The Company's principal operations are conducted from a leased property consisting of approximately 164,000 square feet of space located at 7887 East Belleview Avenue, Englewood, Colorado, 80111. The Company leases the space from an affiliate of the Prior Owner pursuant to a lease that expires in July, 2016. The Company paid rental expenses under the lease during 1995 of $1.4 million. The Company previously operated from a leased property consisting of approximately 11,500 square feet of space located at 200 Crescent Court, Suite 1650, Dallas, Texas, 75201. In the fourth quarter of 1994, the investment operations of the Company were relocated to Englewood, Colorado and the lease was subsequently terminated in the first quarter of 1995. The Company incurred rental and operating expense payments under the Dallas lease of $78,337 and $207,000 during 1995 and 1994, respectively. The Company's leased space in Denver and Dallas is sufficient to meet its currently anticipated needs.
With the acquisition of Lamar Life in 1995, the Company also acquired Lamar Life's home office building located at 317 E. Capitol, Jackson, Mississippi, 39201. This property contains approximately 88,279 square feet of space. Lamar Life's group accident and health processing facilities remain at the Jackson location, with approximately 15% of the total square footage under lease to non-affiliates.
- ------------------------ (1) Data as of and for the year ended December 31, 1995, includes the operations and financial position of the Lamar companies for the period subsequent to the Lamar acquisition on April 28, 1995. See Notes 1 and 2 of Notes to Consolidated Financial Statements.
(4) Operating margin consists of operating earnings (losses) excluding income taxes, minority interest, interest expense, amortization of goodwill, realized gains (losses) and related amortization divided by total revenues excluding the effects of realized gains (losses).
(5) Annualized premiums on new life insurance sales represents the total recurring annual premium on a new life insurance contract on which the Company has collected the first modal premium payment. Gross amounts reflect the total annualized premium for all policies on which premiums were received and accepted by the Company, and net amounts are reduced by annualized premiums on policies which, subsequent to issuance by the Company, were surrendered by policyholders within the initial grace period.
The Company sells a diverse portfolio of universal life and, to a lesser extent, annuity products. Premiums shown on the Company's consolidated financial statements in accordance with GAAP consist of premiums received for whole life or term life insurance products, as well as that portion of the Company's annuity products which have life contingencies. In connection with that portion of single premium annuity contracts without life contingencies, as well as single and flexible premium deferred annuities and universal life insurance, premiums collected by the Company are not reported as premium revenues, but rather are reported as deposit liabilities. With respect to these products, revenues are recognized over time in the form of investment income on invested funds, surrender charges and mortality and other charges deducted from the policyholders' account balance.
Certain costs related to the acquisition of new business are defined as "deferred policy acquisition costs" and are amortized in proportion to the recognition of earnings from the business. Costs deferred include principally commissions, and to a lesser degree, certain expenses of the policy issue and underwriting departments, and certain variable sales expenses. Under certain circumstances, deferred policy acquisition costs will be expensed earlier than originally estimated, including those circumstances where actual mortality experience is higher than actuarially expected and where interest spreads (the difference between interest credited to universal life and annuity fund balances, and related investment yields on assets) are below initial estimates.
The Company has aggressively pursued its strategy of enhancing revenue growth and profitability since the acquisition of its life insurance subsidiaries in March 1990 through: (i) the increase in sales by its existing independent agency force; (ii) the recruitment of additional highly motivated experienced agents; (iii) the reduction and control of costs; and (iv) the acquisition of life insurance subsidiaries with consistent or complementary products and distribution systems.
The following table sets forth the results of operations of the Company:
Universal life charges ceded to client companies consist of monthly mortality charges and administrative fees which are ceded to entities in the Company's network of agent owned reinsurance companies and affiliated companies. The amount of such charges ceded increased 32.7% from $22.3 million in 1994 to $29.6 million in 1995. This increase is the result of added production in existing client companies and the merger of certain inactive client companies into existing active client companies during 1995.
Revenues from surrender charges represent fees assessed on terminating policies, net of surrender charges ceded to client companies. Such charges are consistent in 1995 with those in 1994. Increases or decreases in surrender charges are based on termination rates and the product mix of terminations. Surrender charges include $2.0 million of charges on Lamar Life policies.
