(1)Represents long-term portion of "Due to Parent Corporation" amounts disclosed in the Consolidated Financial Statements.
Of the amount released in 1997, $15.1 million was attributable to participating policyholders and, therefore, had no effect on the net income of the Company.
In addition to the contingent tax liability release described above, the Company's income tax provisions for 1997 and 1996 also reflect increases for additional contingent items related to open tax years where it was determined to be probable that additional tax liabilities could be owed based on changes in facts and circumstances. The increase in 1997 was $16.0 million, of which $10.1 million was attributable to participating policyholders and, therefore, had no effect on the net income of the Company. The increase in 1996 was $5.6 million.
Realized investment gains increased in recent years from a realized investment loss of $21.1 million in 1996 to realized investment gains of $9.8 million and $38.2 million in 1997 and 1998, respectively. The decrease in interest rates in 1998 and 1997 resulted in gains on sales of fixed maturities totaling $38.4 million and $16.0 million in 1998 and 1997, respectively, while higher interest rates contributed to $11.6 million of fixed maturity losses in 1996. Increases in the provision for asset losses of $0.6 million and $7.6 million, respectively, were recognized in 1998 and 1997.
Total benefits and expenses increased $213.9 million or 11% in 1998 when compared to the year ended December 31, 1997. The increase in 1998 was due to a combination of the acquisition of AH&L which resulted in benefits and expenses of $258.3 million and overall growth in the group health business, partially offset by a decrease in policyholder benefits related to reinsurance transactions of $109.4 million. Excluding these items, benefits and expenses would have increased $64.6 million or 3% in 1998. The increase from 1996 to 1997 was the result of increased operating expenses associated with the cost of developing HMOs and FASCorp's business, and system enhancements.
Total assets increased $3.0 billion or 14% in 1998 when compared to the year ended December 31, 1997. Separate account assets increased $2.3 billion primarily due to the strength of the equity markets in the United States. Invested assets increased $464.5 million, of which $258.6 million was attributable to AH&L. The remaining growth of $205.9 million represents a 2% increase in invested assets over 1997, which was primarily attributable to the consideration received in connection with the reinsurance agreements discussed previously.
On July 8, 1998, the Company acquired the outstanding common stock of AH&L, a subsidiary of Anthem, Inc. (the Blue Cross and Blue Shield licensee for Indiana, Kentucky, Ohio, and Connecticut). This acquisition strengthened the Employee Benefits segment by providing nearly $975.0 million of annualized health and life premium income and self-funded premium equivalents, and approximately 450,000 additional health care members and approximately 75 group sales representatives.
The cost of the acquisition was $82.7 million. The purchase price was based on adjusted book value and is subject to further minor adjustments. The acquisition was accounted for as a purchase and was financed through internally generated funds. The fair value of tangible assets acquired and liabilities assumed was $379.9 million and $317.4 million, respectively. Goodwill of $20.2 million was recorded at the time of the acquisition.
The majority of AH&L's customers are in the Company's target market of small to mid-size employers who prefer to self-fund their benefit plans. As of November 1, 1998, the Company began integrating the AH&L business to a common systems platform with a scheduled completion date of July 1999. New and existing customers are being migrated to the Company's One Health Plan network, which will provide substantial new growth for the One Health Plan subsidiary organization.
Life and health premium and fee income for AH&L since the date of acquisition totaled $241.1 million, while self-funded premium equivalents were $281.3 million. The Company recorded a small loss associated with AH&L operations in 1998. The results of AH&L since the date of acquisition are included in the Employee Benefits segment.
