Prairie's Home Office building is located at 440 Mount Rushmore Road, Rapid City, South Dakota. The building contains approximately 44,000 square feet, of which approximately 34,000 square feet are utilized for Company purposes, while the remainder of the building is leased to outside tenants. This six-story building and the underlying real property are subject to mortgage indebtedness (capitalized lease) of approximately $476,000 as of December 31, 1994. The book value of the property at December 31, 1994 is approximately $3.4 million.
Prairie leases marketing and administrative space in several other locations. The aggregate monthly rental for these locations is approximately $4,000.
In addition, Prairie is obligated on leases for space previously used for administrative purposes. This space is currently being sub-leased. The net monthly rental is approximately $5,500.
Laurentian Capital's net income for 1994 was $9.5 million, or $1.22 per share, as compared to net income of $8.2 million, or $1.05 per share, in 1993 and a net income of $6.7 million, or $0.80 per share, in 1992. Excluding the cumulative effect of the adoption of Statement of Financial Accounting Standards No. 109, 'Accounting for Income Taxes' ('SFAS 109'), which contributed $0.4 million to net income in 1993, the Company's net income for 1993 was $7.8 million, or $1.00 per share.
The 1994 net income of $9.5 million, or $1.22 per share, compares favorably to 1993 net income of $8.2 million, or $1.05 per share. The improvement in net income was due primarily to increased life sales, a lower effective tax rate, and reduced interest expense on the Company's debt. During 1994, the Company refinanced its debt at a lower interest rate and used internal funds to repay $10 million of the debt.
The 1992 net income of $6.7 million, or $0.80 per share, compared favorably to 1991 net income of $5.4 million, or $0.63 per share. The improvement in net income was due primarily to increased investment income and lower death and health claim benefits. In addition, substantially lower levels of realized investment gains were included in 1992 net income than in the prior year.
The following table sets forth for the periods shown the amount of premium income and the percentage change in each from the prior period:
Premium income improved in 1993 as compared to 1992 due to improvements in new sales and inforce persistency at Prairie and Loyal. Loyal's accident and health premium, primarily related to a cancer indemnity product, accounted for most of the increase.
The following table sets forth for the periods shown the amount of net investment income, realized investment gains and other income and the percentage increase (decrease) from the corresponding prior periods.
During 1993, there was an increase of 5.2% in net investment income, realized investment gains and other income as compared to 1992. This increase resulted primarily from a $2.7 million increase in realized investment gains. During 1993, the Company experienced substantial prepayments on its fixed maturity investments as individuals and corporations refinanced their debt obligations. The significant prepayments received in 1993 were reinvested at lower interest rates. The Company's increased level of realized investment gains resulted primarily from the exercise of call provisions on these debt obligations, usually at a premium. Net investment income remained stable as a lower portfolio yield was offset by increased invested assets.
During 1992, there was a decrease of 2.4% in net investment income, realized investment gains and other income as compared to 1991. This decrease resulted primarily from a $3.6 million decline in realized investment gains. During 1992, $4.7 million in other than temporary impairments were recorded, principally to reduce real estate to appraised values, as compared to $0.9 million in 1991. Net investment income in 1992 increased $1.6 million when compared to 1991, due to growth in the Company's invested asset base combined with the accelerated recognition of income on mortgage-backed securities due to increases in prepayment activity.
The following table sets forth for the periods shown the benefits and expenses incurred by the Company as a percentage of premium income:
Expenses as a percentage of premium income in 1994 decreased to 53.8% as compared to 56.2% in 1993. Interest expense during 1994 was $1.3 million lower than during 1993 due to the refinancing of the Company's debt. The refinanced principal was $10 million less than the debt at December 31, 1993, and the effective interest rate was also lower on the refinanced amount due to the maturity of an Interest Rate Swap Agreement.
Expenses as a percentage of premium income in 1992 remained fairly stable when compared to 1991. Following a period of administrative consolidation, operational efficiencies continued during the year.