Net investment income increased $51.7 million, or 22.9%, from $225.4 million in 1994 to $277.1 million in 1995. This change reflected an increase in the amount of invested assets, following the Lamar Life acquisition, which was partially offset by a lower effective yield on investments made during 1995. Average invested assets, excluding assets subject to reverse repurchase financing arrangements, were $3.8 billion during 1995, compared to $2.9 billion during 1994. The increase was due primarily to deposits on annuities and universal life policies and the Lamar Life acquisition. The effective yield on invested assets was 7.3% for the year ended December 31, 1995, compared to 7.7% for the year ended December 31, 1994.
The Company's realized gains (losses) changed from a net realized loss of $19.7 million in 1994 to a net realized gain of $15.8 million in 1995. Net realized losses in 1994 were primarily the result of
AMORTIZATION OF DEFERRED POLICY ACQUISITION COSTS, COST OF INSURANCE ACQUIRED, AND DEFERRED POLICY FEES
The Company's interest expense increased by approximately $7.2 million between the 1994 and 1995 periods. The 1995 expense includes $4.2 million relating to interest due or paid to the federal government on tax deficiencies from prior years and $0.5 million recorded as a one-time expense in purchase accounting upon the acquisition of Lamar. The above items notwithstanding, interest expense increased as a result of additional borrowings under the Company's senior credit facility. The Company borrowed $36 million in April of 1995 relating to the Lamar acquisition and borrowed an additional $14 million in December of 1995 to further improve the statutory capital and surplus of certain of its life insurance subsidiaries. Additional borrowings during 1995 were partially offset by scheduled quarterly principal payments on the senior loan totaling $15 million. Also, the Company's average borrowing rates (on which interest expense on the senior credit facility was based) increased from 6% during 1994 to 7% during 1995. Such rates float with LIBOR and can be fixed by the Company for periods of up to six months.
In general, the provision (benefit) for federal income taxes reflected in the Company's operating results is computed using the prevailing statutory corporate rate of 35% in 1995 and 1994, as adjusted primarily for the nondeductibility of certain items such as the amortization of goodwill. The 1995 provision also reflects the recognition of various tax contingencies based on ongoing examinations of prior tax years. The effective rate reflected in the Company's financial statements was approximately 20% for 1995, and 36% for 1994. See Note 12 of the Notes to Consolidated Financial Statements.
The Company's Consolidated Statements of Cash Flows reflect net cash used by operating activities of $56.6 million and $22.7 million for the years ended December 31, 1995 and 1994, respectively. Included in cash flows from financing activities are policyholder contract deposits and withdrawals which provided net cash flows of $196.9 million and $188.5 million for the years ended December 31, 1995 and 1994, respectively. The deposits and withdrawals are reported as financing activities pursuant to applicable financial reporting rules; however, the Company considers charges for mortality and administration, net of interest credited, as assessed against policyholder deposits, to be basic to the Company's core insurance operations.
Revenues from surrender charges represent fees assessed on terminating policies, net of surrender charges ceded to client companies. Such charges are consistent in 1994 with those in 1993. Increases or decreases in surrender charges are based on termination rates and the product mix of terminations.
Reinsurance premiums ceded represent coinsured traditional premiums as well as yearly renewal term reinsurance premiums on traditional and universal life policies for risks in excess of the Company's maximum retention. The Company does not retain the mortality risk for any policy to the extent the risk exceeds the Company's stated retention, which ranged in 1994 from $350,000 to $500,000. The reinsurance premiums increased by 2.2% from $27.5 million in 1993 to $28.1 million in 1994.
The Company's realized gains (losses) decreased from a net realized gain of $18.4 million in 1993 to a net realized loss of $19.7 million in 1994. Realized gains were strong in 1993 principally due to the
declining interest rate environment which produced increases in the market values of the Company's fixed maturity portfolio. The Company sold certain appreciated investments, primarily consisting of investment grade fixed maturities during 1993, which resulted in gains which were partially offset by realized losses of $54.5 million in 1993 related to other than temporary declines in the market value of certain debt securities. A substantial portion of the Company's realized gains in 1993 related to insurance business issued after Life Partners completed the Acquisition. Net realized losses in 1994 were primarily the result of sales of certain fixed income securities during a period of rising market interest rates, write-downs of $7.1 million related to other than temporary declines in the market value of certain invested assets, and $6.8 million of other realized losses. In accordance with applicable financial reporting rules, the net amortization of deferred policy acquisition costs and deferred policy fees was accelerated by $12,000 during 1994 and $4,700,000 during 1993 in conjunction with the recognition of these gains (losses).
