2001 benefits to policyholders included pre-tax charges related to the terrorist events of September 11, 2001, of $4.3 million for Employee Benefits and $0.7 million for Individual Insurance. These charges were excluded from the calculation of the benefit ratio.
2002 statutory results reflect the $200 million capital contribution from StanCorp in connection with the Teachers Insurance and Annuity Association of America reinsurance assumption and the related initial commission and expense allowance of $75 million paid and expensed in 2002.
Operating expenses as a percentage of premiums for the Employee Benefits business reflect expenses related to the continuation of improvements in our customer service and product delivery systems. We expect operating expenses to continue at these levels in 2006.
Contract administration fees in the Retirement Plans segment, fees on administrative services only contracts in the Employee Benefits segment and administration fees from our mortgage loan and investment advisory companies have been reclassified to administrative fees in revenues. These fees were formerly included in premiums, other revenue and net investment income, respectively.
The following table sets forth premium and administrative fee growth as a percentage by segment for the years ended December 31:
Continuing strong sales in 2005, growth in our in force block of business from employment growth and wage growth (organic growth), and comparatively favorable persistency in our Employee Benefits segment resulted in stronger premium growth for 2005 compared to 2004. Sales, reported as annualized new premiums and measured on a contract effective date basis for the Employee Benefits segment, were $324.9 million for 2005, nearly equal to the record sales of $330.3 million for 2004. Persistency, measured as a percentage of premiums, increased to 88.2% for 2005, compared to 85.6% for 2004. The Employee Benefits segment is our largest segment representing over 90% of consolidated premiums. See “Business Segments.”
Our operating expense structure is currently heavily variable in that a substantial portion of our on-going expenses are personnel related. Therefore, increased business activity, as evidenced by premium growth, has a direct impact on expenses. Premium growth excluding ERRs for 2005 was 10.9% compared to 2004. Premium growth excluding ERRs for 2004 was 3.6% compared to 2003.
Net Increase in Deferred Acquisition Costs (“DAC”) and Value of Business Acquired (“VOBA”)
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 benefit. The combined federal and state effective tax rates were 35.2%, 31.7% and 34.8% for 2005, 2004 and 2003, respectively. Income taxes for 2004 included a reduction of approximately $7 million from the resolution of prior years’ tax examinations and certain state income tax matters. We do not expect similar reductions in income taxes to recur.
We operate through three segments: Employee Benefits, Individual Insurance and Retirement Plans. Measured as a percentage of total revenues, revenues for each of our three segments for 2005 were 84.3% for Employee Benefits, 10.0% for Individual Insurance and 4.2% for Retirement Plans.
As the Employee Benefits segment is our largest segment, it substantially influences our consolidated financial results. This segment sells disability, life, accidental death and dismemberment (“AD&D”), and dental insurance to employer groups. Income before income taxes for the Employee Benefits segment increased 12.9% to $273.3
Persistency. Persistency for the Employee Benefits segment increased to 88.2% in 2005, compared to a stable 85.6% for both 2004 and 2003. We believe our high levels of persistency demonstrate our commitment to customer service and pricing discipline, which reduces the likelihood of significant rate increases upon renewal of the contract.
In addition, we continued to experience favorable and sustained claims recovery patterns for Employee Benefits group long term disability insurance and, as a result of our on-going assessment of those recovery patterns, we released reserves, which decreased benefits to policyholders, totaling $9 million and $12 million for 2005 and 2004, respectively. We do not currently anticipate similar reserve releases for 2006. In addition, benefits to policyholders for 2004 included a $9.0 million premium deficiency reserve established during the first quarter of 2004 as a result of a pricing miscalculation on long term disability contracts with one large Employee Benefits customer.
Operating expenses as a percentage of premiums were 15.2%, 14.8% and 14.2% for 2005, 2004 and 2003, respectively. See “Consolidated Results of Operations-Benefits and Expenses-Operating Expenses.”
The Individual Insurance segment sells disability insurance and fixed-rate annuities, including life contingent annuities, to individuals. Most of the deposits on our annuity business are not recorded as premiums, but rather are recorded as liabilities. Annuity deposits earn investment income, a portion of which is credited to policyholders. Annuity premiums consist of premiums on life contingent annuities, which are a small portion of sales.
