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 and the transaction with LOTS discussed earlier in this Item 1, the Company now occupies approximately 48% of the available office space. The Company has leased about 33% of the remaining space to third party tenants. Annual rental income to the Company under these sub-leases totals $84,000. 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. Except as otherwise noted, the remaining business operations of the Company and all of the subsidiaries are conducted at the above address in Camp Hill, Pennsylvania.
NOTE 1: The financial data for the years ended December 31, 1993 through 1996 has been restated to reflect the operating results of the Company s Automotive Resource Division as a discontinued operation.
NOTE 2: The earnings per share amounts presented above have been computed in accordance with Statement of Financial Accounting Standards No. 128, Earnings Per Share (SFAS 128). Adoption of SFAS 128 did not result in the restatement of any per share amounts for years prior to 1997. For further discussion of the calculation of per share amounts under SFAS 128, see Note 18 of the Notes to Consolidated Financial Statements appearing elsewhere in this Form 10-K.
The most significant event affecting the Company in 1997 was the termination of the planned merger with LaSalle Group, Inc. (the "Merger"). As discussed below, the Company entered into an Agreement and Plan of Merger with LaSalle in October of 1996 in order to preserve shareholder value in light of the Company's recurring operating losses which had significantly reduced its total capital and its liquidity position. The Merger would have resulted in the cash payment of $3.78 per share to the Company's common shareholders. The Company was forced to terminate the Merger because, despite repeated assurances to the contrary, LaSalle was unable to provide the cash funds necessary to complete the Merger.
As stated above, in December 1997, the Company entered into an Agreement to sell its remaining business operations, following the sale of its auto auction business in 1996 and the sale in early 1997 of the rest of its individual life insurance business. Consequently all of these businesses have been presented in the Consolidated Financial Statements appearing elsewhere in this Form 10-K as discontinued operations. The Company's continuing operations now consist principally of (i) earned premiums and related acquisition and claims costs associated with a very small closed block of extended service contract business, (ii) investment income on existing assets, (iii) fee income from LOTS from the sale of the Company's customer accounts and (iv) overhead expenses. A discussion of the material factors which affected the Company's results from continuing operations and, where applicable, the results from its discontinued operations is presented below. Information for 1996 and 1995 is also presented for comparative purposes.
The Company's pre-tax loss from continuing operations decreased from a restated level of $2.3 million in 1996 to a loss of $1.7 million in 1997. In 1995, the restated loss was $1.9 million. As indicated above, continuing operations are now limited primarily to fee revenues from LOTS, investment income and corporate expenses. The block of extended service business produces a relatively insignificant amount of operating income or loss. A decrease in corporate expenses in 1997 is the major reason for the reduced loss from continuing operations compared to 1996. The 1997 results were adversely affected by a $744,000 write-down of the Company's real estate holdings, including its home office building which is classified with property and equipment.
As shown in Note 5 of the Notes to Consolidated Financial Statements, the pre-tax operating results of this discontinued division, including the estimated pre-tax loss on disposal of the business, declined significantly in 1997 to a loss of $5.5 million compared to a restated loss of $1.3 million in 1996 and a restated loss of $875,000 in 1995. A $3.1 million estimated loss on the sale of the credit insurance business in 1998, which has been reflected in the 1997 financial statements as a write-down of deferred policy acquisition costs, and a $381,000 charge for employee severance payments are the major reasons for the decline in operating results of this discontinued segment. Increased life and disability claims on business retained by the Company (i.e., business not reinsured to producer-owned captives) also contributed to the poorer operating results in 1997.
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 completed a reinsurance transaction with World Insurance Company ("World"), which was effective January 1, 1998, pursuant to which World recaptured the universal life insurance business previously assumed by the Company from World through a joint venture agreement which began in 1987. World initially paid a recapture consideration to the Company in the amount of $1. 05 million. In exchange, the Company transferred to World assets supporting the net statutory basis policy reserves for this business. Based on the recapture consideration received, the Company wrote off $1.4 million in deferred policy acquisition costs which were not recoverable. This write-off, which totaled $914,000 on an after-tax basis, was presented as a loss on disposal of the discontinued segment in the Company's 1996 financial statements.
During 1997, the Company incurred $22,000 of final expenses relating to the auction business which have been presented as an additional loss on disposal of the discontinued business.
Invested assets at December 31, 1997 were $41 million compared to $51.2 million at the end of 1996. A substantial portion of the decline is the result of the settlement on the reinsurance transaction with World, in which the Company transferred approximately $8.8 million in cash and investments to World. In addition, the asset base at December 31, 1996 included approximately $500,000 which was required in the first quarter of 1997 to pay the Federal and state income taxes on the gain from the sale of the Company's auto auction business in 1996.
