Principal properties owned by Standard Insurance Company (“Standard”) and used by the Company consist
of two office buildings in downtown Portland, Oregon: the Standard Insurance Center, with approximately 460,000 square feet; and the Standard Plaza, with approximately 220,000 square feet. Both of our business segments use the facilities described above. We also own two buildings in Hillsboro, Oregon, each with 72,000 square feet of office space. The Hillsboro offices are used by StanCorp Mortgage Investors, LLC and our group insurance claims operations. In addition, Standard leases approximately 160,000 square feet of office space located in downtown Portland, Oregon, for home office and claims operations and 60,000 square feet of offsite storage. As part of our restructuring plan adopted in January 2009, we began the process of closing 12 offices with the intention of centralizing these offices to identified locations. At December 31, 2009 we leased 59 offices under commitments of varying terms to support our sales and regional processing offices throughout the United States. Management believes that the capacity and types of facilities are suitable and adequate. See Part II, Item 8, “Financial Statements and Supplementary Data-Notes to Consolidated Financial Statements-Note 1-Summary of Significant Accounting Policies-Property and equipment, net.”
Includes operating expenses, commissions and bonuses, premium taxes, and the net increase in deferred acquisition costs, value of business acquired and intangibles.
The following management assessment of the financial condition and results of operations should be read in conjunction with the consolidated financial statements and related notes thereto contained in Item 8, “Financial Statements and Supplementary Data.” Our consolidated financial statements and certain disclosures made in this Form 10-K have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and require us to make estimates and assumptions that affect reported amounts of assets and liabilities and contingent assets and contingent liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during each reporting period. The estimates most susceptible to material changes due to significant judgment are identified as critical accounting policies. The results of these estimates are critical because they affect our profitability and may affect key indicators used to measure our performance. See “Critical Accounting Policies and Estimates.”
Net income per diluted share was $4.26, $3.30 and $4.35 for the years 2009, 2008 and 2007, respectively. Net income for these same periods was $208.9 million, $162.9 million and $227.5 million, respectively. The increase in net income for 2009 reflected a decline in after-tax net capital losses and increased net investment income in the Asset Management segment, partially offset by after-tax one-time costs and declines in premiums in our group insurance businesses.
After-tax net capital losses were $17.3 million, $83.4 million and $0.4 million for 2009, 2008 and 2007, respectively. We recorded after-tax one-time costs in operating expenses of $12.0 million for 2009 for severance costs, lease terminations and other expenses associated with our operating efficiency initiatives. Net investment income in the Asset Management segment increased $50.2 million or 27.3% due to increased individual annuity assets under administration. Premiums for the Insurance Services segment declined $41.9 million or 2.0%. The decline in premiums for 2009 was attributable to our group insurance business, which was affected by a lack of organic growth due
Over the past year, we have witnessed a significant widening of credit spreads followed by an equally significant tightening of those credit spreads, which we are experiencing today. Economists remain highly divergent in their expectations of future interest rate trends. As we go forward, we intend to maintain our process of careful asset -liability management, using discount rates to establish reserves on new claims that reflect new money rates on assets supporting those reserves, less an appropriate margin. Given the uncertainty of the movement of future interest rates, this may result in significantly higher or lower discount rates.
For 2010, we have established the following expectations, which will affect our annual financial results:
Return on average equity, excluding after-tax net capital gains and losses from net income and accumulated other comprehensive income and losses from equity, to be toward the lower end of our target range of 14% to 15% given the low interest rate environment.
Revenues consist of premiums, administrative fees, net investment income and net capital gains and losses. Total consolidated revenues increased 3.9% to $2.77 billion for 2009 compared to 2008, and decreased 1.6% to $2.67 billion for 2008 compared to 2007. Historically, premium growth in our Insurance Services segment and administrative fee revenues growth in our Asset Management segment have been the primary drivers of consolidated revenue growth. The increase for 2009 reflected a decrease in net capital losses of $101.9 million and an increase in net investment income of $45.5 million. These increases in revenues were partially offset by declines in premiums from our Insurance Services segment and decreases in administrative fee revenues from our Asset Management segment. Net capital losses are reflected in the Other category.
The following table sets forth percentages of premium growth, administrative fee revenues growth and net investment income growth by segment for the years ended December 31:
Experience rated refunds (“ERRs”) decreased by $4.4 million to $40.2 million for 2009. ERRs represent refunds paid for favorable claims experience to certain group contract holders. Premium growth for 2008 was partially offset by an increase in ERRs of $7.4 million to $44.6 million, compared to $37.2 million for 2007. See “Business Segments-Insurance Services Segment.”
