(2) Amounts have been derived from the Annual Statements of Life Reassurance Corporation of America ("LRCA") and Reassure America Life Insurance Company ("REALIC"), as filed with insurance regulatory authorities and prepared in accordance with statutory accounting practices. For purposes of this presentation, capital and surplus is defined as statutory capital and surplus of LRCA only, as its capital and surplus materially reflects that of the combined insurance subsidiaries plus the Asset Valuation Reserve ("AVR") and the Interest Maintenance Reserve ("IMR") of LRCA and REALIC.
(3) Liabilities and life insurance in force include the combined amounts for LRCA, TexasRe Life Insurance Company ("TexasRe"), and in 1996 and 1995, REALIC. For purposes of computing the ratio of statutory capital and surplus to liabilities, the denominator consists of liabilities excluding AVR and IMR.
With the exception of historical information, the matters contained in the following analysis are "forward looking statements," within the meaning of Section 27A of the Securities Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934, as amended. Such statements may include, but are not limited to, projections of earnings, revenues, income, or loss, capital expenditures, plans for future operations and financing needs or plans, as well as assumptions relating to the foregoing.
Forward looking statements are inherently subject to risks and uncertainties, some of which cannot be predicted or quantified. Future events and actual results, performance and achievements could differ materially from those set forth in, contemplated by or underlying the forward looking statements. Such factors include, but are not limited to, general economic and business conditions which may impact the need and/or financial ability to obtain reinsurance, insurance or retrocessional reinsurance; changes in laws and government regulations applicable to Life Re; the ability of Life Re to successfully implement its operating strategies (which strategies are described herein); material fluctuations in interest rate levels; material changes in morbidity and mortality experience; material changes in the level of operating expenses; and the success or failure of certain of Life Re's clients in premium writing.
The remainder of 1996 policy revenues was derived from Administrative Reinsurance(service mark). This business represents the acquisition of closed blocks of primary insurance policies (both interest sensitive and traditional) and annuity contracts and is expected to become a more significant component of policy revenues in the future.
Through its acquisition of REALIC in 1995, Life Re put into place a platform for acquiring and administering blocks of insurance in force. This platform, known as Administrative Reinsurance(service mark), provides a mechanism for an insurer to transfer to REALIC administrative responsibilities to facilitate the insurer's exit from a line of business by means of reinsurance or sale.
During 1996, Life Re, through REALIC, completed several such transactions (collectively, "Transactions") (see Note 3 of "Notes to Consolidated Financial Statements"). The Transactions increased total assets and liabilities by approximately $400 million. The assets received consisted primarily of cash and high quality investments and the liabilities assumed consisted primarily of future policy benefits on traditional life insurance policies and account values on annuities and interest sensitive life insurance policies. For 1996, the Transactions contributed policy revenues totaling $10.9 million and approximately $10.8 million of investment income.
Earnings before realized investment gains and federal income taxes increased by $7.8 million to $58.9 million in 1996 compared with $51.1 million in 1995 and $52.7 million in 1994. The increase in 1996 was primarily due to earnings from the Transactions and increased business in force within ordinary reinsurance.
Policy revenues by major source for the three year period are as follows:
Ordinary reinsurance $268.9 $243.7 $225.0 Group reinsurance 164.1 136.8 125.9 Administrative Reinsurance(service mark) 18.0 2.7 -- $451.0 $383.2 $350.9
The growth in ordinary reinsurance revenues was largely due to new reinsurance agreements entered into during the last two years, as first year premiums totaled $36.2 million in 1996 and increased by 68% and 17% during 1996 and 1995, respectively. The ordinary reinsurance lapse rate has ranged from 9-11% during the last three years.
The growth in Administrative Reinsurance(service mark) policy revenues has been due to the Transactions. Future revenue growth from Administrative Reinsurance(service mark) depends on Life Re's ability to identify and complete similar transactions.
