Management believes that the capacity and types of facilities are suitable and adequate for the present and foreseeable future.
Represents costs related to the Plan of Reorganization (see Item 1, “Business-General”).
The following analysis of the consolidated financial condition and results of operations of StanCorp Financial Group, Inc. (“StanCorp”) and its subsidiaries (collectively, the “Company”) should be read in conjunction with the consolidated financial statements and related notes thereto.
The management of the Company has made in this Form 10-K, and from time to time may make in its public filings, news releases and oral presentations and discussions, certain statements related to projected growth and future events. Such statements may relate to regulatory actions, the intent, belief, or current expectations of the Company’s management, the future operating performance of the Company and other statements regarding matters that are not historical facts. These statements are “forward-looking” statements as that term is defined in the Private Securities Litigation Reform Act of 1995. Because such statements are subject to risks and uncertainties, actual results in future periods may differ materially from those expressed or implied by such forward-looking statements. Factors that could cause actual results to differ materially from those expressed or implied by such forward-looking statements include, but are not limited to: (i) claims experience and deterioration in morbidity, mortality, and persistency, (ii) changes in interest rates or the condition of the national economy, (iii) changes in the regulatory environment at the state or Federal level, (iv) competition from other insurers and financial services companies, (v) achievement of financial objectives including premium growth, growth in assets under management, or other growth objectives, (vi) asset credit quality and delinquencies on bonds and commercial mortgage loans, (vii) successful entry into the New York insurance market, (viii) achievement of expense management objectives, (ix) changes in claims paying ability ratings, (x) adverse findings in litigation or other legal proceedings, (xi) availability and adequacy of reinsurance and catastrophe reinsurance coverage, (xii) potential charges resulting from membership in a catastrophe reinsurance pool, (xiii) events of terrorism, (xiv) adequacy of the diversification of geographic or industry risk, (xv) ability to achieve financing objectives, and (xvi) on-going risks associated with dependence on information technology systems.
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 and laws. If it is determined to be more likely than not that a deferred tax asset will not be realized, a valuation allowance will be established. Amounts provided for uncertainties and adjustments primarily reflect uncertainties related to the use of estimates and the subsequent resolution of those uncertainties. Resolution occurs when amounts provided on an estimated basis are known or when the tax year closes.
Effective October 1, 2000, Standard Insurance Company (“Standard”) acquired a substantial block of individual disability insurance business, through a reinsurance transaction, from Minnesota Life Insurance Company (“Minnesota Life”). Standard paid a ceding commission of approximately $55 million and received approximately $500 million in assets and corresponding liabilities. In accordance with the agreement with Minnesota Life, Standard established a trust for the benefit of Minnesota Life. The market value of assets required to be maintained in the trust at December 31, 2001 was $547.3 million. Accompanying this transaction was an agreement that provides access to Minnesota Life agents who now market Standard’s individual disability insurance products.
The Company’s stated financial objectives are to grow premiums at 10% to 12% per year, grow operating income (net income excluding after tax realized capital gains or losses and special items, which in 2000 consisted of severance costs associated with disposition of the individual insurance product line) per diluted common share 12% to 15% per year, and increase annual operating return on average equity to 13% to 14% by the end of 2003.
The Company reaffirms its financial objectives for 2002 and has established a new financial objective to increase annual operating return on average equity to 14% to 15% by the end of 2005.
Premiums increased $129.7 million, or 11.8%, in 2001 primarily from premium growth in the Employee Benefits-Insurance segment, offset in part by a decrease in premiums in the Individual Insurance segment as a result of the combined effect of two reinsurance transactions. Premiums increased $142.8 million, or 14.9%, in 2000 compared to 1999 primarily from premium growth in the Employee Benefits-Insurance segment. Management believes the rate of premium growth in 2002 may be at a lower level than achieved in 2001 primarily due to economic uncertainties, including higher levels of national unemployment and caution on the part of employers when introducing new employee benefits, but still within the Company’s stated financial objectives. (See “-Selected Segment Information.”)