(Millions) Years Ended December 31, ---------------------------------- INCOME STATEMENT 1998 1997 1996 ---------- ---------- ---------- DATA Premiums 747 465 486 Fee income 445 358 321 Net investment income 95 100 88 Realized investment gains (losses) 8 3 (3) ---------- ---------- ---------- Total Revenues 1,295 926 892
Policyholder benefits 590 371 406 Operating expenses 547 428 368 ---------- ---------- ---------- ---------- ---------- ---------- Total benefits and expenses 1,137 799 774 ---------- ---------- ---------- Income from operations 158 127 118 Income tax expense 51 29 22 ========== ========== ========== Net Income 107 98 96 ========== ========== ==========
Deposits for investment-type contracts 37 25 34 Deposits to separate accounts 1,568 1,403 1,109 Self-funded premium equivalents 2,606 2,039 1,940
o significant growth in 401(k) assets under administration, o increased sales and improved customer retention in group life and health, o favorable mortality results, and o license approval for four HMO subsidiaries, for a total of 14 fully operational HMOs.
401(k) premiums and deposits for 1998 and 1997 increased 14% and 25%, respectively, as the result of higher recurring deposits from existing customers and sales in 1997. Assets under administration (including third-party administration) in 401(k) increased 26% over 1997 to $6.7 billion and 38% from 1996 to 1997, primarily due to strong equity markets.
In addition to the Company's internally-managed funds, the Company offers externally-managed funds from recognized mutual funds companies such as AIM, Fidelity, Putnam, American Century, Founders and T. Rowe Price. This strategy, supported by participant education efforts, is validated by the fact that 99% of assets contributed in 1998 were allocated to variable funds.
In 1999, the Company will continue to enhance managed care programs and services, further HMO development, seek National Committee for Quality Assurance accreditation for its HMOs, refine quality assurance programs and introduce member communications directed at health improvements. Management intends to enhance the health claims payment system in 1999 to provide medical auto-adjudication capabilities to reduce administrative expenses and improve claims processing time. The Company will enhance the 401(k) product for large cases by adding additional investment fund options, reviewing and replacing current funds, as well as offering funds outside the annuity contract. The Company plans to add the 401(k) product to AH&L's product portfolio in the latter part of 1999.
Policyholder benefits 872 1,014 950 Operating expenses 141 124 101 ------------ ----------- ---------- Total benefits and expenses 1,013 1,138 1,051 ------------ ----------- ---------- Income from operations 138 81 47 Income tax expense 48 20 8 ============ =========== ========== Net Income 90 61 39 ============ =========== ==========
o significant growth in participants and separate account funds primarily attributable to the public/non-profit business, o very good persistency in all lines of business, and o strong sales of BOLI.
Net income for Financial Services increased 48% in 1998 and 56% in 1997. The improvement in earnings in 1998 reflects higher earnings from an increased asset base, an increase in investment margins, and larger capital gains on fixed maturities. The 1997 earnings improvement was the result of a reduction of the mortgage provision for asset impairments, increased fee income on a larger asset base, capital gains on fixed maturities and an increase in investment margins. The changes in income tax provisions discussed above under "Company Results of Operations" resulted in increases in net income for the Financial Services segment of $3.6 million and $7.4 million in 1997 and 1996, respectively.
Premiums decreased $5.9 million or 26%, from $22.6 million in 1997 to $16.8 million in 1998. Premiums decreased $4.0 million or 15%, from $26.7 million in 1996 to $22.6 million in 1997. The decrease in both years is attributable to the continuing trend of policyholders selecting variable annuity options (separate accounts) as opposed to the more traditional fixed annuity products.
Deposits to separate accounts decreased $101.5 million or 14%, from $742.1 million in 1997 to $640.6 million in 1998. Deposits to separate accounts increased $413.6 million or 126% from $328.5 million in 1996 to $742.1 million in 1997. The decrease in 1998 was the result of 1997 being inflated by the receipt of a large single deposit in the amount of $120.0 million. The increase in 1997 was due to a combination of the $120.0 million deposit and the commencement of marketing a new fixed and variable qualified and non-qualified annuity product through Charles Schwab & Co., Inc., which resulted in $239.9 million in deposits to separate accounts (the amount of such deposits from Schwab in 1998 was $204.7 million).
The Financial Services segment's savings business experienced strong growth in 1998. The number of new participants in 1998 was 151,300 compared to 129,200 in 1997 (51,900 in 1996), bringing the total lives under administration to 643,200 in 1998 and 536,200 in 1997. BenefitsCorp sold 21 new large employer cases compared to 13 in 1997 and increased the penetration of existing cases by enrolling new employees.