Premium growth in our Individual Insurance segment is driven primarily by sales and persistency of individual disability insurance. Premiums increased 24.6% to $118.2
million for 2005 compared to 2004, and 11.1% to $94.9 million for 2004 compared to 2003. Individual disability premiums for this segment increased 17.0% to $109.4 million for 2005 compared to 2004, and 11.7% to $93.5 million for 2004 compared to 2003, reflecting stronger disability sales and persistency.
Premiums for life contingent annuities, which can vary from quarter to quarter, were $8.8 million, $1.4 million and $1.7 million for 2005, 2004 and 2003, respectively.
Individual fixed-rate annuity deposits decreased 34.8% to $119.9 million for 2005 compared to 2004. The decrease for 2005 was primarily due to competition from shorter-term investment and equity-indexed products, which offer higher yields in the current interest rate environment. Individual fixed-rate annuity deposits increased 32.0% to $184.0 million for 2004 compared to 2003. The increase for 2004 was primarily due to growth in our independent brokerage and financial institution distribution channels. Deposits from fixed-rate annuities are not reported in premiums, but are included in annuity assets under management.
Generally, we expect benefits to policyholders measured as a percentage of premiums (benefit ratio) to trend down over time to reflect the growth in this segment 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 from 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 segment. The benefit ratio for this segment can fluctuate widely from quarter to quarter.
While premiums for the Individual Insurance segment increased 24.6% for 2005 compared to 2004, benefits to policyholders increased 19.4% for the same comparative periods. The benefit ratio was 83.8% for 2005 compared to 87.5% for 2004 and 87.8% for 2003. The comparatively favorable benefit ratio for 2005 compared to 2004 reflected continued growth outside of the large block of disability business assumed in 2000 from Minnesota Life. While premiums for the Individual Insurance segment increased 11.1% for 2004 compared to 2003, benefits to policyholders increased 10.7% for the same comparative periods.
Income before income taxes for the Retirement Plans segment was $10.9 million, $7.9 million and $5.3 million for 2005, 2004 and 2003, respectively. At December 31, 2005, we reached assets under management of $4.22 billion.
Contract administration fees in the Retirement Plans segment have been reclassified to administrative fees in revenues. These fees were formerly included in premiums.
Benefits to policyholders for the Retirement Plans segment consist primarily of the effects of changes in reserves for life contingent annuities sales, which closely approximate the premiums recorded. Life contingent annuity sales can vary widely from quarter to quarter.
StanCorp Mortgage Investors originates and services small 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 sold to institutional investors. StanCorp Mortgage Investors contributed income before income taxes and intercompany eliminations of $11.2 million, $12.1 million and $11.2 million for 2005, 2004 and 2003, respectively. Supporting both internal and external investor demand, commercial mortgage loan originations were $996.4 million, $1.17 billion and $930.6 million for 2005, 2004 and 2003, respectively. The decrease in originations for 2005 reflected a more competitive origination market for commercial mortgage loan financing. The level of commercial mortgage loan originations in any quarter is influenced by market conditions as the Company responds to changes in interest rates, available spreads and borrower demand.
At December 31, 2005, StanCorp Mortgage Investors serviced $3.10 billion in commercial mortgage loans for subsidiaries of StanCorp and $1.14 billion for other institutional investors, compared to $2.95 billion serviced for subsidiaries of StanCorp and $747.9 million serviced for other institutional investors at December 31, 2004. Capitalized commercial mortgage loan servicing rights associated with commercial loans serviced for other institutional investors were $3.3 million and $2.1 million at December 31, 2005 and 2004, respectively.