Investment income increased by 26% in 1996 to $124.3 million and by 20% in 1995 to $98.6 million. These increases were largely due to the growth in invested assets from the REALIC acquisition in 1995 and the Transactions completed in 1996. This rate of growth is dependent on new Administrative Reinsurance(service mark) transactions and, to a lesser extent, new ordinary reinsurance business. The weighted average portfolio yield rate (amortized cost basis) was 7.8% in 1996 and 8.2% in 1995 and 1994.
Policy benefits increased by 18% in 1996 and 15% in 1995. These increases resulted from higher volumes of group business and increased life insurance in force, which was significantly impacted by the acquisition of REALIC and the completion of the Transactions. As a percentage of policy revenues, policy benefits were 74% in each of 1996 and 1995 and 70% in 1994. The increase experienced in the last two years was primarily due to an increase in revenues generated under reinsurance treaties with no acquisition costs, coinsurance involving paid-up insurance and Administrative Reinsurance(service mark), which produces no new business and, therefore, generally has a higher ratio of benefits to policy revenues.
Interest credited to policyholder accounts increased by 63% to $34.6 million in 1996 and by 42% to $21.2 million in 1995. These increases are attributable to the acquisition of REALIC and the Transactions as the majority of the policy benefit liabilities acquired in these transactions are interest sensitive.
Interest expense, including facility fees and agency fees, decreased to $8.4 million in 1996 from $10.7 million in 1995 and $9.1 million in 1994. This decrease was due to i) a decrease in the weighted average variable rate charged on outstanding debt, which decreased to 6.2% in 1996 from 7.1% in 1995 and ii) a decrease in the outstanding principal balance to $125.0 million resulting from the first quarter of 1996 repayment of $15.0 million. The effective interest rate as of December 31, 1996 was 6.0%.
Other operating expenses increased significantly in 1996 mainly due to i) third party administration fees incurred by REALIC, ii) higher compensation costs related to the Transactions and iii) higher staffing levels. REALIC utilizes the services of a third party administrator to administer all of its business; accordingly, to the extent the Company is successful in expanding Administrative Reinsurance(service mark), its operating expenses will continue to increase. Other operating expenses were essentially level in 1995 and 1994 as Canadian currency remeasurement losses incurred in 1994 totaling $4.2 million were partially offset by third party administrator fees incurred in connection with Administrative Reinsurance(service mark) and by higher employee-related and consulting costs in 1995.
Life Re's fixed maturity securities, which constituted 94%, or $1,720.6 million, of the total fair value of its invested assets as of December 31, 1996, are predominantly investment grade, liquid securities with varying maturity dates. The fair value of such investments may vary depending on economic and market conditions, the level of interest rates and the perceived creditworthiness of the issuer.
At December 31, 1996, collateralized mortgage obligations and mortgage-backed pass-through securities represented approximately 21% of Life Re's invested assets. Certain of such investments may be subject to significant prepayment risk and, therefore, are susceptible to fluctuations in the level of interest rates.
During 1996, 1995 and 1994, proceeds from sales of fixed maturities amounted to $253.4 million, $370.8 million and $134.8 million, respectively. The net gains realized from such sales were $1.8 million, $4.5 million and $0.4 million for the respective periods. The majority of the 1996 and 1995 sales was attributable to the restructuring of portfolios acquired in connection with the acquisition of REALIC and the completion of the Transactions.
Real estate and mortgages (at cost) totaled $7.0 million at December 31, 1996 and were acquired as part of the Transactions. Mortgage loans comprise the majority of this amount.
Asset/liability management techniques are utilized by the Company to minimize the risks associated with interest rate fluctuations. For interest sensitive policy benefits, Life Re seeks to invest in assets with equal durations while attaining a targeted rate of return. The Company currently does not engage in hedging transactions to mitigate the effects of interest rate fluctuations.
Shareholders' equity increased by $10.8 million to $290.1 million at December 31, 1996 from $279.3 million at December 31, 1995, primarily as a result of net income of $54.2 million, partially offset by a decrease in net unrealized appreciation of securities of $24.5 million, treasury stock purchases of $17.0 million and common shareholder dividends of $5.5 million.
