Net income per diluted share was $4.35, $3.73 and $3.76 for the years 2007, 2006 and 2005, respectively. Net income for these same periods was $227.5 million, $203.8 million and $211.1 million, respectively. The increase in net income for 2007 compared to 2006 reflected premium growth and comparatively favorable claims experience in our group insurance and individual disability businesses. Net income for 2006 was affected by premium growth, offset by comparatively higher claims expense. Premium growth in the Insurance Services segment was 7.1%, 6.1% and 10.1% for 2007, 2006 and 2005, respectively. For the Insurance Services segment, claims experience for the group insurance products, as indicated by the benefit ratio (benefits to policyholders and interest credited measured as a percentage of premiums), was 77.4%, 78.3% and 75.8% for 2007, 2006 and 2005,
For 2008, the Company has established the following expectations, which will affect our annual financial results:
Premium growth in the range of 6% to 8%, a rate we expect will maintain our historical pattern of growing at least 1% to 2% more than the industry growth rate.
An annual benefit ratio in the range of 77.5% to 79.5% for the group insurance business, noting that our actual experience over the last four years has been toward the lower end of this range. Claims experience can fluctuate widely from quarter to quarter.
Revenues primarily consist of premiums, administrative fees and net investment income. Total revenues increased 8.7% to $2.71 billion for 2007 compared to 2006 and 6.7% to $2.49 billion for 2006 compared to 2005.
The following table sets forth percentages of premium and administrative fee growth, and net investment income growth by segment for the years December 31:
Net investment income increased 7.8% to $516.3 million for 2007 compared to 2006 and 2.9% to $478.9 million for 2006 compared to 2005. Net investment income primarily is affected by changes in levels of invested assets, interest rates, the change in fair value of derivative assets and commercial mortgage loan prepayment fees.
The increase in net investment income for 2007 compared to 2006 was primarily due to an increase of 4.9% to $8.47 billion in average invested assets resulting from operations, and an increase in assets related to proceeds of $300 million from junior subordinated debentures (“Subordinated Debt’) issued in May 2007. Average invested assets do not include cash and cash equivalents. Also contributing to the increase was an increase in premiums on called bonds, primarily in the first six months of 2007. Premiums on called bonds were $2.0 million for 2007, compared to $0.5 million for 2006. The increase in net investment income was partially offset by decreases in the fair value of derivative assets and lower portfolio yield of commercial mortgage loans. The fair value adjustment to derivative assets was a decrease of $1.0 million for 2007, compared to an increase of $0.9 million for 2006. The portfolio yield for commercial mortgage loans decreased to 6.36% at the end of 2007 from 6.40% at the end of 2006. The portfolio yield for fixed maturity securities remained stable at 5.57% at the end of 2007 and 2006.
Commercial mortgage loan prepayment fees were $9.7 million, $9.8 million and $13.4 million for 2007, 2006 and 2005, respectively. Approximately 85% of our commercial mortgage loans have a provision that requires the borrower to pay a prepayment fee that assures that the Company’s expected cash flow from commercial mortgage loan investments will be protected in the event of prepayment. Since 2001, all new commercial mortgage loans originated by the Company contain this prepayment provision. The remainder of our commercial mortgage loans contains fixed prepayment fees that mitigate prepayments, but may not fully protect the Company’s expected cash flow in the event of prepayment.
The growth in benefits to policyholders, including interest credited, is driven by different factors for each of our product segments. For the Insurance Services segment, three primary factors drive benefits to policyholders: premium growth (reserves are established in part based on premium levels), claims experience, and the assumptions used to establish related reserves. The predominant factors affecting claims experience are incidence measured by the number of claims and severity measured as the length of time a disability claim is paid and the size of the claim. The assumptions used to establish the related reserves reflect expected incidence and
severity, as well as new investment interest rates and overall portfolio yield, both of which affect the discount rate used to establish reserves. See “Critical Accounting Policies and Estimates-Reserves.”
The increase in benefits to policyholders, including interest credited, for the Insurance Services segment for 2007 compared to 2006 resulted from business growth as evidenced by premium growth, partially offset by comparatively favorable claims experience in our group insurance and individual disability insurance businesses. See “Business Segments-Insurance Services Segment-Benefits and Expenses-Benefits to Policyholders (including interest credited).”
The increase in benefits to policyholders, including interest credited, for the Asset Management segment for 2007 compared to 2006 resulted primarily from increased interest credited related to growth in general account assets in our retirement plans and individual fixed annuities businesses. Growth in interest credited for this segment was affected by higher SFAS No. 133 liability accruals for our small block of indexed annuities. In 2007, interest credited was increased by $1.6 million due to the effects of this valuation. In addition, benefits to policyholders for the Asset Management segment increased in 2007 compared to 2006 due to an increase in life-contingent annuity sales for our individual fixed annuities business.
The increase in benefits to policyholders, including interest credited, for the Asset Management segment for 2006 compared to 2005 resulted from an increase in assets under administration due to favorable customer retention,
growth in general account assets in our retirement plans and individual fixed annuities businesses, offset by reduced interest crediting rates due to lower new investment interest rates and overall portfolio yield. Growth in general account assets for our retirement plans and individual fixed annuities businesses was 6.4% for 2007 compared to 2006, and 10.2% for 2006 compared to 2005. In addition, a significant increase in the sales of life-contingent annuities for our individual fixed annuities business in 2005 increased benefits to policyholders for that period. See “Business Segments-Asset Management Segment-Benefits and Expenses-Benefits to Policyholders.”
Operating expenses increased 17.4% to $434.8 million for 2007 compared to 2006, and 8.7% to $370.3 million for 2006 compared to 2005. The increase in operating expenses was primarily due to the integration of Invesmart since 2007 included a full year of Invesmart expenses compared to a half year of expenses in 2006. The additional increase in operating expenses was due to business growth as evidenced by growth in assets under administration and up-front costs related to the consolidation of some of our trust and insurance platforms. In addition, we acquired DPA, Inc. during the third quarter of 2007. DPA, Inc. is a retirement plan business based in Portland, Oregon. Operating expenses for DPA, Inc. during 2007 were approximately $1.9 million. There were also additional costs related to the installation of a large national account group policy sold in our group insurance business that contributed approximately $8.5 million to the overall increase in operating expenses for 2007. The installation of the large national account included capitalized software and system costs that will be depreciated
and amortized through 2012. The depreciation and amortization costs will add an average of $3.0 million to operating expenses for the next five years.
The increase in operating expenses for 2006 was primarily due to expenses related to the operations of Invesmart. Excluding expenses from the Invesmart operations, operating expense growth for 2006 was 2.7%. Operating expense growth is typically influenced by business growth as evidenced by premium and administrative fee growth. Premium and administrative fee growth for 2007 was 9.0% compared to 2006, and for 2006 was 7.6% compared to 2005. See “Business Segments.”
Net Decrease in Deferred Acquisition Costs (“DAC”), Value of Business Acquired (“VOBA”) and Intangibles
and Goodwill.” The net deferral for DAC, VOBA and intangibles for 2007 decreased $1.0 million compared to 2006 and increased $10.2 million for 2006 compared to 2005. In addition, a cumulative effect adjustment of $39.4 million after-tax was recorded as a reduction to retained earnings as of January 1, 2007, as a result of the adoption of Statement of Position (“SOP”) 05-1, Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection With Modifications or Exchanges of Insurance Contracts.
Total income taxes may differ from the amount computed by applying the federal corporate tax rate of 35% because of the net result of permanent differences and the inclusion of state and local income taxes, net of the federal tax benefit. The combined federal and state effective tax rates were 33.4%, 34.2% and 35.2% for 2007, 2006 and 2005, respectively. See Item 8, “Note 10-Income Taxes” for more information on the change in the effective tax rate.
Net capital gains and losses on investments, return on capital not allocated to the product segments, holding company expenses, interest on debt and adjustments made in consolidation are reflected in “Other.”
