Principal properties owned by Standard Insurance Company (“Standard”) and used by StanCorp Financial Group, Inc. or its subsidiaries consist of two office buildings in downtown Portland, Oregon: the Standard Insurance Center, with approximately 460,000 square feet; and the Standard Plaza, with approximately 220,000 square feet. All of our business segments use the facilities described above. We also own two office buildings in Hillsboro, Oregon, each with approximately 72,000 square feet. The Hillsboro office buildings are used by StanCorp Mortgage Investors, LLC and our Employee Benefits claims operations. In addition, Standard leases approximately 160,000 square feet of office space located in downtown Portland, Oregon, for home office and claims operations. We lease 43 offices under commitments of varying terms to support our sales and regional processing offices throughout the United States. Management believes that the capacity and types of facilities are suitable and adequate for operations. See Part II, Item 8, “Financial Statements and Supplementary Data-Notes to Consolidated Financial Statements-Note 1-Summary of Significant Accounting Policies-Property and Equipment, Net.”
(1) Includes operating expenses, commissions and bonuses, premium taxes, and the net increase in deferred acquisition costs, value of business acquired and other intangible assets.
(3) Effective January 1, 2015, we adopted Accounting Standards Update (“ASU”) No. 2014-01, Accounting for Investments in Qualified Affordable Housing Projects on a retrospective basis. In accordance with ASU No. 2014-1, we adjusted our financial results for periods prior to 2015.
Management believes that measuring net income return on average equity excluding after-tax merger related expenses and after-tax net capital gains and losses from net income and AOCI from equity provides investors with a better measure of return. AOCI is excluded from equity because the low turnover of our portfolio of fixed maturity securities-available-for-sale (“fixed maturity securities”) may not be such that unrealized gains and losses reflected in AOCI are ultimately realized.
StanCorp Financial Group, Inc., through its subsidiaries marketed as The Standard-Standard Insurance Company (“Standard”), The Standard Life Insurance Company of New York, Standard Retirement Services, Inc. (“Standard Retirement Services”), StanCorp Mortgage Investors, LLC (“StanCorp Mortgage Investors”), StanCorp Investment Advisers, Inc., StanCorp Real Estate, LLC and StanCorp Equities, Inc. (“StanCorp Equities”)-is a leading provider of financial products and services. StanCorp’s subsidiaries offer group and individual disability insurance, group life and accidental death and dismemberment (“AD&D”) insurance, group dental and group vision insurance, absence management services, retirement plans products and services, individual annuities, and origination and servicing of fixed-rate commercial mortgage loans.
On July 23, 2015, we entered an Agreement and Plan of Merger (“Merger Agreement”) with Meiji Yasuda Life Insurance Company (“Meiji Yasuda”) under which Meiji Yasuda will acquire all of our outstanding shares for $115.00 per share. Options, awards of restricted stock units and awards of performance-based restricted stock units granted or issued under various benefit plans will be paid out as described in Part II, Item 8, “Financial Statements and Supplementary Data-Notes to Consolidated Financial Statements-Note 22-Proposed Merger with Meiji Yasuda-Treatment of Equity Incentive Awards.” On February 8, 2016, we informed the New York Stock Exchange that StanCorp and Meiji Yasuda have received all regulatory approvals for Meiji Yasuda’s previously announced acquisition of StanCorp, and that the closing of the proposed merger (the “Merger”) is anticipated to occur on March 7, 2016, subject to the satisfaction of all necessary conditions to closing.
Net income excluding after-tax merger related expenses and after-tax net capital losses was $5.47 per diluted share for 2015, compared to $5.01 per diluted share for 2014. The increase in net income per diluted share was primarily due to more favorable claims experience and higher premiums in Employee Benefits and Individual Disability, partially offset by higher operating expenses and higher commissions and bonuses.
Employee Benefits reported income before income taxes of $195.3 million for 2015, compared to $215.5 million for 2014. The decrease was primarily due to higher operating expenses and higher commissions and bonuses, primarily resulting from higher sales. Employee Benefits premiums increased 5.7% to $1.95 billion for 2015 from $1.84 billion for 2014. The increase was primarily due to higher sales for 2015 and favorable retention of existing customers. Employee Benefits annualized new sales were $316.9 million for 2015, compared to $215.6 million for 2014. The increase in sales for 2015 reflected an increase in proposal activity. The benefit ratio for Employee Benefits, measured as benefits to policyholders and interest credited as a percentage of premiums, was 77.4% for 2015, compared to 77.8% for 2014. The average discount rate used for newly established long term disability claim reserves was 3.94% for 2015 and 4.00% for 2014. A 25 basis point increase or decrease in the discount rate currently results in a corresponding increase or decrease in the quarterly pre-tax income of approximately $2 million or approximately $8 million for the full year.
Asset Management reported income before income taxes of $86.8 million for 2015, compared to $77.9 million for 2014. The increase was primarily due to commercial mortgage loan prepayment fee revenues and bond call premiums adding $15.3 million of
In addition, we deployed $59.4 million of capital through our annual cash dividend to shareholders for 2015, while maintaining a strong balance sheet and growing book value per share, excluding AOCI and accumulated other comprehensive loss, by 7.5% over the past 12 months.
Our consolidated financial statements and certain disclosures made in this Form 10-K have been prepared in accordance with GAAP and require us to make estimates and assumptions that affect reported amounts of assets and liabilities and disclosures of contingent assets and contingent liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods. The estimates most susceptible to material changes due to significant judgment (identified as the “critical accounting policies”) are those used in determining investment valuations, the reserves for future policy benefits and claims, deferred acquisition costs (“DAC”), value of business acquired (“VOBA”) and other intangible assets, pension and postretirement benefit plans and the provision for income taxes. The results of these estimates are critical because they affect our profitability and may affect key indicators used to measure our performance. These estimates have a material effect on our results of operations and financial condition.
If we determine an other-than-temporary impairment (“OTTI”) exists and we do not have the intent to sell the security and determine that it is not more likely than not that we will be required to sell the security, we separate the OTTI of fixed maturity securities into an OTTI related to credit loss and an OTTI related to noncredit loss. The OTTI related to credit loss represents the portion of losses equal to the difference between the present value of expected cash flows, discounted using the pre-impairment yields, and the amortized cost basis. All other changes in value represent the OTTI related to noncredit loss. The OTTI related to credit loss is recognized in earnings in the current period, while the OTTI related to noncredit loss is deemed recoverable and is recognized in other comprehensive income (loss). The cost basis of the fixed maturity security is permanently adjusted to reflect the credit loss. Once an impairment has been recorded, we continue to review the OTTI securities for further potential impairment.
The carrying value of commercial mortgage loans represents the outstanding principal balance less a loan loss allowance for probable uncollectible amounts. The commercial mortgage loan loss allowance is estimated based on evaluating known and inherent risks in the loan portfolio and consists of a general loan loss allowance and a specific loan loss allowance. The general loan loss allowance is based on our analysis of factors including changes in the size and composition of the loan portfolio, debt coverage ratios, loan-to-value ratios, actual loan loss experience and individual loan analysis. An impaired commercial mortgage loan is a loan where we do not expect to receive contractual principal and interest in accordance with the terms of the original loan agreement. A specific allowance for losses is recorded when a loan is considered to be impaired. We also hold specific allowances for losses on certain performing loans that we continue to monitor and evaluate. Impaired commercial mortgage loans without specific allowances for losses are those for which we have determined that it remains probable that we will collect all amounts due. In addition, for impaired commercial mortgage loans, we evaluate the loss to dispose of the underlying collateral, any significant out of pocket expenses the loan may incur, the loan-to-value ratio and other quantitative information we have concerning the loan. Negotiated reductions of principal are generally written off against the allowance, and recoveries, if any, are credited to the allowance. See “Liquidity and Capital Resources-Investing Cash Flows-Commercial Mortgage Loans.”
Real Estate Owned is initially recorded at net realizable value, which includes an estimate for disposal costs. This amount may be adjusted in a subsequent period as additional information is received. Real Estate Owned is initially considered an investment held for sale and is expected to be sold within one year from acquisition. For any real estate expected to be sold, an impairment is recorded if we do not expect the investment to recover its carrying value prior to the expected date of sale. Once an impairment has been recorded, we continue to review the investment for further potential impairment.
Other invested assets include tax-advantaged investments, derivative instruments, policy loans and common stock. Valuation adjustments for these investments are recognized using the specific identification method.
We use interest rate swaps to reduce the risks from changes in interest rates, to manage interest rate exposures arising from asset and liability mismatches, to protect against variability in future cash flows, and to protect the value of our investments. These interest rate swaps are designed to qualify for hedge accounting as cash flow and fair value hedges. Valuations for interest rate swaps are sensitive to changes in the interest rate environment. Interest rate swaps are recognized as either other invested assets or other liabilities and are reported at fair value. To qualify for hedge accounting, we document the risk management objective and strategy for undertaking the hedging transaction and the designation of the hedge as either a cash flow hedge or a fair value hedge at the inception of the hedging transaction. Included in this documentation is a description of how the interest rate swap is expected to hedge the designated risk related to specific assets or liabilities and a description of the method that will be used to retrospectively and prospectively assess the hedge effectiveness, the method that will be used to measure ineffectiveness and how ineffectiveness will be recorded.
If we dispose of a hedged item, we terminate the related interest rate swap and recognize a capital gain or loss on termination.
Index-based interest guarantees and S&P 500 Index options do not qualify for hedge accounting. We sell indexed annuities, which permit the holder to elect a fixed interest rate return or an indexed return, where interest credited to the contracts is based on the performance of the S&P 500 Index, subject to an upper limit or cap and minimum guarantees. Policyholders may elect to rebalance between interest crediting options at renewal dates annually. At each renewal date, we have the opportunity to re-price the indexed component by changing the cap, subject to minimum guarantees. We estimate the fair value of the index-based interest guarantees for the current period and for all future reset periods until contract maturity. Changes in the fair value of the index-based interest guarantees are recorded in interest credited.
We periodically evaluate FHLB of Des Moines common stock for OTTI. Our determination of whether this investment is impaired is based on our assessment of the ultimate recoverability of cost rather than by recognizing temporary declines in value. We did not record OTTI related to the FHLB of Des Moines common stock for 2015. We did not record OTTI related to the FHLB of Seattle common stock for 2014.
