WNC's home office building is in a five-story, 175,000 square-foot office building located at 300 Tower Parkway, Lincolnshire, Illinois. The building is leased from a joint venture partnership in which Washington National Development Company (WNDC), a subsidiary of WNIC, has a one-third interest. WNC first occupied the property in May, 1993 and WNIC signed a twenty-year lease to occupy the building.
WNDC has a fifty percent interest in a joint venture partnership that owns a 22,000 square-foot data center in Vernon Hills, Illinois, that is leased and occupied solely by WNIC. WNIC first occupied the property in April, 1993 and signed a twenty-year lease.
The Company employs a decentralized operating structure and utilizes distinct distribution systems to access each of its targeted markets and to provide timely, individualized service to its customers. The Company emphasizes the sale of market-driven products, a profit-oriented rather than a volume-oriented approach to underwriting, tight expense controls, and a proactive approach to market and regulatory changes. The Company continually evaluates new products and markets in order to capitalize on potential opportunities and to anticipate and respond effectively to business and regulatory changes.
Strategy The Company's current focus is on continuing the improvement in its operating performance, principally through a strategy of disciplined revenue growth in each of the three core businesses along with further reductions in expense ratios. The Company seeks to achieve revenue growth primarily by expanding its sale of existing and new products and services within targeted markets that are underserved by other insurance carriers. The Company anticipates that additional revenue growth may result from certain cross-marketing opportunities within its businesses and selected acquisitions of profitable blocks of business. Additionally, the Company believes that its life insurance and annuities business complements the Company's more cyclical health businesses, thereby providing greater stability to the Company's earnings base. The Company seeks to achieve reductions in its expense ratios through infrastructure improvements, ongoing work flow re-engineering, and revenue growth.
Net Investment Income. Net investment income decreased $3.4 million, or 1.8%, to $183.7 million in 1993 from $187.1 million in 1992. The decrease was due to a general decline in market interest rates which caused a decline in the Company's portfolio yield from 8.6% to 8.0%, offset in part by an increase in invested assets. Invested assets at December 31, 1993 increased $122.4 million from December 31, 1992, principally due to deposits on life insurance policies and annuity contracts exceeding withdrawals combined with proceeds from a secondary stock offering in the third quarter of 1993.
Insurance Benefits Paid or Provided. Insurance benefits paid or provided increased $10.6 million, or 2.6%, from $409.8 million in 1992 to $420.4 million in 1993. The increase was primarily due to increased individual health insurance benefits of $29.2 million resulting from an increase in the block of in force business and the reinsurance transaction referred to above. Partially offsetting this was a decline in life insurance and annuities benefits of $16.6 million resulting from a decrease in interest credited on interest-sensitive products, favorable mortality experience, and the annual review of benefits assumptions, discussed below in "Amortization of Deferred Insurance Costs."
Amortization of Deferred Insurance Costs. Amortization of deferred insurance costs increased $10.8 million, or 39.9%, in 1993 to $37.9 million from $27.1 million in 1992. The change was primarily due to increased amortization of $3.5 million in the individual health insurance segment resulting from an increase in the block of in force business and $3.6 million due to the annual review of amortization assumptions in the life insurance and annuities segment, partially offset by the decrease in benefits, discussed above.
Net Income (Loss). Net income for 1993 was $26.7 million compared to a net loss of $6.0 million in 1992. The improvement in net income resulted primarily from the charges in the first quarter of 1992 relating to the adoption of two new accounting standards described above and improved operations in the individual health and life insurance and annuities segments, partially offset by a decline in group products operating income and the charge relating to the new accounting standard in the first quarter of 1993.
Pretax income for the life insurance and annuities segment increased 28.7% to $28.1 million in 1993 from $21.9 million in 1992. The increase was primarily due to improved interest rate spreads, as the interest credited on account balances was reduced more than the reduction in the yield on invested assets, and favorable mortality experience. Also contributing to the improvement was a charge of $2.8 million for anticipated guaranty fund assessments recorded in 1992 compared to $0.5 million in 1993. Partially offsetting these increases were charges in 1993 of $1.6 million to combine the Company's data centers, implement work flow re-engineering at UPI, and transfer the administration of WNIC's closed block of life insurance to UPI.