Net investment income, which is affected primarily by changes in the overall interest rate environment and levels of invested assets, decreased $9.8 million, or 2.7%, in 2001 compared to 2000. The decrease primarily related to the net reduction of invested assets of $290 million as a result of the combined effect of two reinsurance transactions in the Individual Insurance segment. The decrease was offset in part by asset growth in the Company’s other segments. In addition, the portfolio yield decreased due to overall declines in the interest rate environment. The portfolio yield for the fixed maturity securities decreased to 6.79% at December 31, 2001, from 7.01% at December 31, 2000. The portfolio yield for commercial mortgage loans decreased to 8.22% at December 31, 2001, from 8.34% at December 31, 2000. Portfolio yields may increase or decrease in the future depending on changes in the overall interest rate environment and other factors.
Policyholder benefits increased $109.8 million, or 12.1%, in 2000 compared to 1999. The increase resulted primarily from business growth, as evidenced by premium growth, in the Employee Benefits-Insurance segment.
Methods used by the Company to manage risk include, but are not limited to, sound product design and underwriting, effective claims management, disciplined pricing, distribution expertise, broad distribution of risk by geography, industry, occupation, customer size and salary range, and maintenance of a strong balance sheet. As a part of risk management, the Company has maintained reinsurance and catastrophe reinsurance in the past for protection from fluctuations. Subsequent to the events of September 11, 2001 the Company entered into a catastrophe reinsurance pool. The pool covers group life and accidental death and dismemberment for about 40 participating members of the pool. The reinsurance pool brings exposure to potential losses experienced by other participating members of the pool but substantially increases the Company’s catastrophe reinsurance coverage to approximately $200 million per event. If the Company had been in 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 $5.0 million actually incurred. An occurrence of a significant catastrophic event, 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.
Operating expenses increased $13.8 million, or 7.4%, in 2001 compared to 2000, and $21.4 million, or 12.9%, in 2000 compared to 1999. The increases for both comparative periods were primarily from operating expense growth in the Employee Benefits-Insurance segment to support business growth as evidenced by premium growth. Operating expenses have generally been managed to a rate of growth less than the rate of premium growth. However, the margin between the rate of operating expense growth and the rate of premium growth has fluctuated from year to year. In 2001 operating expense growth was unusually low compared to premium growth. Management believes that this unusually favorable margin between operating expense growth and premium growth may not be maintained in 2002 due to the possibility that the rate of premium growth in 2002 may be at a lower level than achieved in 2001. A reduction in the rate of premium growth could be caused by economic uncertainties, including higher levels of national unemployment and caution on the part of employers when introducing new employee benefits. Over time, however, management continues to expect that operating expenses will grow at a rate that is less than the rate of premium growth.
Commissions and bonuses primarily represent sales based compensation that vary depending on the product, whether the sale is in its first year or a renewal year, and other factors. Therefore, commissions will tend to fluctuate with premiums, but not directly. Commissions and bonuses increased $15.6 million, or 15.2%, for 2001 compared to 2000, and increased $19.4 million, or 23.3%, for 2000 compared to 1999. The increases for both comparable periods were primarily due to increased sales for disability income and annuity products in the Individual Insurance segment (see “-Selected Segment Information”).
Net Increase in Deferred Policy Acquisition Costs and Value of Business Acquired
The net reduction in expense for deferral and amortization of policy acquisition costs was $16.3 million for 2001 compared to $7.1 million for 2000, and $0.2 million in 1999. The net reduction in expense for both comparative periods resulted primarily from deferral of higher commissions in the Individual Insurance segment related to the two reinsurance transactions (see “-Commissions and Bonuses” and “Selected Segment Information - Individual Insurance Segment”). Management anticipates the 2002 rate of growth in the net reduction in expense for deferral and amortization of policy acquisition costs to approximate the rate of premium growth.
Total income taxes 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 35.6%, 32.9% and 34.0% for 2001, 2000
and 1999, respectively. The higher effective rate in 2001 compared to 2000 resulted primarily from a change in the tax return filing status and amounts provided for uncertainties. The lower effective rate in 2000 compared to 1999 resulted primarily from reorganization expenses in 1999, which generally were not deductible. The years currently open for audit by the Internal Revenue Service are 1996 through 2001. (See “-Liquidity and Capital Resources-Operating Cash Flows” and Item 8, “Financial Statements and Supplementary Data-Notes to Consolidated Financial Statements.”)