Policy reserves include reserves established for individual disability insurance, individual and group immediate annuity businesses and individual life insurance. Policy reserves are calculated using our best estimates of assumptions and considerations at the time the policy was issued, which includes an adjustment for the effect of adverse deviations in actual experience. These assumptions may need to be subsequently modified if policy reserves are projected to be inadequate. We maintain a policy reserve for as long as a policy is in-force, even after a separate claim reserve is established.
Policy reserves for our individual and group immediate annuity business are established when a policy is issued and represent the present value of future payments due under the annuity contracts. As the contracts are single premium contracts, there is no projected future premium. Assumptions used to calculate immediate annuity policy reserves may vary by the age and gender of the annuitant and year of policy issue.
Effective January 1, 2001, substantially all of our individual life insurance policies and the associated reserves were ceded to Protective Life Insurance Company (“Protective Life”) under a reinsurance agreement. Effective February 1, 2015, Protective Life was acquired by The Dai-ichi Life Insurance Company, Limited (“Dai-ichi Life”) and is a wholly-owned subsidiary of Dai-ichi Life. If Protective Life were to become unable to meet its obligations, Standard would retain the reinsured liabilities. The acquisition has not had, and we do not expect it to have a material effect on our business, financial position, results of operations or cash flows. The associated reserves remain on our consolidated balance sheets and an equal amount is recorded as recoverable from the reinsurer. We also retain a small number of individual policies arising out of individual conversions from our group life policies.
The following table sets forth the average discount rate used for newly incurred long term disability insurance claim reserves and life waiver reserves:
The reserve discount rate is reviewed quarterly and reflects our current and expected new investment yields. The discount rate is based on the average rate we received on newly invested assets attributable to the corresponding line of business during the previous 12 months, less a margin. We also consider our average investment yield and average discount rate on our entire block of claims when deciding whether to increase or decrease the discount rate. A 25 basis point increase or decrease in the discount rate currently results in a corresponding increase or decrease in quarterly pre-tax income of approximately $2 million or approximately $8 million for the full year. We do not adjust Employee Benefits premium rates based on short-term fluctuations in investment yields. Any offsetting adjustments of Employee Benefits premium rates due to sustained changes in investment yields can take from one to three years given that most contracts have rate guarantees in place.
As a result of studies of our long-term trends compared to reserving assumptions for our group long term disability insurance, we did not adjust our IBNR claim reserves in 2015, 2014 or 2013.
We evaluate the claim termination rate assumptions for the reserves on a small Minnesota Life Insurance Company (“Minnesota Life”) block of individual disability claims annually. These assumptions were refined in 2015, 2014 and 2013, which resulted in an increase in reserves of $1.8 million, $2.7 million and $2.1 million, respectively. Our block of business is relatively small, and as a result, we view a blend of established industry tables and our own experience as a more appropriate method for establishing reserve levels compared solely to our own experience. We will continue to monitor the credibility of our developing experience and the use of available industry tables, and, if necessary, will adjust reserves accordingly. We also refined our reserve calculation for certain other individual disability reserves, which resulted in a net increase in our individual disability reserves of $4.6 million, $2.0 million and $5.1 million in 2015, 2014 and 2013, respectively. The combination of these adjustments resulted in an overall net increase to individual disability reserves of $6.4 million, $4.7 million and $7.2 million in 2015, 2014 and 2013, respectively.
We defer certain acquisition costs that vary with and are directly related to the origination of new business and placing that business in-force. Certain costs related to obtaining new business and acquiring business through reinsurance agreements have been deferred and will be amortized to match related future premiums or gross profits as appropriate. We normally defer certain acquisition-related commissions and incentive payments, certain costs of policy issuance and underwriting, and certain printing costs. Assumptions used in developing DAC and amortization amounts each period include the amount of business in-force, expected future persistency, withdrawals, interest rates and profitability. These assumptions are modified to reflect actual experience when appropriate. Additional amortization of DAC is charged to current earnings to the extent it is determined that future premiums or gross profits are not adequate to cover the remaining amounts deferred. Changes in actual persistency are reflected in the calculated DAC balance. Costs that are not directly associated with the acquisition of new business are not deferred as DAC and are charged to expense as incurred. Generally, annual commissions are considered expenses and are not deferred.
Our other intangible assets are subject to amortization and consist of certain customer lists from Asset Management businesses acquired and an Individual Disability marketing agreement. Customer lists have a combined estimated weighted-average remaining life of approximately 4.3 years and will be fully amortized by the end of 2022. The marketing agreement accompanied the Minnesota Life transaction and provides access to Minnesota Life agents, some of whom now market Standard’s individual disability insurance products. The Minnesota Life marketing agreement will be fully amortized by the end of 2023. The accumulated amortization of other intangible assets was $55.5 million and $48.4 million at December 31, 2015 and 2014, respectively. In 2015, we recorded a $4.5 million impairment to other intangible assets. The impairment was related to the sale of the assets of our private client wealth management business. We did not record an impairment to other intangible assets in 2014 or 2013.
We also have a postretirement benefit plan that includes medical, prescription drug benefits and group term life insurance. Eligible retirees are required to contribute specified amounts for medical and prescription drug benefits that are determined periodically and are based on retirees’ length of service and age at retirement. The postretirement benefit plan is limited to eligible participants that retired prior to July 1, 2013.
We are required to recognize the funded status of our pension and postretirement benefit plans as an asset or liability on our consolidated balance sheets. For pension plans, this is measured as the difference between the plan assets at fair value and the projected benefit obligation as of the balance sheet date. For our postretirement plan, this is measured as the difference between the plan assets at fair value and the accumulated benefit obligation as of the year-end balance sheet date. Unrecognized actuarial gains or losses, prior service costs or credits, and transition assets are amortized, net of tax, out of accumulated other comprehensive income or loss as components of net periodic benefit cost.
The weighted-average discount rate is an interest assumption used to convert the benefit payment stream to present value. The discount rate is selected based on the yield of a portfolio of high quality corporate and municipal bonds with durations that are similar to the expected distributions from the employee benefit plan.
The actuarial present value of accumulated plan benefits is determined annually by applying actuarial assumptions to adjust the accumulated plan benefits to reflect the discount rate and the probability of payment between the valuation date and the expected date of payment. Changes in these assumptions, including the assumptions for mortality, are inherent in the estimations and assumptions process.
For the postretirement benefit plan, the expected long-term rate of return on assets was developed by considering the historical returns and the future expectations for returns, as well as the target asset allocation. In addition, the assumption for the health care cost trend rates also affect expenses and liabilities for the postretirement benefit plan. Assumed health care cost trend rates have a significant effect on the amounts reported for the health care plans. A one-percentage-point change in assumed health care cost trend rates would have the following effects:
GAAP requires management to use a more likely than not standard to evaluate whether, based on available evidence, each deferred tax asset will be realized. A valuation allowance is recorded to reduce a deferred tax asset to the amount expected to be
realized. We have recorded a deferred tax asset for loss carryforwards. Realization is dependent on generating sufficient taxable income prior to expiration of the loss carryforwards. Although realization is not assured, management believes it is more likely than not that the deferred tax asset for federal loss carryforwards will be realized. The amount of the deferred tax asset considered realizable, however, could be reduced if estimates of future taxable income during the carryforward period are reduced. Management has established a valuation allowance on some state and local loss carryforwards, which it believes are not likely to be realized.
Income tax expense may differ from the amount computed by applying the federal corporate tax rate of 35% to pre-tax income because of the net results of permanent differences between book and taxable income, tax credits, amortization of tax-advantaged investments that qualify as affordable housing investments and the inclusion of state and local income taxes, net of the federal tax benefit. See Item 8, “Financial Statements and Supplementary Data-Notes to Consolidated Financial Statements-Note 7-Income Taxes.”
Revenues consist of premiums, administrative fees, net investment income and net capital gains and losses. Historically, premium and net investment income growth in Insurance Services and administrative fee and net investment income growth in Asset Management have been the primary drivers of consolidated revenue growth.
Net investment income is primarily affected by changes in levels of invested assets, portfolio yields, fluctuations in the change in fair value of our S&P 500 Index options related to our equity-indexed annuity product, commercial mortgage loan prepayment fee revenues, bond call premiums on fixed maturity securities, operating losses related to our tax-advantaged investments that do not qualify as affordable housing investments and state premium tax credits and the related investment losses for tax-advantaged investments with state premium tax credits.
Net capital gains and losses are reported in the Other category and are not likely to occur in a stable pattern. Net capital gains and losses primarily occur as a result of sales of our assets for more or less than carrying value, OTTI of investments in our bond portfolio, provisions to our commercial mortgage loan loss allowance, impairments of real estate and impairments of other invested assets.
Benefits to policyholders for Insurance Services are primarily affected by the following factors:
Reserve assumptions-the assumptions used to establish the related reserves reflect expected incidence and severity, and the discount rate. The discount rate is affected by new money investment rates and the overall portfolio yield. See “Critical Accounting Policies and Estimates-Reserves for Future Policy Benefits and Claims.”
The discount rate for newly established claim reserves is reviewed quarterly and reflects our current and expected new investment yields. The discount rate is based on the average rate we received on newly invested assets attributable to the corresponding line of business during the previous 12 months, less a margin. We also consider our average investment yield and average discount rate on our entire block of claims when deciding whether to increase or decrease the discount rate. A 25 basis point increase or decrease in the discount rate currently results in a corresponding increase or decrease in the quarterly pre-tax income of approximately $2 million or approximately $8 million for the full year. See “Critical Accounting Policies and Estimates-Reserves for Future Policy Benefits and Claims-Claim Reserves.”
Interest credited represents interest paid to policyholders on retirement plan general account assets, individual fixed-rate annuity deposits and index-based interest guarantees in Asset Management and interest paid on life insurance proceeds on deposit in Insurance Services. Interest credited is primarily affected by the following factors:
Net income was $214.5 million for 2015, compared to $210.3 million for 2014. The increase in net income was primarily due to more favorable claims experience and higher premiums in Employee Benefits and Individual Disability, partially offset by higher operating expenses and higher commissions and bonuses.
The increase in premiums for 2015 compared to 2014 was primarily due to higher annualized new sales and favorable retention of existing customers in Employee Benefits and Individual Disability. See “Business Segments-Insurance Services.”
The increase in administrative fees for 2015 compared to 2014 was primarily due to the increase in retirement plan assets under administration. See “Business Segments-Asset Management.”