Total policyholder benefits increased $8.7 million, or 8.5%, from $102.2 million in 1993 to $110.9 million in 1994, due primarily to an increase in death benefits, which occurred as a result of the growth in the Company's universal life in-force block of business. The Company's mortality experience was lower than actuarially expected in 1993, while mortality experience was consistent with that expected in 1994.
Other operating expenses consist of general, administrative, and other operating costs. These costs were $51.9 million in 1993 and $52.7 million in 1994. Included in the 1994 amount are one-time charges of $2.4 million related to guarantee fund assessments and $3.5 million related to litigation provisions.
Amortization of deferred policy acquisition costs, cost of insurance acquired and deferred policy fees decreased 11.2% between 1993 and 1994 from $52.0 million to $46.2 million. The amortization related to realized gains, included therein, decreased from $4,700,000 in 1993 to $12,000 in 1994. The amortization of the cost of insurance acquired is lower in 1994 due to the aging of the related blocks of business. Also, amortization of deferred policy acquisition costs on universal life type products are amortized with interest in relation to the present value of expected gross profits on the products. As such estimates of expected gross profits are revised, retrospective adjustments are reflected in current operations, causing amortization of deferred policy acquisition costs to vary from period to period.
In general, the provision for federal income taxes reflected in the Company's operating results is computed using the prevailing statutory corporate rate of 35% in 1993 and 1994, as adjusted primarily for the nondeductibility of certain items such as the amortization of goodwill. Additionally, total income tax expense in 1993 reflects a $1.1 million charge for the cumulative effect on the deferred tax liability for the adoption by the Company of increased statutory federal tax rates from 34% to 35% at September 30, 1993. The effective rate reflected in the Company's financial statements was approximately 37% for 1993, and 36% for 1994. See Note 12 of the Notes to Consolidated Financial Statements.
The Company derives a substantial portion of its total revenues from investment income. The Company's investments are managed by an in-house investment staff and certain external investment managers. The Company's investment strategy is designed to achieve superior risk-adjusted returns consistent with its investment philosophy of maintaining a largely investment grade, fixed maturity portfolio and providing adequate liquidity for expected liability durations and other requirements. The Company's investment portfolio is substantially duration matched, with an average aggregate portfolio duration of 4.8 years at December 31, 1995, as compared to 6.1 years at December 31, 1994. The Company's investments in mortgages and real estate represented 2.9% of total cash and invested assets at December 31, 1995.
The Company's asset-liability management program includes: (i) designing and developing products which encourage persistency, thereby creating a stable liability structure; and (ii) structuring the investment portfolio with duration and cash flow characteristics consistent with the duration and cash flow characteristics of the Company's insurance liabilities. The Company's investments must comply with certain contractual and regulatory restrictions. See "Business -- Regulation."
The NAIC assigns securities quality ratings and uniform prices called "NAIC designations" that are used by insurers when preparing their annual statements. The NAIC assigns designations to publicly traded as well as privately placed securities. The designations assigned by the NAIC range
from class 1 to class 6, with a rating in class 1 being of the highest quality. The following table sets forth the composition of the Company's fixed maturity securities according to NAIC designations and Standard and Poors ("S&P") ratings at December 31, 1995:
- ------------------------ (1) Comparisons between NAIC designations and S&P ratings are published by the NAIC. S&P has not rated some of the fixed maturity securities in the Company's portfolio.
guidelines, to borrowing against certain fixed maturity investment securities. Such borrowings are substantially matched for duration characteristics. Investment borrowings totaled $73.6 million at December 31, 1995.
The primary sources of liquidity for Life Partners' subsidiaries include their operating cash flows, dividends, tax sharing payments from other subsidiaries, and short-term investments, which principally consist of commercial paper, certificates of deposit, money market funds, and U.S. Treasury Bills generally maturing within 90 days. The net cash provided by operating activities and net policyholder contract deposits of Life Partners' insurance subsidiaries after the payment of policyholder contract withdrawals, equaled $140.3 million in 1995, $165.8 million in 1994, and $288.4 million in 1993.