The following table sets forth selected segment information at or for the years ended December 31:
The Employee Benefits-Insurance segment’s products are designed for groups ranging in size from two lives to over 150,000 lives. The Company is a leading provider of group life and long and short term disability insurance products, serving more than 33,000 employer groups representing more than 5.6 million employees. The Employee Benefits-Insurance segment also markets group dental insurance and accidental death and dismemberment (“AD&D”) insurance. As the largest of the Company’s three segments, Employee Benefits-Insurance premiums accounted for 91.7%, 88.3% and 89.2% of the Company’s total premiums for 2001, 2000 and 1999, respectively.
Excluded from the computation of the benefit ratio for 2001 were $4.3 million in pre-tax charges incurred as a result of the terrorist events of September 11.
Net investment income increased $22.1 million, or 13.4%, for 2001 compared to 2000, primarily resulting from an increase in average invested assets supporting the segment of 12.2% for the same comparative periods. During 2001, there were revisions to certain disability insurance Risk-Based Capital factors that reduced the level of capital required for this segment. In 2002, the reduced capital requirement will result in decreased average invested assets supporting this segment and therefore decreased net investment income. Offsetting increases in average invested assets and net investment income will benefit the Company’s other businesses (see “-Liquidity and Capital Resources-Risk-Based Capital”).
business growth, as evidenced by premium growth, combined with stable claims experience. The benefit ratio for 2001, excluding the $4.3 million in pre-tax charges related to the terrorist events of September 11, was 82.1%, the same as for 2000. Policyholder benefits are affected by claims experience, which can fluctuate significantly from period to period. (See “-Selected Segment Information.”)
The Individual Insurance Segment sells disability insurance and fixed rate annuities to individuals. Two transactions were completed in 2000 and 2001 for the segment. One transaction, effective October 1, 2000, involved acquiring a substantial block of individual disability insurance business, which management believes has higher growth potential and for which the Company possesses economies of scale, market differentiation and expertise. The second transaction, effective January 1, 2001, involved selling the individual life insurance product line, for which Standard did not possess economies of scale (see “-Acquisition and Disposition of Product Lines”). The timing of the two transactions was such that the fourth quarter of 2000 included results from both blocks of business, distorting growth trends when comparing 2001 results to 2000 results. Also, the individual life insurance block of business sold was larger than the disability insurance block of business acquired, resulting in overall decreases in revenues, benefits and expenses in 2001. The following table sets forth selected financial data for the Individual Insurance segment for the years ended December 31:
Excluded from the computation of the benefit ratio for 2001 were $0.7 million in pre-tax charges incurred as a result of the terrorist events of September 11.
Excludes after tax realized capital gains or losses and special items in 2000, which consisted of severance costs associated with disposition of the individual life product line.
Operating expenses decreased $4.9 million, or 17.6%, in 2001 compared to 2000, and increased $2.1 million, or 8.2%, in 2000 compared to 1999. The decrease in 2001 primarily resulted from the two reinsurance transactions discussed above, including related staff reductions. Operating expenses in 2000 included expenses from the individual disability insurance block of business acquired in the fourth quarter of 2000, as well as $1.9 million for severance costs related to the disposition of the individual life insurance product line.
Commissions and bonuses increased $7.9 million, or 53.7%, in 2001 compared to 2000, and $2.5 million, or 20.5%, in 2000 compared to 1999. The increases are primarily related to increased sales for the segment.
The net reduction in expenses for deferred policy acquisition costs and value of business acquired was $11.8 million in 2001 and $1.2 million in 2000, compared to an increase in expense of $2.8 million in 1999. The net reductions in expenses for 2001 and 2000 primarily reflect higher commissions.