As the Insurance Services segment is our largest segment, it substantially influences our consolidated financial results. Income before income taxes for the Insurance Services segment was $322.6 million, $282.4 million and $300.1 million for 2007, 2006 and 2005, respectively. Income before income taxes for this segment for 2007 was affected by premium growth and comparatively favorable claims experience in our group insurance and individual disability businesses. Income before income taxes for 2006 for this segment was affected by premium growth, comparatively less favorable claims experience in our group insurance products and operating expense growth less than premium growth.
Following are key indicators that management uses to manage and assess the performance of the Insurance Services segment:
Premiums for the Insurance Services segment increased 7.1% for 2007 compared to 2006, and 6.1% for 2006 compared to 2005. The primary factors that contribute to premium growth for the Insurance Services segment are sales and persistency for all of our insurance products and organic growth in our group insurance product lines due to
Net investment income for the Insurance Services segment increased 4.0% to $325.8 million for 2007 compared to 2006 and 3.3% to $313.4 million for 2006 compared to 2005. The increase in net investment income for 2007 compared to 2006 was primarily affected by growth in average invested assets due to premium growth and by additional income related to premiums on called bonds for this segment of $1.2 million for 2007 compared to $0.3 million for 2006. The increase in net investment income for 2006 compared to 2005 was primarily affected by growth in average invested
Three primary factors drive benefits to policyholders: premium growth (reserves are established in part based on premium levels), claims experience and the assumptions used to establish related reserves. The predominant factors affecting claims experience are claims incidence measured by the number of claims and claims severity measured as the length of time a disability claim is paid and the size of the claim. The assumptions used to establish the related reserves reflect claims incidence and claims severity, in addition to new-money investment interest rates and overall portfolio yield, as both affect the discount rate used to establish reserves.
Because premium growth is one of the primary factors that drive benefits to policyholders, the benefit ratio, calculated as benefits to policyholders and interest credited as a percentage of premiums, is utilized to provide a measurement of claims normalized for premium growth. The benefit ratio for our group insurance product lines for 2007 was 77.4%, compared to 78.3 % for 2006 and 75.8% for 2005. The group benefit ratio for 2007 was just below the Company’s estimated annual range of 77.5% to 79.5% for 2007.
The benefit ratio for our individual disability business was 69.3% for 2007 compared to 79.4% for 2006, primarily reflecting favorable claims experience in 2007. The benefit ratio for our individual disability business was 79.2% for 2005.
Due to the small size of our individual disability business, claims experience and, therefore, the benefit ratio can fluctuate more widely from quarter to quarter than that of our group insurance business.
Generally, we expect the individual disability benefit ratio to trend down over time to reflect the growth in the business outside of the large block of disability business assumed in 2000 from Minnesota Life, and the corresponding shift in revenues from net investment income to premiums. The decrease year to year in the expected benefit ratio does not necessarily indicate an increase in profitability; rather it reflects a change in the mix of revenues from the business.
The discount rate used in the fourth quarter of 2007 for newly established long term disability claim reserves was 5.35%, which decreased from 5.50% used during the first three quarters of 2007.
If investment rates prove to be lower than provided for in the margin between the new money investment rate and the reserve discount rate, we could be required to increase reserves, which could cause expense for benefits to policyholders to increase. The margin at December 31, 2007, in our overall block of business for group insurance between invested asset yield and weighted-average reserve discount rate was 40 basis points. See “Liquidity and Capital Resources.”
Assets under administration for this segment, including retirement plans, individual fixed annuities and outside managed commercial mortgage loans, were $22.37 billion at December 31, 2007, which was a $3.35 billion increase compared to December 31, 2006. The increase was due to continued deposit growth, good customer retention, strong mortgage originations for other investors and equity market
Benefits to policyholders for the Asset Management segment represents current and future benefits on life-
contingent annuities, which vary with life-contingent annuity sales. Benefits to policyholders for the Asset Management segment increased $6.4 million to $22.4 million for 2007 compared to 2006 and decreased $3.4 million to $16.0 million for 2006 compared to 2005. Changes in the level of benefits to policyholders will approximate changes in premium levels because these annuities primarily are single-premium life-contingent annuity products with a significant portion of all premium payments established as reserves.
Interest credited represents interest paid to policyholders on retirement plan general account assets and individual fixed annuity deposits. Interest credited for the Asset Management segment increased 9.8% to $92.7 million for 2007 compared to 2006, and 11.2% to $84.4 million for 2006 compared to 2005. Interest credited to retirement plan customers increased primarily due to an increase in the interest-crediting rate to retirement plan customers and increases in average balances. Interest credited to individual fixed annuity deposits included the indexed annuity products first offered in 2006. The interest credited to the indexed annuities increased $4.3 million for 2007 compared to 2006 primarily due to increases in the S&P 500 Index and average balances. Average assets under administration for individual fixed annuities increased 6.4% for 2007 compared to 2006, and 6.7% for 2006 compared to 2005. Interest credited also includes changes in fair value of index-based interest guarantees. See Item 8 “Financial Statements and Supplementary Data-Notes to Consolidated Financial Statements-Note 7, Derivative Financial Instruments.”
related to operating the Invesmart business, operating expenses for 2006 increased 14.1% to $58.1 million compared to 2005.
In addition to our two segments, we report our holding company and corporate activity in “Other.” This category includes net capital gains and losses, return on capital not allocated to the product segments, holding company expenses, interest on debt and adjustments made in consolidation.
We manage interest rate risk, in part, through asset/liability analyses. In keeping with presently accepted actuarial standards, the Company has made adequate provisions for the anticipated cash flows required to meet contractual obligations and related expenses, through the use of statutory reserves and related items at December 31, 2007.
As a percentage of our fixed maturity investments, callable bonds were 2.4% at December 31, 2007. Since 2001, all commercial mortgage loans originated by us contain a provision requiring the borrower to pay a prepayment fee to assure that our expected cash flow from commercial mortgage loan investments would be protected in the event of prepayment. Approximately 85% of our commercial mortgage loan portfolio contains this prepayment provision. The remainder of our commercial mortgage loans contains fixed prepayment fees that mitigate prepayments, but may not fully protect our expected cash flow in the event of prepayment.
The insurance laws of the states of domicile and other states in which the insurance subsidiaries conduct business regulate the investment portfolios of the insurance subsidiaries. Relevant laws and regulations generally limit investments to bonds and other fixed maturity securities, mortgage loans, common and preferred stock and real estate. Decisions to acquire and dispose of investments are made in accordance with guidelines adopted and modified from time to time by the insurance subsidiaries’ boards of directors. Each investment transaction requires the approval of one or more members of senior investment staff, with increasingly higher approval authorities required for transactions that are more significant. Transactions are reported quarterly to the finance and operations committee of the board of directors for Standard and to the board of directors for The Standard Life Insurance Company of New York.
Net cash used in investing activities was $597.0 million, $749.3 million and $664.9 million for 2007, 2006 and 2005, respectively. The decrease in the net use of cash in investing activities from 2007 compared to 2006 was primarily due to the July 2006 purchase of Invesmart. Invesmart was a national retirement financial services company and is now part of our Asset Management segment. There were no similar sized acquisitions during 2007. In addition, contributing to the decrease in cash used was a $606.9 million increase in proceeds from investments sold, matured or repaid. This increase was partially offset by a $495.5 million increase in cash used by the combination of new mortgage originations, purchases of fixed maturity securities, and purchases of real estate investments. Partially offsetting the overall decrease in investing cash used for acquisitions was the Company’s increased use of cash for short-term investments. The increased use of cash for short-term investments was primarily due to the investment of cash received through the Subordinated Debt offering in May 2007.
Our target investment portfolio allocation is approximately 60% fixed maturity securities and 40% commercial mortgage loans. At December 31, 2007, our portfolio consisted of 57.2% fixed maturity securities, 41.9% commercial mortgage loans, 0.8% real estate and 0.1% short-term investments.