At December 31, 1995, the investment portfolio of the Company included cash and short-term investments totaling $197.7 million, as well as $1,297.0 million of U.S. government, agency-backed and mortgage-backed securities available-for-sale and $1,226.0 million of publicly traded investment grade bonds available-for-sale that could be readily converted to cash at or near carrying value. These liquid investments totaled approximately $2.5 billion and constituted approximately 63.4% of the Company's cash and invested assets at December 31, 1995. This investment portfolio provided total interest income and maturing principal payments of $441.7 million during 1995, $378.0 million during 1994, and $474.5 million during 1993.
The NAIC has adopted risk based capital ("RBC") rules which became effective December 31, 1993. See "Business -- Regulation." In states which adopt the NAIC regulations, the new RBC rules provide for various regulatory actions when the ratio of a company's total adjusted capital to its Company Action Level RBC fall below 100%. At December 31, 1995, Massachusetts General, Philadelphia Life, and Lamar Life, the only subsidiaries currently writing new business, had total adjusted capital of 222%, 263%, and 439% of their Company Action Level RBC, respectively.
The Company does not believe that inflation has had a material effect on its consolidated results of operations. The Company manages its investment portfolio in part to reduce its exposure to interest rate fluctuations. In general, the market value of the Company's fixed maturity portfolio increases or decreases in inverse relationship with fluctuations in interest rates, and the Company's net investment income increases or decreases in direct relationship with interest rate changes. For example, if interest rates decline (as was the case in 1995), the Company's fixed maturity investments generally will increase in market value, while net investment income will decrease as fixed income investments mature or are sold and proceeds are reinvested at the declining rates, and vice versa.
During 1995, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 121, ACCOUNTING FOR THE IMPAIRMENT OF LONG LIVED ASSETS AND FOR LONG LIVED ASSETS TO BE DISPOSED OF ("SFAS 121"), which is effective for fiscal years beginning after December 15, 1995. The Company does not believe that the application of the provisions of SFAS 121 will have a material effect on its financial condition or results of operations.
Certain financial information presented depends upon management's estimates and judgments regarding the ultimate outcome of transactions which are not yet complete. Management believes these estimates and judgments are fair and reasonable in view of present conditions and available information.
The Audit Committee of the Board of Directors, composed solely of nonmanagement directors, meets periodically with management and the independent accountants to review internal accounting control, audit activities and financial reporting matters. The independent accountants have full and free access to the Audit Committee.
We have audited the accompanying consolidated balance sheets of Life Partners Group, Inc. and Subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1995. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
As more fully explained in Note 1(d) to the consolidated financial statements, the Company adopted Statement of Financial Accounting Standard No. 115, "Accounting For Certain Investments in Debt and Equity Securities", effective December 31, 1993.
LIFE PARTNERS GROUP, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
LIFE PARTNERS GROUP, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
The consolidated financial statements include the accounts of Life Partners Group, Inc. ("Life Partners") and its wholly-owned subsidiaries (together the "Company") from the date of acquisition. The subsidiaries consist of Philadelphia Life Insurance Company ("Philadelphia Life"), Massachusetts General Life Insurance Company ("Massachusetts General"), Lamar Life Insurance Company ("Lamar Life"), Wabash Life Insurance Company ("Wabash"), Independent Processing Services, Inc. ("IPS"), Travel Partners Group, Inc. ("TPG"), Philadelphia Life Asset Planning Company ("PLAPCO"), Stratford Capital Group, Inc. ("Stratford Capital"), Lamar Life International, Inc. ("LLII"), Whitehall Fund Managers, Inc. ("WFM"), Eagles National Corporation ("ENC"), and Partners Risk Management Company ("PRMC").
All significant intercompany accounts and transactions have been eliminated in consolidation.
The Company's insurance subsidiaries maintain their accounts in conformity with accounting practices prescribed or permitted by state insurance regulatory authorities. In the accompanying financial statements such accounts have been adjusted to conform with generally accepted accounting principles ("GAAP") (see Note 13).
Life Partners is an insurance holding company that, through its three principal life insurance subsidiaries, sells a diverse portfolio of universal life insurance and annuity products to individuals. The Company also maintains an existing block of traditional, universal life and annuity business in force. The Company markets its life insurance products through two separate marketing systems; the Client Company marketing system (including affiliated companies) and the Regional Director marketing system. While both systems rely on independent agents to consummate sales, the Client Company System further offers qualified members of its life insurance sales force the opportunity to participate in and share in the profitability of an agent-owned reinsurance company. Of the Company's total gross annualized premiums on new life insurance sales, 71.6%, 77.6%, and 71.9% were generated by agents participating in the Client Company marketing system during 1995, 1994 and 1993, respectively.
