Since September 1989, the Company has maintained its executive and business offices in a leased building located at 1200 Camp Hill By-Pass, Camp Hill, Pennsylvania. The office building contains approximately 44,500 square feet of office space. Prior to 1993, the Company leased the entire facility at an annual rental of $421,000, plus insurance, taxes and utilities. As a result of the termination in 1992 of all new business functions in the Individual Life Insurance Division, the Company now occupies approximately 67% of the available office space. The Company has leased about 66% of the remaining space to third party tenants. Annual rental income to the Company under these sub-leases totals $83,000. In March of 1994, the Company exercised its option to acquire a 50% interest in its home office building, which reduced the Company s annual rent to $204,000. The option price was approximately $1.75 million. In late 1996, the Company, along with the other 50% owner, granted an option to purchase the home office building to an unrelated third party. The option expired in March 1997 and was not renewed. Except as otherwise noted, the business operations of the Company and all of the subsidiaries are conducted at the above address in Camp Hill, Pennsylvania.
A more detailed discussion of the operating performance of each of the Company's business segments, including the two discontinued businesses, is presented later in this analysis under Results of Operations.
Premium revenues from credit insurance, the Division's principal product, declined 9.5% in 1996 from $33.1 million to $30 million. In 1995, premiums decreased 3.3% from the $34.3 million in premiums written in 1994. The cancellation of unprofitable business played a major part in the reduction in premiums in both 1996 and in 1995. As a result of continued unprofitable results, all of the Division's accounts in the state of North Carolina and numerous accounts in Virginia and Ohio were canceled during 1996. A similar action was taken in the state of Kentucky in 1995. Excluding these accounts, the 1996 drop in premium revenues was nominal. The Division's credit insurance premium production remains significantly below pre-1990 levels due to the declines which occurred during the economic recession of the early 1990's. A consequence of the decline in written premiums has been a reduction in earned premiums, which in turn has resulted in a substantial increase in operating expense ratios since 1989. Higher expense ratios have been a key reason for the unprofitable operating results the Division has experienced in recent years. During 1996, the Company lost the endorsement of the Pennsylvania Automotive Association which it held since 1987. The Company believes that the loss of the endorsement will have some effect on its future premium production in Pennsylvania, although it is not expected to have a materially adverse impact on future operating results.
In July 1996, the Company and its joint venture partner canceled an agreement whereby the companies shared in the profits from the credit insurance business written by the Company in Pennsylvania, the Company's most profitable credit insurance state. As a result, on credit premiums produced in Pennsylvania after July, the Company will now retain the profits or losses which were previously shared with the joint venture partner. As consideration for terminating the venture, the Company has agreed to pay its former partner $500,000 in cash at the time the above-referenced merger with LaSalle is consummated. In the event the LaSalle merger is not completed, any payment to the joint venture partner will be determined under a separate calculation. If the proposed merger with LaSalle is completed, LaSalle's strategy to return the Company's credit insurance operation to profitability will include acquisitions of other credit insurance companies and other blocks of credit insurance business, expansion of the Company's marketing territory and growth in existing markets. LaSalle intends to provide additional capital not only to finance growth by also to build the insurance subsidiaries' capital base in order to improve the ratings of those companies by insurance rating agencies.
Operations in the Individual Life Insurance Division in 1996 and 1995 were limited to one closed block of assumed universal life business, following the sale of the Division's direct universal life business in 1994 and the sale of its traditional whole life and term business in 1992. In March 1997, the Company signed an agreement with World Insurance Company ("World"), pursuant to which World will recapture the universal life business previously assumed by the Company from World through a joint venture agreement which began in 1987. World will pay a recapture consideration to the Company in the amount of $1.05 million. In exchange, the Company will transfer to World assets supporting the net statutory basis policy reserves for this business. Based on the recapture consideration to be received, the Company has written off $1.4 million in deferred policy acquisition costs which are not recoverable. This write-off, which totaled $914,000 on an after-tax basis, has been presented as a loss on disposal of the discontinued segment in the Company's 1996 financial statements.
On November 6, 1996, the Company sold the auto auction business and related operating assets (property and equipment and inventories) of Interstate Auto Auction to ADESA Pennsylvania, Inc. for cash of $4.85 million. The Division's pre-tax income for the first nine months of 1996, which excludes any continuing overhead, was $554,000 compared to income of $732,000, as restated to eliminate any continuing overhead, in 1995. The operating results of the auto auction after September 30, 1996, when the Company finalized its plan to dispose of the business, have been included with the gain realized on the disposal of the auction business. The auction generated an $84,000 pre-tax loss ($57,000 after taxes) during this period.
Approximately $1.7 million of the proceeds from the sale of the auto auction business was used to repay the remaining amount due on the Company's bank loans.