Liquidity refers to a company s ability to meet its financial obligations and commitments as they come due. The Company s operating subsidiaries have historically met most of their cash requirements from funds generated from operations. However, the recurring operating losses incurred by the subsidiar- ies have significantly reduced the subsidiaries and, in turn, the Company s liquidity positions, resulting in the decision to sell the Company s remaining business, liquidate all assets, distribute cash to the shareholders and ultimately dissolve.
Because of the Company s current plans to liquidate its assets, distribute cash to its shareholders and ultimately dissolve, the effects of inflation on the Company are minimal.
The consolidated financial statements for the years ended December 31, 1997, 1996 and 1995 have been audited by Arthur Andersen LLP, independent auditors. Such audits were conducted in accordance with generally accepted auditing standards, and include a review and evaluation of our internal accounting control structure, tests of the accounting records and other audi- ting procedures they consider necessary to express their informed professional opinion on the consolidated financial statements.
We have audited the accompanying consolidated balance sheets of Consumers Financial Corporation (a Pennsylvania corporation) and subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of operations, shareholders equity and cash flows for each of the three years in the period ended December 31, 1997. These financial statements and the sche- dules referred to below are the responsibility of the Company s management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.
The accompanying financial statements have been prepared assuming the Company will continue as a going concern. As discussed in Note 5 of the Notes to Consolidated Financial Statements, the Company has discontinued the opera- tions of its credit insurance, individual life insurance and auto auction segments and has adopted a plan of liquidation and dissolution. As further discussed in Note 5, the Company has suffered recurring losses from operations that have significantly reduced its net capital and liquidity position and it has significantly reduced its number of employees, all of which raise substantial doubt about the Company s ability to continue as a going concern. Management s plans in regard to these matters are also described in Note 5. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.
CONSUMERS FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
The Company has incurred operating losses over the past five years which have significantly reduced its net worth and its liquidity position. In late 1997, the Company signed an agreement to sell its core credit insurance and related products business, which had been its only remaining business opera- tion, following the sales in 1994 and 1997 of all of its universal life insurance business and the 1996 sale of its auto auction business. After the sale of the credit insurance business, the Company s income or loss from continuing operations will consist principally of (i) earned premium and related costs associated with a small, closed block of extended service contract business, (ii) fee revenues which will be received from LOTS, (iii) investment income on remaining assets and (iv) corporate expenses.
On March 24, 1998, the Company s shareholders approved a plan of liquidation and dissolution (the Plan of Liquidation and Dissolution) pursuant to which the Company intends to liquidate its remaining assets, provide for all of its liabilities, redeem its preferred stock at par value and distribute all remaining cash to its common shareholders. Inasmuch as certain payments from LOTS will be received over a five-year period, the final distribution to the common shareholders will not be made until late in 2002.
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) and Consumers Car Care Corporation. Investors Fidelity Life Assurance Corp. (Investors Fidelity) and Consumers Reinsurance Company are subsidiaries of Consumers Life. All material intercompany accounts and transactions have been eliminated.
Mortgage loans on real estate are carried at the unpaid principal balance. Policy loans are carried at their unpaid balance. Other invested assets, excluding real estate partnerships, and short-term investments are carried at cost. Investments in real estate partnerships are reported at equity.
Mortgage loans 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. The carrying amounts for policy loans approximate their fair values.
The costs of acquiring new business, including costs incurred subsequent to the year of issue in excess of the ultimate level costs, principally commissions, certain sales salaries and those home office expenses that vary with and are primarily related to the production of new business, have been deferred. Deferred policy acquisition costs related to universal life-type policies and investment products were amortized in relation to the present value of expected gross profits on the policies. Acquisition costs relating to single premium credit insurance have been amortized so as to charge each year's operations in direct proportion to premiums earned. Deferred policy acquisition costs are expensed when such costs are deemed not to be recoverable from future earned premiums and investment income or, when applicable, from the estimated proceeds to be received from the sale of the related insurance business.
Real estate is carried at the lower of cost or fair value, less estimated selling costs.
(e) The statutory liabilities for the interest maintenance reserve and asset valuation reserve, designed to lessen the impact on surplus of market fluctuations of securities and mortgage loans, have not been provided in the financial statements.
(g) Commission allowances pertaining to financing-type reinsurance agreements are not included in results of operations.
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, 1997, approximately $1.7 million of Consumers Life's net assets cannot generally be transferred to the parent company and $619,000 is available for transfer during 1998 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.
Direct contacts were made with numerous potential buyers to solicit their interest in participating in an auction process to acquire either the Company or its various business operations and assets. Separate groups of potential bidders were solicited for the Company s credit insurance business and auto auction business. Because the direct writer of the assumed individual life business, World Insurance Company (World), had an option to recapture that business, the Company conducted negotiations with World to sell the remaining inforce business back to World.
