(2) Includes operating expenses, commissions and bonuses, premium taxes, and the net increase in deferred acquisition costs and value of business acquired.
(4) Pro forma weighted-average shares outstanding for 1999, basic and diluted, are as if the initial public offering had occurred on January 1, 1999.
We have made in this Form 10-K, and from time to time may make in our public filings, news releases and oral presentations and discussions, certain statements which are not based on historical facts. These statements are “forward-looking” and, accordingly, involve risks and uncertainties that could cause actual results to differ materially from those discussed. Although such forward-looking statements have been made in good faith and are based on reasonable assumptions, there is no assurance that the expected results will be achieved. Please refer to our discussion of such forward-looking statements under the heading “Forward-Looking Statements.”
Our financial results for 2003 were strong despite challenging economic conditions. Net income for 2003 was $5.33 per diluted share, compared to $3.73 per diluted share for 2002. The strong results reflected growth in each of StanCorp’s business segments, favorable claims experience, inclusion of the block of group disability and group life business assumed from Teachers Insurance and Annuity Association of America (“TIAA”), as well as net capital gains in 2003 compared to net capital losses in 2002. Other factors contributing to the solid results included strong growth in assets under management in the Retirement Plans segment, higher fees earned in connection with commercial mortgage loan originations and an increased level of commercial mortgage loan prepayments.
Group employee benefits insurance (our Employee Benefits segment) is our largest business and represented 93.2%, 92.8% and 91.7% of total premiums for the years ended December 31, 2003, 2002 and 2001, respectively.
Claims volatility. We have a large and well diversified group insurance business. However, our claims results can be volatile when measured on a quarterly basis and can exceed or be below our expected benefit ratio (the ratio of policyholder benefits to premiums) for a given year. In recent years, our claims experience has been favorable compared to our expectations, but this favorable experience may not necessarily continue into the future.
State insurance departments require insurance enterprises to maintain minimum levels of capital and surplus. Our target is generally to maintain capital at 265% to 275% of the company action level risk-based capital (“RBC”), the minimum required by regulators to avoid remedial action by
Recently, with premium growth at levels lower than our long-term objective, our excess capital has accumulated beyond the targeted excess level by approximately $50 million as of December 31, 2003 after funding interest payments, holding company operating expenses and our historical annual shareholder dividend. If not utilized, the excess of capital over our targeted level would reduce return on average equity for 2004, as the rate of return we would earn on the related investments would be less than we would expect to achieve if invested in businesses meeting our return objectives.
The lower premium growth anticipated for 2004 will reduce the growth in net income. In addition, growth in net income for 2004 will be reduced by increased technology expense discussed above. Net income for 2004 may be affected by favorable and sustained claim recovery patterns in our Employee Benefits segment. As a result, we are adjusting our expected benefit ratio for the Employee Benefits segment moving forward to a range of 81% to 83% (previously our expected range was 82% to 84%).
Total revenues increased $312.2 million, or 17.8%, in 2003 compared to 2002, and $165.2 million, or 10.4%, in 2002 compared to 2001. Revenues consist primarily of premiums, net investment income, and net capital gains and losses.
Premium growth, excluding assumed blocks of business (unless in both comparable periods) and ERRs, for 2003 and 2002 was 7.8% and 8.7%, respectively. As discussed in the Executive Summary above, premium growth for 2003 (as defined above) was below our targeted level primarily due to the effects of economic conditions on our Employee Benefits segment, which are expected to continue into 2004.
ERRs were $18.6 million, $13.5 million, and $16.0 million for 2003, 2002, and 2001, respectively.
Also as a result of challenging economic conditions and competition for experienced employee benefits sales representatives, we ended 2003 with 151 sales representatives, six fewer than at the end of 2002. We are working to increase the number of sales representatives to 185 by the end of 2004 as was our original plan, yet achievement of this goal may be affected by economic and competitive conditions.
• 2003 premiums for this segment included a $3.8 million premium reduction related to an experience rated reinsurance agreement, entered into in 2002, covering policies related to the Minnesota Life Insurance Company (“Minnesota Life”) block of business assumed in October 2000. Our experience for policies covered by the agreement was more favorable than anticipated for the policy year ended June 30, 2003, and we received refunds of reinsurance premiums. Prospectively, compared to 2003 premiums, we expect that the agreement will result in a reduction to premiums of approximately $9 million annually. Overall, the annual expected effect of the reinsurance agreement is a $1 million reduction to income before income taxes.
Premium growth in our Retirement Plans segment was $4.3 million, or 22.6% for 2003 compared to 2002. Premiums for this segment include plan administration fees, fees based on average market values of assets under management, and premiums for life contingent annuities sold, which can vary significantly from year to year.
