The following table sets forth selected financial data at or for the years ended December 31 and should be read in conjunction with Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Item 8, “Financial Statements and Supplementary Data”:
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 insurance (“AD&D”), group dental and group vision insurance, absence management services, retirement plans products and services, individual annuities, origination and servicing of fixed-rate commercial mortgage loans and investment advice.
The annual Employee Benefits benefit ratio was 78.9% for 2013, compared to 83.9% for 2012. The decrease in the annual benefit ratio was primarily due to pricing actions implemented on our long term disability business and an improvement in long term disability claims incidence. The annual Individual Disability benefit ratio was 63.9% for 2013, compared to 65.8% for 2012. Claims experience can fluctuate widely from quarter to quarter and tends to be more stable when measured over a longer period of time. Operating expenses were reduced by $20.6 million for the first half of 2013 due to the amendment of the postretirement medical plan. Asset Management reported income before income taxes of $79.3 million for 2013, compared to $64.0 million for 2012. The increase was primarily due to higher administrative fee revenues as a result of the increase in assets under administration and lower benefits to policyholders as a result of favorable mortality experience in the individual annuity business.
These results show our commitment to our strategy of obtaining and retaining profitable business. As we look to 2014, we will face ongoing macro-economic factors: a persistent low interest rate environment, a price sensitive group insurance marketplace, elevated unemployment levels and challenges to wage and employment growth of our customers. Despite these challenges, we will continue to focus on our long-term objectives and address challenges that arise with financial discipline and from a position of financial strength. We manage for long-term profitability by focusing on business diversification, disciplined product pricing, sound underwriting, effective claims management and high-quality customer service.
We intend to preserve the value of our business by continuing to provide excellent service to our customers. We will optimize shareholder value through sustainable profitability by investing in new product and service capabilities and through the strategic use of capital. We believe these actions along with our strong performance in 2013 and a slowly improving economy position us well for growth in 2014 and beyond.
For a discussion of our consolidated results of operations and business segment results, see “Consolidated Results of Operations.”
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, deferred acquisition costs (“DAC”), value of business acquired (“VOBA”) and other intangible assets, the reserves for future policy benefits and claims, 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.
Capital gains and losses for fixed maturity securities are recognized using the specific identification method. If a fixed maturity security’s fair value declines below its amortized cost, we must assess the security’s impairment to determine if the impairment is other than temporary.
In our quarterly impairment analysis, we evaluate whether a decline in value of the fixed maturity security is other than temporary by considering the following factors:
We maintain an internally identified list of fixed maturity securities with characteristics that could indicate potential impairment (“watch list”). At December 31, 2013, our fixed maturity securities watch list totaled $2.4 million at fair value and $2.5 million at amortized cost. We recorded $1.1 million of OTTI related to credit loss due to impairments for 2013, compared to $3.2 million for 2012. We recorded no OTTI related to noncredit loss for 2013 and 2012. See Item 8, “Financial Statements and Supplementary Data-Notes to Consolidated Financial Statements-Note 1-Summary of Significant Accounting Policies-Investment Valuations-Fixed Maturity Securities-Available-for-Sale” for further disclosures.
In conjunction with determining the extent of credit losses associated with fixed maturity securities, we utilize certain information in order to determine the present value of expected cash flows discounted using pre-impairment yields. Some of these input factors include, but are not limited to, original scheduled contractual cash flows, current market spread information, risk-free rates, fundamentals of the industry and sector in which the issuer operates, and general market information.
Fixed maturity securities are classified as available-for-sale and are carried at fair value on the consolidated balance sheet. See Item 8, “Financial Statements and Supplementary Data-Notes to Consolidated Financial Statements-Note 9-Fair Value” for a detailed explanation of the valuation methods we use to calculate the fair value of our financial instruments. Valuation adjustments for fixed maturity securities not accounted for as OTTI are reported as net increases or decreases to other comprehensive income (loss), net of tax, on the consolidated statements of comprehensive income.
Real estate is comprised of two components: real estate investments and real estate acquired in satisfaction of debt through foreclosure or the acceptance of deeds in lieu of foreclosure on commercial mortgage loans (“Real Estate Owned”).
Total real estate was $65.7 million at December 31, 2013, compared to $95.5 million at December 31, 2012. The $29.8 million decrease in total real estate during 2013 was primarily due to the sale of Real Estate Owned and the impairments on Real Estate Owned.
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 accomplish matching against 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.
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. We amortize 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.
Our other intangible assets are subject to amortization and consist of certain customer lists from an Asset Management business acquired and an individual disability marketing agreement. Customer lists have a combined estimated weighted-average remaining life of approximately 6.8 years. 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 $42.6 million and $36.5 million at December 31, 2013 and 2012, respectively.
Reserves include policy reserve liabilities and claim reserve liabilities and represent amounts to pay future benefits and claims. Claim reserve liabilities are for claims that have been incurred or are estimated to have been incurred but not yet reported to us. Policy reserve liabilities reflect our best estimate of assumptions at the time of policy issuance including adjustments for adverse deviations in actual experience.
These reserves are primarily incurred but not reported (“IBNR”) claim reserves associated with our disability products. Finally, a small amount of reserves is held based entirely upon subjective judgment. These reserves are generally set up as a result of unique circumstances that are not expected to continue far into the future and are released according to pre-established conditions and timelines.
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, adjusted for the effect of adverse deviations in actual experience. These assumptions are not subsequently modified unless policy reserves become inadequate, at which time we may need to change assumptions to increase reserves. We maintain a policy reserve for as long as a policy is in force, even after a separate claim reserve is established.
Effective January 1, 2001, substantially all of our individual life policies and the associated reserves were ceded to Protective Life Insurance Company (“Protective Life”) under a reinsurance agreement. If Protective Life were to become unable to meet its obligations, Standard would retain the reinsured liabilities. Therefore, the associated reserves remain on Standard’s consolidated balance sheets and an equal amount is recorded as a recoverable from the reinsurer. We also retain a small number of individual policies arising out of individual conversions from our group life policies.
Reserve discount rates for newly incurred claims are reviewed quarterly and, if necessary, are adjusted to reflect our current and expected new investment yields. The discount rate is based on the average rate we received on newly invested assets 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. The decrease in the average discount rate from 2013 to 2012 was primarily the result of a continued low interest rate environment. A 25 basis point decrease in the discount rate for newly established long term disability claim reserves results in a corresponding decrease in quarterly pre-tax income of approximately $2 million. 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.