The Company’s financial instruments are exposed to financial market volatility and potential disruptions in the market that may result in certain financial instruments becoming less valuable. Financial market volatility includes interest rate risk. The Company has analyzed the estimated loss in fair value of certain market sensitive financial assets
held at December 31, 2005 and 2004, given a hypothetical 10% increase in interest rates, and related qualitative information on how the Company manages interest rate risk. The interest rate sensitivity analysis was based upon the Company’s fixed maturity securities and commercial mortgage loans held at December 31, 2005 and 2004. Interest rate sensitivity of the Company’s financial assets was measured assuming a parallel shift in interest rates. All security yields were increased by 10% of the year-end 10-year U.S. Government Treasury bond yield, or 0.44% and 0.42% for the 2005 and 2004 analyses, respectively. The change in fair value of each security was estimated as the change in the option adjusted value of each security. Option adjusted values were computed using Company payment models and provisions for the effects of possible future changes in interest rates. The analyses did not explicitly provide for the possibility of non-parallel shifts in the yield curve, which would involve discount rates for different maturities being increased by different amounts. The actual change in fair value of the Company’s financial assets can be significantly different from that estimated by the model. The hypothetical reduction in the fair value of the Company’s financial assets that resulted from the model was estimated to be $169 million and $162 million at December 31, 2005 and 2004, respectively.
Net cash provided by operations is net income adjusted for non-cash items and accruals. Net cash provided by operating activities was $407.1 million, $404.8 million and $337.4 million for 2005, 2004 and 2003, respectively.
The Company maintains a diversified investment portfolio consisting primarily of fixed maturity securities and fixed-rate commercial mortgage loans. Investing cash inflows consist primarily of the proceeds of investments sold, matured or repaid. Investing cash outflows consist primarily of payments for investments acquired or originated.
Commercial mortgage loans in California accounted for 31.2% of our commercial mortgage loan portfolio at December 31, 2005. Through this concentration, we are exposed to potential losses resulting from the risk of an economic downturn in California as well as to certain catastrophes, such as earthquakes, that may affect the state. 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. 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, we cannot provide assurance that material catastrophe or earthquake damage to the properties in our commercial mortgage loan portfolio will not occur.
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. 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.
Under the laws of certain states, contamination of 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 the Company’s 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 consist primarily of policyholder fund deposits and withdrawals, borrowings and repayments on the
We had debt to total capitalization ratios of 16.2% and 17.0% at December 31, 2005 and 2004, respectively. Our ratio of earnings to fixed charges for the years ended December 31, 2005 and 2004, was 4.0x and 3.9x, respectively.
State insurance departments require insurance enterprises to maintain minimum levels of capital and surplus. Our target is generally to maintain capital at 265% to 275% of the company action level of Risk-based Capital (“RBC”) required by regulators (this equates to 530% to 550% of the authorized control level RBC required by our states of domicile). At December 31, 2005, statutory capital (adjusted to exclude asset valuation reserves) for our regulated insurance subsidiaries totaled $1.06 billion, or 321% of the company action level RBC (which equated to 642% of the authorized control level RBC by the National Association of Insurance Commissioners (“NAIC”) guidelines).
At December 31, 2005, our total capital in excess of targeted RBC and holding company requirements was approximately $230 million. We will continue to maintain our three priorities, in the following order, for the remaining excess capital:
fund acquisitions that are consistent with our mission and meet our return objectives, and
The levels of excess capital 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 excess capital. At very high levels of premium growth, we could generate the need for capital infusions. At lower levels of premium growth, we generate more excess capital. With premium growth at levels lower than our long-term objective in 2003 and 2004, we have accumulated excess capital. If not utilized, return on average equity for 2006 and future years may be lower than without excess capital, as the rate of return available from the related investments could be less than we would expect to achieve if invested in businesses meeting our return objectives.
StanCorp’s ability to pay dividends to its shareholders, repurchase its shares and meet its obligations substantially depends upon the receipt of distributions from its subsidiaries, including Standard. Standard’s ability to pay dividends to StanCorp is affected by factors deemed relevant by Standard’s board of directors, including the ability to maintain adequate RBC according to Oregon law. Under Oregon law, Standard may pay dividends only from the earned surplus arising from its business. It also must receive the prior approval of the Director of the Oregon Department of Consumer and Business Services - Insurance Division (“Oregon Insurance Division”) to pay a dividend if such dividend exceeds certain statutory limitations. The current statutory limitations are the greater of (a) 10% of Standard’s combined capital and surplus as of December 31 of the preceding year, or (b) the net gain from operations after dividends to policyholders and federal income taxes before realized capital gains or losses for the 12-month period ended on the December 31 preceding. In each case, the limitation must be determined under statutory accounting practices. Oregon law gives the Oregon Insurance Division broad discretion to disapprove requests for dividends in excess of these limits. The current amount of distributions approved by the board of directors, based on excess capital at December 31, 2005, is $179 million. We anticipate seeking approval of a distribution from the Oregon Insurance Division during 2006.