Group Products. Revenues for the group products segment were $234.6 million in 1993 compared to $231.2 million in 1992, an increase of 1.5%. The increase was primarily due to an increase in the amount of business in force in the education product line resulting from sales in 1992 and 1993 and premium rate increases averaging 7% in the employee benefits product line. These increases were partially offset by a decline of approximately $6 million from the termination of a large group life insurance contract, with approximately $3 billion of life insurance in force, in the third quarter of 1993. The annual premiums and related benefits related to this contract were each approximately $11 million. The termination of this contract will not materially affect net income.
Pretax income for the group products segment was $6.1 million in 1993 compared to $10.2 million in 1992. The decline was primarily due to higher medical claims, less favorable mortality experience, and increased operating expenses, including the receipt in the first quarter of 1992 of an expense refund of $1.8 million in connection with a withdrawal from a partnership. Also included in operating expenses in 1993 were charges of $1.7 million related to the combination of the individual health and employee benefits divisions. These increases were partially offset by favorable disability claims experience in 1993.
Sales of individual health policies declined in 1993 compared to 1992 in part due to a decision to maintain pricing margins in spite of increased pricing competition. The Company expects such increased pricing competition to continue in 1994. However, as a result of an expanded sales force from the reinsurance agreements described below, the Company expects new sales will increase in 1994.
Effective in the 1993 second quarter, the Company entered into a reinsurance agreement with The Harvest Life Insurance Company (Harvest Life) that provides that the Company will reinsure 100% of a block of major medical business issued by Harvest Life. Harvest Life will continue to administer this business for a period of at least three years. As part of the reinsurance agreement, Harvest Life has agreed to market the Company's major medical products in place of its own major medical products through Harvest Life's career agent sales force. Harvest Life agents sell to insureds in rural areas, primarily farming communities. In addition to $23.2 million of premium revenue and $0.2 million of other income recorded in 1993, insurance benefits of $15.5 million and insurance and general expenses of $6.9 million were attributable to the reinsurance agreement.
Corporate and Other. The corporate and other segment includes realized investment gains and losses, the operations of non-insurance lines of business, and corporate expenses. For 1993, the pretax loss was $0.9 million compared to a loss of $2.5 million in 1992. The improvement was primarily due to the previously mentioned decrease in realized investment losses.
Revenues for this segment are expected to increase slightly in 1994 due to investment income on a portion of the proceeds from the third quarter 1993 stock offering.
Year Ended December 31, 1992 Compared to Year Ended December 31, 1991
Net Investment Income. Net investment income decreased $12.3 million, or 6.1%, from $199.4 million in 1991 to $187.1 million in 1992. The decrease was due to a lower average yield on invested assets in 1992, which decreased from 9.1% in 1991 to 8.6% in 1992, resulting from a general decline in interest rates combined with the Company's reinvestment of assets in higher quality, lower yielding securities.
Loss on Divestitures. The 1991 pretax net loss consisted of a $1.8 million loss on the sale of a subsidiary, partially offset by a gain on blocks of business sold by WNIC. See Note J to the Consolidated Financial Statements for further information.
Insurance and General Expenses. Insurance and general expenses, including a $4.0 million gain from the reduction of postretirement benefits, decreased $19.9 million, or 15.7%, from $127.0 million in 1991 to $107.1 million in 1992. The decline resulted primarily from the elimination of $3.7 million of expense from the sale of discontinued lines and a $7.7 million planned decrease in operating expenses in the group products segment.
Income Taxes. Income taxes increased $6.9 million from $2.6 million in 1991 to $9.5 million in 1992 due primarily to the higher level of pretax income of $26.4 million in 1992, versus a pretax loss of $0.4 million in 1991.
Net Loss. Net loss increased $3.0 million from $3.0 million in 1991 to $6.0 million in 1992. The change was primarily as a result of the $22.8 million cumulative effect of changes in accounting principles described above, partially offset by the increase in income before such changes of $19.8 million.
Pretax income for the life insurance and annuities segment decreased 8.9% to $21.9 million in 1992 compared to $24.0 million in 1991. The decline was primarily due to 1992 accruals for anticipated guaranty fund assessments of $2.8 million.
Individual Health. Revenues for the individual health insurance segment increased 30.5% to $107.6 million in 1992 compared to $82.4 million in 1991. Revenues for this segment primarily increased due to an increase in the amount of business in force and an increase in premium rates.
Pretax loss for the individual health insurance segment declined $10.6 million to $3.2 million for 1992 compared to a loss of $13.8 million in 1991. The decline in the loss from 1991 was primarily due to a larger premium base over which to spread fixed operating expenses for this segment and an improved ratio of claims to premium revenues in 1992.