Claim termination rates can vary widely from quarter to quarter. The claim termination assumptions used in determining our reserves represent our expectation for claim terminations over the life of our block of business and will vary from actual experience in any one quarter. While we have experienced some variation in our claim termination experience, we did not see any prolonged or systemic change in 2013 that would indicate a sustained underlying trend that would affect the claim termination rates used in the calculation of reserves.
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. As of January 1, 2006, participation in the postretirement benefit plan is closed to new participants. This plan is sponsored and administered by Standard. At the end of 2012, the postretirement benefit plan was amended to reduce future benefits to plan participants that were either not eligible to or chose not to retire on or before July 1, 2013. The 2012 amendment did not affect future benefits for employees who were retired as of July 1, 2013. In addition, as of December 31, 2011, the group term life insurance benefit was curtailed for plan participants who were not retired at December 31, 2011.
We are required to recognize the funded status of our pension and postretirement benefit plans as an asset or liability on the balance sheet. For pension plans, this is measured as the difference between the plan assets at fair value and the projected benefit obligation as of the year-end 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.
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 in the near term 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.
We record income tax interest and penalties in the income tax provision according to our accounting policy. See Item 8, “Financial Statements and Supplementary Data-Notes to Consolidated Financial Statements-Note 7-Income Taxes.”
Premiums for Insurance Services are the primary driver of consolidated premiums and are affected by sales, persistency, organic growth in our Employee Benefits segment, which is derived from existing policyholders’ employment and wage growth, and Experience Rated Refunds (“ERRs”). ERRs represent cost sharing arrangements with certain group contract holders that provide refunds to the contract holders when claims experience is more favorable than contractual benchmarks, and provide for additional premiums to be paid when claims experience is less favorable than contractual benchmarks. ERRs can fluctuate widely from quarter to quarter depending on the underlying experience of specific contracts.
Net investment income is primarily affected by changes in levels of invested assets, portfolio yields, fluctuations in the change in fair value of our Standard & Poor’s (“S&P”) 500 Index call spread options (“S&P 500 Index options”) related to our indexed annuity product, commercial mortgage loan prepayment fee revenues, bond call premiums on fixed maturity securities and operating losses related to our tax-advantaged investments.
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.”
Net income for 2013 was $228.5 million, compared to $138.5 million for 2012. The increase in net income was primarily due to more favorable claims experience in Employee Benefits, lower operating expenses as a result of expense management actions, and higher earnings in the Asset Management and Individual Disability segments for 2013. Operating expenses were reduced by $20.6 million for the first half of 2013 due to the amendment of the postretirement medical plan.
The decrease in revenues for 2013 compared to 2012 was primarily due to a decrease in Employee Benefits premiums. The decrease was partially offset by an increase in Individual Disability premiums and an increase in administrative fees from Asset Management. See “Business Segments-Insurance Services” and “Business Segments-Asset Management.”
The decrease in premiums for 2013 compared to 2012 was primarily due to a decrease in Employee Benefits premiums as a result of lower Employee Benefits sales and from the impact of ERRs. See “Business Segments-Insurance Services.”
The increase in net investment income for 2013 compared to 2012 was primarily due to higher contributions from the change in fair value of our S&P 500 Index options related to our indexed annuity product. In addition, commercial mortgage loan prepayment fee revenues contributed $16.6 million to net investment income in 2013, compared to $13.2 million in 2012. These increases were partially offset by lower average portfolio yields for both fixed maturity securities and commercial mortgage loans, and lower bond call premiums of $5.3 million in 2013, compared to $8.0 million in 2012. See “Business Segments-Insurance Services” and “Business Segments-Asset Management.”
The increase in net capital losses for 2013 compared to 2012 was primarily due to an increase in the provision to our commercial mortgage loan loss allowance and capital losses on Real Estate Owned. These capital losses were partially offset by net capital gains related to the sale of certain fixed maturity securities. See “Business Segments-Other.”
The increase in interest credited for 2013 compared to 2012 was primarily due to growth in our retirement plan general account assets under administration and individual fixed-rate annuity assets under administration, partially offset by a decrease in the average interest-crediting rate for our annuity products. See “Business Segments-Asset Management.”
The decrease in operating expenses for 2013 compared to 2012 was primarily due to expense management actions. Operating expenses were reduced by $20.6 million for the first half of 2013 due to the amendment of the postretirement medical plan. See “Business Segments-Other.”
The net increase in DAC, VOBA and other intangible assets was primarily due to higher Employee Benefits commissions and bonuses in 2013 compared to 2012.
Net income for 2012 was $138.5 million, compared to $136.7 million for 2011. The increase in net income was primarily due to higher net investment income from bond call premiums and commercial mortgage loan prepayment fee revenues, higher premiums in Employee Benefits, a lower effective income tax rate and higher earnings in Asset Management. The increase was partially offset by a comparatively higher Employee Benefits benefit ratio as a result of a 95 basis point lower average discount rate in 2012 compared to 2011 used for newly established long term disability claim reserves.
The decrease in administrative fees for 2012 compared to 2011 was primarily related to a decrease in average retirement plan trust assets under administration. See “Business Segments-Asset Management.”
The increase in benefits to policyholders for 2012 compared to 2011 was primarily due to a 95 basis point decrease in the average discount rate used for newly established long term disability claim reserves. See “Business Segments-Insurance Services”
The decrease in the effective tax rate for 2012 compared to 2011 was primarily due to the utilization of tax credits from tax-advantaged investments. The effective tax rate was also lower due to permanent book-to-tax differences relative to a lower level of taxable income for 2012.
We collectively view and operate our businesses as Insurance Services and Asset Management, which both deliver distinct value to customers and shareholders. Insurance Services contains two reportable product segments, Employee Benefits and Individual Disability. Asset Management is reported as a separate reportable segment. Holding company and corporate activities are reported in the Other category. Due to the growth in the Individual Disability business in relation to total Insurance Services over the last several years, Individual Disability has become a separate reportable product segment within Insurance Services in 2013. Resources are allocated and performance is evaluated at the segment level. Insurance Services include our traditional risk acceptance businesses that reflect the application of our specialized expertise in the development, underwriting and administration of insurance products and services. Insurance Services offers group and individual disability insurance, group life and AD&D insurance, group dental and group vision insurance, and absence management services. Asset Management provides investment and asset management products and services and offers full-service 401(k) plans, 403(b) plans, 457 plans, defined benefit plans, money purchase pension plans, profit sharing plans and non-qualified deferred compensation products and services. Asset Management also offers investment advisory and management services, financial planning services, origination and servicing of fixed-rate commercial mortgage loans and individual
fixed-rate annuity products. The Other category includes return on capital not allocated to the product segments, holding company expenses, operations of certain unallocated subsidiaries, interest on debt, unallocated expenses, net capital gains and losses and adjustments made in consolidation.