The increase in net capital losses for 2015 compared to 2014 was primarily due to impairment losses of certain tax-advantaged investments that did not qualify as affordable housing investments and other-than-temporary impairment losses on certain fixed maturity securities, partially offset by a decrease in the provision to our commercial mortgage loan loss allowance. See “Business Segments-Other.”
The net increase in DAC, VOBA and other intangible assets for 2015 compared to 2014 was primarily due to an increase in deferrals for Employee Benefits and for individual annuities, both due to higher sales. This was partially offset by an increase in the margin between net investment income and interest credited for our fixed deferred annuity products, which results in an increase in amortization. See “Business Segments-Insurance Services” and “Business Segments-Asset Management.”
Net income was $210.3 million for 2014, compared to $225.6 million for 2013. The decrease in net income was primarily due to lower operating expenses for 2013, which included savings of $20.6 million due to the amendment of our postretirement medical plan, which did not recur in 2014.
The increase in operating expenses for 2014 compared to 2013 was primarily due to expense management actions taken in the first half of 2013 and an increase in compensation related costs. Operating expenses were reduced by $20.6 million for the first half of 2013 due to the amendment of our postretirement medical plan, which did not recur in 2014. See “Business Segments-Other.”
The net increase in DAC, VOBA and other intangible assets for 2014 was relatively flat compared to 2013 and was primarily due to an increase in deferrals for individual annuities, which was primarily due to higher individual annuity sales. This increase was partially offset by an increase in the margin between net investment income and interest credited for our fixed deferred annuity products and an increase in DAC amortization for individual annuities related to unlocking. See “Business Segments-Asset Management.”
The decrease in the effective income tax rate for 2014 compared to 2013 was primarily due to the utilization of tax credits from tax-advantaged investments. See Item 8, “Financial Statements and Supplementary Data-Notes to Consolidated Financial Statements-Note 7-Income Taxes” for more information.
The increase in benefits to policyholders (including interest credited) for Insurance Services for 2015 compared to 2014 was primarily due to business growth as a result of a 5.7% increase in premiums in Employee Benefits. Benefits to policyholders related to incurred claims increased 0.1% compared to the incurred claims for 2014, which primarily resulted from business growth, offset by a 2.8% reduction in long term disability insurance claims incidence for 2015 compared to 2014.
The benefit ratio for Employee Benefits was 77.4% for 2015, compared to 77.8% for 2014. The decrease in the benefit ratio was primarily due to more favorable claims experience for 2015 compared to 2014. The more favorable claims experience for 2015 did not result in a significant change in our underlying assumptions or methods used to determine the claim reserves, primarily due to the long-term nature of our group long term disability insurance business and the materiality of other factors, including the potential impact of economic uncertainty. We monitor trends in reserve assumptions and when these trends become credible and are expected to persist, we incorporate these factors into our reserves to ensure the best estimates are established.
The benefit ratio for Individual Disability decreased to 55.7% for 2015, compared to 65.3% for 2014. Due to the relatively small size of the Individual Disability business, the benefit ratio generally fluctuates more than Employee Benefits. See “Critical Accounting Policies and Estimates-Reserves for Future Policy Benefits and Claims-Claim Reserves” for more information.
The increase in commissions and bonuses for Insurance Services for 2015 compared to 2014 was primarily due to an increase in sales and favorable retention of existing customers.
The increase in premium taxes for Insurance Services for 2015 compared to 2014 was primarily due to an increase in premiums during 2015.
Year Ended December 31, 2014 Compared to Year Ended December 31,
The decrease in net investment income for Insurance Services for 2014 compared to 2013 was primarily due to lower portfolio yields for both fixed maturity securities and commercial mortgage loans for 2014 compared to 2013.
The decrease in benefits to policyholders (including interest credited) for Insurance Services for 2014 compared to 2013 was primarily due to more favorable claims experience in the group life and group disability businesses of Employee Benefits. Benefits to policyholders related to incurred claims for 2014 decreased 6.5% compared to the incurred claims for 2013, which primarily resulted from a 1.6% reduction in long term disability insurance claims incidence for 2014 compared to 2013.
The benefit ratio for Employee Benefits was 77.8% for 2014, compared to 78.9% for 2013. Contributing to the decrease in the Employee Benefits benefit ratio was a 25 basis point higher average discount rate used for newly established long term disability insurance claim reserves and life waiver reserves for 2014 compared to 2013. The increase in the discount rate was primarily due to the mix and timing of new investments we acquired and the yields on these new investments attributable to the corresponding line of business. See “Critical Accounting Policies and Estimates-Reserves for Future Policy Benefit and Claims” for more information.
The favorable claims experience for 2014 did not result in a significant change in our underlying assumptions or methods used to determine the claim reserves, primarily due to the long-term nature of our group long term disability insurance business and the materiality of other factors, including the potential impact of economic uncertainty. We monitor trends in reserve assumptions and when these trends become credible and are expected to persist, we incorporate these factors into our reserves to ensure the best estimates are established.
The decrease in commissions and bonuses for Insurance Services for 2014 compared to 2013 was primarily due to lower Employee Benefits premiums and sales.
The increase in net investment income for Asset Management for 2015 compared to 2014 was primarily due to an increase in commercial mortgage loan prepayment fee revenues and bond call premiums and an increase in retirement plan general account and individual annuity assets under administration at December 31, 2015 compared to December 31, 2014. Commercial mortgage loan prepayment fee revenues and bond call premiums were $16.8 million for 2015, compared to $11.2 million for 2014. The increase was partially offset by changes in the fair value of our S&P 500 Index options related to our equity-indexed annuity product, which decreased net investment income by $0.8 million for 2015, compared to an increase to net investment income of $8.6 million for 2014.
The increase in operating expenses for Asset Management for 2015 compared to 2014 was primarily to support business growth, consistent with growth in retirement plan assets under administration.
The increase in commissions and bonuses for Asset Management for 2015 compared to 2014 was primarily due to higher individual annuity sales.
Income before income taxes for Asset Management was $77.9 million for 2014, compared to $79.3 million for 2013. The decrease was primarily due to the change in fair values of the hedging assets and liabilities related to our equity-indexed annuity product, which decreased income before income taxes by $0.5 million for 2014, compared to an increase of $2.6 million for 2013. The decrease was partially offset by an increase in administrative fees for 2014 compared to 2013, which was primarily due to an increase in assets under administration.
The decrease in net investment income for Asset Management for 2014 compared to 2013 was primarily due to lower portfolio yields for both fixed maturity securities and commercial mortgage loans and the change in fair value of the S&P 500 Index options related to our equity indexed annuity product. The change in fair value of the S&P 500 Index options increased net investment income by $8.6 million for 2014, compared to an increase of $14.4 million for 2013.
The following table sets forth results and key indicators for the Other category:
The Other category reported a loss before income taxes of $42.2 million for 2014, compared to a loss before income taxes of $33.8 million for 2013. Net capital losses were $12.1 million for 2014, compared to $12.8 million for 2013. The loss before income taxes excluding net capital losses was $30.1 million for 2014, compared to $21.0 million for 2013. The increase in the loss before income taxes for 2014 was primarily due to the amendment of our postretirement medical plan that resulted in a $20.6 million decrease in operating expenses for the first half of 2013, which did not recur in 2014.
The increase in net investment income for the Other category for 2014 compared to 2013 was primarily due to an increase in invested assets allocated to the Other category.
The decrease in net capital losses for the Other category for 2014 compared to 2013 was primarily due to a decrease in the provision for our commercial mortgage loan losses and lower capital losses associated with the sale of real estate. These lower net capital losses were partially offset by a decrease in net capital gains related to the sale of certain fixed maturity securities.
Interest rate risk management, along with asset-liability analysis informs us of an appropriate allocation of invested assets to mitigate our interest rate risk exposure. We also use interest rate swaps, whereby we agree with another party to exchange, at specific intervals, the difference between fixed-rate and floating rate interest amounts as calculated by reference to an agreed notional amount, in fair value hedging relationships to reduce interest rate exposure arising from asset and liability duration mismatches. In accordance with presently accepted actuarial standards, we have made adequate provisions for the anticipated cash flows required to meet contractual obligations and related expenses through the use of statutory reserves and related items in light of the assets held at December 31, 2015.
Our financial instruments are exposed to financial market volatility and potential disruptions in the market that may result in certain financial instruments becoming less valuable. Financial market volatility includes interest rate risk. We have analyzed the estimated loss in fair value of certain market sensitive financial assets held at December 31, 2015 and 2014, using a hypothetical 10% increase in interest rates and related qualitative information on how we manage interest rate risk. The interest rate sensitivity analysis
Additionally, a cash management process is in place that anticipates short-term cash needs. Depending upon capital market conditions, anticipated cash needs may be covered by liquid asset holdings or a draw upon our line of credit. In almost all cases, borrowed funds can be retired from normal operating cash flows in conjunction with adjustments to long-term investing practice within half a year. For more information about our line of credit, see “-Financing Cash Flows,” and Part I, Item 1A, “Risk Factors.”
Our target investment portfolio allocation is approximately 60% fixed maturity securities and 40% commercial mortgage loans with a maximum allocation of 45% to commercial mortgage loans. At December 31, 2015, total cash and investments consisted of 55.1% fixed maturity securities, 39.0% commercial mortgage loans, 3.2% cash and cash equivalents, 2.5% other invested assets and 0.2% real estate.
The following table sets forth key indicators of our fixed maturity securities portfolio:
The increase in commercial mortgage loan originations for 2015 compared to 2014 was primarily due to an increase in commercial real estate market activity. The decrease in 2014 compared to 2013 was primarily due to an increase in competition in the commercial real estate market.
The estimated average loan-to-value ratio for the overall portfolio was less than 70% at December 31, 2015. The average loan balance of our commercial mortgage loan portfolio was approximately $0.8 million at December 31, 2015. We have the contractual ability to pursue personal recourse on approximately 71% of our loans and partial personal recourse on a majority of the remaining loans. The weighted-average capitalization rate for the portfolio at December 31, 2015 was approximately 8%. Capitalization rates, which vary by property type and geographic region, are used as part of our annual internal analysis of our commercial mortgage loan portfolio. The rate is used in converting the property’s income to an estimated property value.