There is no amount available for payment of dividends by The Standard Life Insurance Company of New York in 2006. There are no regulatory restrictions on dividends from non-insurance subsidiaries to StanCorp. StanCorp Mortgage Investors paid dividends to StanCorp of $13 million and $10 million for 2005 and 2004, respectively.
Standard & Poor’s, Moody’s Investors Service, Inc., Fitch, Inc. and A.M. Best Company provide credit ratings on our senior notes. As of February 2006, ratings from these agencies were BBB+, Baa1, A- and bbb+, respectively. In July 2005, A.M. Best Company assigned an issuer credit rating of a+ to StanCorp.
In the normal course of business, the Company is involved in various legal actions and other state and federal proceedings. A number of actions or proceedings were pending as of December 31, 2005. In some instances, lawsuits include claims for punitive damages and similar types of relief in unspecified or substantial amounts, in addition to amounts for alleged contractual liability or other compensatory damages. In the opinion of management, the ultimate liability, if any, arising from the actions or proceedings is not expected to have a material adverse effect on the Company’s business, financial position, results of operations or cash flows.
The Company’s long-term debt obligations consisted primarily of the $250.0 million 6.875%, 10-year senior notes. Interest payable related to long-term debt obligations totals $126.9 million for the periods shown in the table. The operating lease obligations include leases on certain buildings and equipment under non-cancelable operating leases, software maintenance, licensing, and telecommunication commitments, all expiring in various years through 2013 with renewal options ranging from one to nine years.
In the normal course of business, the Company commits to fund commercial mortgage loans generally up to 90 days in advance. At December 31, 2005, the Company had outstanding commitments to fund commercial mortgage loans totaling $118.6 million, with fixed interest rates ranging
from 5.50% to 6.50%. These commitments generally have fixed expiration dates. A small percentage of commitments expire due to the borrower’s failure to deliver the requirements of the commitment by the expiration date. In these cases, the Company will retain the commitment fee and good faith deposit. Alternatively, if we terminate a commitment due to the disapproval of a commitment requirement, the commitment fee and good faith deposit may be refunded to the borrower, less an administrative fee.
The insurance obligations in the table are actuarial estimates of the cash required to meet our obligations for future policy benefits and claims. These estimates do not represent an exact calculation of our future benefit liabilities, but are instead based on assumptions, which involve a number of factors, including mortality, morbidity, recovery, the consumer price index, reinsurance arrangements and other sources of income for people on claim. Assumptions may vary by age and gender and, for individual policies, occupation class of the claimant; time elapsed since disablement; and contract provisions and limitations. Certain of these factors could be materially affected by changes in social perceptions about work ethics, emerging medical perceptions and legal interpretations regarding physiological or psychological causes of disability, emerging or changing health issues and changes in industry regulation. Changes in one or more of these factors or if actual claims experience is materially inconsistent with our assumptions, could cause actual results to be materially different from the information presented in the table. Not included in the table is approximately $837.4 million in other reserve liabilities where the amount and timing of related payouts cannot be reasonably determined.
Insolvency regulations exist in many of the jurisdictions in which subsidiaries of the Company 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 the Company from January 1, 2003, through December 31, 2005, aggregated $0.3 million. At December 31, 2005, the Company maintained a reserve of $0.8 million for future assessments with respect to currently impaired, insolvent or failed insurers.
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.
Statutory net gains from insurance operations before federal income taxes were $314.0 million, $275.8 million and $214.2 million for 2005, 2004 and 2003, respectively. Statutory capital (adjusted to exclude asset valuation reserves) for our insurance regulated subsidiaries totaled $1.06 billion and $1.02 billion at December 31, 2005 and 2004, respectively.
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 impairments, the reserves for future policy benefits and claims, DAC and VOBA, 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.
Quarterly, we evaluate the appropriateness of the discount rate used to establish new long term disability claim reserves. We determine the discount rate based on the average rate of return on invested assets we acquire during the quarter less a margin to allow for reinvestment risk and credit quality
deterioration. If assets are subsequently reinvested at rates less than the established discount rate on the reserves or credit quality deterioration is worse than provided for in the margin, we could be required to increase our reserves.