The decrease in premiums for Employee Benefits for 2013 compared to 2012 was primarily due to lower Employee Benefits sales for 2013 and from the impact of ERRs. ERRs decreased premiums by $13.1 million for 2013 and increased premiums by $4.0 million for 2012. See “Basis of Presentation-Premiums” for more information regarding ERRs.
The increase in premiums for Individual Disability for 2013 compared to 2012 was primarily due to a high persistency level and sales for 2013.
The decrease in net investment income for Insurance Services for 2013 compared to 2012 was primarily due to lower portfolio yields on fixed maturity securities and commercial mortgage loans. In addition, bond call premiums decreased to $2.0 million for 2013, compared to $5.3 million for 2012 and operating losses on tax-advantaged investments increased to $11.9 million for 2013, compared to $9.5 million for 2012. The decrease in net investment income was partially offset by an increase in commercial mortgage loan prepayment fee revenues to $10.0 million for 2013, compared to $7.8 million for 2012.
The decrease in income before income taxes for Insurance Services for 2012 compared to 2011 primarily due to a comparatively higher Employee Benefits benefit ratio as a result of a 95 basis point lower average discount rate used for newly established long term
The increase in premiums for Employee Benefits for 2012 compared to 2011 was primarily due to more favorable ERRs, partially offset by lower Employee Benefits sales and persistency for 2012. ERRs increased premiums by $4.0 million for 2012 and decreased premiums by $12.5 million for 2011.
The increase in premiums for Individual Disability for 2012 compared to 2011 was primarily due to a high persistency level and sales for 2012.
The increase in benefits to policyholders (including interest credited) for Insurance Services for 2012 compared to 2011 was primarily due to a 95 basis point decrease in the average discount rate used for newly established long term disability claim reserves. In addition, we recorded a net increase in group long term disability reserves of $3.7 million, and a net increase in Individual Disability reserves of $3.8 million as part of our regular annual assessments of the adequacy of reserves for 2012. We recorded a net increase in Individual Disability claims reserves of $3.6 million and made no similar adjustments to group long term disability reserves for 2011. See “Critical Accounting Policies and Estimates” for more information.
The benefit ratio for Individual Disability decreased to 65.8% for 2012, compared to 67.3% for 2011.
The increase in administrative fees for Asset Management for 2013 compared to 2012 was primarily due to an increase in assets under administration. Assets under administration increased 13.8% to $24.70 billion at December 31, 2013, compared to $21.69 billion at December 31, 2012, primarily due to higher equity values for retirement plan assets under administration.
The decrease in administrative fees for Asset Management for 2012 compared to 2011 was primarily due to a lower amount of average retirement plan trust assets under administration during 2012. The average retirement plan trust assets under administration were $7.79 billion and $8.11 billion for 2012 and 2011, respectively.
The increase in interest credited for Asset Management for 2012 compared to 2011 was primarily due to the change in fair value of our index-based interest guarantees, and an increase in our individual fixed-rate annuity and retirement plan general account assets under administration. The change in fair value of index-based interest guarantees was $6.4 million for 2012 compared to $1.3 million for 2011.
The Other category reported a loss before income taxes of $38.7 million for 2013, compared to a loss before income taxes of $60.4 million for 2012. Net capital losses were $15.7 million for 2013, compared to $8.7 million for 2012. The loss before income taxes for 2013 included lower operating expenses, higher net investment income and lower interest expense.
The increase in net capital losses for Other for 2013 compared to 2012 was primarily due to the provision to our commercial mortgage loan loss allowance and capital losses on Real Estate Owned. These capital losses were partially offset by net capital gains related to the sale of certain fixed maturity securities.
The decrease in operating expenses for Other for 2013 compared to 2012 was primarily due to the result of expense management actions. Operating expenses were reduced by $20.6 million for the first half of 2013 due to the amendment of the postretirement medical plan.
On August 10, 2012, we issued $250 million of 5.00%, 10-year senior notes (“2022 Senior Notes”). On September 28, 2012, we used the net proceeds from the issuance to repay our $250 million of 6.875%, 10-year senior notes (“2012 Senior Notes”) due October 1, 2012. The decrease in interest expense for Other for 2013 compared to 2012 was primarily due to the overlap of the outstanding 2022 Senior Notes with the 2012 Senior Notes, and the lower interest rate on the 2022 Senior Notes resulting in lower interest expense for 2013 of approximately $5 million.
The increase in net capital losses for Other for 2012 compared to 2011 was primarily due to lower capital gains on the sale of real estate investments for 2012 compared to 2011, partially offset by a lower increase to the provision to our commercial mortgage loan loss allowance and lower losses on Real Estate Owned.
We manage interest rate risk, in part, through asset-liability analyses. 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 at December 31, 2013.
Net cash provided by operating activities is net income adjusted for non-cash items and accruals, and was $279.6 million, $375.7 million and $254.1 million for 2013, 2012 and 2011, respectively. These changes were mainly due to fluctuations in future policy benefits and claims due to favorable claims experience in Employee Benefits and other assets and other liabilities, mainly attributable to timing differences. We typically generate positive cash flows from operating activities, as premiums collected from our insurance products and income received from our investments exceed policy acquisition costs, benefits paid, redemptions and operating expenses. These positive cash flows are then invested to support the obligations of our insurance products and required capital supporting these products. Our cash flows provided by operating activities are affected by the timing of premiums, administrative fee revenues, and investment income received and expenses paid.
Net cash used in investing activities was $504.3 million, $763.0 million and $595.4 million for 2013, 2012 and 2011, respectively. The decrease in net cash used in investing activities for 2013 compared to 2012 was primarily due to an increase in proceeds from the sale or repayment of commercial mortgage loans partially offset by an increase in acquisition or origination of commercial mortgage loans. Our target investment portfolio allocation is approximately 60% fixed maturity securities and 40% commercial mortgage loans with a maximum allocation of 45% in commercial mortgage loans. At December 31, 2013, total cash and investments consisted of 54.1% fixed maturity securities, 41.1% commercial mortgage loans, 2.9% cash and cash equivalents, 1.4% other invested assets and 0.5% real estate.