At December 31, 1993, the Company had invested assets of $2.4 billion. The following table sets forth certain information about the Company's investment portfolio as of that date:
Fixed Maturity Investments The carrying value of fixed maturity investments at December 31, 1993 was $1.8 billion, or 74.7% of the Company's invested assets. This amount increased from $1.6 billion, or 69.5% of the Company's invested assets at December 31, 1992 primarily due to the Company making new investments principally in investment grade fixed maturity securities. At December 31, 1993 and December 31, 1992, the fair value of the Company's fixed maturity investments exceeded the carrying value by $82.3 million and $56.9 million, respectively.
The Company's policy for rating fixed maturity investments is to use the rating on such investments as determined by Standard & Poor's Company (S&P's) or Moody's Investor Service, Inc. (Moody's). If an investment has a split rating (i.e., different ratings from the two rating services) the Company categorizes the investment under the lower rating. For those investments that do not have a rating from either S&P's or Moody's, the Company categorizes those investments on ratings assigned by the National Association of Insurance Commissioners (NAIC), whose ratings are as follows: NAIC Class 1 is considered equivalent to a AAA/Aaa, AA/Aa, or A rating; NAIC Class 2, BBB/Baa; and NAIC Classes 3-6, BB/Ba and below. Fixed maturity investments that are not rated by S&P's or Moody's (unrated private placements), but instead rated with comparable NAIC ratings, comprise 0.4% of AAA-rated investments, 1.7% of AA-rated, 4.1% of A-rated, 23.2% of BBB-rated, and 50.2% of investments rated BB and lower at December 31, 1993.
The composition of the Company's fixed maturity portfolio, based on S&P's and Moody's ratings at December 31, 1993, was as follows:
Certain mortgage-backed securities are subject to significant prepayment risk. This is due to the fact that in periods of declining interest rates, mortgages may be repaid more rapidly than scheduled as individuals refinance higher-rate mortgages to take advantage of lower rates. As a result, holders of mortgage-backed securities may receive large prepayments on their investments that cannot be reinvested at interest rates comparable to the rates on the prepaid mortgages.
Planned amortization class (PAC) and target amortization class (TAC) tranches, which together comprised 12.4% of the Company's invested assets at December 31, 1993, are designed to amortize in a manner that shifts the primary risk of prepayment of the underlying collateral to investors in other tranches of the CMO. The PAC and TAC instruments tend to be less sensitive to prepayment risk.
Sequential classes, which comprised 1.5% of the Company's invested assets at December 31, 1993, may have prepayment characteristics similar to mortgage-backed pass-through securities. Support classes, which comprised 1.0% of the Company's invested assets at December 31, 1993, are the most sensitive to prepayment risk.
Mortgage Loans and Real Estate The Company had investments in mortgage loans of $391.7 million at December 31, 1993 compared to $452.0 million at December 31, 1992. Investments in mortgage loans declined primarily due to prepayments and amortization of the mortgage loan portfolio. Of the outstanding loans at December 31, 1993, $3.7 million (net of allowances of $3.9 million), or 0.9%, were delinquent 60 days or more as to interest or principal.
At December 31, 1993, the Company's insurance subsidiaries had a delinquent mortgage loan ratio (mortgage loans overdue 60 days or in foreclosure, before allowances, as compared to the total mortgage portfolio before allowances) of 1.1% compared to 2.2% at December 31, 1992. The industry average delinquent mortgage loan ratio for residential and commercial mortgages, as measured by the American Council of Life Insurance, was 4.5% at December 31, 1993.
The Company actively manages its non-current investments through restructuring of mortgages and sales and leasing of foreclosed real estate in order to achieve the highest current return as well as to preserve capital. Restructured loans, where modifications of the terms of the mortgage loan have generally occurred and which are considered current investments, were $16.9 million at December 31, 1993 compared to $18.2 million at December 31, 1992. At December 31, 1993, the Company's mortgage loan portfolio included $6.9 million of mortgage loans, before allowances, overdue at least three months and on which no interest income was being accrued. The Company does not expect the non-current investments to have a material adverse effect on its liquidity or ability to hold its other investments to maturity. This is primarily due to the relatively small amount of these non-current investments as compared to total invested assets and to the total amount of high quality, liquid investments.