• The portfolio yield for fixed maturity securities decreased to 5.94% in 2003, from 6.22% in 2002 and 6.79% in 2001. The portfolio yield for commercial mortgage loans decreased to 7.28% in 2003, from 7.94% in 2002 and 8.22% in 2001. The decreases in our portfolio yields are consistent with changes in the overall interest rate environment for the same periods.
Three primary factors drive benefits to policyholders: premium growth (reserves are established in part based on premium levels), claims experience, and the assumptions used to establish related reserves. The predominant factors affecting claims experience are incidence (number of claims) and duration (length of time a disability claim is paid). The assumptions used to establish the related reserves include these factors as well as new investment interest rates, which affect the discount rate used to establish reserves. Please refer to our discussion of how we establish reserves under the heading “Critical Accounting Policies and Estimates.”
2001. The factors causing net increases in the Employee Benefits segment were:
• Claims experience (mortality and morbidity) was favorable compared to our expectations for 2003, 2002, and 2001. See “Business Segments.”
The following table sets forth operating expenses by segment for the years ended December 31:
• Operating expenses for 2003 and 2002 included transitional administrative fees related to the TIAA block of business totaling $8.1 million and $10.5 million, respectively. We concluded the transition during the second quarter of 2003 and anticipate no further transitional administrative fees for this agreement.
Managing levels of operating expenses is important to maintaining competitive pricing. We measure expenses on a segment level against the most relevant operating measure. In the Employee Benefits segment, the measure is against premiums. In the Individual Insurance segment, the measure is against total revenues. In the Retirement Plans segment, the measure is against assets under management.
The following table sets forth relevant operating expense ratios by segment for the years ended December 31:
management. Because our cost structure for this segment is heavily weighted toward fixed costs, we expect the operating expense ratio to decline as assets under management increase.
The following table sets forth income statement activity for DAC and VOBA for the years ended December 31:
Deferrals and amortization for all years presented have been affected by the businesses assumed from TIAA and Minnesota Life. See “Business Segments-Employee Benefits Segment” and “Business Segments-Individual Insurance Segment.”
Employee Benefits is our largest segment and substantially influences our consolidated financial results. See “Consolidated Results of Operations.”
The following table sets forth the financial results for the Employee Benefits segment for the years ended December 31:
Prior to 2002, it had been our practice to maintain a 50 to 75 basis point margin between our average new money investment rate for a quarter and the discount rate used to establish new long term disability reserves over a 12 month period. Given the current low interest rate environment, and correspondingly lower reinvestment risk, our targeted margin range for newly incurred claims is approximately 30 basis points over a 12 month period as long as the earned rate on new investments is less than 6%.
Looking to 2004 for this segment, we have been experiencing favorable and sustained claims recovery patterns in our group disability insurance. If these recovery patterns continue at their current levels, we estimate that in 2004 a favorable impact on pre-tax income of up to $12 million may result. As a result, we are adjusting our expected benefit ratio for the Employee Benefits segment moving forward to a range of 81% to 83% (previously our expected range was 82% to 84%).
The Individual Insurance segment sells disability insurance and fixed-rate annuities, including life contingent annuities, to individuals.
Most of the deposits on our annuity business are not recorded as premiums. Annuity premiums consist of premiums on life contingent annuities, which are a small portion of sales. Annuity deposits are recorded as a liability and therefore not reflected as premiums. Annuity deposits earn investment income, a portion of which is credited to the policyholders.
(1) Pre-tax charges of $0.7 million incurred as a result of the terrorist events of September 11, 2001 were excluded from the computation of the benefit ratio for 2001.
The benefit ratio for the Individual Insurance segment (the ratio of policyholder benefits to premiums) was 87.8%, 99.8%, and 104.5% for 2003, 2002 and 2001, respectively. In 2003 and 2002, we had both favorable claims incidence and duration. Each year we reset the expected benefit ratio range for this segment to reflect the growth in the segment outside of the large block of business we assumed in 2000 from Minnesota Life, and the corresponding change in revenues from net investment income to premiums. Accordingly, we have lowered our expected benefit ratio range for 2004 to 80% to 95%, but we expect the volatility in this ratio to continue, especially when measured on a quarterly basis. In this segment, a lower benefit ratio does not necessarily indicate an increase in profitability, rather a change in the mix of revenues from the business.
The following table sets forth the financial results for the Retirement Plans segment for the years ended December 31:
Following are key indicators that management uses to manage and assess the performance of the Retirement Plans segment:
For a discussion of premiums and assets under management, see “Consolidated Results of Operations.” With the higher level of invested assets and modest future expense increases, we expect to see continued consistent profitability for this segment.
Interest credited as a percentage of net investment income declined in 2003, compared to 2002 and 2001. The change in interest credited correlates with the change in interest rates on invested assets.