Net investment income increased 8.4% to $586.5 million for 2009 compared to 2008, and increased 4.8% to $541.0 million for 2008 compared to 2007. Net investment income is affected by changes in levels of invested assets, interest rates, the change in fair value of derivative assets and commercial mortgage loan prepayment fees.
The decrease in net capital losses for 2009 was primarily due to the recovery of the market value of certain fixed maturity securities. Net capital losses for 2009 were primarily due to a $21.1 million additional provision to our commercial mortgage loan loss allowance, $29.1 million from the sales of fixed maturity securities that included losses on holdings in financial institutions, including holdings of certain insurance companies that were
downgraded by rating agencies during the current year and $5.9 million in OTTI on fixed maturity securities. The capital losses for 2009 were partially offset by $29.6 million of capital gains from the sale of certain fixed maturity securities.
The net capital losses in 2008 were primarily due to OTTI related to a decline in the market value of certain fixed maturity securities where management determined recovery or the intent to hold the securities was uncertain. In addition, net capital losses were the result of OTTI of fixed maturity securities belonging to various economic sectors, including fixed maturity security holdings of certain bond insurers, financial institutions and several regional banks.
The following table sets forth benefits to policyholders by segment for the years ended December 31:
The slight decrease in benefits to policyholders for 2008 compared to 2007 was primarily due to comparatively favorable claims experience in our group insurance
business and slowing business growth in the fourth quarter as evidenced by decreased premiums in the fourth quarter of 2008. See “Business Segments-Insurance Services Segment-Benefits and Expenses-Benefits to Policyholders.”
Operating expenses increased 1.5% to $476.2 million for 2009 compared to 2008, and increased 7.9% to
We defer certain commissions, bonuses and operating expenses, which are considered acquisition costs. These costs are then amortized into expenses over a period not to exceed the life of the related policies, which for group insurance contracts is the initial premium rate guarantee period, which averages 2.5 years. VOBA primarily represents the discounted future profits of business assumed through reinsurance agreements. A portion of VOBA is amortized each year to achieve matching against expected gross profits. Our intangibles, consisting of customer lists and marketing agreements, are also subject to amortization. Customer lists were obtained through acquisitions and have a combined estimated weighted-average remaining life of approximately 9.3 years. The amortization for the marketing agreement with the Minnesota Life Insurance Company (“Minnesota Life”) is up to 25 years. See “Critical Accounting Policies and Estimates-DAC, VOBA and Other Intangible Assets.” The net deferral for DAC, VOBA and intangibles for 2009 decreased $28.9 million compared to 2008 and increased $14.5 million for 2008 compared to 2007. Net deferrals decreased $25.7 million in the individual annuity business for 2009, primarily due to lower individual annuity sales and an increase in DAC amortization resulting from derivative gains from our indexed annuities. In addition, net deferrals in the Insurance Services segment decreased $4.0 million for 2009, primarily due to lower individual disability sales and the termination of a small block of individual disability contracts. The large increase in net deferrals in 2008 was due to an increase in individual annuity sales.
The primary factors that affect premium growth for the Insurance Services segment are sales and persistency for all of our insurance products and organic growth in our group insurance product lines due to employment and wage rate growth from existing group policyholders.
reduced persistency caused in part by competitive pressure on pricing as our customers continued to navigate a challenging economy that began in the second half of 2008. The increase in individual disability premiums for 2009 primarily related to approximately $18 million received related to the termination of reinsurance on a small block of individual disability reinsured policies and claims compared to $3.7 million received for a similar reinsurance termination in 2008. Offsetting the premiums received in these terminations of reinsurance were approximately $18 million and $3.9 million in additional reserves assumed in 2009 and 2008, respectively. The termination of these agreements was made primarily for the purpose of gaining administrative efficiencies. Premium growth in 2008 was also affected by a 2007 single reserve buyout of $19.3 million. Premium growth for 2008 compared to 2007, adjusted for the single reserve buyout of $19.3 million, was 3.2%.