Consolidated Statements of Changes in Shareholders’ Equity for the years ended December 31, 2005, 2004 and 2003
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of December 31, 2005, based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 2, 2006 expressed an unqualified opinion on management’s assessment of the effectiveness of the Company’s internal control over financial reporting and an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
StanCorp is a leading provider of employee benefit products and services serving the life and disability insurance needs of employer groups and individuals. Through our subsidiaries, we have the authority to underwrite insurance products in all 50 states. We also provide accidental death and dismemberment (“AD&D”), dental insurance, annuity products, retirement plan products and services and investment advisory services. Our mortgage business originates and services small fixed-rate commercial mortgage loans for the investment portfolios of our insurance subsidiaries and for sale to institutional investors. We operate through three segments: Employee Benefits, Individual Insurance and Retirement Plans, each of which is described below.
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 services to our retirement plan clients and other individuals. It also provides
StanCorp Equities is a licensed broker-dealer. For the sale of registered contracts, a broker-dealer must serve as principal underwriter and distributor, providing supervision and oversight that is required by the National Association of Securities Dealers. Standard has developed a registered contract to expand its market to 403(b) plans, 457 tax-exempt plans and nonqualified deferred compensation plans of private employers. StanCorp Equities is the principal underwriter and distributor of registered contracts for Standard.
Certain subsidiaries of StanCorp have interests in low-income housing investments. Individually, the interests in these subsidiaries do not represent a significant subsidiary pursuant to the definition in Financial Accounting Standards Board (“FASB”) Interpretation No. 46, “Consolidation of Variable Interest Entities,” nor do they meet the requirements for consolidation. The total equity investment in these interests approximated $21 million and $19 million at December 31, 2005 and 2004, respectively.
Minority interest related to consolidated entities included in other liabilities was $143.7 million at December 31, 2005, and $0.6 million at December 31, 2004. The increase was due to the establishment of a new subsidiary, which invests in commercial mortgage loans originated by StanCorp Mortgage Investors.
The consolidated financial statements include StanCorp and its subsidiaries. Intercompany balances and transactions have been eliminated. Certain 2004 and 2003 amounts have been reclassified to conform to the current presentation. Contract administration fees in the Retirement Plans segment, fees on administrative services only contracts in the Employee Benefits segment and administration fees from our mortgage loan and investment advisory companies have been reclassified to administrative fees in revenues. These fees were formerly included in premiums, other revenue and net investment income, respectively.
On November 14, 2005, the Board declared a two-for-one stock split of the Company’s common stock effected in the form of a 100% common stock dividend. All shareholders of record on November 25, 2005 received one additional share of common stock for each share held on that date. The additional shares of common stock were distributed to shareholders of record in the form of a stock dividend on December 9, 2005. All share and per share amounts in the accompanying consolidated financial statements and related notes have been adjusted to reflect the stock split for all periods presented.
Our consolidated financial statements and certain disclosures made in this Form 10-K have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and require us to make estimates and assumptions that affect reported amounts of assets and liabilities and disclosures of contingent assets and 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 (the “critical accounting policies”) are those used in determining impairments, the reserves for future policy benefits and claims, deferred acquisition costs (“DAC”) and value of business acquired (“VOBA”), 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.
will not recover. During the six month period, or as long as the holding is valued below 80% of its book value, the holding is watched for potential permanent impairment. At December 31, 2005, we held no issues that had market values below 80% of their book value.
Investment securities include fixed maturity securities. Fixed maturity securities are classified as available-for-sale and are carried at fair value on the consolidated balance sheets. Valuation adjustments are reported as net increases or decreases to other comprehensive income (loss), net of tax, on the consolidated statements of income and comprehensive income.
Non-affiliated tenants leased approximately 40.6%, 41.6% and 41.8% of the home office properties at December 31, 2005, 2004 and 2003, respectively. Income from the leases is included in net investment income.