Our largest concentration of commercial mortgage loan property type was retail properties, which primarily consisted of convenience related properties in strip malls, convenience stores and restaurants. Our exposure to retail properties is diversified among various borrowers, properties and geographic regions. In addition, retail commercial lending represents an area of experience and expertise, where careful underwriting and consistent surveillance mitigate risks surrounding our commercial mortgage lending in this area. See Item 8, “Financial Statements and Supplementary Data-Notes to Consolidated Financial Statements-Note 10-Investments-Commercial Mortgage Loans.”
At December 31, 2015, our ten largest borrowers represented less than 7% of our total commercial mortgage loan portfolio balance. Our largest borrower concentrations within our commercial mortgage loan portfolio consisted of one borrower that comprised less than 2% of our total commercial mortgage loan portfolio balance. The second largest borrower comprised less than 1% of our total commercial mortgage loan portfolio balance.
In the normal course of business, we commit to fund commercial mortgage loans generally up to 90 days in advance. At December 31, 2015, we had outstanding commitments to fund commercial mortgage loans totaling $227.0 million, with fixed interest rates ranging from 4.00% to 6.75%. These commitments generally have fixed expiration dates. A small percentage of commitments expire due to the borrower’s failure to deliver the requirements of the commitment by the expiration date. In these cases, we will retain the commitment fee and good faith deposit. Alternatively, if we terminate a commitment due to the disapproval of a commitment requirement, the commitment fee and good faith deposit may be refunded to the borrower, less an administrative fee.
Commercial mortgage loan foreclosures may result in the sale of the property to a third party at the time of foreclosure, resulting in fewer properties transferred to Real Estate Owned than the number of loans foreclosed during the period. Commercial mortgage loans may have multiple properties as collateral, resulting in more properties transferred to Real Estate Owned than the number of loans foreclosed during the period. Real Estate Owned is initially recorded at estimated net realizable value, which includes an estimate for disposal costs. These amounts may be adjusted in a subsequent period as additional market information regarding fair value is received, however, these adjustments would not result in a carrying value greater than the initial recorded amount. The book value of real estate acquired during 2015 decreased compared to 2014 primarily due to fewer property foreclosures. See “Critical Accounting Policies and Estimates-Investment Valuations-Commercial Mortgage Loans” for our commercial mortgage loan loss allowance policy.
The decrease in the commercial mortgage loan loss allowance for 2015 compared to 2014 was primarily due to a decrease in the general loan loss allowance. The decrease in the net charge-offs for 2015 compared to 2014 was primarily due to lower losses related to charges associated with commercial mortgage loans leaving the portfolio for 2015. The lower provision and net charge-offs for the commercial mortgage loan loss allowance for 2014 compared to 2013 were primarily due to lower losses associated with foreclosures, accepted deeds in lieu of foreclosure on commercial mortgage loans and other related charges associated with commercial mortgage loans leaving the portfolio for 2014. The decrease in the commercial mortgage loan loss allowances for 2014 compared to 2013 was primarily due to fewer loans with a general loan loss allowance and specific loan loss allowance.
State insurance departments require insurance enterprises to maintain minimum levels of capital and surplus. Our target for our statutory insurance subsidiaries is generally to maintain statutory capital and surplus at 300% of the Company Action Level of Risk-Based Capital (“RBC”) required by regulators, which is 600% of the Authorized Control Level RBC required by our states of domicile. The statutory insurance subsidiaries capital and surplus as a percentage of the Company Action Level RBC was approximately 410% at December 31, 2015. At December 31, 2015, capital and surplus, adjusted to exclude asset valuation reserves, for our regulated statutory insurance subsidiaries totaled $1.27 billion.
Standard has a $250.0 million subordinated surplus note (“Surplus Note”), payable to StanCorp. The Surplus Note matures in 2042 and bears an interest rate of 5.25%, with interest payments due March 31, June 30, September 30 and December 31 of each year. Standard has the right to prepay the principal balance of the Surplus Note, in whole or in part, at any time or from time to time, without penalty. In accordance with the requirements of the National Association of Insurance Commissioners (“NAIC”), the Surplus Note provides that no interest or principal payments may be made by Standard without the prior approval of the Oregon Insurance Division, interest will not be represented as an addition to the instrument, interest will not accrue additional interest and any payments with respect to the Surplus Note will be subordinate to Standard’s other obligations to policyholders, lenders and creditors.
During 2015 and 2014, Standard made distributions to StanCorp totaling $200.0 million and $390.0 million, respectively, including an extraordinary distribution in September 2014 totaling $240.0 million that was used to capitalize StanCap Insurance Company, Inc. (“StanCap Insurance Company”). Effective September 30, 2014, StanCap Insurance Company entered into a reinsurance agreement with Standard to reinsure Standard’s group life and AD&D business. This reinsurance agreement between StanCap Insurance Company and Standard replaced the yearly renewable term group life reinsurance agreement with Canada Life Assurance Company, which was terminated effective September 30, 2014. As a result of the extraordinary distribution in September 2014, dividends required approval from the Oregon Insurance Division through September 2015 and were considered extraordinary.
As permitted by the Merger Agreement, on October 21, 2015, our Board of Directors declared an annual cash dividend of $1.40 per common share. The dividend was paid on November 30, 2015 to shareholders of record on November 10, 2015. In 2014 and 2013, we paid an annual cash dividend of $1.30 and $1.10 per common share, respectively. Our Board of Directors has increased the annual dividend per common share to shareholders each year for the past 16 consecutive years. The declaration and payment of dividends to shareholders is subject to the discretion of our Board of Directors. For more information, see Item 8, “Financial Statements and Supplementary Data-Notes to Consolidated Financial Statements-Note 22-Proposed Merger with Meiji Yasuda.” In addition, the declaration and payment of dividends would be restricted if we elect to defer interest payments on our Subordinated Debt. If elected, the restriction would be in place during the interest deferral period, which cannot exceed five years. We have not deferred interest on the Subordinated Debt, and have paid dividends each year since our initial public offering in 1999.
On February 11, 2014, our Board of Directors authorized the repurchase of up to 3.0 million shares of StanCorp common stock through December 31, 2015 (“February 2014 Authorization”). The February 2014 Authorization, which took effect upon the completion of a prior repurchase authorization during the second quarter of 2014, expired on December 31, 2015. Share repurchases under the repurchase program were made in the open market or in negotiated transactions in compliance with the safe harbor provisions of Rule 10b-18 under regulations of the Securities Exchange Act of 1934 (“Exchange Act”). We did not repurchase shares in 2015 and do not anticipate further share repurchases pending completion of the merger with Meiji Yasuda.
(1) The estimated payments expected to be due by period for insurance obligations reflect future estimated cash payments, for pending and future potential claims, to be made to policyholders and others for future policy benefits, policyholders’ account balances, policyholders’ dividends, and reinsurance payables. These future estimated net cash payments are based on mortality, morbidity, lapse and other assumptions comparable with our experience, consider future premium receipts on current policies in-force, and assume market growth and interest crediting consistent with assumptions used in amortizing DAC and VOBA. These net cash payments are undiscounted with respect to interest and, as a result, the sum of the net cash payments shown for all years in the table of $7.54 billion exceeds the corresponding liability amount of $5.86 billion included in the Consolidated Financial Statements as of December 31, 2015. We have made significant assumptions to determine the future estimated net cash payments related to the underlying policies and contracts. Due to the significance of the assumptions used, actual net cash payments will differ, possibly materially, from these estimates.
(2) While historical withdrawal patterns indicate withdrawal primarily occurs in periods in excess of one year, policyholder fund obligations in the amount of $5.28 billion have been included in the less than one year column of the table as they may be withdrawn upon request. These net cash payments are undiscounted with respect to interest but reflect an offsetting effect due to reinsurance receivables and, as a result, the sum of the net cash payments shown for all years in the table of $6.48 billion differs from the corresponding liability amount of $7.05 billion included in the Consolidated Financial Statements as of December 31, 2015. Due to the significance of the assumptions used, actual net cash payments will differ, possibly materially, from these estimates.
(3) Separate account liabilities are legally insulated from general account obligations, and it is generally expected these liabilities will be fully funded by separate account assets and their related cash flows. While historical withdrawal patterns indicate withdrawal primarily occurs in periods in excess of one year, separate account liabilities in the amount of $7.03 billion have been included in the less than one year column of the table as they may be withdrawn upon request.
In the normal course of business, we commit to fund commercial mortgage loans generally up to 90 days in advance. At December 31, 2015, we had outstanding commitments to fund commercial mortgage loans totaling $227.0 million, with fixed interest rates ranging from 4.00% to 6.75%. These commitments generally have fixed expiration dates. A small percentage of commitments expire due to the borrower’s failure to deliver the requirements of the commitment by the expiration date. In these cases, we will retain the commitment fee and good faith deposit. Alternatively, if we terminate a commitment due to the disapproval of a commitment requirement, the commitment fee and deposit may be refunded to the borrower, less an administrative fee.
Insolvency regulations exist in many of the jurisdictions where our subsidiaries do business. Such regulations may require insurance companies operating within the jurisdiction to participate in guaranty associations. The associations levy assessments against their members to pay benefits to policyholders of impaired or insolvent insurance companies. Association assessments levied against us were $0.7 million for 2015 and 2014, and $1.9 million for 2013. At December 31, 2015, we maintained a reserve of $0.3 million for future assessments with respect to currently impaired, insolvent or failed insurers.
Standard and The Standard Life Insurance Company of New York prepare their statutory financial statements in accordance with accounting practices prescribed or permitted by their states of domicile. Prescribed statutory accounting principles include state laws, regulations, and general administrative rules, as well as the Statements of Statutory Accounting Practices set forth in publications of the NAIC.
Deferred tax assets, net of deferred tax liabilities, are included in the regulatory financial statements but are limited to those deferred tax assets that will be realized within three years.
The decrease in Statutory Results for 2015 compared to 2014 was primarily due to a statutory reserve adjustment in the individual annuities line of business. The decrease in Statutory Results for 2014 compared to 2013 was primarily due to lower net investment income and the adoption of new statutory accounting guidance for share-based compensation, partially offset by more favorable claims experience in Employee Benefits.
The following table sets forth statutory capital and the associated asset valuation reserve:
Failure to timely complete the Merger with Meiji Yasuda could adversely impact our stock price, business, financial condition and results of operations.
Changes in the regulatory environment at the state or federal level.
Experience in delinquency rates or loss experience in our commercial mortgage loan portfolio.
Concentration of commercial mortgage loan assets collateralized in certain states such as California.