Other businesses include StanCorp Mortgage Investors, which contributed income before income taxes of $11.2 million, $7.7 million, and $6.6 million for 2003, 2002, and 2001, respectively, before intercompany eliminations. Supporting both internal and external investor demand, StanCorp Mortgage Investors originated a record $930.6 million of commercial mortgage loans in 2003, a 63.0% increase over 2002. StanCorp Mortgage Investors managed $677.1 million for other investors as of December 31, 2003. We have specialized expertise in the origination and servicing of small commercial mortgage loans and have generated growth in commercial mortgage loan originations in recent years.
It is management’s objective to generally align the cash flow characteristics of assets and liabilities to ensure that the Company’s financial obligations can be met under a wide variety of economic conditions. In meeting the objectives, management may choose to liquidate certain investments and reinvest in alternate investments to better match the cash flow characteristics of assets to liabilities. See “-Investing Cash Flows.”
The Company’s financial instruments are exposed to financial market volatility and potential disruptions in the market that may result in certain financial instruments becoming less valuable. Financial market volatility includes interest rate risk. In accordance with Item 305 of Regulation S-K of the Securities and Exchange Commission (“SEC”), the Company has analyzed the estimated loss in fair value of certain market sensitive financial assets held at December 31, 2003 and 2002, given a hypothetical 10% increase in interest rates, and related qualitative information on how the Company manages interest rate risk. The interest rate sensitivity analysis was based upon the Company’s fixed maturity securities and commercial mortgage loans held at December 31, 2003 and 2002. Interest rate sensitivity of the Company’s financial assets was measured assuming a parallel shift in interest rates. All security yields were increased by 10% of the year end 10-year U.S. Government Treasury bond yield, or 0.42% for the 2003 analysis and 0.40% for the 2002 analysis. The change in fair value of each security was estimated as the change in the option adjusted value of each security. Option adjusted values were computed using company payment models and provisions for the effects of possible future changes in interest rates. The analyses did not explicitly provide for the possibility of non-parallel shifts in the yield curve, which would involve discount rates for different maturities being increased by different amounts. The actual change in fair value of the Company’s financial assets can be significantly different from that estimated by the model. The hypothetical reduction in the fair value of the Company’s financial assets that resulted from the model was estimated to be $154 million and $80 million at December 31, 2003 and 2002, respectively.
The insurance laws of the states of domicile and other states in which the insurance subsidiaries conduct business regulate the investment portfolios of the insurance subsidiaries. Relevant laws and regulations generally limit investments to bonds and other fixed maturity securities, mortgage loans, common and preferred stock, and real estate. Decisions to acquire and dispose of investments are made in accordance with guidelines adopted and modified from time to time by the insurance subsidiaries’ boards of directors. The Company does not currently use derivatives, such as interest rate swaps, currency swaps, futures, or options, to manage interest rate risk or for speculative purposes, but may use such instruments to manage interest rate risk in the future. Each investment transaction requires the approval of one or more members of senior investment staff, with increasingly higher approval authorities required for transactions that are more significant. Transactions are reported quarterly to the finance and operations committee of the board of directors for Standard and to the audit committee of the board of directors for The Standard Life Insurance Company of New York.
Net cash used in investing activities was $743.6 million, $637.9 million, and $649.9 million for 2003, 2002, and 2001, respectively. Net cash used in investing activities in 2003 and 2002 included commercial mortgage loan originations of $930.6 million and $570.8 million, respectively. We target our investment portfolio to be approximately 60% fixed maturity securities and 40% commercial mortgage loans. At December 31, 2003, our portfolio consisted of 66% fixed maturity securities and 34% commercial mortgage loans. Depending on interest rate trends, we anticipate that the substantial refinancing activity that occurred in 2003 will slow in 2004 and we will be able to achieve a year end investment portfolio ratio of approximately 62% fixed maturity securities and 38% commercial mortgage loans, and return to our target levels in following years. Net cash used in investing activities for 2002 included investments in fixed maturity securities related to proceeds from the TIAA business and approximately $200 million in proceeds received from the initial public debt offering.
At December 31, 2003, our fixed maturity securities portfolio had gross unrealized capital gains of $264.2 million and gross unrealized capital losses of $9.8 million. Unrealized losses can be indicative of impairment concerns, or can simply reflect the acquisition of fixed maturity securities at interest rates lower than those currently available.