We recorded OTTI of $1.1 million and $3.2 million for 2013 and 2012, respectively. See “Critical Accounting Policies and Estimates-Investment Valuations-Fixed Maturity Securities.” We did not have any direct exposure to sub-prime or Alt-A mortgages in our fixed maturity securities portfolio at December 31, 2013. At December 31, 2013, we did not have any direct exposure to euro zone government issued debt or debt issued by investment and commercial banks headquartered in Portugal, Ireland, Italy, Greece or Spain. At December 31, 2013, fixed maturity securities issued by investment and commercial banks headquartered in other euro zone countries represented 0.9%, or $60.7 million, of our fixed maturity securities portfolio. There were no impairments on the fixed maturity securities with euro zone exposure for 2013.
StanCorp Mortgage Investors originates and services fixed-rate commercial mortgage loans for the investment portfolios of our insurance subsidiaries and generates additional fee income from the origination and servicing of commercial mortgage loans participated to institutional investors. The level of commercial mortgage loan originations in any period is influenced by market conditions as we respond to changes in interest rates, available spreads and borrower demand.
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.
The decrease in the commercial mortgage loan loss allowance for 2013 compared to 2012 was primarily due to the decrease in the general loan loss allowance which was driven by improvement in the composition of the commercial mortgage loan portfolio that impacts the general loan loss allowance. This decrease was partially offset by an increase in the specific loan loss allowance. The increase in charge-offs was primarily due to higher losses related to foreclosures, accepted deeds in lieu of foreclosure on commercial mortgage loans and other related charges associated with commercial mortgage loans leaving the portfolio for 2013. The lower provision and net charge-offs for the commercial mortgage loan loss allowance for 2012 compared to 2011 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 2012. The decreases in the specific and general loan loss allowances at 2012 compared to 2011 were primarily due to a decrease in impaired commercial mortgage loans and the composition of the commercial mortgage loan portfolio at 2012.
We maintain a four-year, $250 million senior unsecured revolving credit facility (“Facility”). Upon our request and with consent of the lenders under the Facility, the Facility can be increased to $350 million. In June 2013, the termination date of the Facility was extended to June 22, 2017. At our option and with the consent of the lenders under the Facility, the termination date can be extended one additional year to June 22, 2018. We expect to use any borrowings under the Facility for working capital, general corporate purposes and for issuance of letters of credit.
we were in compliance with all covenants under the Facility and had no outstanding balance on the Facility. We believe we will continue to meet the financial covenants throughout the life of the Facility.
We have $250 million of 5.00%, 2022 Senior Notes, which mature on August 15, 2022. Interest is paid semi-annually on February 15 and August 15.
We have $300 million of 6.90%, junior subordinated debentures (“Subordinated Debt”), which mature on June 1, 2067, and are non-callable prior to June 1, 2017. The principal amount of the Subordinated Debt is payable at final maturity. Interest is payable semi-annually at 6.90% on June 1 and December 1 until June 1, 2017, and quarterly thereafter at a floating rate equal to three-month LIBOR plus 2.51%. We have the option to defer interest payments for up to five years. The declaration and payment of dividends to shareholders would be restricted if we elected to defer interest payments on our Subordinated Debt. If elected, the restriction would be in place during the interest deferral period. We have not deferred interest on the Subordinated Debt.
from the Oregon Insurance Division is $195.1 million. As of December 31, 2012, Standard’s net gain from operations after dividends to policyholders and federal income taxes and before capital gains or losses for the 12-month period then ended was $132.7 million and capital and surplus was $1.19 billion. Based upon Standard’s results for 2012, the amount of ordinary dividends and other distributions available in 2013, without prior approval from the Oregon Insurance Division was $132.7 million.
Dividends paid from Standard to StanCorp will be based on levels of available capital and needs at the holding company, which are driven by the financial results of Standard and the Company as a whole. Standard paid ordinary cash dividends to StanCorp of $70.0 million and extraordinary cash dividends to StanCorp of $60.0 million during 2013. Standard paid extraordinary cash dividends to StanCorp of $310.0 million and ordinary cash dividends to $10.0 million for 2012. Standard paid ordinary cash dividends to StanCorp of $87.8 million for 2011.
(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 $7.50 billion exceeds the corresponding liability amount of $5.85 billion included in the Consolidated Financial Statements as of December 31, 2013. 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.
Other long-term obligations reflected in our balance sheet at December 31, 2013, included $194.6 million in expected benefit payments for supplemental, home office, and field office retirement plans, $32.3 million in expected benefit payments for the postretirement benefit plan, $31.7 million in capital commitments related to our tax-advantaged investments, a $13.0 million tax reimbursement liability related to the block of life insurance business sold to Protective Life in 2001, and a $11.6 million liability for our deferred compensation plan.
Insolvency regulations exist in many of the jurisdictions in which 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 for the purpose of paying benefits due to policyholders of impaired or insolvent insurance companies. Association assessments levied against us were $1.9 million, $0.2 million and $0.9 million for 2013, 2012 and 2011, respectively. At December 31, 2013, we maintained a reserve of $0.6 million for future assessments with respect to currently impaired, insolvent or failed insurers.
The increase in Statutory Results for 2013 compared to 2012 was primarily due to more favorable claims experience in Employee Benefits. The decrease in Statutory Results for 2012 compared to 2011 was primarily due to an increase in group long term disability reserves due to higher claims experience.
See Item 8, “Financial Statements and Supplementary Data- Notes to Consolidated Financial Statements-Note 1-Summary of Significant Accounting Policies-Accounting Pronouncements.”
Growth of sales, premiums, annuity deposits, cash flows, assets under administration including performance of equity investments in the separate account, gross profits and profitability.
Consolidated Statements of Income for the years ended December 31, 2013, 2012 and
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, 2013, based on the criteria established in Internal Control-Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 26, 2014 expressed an unqualified opinion on the Company’s internal control over financial reporting.
(1) Net of tax benefit of $111.1 million and tax expenses of $38.3 million and $55.9 million for 2013, 2012 and 2011, respectively.
(3) Net of tax expenses of $22.2 million and $0.2 million and tax benefit of $14.3 million for 2013, 2012 and 2011, respectively.
StanCorp Investment Advisers is a Securities and Exchange Commission (“SEC”) registered investment adviser providing performance analysis, fund selection support, model portfolios and other investment advisory, financial planning, and investment management services to its retirement plan clients, individual investors and subsidiaries of StanCorp.
