's cash dividend requirements. During 1997, the maximum amount available for distribution to ALLIED Life Financial Corporation from ALLIED Life without regulatory approval of the Iowa Insurance Commissioner is $5,217,368.
The ESOP established by the Company is a nonleveraged defined contribution plan. The ESOP covers all employees who meet eligibility requirements. Shares of the ESOP Series are allocated annually to each employee's account pursuant to a formula based on employee compensation and years of service and held in trust until the employee's termination, retirement, or death. The Company recognized compensation expense for the amount contributed to the ESOP.
The Company's ESOP expense was $238,000, $176,000, and $207,000 in 1996, 1995, and 1994, respectively. During 1996, 1995, and 1994, the ESOP Trust received $95,163, $84,826, and $13,257, respectively, from dividends on the ESOP Series, which was used to purchase stock for participants.
In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred income tax assets will not be realized. Management considers primarily the scheduled reversal of deferred income tax liabilities and tax planning strategies in making this assessment and believes it is more likely than not the Company will realize the benefits of these deductible differences at December 31, 1996.
Prior to 1984, life insurance companies were permitted to defer from taxation a portion of statutory income. At December 31, 1983, the Company had accumulated approximately $3,300,000 of this deferred income in what is referred to as its policyholders' surplus account. This amount was frozen under the Deficit Reduction Act of 1984 and could become taxable in the future only under certain conditions that management considers remote. The accumulated amount of income subject to current taxation less certain adjustments is set aside in another special memorandum tax account called a shareholders' surplus account. Dividends paid by the Company in excess of the balance in the shareholder's surplus account cannont be paid without a portion of policyholders' surplus becoming taxable. The balance of the shareholders' surplus account as approximately $49,000,000 as of December 31, 1996.
The Company is a party to lawsuits arising in the normal course of business. The Company believes the resolution of these lawsuits will not have a material adverse effect on its financial condition or results of operations.