Our fixed maturity securities totaled $5.0 billion at December 31, 2007. We believe that we maintain prudent diversification across industries, issuers and maturities. Our corporate bond industry diversification targets are based on
the Lehman Investment Grade Credit Index, which is reasonably reflective of the mix of issuers broadly available in the market. We also target a specified level of government, agency and municipal securities in our portfolio for credit quality and additional liquidity. The overall credit quality of our fixed maturity securities investment portfolio was A (Standard & Poor’s) at December 31, 2007. The percentage of fixed maturity securities below investment-grade was 4.1% and 3.6% at December 31, 2007 and 2006, respectively. At December 31, 2007, bonds on our watch list totaled approximately $49.3 million. We did not have any direct exposure to sub-prime or Alt-A mortgages in our fixed maturity securities portfolio at December 31, 2007. We held investments in debt securities issued by bond insurers at December 31, 2007, with $33.5 million in market value and $40.7 million in book value. The Company intends to hold these securities to maturity and will continue to evaluate these holdings, but currently expects the fair values of its investments in debt securities issued by bond insurers to recover as these debt securities approach their maturity dates. Should the credit quality of our fixed maturity securities decline, there could be a material adverse effect on our business, financial position, results of operations or cash flows.
At December 31, 2007, our fixed maturity securities portfolio had gross unrealized capital gains of $115.8 million and gross unrealized capital losses of $52.4 million. Unrealized gains and losses primarily result from holding fixed maturity securities with interest rates higher or lower, respectively, than those currently available at the reporting date.
StanCorp Mortgage Investors originates and services fixed-rate commercial mortgage loans for the investment portfolios of our insurance subsidiaries and generates additional fee income from the origination and servicing of commercial mortgage loans participated to institutional investors.
Commercial mortgage loan originations for internal and external investors were $1.45 billion, $942.8 million and $996.4 million for 2007, 2006 and 2005, respectively. The increased originations in 2007 reflected a return to a more traditional origination market with the securitized lenders essentially out of the market for loans, making the market less competitive with wider spreads. The decrease in originations in 2006 reflected a more competitive origination market for commercial mortgage loan financing. The level of commercial mortgage loan originations in any year is influenced by market conditions as we respond to changes in interest rates, available spreads and borrower demand.
At December 31, 2007, StanCorp Mortgage Investors serviced $3.66 billion in commercial mortgage loans for subsidiaries of StanCorp and $1.90 billion for other institutional investors, compared to $3.32 billion serviced for subsidiaries of StanCorp and $1.41 billion for other institutional investors at December 31, 2006.
At December 31, 2007, there were four commercial mortgage loans totaling $1.9 million in our portfolio that were more than sixty days delinquent, of which two commercial mortgage loans with a total balance of $0.7 million were in the process of foreclosure. We had a net balance of restructured loans of $3.4 million at December 31, 2007, and a commercial mortgage loan loss reserve of $3.0 million. At December 31, 2007, we do not have any direct exposure to sub-prime or Alt-A mortgages. The delinquency rate and loss performance of our commercial mortgage loan portfolio is in line with the recent industry averages as reported by the American Council of Life Insurers. The performance of our commercial mortgage loan portfolio may fluctuate in the future. Should the delinquency rate or loss performance of our commercial mortgage loan portfolio increase, the increase could have a material adverse effect on our business, financial position, results of operations or cash flows.
At December 31, 2007, our commercial mortgage loan portfolio was collateralized by properties with the following characteristics:
At December 31, 2007, our commercial mortgage loan portfolio was diversified regionally as follows:
exposed to potential losses resulting from an economic downturn in California as well as to certain catastrophes, such as earthquakes and fires, which may affect certain areas of the state. We require borrowers to maintain fire insurance coverage to provide reimbursement for any losses due to fire. Although we diversify our commercial mortgage loan portfolio within California by both location and type of property in an effort to reduce certain catastrophe and economic exposure, such diversification may not eliminate the risk of such losses. Historically, the delinquency rate of our California-based commercial mortgage loans has been substantially below the industry average and consistent with our experience in other states. In addition, we do not require earthquake insurance for properties on which we make commercial mortgage loans, but do consider the potential for earthquake loss based upon seismic surveys and structural information specific to each property when new loans are underwritten. We do not expect the exposure to catastrophe or earthquake damage to the properties in our commercial mortgage loan portfolio located in California to have a material adverse effect on our business, financial position, results of operations or cash flows. However, if economic conditions in California decline, we could experience a higher delinquency rate on the portion of our commercial mortgage loan portfolio located in California, which could have a material adverse effect on our business, financial position, results of operations or cash flows.
Under the laws of certain states, environmental contamination of a property may result in a lien on the property to secure recovery of the costs of cleanup. In some states, such a lien has priority over the lien of an existing mortgage against such property. As a commercial mortgage lender, we customarily conduct environmental assessments prior to making commercial mortgage loans secured by real estate and before taking title through foreclosure on real estate collateralizing delinquent commercial mortgage loans held by us. Based on our environmental assessments, we believe that any compliance costs associated with environmental laws and regulations or any remediation of affected properties would not have a material adverse effect on our business, financial position, results of operations or cash flows. However, we cannot provide assurance that material compliance costs will not be incurred by us.
Financing cash flows primarily consist of policyholder fund deposits and withdrawals, borrowings and repayments on the line of credit, borrowings and repayments on long-term debt, repurchases of common stock and dividends paid on common stock. Net cash provided by financing activities was $261.1 million, $362.0 million and $265.7 million for 2007, 2006 and 2005, respectively. The decrease for 2007 resulted from several offsetting factors. Cash inflows from a $300 million Subordinated Debt offering in May 2007 were offset by increased repurchases of common stock, the elimination of cash inflows from a third party minority interest in a limited liability company that was dissolved in December 2006 and slightly slower growth in policyholder fund deposits, net of withdrawals. The increase for 2005 primarily resulted from the third party interest in the limited liability company created for the purpose of holding commercial mortgage loans originated by StanCorp Mortgage Investors. The minority third party investment totaled $143.2 million for 2005. Standard retained its ownership share of the commercial mortgage loans upon the dissolution of the limited liability company. The non-cash transaction in the Consolidated Statements of Cash Flows for 2006 represented the transfer of commercial mortgage loans to the minority shareholders at dissolution. The Company repurchased common stock at a total cost of $235.6 million, $70.1 million and $106.4 million for 2007, 2006 and 2005, respectively.
On June 15, 2006, the Company established a five-year, $200 million senior unsecured revolving credit facility (“Facility”). On May 9, 2007, the Facility was amended to extend the expiration date by one year to June 15, 2012. At the option of StanCorp and with the consent of the lenders under the Facility, the termination date can be extended for an additional one-year period. Additionally, upon the request of StanCorp and with consent of the lenders under the Facility, the Facility can be increased by up to $100 million to a total of up to $300 million. Borrowings under the Facility will be used to provide for working capital and general corporate purposes of the Company and its subsidiaries and the issuance of letters of credit.
Under the agreement, StanCorp is subject to customary covenants that take into consideration the impact of material
transactions, changes to the business, compliance with legal requirements and financial performance. The two financial covenants are based on our total debt to total capitalization ratio and consolidated net worth. The Facility is subject to performance pricing based upon our total debt to total capitalization ratio and includes interest based on a Eurodollar margin, plus facility and utilization fees. At December 31, 2007, StanCorp was in compliance with all covenants under the Facility and had no outstanding balance on the Facility. StanCorp currently has no commitments for standby letters of credit, standby repurchase obligations or other related commercial commitments.
StanCorp filed a $1.0 billion shelf registration statement with the Securities and Exchange Commission, which became effective on July 23, 2002, and expires on December 1, 2008, registering common stock, preferred stock, debt securities and warrants. On September 25, 2002, we completed an initial public debt offering of $250 million of 6.875%, 10-year senior notes (“Senior Notes”), pursuant to the shelf registration statement. The principal amount of the Senior Notes is payable at maturity and interest is payable semi-annually in April and October. Upon expiration of the $1.0 billion shelf registration statement in December 2008, the Company, as a well-known seasoned issuer, has the ability to file an automatic shelf registration statement for subsequent security issuances.
