Ohio State and Investors Guaranty operations are conducted from approximately 83,800 square feet of leased office space located at 2500 Farmers Drive, Columbus, Ohio 43235. The lease expires in April 2000.
The volume of the Company's insurance in force has increased 156% from $18.5 billion in 1989 to $47.4 billion in 1997. This growth has been the result of a combination of acquisitions, reinsurance assumed and new business written. The growth in the Company's volume of life insurance inforce for the last three years is summarized in the following table.
In October 1995, in connection with administrative agreements entered into with Ohio Casualty and Ohio Life, an unaffiliated company (the "Reinsurer") reinsured 100% of the insurance business of Ohio Life on a coinsurance basis. The Reinsurer then reinsured certain risks on these same liabilities to Great Southern on a modified coinsurance basis. The associated policy liabilities were approximately $278 million at December 31, 1997.
In July 1996, the Company entered into similar agreements with the Reinsurer and Fremont Life. The associated policy liabilities involved in the transaction were approximately $371 million at December 31, 1997.
On April 15, 1997, Great Southern acquired all of the outstanding common stock of Ohio State and Investors Guaranty ("Ohio State Acquisition") from Farmers Group, Inc. On the acquisition date, Ohio State and Investors Guaranty had combined assets of $1,039 million and liabilities of $694 million. The acquisition was accounted for as a purchase. On April 16, 1997, Ohio State and Investors Guaranty entered into separate coinsurance agreements to reinsure 100% of their insurance liabilities to the Reinsurer in exchange for a ceding commission of $145.7 million. Concurrently, the Reinsurer and Great Southern entered into a modified coinsurance agreement under which the Reinsurer ceded certain risks on a 70% quota share basis on the same insurance liabilities to Great Southern. The results of operations of these acquired policies from the date of acquisition, less the net 30% coinsurance, are included in the Company's results of operations. The Reinsurer will receive 100% of the statutory profits from the reinsured policies until the Reinsurer has recovered the initial ceding commission.
The effects of the above transactions, collectively referred to as the Acquisitions, on the individual income statement components, excluding the costs of financing, are set forth in the table below (in millions).
Net investment income. Net investment income increased $32.6 million to $219.3 million in 1997 from $186.7 million in 1996. Excluding the net investment income from invested assets associated with the Acquisitions, net investment income increased $3.1 million, primarily attributable to (i) changes in expected prepayments on mortgage-backed securities and (ii) an increase in income of the Company's equity subsidiaries.
Interest expense. Interest expense decreased $0.2 million to $12.1 million in 1997 from $12.3 million in 1996. Average outstanding indebtedness was $133.1 million with an average cost of 9.06% in 1997 compared with average outstanding indebtedness of $133.5 million with an average cost of 9.19% in 1996.
Income before provision for income taxes increased $9.9 million to $40.8 million in 1996 from $30.9 million in 1995. The primary reasons for the net increase were (i) income resulting from the Acquisitions and (ii) gain from the disposition of the Company's interest in GSSW, partially offset by (iii) a decrease in net investment income, (iv) an increase in death benefits and (v) an increase in other operating expenses. These items and significant changes in individual income statement components are discussed in more detail below.
Premiums and policy revenues. Premiums and policy revenues totaled $165.6 million in 1996 compared to $140.1 million in 1995. Excluding the effects of the Acquisitions, premiums and policy revenue decreased by $3.8 million from 1995 to 1996. Premiums and policy revenues from historical business decreased $2.8 million and $1.0 million, respectively, between 1996 and 1995. The decrease is primarily due to the company currently writing small amounts of new traditional life insurance products and, therefore, traditional life insurance premiums are decreasing as this amount of in-force business decreases. A portion of the decreasing policy revenues between 1996 and 1995 resulted from $0.4 million of non-recurring surrender charges realized in 1995 related to certain group life annuities.
Collected premiums on interest sensitive and annuity products increased by $69.4 million from 1995 to 1996. This increase in collected premiums is not reflected in premiums and policy revenues because generally accepted accounting principles require that premiums collected on these types of products be treated as deposit liabilities rather than revenues.
Net investment income. Net investment income increased $34.7 million to $186.7 million in 1996 from $152.0 million in 1995. Excluding the investment income resulting from the Acquisitions, investment income decreased $6.2 million, primarily attributable to (i) a decrease in income from the Company's equity subsidiaries and (ii) changes in expected prepayments on mortgage-backed securities.
Americo has outstanding $100.0 million senior subordinated notes that it issued in 1993. These senior subordinated notes bear interest at 9.25% and mature in May 2005. The notes are redeemable at the option of Americo beginning in 1998. The redemption prices are in excess of par in 1998 and 1999.
In connection with the acquisition of Victory Life in July 1995, Americo issued notes payable to the seller with face amounts aggregating $17 million and borrowed $21 million under a $70 million credit agreement with a syndicate of banks. Of the $17 million face amount of notes payable issued to the seller, $5 million mature in 2015 and the remaining $12 million mature in 24 equal semi-annual installments which began in 1995. The notes are carried at their discounted value, which assumes an average effective rate of 11.6%.
At December 31, 1997, United Fidelity had four surplus debentures payable to Americo with an aggregate outstanding unpaid balance of $137.3 million. The terms of the surplus debentures have been established to provide for the payment of principal and interest to Americo in amounts sufficient to make payments on the Company's external debt obligations in accordance with their payment schedules. The surplus debentures and their payment schedules have been approved by the Texas Department of Insurance; therefore, each scheduled payment will not require the approval of the Texas Department of Insurance.