Consolidated Statements of Comprehensive Income for the years ended December 31, 2015, 2014 and
Consolidated Statements of Cash Flows for the years ended December 31, 2015, 2014 and
We have audited the accompanying consolidated balance sheets of StanCorp Financial Group, Inc. and subsidiaries (the “Company”) as of December 31, 2015 and 2014, and the related consolidated statements of income, comprehensive income, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2015. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2015, based on the criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report February 26, 2016 expressed an unqualified opinion on the Company’s internal control over financial reporting.
(4) Net of tax expenses of $4.7 million and $0.9 million and tax benefit of $3.2 million for 2015, 2014 and 2013, respectively.
As used in Item 8, the terms “StanCorp,” “Company,” “we,” “us” and “our” refer to StanCorp Financial Group, Inc. and its subsidiaries, unless the context otherwise requires.
Standard, the Company’s largest subsidiary, underwrites group and individual disability insurance and annuity products, group life and accidental death and dismemberment (“AD&D”) insurance, and provides group dental and group vision insurance, absence management services and retirement plan products. Founded in 1906, Standard is domiciled in Oregon, licensed in all states except New York, and licensed in the District of Columbia and the U.S. territories of Guam, Puerto Rico and the Virgin Islands.
StanCorp Mortgage Investors originates and services fixed-rate commercial mortgage loans for the investment portfolios of the Company’s insurance subsidiaries. StanCorp Mortgage Investors also generates additional fee income from the origination and servicing of commercial mortgage loans participated to institutional investors.
StanCorp Investment Advisers is a Securities and Exchange Commission (“SEC”) registered investment adviser providing performance analysis, fund selection support, model portfolios and other investment management services. In January 2015, StanCorp reached an agreement to sell the assets of its private client wealth management business within StanCorp Investment Advisers to a third party. The sale was completed during the second quarter of 2015. StanCorp Investment Advisers remains a wholly-owned subsidiary of StanCorp.
StanCorp Real Estate is a property management company that owns and manages the Hillsboro, Oregon home office properties and other properties held for investment and held for sale. StanCorp Real Estate also manages the Portland, Oregon home office properties.
under PAM. Under PAM, the cost of the investment is amortized in each period in proportion to the tax credits and the tax benefits from tax losses received in that period to total benefits to be received over the life of the investment and allows the amortization of the investment and the tax benefits to be recorded in income taxes on the consolidated statements of income. The Company adopted this ASU retrospectively and applied this guidance to all prior periods presented in the comparative financial statements. The adoption of this ASU changes the timing of the benefit realized in net income, but does not change the cumulative total benefit to net income over the life of the investments.
If it is determined a loan is impaired, a specific allowance is recorded.
An impaired commercial mortgage loan is a loan where the Company does not expect to receive contractual principal and interest in accordance with the terms of the original loan agreement. A specific allowance for losses is recorded when a loan is considered to be impaired and it is probable that all amounts due will not be collected based on the terms of the original agreement. The Company also holds specific loan loss allowances on certain performing commercial mortgage loans that it continues to monitor and evaluate. Impaired commercial mortgage loans without specific allowances for losses are those for which the Company has determined that it remains probable that all amounts due will be collected although the timing or nature may be outside the original agreement terms. In addition, for impaired commercial mortgage loans, the Company evaluates the cost to dispose of the underlying collateral, any significant out of pocket expenses the loan may incur and other quantitative information management has concerning the loan. Portions of loans that are deemed uncollectible are charged-off against the allowance, and recoveries, if any, are credited to the allowance. See “Note 10-Investments-Commercial Mortgage Loans.”
The Company records interest income in net investment income and continues to recognize interest income on delinquent commercial mortgage loans until the loans are more than 90 days delinquent. Interest income and accrued interest receivable are reversed when a loan is more than 90 days delinquent. For loans that are less than 90 days delinquent, management may reverse interest income and accrued interest receivable if there is a question on the collectability of the interest. Interest income on loans in the 90-day delinquent category is recognized in the period the cash is collected. The Company resumes the recognition of interest income when the loan becomes less than 90 days delinquent and management determines it is probable that the loan will remain performing.
The Company records impairments when it is determined that the decline in fair value of an investment below its carrying value is other than temporary. The impairment is recorded to net capital losses, and the carrying value of the investment is adjusted to reflect the impairment. There were no impairments recorded on real estate investments for 2015, 2014 or 2013.
Real Estate Owned is initially recorded at net realizable value, which includes an estimate for disposal costs. This amount may be adjusted in a subsequent period as additional information is received. Real Estate Owned is initially considered an investment held for sale and is expected to be sold within one year from acquisition. For any real estate expected to be sold, an impairment is recorded if the Company does not expect the investment to recover its carrying value prior to the expected date of sale. Once an impairment has been recorded, the Company continues to review the investment for further potential impairment. Impairments recorded on Real Estate Owned were $2.2 million, $5.2 million and $8.7 million for 2015, 2014 and 2013, respectively.
The Company’s tax-advantaged investments are structured as limited partnerships. The Company has purchased tax-advantaged investments opportunistically due to the higher risk-adjusted returns. The primary sources of investment return are tax credits and the tax benefits from tax losses.
Tax-advantaged investments that do not qualify as affordable housing investments are accounted for under the equity method of accounting. Under the equity method of accounting, tax credits received from these investments are reported in the consolidated statements of income as a reduction of income taxes. The Company’s share of the operating losses of the limited partnerships decreases the carrying value of the investments and is reported as a component of net investment income.
A derivative instrument designated as part of a hedging relationship must be assessed as being highly effective in offsetting the designated risk of the hedged item. Hedge effectiveness is assessed at inception and at least quarterly throughout the life of the designated hedging relationship, using qualitative and quantitative methods. Qualitative methods include comparison of critical terms of the interest rate swap to the hedged item. Quantitative methods include regression or other statistical analysis of changes in the fair value or cash flows associated with the hedge relationship.
In the consolidated balance sheets, the Company offsets fair value amounts recognized for interest rate swaps. See “Note 11-Derivative Financial Instruments.”
Index-based interest guarantees and S&P 500 Index options do not qualify for hedge accounting. The Company sells indexed annuities, which permit the holder to elect a fixed interest rate return or an indexed return, where interest credited to the contracts is based on the performance of the S&P 500 Index, subject to an upper limit or cap and minimum guarantees. Policyholders may elect to rebalance between interest crediting options at renewal dates annually. At each renewal date, the Company has the opportunity to re-price the indexed component by changing the cap, subject to minimum guarantees. The Company estimates the fair value of the index-based interest guarantees for the current period and for all future reset periods until contract maturity. Changes in the fair value of the index-based interest guarantees are recorded in interest credited.
DAC for group and individual disability insurance products and group life insurance products is amortized over the life of related policies in proportion to future premiums. The Company amortizes DAC for group disability and life insurance products over the initial premium rate guarantee period, which averages 2.5 years. DAC for individual disability insurance products is amortized in proportion to future premiums over the life of the contract, averaging 20 to 25 years with approximately 50% and 75% expected to be amortized by years 10 and 15, respectively.
VOBA primarily represents the discounted future profits of business assumed through reinsurance agreements. The Company has established VOBA for a block of individual disability insurance business assumed from Minnesota Life Insurance Company (“Minnesota Life”) and a block of group disability and group life insurance business assumed from Teachers Insurance and Annuity Association of America (“TIAA”). VOBA is generally amortized in proportion to future premiums for group and individual disability insurance products and group life insurance products. However, the VOBA related to the TIAA transaction associated with an in-force block of group long term disability insurance claims for which no ongoing premium is received is amortized in proportion to expected gross profits. If actual premiums or future profitability are inconsistent with the Company’s assumptions, the Company could be required to make adjustments to VOBA and related amortization. The VOBA associated with the TIAA transaction is amortized in proportion to expected gross profits with an amortization period of up to 20 years. For the VOBA associated with the Minnesota Life block of business assumed, the amortization period is up to 30 years and is amortized in proportion to future premiums.
In August 2015, the FASB issued ASU No. 2015-14, which deferred the effective date of ASU No. 2014-09 for annual reporting periods and interim reporting periods within those annual periods beginning after December 15, 2017. Early adoption is permitted. The Company’s revenue is primarily from insurance contracts and financial instruments; therefore, the Company does not expect this ASU to have a material effect on its financial position, results of operations or cash flows.
In April 2015, the FASB issued ASU No. 2015-03, Interest-Imputation of Interest (Subtopic 835-30) Simplifying the Presentation of Debt Issuance Costs. The main objective of ASU No. 2015-03 is to simplify the presentation of debt issuance costs by requiring debt issuance costs be considered a direct reduction in the carrying value of the debt liability for presentation purposes. Amortization of debt issuance costs will be reported as interest expense.
ASU No. 2016-01, Financial Instruments-Overall (Subtopic 825-10) Recognition and Measurement of Financial Assets and Financial Liabilities
In January 2016, the FASB issued ASU No. 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities. The main objective of ASU No. 2016-01 is to develop targeted improvements to the reporting model for financial instruments. Under this guidance, entities will be required to recognize changes in fair value in net income for equity investments measured at fair value, amend disclosures for fair value of financial instruments, evaluate the need for valuation allowance on a deferred tax asset related to available-for-sale securities in combination with other deferred tax assets, and simplify the impairment assessment of equity investments.
In February 2016, the FASB issued ASU No. 2016-02, Leases. The main objective of ASU No. 2016-02 is to provide a new comprehensive model for lease accounting. Under this guidance, lessees and lessors should apply a “right-of-use” model in accounting for all leases (including subleases) and eliminate the concept of operating leases and off-balance sheet leases.
The Company has two active share-based compensation plans: the 2002 Stock Incentive Plan (“2002 Plan”) and the 1999 Employee Share Purchase Plan (“ESPP”). The 2002 Plan authorizes the Board of Directors to grant incentive or non-statutory stock options and stock awards to eligible employees and certain specified parties. The Company’s ESPP allows eligible employees to purchase StanCorp common stock at a discount. Of the 7,000,000 shares of common stock authorized for the 2002 Plan, 2,567,220 shares or options for shares remain available for grant at December 31, 2015. Of the 3,500,000 shares authorized for the ESPP, 1,336,257 shares remain available for issuance at December 31, 2015.
annual grants as determined by management. Officers may also receive options when hired or promoted to an officer position. In addition, the Chief Executive Officer has authority to award a limited number of options at his discretion to non-executive officers and other employees. Options are granted with an exercise price per share equal to the closing market price of StanCorp common stock on the grant date. Options typically vest in four equal installments on the first four anniversaries of the vesting reference date. Option awards to certain officers vest if the officer’s employment is terminated by the Company without cause or the officer terminates for good reason within 24 months after a change of control of the Company as defined in the Company’s change of control agreement. Options generally expire 10 years from the grant date.