State insurance departments require insurance enterprises to maintain minimum levels of capital and surplus. At December 31, 2007, the insurance subsidiaries capital was approximately 301% of the company action level of Risk-based Capital (“RBC”) required by regulators, which is 601% of the authorized control level RBC required by our states of domicile. We expect to maintain a target capital of approximately 300% of the company action level of the insurance company. We expect to distribute capital in excess of the target to the holding company. At December 31, 2007, statutory capital, adjusted to exclude asset valuation reserves, for our regulated insurance subsidiaries totaled $1.15 billion.
The levels of capital in excess of targeted RBC we generate vary inversely in relation to our levels of premium growth, primarily due to initial reserve requirements, certain regulatory capital requirements based on premiums and certain acquisition costs associated with policy issuance. At higher levels of premium growth, we generate less capital in excess of targeted RBC. At very high levels of premium growth, we could generate the need for capital infusions. At lower levels of premium growth, we generate more capital in excess of targeted RBC. At our expected growth rate, we anticipate generating capital in excess of our 300% target of $125 to $150 million in 2008.
continually review the financial performance and condition of insurance companies, including ours. In addition, credit ratings on our Senior Notes and Subordinated Debt are tied to our financial strength ratings. A ratings downgrade could increase surrender levels for our annuity products, could adversely affect our ability to market our products and could increase costs of future debt issuances. Standard & Poor’s, Moody’s Investors Service, Inc. and A.M. Best Company provide financial strength and credit ratings.
Standard & Poor’s, Moody’s Investor Services, Inc. and A.M. Best Company also provide credit ratings on StanCorp’s Subordinated Debt. As of February 2008, ratings from these agencies were BBB, Baa2 and bbb-, respectively.
See discussion of loan commitments, “Liquidity and Capital Resources, Investing Cash Flows, Commercial Mortgage Loans.”
See Item 8, “Financial Statements and Supplementary Data-Notes to Consolidated Financial Statements-Note 19-Contingencies and Commitments.”
Insolvency regulations exist in many of the jurisdictions in which our subsidiaries do business. Such regulations may require insurance companies operating within the jurisdiction to participate in guaranty associations. The associations levy assessments against their members for the purpose of paying benefits due to policyholders of impaired or insolvent insurance companies. Association assessments levied against us from January 1, 2005, through December 31, 2007, aggregated $0.5 million. At December 31, 2007, we maintained a reserve
Statutory accounting practices differ in some respects from GAAP. The principal statutory practices that differ from GAAP are: a) bonds and commercial mortgage loans are reported principally at amortized cost; b) asset valuation and the interest maintenance reserves are provided as prescribed by the NAIC; c) certain assets designated as non-admitted, principally deferred tax assets, furniture, equipment, and unsecured receivables, are not recognized as assets, resulting in a charge to statutory surplus; d) annuity considerations with life contingencies, or purchase rate guarantees, are recognized as revenue when received; e) reserves for life and disability policies and contracts are reported net of ceded reinsurance and calculated based on statutory requirements, including required discount rates; f) commissions, including initial commissions and expense allowance paid for reinsurance assumed, and other policy acquisition expenses are expensed as incurred; g) initial commissions and expense allowance received for a block of reinsurance ceded net of taxes are reported as deferred gains in surplus and recognized as income in subsequent periods; h) federal income tax expense includes current income taxes defined as current year estimates of federal income taxes and tax contingencies for current and all prior years and amounts incurred or received during the year relating to prior periods, to the extent not previously provided; i) deferred tax assets, net of deferred tax liabilities, are included in the regulatory financial statements but are limited to those deferred tax assets that will be realized within one year; j) surplus notes are included in capital and surplus; and k) interest on surplus notes is not recorded as a liability nor an expense until approval for payment of such interest has been granted by the commissioner of the state of domicile.
Our consolidated financial statements and certain disclosures made in this Form 10-K have been prepared in accordance with GAAP and require us to make estimates and assumptions that affect reported amounts of assets and liabilities and contingent assets and contingent liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods. The estimates most susceptible to material changes due to significant judgment (identified as the “critical accounting policies”) are those used in determining asset impairments, DAC, VOBA, other intangibles and goodwill, the reserves for future policy benefits and claims, and the provision for income taxes. The results of these estimates are critical because they affect our profitability and may affect key indicators used to measure the Company’s performance. These estimates have a material effect on our results of operations and financial condition.
DAC, VOBA, other intangible assets and goodwill are considered intangible assets. These intangible assets are generally originated through the issuance of new business or the purchase of existing business, either by purchasing blocks of insurance policies from other insurers or by the outright purchase of other companies. Our intangible assets are subject to impairment tests on an annual basis, or more frequently if circumstances indicate that carrying values may not be recoverable.
Acquisition costs we have deferred as DAC are those costs that vary with and primarily are related to the acquisition, and in some instances the renewal of insurance products. These costs are typically one-time expenses that represent the cost of originating new business and placing that business in force. Certain costs related to obtaining new business and acquiring business through reinsurance agreements have been deferred and will be amortized to accomplish matching against related future premiums or gross profits, as appropriate. We normally defer certain acquisition-related commissions and incentive payments, certain costs of policy issuance and underwriting, and certain printing costs. Assumptions used in developing DAC and amortization amounts each period include the amount of business in force, expected future persistency, withdrawals, interest rates and profitability. These assumptions are modified to reflect actual experience when appropriate. Additional amortization of DAC is charged to current earnings to the extent it is determined that future premiums or gross profits are not adequate to cover the remaining amounts deferred. DAC totaled $202.3 million and $208.5 million at December 31, 2007 and 2006, respectively. Changes in actual persistency are reflected in the calculated DAC balance. Costs that do not vary with the production of new business are not deferred as DAC and are charged to expense as incurred.
VOBA primarily represents the discounted future profits of business assumed through reinsurance agreements. We have established VOBA for a block of individual disability business assumed from Minnesota Life and a block of group disability and group life business assumed from Teachers Insurance and Annuity Association of America (“TIAA”). VOBA is generally amortized in proportion to future premiums for group and individual disability insurance products and group life products. However, a portion of the VOBA related to the TIAA transaction associated with an in force block of group long term disability claims for which no ongoing premium is received is amortized in proportion to expected gross profits. If actual premiums or future profitability are inconsistent with our assumptions, we could be required to make adjustments to VOBA and related amortization. For the VOBA associated with the Minnesota Life block of business reinsured, the amortization period is up to 30 years and is amortized in proportion to future premiums. The amortization period of the intangible asset for the marketing agreement with Minnesota Life is up to 25 years. The VOBA associated with the TIAA transaction is comprised of two parts with differing amortization methods. The amortization periods are up to 10 years for VOBA that is amortized in proportion to premiums and up to 20 years for VOBA that is amortized in proportion to expected gross profits. VOBA totaled $34.4 million and $53.7 million at December 31, 2007 and 2006, respectively. Upon adoption of SOP 05-1, the premium portion of the VOBA related to TIAA was recorded as a $10.0 million reduction to retained earnings.
with the purchase of Invesmart, and related to the Asset Management segment. Additional customer lists were acquired with the purchase of DPA, Inc. and with the acquisition by StanCorp Investment Advisers of small investment advisory firms. Customer lists have a combined estimated weighted-average remaining life of approximately 9.7 years. The marketing agreement accompanied the Minnesota Life transaction and provides access to Minnesota Life agents, some of whom now market Standard’s individual disability insurance products. The amortization period for the Minnesota Life marketing agreement is up to 25 years. Other intangible assets totaled $52.1 million and $47.0 million at December 31, 2007 and 2006, respectively.
Reserves represent amounts to pay future benefits and claims. Developing the estimates for reserves (and therefore the resulting impact on earnings) requires varying degrees of subjectivity and judgment, depending upon the nature of the reserve. For most of our reserves, the calculation methodology is prescribed by various accounting and actuarial standards, although judgment is required in the determination of assumptions to use in the calculation. At December 31, 2007, these reserves represented approximately 87% of total reserves held or $4.50 billion. We also hold reserves that lack a prescribed methodology but instead are determined by a formula that we have developed based on our own experience. Because this type of reserve requires a higher level of subjective judgment, we closely monitor its adequacy. These reserves, which are primarily incurred but not reported reserves associated with our disability products represented approximately 13% of total reserves held at December 31, 2007, or $653.2 million. Finally, a small amount of reserves is held based entirely upon subjective judgment. These reserves are generally set up as a result of unique circumstances that are not expected to continue far into the future and are released according to pre-established conditions and timelines. These reserves represented less than 1% of total reserves held at December 31, 2007, or $10.2 million.
