Prairie's Home Office building is located at 440 Mount Rushmore Road, Rapid City, South Dakota. The building contains approximately 44,000 square feet, of which approximately 34,000 square feet are utilized for Company purposes, while the remainder of the building is leased to outside tenants. This six-story building and the underlying real property are subject to mortgage indebtedness (capitalized lease) of approximately $741,000 as of December 31, 1993. The book value of the property as of December 31, 1993 is approximately $3.5 million.
The following is an analysis of the results of operations and financial condition of Laurentian Capital and its consolidated subsidiaries. The consolidated financial statements and related notes and schedules included elsewhere in the Form 10-K should be read in conjunction with this analysis. Certain reclassifications have been made to prior year amounts for comparative purposes.
Laurentian Capital's net income for 1993 was $8.2 million, or $1.05 per share, as compared to net income of $6.7 million, or $0.80 per share, in 1992 and a net income of $5.4 million, or $0.63 per share, in 1991. Excluding the cumulative effect of the adoption of Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes" ("SFAS 109"), which contributed $0.4 million to net income, the Company's net income for 1993 was $7.8 million, or $1.00 per share.
The 1992 net income of $6.7 million, or $0.80 per share, compares favorably to 1991 net income of $5.4 million, or $0.63 per share. The improvement in net income was due primarily to increased investment income and lower death and health claim benefits. In addition, substantially lower levels of realized investment gains were included in 1992 net income than in the prior year.
Premium income was fairly stable in 1991 as compared to 1990. Increases in new life insurance sales at Prairie were offset by declines in renewals at Loyal and Defender.
During 1993, there was an increase of 5.2% in net investmest income, realized investment gains and other income as compared to 1992. This increase resulted primarily from a $2.7 million increase in realized investment gains. During 1993, the Company experienced substantial prepayments on its fixed maturity investments as individuals and corporations refinanced their debt obligations. Corporate refinancings occurred through call provisions, whereby corporations usually pay a premium over par value to recall their obligations. The Company's increased level of realized investment gains resulted primarily from the exercise of call provisions, usually at a premium. The significant prepayments received in 1993 were reinvested at lower interest rates and are expected to lower the portfolio yield in the future. Net investment income remained stable as the lower portfolio yield was offset by increased invested assets. During 1993, two inactive subsidiaries were sold for $587,000, which is reflected in other income.
During 1992, there was a decrease of 2.4% in net investment income, realized investment gains and other income as compared to 1991. This decrease resulted primarily from a $3.6 million decline in realized investment gains. During 1992, $4.7 million in other than temporary impairments were recorded, as compared to $0.9 million in 1991. The impairments were primarily related to adjustments in the carrying value of certain real estate investments to appraised values due to depressed market conditions. Net investment income increased $1.6 million when compared to 1991, as growth in the Company's invested asset base combined with the accelerated recognition of income from discount amortization on mortgage-backed securities due to increases in prepayment activity more than offset the decline in overall portfolio yield. In addition, a former subsidiary was sold in the fourth quarter of 1992, resulting in an increase to other income of $570,000.
During 1991, an increase of 17.0% was recorded in net investment income, realized investment gains (losses) and other income as compared to 1990. This increase resulted primarily from an increase in realized investment gains which accounted for 14.2% of the increase. Net investment income accounted for 4.3% of the increase, primarily as a result of an investment portfolio restructuring that emphasized the conversion of non-income producing assets into investment grade debt securities.
Benefits for 1993 increased as a percentage of premium to 94.7% from 90.4% in 1992. The increase in benefits was due primarily to higher levels of death and health claims in 1993 as compared to 1992. During 1993, the Company achieved sales improvement in single premium funeral related life insurance and cancer indemnity products. Both products have a higher initial benefit to premium ratio than the existing inforce insurance business and substantially account for the increase in benefit ratio. As a result of the continued emphasis on these specialty lines, this trend of increasing ratio is expected to continue.
Expenses as a percentage of premium income in 1993 decreased to 56.2% as compared to 59.5% in 1992. The decrease is due primarily to continued emphasis on cost containment and reduction as indicated by a $1.7 million decline in selling and administrative expenses. The Company is continuing to invest in its pre-need life insurance segment with improved efficiency.
Expenses as a percentage of premium income decreased from 65.4% in 1990 to 58.4% in 1991. The decrease was attributable to lower levels of administrative and selling expenses achieved through cost reduction initiatives.
The Company's effective tax rate for the year ended December 31, 1993 was 31.5%, as compared to 34% for the year ended December 31, 1992. The primary reason the effective tax rate for the year ended December 31, 1993 was lower than the enacted statutory tax rate of 34% was due to the elimination of valuation allowances associated with the deferred tax asset related to certain real estate assets sold in 1993. Excluding the effect of these real estate transactions, the effective rate for 1993 would have been marginally higher than the effective rate for 1992.