Standard Management manages certain real estate properties held for sale from time-to-time in conjunction with our real estate business.
Fixed maturity security capital gains and losses are recognized using the specific identification method. If a debt security’s fair value declines below its amortized cost, the Company must assess the security’s impairment to determine if the impairment is other than temporary.
In the Company’s quarterly fixed maturity security impairment analysis, management evaluates whether a decline in value of the fixed maturity security is other than temporary by considering the following factors:
If it is determined an other-than-temporary impairment (“OTTI”) exists, we separate the OTTI of debt 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. The cost basis of the fixed maturity security is permanently adjusted to reflect the credit related impairment. Once an impairment charge has been recorded, the Company continues to review the OTTI securities for further potential impairment.
Real Estate Owned is initially recorded at the lower of cost or 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 charge 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 charge has been recorded, the Company continues to review the investment for further potential impairment. Impairments recorded on Real Estate Owned were $8.7 million, $3.0 million and $15.8 million for 2013, 2012 and 2011 respectively.
Tax-advantaged investments are accounted for under the equity method of accounting. These investments are structured as limited partnerships for the purpose of investing in the construction and rehabilitation of low-income housing and to provide favorable returns to investors. The Company has invested in tax-advantaged investments due to the higher returns associated with these investments relative to their perceived risk. The primary sources of investment return are tax credits and the tax benefits derived from passive losses on the investments, both of which may exhibit variability over the life of the investment. Tax credits received from these investments are reported in StanCorp’s consolidated statements of income as either a reduction of state premium taxes, or a reduction of income tax. StanCorp’s share of the operating losses of the limited partnerships decrease the basis in the investments and are reported as a component of net investment income. If the net present value of expected future cash flows of the tax-advantaged
investments is less than the current book value of the investments, the Company evaluates whether a decline in value is other than temporary. If it is determined an OTTI exists, the investment is written down to the net present value of expected future cash flows and the OTTI is recognized as a capital loss.
Net investment income and capital gains and losses related to separate account assets and liabilities are included in the separate account assets and liabilities.
The Company’s other intangible assets are subject to amortization and consist of certain customer lists from Asset Management business acquired and an individual disability marketing agreement. Customer lists have a combined estimated weighted-average remaining life of approximately 6.8 years. 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.
Property and equipment are stated at cost less accumulated depreciation. The Company depreciates property and equipment using the straight-line method over the estimated useful lives with a half-year convention. The estimated useful lives are generally 40 years for properties, range from three to ten years for equipment and range from three to five years for capitalized software. Leasehold improvements are depreciated over the lesser of the estimated useful life of the asset or the life of the lease. Depreciation expense for 2013, 2012 and 2011 was $19.9 million, $24.1 million and $28.0 million, respectively. The Company reviews property and equipment for impairment when circumstances or events indicate the carrying amount of the asset may not be recoverable and recognizes a charge to earnings if an asset is impaired.
Non-affiliated tenants leased 33.8%, 33.3% and 35.3% of the corporate headquarters in Portland, Oregon at December 31, 2013, 2012 and 2011, respectively. Income from the leases is included in net investment income.
Company’s future benefit liabilities but are instead estimates based on assumptions and considerations concerning a number of factors, which include:
Other policyholder funds are liabilities for investment-type contracts and are based on the policy account balances including accumulated interest. Other policyholder funds also include amounts related to advanced premiums of $186.1 million and $186.7 million at December 31, 2013 and 2012, respectively, and premiums on deposit and experience rated liabilities totaling $193.5 million and $216.1 million at December 31, 2013 and 2012, respectively.
In July 2013, the Financial Accounting Standards Board issued ASU No. 2013-11, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists. The main objective of ASU No. 2013-11 is to eliminate diversity in practice resulting from a lack of guidance on this topic. Under the guidance provided in this ASU, entities are required to present an unrecognized tax benefit in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward. If no such net operating loss carryforward is available at the reporting date, the unrecognized tax benefit should be presented in the financial statements as a liability.
ASU No. 2013-11 is effective for fiscal years beginning after December 15, 2013, and interim periods within those years. The Company does not currently have any unrecognized tax benefits. Therefore, the Company does not expect this ASU to have a material effect on its asset and liability disclosures in the financial statements.
ASU No. 2014-01, Accounting for Investments in Qualified Affordable Housing Projects
In January 2014, the Financial Accounting Standards Board issued ASU No. 2014-01, Accounting for Investments in Qualified Affordable Housing Projects. The main objective of ASU No. 2014-01 is to provide guidance on accounting for investments in affordable housing projects that qualify for low income housing tax credit. Under this guidance, entities could make a policy election to account for qualified affordable housing projects under the proportionate amortization method (“PAM”) of accounting. Under the PAM, the cost of low income housing tax credit investments is amortized in each period in proportion to the tax credits and benefits of tax losses received in that period and allows the benefits from tax losses on the asset, the losses that reduce the asset balance of the investment and the tax credits to be recorded in the income tax expense line.
ASU No. 2014-01 is effective for annual periods and interim reporting periods within those annual periods beginning after December 15, 2014. Early adoption is permitted. The Company currently invests in affordable housing projects that qualify for low income housing tax credit and is assessing the requirements for accounting for these investments under the PAM.
The following table sets forth the calculation of net income per basic and diluted weighted-average common shares outstanding:
The fair value of each option award 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 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 $16.15, $13.73 and $16.87 for 2013, 2012 and 2011, respectively.
The total intrinsic value of the options exercised was $14.4 million, $3.2 million and $1.8 million for the same periods, respectively. The amount that the Company received from the exercise of stock options was $50.2 million, $7.6 million and $3.5 million for 2013, 2012 and 2011, respectively. The related tax benefit derived from the tax deduction received by the Company for the difference between the market price of StanCorp common stock and the exercise price when the options were exercised was $3.6 million, $1.1 million and $0.6 million for 2013, 2012 and 2011, respectively.
Beginning in the first quarter of 2013, the Company granted 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 withholdings.
The Company grants Performance shares to designated senior officers as long-term incentive compensation. The payout for these awards is based on the Company’s financial performance over a three-year period. Performance Share grants represent the maximum number of shares of StanCorp common stock issuable to the designated senior officers if specified criteria are met. The actual number of shares issued at the end of the performance period is based on continued employment and satisfaction of Company financial performance conditions, with a portion of the shares withheld to cover required tax withholding.