The primary sources of funds for Life Re Corporation (the "Parent") consist of dividends and surplus debenture principal and interest payments from TexasRe, which are further funded by dividends from LRCA to TexasRe. The ability of the Parent to make payments of principal and interest as well as to continue to pay common stock dividends is ultimately dependent on the statutory earnings and surplus of its subsidiaries. The following table shows surplus debenture principal and interest payments received and dividends received by the Parent for the last three years as well as dividends available for payment in that year without prior approval of state regulatory authorities:
The unpaid principal amount of the surplus debentures at December 31, 1996 was $160.5 million. The interest rate payable under the terms of the surplus debentures is the same as the interest rate under the 1995 Credit Agreement. In 1995, the principal amortization terms of the surplus debentures were changed to conform to the terms of the 1995 Credit Agreement.
Currently, no prior approval of the Texas Insurance Commissioner is required to prepay or pay scheduled interest or principal on the surplus debentures provided that, after giving effect to any such payment, the statutory surplus of TexasRe exceeds $125.0 million.
The growth in ordinary life reinsurance new business was substantial in 1996 and 1995, with increases in first year reinsurance premiums totaling 68% and 17%, respectively. Although the Company does not expect the rate of growth experienced in 1996 to continue, its objective is to increase ordinary life reinsurance new business written by more than 20% during 1997. This growth could be constrained by i) competition, which could dilute the profitability of this business, ii) the success of ceding companies in writing primary business, and iii) the availability of statutory capital and surplus, which generally is absorbed by writing new business.
As a significant portion of the credit business is retroceded, Life Re's earnings from this business will result principally from investment income on assets relating to unearned premium reserves and not the underwriting results of this business. The amount of investment income generated is dependent on the volume of business produced. As consideration for this arrangement, Life Re pays contingent consideration to Aon based on business written for a five year period.
Report of Management . . . . . . . . . . . . . . . . .38 Report of Independent Auditors. . . . . . . . . . . . .39 Consolidated Balance Sheets at December 31, 1996 and 1995 . . . . . . . . . . . . . . . . . . . .40 Consolidated Statements of Income for the years ended December 31, 1996, 1995 and 1994. . . . . . . .41 Consolidated Statements of Changes in Shareholders' Equity for the years ended December 31, 1996, 1995 and 1994. . . . . . . .42 Consolidated Statements of Cash Flows for the years ended December 31, 1996, 1995 and 1994. . . . . . . .43 Notes to Consolidated Financial Statements. . . . . . .44
Schedule II Condensed Financial Information of Registrant. . . . . . . . . . . . . .65
All other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and therefore have been omitted or the information is presented in the consolidated financial statements or accompanying notes.
Management has established and maintains a system of internal control that provides reasonable assurance as to the integrity and reliability of the financial statements, the protection of assets from unauthorized use or disposition and the prevention and detection of fraudulent financial reporting. In addition, the adequacy and effectiveness of the system of internal control is reviewed periodically by the Company's internal auditors.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Life Re Corporation and subsidiaries at December 31, 1996 and 1995, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
Life Re Corporation and Subsidiaries Notes to Consolidated Financial Statements December 31, 1996
The consolidated financial statements of Life Re Corporation and subsidiaries (the "Company") include the accounts of TexasRe Life Insurance Company ("TexasRe"), Life Reassurance Corporation of America ("LRCA"), Life Re International, Ltd. and Reassure America Life Insurance Company ("REALIC")(Note 3). All significant intercompany balances and transactions have been eliminated. The accompanying financial statements have been prepared in accordance with generally accepted accounting principles. Certain reclassifications have been made to prior years' financial statements to conform to the current year's presentation. All dollar amounts are reported in thousands unless otherwise indicated.
The Company provides ordinary life reinsurance, group life reinsurance, group accident and health and special risk reinsurance, Administrative Reinsurance(service mark) and automobile credit reinsurance. The Company reinsures mortality and morbidity risks, and investment related risks associated with interest sensitive products. The Company reinsures life insurance risks predominately on a direct basis with ceding companies. A significant portion of the group accident and health and special risk business is obtained through brokers or other intermediaries. Generally, the Company assumes group health and special risk business through participation in reinsurance pools which are operated by managing general underwriters.