The fair value of each option award granted was estimated using the Black-Scholes option pricing model as of the grant date using the assumptions noted in the following table. The Black-Scholes option pricing model uses the expected term as an input with the calculated option value varying directly with the length of time until exercise. The Company bases its estimate of the expected term on an analysis of the historical exercise experience of similar options granted to similar employee or director groups. The expected term given below represents the weighted-average expected term of options granted. Expected stock price volatility is based on the volatility of StanCorp’s common stock price per share over the prior period equal in duration to the expected term. The dividend rate is the rate expected to be paid over the expected term, generally estimated to be equal to the rate for the year prior to the grant. The risk-free rate is the interest rate on a U.S. Treasury bond of a maturity closest to the expected term of the option granted.
The weighted-average grant date fair value of options granted was $18.78, $23.29 and $16.15 for 2015, 2014 and 2013, respectively.
The compensation cost of stock options is recognized over the vesting period, which is also the period over which the grantee must provide services to the Company. At December 31, 2015, the total cost related to unvested option awards that had not yet been recognized in the financial statements was $4.4 million. This cost will be recognized over a remaining weighted-average vesting period of 2.3 years.
The Company currently grants three types of stock awards: restricted stock unit awards (“RSUs”), performance-based stock awards (“Performance Shares”) and non-employee director stock awards (“Director Stock Grants”). Under the 2002 Plan, the Company had 1,023,843 shares available for issuance as stock award grants at December 31, 2015.
The Company grants annual RSUs to officers and senior officers of the Company. RSUs typically cliff vest three years from the grant date. The actual number of shares issued is based on continued employment with a portion of shares withheld to cover required tax withholding.
The Company granted 97,512, 77,634 and 129,172 Performance Shares for 2015, 2014 and 2013, respectively.
The compensation cost of Performance Shares is based on an estimate of the number of shares that will be earned and cost is recognized over the vesting period. The cost the Company will ultimately recognize as a result of these stock awards is dependent on the Company’s financial performance. Assuming that the maximum performance is achieved for each performance goal, $8.1 million in additional compensation cost would be recognized through 2017. Assuming that the target performance is achieved, this cost would be recognized over a remaining weighted-average vesting period of 1.6 years. The target payout is 50% of the maximum performance shares. Assuming that the target performance is achieved for each performance goal, $2.7 million in additional compensation cost would be recognized through 2017.
The Company issued 15,007, 17,294 and 20,099 shares of StanCorp common stock for 2015, 2014 and 2013, respectively, related to the vesting of the annual Director stock grant for 2014, 2013 and 2012. The weighted-average fair value per share for the shares issued was $62.46, $45.74 and $44.12 for the same periods, respectively.
On July 23, 2015, the Company entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Meiji Yasuda Life Insurance Company (“Meiji Yasuda”) and MYL Investments (Delaware) Inc., a Delaware corporation and wholly-owned subsidiary of Meiji Yasuda (“Merger Sub”), providing for the merger of Merger Sub with and into the Company (the “Merger”), with the Company surviving the Merger as a wholly-owned subsidiary of Meiji Yasuda. For information about the impact the Merger with Meiji Yasuda will have on share-based compensation, see “Note 22-Proposed Merger with Meiji Yasuda-Treatment of Equity Incentive Awards.”
The Company recognizes the funded status of the pension plans as an asset or liability on the balance sheet. The funded status is measured as the difference between the fair value of the plan assets and the projected benefit obligation as of the year-end balance sheet date.
The following table sets forth the components of net periodic benefit (credit) cost, other changes in plan assets and benefit obligations recognized in other comprehensive (income) loss, and assumptions used in the measurement of the net periodic benefit cost and the benefit obligations:
The long run rate of return for the employee pension plan portfolio is derived by calculating the average return for the portfolio monthly, from 1971 to the present, using the average mutual fund manager returns in each asset category, weighted by the target allocation to each category.
The following tables set forth the estimated fair values of pension plan assets and liabilities measured and recorded at fair value on a recurring basis:
Eligible employees are covered by a qualified deferred compensation plan sponsored by Standard under which a portion of the employee contribution is matched. Employees not eligible for the employee pension plan are eligible for an additional non-elective employer contribution. Contributions to the plan for 2015, 2014 and 2013 were $11.9 million, $10.7 million and $9.9 million, respectively.
Standard sponsors and administers a postretirement benefit plan that includes medical, prescription drug benefits and group term life insurance. Eligible retirees are required to contribute specified amounts for medical and prescription drug benefits that are determined periodically and are based on retirees’ length of service and age at retirement. As of 2006, participation in the postretirement benefit plan was closed to new participants. An amendment announced in 2012 reduced future benefits for plan participants that did not retire by July 1, 2013.
In 2016, no estimated prior service credit or net loss (gain) for the postretirement benefit plan will be amortized from accumulated other comprehensive loss (income) into net periodic benefit cost. The projected discounted cash flow obligation for the postretirement benefit plan was $23.7 million and $24.7 million at December 31, 2015 and 2014, respectively.
The Company contributed $0.5 million, $0.5 million and $0.4 million to fund the postretirement benefit plan in 2015, 2014 and 2013, respectively. The Company expects to make contributions of $0.7 million to its postretirement benefit plan in 2016. No plan assets are expected to be returned to the Company in 2016.
Intersegment revenues are comprised of administrative fees charged by Asset Management to manage the fixed maturity securities and commercial mortgage loan portfolios for the Company’s insurance subsidiaries. Intersegment fees are determined based on the level of assets in the insurance subsidiaries’ fixed maturity securities and commercial mortgage loan portfolios.
The following table sets forth the tax effect of temporary differences that gave rise to significant portions of the net deferred tax liabilities:
The Company is carrying forward net operating losses (“NOLs”) of $31.8 million that originated in StanCorp and certain subsidiaries. The losses will be used in future years to offset taxable income from those entities to the degree allowed by the Internal Revenue Code. If unutilized, these losses would expire between the years 2029 to 2032.
Realization of the Company’s NOL carryforwards is dependent upon generating sufficient taxable income of the appropriate character before expiration of the losses. Although realization is not assured, management believes it is more likely than not that all of the deferred tax asset relating to the federal loss carryforwards will be realized. The amount of the deferred tax asset considered realizable could be reduced in the future if estimates of expected taxable income during the carryforward period are reduced.
As of December 31, 2015, the Company is subject to examination by the IRS for the years 2012 through 2015.
The Company did not have any material unrecognized tax benefits at December 31, 2015 and 2014. The Company records interest paid on income tax liabilities as interest expense and income tax penalties incurred as an operating expense. See “Note 1-Summary of Significant Accounting Policies-Income Taxes.”
Goodwill is related to Asset Management and totaled $36.0 million at both December 31, 2015 and 2014. Goodwill is not amortized and is tested at least annually for impairment. If indicators of impairment appear throughout the year, or in the event of material changes in circumstances, the test will be more frequent. The Company performs a step-one test and compares the carrying value of the tested assets with the fair value of the assets. Fair value is measured using a combination of the income approach and the market approach. The income approach consists of utilizing the discounted cash flow method that incorporates the Company’s estimates of future revenues and costs, discounted using a market participant weighted-average cost of capital. The estimates the Company uses in the income approach are consistent with the plans and estimates that the Company uses to manage its operations. The market approach utilizes multiples of profit measures in order to estimate the fair value of the assets. As the income approach more closely aligns with how the Company internally evaluates and manages its business, the Company weights the income approach more heavily than the market approach in determining the fair value of the assets. However, the Company performs testing to ensure that both models are providing reasonably consistent results. Additionally, the Company performs sensitivity analysis on the key input factors in these models to determine whether any input factor or combination of factors moving moderately in either direction would change the results of these tests. Through the performance of these tests, the Company determined the fair value of goodwill exceeded the carrying value, and concluded that it was not impaired as of December 31, 2015.
Assets and liabilities recorded at fair value are disclosed using a three-level hierarchy. The classification of assets and liabilities within the hierarchy is based on whether the inputs to the valuation methodology used for measurement are observable or unobservable. Observable inputs reflect market-derived or market-based information obtained from independent sources while unobservable inputs reflect the Company’s estimates about market data.
The following tables set forth the carrying value and the estimated fair value of each financial instrument:
The contractual terms of nearly every mortgage loan subject to valuation.
The use of risk characteristics including stabilized debt coverage ratio and loan-to-value ratio.
Variations in valuation spread between loans based on individual risk characteristics.
The pricing services also take into account perceived market movements and sector news, as well as a bond’s terms and conditions, including any features specific to that issue that may influence risk, and thus marketability. Depending on the security, the priority of the use of observable market inputs may change as some observable market inputs may not be relevant or additional inputs may be necessary.
The pricing services provide quoted market prices when available. Quoted prices are not always available due to bond market inactivity. The pricing services obtain a broker quote when sufficient information, such as security structure or other market information, is not available to produce a valuation. Valuations and quotes obtained from third-party commercial pricing services are non-binding and do not represent quotes on which one may execute the disposition of the assets.
The significant unobservable inputs used in the fair value measurement of the reporting entity’s bonds are valuations and quotes received from analytical reviews and broker quotes. Significant increases or decreases in any of those inputs in isolation would result in a significantly lower or higher fair value measurement. Generally, a change in the assumption used for the pricing evaluation is accompanied by a directionally similar change in the assumption used for the methodologies.
The Company calculates the fair value for its S&P 500 Index options using the Black-Scholes option pricing model and parameters derived from market sources. The Company’s valuations maximize the use of observable inputs, which include direct price quotes from the Chicago Board Options Exchange (“CBOE”) and values for on-the-run treasury securities and London Interbank Offered Rate (“LIBOR”) as reported by Bloomberg. Unobservable inputs are estimated from the best sources available to the Company and include estimates of future gross dividends to be paid on the stocks underlying the S&P 500 Index, estimates of quoted market prices and the spread between the bid and ask prices, and estimates of implied volatilities on options. Valuation parameters are calibrated to replicate the actual end-of-day market quotes for options trading on the CBOE. The Company performs additional validation procedures such as the daily observation of market activity and conditions and the tracking and analyzing of actual quotes provided by banking counterparties each time the Company purchases options from them. Additionally, in order to help validate the values derived through the procedures noted above, the Company obtains indicators of value from representative investment banks.