Commercial mortgage loans in California account for 37.0% of our commercial mortgage loan portfolio at December 31, 2003. Due to this concentration, we are exposed to potential losses resulting from the risk of an economic downturn in California as well as to certain catastrophes, such as earthquakes, that may affect the region. Although we diversify our commercial mortgage loan portfolio within California by both location and type of property in an effort to reduce earthquake exposure, such diversification may not eliminate the risk of such losses. We do not require earthquake insurance for properties on which we make commer -
Under the laws of certain states, contamination of a property may give rise to a lien on the property to secure recovery of the costs of cleanup. In some states, such a lien has priority over the lien of an existing mortgage against such property. As a commercial mortgage lender, we customarily conduct environmental assessments prior to making commercial mortgage loans secured by real estate and before taking title through foreclosure on real estate collateralizing delinquent commercial mortgage loans held by us. Based on our environmental assessments, we believe that any compliance costs associated with environmental laws and regulations or any remediation of affected properties would not have a material adverse effect on the Company’s business, financial position, results of operations or cash flows. However, we cannot provide assurance that material compliance costs will not be incurred by us, which could have a material adverse effect on the Company’s business, financial position, results of operations or cash flows.
Financing cash flows consist primarily of policyholder fund deposits and withdrawals, borrowings and repayments on the line of credit, borrowings and repayments on long-term debt, repurchase of common stock, and dividends paid on common stock. Net cash provided by financing activities was $233.9 million for 2003, compared to $252.0 million for 2002. Policyholder fund deposits net of withdrawals increased in 2003, primarily due to higher individual annuity sales in the Individual Insurance segment and higher deposits into the Retirement Plans segment general account assets, both of which reflected increased consumer interest in fixed-income investments during that time period. Net cash provided by financing activities in 2002 included our initial public debt offering and repayment of our line of credit.
StanCorp filed a $1.0 billion shelf registration statement with the SEC, which became effective on July 23, 2002, registering common stock, preferred stock, debt securities, and warrants. On September 25, 2002, we completed an initial public debt offering of $250.0 million of 6.875%, 10-year senior notes, pursuant to the shelf registration statement. The principal amount of the senior notes is payable at maturity and interest is payable semi-annually in April and October. Approximately $200 million was used to support payment of the $75 million ceding commission to TIAA to assume the block of business and to maintain Standard’s
RBC ratio at our targeted level. The remaining proceeds were used to pay our annual dividend to shareholders, to fund a modest level of share repurchases and for general corporate purposes.
Our target is generally to maintain capital at 265% to 275% of the company action level RBC, the minimum required by state regulators to avoid remedial action by our insurance subsidiaries (this equates to 530% to 550% of the authorized control level RBC by our states of domicile), plus an amount approximating 5% of consolidated equity excluding accumulated other comprehensive income. At December 31, 2003, our statutory capital (adjusted to exclude asset valuation reserves) was $924.9 million, or 319% of the company action level RBC (which equates to 638% of the authorized control level RBC by our states of domicile). The primary reason we maintain capital above targeted levels is to provide timing flexibility should we wish to access capital markets to finance growth or acquisitions. Recently, with premium growth at levels lower than our long-term objective, our excess capital has accumulated beyond the targeted excess level by approximately $50 million as of December 31, 2003 after funding interest payments, holding company operating expenses and our historical annual shareholder dividend.
StanCorp’s ability to pay dividends to its shareholders, repurchase its shares, and meet its obligations substantially depends upon the receipt of distributions from its subsidiaries, including Standard. Standard’s ability to pay dividends to StanCorp is affected by factors deemed relevant by Standard’s board of directors, including the ability to maintain adequate capital according to Oregon law. See “-Risk-Based Capital” above. Under Oregon law, Standard may pay dividends only from the earned surplus arising from its business. It also must receive the prior approval of the Director of the Oregon Department of Consumer and Business Services (the “Oregon Department”) to pay a dividend if such dividend exceeds certain statutory limitations. The current statutory limitations are the greater of (a) 10% of Standard’s combined capital and surplus as of December 31st 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 twelve-month period ended on the December 31st last preceding. In each case, the limitation must be determined under statutory accounting practices. Oregon law gives the Oregon Department broad discretion to disapprove requests for dividends in excess of these limits.
In August 2003, Standard made an extraordinary distribution to StanCorp of $200 million from its paid-in capital and contributed surplus. Concurrently, Standard borrowed the distributed amount from StanCorp and issued a $200 million subordinated surplus note. Both transactions eliminate in consolidation. The extraordinary distribution is a reduction of the paid-in capital that was recorded in con -
Congress passed a tax cut in May 2003 reducing the tax rate applicable to dividends received by individual taxpayers to 15% through 2008. With dividends received by individual taxpayers now taxed at the same rate as long term capital gains, dividends and share repurchases are equally advantageous to individuals, where previously share repurchases were more advantageous as a method of providing a return to individual shareholders. On November 3, 2003, the board of directors of StanCorp declared an annual dividend of $0.70 per share of common stock. The dividend was paid on December 5, 2003, to shareholders of record at the close of business on November 14, 2003. The dividend represented a 75% increase over the annual dividend of $0.40 paid per share of common stock in 2002. On November 4, 2002, the board of directors of StanCorp declared an annual dividend of $0.40 per share of common stock. The dividend was paid on December 6, 2002 to shareholders of record on November 15, 2002. The dividend represented a 33% increase from total dividends paid in 2001. The declaration and payment of dividends in the future is subject to the discretion of StanCorp’s board of directors and it is anticipated that annual dividends will be paid in December of each year depending on StanCorp’s financial condition, results of operations, cash requirements, future prospects, regulatory restrictions on distributions from the insurance subsidiaries, the ability of the insurance subsidiaries to maintain adequate capital, and other factors deemed relevant by StanCorp’s board of directors.