The preparation of financial statements in conformity with generally accepted accounting principles requires the use of estimates and assumptions developed by management. Any adjustments to reported bases of assets or liabilities resulting from changes in estimates are reflected in earnings in the period the estimates are revised.
Fixed maturities in these notes include both fixed maturity securities which are part of assets held by ceding company under reinsurance treaty and those included in the caption fixed maturities in the accompanying consolidated balance sheets.
Short-term investments are stated at cost and policy loans are stated at aggregate unpaid principal balances.
Realized investment gains and losses are reported net of related expenses and include the amount of amortization of deferred policy acquisition costs and value of business acquired resulting from the inclusion of such realized gains or losses in the gross profits used for the calculation of such amortization.
Investment securities: Fair values of fixed maturities and equity securities are obtained from independent pricing services which generally use quoted market prices, where available. For securities for which quoted market prices are not available and for securities which independent pricing services are unable to price, fair values are obtained from the Company's outside portfolio managers, who obtain them from broker/dealers or estimate them using analytic pricing methods. These pricing methods determine fair values by discounting expected future cash flows using current market rates applicable to the yield, credit quality and maturity of comparable quoted securities. The fair values resulting from the application of these methods are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Such derived fair value estimates may not be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlements of the instruments.
Premiums are recognized as revenues over the premium paying periods of the policies. Benefits and expenses are provided against such revenues to recognize profits over the estimated lives of the policies through the provision for future policy benefits and the deferral and amortization of policy acquisition costs.
The following pro forma financial information has been prepared assuming the acquisition of REALIC had occurred at the beginning of each of the periods presented and reflects certain purchase accounting adjustments, including amortization of the value of business acquired, net of related income tax effects. The pro forma results are not necessarily indicative of the results that would have occurred had the acquisition been consummated as of the assumed dates nor are they necessarily indicative of future operating results.
The following pro forma financial information has been prepared assuming REALIC's purchase of these two subsidiaries had occurred at the beginning of each of the periods presented and reflects certain purchase accounting adjustments, including amortization of the value of business acquired, net of related income tax effects. The pro forma results are not necessarily indicative of the results that would have occurred had these transactions been consummated as of the assumed dates nor are they necessarily indicative of future operating results. The pro forma results reflect realized investment gains and other income of the acquired companies of $1,496 in 1996 and realized investment losses, net of other income, of $7,309 in 1995 resulting primarily from writedowns of a common stock investment in I.C.H. Corporation and certain real estate. Also included in 1995 is a $4,000 litigation settlement charge.
Effective May 31, 1996, REALIC acquired a block of insurance in force under an assumption reinsurance agreement whereby it assumed liabilities for future policy benefits totaling $124,245. Assets totaling $107,334, principally cash, were transferred to REALIC by the ceding company.
Fair Value Fixed maturities: Green Tree Financial Corporation $ 29,471 Federal National Mortgage Association $ 91,478 Federal Home Loan Mortgage Corporation $149,540
Fixed maturities $120,759 $ 95,391 $79,867 Short-term investments 1,901 3,010 1,518 Other 3,905 1,931 2,675
Total investment income 126,565 100,332 84,060 Investment expenses (2,225) (1,716) (1,622)
Realized investment gains are as follows: Years Ended December 31, Sales: 1996 1995 1994
[S] [C] [C] [C] Realized gains $18,744 $ 6,497 $ 2,581 Realized losses (3,383) (1,973) (2,212)
On March 18, 1996, Life Re Corporation sold its equity investment in Nacolah Holding Corporation ("Nacolah"), the parent of The North American Company for Life and Health Insurance, in connection with the acquisition of Nacolah by Sammons Enterprises, Inc. The Company received proceeds of $25,057 and recorded a realized investment gain of $13,540.