The increases discussed above were partially offset by a $923,000 reduction in the carrying value of the Company's bond portfolio as a result of higher interest rates since the end of 1995. The Company's bond portfolio is carried at fair value pursuant to the requirements of Statement of Financial Accounting Standards No. 115, based on the Company's determination that all of its bonds should be considered as "available-for-sale", although the Company has no current intentions to sell any of these securities (except for approximately $8.3 million in bonds which were sold in 1997 in order to complete the above- referenced sale transaction with World - see the Individual Life Insurance Division section of this Management s Discussion and Analysis). The unrealized appreciation or depreciation on available-for-sale securities is reported as a separate component of shareholders' equity.
During 1996, the Company increased its loan loss reserves for mortgage loans and investment and non-investment real estate by $35,000. Loan loss reserves were increased by $93,000 and $450,000 in 1995 and 1994, respectively. Management believes that its reserves at December 31, 1996 are adequate to cover any possible losses which may develop in its mortgage loan and real estate portfolios. The carrying value of these investments at December 31, 1996 was $3.4 million compared to $10.7 million at the end of 1995.
During 1996, the Company's mortgage loan portfolio declined from $7 million to $2.3 million. The substantial reduction is the result of the early payoff of four mortgages with balances at the end of 1995 of $2.7 million and the sale to a local bank of seven loans with balances totaling $2 million. The proceeds from these transactions were reinvested primarily in bonds.
The principal sources of cash funds of the life insurance subsidiaries are premiums and investment income, as well as proceeds from sales and maturities of investments. These companies use cash primarily to pay commissions, claims and operating expenses. Credit insurance is the Company s principal product line and credit insurance premiums are therefore the Company s principal source of premium revenues. Credit insurance premium levels during the past five years are substantially lower than the premium levels prior to the economic recession in the early 1990's. This continued reduction in cash funds has depleted most of the Company s short-term cash reserves and has caused some decline in its long-term investment base. The assessment by the Company s management and its Board of Directors that this decrease in revenues and the related decline in operating results could not be reversed within a reasonable period of time led to the decision in early 1996 to evaluate other alternatives to best serve the interests of its shareholders. This evaluation process, in turn, led to the proposed merger transaction discussed in the Overview section of this Management s Discussion and Analysis and in Note 4 of the Notes to Consolidated Financial Statements.
James C. Robertson R. Fredric Zullinger Chairman, Chief Executive Officer Chief Financial Officer and President
As discussed in Note 3 to the consolidated financial statements, in 1994 the Company changed its method of recognizing earnings on credit disability insurance.
Consumers Financial Corporation is an insurance holding company which, through its subsidiaries, is a leading provider of credit life and credit disability insurance in the Middle Atlantic region of the United States.
The consolidated financial statements include the accounts of Consumers Financial Corporation (the Company) and its wholly-owned subsidiaries, the most significant of which are Consumers Life Insurance Company (Consumers Life), Interstate Auto Auction, Inc. (Interstate) and Consumers Car Care Corporation. Consumers Life Insurance Company of North Carolina, Investors Fidelity Life Assurance Corp. and Consumers Reinsurance Company are subsidiaries of Consumers Life. All material intercompany accounts and transactions have been eliminated. Use of estimates
Fixed maturities includes bonds, notes and certificates of deposit maturing after one year. Management determines the appropriate classification of bonds and notes at the time of purchase and reevaluates such designation as of each balance sheet date. These securities are classified as held-to-maturity when the Company has the positive intent and ability to hold the securities to maturity. Held-to-maturity securities are stated at amortized cost. All other bonds and notes are classified as available-for-sale. Available-for-sale securities are carried at fair value, with the unrealized gains and losses, net of income taxes, reported as a separate component of shareholders equity. The amortized cost of securities in this category is adjusted for amortization of premiums and accretion of discounts to maturity. All certificates of deposits maturing after one year are deemed to be held to maturity. Equity securities (common and non-redeemable preferred stocks) held by the insurance subsidiaries are stated at fair value.
Realized gains and losses and provisions for permanent losses on investments are included in the determination of operating income. Net unrealized appreciation or depreciation of debt securities and preferred and \ common stocks, which represents the difference between fair value and aggregate cost, is included in a separate shareholders' equity account. The "specific identification" method is used in determining the cost of investments sold.
Investment securities: Fair values for fixed maturity securities are based on quoted market prices, where available. For fixed maturity securities not actively traded, fair values are estimated using values obtained from independent pricing services or, in the case of private placements, are estimated by discounting expected future cash flows using a current market rate applicable to the yield, credit quality and maturity of the investments. The fair values for equity securities are based on quoted market prices and are recognized in the balance sheet (see Note 6).
