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, 1999.
Savers Marketing leases approximately 11,500 square feet in an office building located at 8064 North Point Boulevard, Winston-Salem, North Carolina, under the terms of a lease that expires on September 30, 2001.
SMC SELECTED HISTORICAL FINANCIAL DATA (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
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.
(b)Total capitalization is the sum of SMC's debt (long term debt, notes payable and capital lease obligations), redeemable preferred stock and shareholders' equity.
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 SMC's liquidity and capital resources. This discussion should be read in conjunction with the accompanying Consolidated Financial Statements, related Notes and selected historical financial data.
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, and health care regulation affecting the Company's supplemental health 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.
SMC acquired Shelby Life on November 8, 1996, Savers Life on March 12, 1998 and Midwestern Life on October 30, 1998. These acquisitions were accounted for using the purchase method of accounting. Therefore, these subsidiaries are included in the SMC Consolidated Financial Statements commencing with their respective acquisition effective dates.
When interest rates fall, SMC generally attempts to adjust the credited interest rates subject to competitive pressures. Although SMC believes that such strategies will continue to permit it to achieve a positive spread, a significant decline in the yield on SMC's investments could adversely affect the results of operations and financial condition of SMC.
The cost of the capital required to fund the acquisition or recapture.
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, 1998 and current assumptions as to future events on all policies in force, will be between 6% and 9% in each of the years 1999 through 2003.
Gross amortization $5,771 $5,450 $4,940 $4,384 $3,874 Interest accreted 1,489 1,191 932 742 601 Net amortization $4,282 $4,259 $4,008 $3,642 $3,273
The amounts included in the foregoing table do not include any amortization of DAC resulting from the sale of new products after December 31, 1998. 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.
ACCOUNTING FOR ANNUITIES AND UNIVERSAL AND INTEREST-SENSITIVE LIFE PRODUCTS. The Company primarily accounts for its annuity, universal and interest-sensitive life policy deposits in accordance with Statement of Financial Accounting Standards No. 97 ("SFAS No. 97"), "Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses on the Sale of Investments". Under SFAS No. 97, a benefit reserve is established at the time of policy issuance in an amount equal to the deposits received. Thereafter, the benefit reserve is adjusted for any additional deposits, interest credited and partial or complete withdrawals. Revenues for annuities and universal and interest-sensitive life policies, other than certain non-interest sensitive annuities, consist of policy charges for surrenders and partial withdrawals, mortality and administration, and investment income earned. Such revenues do not include the annuity, universal and interest-sensitive life policy deposits. Expenses related to these products include interest credited to policyowner account balances, operating costs for policy administration, amortization of DAC and mortality costs in excess of account balances.
The following tables and narratives summarize the results of our operations by business segment.
SMC's 1998 operating earnings were $4.4 million, or 58 cents per diluted share, up 87% and 35%, respectively over 1997. Operating earnings increased as a result of i) increased spread revenues due to an increase in weighted average insurance liabilities (primarily due to the inclusion of Savers Life and Midwestern Life operations), ii) favorable mortality experience, iii) fees from administration contracts and iv) increased fees from separate accounts. The percentage increase in operating earnings was greater than the percentage increase in operating earnings per diluted share primarily because of the 67% increase in weighted average diluted common shares or equivalents outstanding during the period. This increase in weighted average shares outstanding resulted primarily from issued shares in connection with the acquisitions of Savers Life and Midwestern Life.
SMC's 1997 operating earnings were $2.4 million, or 43 cents per diluted share, up 103% and 104%, respectively over 1996. Operating earnings increased as a result of i) increased spread revenues due to an increase in weighted average insurance liabilities (primarily due to the inclusion of Shelby Life operations), ii) a nonproportional increase in operating expenses relative to the increase in weighted average insurance liabilities, iii) fees from administration contracts, and iv) decreased premium deficiency reserves.
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. 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 operating expenses.
Life premiums were up $1.4 million or 19% 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.
Life premiums decreased $3.3 million or 32% in 1997, to $7.0 million. The decrease is attributable to the recapture of premiums ceded of $4.2 million due to the termination and recapture of a reinsurance agreement with National Mutual offset by an increase of premium income of $1.7 million earned from the inclusion of Shelby Life.