The estimated fair value of the interest rate swaps is determined through a pricing model. The interest rate swaps qualify as Level 2 under the fair value hierarchy since their valuation is based on a model for which all significant assumptions are observable in the market.
The Company uses the income approach valuation technique to determine the fair value of index-based interest guarantees. The liability is the present value of future cash flows attributable to the projected index growth in excess of cash flows driven by fixed interest rate guarantees for the indexed annuity product. Level 3 assumptions for policyholder behavior and future index crediting rate declarations significantly influence the calculation. Index-based interest guarantees are included in the other policyholder funds line on the Company’s consolidated balance sheets.
While valuations for the S&P 500 Index options are sensitive to a number of variables, valuations for S&P 500 Index options purchased are most sensitive to changes in the estimates of bid ask spreads, or the S&P 500 Index value, and the implied volatilities of this index. Significant fluctuations in any of those inputs in isolation would result in a significantly lower or higher fair value measurement. Generally, an increase or decrease used in the assumption for the implied volatilities and in the S&P 500 Index value would result in a directionally similar change in the fair value of the asset.
Valuations for commercial mortgage loans measured at fair value on a nonrecurring basis using significant unobservable Level 3 inputs are sensitive to a number of variables, but are most sensitive to net operating income and the applied capitalization rate. Generally, an increase or decrease resulting from a change in the stabilized net operating income from the collateralized property would result in a directionally similar change in the fair value of the asset. An increase or decrease in the assumption for the capitalization rate would result in a directionally opposite change in the fair value of the asset.
Changes in the fair value of fixed maturity securities that are not designated as part of a hedging relationship are recorded to other comprehensive income. Changes in the fair value of the S&P 500 Index options are recorded to net investment income. Changes in the fair value of the index-based interest guarantees are recorded to interest credited and are sensitive to a number of variables and assumptions. As a result of the Company’s annual update of the key assumptions used to value index-based interest guarantees, interest credited increased $0.6 million for 2015 and decreased $4.0 million and $4.1 million for 2014 and 2013, respectively.
The following table sets forth the assets measured at fair value on a nonrecurring basis as of December 31, 2015 that the Company continued to hold:
Commercial mortgage loans measured on a nonrecurring basis with a carrying amount of $74.2 million were written down to their fair value of $56.0 million, less selling costs, at December 31, 2014. The specific commercial mortgage loan loss allowance related to these commercial mortgage loans was $23.8 million at December 31, 2014. The Real Estate Owned measured on a nonrecurring basis as of December 31, 2014, and still held at December 31, 2014 had net capital losses totaling $1.2 million for 2014. See “Note 10-Investments-Commercial Mortgage Loans” for further disclosures regarding the commercial mortgage loan loss allowance.
Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations. Mortgage-backed and asset-backed securities are shown separately, as they are not due at a single maturity date. Callable bonds, excluding bonds with make-whole provisions and bonds with provisions that allow the borrower to prepay near maturity, represented 3.6%, or $282.3 million, of the Company’s fixed maturity securities portfolio at December 31, 2015. At December 31, 2015, the Company did not have any direct exposure to sub-prime or Alt-A mortgages in its fixed maturity securities portfolio.
The following tables set forth the gross unrealized losses and fair value of fixed maturity securities, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position:
Due to the concentration of commercial mortgage loans in California, the Company could be exposed to potential losses as a result of an economic downturn in California as well as certain catastrophes, such as earthquakes and fires, which may affect the region.
The carrying value of commercial mortgage loans represents the outstanding principal balance less a loan loss allowance for probable uncollectible amounts. The commercial mortgage loan loss allowance is estimated based on evaluating known and inherent risks in the loan portfolio and consists of a general and a specific loan loss allowance.
The following table sets forth changes in the commercial mortgage loan loss allowance:
Changes in the commercial mortgage loan loss allowance can result from the number of commercial mortgage loans with a specific loan loss allowance and general loan loss allowance and the composition factors of the commercial mortgage loan portfolio. Changes in the provision and charge-offs can result from losses related to foreclosures, accepted deeds in lieu of foreclosure on commercial mortgage loans and other related charges associated with commercial mortgage loans in the commercial mortgage loan portfolio.
Changes in the carrying value of impaired commercial mortgage loans can result from a change in the number of commercial mortgage loans with a specific loan loss allowance. As of December 31, 2015 and December 31, 2014, the Company did not have any commercial mortgage loans greater than 90 days delinquent that were accruing interest. See “Note 1-Summary of Significant Accounting Policies-Investment Valuations-Commercial Mortgage Loans” for the policies regarding interest income for delinquent commercial mortgage loans.
The amount of interest income recognized on impaired commercial mortgage loans was $4.4 million, $5.3 million and $4.2 million for 2015, 2014 and 2013, respectively. The cash received by the Company in payment of interest on impaired commercial mortgage loans was $4.3 million, $4.8 million and $3.8 million for 2015, 2014 and 2013, respectively. See “Note 1-Summary of Significant Accounting Policies-Investment Valuations-Commercial Mortgage Loans” for policies regarding interest income for delinquent commercial mortgage loans.
The following table sets forth gross capital gains and losses by investment type:
(1) In 2015, the Company recorded impairments of $11.5 million related to tax-advantaged investments and $4.5 million related to the sale of the assets of the Company’s private client wealth management business.
Securities deposited for the benefit of policyholders in various states, in accordance with state regulations, amounted to $6.9 million and $7.2 million at December 31, 2015 and 2014, respectively.
In the second quarter of 2015, the FHLB of Seattle completed its merger with the FHLB of Des Moines. The merger has not had a material effect on the Company’s business, financial position, results of operations, cash flows, or existing funding agreements with the FHLB, and is not anticipated to impact the Company’s utilization of the FHLB program or its products in the future. Standard issues collateralized funding agreements and invests the cash received from advances to support various spread-based businesses and enhance its asset-liability management. Membership also provides an additional funding source and access to financial services that can be used as an alternative source of liquidity. At December 31, 2015, Standard owned $20.9 million of FHLB of Des Moines common stock related to its membership and activity in the FHLB of Des Moines. At December 31, 2015, Standard had $273.0 million outstanding under funding agreements with the FHLB of Des Moines and pledged $333.5 million of commercial mortgage loans as collateral for its outstanding advances. At December 31, 2014, Standard had $139.0 million outstanding under funding agreements with the FHLB of Seattle and pledged $174.4 million of commercial mortgage loans as collateral for its outstanding advances.
Valuations for interest rate swaps are sensitive to changes in the interest rate environment. Interest rate swaps are recognized by the Company as either other invested assets or other liabilities and are reported at fair value based on their value at the end of the current reporting period. To qualify for hedge accounting, the Company documents the risk management objective and strategy for undertaking the hedging transaction and the designation of the hedge as either a cash flow hedge or a fair value hedge at the inception
of the hedging transaction. Included in this documentation is how the interest rate swap is expected to hedge the designated risk related to specific assets or liabilities as well as a description of the method that will be used to retrospectively and prospectively assess the hedge effectiveness, the method that will be used to measure ineffectiveness and how this ineffectiveness will be recorded.
A derivative instrument designated as part of a hedging relationship must be assessed as being highly effective in offsetting the designated risk of the hedged item. Hedge effectiveness is assessed at inception and at least quarterly throughout the life of the designated hedging relationship, using qualitative and quantitative methods. Qualitative methods include comparison of critical terms of the derivative to the hedged item. Quantitative methods include regression or other statistical analysis of changes in the fair value or cash flows associated with the hedge relationship.
Cash settlement activity of derivative contracts is reported in the consolidated statements of cash flows as a component of proceeds from sales or acquisition of other invested assets.
In the second quarter of 2015, the Company entered into $252.9 million of interest rate swaps as cash flow hedges to mitigate interest rate risk exposure to overall changes in the future cash flows associated with the Company’s junior subordinated debentures (“Subordinated Debt”). The interest rate swaps are used to convert the floating rate of the Company’s Subordinated Debt to a weighted-average fixed rate of 5.13%, beginning June 1, 2017 through June 1, 2042. The changes in the fair value of these interest rate swaps are recorded to other comprehensive income to the extent these interest rate swaps are effective. The fair value of these interest rate swaps included in AOCI was $8.9 million at December 31, 2015. No amounts were reclassified to earnings for 2015. Any ineffectiveness of cash flow hedges is recorded to net capital gains or losses. Interest income, interest expense and fees related to interest rate swaps used in the cash flow hedges of the Company’s Subordinated Debt are recorded as a component of interest expense. See “Note 19-Commitments and Contingencies” for more information.
The Company purchases S&P 500 Index options for its interest crediting strategy used in its indexed annuity product. The S&P 500 Index options do not qualify for hedge accounting. The S&P 500 Index options are purchased from investment banks and are selected in a manner that supports the amount of interest that is expected to be credited in the current year to annuity policyholder
accounts that are dependent on the performance of the S&P 500 Index. The purchase of S&P 500 Index options is part of the Company’s risk management strategy for indexed annuity products. The S&P 500 Index options are exclusively used for risk management. While valuations of the S&P 500 Index options are sensitive to a number of variables, valuations for S&P 500 Index options purchased are most sensitive to changes in the S&P 500 Index value and the implied volatilities of this index. Changes in the fair value of the S&P 500 Index options are recorded to net investment income. The Company generally purchases two S&P 500 Index option contracts per month, which have expiry dates of one year from the date of purchase.
Option premiums paid for the Company’s index option contracts were $9.4 million and $9.3 million for 2015 and 2014, respectively. The Company received $14.3 million and $20.1 million for options exercised for 2015 and 2014, respectively.
The ineffective portion of derivatives accounted for using hedge accounting was not material to the results of operations of the Company for 2015 and 2014 and 2013.
The accumulated amortization of VOBA was $73.4 million and $71.0 million at December 31, 2015 and 2014, respectively. The accumulated amortization of other intangible assets was $55.5 million and $48.4 million at December 31, 2015 and 2014, respectively. See “Note 1-Summary of Significant Accounting Policies-DAC, VOBA and Other Intangible Assets” for a discussion on the amortization policies for VOBA and other intangible assets.