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) managed investments, which were carried at fair value, and were transferred to held-to-maturity. The adoption of SFAS 115 had no effect on net earnings or cash flows. SFAS 115 prohibits restatement of prior years' financial statements.
For purposes of the statements of cash flows, cash and short-term investments include commercial paper, invested cash, and other investments with original maturities of three months or less, and are reflected at cost.
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) not affect net earnings (loss). If a decline in the market value of an individual investment is considered to be other than temporary, the difference between amortized book value and net realizable value is recorded as a realized investment loss. Net realizable value is based on quoted market prices or discounted cash flows in the absence of quoted market prices. The cost of investments sold is determined on a specific identification basis (see Note 4).
Changes in the interest rate environment have a direct, inverse impact on the market value of fixed income investments. It is reasonably possible that changes in interest rates will occur in the near term and that such changes could have a material effect on the carrying value of available-for-sale fixed maturity and equity securities, with an offsetting effect to stockholders' equity, net of the related effects on deferred policy acquisition costs, deferred policy fees, costs of insurance acquired and related deferred income taxes. The impact of the adjustment to investments carried at market value resulting from interest rate fluctuations and related adjustments to other accounts do not have a direct impact on the Company's results of operations.
During 1995, the FASB issued Statement of Financial Accounting Standards No. 121, ACCOUNTING FOR THE IMPAIRMENT OF LONG LIVED ASSETS AND FOR LONG LIVED ASSETS TO BE DISPOSED OF ("SFAS 121"), which is effective for fiscal years beginning after December 15, 1995. The Company does not believe that the application of the provisions of SFAS 121 will have a material effect on its financial condition or results of operations.
Changes in deferred policy acquisitions costs are as follows (in thousands):
Additionally, the Company assumed a block of annuity business in 1993 and consummated the Lamar Life acquisition in 1995 (See Note 2), of which portions of the respective purchase prices were allocated to the cost of the policies acquired. These assets are amortized with interest in relation to expected gross profits, using the assumed crediting interest rate, including direct charge-offs for any excess of the unamortized asset over the present value of expected gross profits. Retrospective adjustments of the amounts related to the 1993 and 1995 business acquired are made when the Company revises its estimates of expected future gross profits and losses with respect to the policies acquired.
Goodwill is amortized on the straight-line basis over a 40 year period. Accumulated amortization of goodwill was $13.8 million and $11.1 million at December 31, 1995 and 1994, respectively. The Company continually evaluates whether current events and circumstances warrant adjustments to
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) the carrying value and/or the estimated amortization period of goodwill and other intangibles. An adjustment to the carrying value or amortization period is based on future undiscounted cash flows. At this time, the Company believes that no significant impairment of the goodwill and other intangibles has occurred and that no reduction of the estimated amortization period is warranted.
At December 31, 1995, the Company reassessed its expectations future gross profits and losses resulting in additional amortization of Deferred Policy Fees (See Note 1(e)).
Assessments are levied on the Company from time to time by guaranty fund associations of states in which it is licensed to provide for payment of covered claims or to meet other insurance obligations, subject to prescribed limits, of insolvent insurance enterprises. Assessments are allocated to an insurer based on the ratio of premiums written by an insurer to total premiums written in the state. The term of the assessments depend on how each guaranty fund association elects to fund its obligation. Assessments levied by certain states may be recoverable through a reduction in future premium taxes. The Company provides a liability, net of discount and estimated premium tax offsets, for estimated future assessments of known insolvencies. Such liability was $2.7 million and $0.5 million at December 31, 1995 and 1994, respectively. The Company determines the liability utilizing a report prepared annually by the National Organization of Life, Health and Accident Guaranty Associations which provides estimates of assessments by insolvency. Although management believes the provision for guaranty fund assessments is adequate for all known insolvencies, and does not currently anticipate the need for any material additions to the reserve for known insolvencies, it is reasonably possible that the estimates on which the provision is based will change and that such changes may result in future adjustments.