On December 16, 2004, the FASB issued Financial Accounting Standard (“FAS”) No.123(R), Share Based Payment, which amends FAS No.123 and FAS No.95, Statement of Cash Flows, effective for fiscal years beginning after June 15, 2005. The FASB also issued FASB Staff Position (“FSP”) No. FAS 123(R)-1, Classification and Measurements of Freestanding Financial Instruments Originally Issued In Exchange for Employee Services under FASB Statement No. 123(R) on August 31, 2005, FSP No. FAS 123(R)-2, Practical Exception to the Application of Grant Date as Defined in FASB Statement No. 123(R) on October 18, 2005, and FSP No. FAS 123(R)-3, Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards on November 10, 2005, which are all effective upon the adoption of FAS No. 123(R) or the effective date of the FSP, whichever is later. The statement and related FSP’s require compensation costs related to share-based payment transactions be recognized in operating expense, including grants prior to 2003 when the Company began to expense option grants (the “modified prospective” method). The use
On September 19, 2005, the American Institute of Certified Public Accountants issued Statement of Position (“SOP”) No. 05-01, Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection With Modifications of Exchanges of Insurance Contracts, effective for internal replacements occurring in fiscal years beginning after December 15, 2006. The SOP defines an internal replacement as modifications in product benefits, features, rights or coverages that occur by the exchange of a contract for a new contract, or by amendment, endorsement, or rider to a contract, or by election of a feature or coverage within an existing contract. Accounting treatment for such replacements depends on whether the replacement contract is considered substantially changed from the original. A substantial change requires treating the new contract as an extinguishment of the original, with all unamortized DAC, unearned revenue liabilities and deferred sales inducement assets from the replaced contract no longer deferred. The Company currently eliminates any unamortized DAC for all replaced business, and is evaluating the remaining potential financial statement effect of SOP 05-1, if any.
Consolidated Financial Statements since December 31, 2003, using the rules of the approved portions of the EITF 03-1 at that time. No additional financial statement impact is expected upon adoption of the FSP in 2006.
We operate through three segments: Employee Benefits, Individual Insurance and Retirement Plans. Resources are allocated and performance is evaluated at the segment level. The Employee Benefits segment sells group disability and life insurance, group dental insurance, and AD&D insurance. The Individual Insurance segment sells disability insurance and fixed-rate annuities to individuals. The Retirement Plans segment offers full-service 401(k), 457, defined benefit,
Prior to 2006, Other included financial service businesses that are generally non-insurance related. These included StanCorp Mortgage Investors, our commercial mortgage lending business, StanCorp Investment Advisers, our registered investment adviser, and StanCorp Equities, our licensed broker-dealer, which serves as the principal underwriter and distributor of registered contracts for Standard. This category also included net capital gains and losses on investments, return on capital not allocated to the product segments, holding company expenses, interest on senior notes, and adjustments made in consolidation.
Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations. Callable bonds represent 2.0%, or $92.2 million, of our investment securities.
Securities deposited for the benefit of policyholders in various states, in accordance with state regulations, amounted to $6.4 million and $5.5 million at December 31, 2005 and 2004, respectively.
The following table sets forth our investments’ gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2005:
The following table sets forth our investments’ gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2004:
Commercial mortgage loans in California account for 31.2% of our commercial mortgage loan portfolio at
December 31, 2005. Due to this concentration, we are exposed to potential losses resulting from the risk of an economic downturn in California as well as to certain catastrophes, such as earthquakes, that may affect the region. Although we diversify our commercial mortgage loan portfolio within California by both location and type of property in an effort to reduce earthquake exposure, such diversification may not eliminate the risk of such losses. 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.
the Company’s business, financial position, results of operations or cash flows.
The Company is carrying forward a net operating loss of $11.0 million that originated in the parent company and The Standard Life Insurance Company of New York. The loss will be used in future years to offset taxable income from those entities to the degree allowed by the Internal Revenue Code. If unutilized, $2.3 million would expire in 2024, $2.5 million would expire in 2025 and $6.2 million would expire in 2026.
A minimum pension liability adjustment is required when the actuarial present value of the accumulated benefit obligation exceeds plan assets. The plan assets of our plans exceed the accumulated benefit obligation. The following table summarizes the projected and accumulated benefit obligations and the fair value of assets for our plans at December 31:
The following table sets forth the Company’s target and actual weighted-average asset allocations for defined benefit pension plans at December 31:
Equity securities in the employee pension plan portfolio totaled $90.1 million and $74.3 million at December 31, 2005 and 2004, respectively. The plan held no StanCorp securities as plan assets at December 31, 2005 and 2004.