The Company’s other intangible assets are subject to amortization and consist of certain customer lists from Asset Management businesses acquired and an Individual Disability marketing agreement. Customer lists have a combined estimated weighted-average remaining life of 4.3 years and will be fully amortized by the end of 2022. The marketing agreement that accompanied the Minnesota Life transaction provides access to Minnesota Life agents, some of whom now market Standard’s individual disability insurance products. The Minnesota Life marketing agreement will be fully amortized by the end of 2023. In 2015, the Company recorded a $4.5 million impairment to other intangible assets. The impairment was related to the sale of the assets of the Company’s private client wealth management business. The Company did not record an impairment to other intangible assets in 2014.
Classified as future policy benefits and claims, but excluded from the table above are amounts recorded for group and individual life reserves, group and individual annuity reserves, and individual disability active life reserves.
The majority of the net liability balances are related to long term disability insurance claims on which interest earned on assets backing the reserves is a key component of reserving and pricing. The year to year development of incurred claims related to prior years is therefore broken out into an interest portion and remaining incurred portion.
In order to limit its losses from large claim exposures, the Company enters into reinsurance agreements with other insurance companies. The Company reviews its retention limits based on size and experience. The maximum retention limit per individual for group life and AD&D is $750,000. The Company’s maximum retention limit for group disability insurance is $15,000 of monthly benefit per individual. The Company’s maximum retention limit for individual disability insurance is $7,500 of monthly benefit per individual.
Effective September 30, 2014, StanCap Insurance Company entered into a reinsurance agreement with Standard to reinsure Standard’s group life and AD&D business. This reinsurance agreement between StanCap Insurance Company and Standard replaced the yearly renewable term group life reinsurance agreement with Canada Life Assurance Company, which was terminated effective September 30, 2014. The intercompany transactions between Standard and StanCap Insurance Company are eliminated in consolidation.
Recoveries recognized under reinsurance agreements were $109.5 million, $92.8 million and $79.8 million for 2015, 2014 and 2013, respectively. Amounts recoverable from reinsurers were $1.00 billion and $994.2 million at December 31, 2015 and 2014, respectively. Of these amounts, $770.2 million and $781.4 million for 2015 and 2014, respectively, were from the reinsurance transaction with Protective Life Insurance Company (“Protective Life”) effective January 1, 2001. Effective February 1, 2015, Protective Life was acquired by The Dai-ichi Life Insurance Company, Limited (“Dai-ichi Life”) and is a wholly-owned subsidiary of Dai-ichi Life. ”See “Note 15-Reinsurance of Blocks of Business.”
Effective January 1, 2001, Standard ceded to Protective Life, through a reinsurance agreement, Standard’s individual life insurance product line. Standard received a ceding commission of approximately $90 million and transferred to Protective Life approximately $790 million in assets and corresponding statutory liabilities. If Protective Life were to become unable to meet its obligations, Standard would retain the reinsured liabilities. Therefore, the liabilities remain on Standard’s consolidated balance sheets, and an equal amount is recorded as a recoverable from the reinsurer. In accordance with the agreement, Protective Life established a trust for the benefit of Standard with assets in the trust required to be equal to Standard’s reinsurance receivable from Protective Life. The Company evaluates the collectability of the amounts recoverable from reinsurers by monitoring the value of assets held in trust and the credit quality of Protective Life. The amount of assets required to be maintained in the trust is determined quarterly.
During 2015 and 2014, Standard made distributions to StanCorp totaling $200.0 million and $390.0 million, respectively. The 2014 distributions included a $240 million extraordinary distribution that was used to capitalize StanCap Insurance Company. Effective September 30, 2014, StanCap Insurance Company entered into a reinsurance agreement with Standard to reinsure Standard’s group life and AD&D business. This reinsurance agreement between StanCap Insurance Company and Standard replaced the yearly renewable term group life reinsurance agreement with Canada Life Assurance Company, which was terminated effective September 30, 2014. As a result of the extraordinary distribution in 2014, dividends required approval from the Oregon Insurance Division through September 2015 and were considered extraordinary.
Since entering into the Merger Agreement dated July 23, 2015 with Meiji Yasuda and Merger Sub, the Company, members of the Company’s Board and the Meiji Yasuda parties have been named as defendants in four putative class action lawsuits brought by purported shareholders of the Company on behalf of the Company’s shareholders challenging the merger. See “Note 22-Proposed Merger with Meiji Yasuda” for more information.
The complaints allege, among other things, that the Company’s directors violated their fiduciary duties to the Company’s shareholders by entering into the Merger Agreement, by putting their personal interests and the interests of the Meiji Yasuda parties ahead of the interests of the Company’s shareholders, and by failing to provide the Company’s shareholders with material information to make an informed vote on the approval of the Merger Agreement. The complaints also allege that the Company and the Meiji Yasuda parties knew of alleged breaches of fiduciary duties and aided and abetted those breaches.
In the normal course of business, the Company is involved in various legal actions and other state and federal proceedings. A number of actions or proceedings were pending at December 31, 2015. In some instances, lawsuits include claims for punitive damages and similar types of relief in unspecified or substantial amounts, in addition to amounts for alleged contractual liability or other compensatory damages. In the opinion of management, the ultimate liability, if any, arising from the actions or proceedings, including the lawsuits mentioned above, is not expected to have a material effect on the Company’s business, financial position, results of operations or cash flows.
The Company’s debt obligations consisted primarily of the $250 million of 5.00% Senior Notes and the $252.9 million of 6.90% Subordinated Debt. See “Note 18-Long-Term Debt” for additional information.
At December 31, 2015, the Company had $273.0 million outstanding under funding agreements with the FHLB of Des Moines, with fixed interest rates ranging from 0.69% to 3.79% that mature in 1 to 15 years. The funding agreements with the FHLB of Des Moines are recorded as other policyholder funds on the Company’s consolidated balance sheets.
At December 31, 2015, the Company had $103.8 million of commitments to fund tax-advantaged investments, which included $102.7 million of commitments to fund tax-advantaged investments that qualify as affordable housing investments. These commitments are recorded as other liabilities on the Company’s consolidated balance sheets, with a corresponding amount recorded as other invested assets.
The following table sets forth the commitments to fund tax-advantaged investments that qualify as affordable housing investments:
In the normal course of business, the Company commits to fund commercial mortgage loans generally up to 90 days in advance. At December 31, 2015, the Company had outstanding commitments to fund commercial mortgage loans totaling $227.0 million, with fixed interest rates ranging from 4.00% to 6.75%. These commitments generally have fixed expiration dates. A small percentage of commitments expire due to the borrower’s failure to deliver the requirements of the commitment by the expiration date. In these cases, the Company will retain the commitment fee and good faith deposit. Alternatively, if the Company terminates a commitment due to the disapproval of a commitment requirement, the commitment fee and good faith deposit may be refunded to the borrower, less an administrative fee.
The following table sets forth expenses incurred related to the expense management initiatives:
During the third quarter of 2015, Meiji Yasuda and the Company filed the required notifications with the Antitrust Division of the U.S. Department of Justice and the Federal Trade Commission. On September 16, 2015, the request for early termination of the applicable waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended was granted.
On September 21, 2015, the Company filed a Definitive Proxy Statement with the Securities and Exchange Commission and provided notice of the special meeting of shareholders held on Monday, November 9, 2015. At the special meeting, shareholders approved the Merger Agreement and other related matters.
On February 8, 2016, the Company informed the New York Stock Exchange that StanCorp and Meiji Yasuda have received all regulatory approvals for Meiji Yasuda’s previously announced acquisition of StanCorp, and that the closing of the Merger is anticipated to occur on March 7, 2016, subject to the satisfaction of all necessary conditions to closing.
Pursuant to the Merger Agreement, at or immediately prior to the Effective Time, each option to purchase shares of common stock, whether vested or unvested, that has an exercise price per share that is less than the Per Share Merger Consideration and that is outstanding immediately prior to the Effective Time, will, as of the Effective Time, become fully vested and be canceled and converted into the right to receive an amount in cash, without interest, less any applicable withholding taxes, determined by multiplying (i) the difference between the Per Share Merger Consideration and the exercise price per share of such option and (ii) the total number of shares of Common Stock subject to such option. At the Effective Time, each option that has an exercise price per share that is greater than or equal to the Per Share Merger Consideration, whether or not exercisable or vested, will be canceled and the holder of such option will not be entitled to receive any payment in exchange for such cancellation.
Pursuant to the Merger Agreement, each award of restricted stock units that corresponds to shares of Common Stock (each, an “RSU Award”) that is outstanding immediately prior to the Effective Time will, as of the Effective Time, become fully vested and be canceled and converted into the right to receive an amount in cash, without interest, less any applicable withholding taxes, determined by multiplying (i) the Per Share Merger Consideration and (ii) the total number of shares subject to such RSU Award.
multiplying (i) the Per Share Merger Consideration and (ii) the number of shares that would be issuable assuming achievement of the applicable performance conditions at target (or such higher level of performance as is contractually required), prorated to reflect the portion of the performance period completed through the effective date of the Merger. To the extent that the performance period in respect to any performance share awards lapses prior to the Effective Time, but any shares earned with respect thereto have not been issued prior to the Effective Time, such award will be canceled and converted into the right to receive an amount in cash, without interest, less any applicable withholding taxes, determined by multiplying (i) the Per Share Merger Consideration and (ii) the number of shares that is determined to be payable based on performance during the completed performance period.
Pursuant to the Merger Agreement, the then current offering period under the Company’s ESPP will be deemed to end immediately prior to the Effective Time, and the amounts contributed by employees through such time will be notionally applied to the purchase of Common Stock pursuant to the terms of the offering, and the participants in such offering will receive an amount in cash, without interest, less any applicable withholding taxes, determined by multiplying (i) the Per Share Merger Consideration and (ii) the number of shares that were notionally purchased with the available employee contributions to the Company’s ESPP. Any cash balance remaining in a participant’s account thereafter because it is less than the amount required to purchase a full share of Common Stock will be returned to the participant.
For information regarding the Merger and related matters, see the Company’s Current Report on Form 8-K filed with the SEC on July 24, 2015, the Definitive Proxy Statement on Schedule 14A filed with the SEC on September 21, 2015, and additional supplemental materials on Schedule A14A filed with the SEC on November 3, 2015.