The Retirement Plans segment offers full-service 401(k) and other pension plan products and services. The segment’s primary sources of revenues include plan administration fees, fees on separate account assets under management and investment return on general account assets under management. In addition, the segment’s premiums and policyholder benefits reflect the conversion of 401(k) plan assets into life contingent annuities, which can be designated by plan participants at the time of retirement. Developing significant future profitability from the segment is dependent upon continued increases in assets under management to improve economies of scale. Management estimates that this segment will reach sustainable profitability when assets under management reach approximately $2.0 billion to $2.5 billion. During 2001, sales of new cases and transfer deposits were higher than the same period in 2000, while termination rates were lower. The improving factors almost entirely offset the effects of declining market values on equity securities held for Retirement Plans participants in the separate account. The following table sets forth selected financial data for the Retirement Plans segment at or for the years ended December 31:
Premiums decreased $2.7 million, or 11.4%, in 2001 compared to 2000 primarily due to a $2.5 million decrease in premiums for life contingent annuities, which resulted in a corresponding decrease in policyholder benefits. Premiums increased $7.1 million, or 42.8%, in 2000 compared to 1999 due to a $5.8 million increase in fees from separate account assets under management as well as a $1.3 million increase in premiums for life contingent annuities.
Net investment income, which includes the return on general account assets under management, increased $1.4 million, or 2.8%, in 2001 compared to 2000 and remained stable in 2000 compared to 1999. The profitability of the Retirement Plans segment is, in part, dependent on the maintenance of targeted interest rate spreads. Therefore interest credited to policyholders should generally trend with net investment income.
Beginning in the third quarter of 2001, the Company deferred $0.9 million in acquisition costs. Costs deferred primarily included initial commissions and incentive compensation payouts on newly established plans, and will be amortized over a period of approximately ten years.
Net cash outflows in 2001 included $137.2 million in cash disbursed related to the sale of the individual life insurance business. The sale involved transferring investments and cash equal to the liabilities ceded, less a ceding commission received by the Company of approximately $90 million. In addition, investing activities included receipt in 2000 and investment in 2001 of $452.3 million related to the acquisition of the individual disability insurance business. The acquisition involved receiving cash equal to the liabilities assumed, less a ceding commission paid by the company of approximately $55 million. (See “-Acquisition and Disposition of Product Lines” and “-Selected Segment Information-Individual Insurance Segment.”)
At December 31, 2001, commercial mortgage loans represented 41.9% of the total invested assets and were collateralized by properties located in the Western region representing 62.0% of the portfolio, Central region representing 22.6% of the portfolio, and the Eastern region representing 15.4% of the portfolio. Of the total mortgage loan portfolio, 40.7% of the collateralized properties were located in the state of California. The Company does not require earthquake insurance for properties on which it makes commercial mortgage loans, but does consider the potential for earthquake loss based upon seismic surveys and structural information specific to each property when new loans are underwritten. The most significant types of collateralized properties in the mortgage loan portfolio include retail properties, representing 48.9% of the portfolio, industrial properties, representing 24.4% of the portfolio, and office properties, representing 19.8% of the portfolio. The remaining 6.9% of properties in the portfolio include commercial, apartment, residential and agricultural properties. The average loan to value ratio on the overall portfolio was 57% at December 31, 2001, and the average loan size was
$0.7 million. The Company’s commercial mortgage loans are subject to both delinquency and default risk. The delinquency and loss performance of the Company’s mortgage loan portfolio have consistently outperformed the industry averages, as reported by the American Council of Life Insurance, by wide margins. At December 31, 2001, there was one loan totaling $0.5 million in the process of foreclosure, and no other delinquencies. The performance of the Company’s mortgage loan portfolio may fluctuate in the future. Should the delinquency rate of the Company’s mortgage loan portfolio increase, the increase could have a material adverse effect on the Company’s business, financial position, results of operations, or cash flows.
Financing cash flows consist primarily of policyholder fund deposits and withdrawals, borrowings and repayments on the line of credit, issuance and repurchase of common stock, and dividends paid on common stock.
The Company’s current source of debt capital is a $100.0 million unsecured line of credit available through June 29, 2002. The interest rate, which is based on current market rates, was 2.38% at December 31, 2001. The line of credit requires a commitment fee, but no compensating balances. Under the credit agreement, the Company is subject to customary covenants, including limitations on indebtedness and maintenance of minimum equity, statutory surplus, and risk-based capital. At December 31, 2001, the Company was in compliance with all such covenants. At December 31, 2001, $81.3 million was outstanding on the line of credit, which was repaid in early 2002 after annual regulatory capital requirements for the insurance subsidiaries were assessed.