The Company's mortgage loan portfolio at December 31, 1993 was diverse with respect to geographic distribution, principal repayment schedule dates, and property type as outlined below:
Cash Flows During 1993, the Company's operating activities generated cash of $104.7 million compared to $93.3 million in 1992. The increase in cash provided by operations in 1993 primarily resulted from improved insurance operations in 1993 compared to 1992.
Financing activities provided cash of $27.1 million and $49.7 million, in 1993 and 1992, respectively. In 1993, $47.3 million of cash was provided by the sale of 2.1 million new shares of common stock and $18.1 million was provided by net receipts from universal life insurance and annuity policies. Partially offsetting these amounts in 1993 was the payment of $17.4 million of short-term notes payable, $9.5 million of mortgage and other notes payable, and $12.2 million of dividends to stockholders. In 1992, $46.0 million of cash was provided by net receipts from universal life insurance and annuity policies and net proceeds from debt, offset in part by $11.1 million of dividends to stockholders.
The fair value of the Company's investment portfolio, primarily fixed maturity investments, is affected by changing interest rates. When interest rates rise, the fair value of the Company's fixed maturity investments declines. In addition, the value of the Company's policy liabilities decreases. In periods of declining interest rates, the fair value of the Company's fixed maturity investments increases, accompanied by an increase in the value of its policy liabilities. The Company estimates that a one percentage point increase in market interest rates would result in a decrease in the fair value of its fixed maturity investments of approximately 5 percent, and a one percentage point decrease in market interest rates would result in an increase in the fair value of its fixed maturity investments of approximately 5 percent. In addition, rising interest rates could result in increased surrenders of life insurance policies and annuities causing the Company to sell fixed maturity investments below cost. In order to minimize the need to sell fixed maturity investments below cost, the Company seeks to maintain sufficient levels of cash and short-term investments.
Dividends The Company's primary sources of funds to pay dividends to stockholders are investments held at the parent and dividends from WNIC. These dividends are subject to restrictions set forth by the Illinois Insurance Department. Illinois state regulations limit the amount of cash that can be withdrawn from WNIC to the greater of the previous year's statutory earnings or 10% of statutory capital and surplus. See Note E for further information.
Health Care Reform On September 22, 1993, President Clinton provided the outline of the Administration's proposal for health care reform and delivered to Congress a more detailed package of the proposal in mid-October. The proposal relies heavily on a federally guaranteed package of health care benefits and medical services, primarily through an employer-based program for working Americans. In addition, the Administration's outline provides for health care coverage for non-working Americans. The Administration's proposal could have the following effects on insurers: (i) partially or fully replace products sold by insurers; (ii) limit the ability of insurers to charge higher rates to or decline to cover, insureds who present greater risks; (iii) limit the ability of insurers to exclude coverage for pre- existing conditions; (iv) mandate the types of insurance benefits to be provided in certain instances; (v) impose insurance rate regulation or additional taxes on insurance premiums or benefits; or (vi) increase competition by expanding employee choice of insurance plans and by requiring the employee to bear the full cost increment for higher priced plans.
In addition to the Administration's plan, a number of members of Congress have proposed alternative health care reform plans. These plans rely, in some instances, more on market-driven reform rather than on government mandated reform and several aspects of the Administration's proposal, such as universal coverage and employer mandates, are being challenged by these alternative plans.
The Company has monitored and will continue to monitor all aspects of the developments surrounding this issue and is preparing strategic responses to its possible outcomes. The Company's health businesses have begun to diversify into product areas, such as supplemental insurance products and disability products, that the Company believes are consistent with its targeted market focus and may be less affected or unaffected by health care reform. Such products may not be a component of a mandated benefits package and may be supplementally purchased by consumers. Health care reform at the federal and state levels may have a material adverse effect on the Company's operating results and financial position, but it is not possible at this time to predict the nature and effects of health care reform or how soon its measures will be adopted and implemented.
During the 1993 fourth quarter, the Company announced that it had combined its individual health division and employee benefits division at WNIC. The combination is designed to accelerate the Company's positioning for strategic business opportunities under health care reform.
A.M. Best's 15 categories of ratings for insurance companies currently range from "A++ (Superior)" to "F (In Liquidation)." According to A.M. Best, an "A" or "A-" rating is assigned to companies which, in A.M. Best's opinion, have achieved excellent overall performance when compared to the standards of the life insurance industry and generally have demonstrated a strong ability to meet their obligations to policyholders over a long period of time. In evaluating a company's statutory financial and operating performance, A.M. Best reviews the company's statutory profitability, leverage, and liquidity, as well as the company's spread of risk, quality and appropriateness of its reinsurance program, quality and diversification of assets, the adequacy of its policy reserves and surplus, capital structure, and the experience and competency of its management. A.M. Best ratings are based upon factors of concern to policyholders, agents, and intermediaries and are not directed toward the protection of investors.