Premium revenue for traditional life insurance products is reported as earned when due. Benefits and expenses are associated with earned premiums so as to result in recognition of profits over the premium paying period. This association is accomplished by means of a provision for future policy benefit reserves and the amortization of deferred policy acquisition costs. Revenues for universal life policies and annuity products consist of policy charges for the cost of insurance, policy administration charges, amortization of policy initiation fees, and surrender charges. Expenses related to these products include interest credited to policy account balances and benefit claims incurred in excess of policy account balances. Premiums earned on group accident and health insurance business are recorded as fees net of ceded commissions in accident and health insurance premiums, net.
Net earnings per common share is based on the weighted average number of common and common equivalent shares outstanding during the periods. Net loss per common share is based on the weighted average number of common shares outstanding. Pursuant to Securities and Exchange Commission Staff Accounting Bulletin No. 83, all common shares issued and options and warrants granted by the Company during the twelve months preceding March 23, 1993, the date of the Company's initial public offering, except those issued to General Electric Capital Corporation ("GE Capital") upon exercise of the GE Capital warrants, have been included in the calculation of common and common equivalent shares outstanding as if they were outstanding for all periods presented (using the treasury stock method and a public offering price of $17.00 per share).
The Company has no material liabilities for postretirement benefits. The liabilities for certain individuals who were vested in the prior owner's plan or in the prior Lamar Life plan are accounted for in accordance with Statement of Financial Accounting Standards No. 106.
The Company has reclassified the presentation of certain prior period information to conform with the 1995 presentation. The reclassifications had no effect on the financial position, results of operations or cash flows of the Company.
The following unaudited pro forma information presents the consolidated results of operations of the Company and Lamar as if the acquisitions had been effective at the beginning of the periods presented, after giving effect to adjustments to reflect the acquisition and the financing related thereto.
(A) On August 12, 1994, the unsecured syndicated credit facility was amended and restated to include a $50 million revolving credit facility and various other modifications. On April 28, 1995, the Company utilized $36 million of the revolving credit facility in the acquisition of Lamar Financial
Any principal portion designated as a base rate loan bears interest at a rate per annum equal to the higher of (a) the Federal Funds Rate for such day plus 1/2 of 1%, or (b) the Prime rate for such day. Any principal portion designated as a eurodollar loan bears interest at a rate per annum based upon the one, two, three, or six month LIBOR rate, plus a 1.0% margin. At December 31, 1995, the entire outstanding term loan principal amount of $106.2 million was designated by the Company as a eurodollar loan, bearing interest based upon the six month LIBOR rate of 6.75%. The outstanding revolving loan principal amount of $50 million was also designated by the Company as a eurodollar loan. Of the outstanding revolving loan principal, $36.0 million bears interest based on the six month LIBOR rate of 6.88%, and $14.0 million bears interest based upon the three month LIBOR rate of 6.69%. The loan agreement under the bank credit facility contains covenants, the most restrictive of which limits payments by the Company for dividends to 3% of net worth as defined in the agreement.
(B) On July 30, 1992, Life Partners completed a public offering of $100 million of unsecured senior subordinated notes. The notes bear interest at the rate of 12 3/4% (payable semi-annually on January 15 and July 15), and the principal of the notes is payable in a single installment at maturity on July 15, 2002. The notes are redeemable at Life Partners' option at any time after July 15, 1997, and there are no sinking fund requirements. The notes may be redeemed by Life Partners at redemption prices of 103.643% and 101.831% of the outstanding principal balances in the 12-month periods commencing July 15, 1997 and 1998, respectively, or at 100% thereafter. One of Life Partners' subsidiaries purchased $4.9 million of the notes in 1993.
The following summary sets forth the principal balance of maturities of notes payable during each of the next five years (in thousands):
The components of interest expense associated with notes payable are as follows (in thousands):
The interest and principal payment terms of surplus debentures payable by Wabash to Life Partners are structured, subject to certain surplus restrictions, to provide sufficient cash to meet all payment terms on these loan agreements (see Note 7).
4. INVESTMENTS Investment income by type of investment was as follows (in thousands):
Realized investment losses for other than temporary declines in the market values of debt securities totaled $9.2 million, $7.1 million, and $54.5 million in 1995, 1994, and 1993, respectively.
Gross gains of $25.3 million and gross losses of $14.8 million were realized in 1995 from the sale of investments in debt securities; gross gains of $19.0 million and gross losses of $22.0 million were realized in 1994; and gross gains of $47.6 million and gross losses of $6.2 million were realized in 1993.