The Company continued to limit sales of GICs and to allow this block of business to contract in response to the highly competitive GIC market. As a result, GIC assets decreased 33% in 1998, to $274.8 million. In 1997, GIC assets decreased 22% from 1996, to $409.1 million.
Customer demand for investment diversification continued to grow during 1998. New contributions to variable business represented 63% of the total 1998 premiums versus 69% in 1997. The Company continues to expand the investment products available through Maxim Series Fund, Inc., and through partnership arrangements with external fund managers. Externally-managed funds offered to participants in 1998 included American Century, Ariel, Fidelity, Founders, INVESCO, Janus, Loomis Sayles, Templeton, T. Rowe Price and Vista.
Fixed maturities, available for sale, at fair value 6,937 6,698 Fixed maturities, held-to-maturity, at amortized cost 2,200 2,083 Mortgage loans 1,133 1,236 Real estate and common stock 122 133 Short-term investments 420 399 Policy loans 2,859 2,657 ========== ========== Total invested assets 13,671 13,206 ========== ==========
Fixed maturity investments include public and privately placed corporate bonds, public and privately placed structured assets and government bonds. This latter category contains both asset-backed and mortgage-backed securities, including collateralized mortgage obligations ("CMOs"). The Company's strategy related to structured assets is to focus on those with lower volatility and minimal credit risk. The Company does not invest in higher risk CMOs such as interest-only and principal-only strips, and currently has no plans to invest in such securities.
Credit Rating 1998 1997 ------------- -------------- --------------- AAA 45.6% 45.7% AA 9.4 8.8 A 23.8 23.8 BBB 20.7 20.7 BB and Below (non-investment grade) 0.5 1.0 -------------- --------------- TOTAL 100.0% 100.0%
At December 31, 1998 and 1997, the Company owned no bonds in default.
During 1998, the mortgage portfolio declined 8% to $1.1 billion, net of impairment reserves. The Company has not actively sought new loan opportunities since 1989 and, as such, has experienced an ongoing reduction in this portfolio's balance.
The common stock portfolio is composed of mutual fund seed money and some private equity investments. The Company anticipates a limited participation in the stock markets in 1999.
The Company has a commitment to fund an addition to its Head Office complex over the next 18 months, totaling approximately $30.0 million.
CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1998 AND 1997 (Dollars in Thousands)
CONSOLIDATED STATEMENTS OF INCOME YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996 (Dollars in Thousands)
Certain reclassifications, primarily related to the presentation of related party transactions and the classification of the release of a contingent liability (see Note 10) have been made to the 1997 and 1996 financial statements.
The Company maintains an allowance for credit losses at a level that, in management's opinion, is sufficient to absorb possible credit losses on its impaired loans and to provide adequate provision for any possible losses inherent in the loan portfolio. Management's judgment is based on past loss experience, current and projected economic conditions, and extensive situational analysis of each individual loan. The measurement of impaired loans is based on the fair value of the collateral.
Participating Fund Account - Participating life and annuity policy reserves are $4,108,314 and $3,901,297 at December 31, 1998 and 1997, respectively. Participating business approximates 32.7% and 50.5% of the Company's ordinary life insurance in force and 71.9% and 91.1% of ordinary life insurance premium income at December 31, 1998 and 1997, respectively.
The Company has also established a Participation Fund Account (PFA) for the benefit of the participating policyholders previously transferred to the Company from the Parent under an assumption reinsurance transaction. The PFA is part of the PPEA. Earnings derived from the operation of the PFA net of a management fee paid to the Company accrue solely for the benefit of the acquired participating policyholders.