Notwithstanding the foregoing, there can be no assurance that A.M. Best will maintain the ratings of the Company's insurance subsidiaries at their present levels. A rating downgrade at either WNIC or UPI could have a materially adverse effect on the ability of that subsidiary to write and retain business.
Inflation and Changing Prices Inflation and changing prices are anticipated by the Company in the pricing of its insurance products. Significant components of health insurance benefits are the medical care inflation rate, policyholder utilization of medical services, and cost-shifting, which is the transfer of medical care provider expenses that are not covered by governmental plans and HMOs to private insurers. As a result of relatively stable general and medical care inflation rates in 1993, WNIC's health insurance pricing assumptions regarding these factors were essentially unchanged from the prior year. For the first quarter of 1994, these assumptions have also not changed materially.
The effect of inflation on operating expenses has not been significant. However, if inflation increases significantly, operating expenses would be expected to increase.
Certain amounts in the 1992 and 1991 financial statements have been reclassified to conform to the 1993 presentation.
Mortgage loans on real estate are carried at unpaid principal, less unearned discount and allowance for possible losses. An allowance for mortgage loan losses is established based on an evaluation of the mortgage loan portfolio, past credit loss experience, and current economic conditions.
Real estate investments are principally carried at cost, less allowances for depreciation and possible losses. Foreclosed real estate is considered held for sale and is recorded at the lower of current carrying value or fair value, less estimated costs of disposal.
Other long-term investments consist principally of venture capital investments which are carried at cost, less other- than-temporary impairments.
Short-term investments include commercial paper, variable demand notes, and money market funds, and are carried at cost.
Interest on bonds, loans, and notes is recorded in income as earned. Income is adjusted for any amortization of premium or discount on these investments. Any excess cash flows arising from prepayments are booked as adjustments to the carrying value of the investment. Income on real estate and other long-term investments is recorded principally on a cash basis. Dividends are recorded as income on ex-dividend dates.
The carrying amounts reported in the balance sheets for cash, short-term investments, short-term borrowings, and accrued investment income approximate their fair values.
Fair values for fixed maturity securities are based on quoted market prices, where available. For fixed maturity securities not actively traded, fair values are estimated using values obtained from independent pricing services or, in the case of private placements, are estimated by discounting expected future cash flows using a current market rate applicable to the yield, credit quality, and maturity of the investments.
Fair values for mortgage loans and policy loans are estimated using discounted cash flow analyses, based on interest rates currently being offered for similar loans to borrowers with similar credit ratings.
Health insurance premiums are earned pro rata over the terms of the policies. For traditional life insurance products, premiums are recognized as revenues when due. Revenues for certain interest-sensitive products consist of charges earned and assessed against policy account balances during the period for the cost of insurance, policy initiation fees, policy administration expenses, and surrenders.
Liabilities for future policy benefits of certain interest-sensitive products represent policy account balances before applicable surrender charges plus certain deferred policy initiation fees that are recognized as income over the term of the policies and a provision for the return of cost of insurance charges. Policy benefits and claims that are charged to expense include interest credited to policy account balances, benefit claims incurred in the period in excess of related policy account balances, and a provision for the return of cost of insurance charges. Credited interest rates for these products ranged from 3.0% to 7.5% at December 31, 1993.
The liabilities for policy and contract claims are determined using case- basis evaluations and statistical analyses. These liabilities represent estimates of the ultimate expected cost of incurred claims and the related claim adjustment expenses. Any required revisions in these estimates are included in operations in the period when such adjustments become determinable.
The cost of purchased businesses in excess of net assets is reported as goodwill and amortized on a straight-line basis, generally over thirty-six years. Goodwill is evaluated based on the prospect for continued growth and the long-term nature of the insurance policies sold. The asset value is considered appropriate. Accumulated amortization of goodwill was $6,023,000 and $5,204,000 at December 31, 1993 and 1992, respectively.
Separate Account assets and liabilities are principally carried at fair value and represent funds that are separately administered for annuity contracts and for which the contract holders bear the investment risk. Investment income and realized gains and losses allocable to Separate Accounts generally accrue to the contract holders and are excluded from the Consolidated Statements of Operations.