The Company's effective tax rate has varied considerably in past years. Prior to 1992, one of the primary reasons for these variances was the difference in reporting groups. For financial statement purposes, the profits and losses of all subsidiaries were reported on a consolidated basis; for tax purposes, Laurentian Capital Corporation filed a separate return, while Loyal and a former subsidiary, Defender, filed a consolidated return, as did Prairie and its subsidiary, Rushmore National Life Insurance Company ("Rushmore"). Filing separate tax group returns caused various effective tax rates to apply to the profits and losses of the financial statement filing group. Beginning in 1992, the Company qualified to file a consolidated life/non-life federal tax return, except for Rushmore, which does not qualify to join in the filing of the consolidated Company return until 1995. The Company elected to file one consolidated return and, therefore, the financial reporting and federal tax reporting groups were primarily the same. However, variations in effective tax rates may persist as a result of limitations imposed by the Code on the utilization of non-life insurance tax losses against life insurance taxable income. For 1992 and prior tax years, under then existing GAAP, effective tax rates also varied as a result of the differences between the tax bases of assets and liabilities and those assigned under purchase accounting ("Purchase Accounting Adjustments"). Pursuant to then existing GAAP, these Purchase Accounting Adjustments were treated as permanent differences. Accordingly, as these differences reversed, they increased or decreased the Company's effective tax rate. For 1993 and subsequent years under SFAS 109, Purchase Accounting Adjustments are treated as temporary differences and changes in these differences will not affect the Company's effective tax rate.
The following table sets forth for the periods shown the net income and the earnings per share:
The increase in net income for 1993 as compared to 1992 of $1.5 million is due to higher realized investment gains, lower operating expenses, recognition of a benefit from the adoption of SFAS 109 and a lower effective tax rate. Continued emphasis on cost containment and cost reduction has improved efficiency in the operations during a period of increased selling activity. Premium rate adjustments on the cancer indemnity product and lower amounts of interest credited to policyholders have provided enhanced profitability.
The life insurance industry normally produces a positive cash flow from operations and scheduled principal repayments from portfolios of fixed maturity investments (bonds and redeemable preferred stocks) and mortgage loans. This cash flow is used to fund an investment portfolio to finance future benefit payments, which represent long-term obligations reserved for using certain assumed interest rates. Since future benefit payments are primarily long-term obligations, the Company's investments are predominately long-term fixed rate instruments such as bonds and mortgage loans which are expected to provide a sufficient return to cover these obligations. The nature and quality of the various types of investments made by a life insurance company must comply with the statutes and regulations imposed by the states in which that company is licensed. These statutes and regulations generally require that securities acquired be investment grade and provide protection for policyholders.
In accordance with generally accepted accounting principles, substantially all of the Company's investments are reported in the financial statements at their original or amortized cost as opposed to market value. At December 31, 1993, the fixed maturity investments had an amortized cost of $458.7 million with a market value of $468.5 million, $9.8 million above amortized cost. The Company had $29.4 million in mortgage loans at December 31, 1993, which could reflect a small premium or discount if those mortgage loans had quoted market prices. The basis used for carrying these long-term fixed rate investments is consistent with the basis used in determining the liability for future policy benefits. Since these assets are invested for terms corresponding to anticipated future benefit payments and carry interest rates in excess of the assumed reserve interest rates, and because they produce predictable cash flows independent of premium income, they should be sufficient to fund the Company's future benefit payments in the ordinary course of business without any need for liquidation prior to maturity.
The Company holds a substantial component of its investment portfolio in mortgage-backed securities and collateralized mortgage obligations (collectively "MBS"). At the end of 1993, the total investment in MBS amounted to $392.8 million, or 67% of total investments. These are instruments collateralized by pools of residential and commercial mortgages, which return interest and principal payments to the investor. Approximately 23% of the Company's MBS holdings are U.S. government agency securities (GNMA, FNMA and FHLMC), which carry either a direct government or a quasi-government guarantee and are rated AAA in terms of quality. The Company also owns non-agency MBS, issued by major U.S. financial institutions, which are rated AAA, AA or A. Non-agency MBS are credit-enhanced in order to achieve a high rating. The form of the credit enhancement is generally a senior/subordinated structure, a limited corporate guarantee from a large financial institution or a letter of credit from a major commercial bank. Historically, residential mortgages in the U.S. have had a very low default rate and the Company's non-agency MBS are well-diversified geographically. Thus, the Company is protected against adverse regional economic conditions. Mortgage-backed securities typically yield more than corporate bonds of similar maturity. MBS also are not subject to so-called event risk, which can cause investment grade bonds of a corporation to become "junk", as a result, for example, of a leveraged acquisition. In addition, MBS are generally very liquid issues with major brokerage houses providing ready markets. However, MBS are subject to prepayment and extension risk which can adversely affect their yield and expected maturity.
Policy loans as of December 31, 1993 were $51.7 million. Policy loan rates for the Company's policies are generally in the 3 1/2% to 8% range, at least equal to the assumed interest rates used for future policy benefits; accordingly, policy loans should not result in negative cash flow.