Effective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109, 'Accounting for Income Taxes' ('SFAS 109'). Under SFAS 109, deferred tax assets or liabilities are computed based on the difference between the financial statement and income tax bases of assets and liabilities applying enacted tax rates. Deferred income tax expenses or benefits are based on the changes in the deferred tax assets or liabilities from period to period.
The Company's effective tax rate for the year ended December 31, 1994 was 24.3%, as compared to 31.5% for the year ended December 31, 1993. The effective tax rate for the year ended December 31, 1994 was lower than the enacted statutory tax rate of 34% due primarily to the reduction in valuation allowances associated with the deferred tax asset related to certain real estate assets sold in 1994, net operating losses utilized in 1994, and temporary differences of the non-life companies. Excluding the effect of these real estate transactions, the effective rate for 1994 would have been marginally higher than the effective rate for 1993.
The increase in net income for 1994 as compared to 1993 of $1.3 million is due to increased life sales (offset by a decrease in the yield of the investment portfolio), lower benefits and expenses, and a lower effective tax rate. Continued emphasis on cost containment and cost reduction has improved efficiency in the operations during a period of increased selling activity. Expenses were further reduced by $1.3 million as a result of the refinancing of the Company's debt at a lower interest rate which occurred during 1994. The Company also repaid $10 million of debt at the date of refinancing using internal funds.
The increase in net income for 1993 as compared to 1992 of $1.5 million was due to higher realized investment gains, lower operating expenses, recognition of a benefit from the adoption of SFAS 109 and a lower effective tax rate.
The increase in net income for 1992 as compared to 1991 of $1.3 million was due to higher investment income and lower death and health claims experience which offset the lower levels of realized investment gains.
The life insurance industry normally produces a positive cash flow from operations and scheduled principal repayments from portfolios of fixed maturity investments (bonds and redeemable preferred stocks) and mortgage loans. This cash flow is used to fund an investment portfolio to finance future benefit payments, which represent long-term obligations reserved for using certain assumed interest rates. Since future benefit payments are primarily long-term obligations, the Company's investments are predominately long-term fixed rate instruments such as bonds which are expected to provide a sufficient return to cover these obligations. The nature and quality of the various types of investments made by a life insurance company must comply with the statutes and regulations imposed by the states in which that company is licensed. These statutes and regulations generally require that securities acquired be investment grade and provide protection for policyholders.
On January 1, 1994, the Company adopted the provisions of Statement of Financial Accounting Standard No. 115, 'Accounting for Certain Investments in Debt and Equity Securities' ('SFAS 115'). SFAS 115 specifically applies to the accounting for fixed income securities, which have historically been reported at amortized cost. SFAS 115 allows for the continued use of amortized cost reporting only for those securities that the Company has designated as fixed maturities held to
The Company holds a substantial component of its investment portfolio in mortgage-backed securities and collateralized mortgage obligations (collectively 'MBS'). At the end of 1994, the book value of the total investment in MBS amounted to $437 million, or 75% of total investments. These are instruments collateralized by pools of residential and commercial mortgages, which return interest and principal payments to the investor. Approximately 27% of the Company's MBS holdings are U.S. government agency securities (GNMA, FNMA and FHLMC), which carry either a direct government or a quasi-government guarantee and are rated AAA in terms of quality. The Company also owns non-agency MBS, issued by major U.S. financial institutions, which are rated AAA, AA or A. Non-agency MBS are credit-enhanced in order to achieve a high rating. The form of the credit enhancement is generally a senior/subordinated structure, a limited corporate guarantee from a large financial institution or a letter of credit from a major commercial bank. Historically, residential mortgages in the U.S. have had a very low default rate and the Company's non-agency MBS are well-diversified geographically. Thus, the Company is protected against adverse regional economic conditions. Mortgage-backed securities typically yield more than corporate bonds of similar maturity. MBS also are not subject to so-called event risk, which can cause investment grade bonds of a corporation to become 'junk', as a result, for example, of a leveraged acquisition. In addition, MBS are generally liquid issues with major brokerage houses providing ready markets. However, MBS are subject to prepayment and extension risk which can adversely affect their yield and expected maturity.