Due to timing of when performance shares vested, the Company did not issue shares for 2013. The Company issued 9,899 and 4,906 shares of StanCorp common stock for 2012 and 2011, respectively, to redeem Performance Shares that vested following the 2011 and 2010 performance periods, net of Performance Shares withheld to cover the required taxes.
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 that 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, $9.5 million in additional cost would be recognized through 2015. The target payout is 50% of the maximum Performance Shares for the 2014 and 2015 performance periods. Assuming that the target performance is achieved for each performance goal, $3.5 million in additional cost would be recognized through 2015. This cost would be recognized over a weighted-average period of 1.4 years.
The following table sets forth the assumptions used to determine the fair value of the ESPP embedded option:
The investment goal of the employee pension plan is to produce long-run portfolio returns that are consistent with reasonable contribution rates and a well-funded plan. To manage the overall risk of the portfolio, the portfolio is reviewed quarterly and rebalanced as necessary to keep the allocation of debt and equity securities within target allocation tolerance levels. The equity securities include pooled separate account funds comprised of large cap growth, large cap blend, large cap value, mid cap blend and foreign mutual funds and are diversified across investment strategies. The employee pension plan held no StanCorp equity securities as plan assets at December 31, 2013 and 2012. The plan invests in a stable asset fund comprised of debt securities included in the general account represented by a Deposit Administration Contract with Standard. Standard maintains the contributions in an unallocated fund, whose assets are invested with other assets in the general account of Standard. The account is credited with earnings on the underlying investments and charged for plan withdrawals and administrative expenses charged by Standard Retirement Services. The stable asset fund contract may subject the plan to concentrations of risk as its contract value is dependent on the ability of Standard to honor its contractual commitments. There are no reserves against the contract value for credit risk of Standard or otherwise.
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 2013, 2012 and 2011 were $9.9 million, $9.9 million and $10.3 million, respectively.
The following table sets forth a reconciliation of the changes in the postretirement benefit plan’s accumulated postretirement benefit obligation, fair value of plan assets and the funded status:
* Assumption for rate of compensation increase was not applicable in determining benefit obligations for 2013, 2012 and 2011 or net periodic benefit cost in 2013 and 2012 due to curtailment of group term life insurance benefit as of December 31, 2011.
The following table sets forth the Company’s target and actual weighted-average asset allocations for the postretirement medical plan:
Eligible executive officers are covered by a non-qualified supplemental retirement plan (“non-qualified plan”). Under the non-qualified plan, a participant is entitled to a normal retirement benefit once the participant reaches age 65. A participant can also receive a normal, unreduced retirement benefit once the sum of his or her age plus years of service is at least 90. The Company recognizes the unfunded status of the non-qualified plan in other liabilities on the balance sheet. The unfunded status was $31.1 million and $27.5 million at December 31, 2013 and 2012, respectively. Expenses were $3.1 million, $1.9 million and $2.5 million for 2013, 2012 and 2011, respectively. The net loss and prior service cost, net of tax, excluded from the net periodic benefit cost and reported as a component of accumulated other comprehensive income were $5.7 million, $4.7 million and $5.7 million at December 31, 2013, 2012 and 2011, respectively.
The Company collectively views and operates its businesses as Insurance Services and Asset Management, which both deliver distinct value to customers and shareholders. Insurance Services contains two reportable product segments, Employee Benefits and Individual Disability. Due to the growth in the Individual Disability business in relation to total Insurance Services over the last several years, Individual Disability has become a separate reportable product segment within Insurance Services in 2013. Asset Management provides investment and asset management products and services and is reported as a separate segment. Holding company and corporate activities are reported in the Other category. Resources are allocated and performance is evaluated at the segment level. Insurance Services offers group and individual disability insurance, group life and AD&D insurance, group dental and group vision insurance, and absence management services. Asset Management offers full-service 401(k) plans, 403(b) plans, 457 plans, defined benefit plans, money purchase pension plans, profit sharing plans and non-qualified deferred compensation products and services. Asset Management also offers investment advisory and management services, financial planning services, origination and servicing of fixed-rate commercial mortgage loans, individual fixed-rate annuity products, group annuity contracts and retirement plan trust products. The Other category includes return on capital not allocated to the product segments, holding company expenses, operations of certain unallocated subsidiaries, interest on debt, unallocated expenses, net capital gains and losses related to the impairment or the disposition of the Company’s invested assets and adjustments made in consolidation. The accounting policies of the segments are the same as those described in the summary of significant accounting policies. See “Note 1-Summary of Significant Accounting Policies.”
Intersegment revenues are comprised of administrative fee revenues charged by the Asset Management segment 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 Company is carrying forward net operating losses (“NOL”) of $58 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 2023 to 2032. In addition, the Company is carrying forward a $53 million federal NOL from a business acquisition. This carryforward is subject to limitations under IRS Section 382, which potentially reduces the annual amount that may be utilized. This NOL carryforward will expire between 2019 and 2024.
The Company did not have any material unrecognized tax benefits at December 31, 2013 and 2012. It is the Company’s accounting policy to record income tax interest and penalties in the income tax provision. See “Note 1-Summary of Significant Accounting Policies-Income Taxes.”
For disclosure purposes, the fair values of commercial mortgage loans were estimated using an option-adjusted discounted cash flow valuation. The valuation includes both observable market inputs and estimated model parameters.
For policy loans, the carrying value represents historical cost but approximates fair value. While potentially financial instruments, policy loans are an integral component of the insurance contract and have no maturity date.
The fair value for long-term debt was predominantly based on quoted market prices as of December 31, 2013 and December 31, 2012, and trades occurring close to December 31, 2013 and December 31, 2012.
The significant unobservable inputs used in the fair value measurement of the reporting entity’s bonds are valuations and quotes received from secondary pricing service, 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 performs control procedures over the external valuations at least quarterly through a combination of procedures that include an evaluation of methodologies used by the pricing service, analytical reviews and performance analysis of the prices against statistics, trends and secondary pricing sources, back testing of sales activity and maintenance of a securities watch list. As necessary, the Company compares prices received from the pricing service to prices independently estimated by the Company utilizing discounted cash flow models or through performing independent valuations of inputs and assumptions similar to those used by the pricing service in order to ensure prices represent a reasonable estimate of fair value. Although the Company does identify differences from time to time as a result of these validation procedures, the Company did not make any significant adjustments as of December 31, 2013 or December 31, 2012.
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 sheet.