In 2005, the Company contributed $26.0 million to the plans, increasing the prepaid benefit cost. The Company is not obligated to make any contributions to its pension plans for 2006.
Eligible executive officers are covered by a non-qualified supplemental retirement plan. The accrued benefit cost was $12.7 million and $11.7 million at December 31, 2005 and 2004, respectively. Expenses were $1.6 million, $1.4 million and $1.4 million for 2005, 2004 and 2003, respectively. As of December 31, 2005, an additional liability of $1.1 million, net of tax, was recognized and reported in accumulated other comprehensive income.
Eligible executive officers, directors, agents and group producers may participate in one of several non-qualified deferred compensation plans under which a portion of the deferred compensation may be matched. The liability for the plans was $7.8 million and $8.2 million at December 31, 2005 and 2004, respectively.
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 will be limited to employees who either have reached the age of 40 as of January 1, 2006, or whose combined age and length of service are equal to or greater than 45 years as of January 1, 2006. The reduction in postretirement benefits did not have a material impact on our financial statements.
At December 31, 2005, the Company had contributed approximately $0.5 million to fund the postretirement benefit plan. The Company expects to make contributions of $0.7 million to its postretirement benefit plan in 2006.
The 1999 Omnibus Stock Incentive Plan authorizes the board of directors of StanCorp to grant eligible employees certain incentive or non-statutory stock options, bonuses and
to StanCorp’s common stock. All options are granted at a stock price of not less than the market value at the date of the option grant and may be exercised for a period not exceeding ten years from the date of the grant. The maximum number of shares of common stock that may be issued under this plan is 3.4 million, substantially all of which had been issued or optioned by the end of 2005.
In 2002, we adopted the 2002 Stock Incentive Plan. This plan authorizes the board of directors to grant eligible employees and certain related parties incentive or non-statutory stock options and restricted stock. The maximum number of shares of common stock that may be issued under this plan is 2.9 million. By the end of 2005, 1.4 million shares, or options for shares had been issued under the 2002 plan. Employee options are subject to a four-year annual step-vesting schedule beginning one year after the date of grant. Directors’ options vest in one year.
The Company grants to certain key management employees restricted stock in which full ownership is not vested until the attainment of certain financial benchmarks (“performance” shares), or the completion of a specified period of employment with the Company (“retention” shares). Grants of performance shares were made in 2004 and 2005 to be released upon attainment of predetermined performance goals for years 2005 through 2008. The Company’s experience with performance shares was as follows for the years ended December 31:
The Company’s experience with retention shares was as follows for the years ended December 31:
The weighted-average grant date fair value of the retention shares granted was $32.47 and $24.41 per share for the shares granted in 2004 and 2003, respectively. There were no retention shares granted in 2005.
maintenance of a strong financial position, maintenance of reinsurance and risk pool arrangements, and sufficient alignment of assets and liabilities to meet financial obligations.
Standard is involved in a reinsurance and third party administration arrangement with The Northwestern Mutual Life Insurance Company (“Northwestern Mutual”) under which 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. Premiums assumed by Standard for the Northwestern Mutual business accounted for 3.4%, 3.5% and 3.4% of the Company’s total premiums for 2005, 2004 and 2003, respectively. In addition to assuming risk, Standard provides product design, pricing, underwriting, legal support, claims management and other administrative services under the arrangement. 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, 2005, was $210.8 million.
In addition to product-specific reinsurance arrangements, we maintain reinsurance coverage for certain catastrophe losses related to group life and AD&D. Through a combination of our participation in a catastrophe reinsurance pool and a catastrophe reinsurance agreement, we have coverage of up to approximately $300 million per event.