As of December 31, 1993, the Company's indebtedness under its then outstanding Revolving Underwriting Facility ('RUF') amounted to $54.8 million, which was due on April 25, 1994. On April 25, 1994, the Company entered into a five year revolving credit facility in the amount of $45 million to refinance part of the RUF. The new credit facility, together with the payment of $10 million by the Company, satisfied the repayment of the RUF. Pursuant to the terms of the new credit facility, the Company will pay interest at a variable rate equal to 1.125% above the London Interbank Offered Rate. There are covenants relating to the Company's activities and financial condition, including a requirement that the Company maintain a minimum net worth, as defined under the new credit facility, of $75 million. In connection with the new credit facility, DLFC has agreed, for the benefit of the lenders, to maintain the minimum net worth at the greater of $75 million and the amount of debt outstanding.
The Company issued approximately 58,000 shares of its Series A Preferred Stock on July 7, 1987. The preferred stock is subject to mandatory redemption provisions which provide that no more than 80% of the original issue will be outstanding at the end of the sixth year after issuance, with additional reductions of 20% of the original issue being required in each of the following four years. During 1994, the Company redeemed 8,524 shares of the preferred stock at $100 per share, in accordance with the mandatory redemption provision, and subsequently retired the stock. In order to satisfy the 1995 mandatory redemption provision, the Company must redeem 9,832 additional shares.
As a holding company, Laurentian Capital's ability to meet debt service obligations and pay operating expenses depends upon receipt of sufficient funds, primarily through dividends, interest and principal payments on a surplus debenture, and management fees from its subsidiaries. The Company's subsidiaries are currently producing earnings and net cash flow sufficient to cover debt service and preferred stock payment requirements at the parent. However, under the insurance laws of the states in which the Company's insurance subsidiaries are domiciled, certain restrictions are imposed on dividends from the subsidiaries to the parent. The insurance laws and regulations generally limit the amount of dividends to the greater of net statutory gain from operations or 10% of statutory surplus, and dividends in excess of these amounts can be paid only with the prior approval of the insurance regulators. The maximum dividend distribution which can be made to the Company by Loyal during 1995 without prior notice or approval is $3.4 million. Upon prior notice to the Division of Insurance of the State of South Dakota ('Division of Insurance'), the maximum dividend distribution which can be made by Prairie States to Prairie National Life Insurance Company ('Prairie National'), a wholly-owned life insurance subsidiary of the Company, during 1995 under current insurance law is $5.6 million. This would then be available to Prairie National to remit interest and principal payments due under its surplus debenture to the Company, subject to prior approval of the state regulatory authorities.
Prairie National purchasing Prairie States, Prairie National issued capital stock and a $35 million surplus debenture to the Company. Interest and repayment of principal on the debenture is subject to prior approval by the Division of Insurance. The surplus debenture is payable in scheduled installments through 2001. Payments of principal and interest require prior approval by the South Dakota insurance commissioner and cannot reduce Prairie National's surplus below a certain required level. As of December 31, 1994, Prairie National exceeded its required level of surplus by $8.1 million. Since April 4, 1992, the date of the restructuring, and through the end of 1994 the Division of Insurance has approved $5.9 million in interest payments associated with the surplus debenture, of which $1.9 million was approved during 1994. Principal payments of $6.5 million were approved by the Division of Insurance during 1994. The effects of these transactions are eliminated in consolidation.
Inflation has significantly increased the cost of health care. The adequacy of premium rates in relation to the level of health claims is constantly monitored and, where appropriate, premium rates on such policies are increased as policy benefits increase. Failure to make such increases commensurate with health care cost increases may result in a loss from health insurance operations.