Three primary factors drive benefits to policyholders: reserves that are established in part based on premium level, claims experience and the assumptions used to establish related reserves. The predominant factors affecting claims experience are claims incidence, measured by the number of claims, and claims severity, measured by the magnitude of the claim and the length of time a disability claim is paid. The assumptions used to establish the related reserves reflect claims incidence and claims severity, in addition to new money investment interest rates and overall portfolio yield, as both affect the discount rate used to establish reserves.
The benefit ratio for our individual disability business was 69.3% for 2009, compared to 78.7% for 2008 and 69.3% for 2007. The decrease in the benefit ratio for 2009 was primarily due to a decline in the severity of new claims and favorable termination experience during 2009. The increase in the benefit ratio for 2008 compared to 2007 primarily reflected less favorable claims experience. The benefit ratios for 2009 and 2008 for our individual disability business included approximately $18 million and $3.7 million, respectively, of premiums and approximately $18 million and $3.9 million, respectively, of additional reserves related to the termination of reinsurance on certain reinsured policies and claims. Excluding the effects of this termination of reinsurance, the benefit ratio would have been 65.8% for 2009, compared to 78.0% for 2008. Due to the relatively smaller size of our individual disability business, claims experience and the corresponding benefit ratio tend to fluctuate widely from quarter to quarter.
If investment rates prove to be lower than provided for in the margin between the new money investment rate and the reserve discount rate, we could be required to increase reserves, which could cause expense for benefits to policyholders to increase. Given the uncertainty of the movement of future interest rates, this may result in significantly higher or lower discount rates. The margin in our overall block of business for group insurance between the invested asset yield and the weighted-average reserve discount rate at December 31, 2009 was 41 basis points. See “Liquidity and Capital Resources.”
Revenues from the retirement plans business include plan and trust administration fees, fees on equity investments held in separate account assets and other assets under administration, and investment income on general account assets under administration. Premiums and benefits to policyholders reflect the conversion of retirement plan assets into life-contingent annuities, which can be selected by plan participants at the time of retirement, including the sale of immediate annuities. Most of the sales for this segment are recorded as deposits and are therefore not reflected as premiums. Individual fixed-rate annuity deposits earn investment income, a portion of which is credited to policyholders.
Revenues for the Asset Management segment increased 14.9% to $382.8 million for 2009 compared to 2008, and increased 9.7% to $333.2 million for 2008 compared to 2007. The increase in revenues for 2009 was primarily due to an increase in net investment income. The increase in net investment income for 2009 compared to 2008 was primarily due to an increase in average individual annuity assets under administration, higher average yields in our commercial mortgage loan portfolios and derivative gains on indexed annuities.
The increase in revenues for 2008 was primarily due to sales growth in our life-contingent individual fixed-rate annuities business. Revenues for 2008 were also affected by increased contract administration fees in our investment advisory business and increased fee revenues related to the origination and servicing of commercial mortgage loans for third parties. Individual fixed-rate annuity sales were $895.4 million for 2008, or 325.0% higher than for 2007 and reflected strong demand, strong growth in our distribution channels and less competition from banks and alternative investments. Revenue growth for 2008 was partially offset by a decrease in revenues in the retirement plans business reflecting the effect of declining equity markets.
Premiums for the Asset Management segment are generated from life-contingent annuities, which are primarily a single-premium product. Premiums and benefits to policyholders reflect both the sale of immediate annuities by our individual annuity business and the conversion of retirement plan assets into life-contingent annuities, which can be selected by plan participants at the time of retirement. Premiums for the segment can vary significantly from quarter to quarter due to low sales volume of life-contingent annuities and the varying size of single premiums. Increases or decreases in premiums for life-contingent annuities correlate with corresponding increases or decreases to benefits to policyholders. Premiums for the Asset Management segment were $34.7 million, $31.1 million and $14.7 million for 2009, 2008 and 2007, respectively. The large increase in premiums for 2008 was due to strong life-contingent annuity sales as a result of strong demand and higher relative return rates.
The increase in net investment income for 2008 was primarily reflective of increases in average retirement plan general account and individual annuity assets under administration. The increase was partially offset by
decreases in commercial mortgage loan prepayment fees and in the fair value of derivative instruments in 2008. Average retirement plan general account assets under administration increased 4.2% to $1.47 billion for 2008 compared to 2007. Average individual annuity assets under administration increased 32.5% to $1.68 billion for 2008 compared to 2007. The significant increase in average individual annuity assets under administration was due to very strong individual annuity sales in 2008. Commercial mortgage loan prepayment fees decreased $2.4 million for 2008 compared to 2007. The fair value of derivative instruments decreased $11.1 million for 2008, compared to a decrease in the fair value of $1.0 million for 2007. See Item 8, “Financial Statements and Supplementary Data-Notes to Consolidated Financial Statements-Note 7-Derivative Financial Instruments.” Excluding the effect of changes in the derivative instruments, net investment income increased 13.8% to $194.9 million for 2008 compared to 2007.