After evaluating numerous offers for the sale of the auto auction business, in November 1996, the Company sold Interstate s auto auction business, all of its property, plant and equipment and inventories and the Interstate name to ADESA Pennsylvania, Inc., an unrelated third party, for cash of $4.85 million. The sale resulted in an after-tax gain of approximately $1.8 million in the fourth quarter of 1996. 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.
The Asset Purchase Agreement provides for the sale of the Company s credit insurance and fee income accounts to LOTS effective October 1, 1997 and the transfer of the Company s marketing personnel and credit insurance administrative functions to LOTS effective January 1, 1998. With respect to the sale of the customer accounts, the Company will receive fees from LOTS over a five-year period based on the amount of credit insurance premiums produced by the customer accounts which were sold. Unlike the transactions described below, the above transactions were not subject to any further conditions and have therefore been completed. Accordingly, the Company has included approximately $132,000, before income taxes, in its 1997 financial statements, representing the fees earned by the Company in the fourth quarter.
As a result of the planned sale of the Company s credit insurance and related operations to LOTS, in the accompanying financial statements, the operating results of the credit insurance and related fee income business have been reported as discontinued operations for all periods presented, and, accordingly, the operating results for periods prior to 1997 have been restated.
At December 31, 1997 and 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. Net investment income is applicable to the following investments:
The amortized cost and estimated fair value of debt securities at December 31, 1997, by contractual maturity, are shown below. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Mortality and withdrawal assumptions generally are based on industry data and the life insurance companies' prior experience. The mortality tables predominantly used in calculating benefit reserves are the 1955 - 1960 Basic Select and Ultimate for males (special graduation) and the 1965 - 1970 Basic Select and Ultimate for males (special graduation).
Future policy benefits reported to regulatory authorities were less than the above total by approximately $905,000 at December 31, 1997.
Future policy benefits and unearned premiums do not include any deduction for reinsurance ceded to other companies. At December 31, 1997 and 1996, future policy benefits relating to such reinsurance totaled $12.2 million and $16.1 million, respectively. These amounts have been classified with Receivables. Unearned premiums with respect to reinsured business totaled $9.6 million and $17.3 million at December 31, 1997 and 1996, respectively. These unearned premiums are separately stated on the Consolidated Balance Sheets as Prepaid Reinsurance Premiums. Insurance in force net of reinsurance ceded was $928,000 at December 31, 1997.
Incurred benefits and losses reinsured in 1997 were $5.2 million compared to $6.2 million in 1996 and $6.7 million in 1995. These amounts have been deducted in arriving at death and other benefits and the increase in future policy benefits in the Consolidated Statements of Operations.
The profit sharing plans, which include an employee stock ownership plan, provide for annual contributions in amounts to be determined by the Board of Directors. Such contributions are based upon the annual compensation of each employee; however, no Company contributions were made in either 1997, 1996 or 1995.
In 1989, the Company entered into an agreement for the lease of office space. The facility contains approximately 44,500 square feet of office space. The term of the lease is ten years with an option to renew for one additional term of five years. Until March 1994, monthly lease payments were $35,000. In March 1994, the Company exercised its option to acquire a 50% interest in this property at a price of $1.75 million. The Company continues to lease the entire building, which is classified as an operating lease, but at monthly rent of $17,000 through July 1999, although the Company has subleased a portion of the office space which it does not otherwise occupy. The Company has no other significant leases.
In August 1997, the Company received a notice of proposed adjustment from the Internal Revenue Service as a result of a recently completed tax examination for the years ended December 31, 1992 and 1993. The Company is currently seeking to have the adjustment rescinded. Based on the current status of the matter, the Company does not believe it is probable that a material amount of additional taxes will be due.
Certain claims, suits and complaints arising in the ordinary course of business have been filed or are pending against the Company or its subsidia- ries. In the opinion of management, based on opinions of legal counsel, adequate reserves, if deemed necessary, have been established for these matters and their outcome will not result in a significant effect on the financial condition or future operating results of the Company or its subsidiaries. The Company has taken certain income tax positions in previous years that it believes are appropriate. If such positions were to be successfully challenged by the Internal Revenue Service, the Company could incur additional income taxes as well as interest and penalties. Management believes that the ultimate outcome of any such challenges will not have a material effect on the Company's s financial statements.
The Redeemable Convertible Preferred Stock (the Preferred Stock ) has a liquidation preference of $10.00 per share and is convertible at any time, unless previously redeemed, into shares of common stock at the rate of 1.482 shares of common stock for each share of Preferred Stock (equivalent to a conversion price of $6.75 per share). The Preferred Stock is redeemable at the option of the Company initially at a redemption price of $10.00 per share.
If, at any time, the Company is in arrears as to preferred dividends or sinking fund appropriations for the Preferred Stock, dividends to holders of the Company's common stock as well as purchases, redemptions or acquisitions by the Company of shares of the Company's common stock are restricted. If the Company is in default in an aggregate amount equal to four quarterly preferred dividends, the holders of the Preferred Stock shall be entitled, only while such arrearage exists, to elect two additional members to the then existing Board of Directors.