At December 31, 1995, the Company held cash and short-term investments of Dreyfus Treasury Cash Management Fund with a carrying amount of $58.7 million, which was greater than 10% of stockholders' equity at December 31, 1995.
The carrying value of investments that have produced no investment income for the three years ended December 31, 1995, 1994 or 1993 was not material to the Company's consolidated financial position.
The Company has only limited involvement with derivative financial instruments and does not use them for trading purposes. They are used to manage well-defined interest rate risks. The Company entered into interest rate swap agreements during 1991 and 1993 for the purpose of minimizing exposure to fluctuations in interest rates of specific assets held by the Company. The notional amount of such matched swaps outstanding at December 31, 1994 and 1993, was $20 million, and $120 million, respectively. During 1994, certain swaps were terminated resulting in an aggregate loss of approximately $6.8 million. During the first quarter of 1995, the Company terminated its remaining swaps which resulted in an aggregate loss of approximately $116,000.
5. CONCENTRATIONS OF CREDIT RISK The Company held unrated or non-investment grade corporate debt securities, excluding senior secured debt securities and mezzanine financing securities, as follows (in millions):
For annuity contracts which do not possess significant insurance risks, cash surrender value is a reasonable estimate of fair value.
(A) It is not practicable to estimate the fair value of policy loans as they have no stated maturity and their rates are set at a fixed spread to related policy liability rates. Policy loans are carried at the aggregate unpaid principal balances in the consolidated balance sheets, and earn interest at rates ranging from 4% to 9%. Individual policy liabilities in all cases equal or exceed outstanding policy loan balances.
(B) Other invested assets consist primarily of limited partnership investments acquired prior to 1995 and carried at cost, for which the determination of fair value is not practicable. The carrying value of limited partnership investments were $42.1 million and $45.8 million at December 31, 1995 and 1994, respectively.
7. STOCKHOLDERS' EQUITY AND RESTRICTIONS (CONTINUED) Generally, the net assets of the other insurance subsidiaries available for transfer to Wabash are limited to the greater of the respective insurance subsidiary's net gain from operations during the preceding year or 10% of the respective subsidiary's net surplus as of the end of the preceding year, as determined in accordance with accounting practices prescribed or permitted by insurance regulatory authorities. Payment of dividends in excess of such amounts would generally require approval by the regulatory authorities. During 1996, $37.7 million is available for payment of dividends by insurance subsidiaries to Wabash without prior approval.
9. COMMON STOCK (CONTINUED) and its stockholders. At issuance, the option price was greater than the fair value of the stock, based on the value negotiations with the option holder and the restrictions placed on the sale of the stock by virtue of a pledge and a stockholders agreement.
In addition, Life Partners has reserved 800,000 shares of Common Stock for future issuance pursuant to a stock option plan which is for the benefit of officers and key employees. Stock options were formally granted by the Compensation Committee of the Life Partners Board of Directors at a price not less than market value on the date of grant. They are exercisable for up to ten years from the date of grant and vest equally over a three or five year period.
Massachusetts General has ceded a block of insurance under a coinsurance agreement generally known as "financial reinsurance." Net statutory surplus provided by this treaty was $1.3 million and $2.9 million at December 31, 1995 and 1994, respectively. Lamar Life has also ceded a block of insurance under a coinsurance agreement that is considered financial reinsurance. Net surplus provided by this treaty was $8.2 million at December 31, 1995. These reinsurance agreements represent financing arrangements and, in accordance with generally accepted accounting principles, are not reflected as reinsurance in the accompanying financial statements except for the risk fees paid to or received from the reinsurers.
The Company held assets and reserves of approximately $192.0 million and $161.6 million at December 31, 1995 and 1994, respectively, under modified coinsurance agreements with reinsurance companies owned by certain of the Company's agents.
During July 1993 the Company entered into a coinsurance agreement whereby the Company received $140.1 million in cash and assumed $154.6 million in annuity fund liabilities, which were subject to surrender penalties aggregating $17.2 million.