Mortgage loans and real estate and policy loans: The fair values for mortgage loans are estimated using discounted cash flow analyses, using interest rates currently being offered for similar loans to borrowers with similar credit ratings. Similarly, real estate fair values are estimated using discounted cash flow analyses. The carrying amounts for policy loans approximate their fair values.
Long-term debt: The carrying amount for long-term debt approximates its fair value. Deferred policy acquisition costs
Costs in excess of underlying net assets of acquired companies and acquired intangible assets are being amortized over the estimated periods expected to benefit (5 - 40 years) using the straight-line and other methods which provide periodic charges to operations proportionate to the anticipated benefits to be received. These intangible assets are periodically reviewed for impairment, based on an assessment of future operations, to ensure that they are appropriately valued.
For individual life insurance contracts, excluding universal life-type policies and investment products, premiums are recognized as revenue over the premium-paying period. Future benefits and expenses are associated with earned premiums, so as to result in recognition of profits principally over the premium-paying period. This association is accomplished by means of the provision for liabilities for future benefits and the deferral and amortization of acquisition costs. Provisions are also made for the risk of adverse deviation from the reserve assumptions over the lives of the contracts. Revenues for universal life-type policies and investment products consist of policy charges for the cost of insurance, policy administration, and surrenders assessed during the period, and expenses include interest credited to policy account balances and benefit claims incurred in excess of policy account balances. For credit insurance, premiums are earned over the terms of the policies, as discussed above. Policy and contract claims include provisions for claims reported and claims incurred but not reported. The Company believes that the liabilities for claims and related expenses are adequate. Anticipated investment income is considered in determining whether future earned premiums on existing credit insurance will be sufficient to cover the present value of future benefits and maintenance expenses and to recover the unamortized portion of deferred policy acquisition costs.
The Company adopted Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation (SFAS 123), in 1996. Under the provisions of SFAS 123, companies can elect to account for stock- based compensation plans using a fair-value based method or continue measuring compensation expense for those plans using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25) and related Interpretations. The Company has elected to continue using the intrinsic value method to account for its stock-based compensation plans. SFAS 123 requires companies electing to continue using the intrinsic value method to make certain pro forma disclosures (see Note 16).
Statement of Financial Accounting Standards No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of (SFAS 121), was adopted as of January 1, 1996. SFAS standardized the accounting practices for the recognition and measurement of impairment losses on certain long-lived assets. The adoption of SFAS 121 had no material effect on the Company s results of operations or financial position.
(c) The liability for future policy benefits and expenses on individual life insurance is based on conservative estimates of expected mortality, morbidity, interest, withdrawals, and future maintenance and settlement expenses, rather than on statutory rates for mortality and interest. For credit life insurance, the liability is based upon the unearned premium reserve, computed as described in Note 1, rather than on statutory rates for mortality and interest. The credit disability policy liability, principally the unearned premium reserve, is calculated as described in Note 1. Effective January 1, 1994, the statutory liability is computed using predominantly the average of the Rule of 78's and Pro Rata methods. Prior to 1994, the statutory liability was computed using primarily the Pro Rata method.
(d) Deferred income taxes, if applicable, are provided as described in Note 17.
(i) Revenues for universal life-type policies and investment products consist of policy charges primarily for the cost of insurance rather than premiums due and/or collected on such policies. Expenses include interest credited to policy account balances and benefit claims incurred in excess of policy account balances rather than the increase in benefit reserves and gross benefit claims incurred for these types of policies.
Dividends and other distributions to the Company from Consumers Life are limited in that Consumers Life is required to maintain minimum capital and surplus in each of the states in which it is licensed, determined in accordance with regulatory accounting practices. The amount of minimum capital and surplus required is $5.5 million. All distributions are further limited by Delaware state insurance laws to the greater of previous year earnings, computed in accordance with statutory accounting principles, or 10% of statutory capital and surplus as of the end of the previous year. In some instances such payments may require the prior approval of the insurance department. Accordingly, based on amounts reported to regulatory authorities, at December 31, 1996, approximately $8.6 million of Consumers Life's net assets cannot generally be transferred to the parent company and $585,000 is available for transfer during 1996 as long as the minimum capital and surplus requirements mentioned above are maintained. Also, any loans or advances to the parent company of a material amount must be reported to the insurance department. The Company may have limited cash funds available to pay dividends in excess of amounts transferred from subsidiaries. In addition, separate restrictions apply to the surplus note owed to the Company by a subsidiary of Consumers Life. Payment of interest and repayment of principal on the note are permitted by the applicable state insurance department as long as the subsidiary's statutory capital and surplus exceeds $3 million.
Insurance laws require that certain amounts be deposited with various state insurance departments for the benefit and protection of policyholders. The approximate carrying amount of such deposits at both December 31, 1996 and 1995 was $5.3 million.