Beginning in 2002, StanCorp’s board of directors approved paying annual, rather than quarterly, dividends to shareholders. The declaration and payment of dividends in the future is subject to the discretion of StanCorp’s board of directors and it is anticipated that annual dividends will be paid in December of each year depending on StanCorp’s financial condition, results of operations, cash requirements, future prospects, regulatory restrictions on the payment of dividends by Standard and the ability of the insurance subsidiaries to maintain adequate capital and other factors deemed relevant by StanCorp’s board of directors.
StanCorp’s ability to pay dividends to its shareholders, repurchase its shares, and meet its obligations substantially depends upon the receipt of dividends from its subsidiaries, including Standard. Standard’s ability to pay dividends is affected by factors deemed relevant by Standard’s board of directors, including the ability to maintain adequate capital (see “-Risk Based Capital”) and Oregon law. In February 2002 Standard’s board of directors approved a $50 million dividend to StanCorp. Upon approval from the Oregon Department, Standard paid an extraordinary cash dividend of $90 million to StanCorp in 2001. The extraordinary dividend was intended to include a return of a voluntary temporary $65 million capital contribution made by StanCorp to Standard in December 2000 due to the timing of two reinsurance transactions (see “-Acquisition and Disposition of Product Lines”).
The Company manages interest rate risk, in part, through asset/liability duration analyses. As part of this strategy, detailed actuarial models of the cash flows associated with each type of insurance liability and the financial assets related to the liabilities are generated under various interest rate scenarios. Both interest risk and investment strategies are examined. The actuarial models include those used to support the statutory Statement of Actuarial Opinion required annually by insurance regulators. According to presently accepted actuarial standards of practice, statutory reserves of the insurance subsidiaries and related items at December 31, 2001 made adequate provision for the anticipated cash flows required to meet contractual obligations and related expenses, in light of the assets actually held.
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. In accordance with Item 305 of Regulation S-K of the Securities and Exchange Commission, the Company has analyzed the estimated loss in fair value of certain market sensitive financial assets held at December 31, 2001 and 2000, given a hypothetical ten percent increase in interest rates, and related qualitative information on how the Company manages interest rate risk. The interest rate sensitivity analysis is
The National Association of Insurance Commissioners (“NAIC”) has implemented a tool to aid in the assessment of the statutory capital and surplus of life and health insurers. This tool, known as Risk-Based Capital (“RBC”), augments statutory minimum capital and surplus requirements. RBC employs a risk-based formula that applies prescribed factors to the various risk elements inherent in an insurer’s business to arrive at minimum capital requirements in proportion to the amount of risk assumed by the insurer. At December 31, 2001, the RBC levels of the Company’s insurance subsidiaries were significantly in excess of that which would require corrective action by the insurance subsidiaries or regulatory agencies.
See Item 8, “Financial Statements and Supplementary Data-Notes to Consolidated Financial Statements.”
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of StanCorp Financial Group, Inc. and subsidiaries as of December 31, 2001 and 2000, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States of America.
Organization and principles of consolidation. StanCorp Financial Group, Inc. (“StanCorp”) was incorporated under the laws of Oregon in 1998. StanCorp was specifically organized as a parent holding company for its subsidiaries. Significant subsidiaries of StanCorp include Standard Insurance Company (“Standard”); The Standard Life Insurance Company of New York; StanCorp Mortgage Investors, LLC; and StanCorp Investment Advisers, Inc. StanCorp is based in Portland, Oregon, and through its subsidiaries has operations throughout the United States.
StanCorp’s largest subsidiary, Standard, underwrites group and individual disability and annuity products, and life and dental insurance for groups. Standard, founded in 1906, is domiciled in Oregon and licensed in 49 states, the District of Columbia and the U.S. Territory of Guam. Standard is an admitted reinsurer in the state of New York. The Standard Life Insurance Company of New York provides long term and short term disability insurance for groups in New York. StanCorp Mortgage Investors, LLC, originates, underwrites and services small commercial mortgage loans for investment portfolios of the insurance subsidiaries as well as generating fee income from the origination and servicing of mortgage loans sold to institutional investors. StanCorp Investment Advisers, Inc. is a Securities and Exchange Commission registered investment adviser providing performance analysis, fund selection support and model portfolios to retirement plan clients.