11. COMMITMENTS, LITIGATION AND CONTINGENT LIABILITIES (CONTINUED) Wabash and Life Partners, as guarantor of the obligations of Wabash, entered into an agreement with Perot Systems Corporation ("Perot") to provide data processing services to the Company through February, 2001. Fees under the servicing agreement are based upon usage, with minimum annual fees of $3.6 million. The agreement is subject to an option available in 1996 whereby Wabash could pay a fee of approximately $4 million to terminate the agreement. The Company is negotiating with Perot regarding this option as part of a review of its data processing arrangements.
12. FEDERAL INCOME TAXES Life Partners and its direct non-life subsidiary companies acquired in the Lamar acquisition file a consolidated non-life federal income tax return. The life insurance subsidiaries file a consolidated life federal income tax return. Non-life subsidiaries of the insurance companies each file a separate federal income tax return.
The components of the provision (benefit) for income taxes on operating earnings (loss) before income taxes and extraordinary items are as follows (in thousands):
A reconciliation of the income tax provision (benefit) based on the prevailing corporate tax rate of 35% to the provision reflected in the consolidated financial statements is as follows (in thousands):
The Company recorded a general provision for tax contingencies of $2.0 million at December 31, 1995. The result of this provision was to decrease the Company's 1995 effective tax rate by 12%.
12. FEDERAL INCOME TAXES (CONTINUED) The temporary differences that give rise to a deferred tax asset (liability) at December 31, 1995 and 1994, relate to the following (in thousands):
As of December 31, 1995, Life Partners has $8.9 million in federal net operating loss carryforwards which have expiration dates from 2006 through 2009.
A valuation allowance of $2.0 million has been established as of the purchase date for certain operating loss carryforwards and temporary differences of non-life companies acquired in the Lamar acquisition. The valuation allowance against deferred tax assets will be continually evaluated and any adjustments will be allocated to reduce goodwill or other noncurrent intangible assets of the acquired companies.
Wabash received written approval from Kentucky Department of Insurance to acquire certain Life Partners insurance subsidiaries as of March 30, 1990 and further received permission for the acquisition of Lamar as of April 28, 1995. Investment practices prescribed by the Commonwealth of Kentucky limit such investments in subsidiaries to 50% of the excess of capital and surplus over the minimum required capital and surplus of $1 million, or such higher percentage of the excess as may be approved. At December 31, 1995, Wabash's investment in affiliates exceeded the 50% limitation by $108.1 million, as permitted by the Kentucky Department of Insurance.
14. RELATED PARTY TRANSACTIONS In connection with the purchase of the life insurance subsidiaries on March 30, 1990, Wabash entered into a financial advisory agreement with certain shareholders pursuant to which certain shareholders provide financial advisory services to Wabash and the other insurance subsidiaries for an annual fee. This fee was $0.5 million for 1993 and 1994. The financial advisory agreement was terminated on December 31, 1994. During 1994, the Company entered into another agreement with these shareholders in which the Company agreed to pay a fee for services rendered in connection with the acquisition of Lamar Life Insurance Company. The fee agreed upon is 1% of the aggregate consideration paid and amounted to $1.3 million. The Company anticipates entering into similar agreements with the shareholders regarding future acquisitions.
14. RELATED PARTY TRANSACTIONS (CONTINUED) During 1993, the Company's previous investment as a limited partner in a fourth acquisition of $2.9 million was converted to common stock of the acquired company. All of the stock was sold during 1994 and 1995.
Noncash financing activities include and the payment of dividends in kind on the preferred stock (see Note 8).
16. SUPPLEMENTAL DATA TO CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED) In connection with the acquisition of Lamar, liabilities were assumed as follows (in thousands):
An extraordinary loss in the amount of $3.9 million was realized by the Company in 1994 due to the amendment and restatement of the borrowings under the bank credit facility, and is reflected net of $1.4 million in estimated taxes.
18. QUARTERLY FINANCIAL DATA (UNAUDITED) Earnings (loss) per common share for each quarter are computed independently of earnings per share for the year. Due to the transactions affecting the weighted average number of shares outstanding in each quarter and due to the uneven distribution of earnings during the year, the sum of the quarterly earnings (loss) per share may not equal the earnings (loss) per share for the year.
Quarterly results of operations are based on numerous estimates, principally related to policy reserves, the amortization of cost of policies purchased, the amortization of cost of policies produced and income taxes. Such estimates are revised quarterly and are ultimately adjusted to year-end amounts. When such revisions are determined, they are reported as part of operations of the current quarter. During the fourth quarter of 1995, the Company reassessed its estimates relating to deferred