Reserves include policy reserves for claims not yet incurred, and claim reserves for liabilities for unpaid claims and claim adjustment expenses for claims that have been incurred or are estimated to have been incurred but not yet reported to us. These reserves totaled $5.02 billion, $4.78 billion and
$4.55 billion at December 31, 2007, 2006 and 2005, respectively, and represented over 96% of total reserves.
Policy reserves totaled $908.3 million, $887.4 million and $871.5 million at December 31, 2007, 2006 and 2005, respectively. Policy reserves include reserves established for individual life and individual disability businesses.
Assumptions used to calculate immediate annuity policy reserves may vary by the age and sex of the annuitant and year of policy issue.
Policy reserves for our individual life block of business totaled $664.5 million, $596.6 million and $588.6 million at December 31, 2007, 2006 and 2005, respectively. Effective January 1, 2001, substantially all of our individual life policies and the associated reserves were ceded to Protective Life Insurance Company under a reinsurance agreement.
Policy reserves are calculated using our best estimates of assumptions and considerations at the time the policy was issued, adjusted to allow for the effect of adverse deviations in actual experience. These assumptions are not subsequently modified unless policy reserves become inadequate at which time we may need to change assumptions to increase reserves.
The amount of monthly benefit paid to the insured less reinsurance recoveries and other offsets.
In 2006, we did adjust the claim termination rate assumptions for a small block of individual disability claims in light of a recently released industry table. This resulted in an increase in reserves of $6 million. These assumptions were further refined in 2007 and resulted in an additional increase in reserves of $7.4 million. Our block of business is relatively small and as a result, we view the new industry table as more credible for establishing reserve levels compared solely to our own experience. We will continue to monitor our developing experience in light of the availability of the new industry table and if necessary will adjust reserves accordingly.
We monitor the adequacy of our reserves relative to our key assumptions. In our estimation, scenarios based on reasonably possible variations in claim termination assumptions could produce a percentage change in reserves for our group insurance lines of business of approximately +/- 0.2% or $9 million. However given that claims experience can fluctuate widely from quarter to quarter, significant unanticipated changes in claim termination rates over time could produce a change in reserves for our group insurance lines outside this range.
The provision for income taxes includes amounts currently payable and deferred amounts that result from temporary differences between financial reporting and tax bases of assets and liabilities as measured by current tax rates. Currently, years open for audit by the Internal Revenue Service are 2004 through 2007.
Some of the statements contained in this Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, including those relating to our strategy and other statements that are predictive in nature, that depend on or refer to future events or conditions or that include words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “estimates” “seeks” and similar expressions, are forward-looking statements within the meaning of Section 21E of the Exchange Act, as amended. These statements are not historical facts but instead represent only management’s expectations, estimates and projections regarding future events. Similarly, these statements are not guarantees of future performance and involve uncertainties that are difficult to predict, which may include, but are not limited to, the factors discussed below. As a provider of financial products and services, our results of operations may vary significantly in response to economic trends, interest rate changes, investment performance and claims experience. Caution should be used when extrapolating historical results or conditions to future periods.
Our actual results and financial condition may differ, perhaps materially, from the anticipated results and financial condition in any such forward-looking statements and, given these uncertainties or circumstances, readers are cautioned not to place undue reliance on such statements. We assume no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
Availability of capital required to support business growth and the effective utilization of excess capital.
Adequacy of the diversification of risk by product offerings and customer industry, geography and size.
Consolidated Statements of Income and Comprehensive Income for the years ended December 31, 2007, 2006 and 2005
As discussed in Note 1 to the consolidated financial statements, on January 1, 2007, the Company changed its method of accounting for deferred acquisition costs upon the adoption of Statement of Position 05-1, Accounting by Insurance Enterprises for
Deferred Acquisition Costs in Connection With Modifications or Exchanges of Insurance Contracts. As also discussed in Notes 1 and 11 to the consolidate financial statements, on December 31, 2006, the Company changed its method of accounting for defined benefit and other postretirement plans upon the adoption of Statement of Financial Accounting Standards No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans.
StanCorp was incorporated under the laws of Oregon in 1998 as a parent holding company and conducts business through its subsidiaries: Standard Insurance Company (“Standard”); The Standard Life Insurance Company of New York; Standard Retirement Services, Inc. (“Standard Retirement Services”); StanCorp Equities, Inc. (“StanCorp Equities”); StanCorp Mortgage Investors, LLC (“StanCorp Mortgage Investors”); StanCorp Investment Advisers, Inc. (“StanCorp Investment Advisers”); StanCorp Real Estate, LLC (“StanCorp Real Estate”); and StanCorp Trust Company. The Company is headquartered in Portland, Oregon and, through its subsidiaries, has operations throughout the United States.
Effective January 1, 2007, the administrative and servicing operations of StanCorp’s retirement plans group annuity contracts offered through Standard and for the trust product formerly offered through Invesmart, Inc. (“Invesmart”), which was acquired in July 2006, began operating under the name Standard Retirement Services. Retirement plans products are offered in all fifty states through Standard or Standard Retirement Services.
StanCorp Investment Advisers is a Securities and Exchange Commission (“SEC”) registered investment adviser providing performance analysis, fund selection support, model portfolios and other investment advisory and investment management services to its retirement plan clients, individual investors and subsidiaries of StanCorp.
For all investments, capital gains and losses are recognized using the specific identification method. Net investment income and capital gains and losses related to separate account assets and liabilities are included in the separate account assets and liabilities. For all investments, we record impairments when it is determined that the decline in fair value of an investment below its amortized cost basis is other than temporary. We reflect impairment charges in net capital gains or losses and permanently adjust the cost basis of the investment to reflect the impairment. In our quarterly impairment analysis, we evaluate whether a decline in value of fixed maturity securities is other than temporary. Factors considered in this analysis include the length of time and the
Our investment portfolio includes fixed maturity securities and commercial mortgage loans. When the fair value of a fixed maturity security is below its amortized cost, and depending on the length of time the condition exists and the extent the fair value is below amortized cost, additional analysis is performed to determine whether an impairment exists. The analysis considers the financial condition and near-term prospects of the issuer, as well as the value of any security we may have in the investment and our intent and ability to hold the investment. At December 31, 2007, issues on our impairment watch list totaled approximately $32.7 million in market value and $41.8 million in book value. We did not have any direct exposure to sub-prime or Alt-A mortgages in our fixed maturity securities portfolio at December 31, 2007. The Company held investments in debt securities issued by bond insurers at December 31, 2007, with $33.5 million in market value and $40.7 million in book value. The Company intends to hold these securities to maturity and will continue to evaluate these holdings, but currently expects the fair values of its investments in debt securities issued by bond insurers to recover as these debt securities approach their maturity dates. Should the credit quality of our fixed maturity securities decline, there could be a material adverse effect on our business, financial position, results of operations or cash flows.
Short-term investments on the consolidated balance sheet at December 31, 2007, consisted of commercial paper.
DAC and amortization amounts each period include the amount of business in force, expected future persistency, withdrawals, interest rates and profitability. These assumptions are modified to reflect actual experience when appropriate. Additional amortization of DAC is charged to current earnings to the extent it is determined that future premiums or gross profits are not adequate to cover the remaining amounts deferred. DAC totaled $202.3 million and $208.5 million at December 31, 2007 and 2006, respectively. Changes in actual persistency are reflected in the calculated DAC balance. Costs that do not vary with the production of new business are not deferred as DAC and are charged to expense as incurred.