Financial strength ratings, which rate claims paying ability, are an important factor in establishing the competitive position of insurance companies. Ratings are important in maintaining public confidence in our company and in our ability to market our products. Rating organizations continually review the financial performance and condition of insurance companies, including our company. In addition, our debt ratings on our senior notes are tied to our financial strength ratings. A ratings downgrade could increase our surrender levels, adversely affect our ability to market our products, and also could increase future debt costs. Financial strength ratings are based primarily on statutory financial information. Standard & Poor’s, Moody’s Investors Service, Inc., Fitch, Inc., and A.M. Best Company provide assessments of our overall financial position.
In January 2003, the Financial Accounting Standards Board (“FASB”) released Interpretation No. 46, Consolidation of Variable Interest Entities (“FIN 46”) which requires that all primary beneficiaries of Variable Interest Entities (“VIE”) consolidate those entities. FIN 46 is effective immediately for VIEs created after January 31, 2003 and to VIEs in which an enterprise obtains an interest after that date. It applies in the first fiscal year or interim period beginning after December 15, 2003 to VIEs in which an enterprise holds a variable interest it acquired before February 1, 2003. In December 2003, the FASB published a revision to FIN 46 (“FIN 46R”) to clarify some of the provisions of the interpretation and to defer the effective date of implementation for certain entities. Under the guidance of FIN 46R, entities that do not have interests in structures that are commonly referred to as special purpose entities are required to apply the provisions of the interpretation in financial statements for periods ending after March 15, 2004. We do not have interests in special purpose entities.
quantitative and qualitative disclosures for securities accounted for under FASB Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities, that are impaired at the balance sheet date but for which an other-than-temporary impairment has not been recognized. This EITF is effective for financial statements for fiscal years ending after December 15, 2003. Effective December 31, 2003, the required disclosures are included in the notes to consolidated financial statements.
The Company’s long-term debt obligations consist primarily of the $250.0 million 6.875%, 10-year senior notes pursuant to the shelf registration statement. Interest payable related to the total long-term obligations totals $161.9 million for the periods shown in the table. The operating lease obligations include leases on certain buildings and equipment under non-cancelable operating leases, software maintenance, licensing, and telecommunication commitments, all expiring in various years through 2010 with renewal options ranging from one to five years.
Other long-term liabilities reflected in the Company’s balance sheet at December 31, 2003 consisted of an $11.5 million tax reimbursement liability related to the block of life insurance business sold to Protective Life Insurance Company in 2001, $17.4 million in liabilities for deferred compensation and supplemental retirement plans, $9.3 million in capital commitments related to our joint venture businesses, and $0.9 million accrued guarantee association payments.
Also included in the other long-term liabilities is $0.8 million that the Company expects to contribute to its postretirement plan in 2004 and the accumulated postretirement benefit obligation totaling $27.5 million at the end of the year, partially funded by plan assets giving us a net liability of $11.8 million reflected in our balance sheet. The projected discounted cash flow obligation for the postretirement plan at December 31, 2003 was $47.3 million.
• year of issue for policy reserves or incurred date for claim reserves;
Certain of these factors could be materially affected by changes in social perceptions about work ethics, emerging medical perceptions and legal interpretations regarding physiological or psychological causes of disability, emerging or changing health issues and changes in industry regu -
lation. If there are changes in one or more of these factors or if actual claims experience is materially inconsistent with our assumptions, we could be required to change our reserves.
Certain costs related to obtaining new business and acquiring business through reinsurance agreements have been deferred 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, which is significantly affected by premium renewal assumptions. These estimates are modified to reflect actual experience when appropriate. If actual persistency, withdrawals, interest rates, or profitability are inconsistent with our assumptions, we could be required to make adjustments to DAC and related amortization.
Deferred acquisition costs for group disability and group life insurance products are amortized in proportion to future premiums generally over five years. DAC for individual disability insurance products are 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. DAC for individual deferred annuities are amortized in proportion to expected gross profits generally over 30 years with approximately 50% to 90% expected to be amortized by years 5 and 15, respectively. DAC for group annuity products are amortized in proportion to expected gross profits over 10 years with approximately 25% expected to be amortized by year five.