In May 1989, the shareholders of the Company approved the Stock Incentive Plan which permits the granting of any or all of the following types of awards: (1) stock options, including incentive stock options and non-qualified stock options and (2) stock appreciation rights (SAR) either in tandem with stock options or free standing. This Plan was intended to enhance the 1982 Stock Option Plan. All officers and salaried key employees of the Company and its subsidiaries and affiliates were eligible to be participants. Persons who served only as directors were not eligible. The Plan provided for the issuance of up to 250,000 shares of Common Stock (the Stock). The shares of Stock deliverable under the Plan consisted in whole or in part of authorized and unissued shares or treasury shares.
The purchase price per share of Stock under any stock option is determined by the Personnel Committee, but cannot be less than 100% of the fair market value of the Stock on the date of the grant of such option. The term of each option is fixed by the Personnel Committee. Options are exercisable at such time or times as determined by the Committee, but no option is exercisable after the expiration of six years from the date the option is granted.
The changes in option shares outstanding during the past three years are as follows:
(b) Distributions, other than stock dividends, are made to shareholders in excess of Shareholders' Surplus as defined by prior law, or
The preferred stock is convertible into 713,275 shares of common stock (see Note 15). Options to purchase 132,000 common shares were outstanding at December 31, 1997 (see Note 16). None of the common shares contingently issu- able upon the conversion of the preferred stock or upon the exercise of the stock options have been included in the computation of diluted per share information because the effect would be antidilutive.
As a result of the disposal of its auto auction business in 1996, the disposal of its remaining block of individual life insurance business in early 1997 and the planned disposal of its credit insurance business in the second quarter of 1998, the Company has no remaining business segments.
As discussed in Note 5, following the sale of its credit insurance business, the Company intends to liquidate its remaining assets, provide for its liabilities, redeem its preferred stock and distribute all remaining cash to its common shareholders pursuant to a Plan of Liquidation and Dissolution. The Company s income or loss from continuing operations now consists principally of (i) earned premiums and related costs associated with an insignificant block of extended service contract business which is in run-off, (ii) investment income on remaining assets, (iii) fee income from LOTS from the sale of the Company s customer accounts, and (iv) overhead expenses. Because the fees related to the sale of the Company s customer accounts will be received from LOTS over a five- year period, and because any distribution which may be due to the Company from the contingency fund cannot be determined until September 30, 2002, the Company will be unable to make a final distribution to its common shareholders until late in 2002.
In connection with the proposed sale of the Company s September 30, 1997 inforce block of credit insurance to LOTS (pursuant to reinsurance agreements which the insurance subsidiaries have entered into with American Republic), the insurance subsidiaries filed the reinsurance agreements with the insurance regulators in their respective domiciliary states and have obtained the required regulatory approval. In connection with the sale of the Company s Arizona- domiciled insurance company to LOTS, LOTS has filed documents with the Arizona Insurance Department in order to obtain its approval. This Form A filing is currently under review by the Arizona insurance regulators.
In September 1996, the Delaware Insurance Department notified Consumers Life that its level of investments in subsidiaries exceeded the amount permit- ted under Delaware Insurance laws by approximately $1.5 million and that the company s capital and surplus should be reduced by the amount of such excess. As indicated above, the company sold one of its subsidiaries in August 1997, resulting in the elimination of the excess investment in subsidiaries problem.
The NAIC has established certain minimum capitalization requirements based on risk-based capital (RBC) formulas. The formulas are designed to identify companies which are undercapitalized and require specific regulatory action based on requirements relating to insurance, business, asset and interest rate risks. At December 31, 1997, each of the Company's insurance subsidiaries have more than sufficient capital to meet the NAIC's RBC requirements. However, if the effects of the surplus relief reinsurance treaties are excluded from the statutory financial statements, certain of the insurance subsidiaries would not meet minimum required RBC levels.
On January 1, 1998, substantially all of the Company s former marketing personnel, who resigned from the Company on December 31, 1997, became employees of LOTS pursuant to the terms of the Asset Purchase Agreement. In addition, LOTS assumed administrative responsibilities for all of the Company s credit insurance business as of that date.
On February 17, 1998, the Delaware Insurance Department approved the reinsurance transaction between Consumers Life and American Republic whereby, effective January 1, 1998, Consumers Life will reinsure its September 30, 1997 block of inforce credit insurance business and all new credit insurance business produced on or after October 1, 1997 to America Republic. On March 30, 1998, the Ohio Insurance Department approved a similar reinsurance transaction between Investors Fidelity and American Republic involving that subsidiary s September 30, 1997 inforce business and new business issued subsequently.