The following table sets forth quantitative information regarding significant unobservable inputs used in Level 3 valuation of assets and liabilities measured and recorded at fair value:
(a) Represents various assumptions derived from market data, which include estimates of bid ask spreads and the implied volatilities for the S&P 500 Index.
For all periods disclosed above, fixed maturity securities transferred into Level 3 from Level 2 are the result of the Company being unable to obtain observable assumptions for these investments in the market. Fixed maturity securities transferred out of Level 3 into Level 2 are the result of the Company being able to obtain observable assumptions for these investments in the market. There were no transfers between Level 1 and Level 2 for 2013 and 2012.
The following table sets forth the changes in unrealized gains (losses) included in net income relating to positions that the Company continued to hold:
Commercial mortgage loans measured on a nonrecurring basis with a carrying amount of $87.7 million were written down to their fair value of $68.7 million, less selling costs, at December 31, 2013. The specific commercial mortgage loan loss allowance related to these commercial mortgage loans was $25.9 million at December 31, 2013. The Real Estate Owned measured on a nonrecurring basis as of December 31, 2013, and still held at December 31, 2013 had capital losses totaling $7.2 million for 2013. Real Estate Owned measured on a nonrecurring basis represents newly acquired properties or properties whose value has been adjusted based on pending sale or other market information.
Commercial mortgage loans measured on a nonrecurring basis with a carrying amount of $74.1 million were written down to their fair value of $53.9 million, less selling costs, at December 31, 2012. The specific commercial mortgage loan loss allowance related to these commercial mortgage loans was $25.6 million at December 31, 2012. The Real Estate Owned measured on a nonrecurring basis as of December 31, 2012 and still held at December 31, 2012 had capital losses totaling $2.1 million for 2012. 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. Callable bonds, excluding bonds with make-whole provisions and bonds with provisions that allow the borrower to prepay near maturity, represented 4.25%, or $302.8 million, of the Company’s fixed maturity securities portfolio at December 31, 2013. At December 31, 2013, the Company did not have any direct exposure to sub-prime or Alt-A mortgages in its fixed maturity securities portfolio. At December 31, 2013, the Company did not have any direct exposure to euro zone government issued debt or debt issued by investment and commercial banks headquartered in Portugal, Ireland, Italy, Greece or Spain. At December 31, 2013, fixed maturity securities issued by investment and commercial banks headquartered in other euro zone countries represented 0.9%, or $60.7 million, of the Company’s fixed maturity securities portfolio. There were no impairments on the fixed maturity securities with euro zone exposure in 2013.
The following tables set forth the gross unrealized losses and fair value of investments, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position:
The Company underwrites mortgage loans on commercial property throughout the United States. In addition to real estate collateral, the Company requires either partial or full recourse on most loans. At December 31, 2013, the Company did not have any direct exposure to sub-prime or Alt-A mortgages in its commercial mortgage loan portfolio.
* Geographic regions obtained from the American Council of Life Insurers Mortgage Loan Portfolio Profile.
The general loan loss allowance is based on the Company’s 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 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 note. 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 contractual 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 written off against the allowance, and recoveries, if any, are credited to the allowance.
The Company assesses the credit quality of its commercial mortgage loan portfolio quarterly by reviewing the performance of its portfolio which includes evaluating its performing and nonperforming commercial mortgage loans. Nonperforming commercial mortgage loans include all commercial mortgage loans that are 60 days or more past due and commercial mortgage loans that are not 60 days past due but are not substantially performing to other original contractual terms.
The increase in the carrying value of impaired commercial mortgage loans at December 31, 2013 compared to December 31, 2012 was primarily due to an increase in commercial mortgage loans with a specific loan loss allowance within the Company’s retail segment during 2013. As of December 31, 2013 and December 31, 2012 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.
There were no troubled debt restructurings identified in the previous 12 months that subsequently defaulted during 2013.
Securities deposited for the benefit of policyholders in various states, in accordance with state regulations, amounted to $7.4 million and $7.9 million at December 31, 2013 and 2012, respectively.
The notional amount of the Company’s S&P 500 Index options at December 31, 2013 and 2012 was $350.5 million and $315.2 million, respectively. Option premiums paid for the Company’s S&P 500 Index option contracts were $9.4 million and $9.5 million for 2013 and 2012, respectively. The Company received $19.3 million and $13.2 million for options exercised in 2013 and 2012, respectively.
The Company does not bear derivative-related risk that would require it to post collateral with another institution, and its index option contracts do not contain counterparty credit-risk-related contingent features. The Company is exposed to the credit worthiness of the institutions from which it purchases its S&P 500 Index options and these institutions continued abilities to perform according to the terms of the contracts. The current values for the credit exposure have been affected by fluctuations in the S&P 500 Index. The Company’s maximum credit exposure would require an increase of approximately 4.27% in the value of the S&P 500 Index. The maximum credit risk is calculated using the cap strike price of the Company’s S&P 500 Index options less the floor price, multiplied by the notional amount of the S&P 500 Index options.
The value of DAC and VOBA is dependent on key assumptions. See “Note 1-Summary of Significant Accounting Policies-DAC, VOBA and Other Intangible Assets” for a discussion of the key assumptions used to determine the values of DAC and VOBA. These assumptions are modified to reflect actual experience when appropriate. Although a change in a single assumption may have an impact on the calculated amortization of DAC or VOBA for balances associated with investment contracts, it is the relationship of that change to the changes in other key assumptions that determines the ultimate impact on DAC or VOBA amortization. Because actual results and trends related to these assumptions vary from those assumed, the Company revises these assumptions annually to reflect its current best estimate of expected gross profits. As a result of this process, known as “unlocking,” the cumulative balances of DAC and VOBA are adjusted with an offsetting benefit or charge to income to reflect changes in the period of the revision. An unlocking event generally occurs as a result of actual experience or future expectations differing from previous estimates. The Company recorded a reduction to VOBA of $1.0 million in 2013 and $0.8 million in 2012 due to changes in expected gross profits related to the block of claims assumed. The Company did not record a similar impairment for 2011. As a result of unlocking, the amortization schedule for future periods is also adjusted.