The Company's accident and health insurance business is of short duration and generally claims are reported within a short period of time after incurral. In the aggregate, there have been no material favorable or adverse developments affecting accident and health insurance claims reserves in 1996, 1995 or 1994.
TexasRe and LRCA file a consolidated federal income tax return with Life Re Corporation. REALIC files a separate federal income tax return.
Value of business acquired and other purchase adjustments 21,157 17,417 Policy receivables, net 1,086 1,641 Total deferred tax liabilities 75,200 68,933 Deferred tax assets: Policy benefits, net 30,884 29,079 Other investment items 2,584 152 Net operating loss carryforwards 211 5,230 Other, net 2,843 1,054 Total deferred tax assets 36,522 35,515 Valuation allowance for deferred tax assets -- (4,775) Net deferred tax assets 36,522 30,740
On November 2, 1995, the Company amended and restated its then existing credit agreement (the "1992 Credit Agreement") to convert the facility to a senior secured revolving and term loan with a total commitment of $160,000 (the "Amended and Restated Credit Agreement"). Under the Amended and Restated Credit Agreement, at the conclusion of the revolving loan period, the loan converts to a five year amortizing term loan in a principal amount equal to the balance of the revolving loan at conversion. During 1996, the maturity date of the revolving loan period was extended to January 1999 and may, with bank consent, be extended for an additional one year period. As of December 31, 1996, borrowings were $125,000. Unamortized deferred loan costs associated with the 1992 Credit Agreement of $1,545, before federal income tax benefit of $541, were charged to income in 1995 as an extraordinary charge.
Borrowings under the Amended and Restated Credit Agreement are secured by a first priority perfected security interest in all of the capital stock and surplus debentures of TexasRe and a negative pledge with respect to the capital stock of LRCA.
The Amended and Restated Credit Agreement contains certain covenants which, among other things, restrict under certain circumstances the payment of dividends and repurchase of treasury stock. Further, certain actions of the Company are limited, including those related to mergers, acquisitions, indebtedness and investments. The Company and the life insurance subsidiaries are required to meet certain financial ratios and maintain a minimum level of statutory surplus.
Interest is payable at a rate or rates equal to i) the greater of (a) the bank's reference rate or (b) the federal funds rate plus 0.50% (the "Alternative Reference Rate" or "ARR") or ii) a margin plus a eurodollar interbank offered rate ("IBOR"). The applicable margin over IBOR is adjustable based on the Company's indebtedness to capitalization ratio as defined, at the end of each quarter.
During 1996, pursuant to the terms of stock repurchase programs approved by the Company's Board of Directors, the Company purchased 581,500 shares of its common stock for an aggregate purchase price of $16,206. Through December 31, 1996, 2,126,700 shares out of a total authorization by the Company's Board of Directors to repurchase 3,000,000 shares have been acquired for a total purchase price of $45,691. Treasury stock also reflects the repurchase of shares of stock from certain officers in accordance with the terms of their stock purchase agreements.
Under the Company's Certificate of Incorporation, 5,000,000 shares of preferred stock are available for future issuance without shareholder approval. The rights, terms and preferences of the preferred stock may be determined by the Company's Board of Directors.
At December 31, 1996, subsidiary net assets, determined in accordance with generally accepted accounting principles, comprised approximately $250,000 of shareholders' equity, of which $16,315 is available for transfer in 1997 without prior approval of state regulatory authorities. Dividends paid to Life Re Corporation by TexasRe were $12,087 in 1996, $15,000 in 1995 and none in 1994.
Life Re Corporation owns $160,500 of surplus debentures issued by TexasRe which provide funds to Life Re Corporation in the form of principal and interest payments. Under the terms of an amendment to TexasRe's surplus debentures, no prior approval of the Texas Department of Insurance is required to pay or prepay scheduled principal or interest on the surplus debentures provided that, after giving effect to any such payment, the statutory surplus of TexasRe exceeds $125,000. Payments of surplus debenture principal and interest to Life Re Corporation by TexasRe totaled $10,008, $29,400 and $7,305 in 1996, 1995 and 1994, respectively.