• the impact of rising medical costs on employer budgets for employee benefits;
• declines in asset credit quality and increases in delinquencies on fixed maturity securities and commercial mortgage loans;
• environmental liability exposure resulting from commercial mortgage loan and real estate investments;
• ability to attract and retain employee sales representatives and managers;
Given these uncertainties or circumstances, you should not place undue reliance on these forward-looking statements. Except to the extent required by the federal securities laws, we undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of StanCorp Financial Group, Inc. and subsidiaries as of December 31, 2003 and 2002, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States of America.
As discussed in Note 1 to the consolidated financial statements, effective January 1, 2003, the Company changed its method of accounting for stock-based compensation to conform to Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation.
We were incorporated under the laws of Oregon as a parent holding company in 1998 and completed our initial public offering of common stock on April 21, 1999. We conduct business through our subsidiaries, including Standard Insurance Company (“Standard”); The Standard Life Insurance Company of New York; StanCorp Mortgage Investors, LLC (“StanCorp Mortgage Investors”); and StanCorp Investment Advisers, Inc. We are headquartered in Portland, Oregon and through our subsidiaries have the authority to underwrite insurance products in all 50 states.
Cash equivalents include investments purchased with original maturities at the time of acquisition of three or fewer months.
Certain costs related to obtaining new business and acquiring business through reinsurance agreements have been deferred 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, which is significantly affected by premium renewal assumptions. These estimates are modified to reflect actual experience when appropriate. If actual persistency, withdrawals, interest rates, or profitability are inconsistent with our assumptions, we could be required to make adjustments to DAC and related amortization. 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. DAC totaled $100.0 million and $75.8 million at December 31, 2003 and 2002, respectively.
The estimated net amortization of VOBA and the related intangible for each of the next five years is as follows:
Property and equipment are stated at cost less accumulated depreciation. The Company provides for depreciation of property and equipment using the half year straight-line method over the estimated useful lives, which are generally 40 years for properties, and from three to ten years for equipment. Leasehold improvements are amortized over the estimated useful life of the asset, not to exceed the life of the lease. Depreciation expense for 2003, 2002, and 2001 was $12.1 million, $11.6 million and $9.0 million, re -
For most of our product lines, we establish and carry as a liability actuarially determined reserves that are calculated to meet our obligations for future policy benefits and claims. These reserves do not represent an exact calculation of our future benefit liabilities, but are instead estimates based on assumptions concerning a number of factors, including: the amount of premiums on existing business that we will receive in the future; the rate of return on assets we purchase with premiums received; expected number and duration of claims; expenses; and persistency, which is the measurement of the percentage of premiums remaining in force from year to year. In particular, our group and individual long term disability reserves are sensitive to assumptions regarding the following factors: claim incidence rates; claim termination rates; discount rates used to value expected future claim payments and premiums; persistency rates; the amount of the monthly benefit paid to the insured (less claim amounts recovered from reinsurers); expense rates, including inflation; historical delay in reporting of claims incurred; age and gender of the claimant, and for individual policies, occupation class of the claimant; year of issue for policy reserves or incurred date for claim reserves; time elapsed since disablement; and contract provisions and limitations.
Premiums from group life, group and individual disability, and traditional life insurance contracts are recognized as revenue when due. Benefits and expenses are matched with recognized premiums to result in recognition of profits over the life of the contracts. The match is accomplished by recording a provision for future policy benefits and unpaid claims and claim adjustment expenses and by setting up and amortizing DAC. Investment-type contract premiums and other policy fee revenues consist of charges for policy administration and surrender charges assessed during the period. Charges related to services to be performed are deferred until earned. The amounts received in excess of premiums and fees are included in other policyholder funds in the consolidated balance sheets. Experience rated refunds (“ERRs”) are computed in accordance with the terms of the contracts with certain group policyholders and are accounted for as an adjustment to premiums.
Other comprehensive income consists of the current increase or decrease in unrealized capital gains and losses on investment securities available-for-sale, net of the related tax effects. The following table sets forth unrealized capital gains and losses and adjustments for realized capital gains and losses at December 31:
For purposes of determining the pro forma expense, the fair value of each option was estimated using the Black-Scholes option pricing model as of the grant date, with the following assumptions for the years ended December 31:
In January 2003, the Financial Accounting Standards Board (“FASB”) released Interpretation No. 46, Consolidation of Variable Interest Entities (“FIN 46”) which requires that all primary beneficiaries of Variable Interest Entities (“VIE”) consolidate that entity. FIN 46 is effective immediately for VIEs created after January 31, 2003 and to VIEs in which an enterprise obtains an interest after that date. It applies in the first fiscal year or interim period beginning after December 15, 2003 to VIEs in which an enterprise holds a variable interest it acquired before February 1, 2003. In December 2003, the FASB published a revision to FIN 46 (“FIN 46R”) to clarify some of the provisions of the interpretation and to defer the effective date of implementation for certain entities. Under the guidance of FIN 46R, entities that do not have interests in structures that are commonly referred to as special purpose entities are required to apply the provisions of the interpretation in financial statements for periods ending after March 15, 2004. We do not have interests in special purpose entities.