After receiving consent from the Delaware Insurance Department, the Company adopted, for statutory reporting purposes, an accelerated method of reserving disability unearned premiums. The change allows the Company to recognize revenue in a manner which more appropriately matches its incidence of claims. In addition to the use of this unearned premium method, the insurance subsidiaries have also requested and received approval from their respective domiciliary states to carry as an admitted asset a receivable for credit insurance premiums, net of commissions, which have been collected by the companies agents but have not yet been remitted to the companies. At December 31, 1996 and 1995, the premiums in process of collection receivable totaled $1.8 million and $2 million, respectively.
As of January 1, 1994, the Company changed its method of earning credit disability premiums for a substantial portion of its credit disability business. The method used prior to 1994 was computed based on the average of the Rule of 78's and the Pro Rata methods, while the new method utilizes a weighted average of those two methods, based on 65% of the Rule of 78's method and 35% of the Pro Rata method. The new weighted average method accelerates the premium earning pattern and provides a better matching of earned premiums with the incidence of incurred disability claims based on the Company s actual experience. The Company s method of amortizing deferred policy acquisition costs for credit disability business was also revised in proportion to the change in earned premiums.
The cumulative effect of this change on years prior to 1994 has been included in results of operations for 1994. This change reduced the 1994 net loss by $299,000 ($.11 per share).
In late September 1996, the Company finalized a plan to dispose of the business and the related operating assets of Interstate as part of an overall plan to merge or otherwise combine its core insurance operations with those of another insurance company. On November 6, 1996, the Company sold Interstate s auto auction business and all of its property, plant and equipment and inventories to ADESA Pennsylvania, Inc., an unrelated third party, for cash of $4.85 million. The sale resulted in a fourth quarter after-tax gain of approximately $1.8 million. The gain on disposal includes a loss from operations of $84,000 from September 30, 1996 ( the measurement date) to December 31, 1996, less an income tax benefit of $28,000. Accordingly, in the accompanying financial statements, Interstate s operating results have been reported as discontinued operations for all periods presented. Interstate s non-operating net assets, principally cash, receivables, investments and trade payables, were retained by the Company.
In March 1997, the Company signed a Recapture Agreement to reinsure its remaining block of individual life insurance business back to the direct writer of the business (see Note 21). The Recapture Agreement provides that the direct writer will pay the Company a recapture consideration equal to $1.05 million in exchange for the transfer by the Company of assets in an amount equal to the net statutory policy reserves for this business. Based upon the recapture consideration to be received, the transaction will result in an after-tax loss of approximately $900,000. This loss has been reflected in the Company s 1996 financial statements.
The Company had previously sold a substantial portion of its direct and assumed universal life business to an unaffiliated company. The business written on a direct basis was coinsured to the acquiring company. The assumed business was transferred to the purchaser with approval of the direct writing company and with no recourse to the Company in the event the purchaser is unable to fulfill its obligations under the reinsurance agreement. These transactions, which took place on December 30, 1994, resulted in the transfer of $32.7 million in policy liabilities and $24.1 million in cash, mortgage loans and policy loans to the purchaser. In addition, $7.7 million in deferred policy acquisition costs were written off. The sale produced a pre-tax gain of $895,000, which was partially offset by a $492,000 loss on the sale of investments necessary to close on the transaction.
Accordingly, in the accompanying financial statements, the operating results of the Company s individual life insurance business have been reported as discontinued operations for all periods presented.
At December 31, 1996 and 1995, the remaining net assets of the discontinued individual life insurance segment consisted of the following:
Investments, which are valued for financial statement purposes as described in Note 1, consist of the following at December 31, 1996:
A portion of the Company's invested funds is restricted as to use. Deposits are required with various state insurance departments for the benefit and protection of policyholders (see Note 2).
At December 31, 1996 and 1995, no mortgage loans or other loans were considered to be non-performing loans.
Accumulated depreciation on investment real estate amounted to $51,000 at December 31, 1995. At December 31, 1996, all the Company s real estate is classified as non-investment real estate, since the Company intends to sell these properties. Accumulated depreciation on the properties at the time they were reclassified totaled $22,663.
The amortized cost and estimated fair values of investments in debt securities at December 31, 1996 and 1995 are as follows:
Proceeds from sales of investments in debt securities and assets held for sale during 1996 were $4.1 million. Gross gains of $6,000 and gross losses of $20,000 were realized on those sales. Proceeds from such sales in 1995 were $4.1 million. Gross gains of $3,000 and gross losses of $29,000 were realized on those sales. Proceeds from sales in 1994 were $9.6 million. Gross gains of $41,000 and gross losses of $38,000 were realized on those sales.
A summary of the consolidated net realized gains (losses) and the change in the difference between cost and quoted or estimated fair value for fixed maturity investments is as follows:
Realized gains and losses in the years ended December 31, 1996, 1995 and 1994 also arose from the sale of other investments.