The amendment to TexasRe's surplus debentures was approved under the consideration that statutory surplus, as defined, in excess of $125,000 be reflected in liabilities to the extent of outstanding surplus debenture interest and principal. Accordingly, at December 31, 1996, surplus debentures of $50,831 were reclassified to liabilities.
The subsidiaries' statutory basis financial statements are prepared in accordance with accounting practices prescribed or permitted by their respective domiciliary states. "Prescribed" statutory accounting practices include state laws, regulations and general administrative rules, as well as publications of the National Association of Insurance Commissioners ("NAIC"). "Permitted" statutory accounting practices encompass all accounting practices that are not prescribed; such practices may differ from state to state, may differ from company to company within a state and may change in the future. The Company does not utilize any permitted accounting practices. The NAIC currently is in the process of codifying statutory accounting practices. That project, when completed, may change prescribed statutory accounting practices and thus may result in changes to the accounting practices that the subsidiaries use to prepare their statutory basis financial statements.
Combined statutory basis net income totaled $16,315, $27,087 and $28,236 in 1996, 1995 and 1994, respectively.
Effective in 1996, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, "Accounting for Stock Based Compensation" ("FAS 123"), which provides for employee stock options to be measured at fair value on the date of grant which is then amortized to expense over the options' vesting period. As permitted by FAS 123, the Company has elected to continue to account for its stock options under Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25") and related Interpretations. Under APB 25, the Company does not incur any expense at the date of grant because the exercise price of the stock options equals the market price of the underlying stock on that date.
Pro forma net income and earnings per share including the effects of amortization of the estimated fair values of employee stock options granted after December 15, 1994 are as follows:
Substantially all full time employees are covered by a noncontributory defined benefit pension plan. Benefits are determined by a formula which relates the pension payable to years of service at retirement, final five year average salary and wages covered by Social Security. Annual contributions to the plan are sufficient to satisfy legal funding requirements. In addition, the Company adopted an unfunded Supplemental Executive Retirement Plan in 1995, which is a nonqualified plan that provides certain officers defined pension benefits in excess of limits imposed by federal tax law. The Company also sponsors a defined contribution savings plan covering substantially all employees with at least six months of service. The Company contributes 50% of the first 6% of salary contributed by employees. Participants vest in Company contributions over a four year period. The combined expense associated with employee benefit plans was $1,151, $1,031 and $515 in 1996, 1995 and 1994, respectively.
In the normal course of business, the Company seeks to limit its exposure to loss by ceding reinsurance to retrocessionaires. In general, the Company retains a maximum of $1,000 on any one life for ordinary life insurance business with certain limited exceptions depending upon age and classification of the risk. Amounts in excess of the retention are ceded to a pool of retrocessionaires. From time to time, the Company has also entered into quota share retrocessional agreements. In general, the Company's policy in regard to group insurance business is to retain not more than $250 of liability on any one life insurance risk, $300 on any one accident or health insurance risk or, for special risk insurance, $1,000 on any one risk. The Company has agreements with group retrocessionaires primarily on an excess basis. Contracts for reinsurance ceded do not relieve the Company from its obligations under contracts for reinsurance assumed. Failure of retrocessionaires to honor their obligations could result in losses to the Company; however, no amounts are deemed uncollectible at December 31, 1996.
Future policy benefits under life insurance contracts $213,001 $161,258 Claims payable under life insurance contracts 19,752 13,602 Accident and health insurance claims reserves 27,446 21,539 Other policy benefits 14,478 1,701 Acquisition costs payable 2,948 11,213 Total amounts receivable on reinsurance ceded $277,625 $209,313
Policy benefits recovered on reinsurance ceded for the years ended December 31, 1996, 1995 and 1994 were $75,971, $90,435 and $55,415, respectively.
Future lease commitments under noncancelable leases for the Company's premises are approximately $1,000 in each of the next five years and total $8,000.
The Company and a ceding company are in arbitration concerning the terms of a reinsurance agreement. The Company does not believe that the outcome will have a material adverse effect on results of operations or financial position.