We have a 50% interest in a real estate joint venture. During 2003, we fully guaranteed the existing debt of the entity, and therefore, effective December 31, 2003, we consolidated the entity. The increase to our reported assets and liabilities was approximately $18.0 million for this entity that previously did not meet consolidation criteria. Certain subsidiaries of StanCorp have interests in real estate low income housing partnerships that were established in previous years. Individually, the interests in these subsidiaries do not represent a significant subsidiary pursuant to the definition in FIN 46, nor do they meet the requirements for consolidation. The total equity investment in these interests approximated $15 million at December 31, 2003.
The fair values of investment securities were based on quoted market prices, where available, or on values obtained from independent pricing services. The fair values of commercial mortgage loans were estimated using option adjusted valuation discount rates. The carrying values of policy loans approximate fair values. While potentially financial instruments, policy loans are an integral component of the insurance contract and have no maturity date.
The following table sets forth amortized cost and estimated fair values of investment securities available-for-sale at December 31:
Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations. Callable bonds represent 1.85%, or $83.7 million, of our fixed maturity securities.
The following table sets forth capital gains (losses) for the years ended December 31:
Securities deposited for the benefit of policyholders in various states, in accordance with state regulations, amounted to $6.3 million and $5.1 million at December 31, 2003 and 2002, respectively.
The Company underwrites commercial mortgage loans and requires collateral on either a partial or full recourse basis. Although the Company underwrites commercial mortgage loans throughout the United States, commercial mortgage loans in California represent a concentration of credit risk. The following table sets forth the geographic concentration of commercial mortgage loans at December 31:
The following table sets forth commercial mortgage loan valuation and allowance provisions for the years ended December 31:
The liability for unpaid claim includes claims adjustment expenses, and other policyholder funds include liabilities for insurance offered on products such as group long term and short term disability, individual disability, group dental, and group AD&D. The liability for unpaid claims and claim adjustment expenses is included in future policy benefits and claims in the consolidated balance sheets. The following table sets forth the change in the liabilities for unpaid claims and claim adjustment expenses for the years ended December 31:
(1) Effective October 1, 2002, Standard entered into a reinsurance agreement with TIAA.
Other policyholder funds at December 31, 2003 and 2002 included $818.1 million and $710.5 million, respectively, of employer-sponsored defined contribution and benefit plans deposits, and $776.5 million and $655.5 million, respectively, of individual deferred annuity deposits.
The difference between taxes calculated as if the statutory federal tax rate of 35% was applied to income before income taxes and the recorded tax expense is reconciled as follows:
The Company uses a December 31 measurement date for all plans. The following table provides a reconciliation of the changes in the pension plans’ projected benefit obligations, fair value of assets and the funded status for the years ended December 31:
The investment goal of the Home Office 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 rebalanced as necessary to keep the allocation within tolerance levels of the target allocation. The portfolio is diversified across a number of equity asset categories and stable value assets. The investment goal of the Field Personnel Pension Plan is to invest in stable value assets in order to maintain its funded status.
The long run rate of return for the Home Office Pension Plan portfolio is derived by calculating the average return for the portfolio monthly, from 1971 to the present, using the average mutual fund manager returns in each asset category, weighted by the target allocation to each category. Because the average equity market value returns over the last 30 years generally have been higher than the long run expected rate of return, the historical average return used to determine the expected return on plan assets was reduced by 20%.
Equity securities of the Home Office Pension Plan portfolio were $67.0 million and $45.5 million at December 31, 2003 and 2002, respectively. The plan held no StanCorp securities as plan assets at December 31, 2003 and 2002.
The Company does not anticipate that it will be required to contribute to its defined benefit pension plans in 2004.
Eligible executive officers are covered by a non-qualified supplemental retirement plan, which is currently unfunded. The accrued benefit cost was $9.2 million and $8.2 million at December 31, 2003 and 2002, respectively. Expenses, including the company match related to the non-qualified supplemental retirement plan were $1.4 million, $1.5 million and $1.4 million in 2003, 2002, and 2001, respectively.
For the postretirement benefit plan, the assumed health care cost trend rates were as follows for the years ended December 31:
The Company expects to make contributions of $0.8 million to its postretirement benefit plan in 2004.
The following tables set forth option activity under the stock-based compensation plan for the years ended December 31:
The weighted-average grant date fair value of option awards in 2003, 2002, and 2001 was $18.28, $21.14, and $20.95, respectively.