Key assumptions, which will affect the determination of expected gross profits for the annuity products are persistency, the spread between investment yields and interest credited, and stock market performance for the group annuity products with assets held in equity funds. For VOBA related to the TIAA group long term disability claims for which no further premiums are due that is amortized in proportion to expected gross profits, the key assumptions that affect the development of expected gross profits are the claim termination rates and investment yields. Although a change in a single assumption may have an impact on the calculated amortization of DAC or VOBA, it is the relationship of that change to the changes in other key assumptions that determines the ultimate impact on DAC and VOBA amortization. Because actual results and trends related to these assumptions do vary from those assumed, the Company revises these assumptions annually to reflect its current best estimate of expected gross profits. As a result of this process, known as “unlocking,” the cumulative balances of DAC and VOBA are adjusted with an offsetting benefit or charge to income to reflect changes in the period of the
revision. An unlocking event that results in an after-tax benefit generally occurs as a result of actual experience or future expectations being favorable compared to previous estimates. An unlocking event that results in an after-tax charge generally occurs as a result of actual experience or future expectations being unfavorable compared to previous estimates. As a result of unlocking, the amortization schedule for future periods is also adjusted. Due to unlocking, DAC and VOBA balances decreased $0.4 million for 2007, and increased $0.3 million for 2006. Based on past experience, future changes in DAC and VOBA balances due to changes in underlying assumptions are not expected to be material. However, significant, unanticipated changes in key assumptions, which affect the determination of expected gross profits may result in a large unlocking event, which could have a material adverse effect on the Company’s financial position or results of operations.
The Company’s other intangible assets are subject to amortization and consist of certain customer lists and a marketing agreement. Customer lists with a value of $28.6 million and a weighted-average amortization period of 10 years were acquired by the Company during the third quarter of 2006, primarily in connection with the purchase of Invesmart, and related to the Asset Management segment. Additional customer lists were acquired with the purchase of DPA, Inc. and with the acquisition by StanCorp Investment Advisers of small investment advisory firms. Customer lists have a combined estimated weighted-average remaining life of approximately 9.7 years. The marketing agreement accompanied the Minnesota Life transaction and provides access to Minnesota Life agents, some of which now market Standard’s individual disability insurance products. The amortization period for the Minnesota Life marketing agreement is up to 25 years. Other intangible assets totaled $52.1 million and $47.0 million at December 31, 2007 and 2006, respectively.
Non-affiliated tenants leased approximately 38.5%, 40.0% and 40.6% of the home office properties at December 31, 2007, 2006 and 2005, respectively. Income from the leases is included in net investment income.
instead estimates based on assumptions and considerations concerning a number of factors, which include:
The amount of monthly benefit paid to the insured (less reinsurance recoveries and other offsets).
Other policyholder funds are liabilities for investment-type contracts and are based on the policy account balances including accumulated interest. Other policyholder funds include amounts related to advanced premiums, premiums on deposit and experience rated liabilities totaling $373.8 million and $357.5 million at December 31, 2007 and 2006, respectively.
Premiums from group life and group and individual disability contracts are recognized as revenue when due. Investment-type contract fee revenues consist of charges for policy administration and surrender charges assessed during the period. Charges related to services to be performed are deferred until earned. The amounts received in excess of premiums and fees are included in other policyholder funds in the consolidated balance sheets. Experience rated refunds (“ERRs”) are computed in accordance with the terms of the
contracts with certain group policyholders and are accounted for as an adjustment to premiums.
Other comprehensive income and loss included changes in unrealized capital gains and losses on investment securities available-for-sale, net of the related tax effects, and changes in unrealized prior service costs and credits and net gains and losses associated with our employee benefit plans, net of the related tax effects. The following table sets forth our other comprehensive income and loss for the years ended December 31:
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities Including an Amendment of FASB Statement No. 115, effective for all entities at the beginning of the first fiscal year that begins after November 15, 2007. Early adoption was permitted as of the beginning of a fiscal year that begins on or before November 15, 2007, provided the entity also elected to apply the provisions of SFAS No. 157, Fair Value Measurements. If adopted by an entity, SFAS No. 159 creates a fair value option whereby a company may irrevocably elect to measure many financial instruments and certain other items at fair value on
an instrument-by-instrument basis with changes in fair value recognized in earnings as those changes occur. An entity can elect the fair value option only at the date of initial adoption of SFAS No. 159. The Company did not elect early adoption of SFAS No. 159. Therefore, the provisions of SFAS No. 159 will become effective for the Company on January 1, 2008. StanCorp is not electing to measure retroactively additional eligible items at fair value that are not currently presented at fair value.
In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements - An Amendment of ARB No. 51. The new statement establishes new accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. Specifically, SFAS No. 160 requires the recognition of a noncontrolling interest (formerly referred to as “minority interest”) as equity in the consolidated financial statements and separate from the parent’s equity. The amount of net income attributable to the noncontrolling interest will be identified and included in consolidated net income on the face of the income statement. SFAS No. 160 clarifies that changes in a parent’s ownership interest in a subsidiary that do not result in deconsolidation are equity transactions if the parent retains its controlling financial interest. In addition, this statement requires that a parent recognize a gain or loss in net income when a subsidiary is deconsolidated. This statement also includes expanded disclosure requirements regarding interests of the parent and its noncontrolling interest. SFAS No. 160 is effective for fiscal years beginning on or after December 15, 2008, and earlier adoption is prohibited. The Company has performed an analysis of the impact that the adoption of SFAS No. 160 will
In November 2007, the SEC issued Staff Accounting Bulletin (“SAB”) No. 109, Written Loan Commitments Recorded at Fair Value Through Earnings. SAB No. 109 provides guidance on the accounting for written loan commitments recorded at fair value under GAAP. Specifically, SAB No. 109 revises the Staff’s views on incorporating expected net future cash flows related to loan servicing activities in the fair value measurement of a written loan commitment. SAB No. 109, which supersedes SAB No. 105, Application of Accounting Principles to Loan Commitments, requires the expected net future cash flows related to the associated servicing of the loan to be included in the measurement of all written loan commitments that are accounted for at fair value through earnings. SAB No. 109 is effective in fiscal quarters beginning after December 15, 2007. StanCorp is currently evaluating the potential financial impact, if any, that the adoption of SAB No. 109 will have on its financial statements.
StanCorp’s operations include two reportable segments: Insurance Services and Asset Management, as well as an “Other” category for activity outside of the two segments. Resources are allocated and performance is evaluated at the segment level. The Insurance Services segment offers group and individual disability insurance, group life and AD&D insurance, and group dental insurance. The Asset Management segment offers full-service 401(K) plans, 457 plans, defined benefit plans, money purchase pension plans, profit sharing plans, 403(b) plans and non-qualified deferred compensation products and services through an affiliated broker-dealer. This segment also offers investment management and financial planning services, commercial mortgage loan origination and servicing, and individual fixed annuities. It also includes the operations of the former Invesmart, a provider of retirement plan services, and investment advisory and management services, acquired in July 2006. Effective January 1, 2007, the administration and servicing operations for the retirement plans group annuity contracts offered through Standard and for the trust product offered through Invesmart, began operating under the name Standard Retirement Services. In the third quarter of 2007, the Asset Management segment added $1.7 billion of assets under administration acquired from DPA, Inc., a retirement business based in Portland, Oregon.
Net capital gains and losses on investments, return on capital not allocated to the product segments, holding
company expenses, interest on debt and adjustments made in consolidation are reflected in “Other.”
The fair values of investment securities were based on quoted market prices, where available, or on values obtained from independent pricing services. The fair values of commercial mortgage loans were estimated using option-
adjusted valuation discount rates. The carrying values of policy loans approximate fair values. While potentially financial instruments, policy loans are an integral component of the insurance contract and have no maturity date.
The following table sets forth the contractual maturities of investment securities available-for-sale at December 31:
Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations. Callable bonds represented 2.4%, or $122.0 million, of our investment securities at December 31, 2007.
Securities deposited for the benefit of policyholders in various states, in accordance with state regulations, amounted to $6.4 million and $6.2 million at December 31, 2007 and 2006, respectively.