Effective January 1, 1993, WNC adopted SFAS 113, "Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts." The statement requires that reinsurance recoverables, including amounts related to claims incurred but not reported and prepaid reinsurance premiums, be reported as assets instead of net of the related liabilities. The adoption resulted in an increase in total assets and liabilities of $58,173,000 and $60,266,000 at December 31, 1993 and 1992, respectively. The adoption had no impact on net income or stockholders' equity.
In June 1993, the FASB issued two new accounting standards. SFAS 114, "Accounting by Creditors for Impairment of a Loan," must be adopted by the Company by January 1, 1995. The standard will require the Company to measure an impaired loan at (i) the present value of expected future cash flows, discounting those cash flows at the loan's effective interest rate, (ii) the fair value of the collateral of an impaired collateral dependent loan, or (iii) an observable market price. The impairment is recognized by a valuation allowance which may be subsequently increased or decreased based on changes in the measurement criteria. The Company is in the process of determining the effect the new standard will have on net income and stockholders' equity but does not expect the effect to be material.
The second standard, SFAS 115, "Accounting for Certain Investments in Debt and Equity Securities," which the Company must adopt prospectively effective January 1, 1994, requires the Company to segregate its fixed maturity portfolio into three separate classifications on the balance sheet: investments held to maturity, trading securities, and investments available for sale. Investments held to maturity will include only those fixed maturities that the Company has a positive intent and ability to hold to maturity. These securities will be carried at amortized cost less write- downs for other-than-temporary impairments. Trading securities will consist of those fixed maturity and equity securities held for short periods of time and will be carried on the balance sheet at fair value, with any change in value reported as a component of income. Investments available for sale will consist of those securities that do not meet the criteria of investments held to maturity or trading securities and will be carried on the balance sheet at fair value, with any change in value recognized as an unrealized gain or loss in stockholders' equity. If a decrease in value of fixed maturity investments is other than temporary, the loss is recognized immediately as a realized loss. In addition, stockholders' equity will be reduced by the estimated amortization of deferred insurance costs that the realization of the unrealized gains would produce. The adoption of this standard at January 1, 1994 will result in an increase in stockholders' equity of approximately $43,000,000. This is the result of changing the carrying value of the current held for sale fixed maturities to fair value, a reduction in deferred insurance costs of $19,000,000, and a related increase in deferred taxes of $14,000,000. There will not be an income statement effect for adoption as the Company does not have a trading portfolio.
The Company foresees that this standard will result in added volatility to stockholders' equity as the standard does not permit a corresponding adjustment to the liabilities that these assets support.
As of December 31, 1993, investments included real estate, mortgage loans, and fixed maturities with a carrying value of $22,158,000 which were non- income producing for the previous twelve months.
A comparison of amortized cost to fair value of fixed maturity investments by category at December 31, 1993 and 1992 is as follows:
Fixed maturities had an increase (decrease) in unrealized gains (the excess of fair value over amortized cost) of $25,438,000, $(4,245,000), and $88,953,000 in 1993, 1992, and 1991, respectively. At December 31, 1993, gross unrealized gains (losses) on investments in equity securities amounted to $386,000 and $(429,000), respectively.
During 1993, 1992, and 1991, non-cash investing activities consisted of real estate acquired through foreclosure of mortgage loans which totaled $4,869,000, $14,302,000, and $3,829,000, respectively.
The fair value of investments in mortgage loans was estimated to be $411,250,000 and $471,082,000 at December 31, 1993 and 1992, respectively. The fair value of policy loans was estimated to be $50,340,000 and $48,246,000 at December 31, 1993 and 1992, respectively.
Interest paid on borrowings by WNC was $1,673,000, $1,313,000, and $2,130,000 in 1993, 1992, and 1991, respectively.
WNC has a line of credit arrangement for short-term borrowings with one bank amounting to $10,000,000, all of which was unused at December 31, 1993. The line of credit arrangement can be renewed annually, but credit can be withdrawn at the bank's option.
Components of WNC's deferred tax liabilities and assets at December 31 are as follows:
The net deferred tax liabilities relate primarily to the future taxable temporary differences for deferred insurance costs. The net deferred tax assets relate primarily to the future deductible temporary differences for policy liabilities and liabilities for employee benefits items. The nature of WNC's deferred tax assets and liabilities is such that the general reversal pattern for these temporary differences should result in a full realization of WNC's deferred tax assets other than capital gain or loss items.