Interest rate swap agreements are used to convert the interest rate on certain fixed maturities from a floating rate to a fixed rate. Interest rate swap transactions generally involve the exchange of fixed and floating rate interest payment obligations without the exchange of the underlying principal amount. Interest rate floors and caps are interest rate protection instruments that require the payment by a counter-party to the Company of an interest rate differential. The differential represents the difference between current interest rates and an agreed-upon rate, the strike rate, applied to a notional principal amount. Foreign currency exchange contracts are used to hedge the foreign exchange rate risk associated with bonds denominated in other than U.S. dollars. Equity swap transactions generally involve the exchange of variable market performance of a basket of securities for a fixed interest rate.
On July 8, 1998, the Company paid $82,669 in cash to acquire all of the outstanding shares of Anthem Health & Life Insurance Company (AH&L). The purchase price was based on AH&L's adjusted book value, and is subject to further minor adjustments. The results of AH&L's operations, which had an insignificant effect on net income, have been combined with those of the Company since the date of acquisition.
The acquisition was accounted for using the purchase method of accounting and, accordingly, the purchase price was allocated to the net assets acquired based on their estimated fair values. The fair value of tangible assets acquired and liabilities assumed was $379,934 and $317,440, respectively. The balance of the purchase price, $20,175, was recorded as excess cost over net assets acquired (goodwill) and is being amortized over 30 years on a straight-line basis. Management intends to finalize its allocation of the purchase price within a year of the transaction, which will likely result in a reallocation of the purchase price, which is not expected to be material.
On September 30, 1998, the Company and the Parent Corporation entered into an Indemnity Reinsurance Agreement pursuant to which the Company reinsured by coinsurance certain Parent Corporation individual non-participating life insurance policies. The Company recorded $45,332 in premium income and an increase in reserves as a result of this transaction. Of the $428,152 in reserves that were recorded as a result of this transaction, $382,820 was recorded under SFAS No. 97 accounting principles. The Company recorded, at the Parent Corporation's carrying amount, which approximates estimated fair value, the following at September 30, 1998 as a result of this transaction:
On September 30, 1998, the Company purchased furniture, fixtures and equipment from the Parent Corporation for $25,184. In February 1997, the Company purchased the corporate headquarters properties from the Parent Corporation for $63,700.
Cash 160,000 Policy reserves 155,798 Bonds 17,975 Due to Parent Corporation 20,373 Other 60 Deferred income taxes 2,719 Undistributed earnings on participating business (855) ----------- --------------- 178,035 178,035
In connection with this transaction, the Parent Corporation made a capital contribution of $7,000 to the Company.
Prior to January 1997, the Parent Corporation administered, distributed, and underwrote business for the Company and administered the Company's investment portfolio under various administrative agreements. Since January 1, 1997, the Company has performed these services for the U.S. operations of the Parent Corporation. The following represents revenue from or payments made to the Parent Corporation for services provided pursuant to these service agreements. The amounts recorded are based upon management's best estimate of actual costs incurred and resources expended based upon number of policies and/or certificates in force.
Reinsurance contracts do not relieve the Company from its obligations to policyholders. Failure of reinsurers to honor their obligations could result in losses to the Company. The Company evaluates the financial condition of its reinsurers and monitors concentrations of credit risk arising from similar geographic regions, activities, or economic characteristics of the reinsurers to minimize its exposure to significant losses from reinsurer insolvencies. At December 31, 1998 and 1997, the reinsurance receivable had a carrying value of $192,958 and $84,364, respectively.
5. NET INVESTMENT INCOME AND NET REALIZED GAINS (LOSSES) ON INVESTMENTS
At December 31, 1998 and 1997, pursuant to fully collateralized securities lending arrangements, the Company had loaned $115,168 and $162,817 of fixed maturities, respectively.
LIBOR - London Interbank Offered Rate CMT - Constant Maturity Treasury Rate
The Company has established specific investment guidelines designed to emphasize a diversified and geographically dispersed portfolio of mortgages collateralized by commercial and industrial properties located in the United States. The Company's policy is to obtain collateral sufficient to provide loan-to-value ratios of not greater than 75% at the inception of the mortgages. At December 31, 1998, approximately 33% of the Company's mortgage loans were collateralized by real estate located in California.