Subsequent to the terrorist events of September 11, 2001, the availability of reinsurance for catastrophe coverage became less certain and more expensive. Accordingly, we entered into a catastrophe reinsurance pool with other insurance companies. This pool spreads catastrophe losses on group life and AD&D over approximately 32 participating members. The annual fees paid by the Company to participate in the pool and claims to date have been minor. As a member of the pool, we are exposed to potential losses experienced by other participating members of approximately $69 million for a single event for losses submitted by a single company, and approximately $172 million for a single event for losses submitted by multiple companies. If we had been a member of the pool on September 11, 2001, the estimated pre-tax charges related to the terrorist events would have been approximately $15 million, compared to pre-tax charges of $5 million incurred. The Company’s percentage share of losses experienced by pool members will change over time as it is a function of our group life and AD&D in
The Terrorism Risk Insurance Act of 2002 (“TRIA”) provided for federal government assistance to property and casualty insurers in the event of material losses due to terrorist acts on behalf of a foreign person or foreign interest. In December 2005, Congress passed the Terrorism Risk Insurance Extension Act of 2005, extending TRIA through the end of 2007. Group life insurance is not currently covered under TRIA. Group life insurance represents a significant portion of our revenues and income. Concentration of risk is inherent in the group life insurance products we offer and we have group life insurance exposure to certain customers in amounts significantly in excess of our catastrophe reinsurance coverage. Because of our concentration of risk, an occurrence of a significant catastrophe or a change in the on-going nature and availability of reinsurance and catastrophe reinsurance could have a material adverse effect on the Company’s business, financial position, results of operations or cash flows.
Effective October 1, 2002, Standard entered into a reinsurance agreement with TIAA to assume TIAA’s group disability and group life insurance business. This business included approximately 1,800 group insurance contracts, representing 650,000 insured individuals. Standard paid a ceding commission of approximately $75 million and received approximately $705 million in assets and corresponding statutory liabilities. If Standard were to 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, 2005, was approximately $567.7 million. Approximately $60 million in VOBA was capitalized related to the reinsurance agreement.
Effective January 1, 2001, Standard ceded to Protective Life, through a reinsurance agreement, Standard’s individual life insurance product line. Standard received a ceding commission of approximately $90 million and transferred to Protective Life approximately $790 million in assets and corresponding statutory liabilities. If Protective Life were to become unable to meet its obligations, Standard would retain the reinsured liabilities. Therefore, the liabilities remain on Standard’s books and an equal amount is recorded as a recoverable from reinsurer. In accordance with the agreement, Protective Life established a trust for the benefit of Standard with assets in the trust required to be equal to Standard’s reinsurance receivable from Protective Life. The amount of assets required to be maintained in the trust is determined quarterly.
Statutory accounting practices differ in some respects from GAAP. The principal statutory practices which differ from GAAP are: a) bonds and commercial mortgage loans are reported principally at amortized cost; b) asset valuation and IMR 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.
proceedings. A number of actions or proceedings were pending as of December 31, 2005. In some instances, lawsuits
include claims for punitive damages and similar types of relief in unspecified or substantial amounts, in addition to amounts for alleged contractual liability or other compensatory damages. In the opinion of management, the ultimate liability, if any, arising from the actions or proceedings is not expected to have a material adverse effect on the Company’s business, financial position, results of operations or cash flows.
At December 31, 2005, minimum future rental receivables on non-cancelable leases of retail and office space with initial terms of one year or more were 2006, $11.9 million; 2007, $11.6 million; 2008, $10.4 million; 2009, $9.2 million and thereafter, $27.1 million.
The insurance obligations in the table are actuarial estimates of the cash required to meet our obligations for
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 $1.95 billion in policyholder funds that may be withdrawn upon request. In addition, amounts presented also exclude separate account liabilities of $3.01 billion.
From time to time, the board of directors has authorized share repurchase programs. Share repurchases are to be effected in the open market or in negotiated transactions in compliance with the safe harbor provisions of Rule 10b-18 under regulations of the Securities Exchange Act of 1934. Execution of the share repurchase program is based upon management’s assessment of market conditions for its common stock and other potential growth opportunities. On November 14, 2005, the board of directors authorized a new share repurchase program of up to 3.0 million shares of StanCorp common stock on a post-stock-split basis. The new repurchase program will be affected in the open market or in
During 2005, the Company repurchased approximately 2.7 million shares of common stock at a total cost of $106.4 million for a volume weighted-average price of $39.90 per common share. At December 31, 2005, the Company had 2,968,000 shares remaining under its current share repurchase program. Also during 2005, the Company acquired 17,558 shares of common stock from an executive officer and from a director to cover tax liabilities resulting from the release of performance-based shares at a total cost of $0.7 million for a volume weighted-average price of $42.44 per common share.