Federal income taxes paid by WNC were $4,100,000, $8,700,000, and $5,300,000 in 1993, 1992, and 1991, respectively. WNC has a nonlife net operating loss carryforward for tax purposes of $2,222,000 that will begin to expire in 2005.
WNC has 10,000,000 shares of $5 par value Preferred Stock authorized that is designated as $2.50 Convertible Preferred Stock. Each share is entitled to a cumulative annual dividend of $2.50, and a preference of $50 in the event of involuntary liquidation and $55 in the event of voluntary liquidation of WNC. Further, each share is convertible at any time into 1.875 shares of Common Stock at the option of the holder and is redeemable at $55 at the option of WNC. Each holder is entitled to one vote for each share held and, except as otherwise provided by law, the $2.50 Convertible Preferred Stock and the Common Stock vote together as one class.
WNC has one outstanding Common Stock Purchase Right for each outstanding share of Common Stock. The Rights will become exercisable only if a person or group acquires 20% or more of WNC's Common Stock or announces a tender offer following which it would hold 30% or more of such Common Stock. If the Rights become exercisable, a holder will be entitled to buy from WNC one share of WNC Common Stock at a price of $100 per share. If, after the Rights become exercisable, WNC is acquired in a merger or other business combination or more than 50% of WNC's assets or earning power are sold, each Right will entitle its holder to buy that number of shares of Common Stock of the acquiring company having a market value of twice the exercise price of the Right. Alternatively, if a 20% WNC stockholder acquires WNC by means of a merger in which WNC and its Common Stock survive or that stockholder engages in self-dealing transactions with WNC, each Right not owned by the 20% holder would become exercisable for that number of shares of WNC Common Stock which have a market value of twice the exercise price of the Right. Until the Rights become exercisable, one additional Right will be distributed with each share of WNC Common Stock issued in the future. The Rights will expire in January 1997. The Rights may be redeemed by WNC at $.01 per Right prior to the time that 20% or more of WNC's Common Stock has been accumulated by a person or group or within ten days thereafter under certain circumstances.
The number of shares used in computing fully diluted earnings per share for 1993 was 11,026,000. This included average shares outstanding plus 383,000 shares of common stock equivalents consisting of dilutive stock options and the assumed conversion of preferred stock.
The statutory accounting practices prescribed for WNC's insurance subsidiaries by regulatory authorities differ from GAAP. The following reconciles statutory capital and surplus to GAAP stockholders' equity at December 31:
Stock options granted from 1991 to 1993 ranged from $10.21 per share to $26.57 per share. Stock options exercised from 1991 to 1993 ranged from $10.21 per share to $21.70 per share. Exercise prices on stock options outstanding range from $10.21 to $27.29 per share.
Washington National Insurance Company (WNIC) and an indirect wholly-owned subsidiary, United Presidential Life Insurance Company (UPI), each have a defined benefit retirement plan covering substantially all employees who have met the prescribed requirements for participation. Both plans have been amended to terminate the accrual of future benefits. Benefits are based principally on years of service and compensation. Generally, the funding policies are to contribute annually amounts required by the Internal Revenue Code (IRC). Contributions are intended to provide benefits attributed to service to date.
Effective January 1, 1991 for WNIC, and March 31, 1993 for UPI, the Company established two defined contribution retirement plans, a money-purchase retirement plan and a discretionary profit sharing plan. Neither plan allows employee contributions. These two plans, in addition to the contributory 401(k) plan, collectively represent the current retirement benefit program. The plans now cover substantially all WNIC and UPI employees who have met the prescribed requirements for participation. The contribution to the 401(k) plan matches employee contributions dollar for dollar up to a maximum of 3% of compensation. The contribution to the money- purchase retirement plan is 3% of each employee's compensation and an additional 3% of compensation in excess of the Social Security wage base. The contribution to the profit sharing plan is at the discretion of the insurance subsidiaries' Boards of Directors in consultation with the Board of Directors of WNC and is based on financial performance. WNC also has supplemental retirement plans under which benefits are paid equal to any amount by which benefits are reduced for any participant in the defined contribution or defined benefit retirement plans due to provisions of the IRC. The liabilities for the supplemental retirement plans at December 31, 1993 and 1992 were immaterial. The net pension expense for the defined contribution plans in 1993, 1992, and 1991 was $2,777,000, $2,110,000, and $1,866,000, respectively.