The ability of life insurance subsidiaries to pay dividends also may be affected by reinsurance treaties. Under reinsurance treaties with an unrelated reinsurer, National Farmers Union is restricted from declaring dividends if adjusted surplus is less than $27.5 million. Adjusted surplus is defined in the treaties as statutory capital and surplus, plus AVR, less the admitted asset value of all affiliated investments. At December 31, 1997, National Farmers Union had adjusted surplus of $39.1 million.
Financial condition. Stockholder's equity increased to $246.9 million at December 31, 1997 from $207.0 million at December 31, 1996. The increase was the result of net income of $22.1 million and an increase in net unrealized investment gains of $19.8 million, less a $2.0 million dividend to FHC. Net unrealized investment gains in 1997 were recorded due to an increase in the market value of both the Company's available for sale fixed maturity securities and its marketable equity securities. See Note 4 to the Company's Consolidated Financial Statements included elsewhere in this Form 10-K for further discussion of the components of the change in net unrealized investment gains.
The changes occurring in the Company's consolidated balance sheet from December 31, 1996 to December 31, 1997 primarily reflect the normal operations of the Company's life insurance subsidiaries, the acquisition of Ohio State and Investors Guaranty, and the related reinsurance transactions discussed in Results of Operations. See Note 3 to the Company's Consolidated Financial Statements included elsewhere in this Form 10-K for further discussion of these transactions.
Statutory capital and surplus of the Company's insurance subsidiaries at December 31, 1997 includes $20.0 million relating to financial reinsurance agreements which is not included in stockholder's equity on a GAAP basis.
Investment Portfolio. The Company has what it considers to be a conservative investment philosophy. The Company's investment portfolio is designed to match investment maturities as closely as possible to the projected cash flow requirements of the Company's outstanding liabilities. The Company's policy is to have a substantial portion of its investment portfolio in fixed income securities with call protection.
In November 1995, the Financial Accounting Standards Board ("FASB") issued "A Guide to Implementation of Statement 115 on Accounting for Certain Investments in Debt and Equity Securities" (the Guide) which, among other things, provided entities with a one time opportunity to transfer some or all securities from held to maturity to available for sale. In December 1995, the Company transferred fixed maturity securities with an amortized book value of $195,207 and a market value of $198,329 out of the held to maturity category into the available for sale category. Additionally, the Company transferred fixed maturity securities with an amortized book value of $169,439 and a market value of $178,883 out of the available for sale category into the held to maturity category.
(2) Carrying amount is amortized cost. The market value of held to maturity securities as December 31, 1997 was $873.9 million.
At December 31, 1997, approximately $165.6 million in carrying value of the Company's investment portfolio consisted of mortgage loans, which were collateralized primarily by multi-family apartments, office buildings and retail properties located in 33 states. Approximately 41% of the portfolio was multi-family apartments, 20% was office buildings, 24% was retail space and 15% was other types of properties. At December 31, 1997, approximately 21% of the mortgage loan portfolio was secured by properties in Texas, and 22% in Missouri and 12% in Kansas. No more than 10% of the remaining portfolio was secured by properties in any one state.
At December 31, 1997, 8.15% of the mortgage loan portfolio consisted of loans with balloon payments that mature before January 1, 1999. At December 31, 1997, mortgage loans delinquent by more than 90 days, as determined on a contract delinquency basis, totaled approximately $0.5 million, which constituted 0.3% of mortgage loans and was 0.02% of cash and invested assets. Loans foreclosed upon and transferred to real estate owned in the Company's consolidated balance sheet totaled $1.6 million, or less than 1% of total mortgage loans at December 31, 1997. The favorable default experience is principally attributed to the Company having been selective in the purchase of mortgages in connection with acquisitions of its life insurance subsidiaries. In light of the current market interest rate environment, the Company may experience prepayments on its mortgage loan portfolio, thus reducing its yield on such portfolio. The Company plans to continue applying its historical underwriting standards to future investments in mortgage loans.
Real estate investments were only 1.3% of the carrying value of the Company's cash and invested assets at December 31, 1997.
Subsequent Event. The Company has entered an agreement with an unrelated party to sell Investors Guaranty. The Company will continue to assume the risks associated with Investors Guaranty policies on a 70% quota share basis. The Company intends to reinsure these risks on an assumption basis in the future.
In December 1997, the American Institute of Certified Public Accountants ("AICPA") approved Statement of Position ("SOP") 97-3, "Accounting by Insurance and Other Enterprises for Insurance-Related Assessments." SOP 97-3 provides guidance for determining when an entity should recognize a liability for guaranty-fund and other insurance-related assessments and a related asset for assessments which may be recovered through future premium tax offsets. The SOP is effective for financial statements for fiscal years beginning after December 15, 1998 with early adoption encouraged. Management has not determined the effects, if any, of adopting this SOP on the Company's consolidated financial statements.
In a declining rate environment, the Company's cost of funds would decrease over time, reflecting lower interest crediting rates on its interest-sensitive and investment products. Should increased liquidity be required for withdrawals, management believes that a significant portion of its investments could be sold without adverse consequences in light of the general strengthening which would be expected in the bond market.