Although the Company underwrites commercial mortgage loans throughout the United States, commercial mortgage loans in California represent a concentration of credit risk at 30% and 31% of our commercial mortgage loan portfolio at December 31, 2007 and 2006, respectively. Through this concentration, we are exposed to potential losses resulting from an economic downturn in California as well as to certain catastrophes, such as earthquakes and fires, which
may affect the state. We require borrowers to maintain fire insurance coverage to provide reimbursement for any losses due to fire. Although we diversify our commercial mortgage loan portfolio within California by both location and type of property in an effort to reduce certain catastrophe and economic exposure, such diversification may not eliminate the risk of such losses. Historically, the delinquency rate of our California-based commercial mortgage loans has been substantially below the industry average and consistent with our experience in other states. In addition, we do not require earthquake insurance for properties on which we make commercial mortgage loans but do consider the potential for earthquake loss based upon seismic surveys and structural information specific to each property when new loans are underwritten. We do not expect the exposure to catastrophe or earthquake damage to the properties in our commercial mortgage loan portfolio located in California to have a material adverse effect on our business, financial position, results of operations or cash flows. However, if economic conditions in California decline, we could experience a higher delinquency rate on the portion of our commercial mortgage loan portfolio located in California, which could have a material adverse effect on the Company’s business, financial position, results of operations or cash flows.
The following table sets forth the amount of commercial mortgage loans on the consolidated balance sheet at December 31, 2007, segregated by origination year.
Commercial mortgage loans foreclosed and transferred to real estate were $0.5 million and $1.8 million for 2007 and 2006, respectively. At December 31, 2007 and 2006, we had commercial mortgage loans totaling $1.9 million and $2.9 million, respectively, that were more than sixty days delinquent and of these amounts, $0.7 million and $1.2 million, respectively, were in the process of foreclosure. The following table sets forth commercial mortgage loan valuation and allowance provisions at December 31:
StanCorp filed a $1.0 billion shelf registration statement with the SEC, which became effective on July 23, 2002, and expires on December 1, 2008, registering common stock, preferred stock, debt securities and warrants. On September 25, 2002, we completed an initial public debt offering of $250 million of 6.875%, 10-year senior notes (“Senior Notes”), pursuant to the shelf registration statement. The principal amount of the Senior Notes is payable at maturity, and interest is payable semi-annually in April and October. Upon expiration of the $1.0 billion shelf registration statement in December 2008, the Company, as a
well-known seasoned issuer, has the ability to file an automatic shelf registration statement for subsequent security issuances.
On May 29, 2007, the Company completed a public debt offering of $300 million of 6.90%, junior subordinated debentures (“Subordinated Debt”). The Subordinated Debt has a final maturity on June 1, 2067, is non-callable at par for the first 10 years and is subject to a replacement capital covenant. The covenant limits replacement of the Subordinated Debt for the first 40 years to be redeemable only with securities that carry equity-like characteristics that are the same as or more equity-like than the Subordinated Debt. The principal amount of the Subordinated Debt is payable at final maturity. Interest is payable semi-annually at 6.90% in June and December for the first 10 years and quarterly thereafter at a floating rate equal to three-month LIBOR plus 2.51%. StanCorp has the option to defer interest payments for up to five years. StanCorp management chose to make the first scheduled payment of $10.5 million in December 2007. StanCorp used approximately $30 million of the proceeds from the sale of the Subordinated Debt to fund the acquisition by StanCorp Real Estate (a wholly owned subsidiary) of certain real estate assets from Standard. Since the Subordinated Debt was issued in May 2007, the Company has repurchased approximately 4.6 million shares of common stock at a repurchase price of $222.7 million. The Company intends to use the remaining debt proceeds to repurchase additional shares of its common stock and for general corporate purposes.
The difference between taxes calculated as if the federal corporate tax rate of 35% was applied to income before income taxes and the recorded tax expense is reconciled as follows:
The Company is carrying forward net operating losses of $8.2 million that originated in StanCorp and The Standard Life Insurance Company of New York. The losses will be used in future years to offset taxable income from those entities to the degree allowed by the IRS Code. If unutilized, $4.6 million would expire in 2023, $2.3 million would expire in 2024 and $1.3 million would expire in 2025. In addition, the Company is carrying forward a $58.5 million federal net operating loss from the acquisition of Invesmart. This carryforward is subject to limitations under IRS Section 382, which potentially reduce the annual amount that may be utilized. This carryforward will expire between 2018 and 2024 with the majority of it expiring in 2022. In addition, as a result of the Invesmart acquisition, the Company has approximately $2.0 million (tax effected) of various state net operating loss carryforwards that expire at various dates through 2025.
Upon adoption of FASB Interpretation No. 48 on January 1, 2007, and throughout 2007, the Company did not have any material unrecognized tax benefits. It is the Company’s accounting policy to record income tax interest and penalties in the income tax provision. See “Note 1-Summary of Significant Accounting Policies-Income Taxes.”
The Company has two non-contributory defined benefit pension plans: the employee pension plan and the agent pension plan. The employee pension plan is for all eligible employees of StanCorp and its subsidiaries and was frozen effective January 2003 for new participants. The agent
pension plan, which is frozen for new participants, is for former field employees and agents. Both plans are sponsored and administered by Standard. The defined benefit pension plans provide benefits based on years of service and final average pay.
The following table sets forth the components of net periodic benefit cost, other changes in plan assets and benefit obligations recognized in other comprehensive income, and obligation assumptions used in the measurement of the benefit obligations for the years ended December 31:
In addition, eligible executive officers are covered by a non-qualified supplemental retirement plan. The unfunded status was $19.9 million and $17.2 million at December 31, 2007 and 2006, respectively. Expenses were $2.3 million, $1.8 million and $1.6 million for 2007, 2006 and 2005, respectively. At December 31, 2007, net loss and prior service cost of $3.9 million, net of tax, was excluded from the net periodic benefit cost and reported as a component of accumulated other comprehensive income. In addition, $19.9 million was reflected in other liabilities. In March 2007, additional executive officers were eligible to participate in the plan, which increased the pension benefit obligation by $2.1 million and decreased accumulated other comprehensive income by $1.4 million, net of tax.
Standard sponsors and administers a postretirement benefit plan that includes medical, prescription drug benefits and group term life insurance. Eligible retirees are required to contribute specified amounts for medical and prescription drug benefits that are determined periodically and are based on retirees’ length of service and age at retirement. Effective January 1, 2006, participation in the postretirement benefit plan is limited to employees who had reached the age of 40 as of January 1, 2006, or whose combined age and length of
service were equal to or greater than 45 years as of January 1, 2006.
The funded or underfunded status of the postretirement benefit plan, reflected as an asset or liability, is measured as the difference between the fair value of plan assets and the accumulated benefit obligation. At December 31, 2007, a liability of $5.1 million was reflected on the balance sheet for this plan.
The gains and losses, and prior servicing costs or credits excluded from the projected benefit obligation are recognized as a component of accumulated other comprehensive (income) loss, net of tax. The following table sets forth the amounts recognized in accumulated other comprehensive income at December 31:
The estimated net gain and prior service credit for the postretirement benefit plan that will be amortized from accumulated other comprehensive income into net periodic benefit cost in 2008 are $0.1 million and $0.4 million, respectively.
The 1999 Omnibus Stock Incentive Plan authorized the board of directors of StanCorp to grant eligible employees certain incentive or non-statutory stock options, bonuses and performance stock options, restricted and foreign stock awards, and stock appreciation and cash bonus rights related to StanCorp’s common stock. The maximum number of shares of common stock that may be issued under this plan is 3.4 million. Substantially all of these shares have been issued or optioned.
Income before income taxes included compensation costs related to all share-based compensation arrangements of $8.7 million, $8.7 million and $6.4 million for 2007, 2006 and 2005, respectively. The related tax benefits were $3.0 million, $3.0 million and $2.2 million for the same periods, respectively.