A summary of the components of the net periodic pension expense for the defined benefit retirement plans follows:
Net periodic pension expense for 1993 includes a $491,000 curtailment gain from the termination of the accumulation of benefits of UPI's defined benefit plan.
The unrecognized transition gain in the preceeding schedule is the amount by which the plans' net assets exceeded the actuarial present value of projected benefit obligations as of January 1, 1985, net of amortization, the date on which current pension accounting standards were adopted. The transition gain is being amortized by credits to income over a fourteen- year period. In addition, the excess of actual investment and actuarial gains and losses realized over those expected are deferred and, when the cumulative deferred amounts exceed certain limits, will be amortized at a rate consistent with a fourteen-year amortization period. Costs created by plan amendments that are associated with prior employee service are also deferred and amortized over fourteen years.
Accrued pension cost and the various net gains and losses not recognized in the consolidated financial statements are compared annually to the plans' funded status. The comparison is made using the plans' accumulated benefit obligations. When a deficiency exists, an adjustment is made for the amount of the deficiency to recognize a minimum liability. At December 31, 1993 and 1992, the pretax adjustment was $3,033,000 and $1,269,000, respectively. The liability and subsequent changes had no effect on net periodic pension expense and were reported directly in stockholders' equity.
Effective December 31, 1992, the WNIC plan was changed to limit future eligibility. Active employees who were not at least age 50 as of December 31, 1992 and whose combination of age and years of service did not total at least 65 as of that date are not eligible for postretirement health insurance benefits and are only eligible for $10,000 of postretirement life insurance benefits. This curtailment resulted in a gain of $4,033,000 recorded as part of operations in the fourth quarter of 1992.
The net periodic postretirement benefit expense includes the following components at December 31:
The following reconciles the plans' accumulated postretirement benefit obligation with amounts recognized in WNC's consolidated balance sheets at December 31:
The effect of reinsurance on premiums and policy charges for the years ended December 31 was as follows:
Reinsurance benefits ceded were $22,685,000, $22,516,000, and $17,372,000 in 1993, 1992, and 1991, respectively.
Rental expenses were $6,900,000, $2,871,000, and $3,039,000 in 1993, 1992, and 1991, respectively.
The Company is party to financial instruments with off-balance-sheet risk in the normal course of business. These financial instruments include commitments to extend credit, commitments to fund investments, standby purchase commitments, and financial guarantees related to various investments in real estate and joint ventures. These instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the consolidated balance sheets.
The exposure to credit loss in the event of nonperformance by the other party to the financial instrument for the aforementioned commitments and guarantees is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. If funded, the commitments and guarantees would be collateralized by the related real estate investments.
Standby purchase commitments and financial guarantees are conditional commitments issued by the Company to guarantee the performance of an unrelated entity to a third party. These purchase commitments and guarantees are primarily issued to support public and private borrowing arrangements, including bond financing and letters of credit, and expire in 1994, 1995, and 1996. The Company does not hold collateral for these conditional commitments; however, in the event of nonperformance by the entity, the Company would be entitled to the underlying collateral, principally commercial real estate properties. In addition, the Company is entitled to share in the appreciation of the collateral on the conditional commitments at the time of sale or refinancing. Management is not aware of any material losses on these conditional commitments. At December 31, 1993 and 1992, standby purchase commitments and guarantees were $24,323,000 and $34,126,000, respectively.
The Company issued financial guarantees on two real estate investments and received $676,000 of consideration, principally in 1986. The estimated fair value at December 31, 1993 of these guarantees is less than $500,000.
See Item 7, "Management's Discussion And Analysis Of Financial Condition And Results Of Operations - Health Care Reform" for a discussion of health care reform and its possible effect on the Company's business.
In the third quarter of 1991, WNC completed the sale of its New York-based life insurance subsidiary. A pretax loss of $16,000,000 was recorded on this sale in 1990. An additional pretax loss of $1,826,000 was recognized in the second quarter of 1991. At June 30, 1991, this subsidiary had assets, principally investments, of $200,000,000 and liabilities, principally policy liabilities, of $176,000,000. In the consolidated statement of operations for 1991, total revenues of $12,200,000 are attributable to this subsidiary.
In the second and third quarters of 1991, WNIC sold blocks of universal life insurance and annuities for a pretax gain of $668,000. The gain is included in net loss on divestitures. The operations of these blocks of business are included in the life insurance and annuities segment. These blocks of business had policy-related assets, principally deferred insurance costs, of $13,000,000 and policy liabilities of $110,000,000.