On April 21, 1999, pursuant to an order by the Director of the Oregon Department of Consumer and Business Services (the “Oregon Department”) approving the Plan of Reorganization dated September 28, 1998, as amended on December 14, 1998, Standard converted from a mutual life insurance company to a stock life insurance company and became a wholly owned subsidiary of StanCorp, an Oregon corporation. Also, on April 21, 1999, StanCorp completed an initial public offering (the “IPO”) of 15.2 million shares of its common stock. The shares of common stock issued in the IPO were in addition to 18.7 million shares of StanCorp common stock distributed to Standard policyholders, pursuant to the Plan of Reorganization, in exchange for their membership interests in Standard.
Deferred policy acquisition costs and value of business acquired, net. Acquisition costs related to the production of new business have been deferred to accomplish matching against related future premiums and gross profits. Such costs may include commissions and incentive payments, certain costs of policy issuance and underwriting and certain variable field office expenses. Deferred costs associated with group life and disability insurance product costs are amortized in proportion to future premiums over periods that generally range from five to ten years. Individual disability insurance product costs are amortized in proportion to future premiums over the life of the contract generally ranging from 15 to 35 years. For individual deferred annuities, group annuities and investment-type contracts, the costs are amortized in proportion to expected gross profits over periods that generally range from 10 to 30 years. The discount rate applied to expected gross profits is revised for actual changes in credited interest rates. Deferred policy acquisition costs are charged to current earnings to the extent it is determined that future premiums or gross profits are not adequate to cover amounts deferred. The value of business acquired represents the discounted future profits of business acquired through a reinsurance transaction which will be amortized over the discounted future premiums expected for the life of the contracts underlying the reinsurance agreement. The net amortization of the value of business acquired for the year ended 2001 was $3.3 million. The estimated net amortization of the value of business acquired for each of the next five years is $3.1 million in 2002, $3.0 million in 2003, $2.9 million in 2004, $2.7 million in 2005, and $2.5 million in 2006.
Property and equipment, net. The following table sets forth the major classifications of the Company’s property and equipment, and accumulated depreciation at December 31:
Property and equipment are stated at cost less accumulated depreciation. The Company provides for depreciation of property and equipment using the straight-line method over the estimated useful lives, which are generally 40 years for properties, and from three to ten years for equipment. Leasehold improvements are amortized over the life of the lease. Depreciation expense for 2001, 2000 and 1999 was $9.0 million, $9.1 million and $8.5 million, respectively. The Company reviews property and equipment for impairment when circumstances or events indicate the carrying amount of the asset may not be recoverable and recognizes a charge to earnings if impaired. Non-affiliated tenants leased approximately 44.5%, 45.6%, and 43.0% of the home office properties for the years ended December 31, 2001, 2000 and 1999, respectively. Income from the leases is included in net investment income.
Future policy benefits and claims. Actuarially determined reserves are established and carried at amounts that are calculated to meet obligations for future policy benefits and claims. The reserves are computed at amounts that, with additions from premiums to be received and with interest on such reserves at certain assumed rates, are expected to be sufficient to meet policy obligations at their maturities or in the event of an insured’s death or disability. Reserves include unearned premiums, premium deposits, claims reported but not yet paid, claims incurred but not reported, and claims in the process of settlement. Reserves are based on actuarially recognized methods for developing assumptions for estimating future policy benefits and claims experience, including an evaluation of interest rates, mortality, morbidity, persistency and expenses. Reserves for assumed reinsurance are computed on bases essentially comparable to direct insurance reserves.
Due to the nature of the underlying risks and the high degree of uncertainty associated with the determination of the liability for future policy benefits and claims, the amounts which will ultimately be paid to settle the liability cannot be determined precisely and may vary from the estimated amounts. Reserves for future policy benefits and claims are periodically evaluated. Based on changes in the assumptions used to establish the reserves, as well as actual policy benefits and claims experience, adjustments are made when appropriate. The establishment of reserves and subsequent increases or decreases are charged as expense in the period the reserves are established, increased, or decreased.