A summary of option activity and options outstanding and exercisable is presented below:
The fair value of each option award under the share-based compensation plans was estimated using the Black-Scholes option pricing model as of the grant date using the assumptions noted in the following table. The Black-Scholes model uses the expected term as an input with the calculated option value varying directly with the length of time until exercise. The Company bases its estimate of expected term on an analysis of the historical exercise experience of similar options granted to similar employee or director groups. The expected term given below represents the weighted-average expected term of options granted. Expected stock price volatility is based on volatility of the Company’s stock over the prior period equal in duration to the expected term. The dividend rate is the rate expected to be paid over the expected term, generally estimated to be equal to the rate for the year prior to the grant. The risk-free rate is the interest rate on a U.S. Treasury bond of a maturity closest to the expected term of the option.
Restricted stock grants are a part of the Company’s long-term compensation for certain senior officers. The Company grants both performance-based and retention-based restricted stock. Under the current plans, the Company had 0.5 million shares available for issuance as restricted stock at December 31, 2007.
Performance-based awards are made to designated senior officers each year and vest with respect to all or a portion of the awards based on the Company’s financial performance for a given year. In years prior to 2007, awards consisted of restricted stock (60%) and cash performance units (40%), which represent a right to receive cash equal to the value of one share of stock subject to the same employment and performance criteria. Both restricted stock and cash performance units are subject to forfeiture if continued employment and financial performance criteria are not met.
On December 8, 2006, the organization and compensation committee of the board of directors of StanCorp approved a revised form of long-term incentive award agreement to be used in connection with future grants of performance-based awards to executives. Under the new agreement, which will apply for the 2009 performance period and thereafter, stock will be issued at the end of the performance period based on satisfaction of employment and financial performance conditions with a portion of the shares withheld to cover required tax withholding (“Stock Performance Units”). These Stock Performance Units are generally granted two years before the performance period. In 2007, there were 83,655
A summary of the activity for performance-based restricted stock outstanding is presented below:
The number of director shares issued was 1,292, 3,617 and 4,210 during 2007, 2006 and 2005, respectively. The weighted-average fair value per share for the shares issued
The weighted-average per-share fair value for the Company’s ESPP offerings was $10.27, $10.68 and $7.66 during 2007, 2006 and 2005, respectively. The Company’s compensation cost resulting from the ESPP was $1.2 million, $1.2 million and $0.9 million for 2007, 2006 and 2005, respectively. The related tax benefit was $0.4 million, $0.4 million and $0.3 million for the same periods, respectively.
In order to limit its losses from large exposures, the Company enters into reinsurance agreements with other
Standard participates in a reinsurance and third party administration arrangement with Northwestern Mutual under which Northwestern Mutual group long term and short term disability products are sold using Northwestern Mutual’s agency distribution system. Generally, Standard assumes 60% of the risk and receives 60% of the premiums for the policies issued. If Standard were to become unable to meet its obligations, Northwestern Mutual would retain the reinsured liabilities. Therefore, in accordance with an agreement with Northwestern Mutual, Standard established a trust for the benefit of Northwestern Mutual with the market value of assets in the trust equal to Northwestern Mutual’s reinsurance receivable from Standard. The market value of assets required to be maintained in the trust at December 31, 2007, was $218.0 million. Premiums assumed by Standard for the Northwestern Mutual business accounted for 3% of the Company’s total premiums for each of the three years 2007, 2006 and 2005. In addition to assuming risk, Standard provides product design, pricing, underwriting, legal support, claims management and other administrative services under the arrangement.
During 2002, Standard formed a strategic marketing alliance with Ameritas Life Insurance Corp. (“Ameritas”) that offers Standard’s policyholders new and more flexible dental coverage options and access to Ameritas’ nationwide preferred provider organization panel of dentists. As part of this alliance, Standard and Ameritas entered into a reinsurance agreement that provides for 20% of the net dental premiums written by Standard and the risk associated with this premium to be ceded to Ameritas.
Recoveries recognized under reinsurance agreements were $60.8 million, $56.4 million and $52.8 million for 2007, 2006 and 2005, respectively. Amounts recoverable from reinsurers were $929.6 million and $913.6 million at December 31, 2007 and 2006, respectively. Of these amounts, $795.4 million and $789.2 million were from the reinsurance transaction with Protective Life Insurance Company (“Protective Life”) effective January 1, 2001. See “Note 15-Reinsurance of Blocks of Business.”
become unable to meet its obligations, TIAA would retain the reinsured liabilities. Therefore, in accordance with the agreement with TIAA, Standard established a trust for the benefit of TIAA with the market value of assets in the trust equal to TIAA’s reinsurance receivable from Standard. The market value of assets required to be maintained in the trust is determined quarterly. The market value of assets required to be maintained in the trust at December 31, 2007, was approximately $451.1 million. Approximately $60 million in VOBA was capitalized related to the reinsurance agreement.
The following table sets forth insurance information at or for the years ended December 31:
Other operating expenses include operating expenses, commissions and bonuses, interest expense, premium taxes, and the net increase in DAC.
with life contingencies, or purchase rate guarantees, are recognized as revenue when received; e) reserves for life and disability policies and contracts are reported net of ceded reinsurance and calculated based on statutory requirements, including required discount rates; f) commissions, including initial commissions and expense allowance paid for reinsurance assumed, and other policy acquisition expenses are expensed as incurred; g) initial commissions and expense allowance received for a block of reinsurance ceded net of taxes are reported as deferred gains in surplus and recognized as income in subsequent periods; h) federal income tax expense includes current income taxes defined as current year estimates of federal income taxes and tax contingencies for current and all prior years and amounts incurred or received during the year relating to prior periods, to the extent not previously provided; i) deferred tax assets, net of deferred tax liabilities, are included in the regulatory financial statements, but are limited to those deferred tax assets that will be realized within one year that are considered admitted assets; j) surplus notes are included in capital and surplus; and k) interest on surplus notes is not recorded as a liability nor an expense until approval for payment of such interest has been granted by the commissioner of the state of domicile.
On June 15, 2006, the Company established a five-year, $200 million senior unsecured revolving credit facility (“Facility”). On May 9, 2007, the Facility was amended to extend the expiration date by one year to June 15, 2012. At the option of StanCorp and with the consent of the lenders under the Facility, the termination date can be extended for an additional one-year period. Additionally, upon the request of StanCorp and with consent of the lenders under the Facility, the Facility can be increased by up to $100 million to a total of up to $300 million. Borrowings under the Facility will be used to provide for working capital and general
corporate purposes of the Company and its subsidiaries and the issuance of letters of credit.
Under the agreement, StanCorp is subject to customary covenants that take into consideration the impact of material transactions, changes to the business, compliance with legal requirements and financial performance. The two financial covenants are based on the Company’s total debt to total capitalization ratio and consolidated net worth. The Facility is subject to performance pricing based upon the Company’s total debt to total capitalization ratio and includes interest based on a Eurodollar margin, plus facility and utilization fees. At December 31, 2007, StanCorp was in compliance with all covenants under the Facility and had no outstanding balance on the Facility. StanCorp currently has no commitments for standby letters of credit, standby repurchase obligations or other related commercial commitments.
The Company’s financing obligations generally include debts, lease payment obligations and commitments to fund commercial mortgage loans. The remaining obligations reflect the long-term portion of other liabilities and the Company’s obligations under our insurance and annuity product contracts.
The following table summarizes the Company’s contractual obligations as of December 31, 2007:
good faith deposit. Alternatively, if we terminate a commitment due to the disapproval of a commitment requirement, the commitment fee and deposit may be refunded to the borrower, less an administrative fee.
Policyholder fund obligations include payments based on currently scheduled withdrawals and annuity benefit payments stemming from liabilities shown on the balance sheet as policyholder funds. Not included in the table is approximately $2.59 billion in policyholder funds that may be withdrawn upon request. In addition, amounts presented also exclude separate account liabilities of $4.39 billion.
During 2007, the Company repurchased approximately 4.8 million shares of common stock at a total cost of $235.6 million for a volume weighted-average price of $48.60 per common share. At December 31, 2007, there were 1.4 million shares remaining under the new share repurchase program. In addition, during 2007, the Company acquired 7,620 shares of common stock from executive officers to cover tax liabilities of these officers resulting from the release of performance-based shares and retention-based shares at a total cost of $0.4 million for a volume weighted- average price of $47.55 per common share, which reflects the market price on the transaction dates.