The liability for unpaid claims, claim adjustment expenses and other policyholder funds includes liabilities for insurance offered on products such as group long term and short term disability, individual disability, group dental and group vision, and group AD&D. The liability for unpaid claims and claim adjustment expenses is established when a claim is incurred or is estimated to have been incurred but not yet reported to the Company and, as prescribed by GAAP, equals the Company’s best estimate of the present value of the liability of future unpaid claims and claim adjustment expenses. This liability is included in future policy benefits and claims in the consolidated balance sheets.
economic uncertainty in 2013, 2012 and 2011. The Company carefully monitors trends in reserve assumptions and when these trends become credible and are expected to persist, the Company incorporates these factors into its reserves to ensure best estimates are established.
Standard maintains a strategic marketing alliance with Ameritas Life Insurance Corp. (“Ameritas”) that offers Standard’s policyholders more flexible dental coverage options and access to Ameritas’ nationwide preferred provider organization panel of dentists. As part of this alliance, Standard and Ameritas entered into a reinsurance agreement. In 2013, the agreement provided for 26.1% of the net dental premiums written by Standard and the risk associated with this premium to be ceded to Ameritas.
Standard participates in a reinsurance and third-party administration arrangement with Northwestern Mutual Life Insurance Company (“Northwestern Mutual”) under which Northwestern Mutual group long term and short term disability products are sold using Northwestern Mutual’s agency distribution system. Generally, Standard assumes 60% of the risk and receives 60% of the premiums for the policies issued. If Standard were to become unable to meet its obligations, Northwestern Mutual would retain the reinsured liabilities. Therefore, in accordance with an agreement with Northwestern Mutual, Standard established a trust for the benefit of Northwestern Mutual with the market value of assets in the trust equal to Northwestern Mutual’s reinsurance receivable from Standard. The market value of assets required to be maintained in the trust at December 31, 2013, was $233.6 million. Premiums assumed by Standard for the Northwestern Mutual business accounted for approximately 3% of the Standard’s total premiums for each of the three years 2013, 2012 and 2011. In addition to assuming risk, Standard provides product design, pricing, underwriting, legal support, claims management and other administrative services under the arrangement.
In 2012, the Company amended its Yearly Renewable Term reinsurance agreement with Canada Life Assurance Company (“Canada Life”). The amendment increased the amount of group life insurance risk to be ceded to Canada Life. The amended agreement limits the Standard’s exposure to losses in the event of a catastrophe impacting its group life business. This amendment to Standard’s reinsurance agreement released approximately $100 million of additional net capital, for a total release of approximately $170 million. This release of capital can fluctuate based on a percentage of Standard’s in-force business. The agreement is subject to termination by either party.
Effective October 1, 2002, Standard entered into a reinsurance agreement with TIAA to assume TIAA’s group disability and group life insurance business. This business included approximately 1,800 group insurance contracts, representing 650,000 insured individuals. Standard paid a ceding commission of approximately $75 million and received approximately $705 million in assets and corresponding statutory liabilities. If Standard were to become unable to meet its obligations, TIAA would retain the reinsured liabilities. Therefore, in accordance with the agreement with TIAA, Standard established a trust for the benefit of TIAA with the market value of assets in the trust equal to TIAA’s reinsurance receivable from Standard. The market value of assets required to be maintained in the trust is determined quarterly. The market value of assets required to be maintained in the trust at December 31, 2013, was $215.1 million. Approximately $60.0 million in VOBA was recorded related to the reinsurance agreement.
Standard and The Standard Life Insurance Company of New York are subject to statutory restrictions that limit the maximum amount of dividends and distributions that they could declare and pay to StanCorp without prior approval of the states in which the subsidiaries are domiciled. Standard’s ability to pay dividends to StanCorp is affected by factors deemed relevant by Standard’s Board of Directors and by Oregon law, which limits Standard’s dividend payments and other distributions to the earned surplus arising from its business. If the proposed dividend or other distribution exceeds certain statutory limitations, Standard must receive prior approval of the Director of the Oregon Department of Consumer and Business Services-Insurance Division (“Oregon Insurance Division”). The current statutory dividend limitations are the greater of (a) 10% of Standard’s combined capital and surplus as of December 31 of the preceding year, or (b) the net gain from operations after dividends to policyholders and federal income taxes and before realized capital gains or losses for the 12-month period ended on the preceding December 31. In each case, the limitation must be determined under statutory accounting practices. Oregon law gives the Oregon Insurance Division broad discretion to approve or decline requests for dividends and other distributions in excess of these limits. As of December 31, 2013, Standard’s net gain from operations after dividends to policyholders and federal income taxes and before capital gains or losses for the 12-month period then ended was $195.1 million and capital and surplus was $1.29 billion. Based upon Standard’s results for 2013, the amount of ordinary dividends and other distributions available in 2014, without additional approval from the Oregon Insurance Division is $195.1 million. As of December 31, 2012, Standard’s net gain from operations after dividends to policyholders and federal income taxes and before capital gains or losses for the 12-month period then ended was $132.7 million and capital and surplus was $1.19 billion. Based upon Standard’s results for 2012, the amount of ordinary dividends and other distributions available in 2013, without additional approval from the Oregon Insurance Division was $132.7 million.
The Company has $300 million of 6.90%, junior subordinated debentures (“Subordinated Debt”), which matures on June 1, 2067 and is non-callable for the first 10 years (prior to June 1, 2017). The principal amount of the Subordinated Debt is payable at final maturity. Interest is payable semi-annually on June 1 and December 1 for the first 10 years up to June 1, 2017, and quarterly thereafter at a floating rate equal to three-month LIBOR plus 2.51%. StanCorp has the option to defer interest payments for up to five years. The declaration and payment of dividends to shareholders would be restricted if the Company elected to defer interest payments on its Subordinated Debt. If elected, the restriction would be in place during the interest deferral period. StanCorp is currently not deferring interest on the Subordinated Debt.
The Company leases certain buildings and equipment under non-cancelable operating leases that expire in various years through 2023. Most of these leases have renewal options for periods ranging from one to ten years.
The Company’s debt obligations consisted primarily of the $250 million 5.00% 2022 Senior Notes and the $300 million 6.90% Subordinated Debt. See “Note 18-Long-Term Debt” for additional information.
In the normal course of business, the Company commits to fund commercial mortgage loans generally up to 90 days in advance. At December 31, 2013, the Company had outstanding commitments to fund commercial mortgage loans totaling $197.6 million, with fixed interest rates ranging from 4.25% to 5.75%. 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.
(1) Net of tax expense of $38.3 million for unrealized gains on fixed maturity securities and $0.2 million for employee benefits, respectively.
(4) Net of tax benefit of $3.1 million for unrealized gains on fixed maturity securities and $3.2 million for employee benefits, respectively.