Recognition of premiums and policyholder benefits. Premiums from group life, group and individual disability, and traditional life insurance contracts are recognized as revenue when due. Benefits and expenses are matched with recognized premiums to result in recognition of profits over the life of the contracts. The match is accomplished by recording a provision for future policy benefits and unpaid claims and claim adjustment expenses and by amortizing deferred policy acquisition costs. Universal life-type and investment-type contract premiums and other policy 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 are computed in accordance with the terms of the contracts with certain group policyholders and are accounted for as a reduction of premiums.
Other comprehensive income (loss). Other comprehensive income (loss) consists of the current increase or decrease in net unrealized investment gains and losses on investment securities available-for-sale, net of the related tax effects. Unrealized gains and losses and the adjustment for realized gains and losses, were as follows for the years ended December 31:
Pro forma information for the year ended December 31, 1999, is presented as if the IPO had occurred on January 1, 1999. On April 21, 1999, Standard converted from a mutual life insurance company to a stock life insurance company.
Reclassification. Certain 2000 and 1999 amounts have been reclassified to conform with the current presentation.
Accounting Pronouncements. In June 2001, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 141, “Business Combinations.” SFAS No. 141 supersedes Accounting Principles Board Opinion No. 16, “Business Combinations” and FASB Statement No. 38, “Accounting for Preacquisition Contingencies of Purchased Enterprises.” The provisions of SFAS No. 141 are required to be applied starting with business combinations initiated after June 30, 2001. The Company does not expect the adoption of SFAS No. 141 to have a material impact on the Company’s financial statements.
Investment securities at estimated fair values were composed of the following at December 31:
The contractual maturities of investment securities available-for-sale were as follows at December 31:
Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations.
Although the Company underwrites commercial mortgages throughout the United States, mortgage loans in California represent a concentration of credit risk. The Company requires mortgage collateral and underwrites loans on either a partial or full recourse basis. The geographic concentration of mortgage loans was as follows at December 31:
The mortgage loan valuation allowance is estimated based on evaluating known and inherent risks in the loan portfolio. The allowance is based on management’s analysis of factors including changes in the size and composition of the loan portfolio, actual loan loss experience, economic conditions, and individual loan analysis. A loan is considered impaired when it is probable that the Company will be unable to collect all amounts due, including principal and interest. Loan impairment is measured using discounted cash flows except when the current fair value, reduced by costs to sell, is determinable. Loans that are deemed uncollectible are written off against the allowance and recoveries, if any, are credited to the allowance. Mortgage loans foreclosed and transferred to real estate were $1.2 million and $2.2 million for 2001 and 1999, respectively. There were no mortgage loans foreclosed and transferred to real estate in 2000. The following table sets forth mortgage loan valuation and allowance provisions for the years ended December 31:
7. LIABILITY FOR UNPAID CLAIMS, CLAIMS ADJUSTMENT EXPENSES AND OTHER POLICYHOLDER FUNDS
Liability for unpaid claims and claims adjustment expenses include liabilities for accident and health insurance offered on products such as group long term and short term disability, individual disability, group dental, and group accidental death and dismemberment. The liability for unpaid claims and claim adjustment expenses are included in future policy benefits and claims in the consolidated balance sheets. The change in the liabilities for unpaid claims and claim adjustment expenses was as follows for the years ended December 31:
Substantially all full-time employees are covered by deferred compensation plans under which a portion of the employee contribution is matched. Contributions by Standard to the plans for 2001, 2000 and 1999 were $2.5 million, $2.2 million and $2.0 million, respectively.
individual disability insurance business, through a reinsurance transaction, from Minnesota Life. (See “-Note 2. Acquisition and Disposition of Product Lines.”)
In addition to product-specific reinsurance arrangements, reinsurance coverage has been maintained in the past for certain catastrophe losses. Subsequent to the terrorist events of September 11, the Company entered into a catastrophe reinsurance pool. The pool covers group life and accidental death and dismemberment for about 40 participating members of the pool. The reinsurance pool brings exposure to potential losses experienced by other participating members of the pool but substantially increases the Company’s catastrophe reinsurance coverage to approximately $200 million per event. If the Company had been in the pool on September 11, the estimated pre-tax charges related to the terrorist events would have been approximately $15 million compared to pre-tax charges of $5.0 million actually incurred. An occurrence of a significant catastrophic event similar to the events of September 11, 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.