Also during 2003, 19,000 retention shares were granted. These shares had a grant date fair value of $48.81.
Standard is involved in a reinsurance and third-party administration arrangement with The Northwestern Mutual Life Insurance Company (“Northwestern Mutual”) under which 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. Premiums assumed by Standard for the Northwestern Mutual business accounted for 3.5%, 3.6%, and 3.9% of the Company’s total premiums in 2003, 2002, and 2001, respectively. In addition to assuming reinsurance risk, Standard provides product design, pricing, state regulatory filings, underwriting, legal support, claims management and other administrative services under the arrangement. 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, 2003 was $181.8 million.
During 2002, Standard formed a strategic marketing alliance with Ameritas Life Insurance Corp. (“Ameritas”) that offers Standard’s policyholders new and 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 that provides for approximately 15% of the net dental premiums written by Standard to be ceded to Ameritas.
Recoveries recognized under reinsurance agreements were $50.3 million, $42.4 million and $34.9 million for 2003, 2002, and 2001, respectively. Amounts recoverable from reinsurers were $871.9 million and $873.9 million at December 31, 2003 and 2002, respectively. Of these amounts, $777.5 million and $809.3 million were from the reinsurance transaction with Protective Life Insurance Company (“Protective Life”) effective January 1, 2001. See “-Note 14, Reinsurance of Blocks of Business.”
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. 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, 2003 was approximately $726 million. Approximately $60 million in VOBA was capitalized related to the reinsurance agreement.
DAC and related amortization include VOBA. Other operating expenses include operating expenses, commissions and bonuses, and the net increase in DAC.
Standard and The Standard Life Insurance Company of New York prepare their statutory financial statements in accordance with accounting practices prescribed or permitted by their states of domicile. Prescribed statutory accounting practices include state laws, regulations, and general administrative rules, as well as the Statements of Statutory Accounting Practices (“SSAP”), set forth in publications of the National Association of Insurance Commissioners (“NAIC”).
In March 1998, the NAIC adopted the Codification of Statutory Accounting Principles (“Codification”), which became effective January 1, 2001. Codification standardized regulatory accounting and reporting among state insurance departments. However, statutory accounting principles also will continue to be established by individual state laws and permitted practices. The Company’s adoption of Codification increased statutory capital and surplus as of January 1, 2001 by approximately $6.1 million. As of January 1, 2003, an additional increase of $6.2 million in surplus was reported in accordance with SSAP 37 to release the unamortized mortgage prepayment penalties included in the Interest Maintenance Reserves (“IMR”). Beginning in 2003, mortgage prepayment penalties are reported as investment income instead of realized capital gains, which are subject to the IMR amortization. The effect of this accounting change on 2003 statutory net income was an increase of $5.8 million.
Statutory accounting practices differ in some respects from GAAP. The principal statutory practices which differ
The following table reconciles the statutory capital and surplus of the insurance subsidiaries as reported to state insurance regulatory authorities with the Company’s GAAP equity at December 31:
In the normal course of business, the Company is involved in various legal actions and other state and federal proceedings. A number of actions or proceedings were pending as of December 31, 2003. In some instances, lawsuits include claims for punitive damages and similar types of relief in unspecified or substantial amounts, in addition to amounts for alleged contractual liability or other compensatory damages. In the opinion of management, the ultimate liability, if any, arising from the actions or proceedings is not expected to have a material adverse effect on the Company’s business, financial position, results of operations or cash flows.
The Company leases certain buildings and equipment under non-cancelable capital and operating leases that expire in various years through 2011, with renewal options for periods ranging from one to five years. Future minimum payments under the leases are 2004, $12.8 million; 2005, $11.5 million; 2006, $8.9 million; 2007, $7.0 million; 2008, $5.8 million and thereafter, $4.3 million. Total rent expense was $12.2 million, $13.9 million and $12.0 million for the years ended December 31, 2003, 2002, and 2001, respectively. At December 31, 2003, minimum future rental receivables on non-cancelable leases with initial terms of one year or more were 2004, $11.7 million; 2005, $10.2 million; 2006, $8.8 million; 2007, $8.1 million; 2008, $6.5 million and thereafter, $13.6 million.
The Company’s long-term debt obligations consist primarily of the $250.0 million 6.875%, 10-year senior notes pursuant to the shelf registration statement. Total interest payable related to the total long-term obligations amount to $161.9 million. The operating lease obligations include leases on certain buildings and equipment under non-cancelable operating leases, software maintenance, licensing, and telecommunication commitments, all expiring in
During 2002, we repurchased 852,999 shares of common stock, at a total cost of $45.5 million, for a volume weighted-average price of $53.34 per common share. Currently, 1.5 million shares are authorized under a share repurchase program approved by the board of directors on February 9, 2004. The program expires December 31, 2005.