Prepaid pension cost 19,091 Undistributed earnings on 3,608 participating business Stockholder's equity 15,483 ------------ ----------- 19,091 19,091
The following table summarizes changes from 1997 to 1998 and from 1996 to 1997, in the benefit obligations and in plan assets for the Company's defined benefit pension plan and post-retirement medical plan. There is no additional minimum pension liability required to be recognized. There were no amendments to the plans due to the acquisition of AH&L.
The Company-sponsored post-retirement medical plan (medical plan) provides health benefits to employees. The medical plan is contributory and contains other cost sharing features, which may be adjusted annually for the expected general inflation rate. The Company's policy will be to fund the cost of the medical plan benefits in amounts determined at the discretion of management.
The Company has a deferred compensation plan providing key executives with the opportunity to participate in an unfunded, deferred compensation program. Under the program, participants may defer base compensation and bonuses, and earn interest on their deferred amounts. The program is not qualified under Section 401 of the Internal Revenue Code. The total of participant deferrals, which is reflected in other liabilities, was $16,102 and $13,952 at December 31, 1998 and 1997, respectively. The participant deferrals earn interest at a rate based on the average 10-year composite government securities rate plus 1.5%. The interest expense related to this plan was $1,185 and $1,019 in 1998 and 1997, respectively.
The Company's income tax provision was favorably impacted in 1997 and 1996 by releases of contingent liabilities relating to taxes of the Parent Corporation's U.S. branch associated with blocks of business that were transferred from the Parent Corporation's U.S. branch to the Company from 1989 to 1993; the Company had agreed to the transfer of these tax liabilities as part of the transfer of this business. The releases recorded in 1997 and 1996 reflected the resolution of certain tax issues with the Internal Revenue Service (IRS) relating to the 1990-1991 and 1988-1989 audit years, respectively. The releases totaled $42,150 for 1997 and $31,200 for 1996; however, $15,100 of the release in 1997 was attributable to participating policyholders and therefore had no effect on the net income of the Company since that amount was credited to the provision for policyholders' share of earnings (losses).
In addition to these releases of contingent tax liabilities, the Company's income tax provisions for 1997 and 1996 also reflect increases for other contingent items relating to open tax years where the Company determined it was probable that additional taxes could be owed based on changes in facts and circumstances. The increase in 1997 was $16,000, of which $10,100 was attributable to participating policyholders and therefore had no effect on the net income of the Company. The increase in 1996 was $5,600. These increases in contingent tax liabilities have been reflected as a component of the deferred income tax provisions for 1997 and 1996 as the Company does not expect near term resolution of these contingencies.
Amounts included in investment assets above include $34,556 and $30,085 related to the unrealized gains on the Company's fixed maturities available-for-sale at December 31, 1998 and 1997, respectively.
The Company's valuation allowance was increased (decreased) in 1998, 1997, and 1996 by $(1,792), $34, and $1,463, respectively, as a result of the re-evaluation by management of future estimated taxable income in its subsidiaries.
Effective January 1, 1998, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 130 "Reporting Comprehensive Income". This Statement establishes new rules for reporting and display of comprehensive income and its components; however, the adoption of this Statement had no impact on the Company's net income or stockholders' equity. This Statement requires unrealized gains or losses on the Company's available-for-sale securities and related offsets for reserves and deferred policy acquisition costs, which prior to adoption were reported separately in stockholder's equity, to be included in other comprehensive income. Prior year financial statements have been reclassified to conform to the requirements of Statement No. 130.
The maximum amount of dividends which can be paid to stockholders by insurance companies domiciled in the State of Colorado are subject to restrictions relating to statutory surplus and statutory net gain from operations. Statutory surplus and net gains from operations at December 31, 1998 were $727,124 and $225,586 (unaudited), respectively. The Company should be able to pay up to $225,586 (unaudited) of dividends in 1999.
Dividends of $6,692, $8,854, and $8,587 were paid on preferred stock in 1998, 1997, and 1996, respectively. In addition, dividends of $73,344, $62,540, and $48,083 were paid on common stock in 1998, 1997, and 1996, respectively. Dividends are paid as determined by the Board of Directors.