Net premium deposits for 1997 received from the sales of FPDA's, interest sensitive annuities and other financial products increased $7.0 million or 16%, to $49.4 million. The increase relates to i) an aggressive marketing campaign targeting high volume marketing companies and ii) the continued development of SMC's distribution system through the marketing support from Standard Marketing, and iii) an increase in the agency base achieved by expanding geographical concentrations in the Mid-south and California.
The net investment yield earned on average invested assets was 7.48%, 7.77% and 7.32% for 1998, 1997 and 1996, respectively. Investment yields fluctuate from period to period primarily due to changes in the general interest rate environment.
Life benefits and claims in 1997 declined $1.3 million or 13%, to $8.9 million due to i) an increase in future policy reserves of $4.2 million in 1996 related to the termination and recapture of the reinsurance agreement with National Mutual. This decrease was somewhat offset by an increase in benefits and claims from adverse mortality experience and $1.2 million of additional benefits from the inclusion of Shelby Life.
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.
During 1997, other operating expenses increased $.8 million or 8%, to $10.3 million. This increase relates to additional expenses as a result of the Shelby Life acquisition in late 1996.
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.
Fee income fluctuates in relationship to total separate account assets and the fees earned on such assets.
During 1998, fees from separate accounts increased $.6 million or 39%, to $2.1 million. This increase is due primarily to an increase in the value of assets held in separate accounts of $42.2 million or 29% , to $190.2 million. Net deposits from sales of unit-linked products by SMI increased $20.6 million or 94%, to $42.5 million. This increase is a continuation of expanded marketing efforts that were initiated in 1996 and 1997.
Net investment income was remained unchanged at $.9 million for 1998 and 1997 on average invested assets of approximately $11.0 million.
The net yield was 7.74%, 7.57% and 6.81% for 1998, 1997 and 1996, respectively.
Benefits and claims include changes to future policyholder benefits and premium deficiency reserves.
Interest payments required in 1999 based on December 31, 1998 balances will be $1.0 million
DIVIDENDS. 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 1999, Standard Life can pay dividends of approximately $4.4 million without regulatory approval.
EQUIPMENT RENTAL FEES. In 1998 and 1997, Standard Management charged subsidiaries $1.1 million per year for the use of equipment owned by Standard Management.
Management believes that the operational cash flow of Standard Life will be sufficient to meet its anticipated needs for 1999. As of December 31, 1998, Standard Life had statutory capital and surplus for regulatory purposes of $43.6 million compared to $25.9 million at December 31, 1997. The increase is primarily due to the issuance of $14.0 million of surplus debentures in connection with the merger of Midwestern Life and Savers Life into Standard Life. The remaining increase is primarily due to 1998 net gain from operations of Standard Life of $1.7 million. 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 $15.8 million and $19.6 million for 1998 and 1997, respectively. If the need arises for cash which is not readily available, additional liquidity could be obtained from the sale of invested assets.
Effective January 1, 1999 the Company decided to no longer sell new business through Dixie Life. All new business will instead be sold through Standard Life. This decision is not expected to have a material effect on operations or financial condition of the Company.
INTERNATIONAL OPERATIONS. SMI dividends are limited to its accumulated earnings without regulatory approval. SMI and Premier Life (Luxembourg) were not permitted to pay dividends in 1998 and 1997 due to accumulated losses. Premier Life (Bermuda) did not pay dividends in 1998 and 1997. SMC does not anticipate any dividends from these companies in 1999.
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:
the need to reduce costs of distribution and overhead; the need to maintain business in force; increased competition; regulatory capital requirements; and technology costs.
The Company is currently assessing the risks associated with their external business relationships, including those with agents and financial institutions. The Company has been informed by approximately 50% of their external business partners that they are or will be Year 2000 ready sometime in 1999. The Company is still accumulating data from the remaining business partners, which it hopes to have concluded by mid 1999.
The Company also assessed what contingency plans will be needed, if any, of its critical systems or those of external business relationships that are not Year 2000 ready after December 31, 1999. The Company does not currently anticipate such a situation, but the consideration of a contingency plan will continue to evolve as new information becomes available.
The failure to correct a Year 2000 problem could result in an interruption, or failure of, a number of normal business activities or operations. However, management has concluded that the Year 2000 issue will not materially affect future financial results, or cause reported financial information to be nonindicative of future operating results or financial condition.