Amortization of deferred policy acquisition costs includes amortization of the value of business acquired through a reinsurance transaction. Other operating expenses include operating expenses, commissions and bonuses, and the net increase in deferred policy acquisition costs.
Statutory accounting practices differ in some respects from GAAP. The principal statutory practices which differ from GAAP are: a) bonds and mortgage loans are reported principally at amortized cost; b) asset valuation and interest maintenance reserves are provided as prescribed by the NAIC; c) certain assets designated as non-admitted, principally furniture, equipment, and unsecured receivables, are not recognized as assets; d) premiums are recognized as income when due, annuity considerations with life contingencies are recognized as income
Standard received written approval from the Oregon Department to include collateral loan balances fully secured by policy cash values as admitted assets, which differs from prescribed statutory accounting practices. Prescribed accounting practices generally require amounts in excess of 80% of the market value of the pledged collateral to be designated as non-admitted. As of December 31, 2000, the permitted practice increased statutory surplus by $12.7 million over the amount that would have been permitted under prescribed accounting practices. Effective January 1, 2001, collateral loans were sold in connection with the reinsurance transaction with Protective Life (see “-Note 2. Acquisition and Disposition of Product Lines”).
Standard and The Standard Life Insurance Company of New York are subject to statutory restrictions that limit the maximum amount of dividends that they could declare and pay to StanCorp without prior approval of the states in which the subsidiary is domiciled. The amount available for payment of dividends by Standard without approval of the Oregon Department is $126.9 million in 2002. There was no amount available for payment of dividends by The Standard Life Insurance Company of New York in 2002.
State insurance departments require insurance enterprises to adhere to minimum Risk-Based Capital (“RBC”) requirements promulgated by the NAIC. At December 31, 2001 and 2000 the insurance subsidiaries’ RBC levels were significantly in excess of that which would require corrective action by the insurance subsidiaries or regulatory agencies. The amount of statutory capital and surplus necessary to satisfy the regulatory action requirements was $108.1 million and $124.3 million at December 31, 2001 and 2000, respectively.
The Company has a $100.0 million unsecured line of credit available through June 29, 2002. The Company is not required to maintain compensating balances, but pays a commitment fee. The interest rate, which is based on current market rates, was 2.38% at December 31, 2001. Under the credit agreement, the Company is subject to customary covenants, including limitations on indebtedness and maintenance of minimum equity, statutory surplus, and risk-based capital. At December 31, 2001, the Company was in compliance with all such covenants. At December 31, 2001, $81.3 million was outstanding on the line of credit.
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. During 2001, the Company repurchased over 1.9 million shares of its common stock at a total cost of $84.7 million, for a weighted-average price per share of $43.65. At December 31, 2001, 1.3 million shares are authorized for repurchase through September 30, 2002.
At December 31, 2001, the Company had outstanding commitments to fund or acquire various assets, generally commercial mortgage loans with interest rates ranging from 6.63% to 8.75%, totaling $91.4 million. The commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The Company evaluates each customer’s credit worthiness individually and may terminate a commitment based on the financial condition of the borrower. Additionally, a small percentage of borrowers allow their commitments to expire without being drawn upon. The Company currently has no commitments consisting of standby letters of credit, guarantees, standby repurchase obligations, or other related commercial commitments.
The Company leases certain buildings and equipment under non-cancelable operating leases that expire in various years through 2009, with renewal options for periods ranging from one to five years. Future minimum payments under the leases are: 2002, $9.5 million; 2003, $6.2 million; 2004, $5.2 million; 2005, $4.5 million; 2006, $3.9 million and thereafter, $8.3 million. Total rent expense was $12.0 million, $9.5 million and $8.0 million for the years ended December 31, 2001, 2000 and 1999, respectively. At December 31, 2001, minimum future rental receivables on non-cancelable leases with initial terms of one year or more were: 2002, $12.2 million; 2003, $11.4 million; 2004, $10.3 million; 2005, $8.9 million; 2006, $7.3 million; and thereafter, $26.6 million.