Interest credited represents interest paid to policyholders on retirement plan general account assets and individual fixed-rate annuity deposits. Interest credited for the Asset Management segment increased 41.0% to $140.9 million for 2009 compared to 2008, and increased 7.8% to $99.9 million for 2008 compared to 2007. The increase in interest credited for 2009 compared to 2008 primarily reflected changes in the fair value of derivatives and growth in average individual annuity assets under administration from individual annuity sales. Average assets under
administration for individual annuities increased 32.7% for 2009 compared to 2008. Interest credited on indexed annuities was reduced by $0.4 million for 2009, compared to a reduction of interest credited of $9.2 million for 2008 primarily due to fluctuations in the Standard & Poor’s (“S&P”) 500 Index.
Operating expenses for the Asset Management segment decreased 3.4% to $126.9 million for 2009 compared to 2008. The decrease was primarily due to a decline in compensation expenses as a result of cost reduction initiatives in 2009. One-time costs are included in the Other category. See “Other.”
The net capital losses in 2008 were primarily due to OTTI related to a decline in the market value of certain fixed maturity securities where management determined recovery or the intent to hold the securities was uncertain. Net capital losses for 2008 were the result of other-than-temporary impairments in the fixed maturity securities belonging to various economic sectors, including fixed maturity security holdings of certain bond insurers, financial institutions and several regional banks. The additional loss before income taxes for 2008 compared to 2007 included additional interest expense of $8.6 million primarily related to the $300 million junior subordinated debentures (“Subordinated Debt”) issued in May 2007. See “Liquidity and Capital Resources-Financing Cash Flows.”
Asset-liability management is a part of our risk management structure. The risks we assume related to asset-liability mismatches vary with economic conditions. The primary sources of economic risk are interest-rate related and include changes in interest rate term risk, credit risk and liquidity risk. It is generally management’s objective to align the characteristics of assets and liabilities so that our financial obligations can be met under a wide variety of economic conditions. From time to time, management may choose to liquidate certain investments and reinvest in different investments so that the likelihood of meeting our financial obligations is increased. See “-Investing Cash Flows.”
Our interest rate risk analysis reflects the influence of call and prepayment rights present in our fixed maturity securities and commercial mortgage loans. The majority of these investments have contractual provisions that require the borrower to compensate us in part or in full for reinvestment losses if the security or loan is retired before maturity. Callable bonds as a percentage of our fixed maturity security investments were 2.8% at December 31, 2009. Since 2001, all commercial mortgage loans originated by us contain a provision requiring the borrower to pay a prepayment fee to assure that our expected cash flow from commercial mortgage loan investments would be protected in the event of prepayment. Approximately 91% of our commercial mortgage loan portfolio contains this prepayment provision. Almost all of the remaining commercial mortgage loans contain fixed percentage prepayment fees that mitigate prepayments but may not fully protect our expected cash flow in the event of prepayment.
information on how we manage interest rate risk. The interest rate sensitivity analysis was based upon our fixed maturity securities and commercial mortgage loans held at December 31, 2009 and 2008. Interest rate sensitivity of our 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 0.38% and 0.23% for the 2009 and 2008 analyses, respectively. 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 our 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 our financial assets can be significantly different from that estimated by the model. The hypothetical reduction in the fair value of our financial assets that resulted from the model was estimated to be $144 million and $78 million at December 31, 2009 and 2008, 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. 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 Insurance Company (“Standard”) and to the board of directors for The Standard Life Insurance Company of New York.
Net cash used in investing activities was $907.6 million, $1.03 billion and $597.0 million for 2009, 2008 and 2007, respectively. The decrease in net cash used in investing activities for 2009 compared to 2008 was primarily due to lower commercial mortgage loan originations and lower individual annuity sales. The increase in net cash used in investing activities from 2008 compared to 2007 was primarily due to increased investments from growth in the individual annuity business.
Our fixed maturity securities totaled $6.17 billion at December 31, 2009. We believe that we maintain prudent diversification across industries, issuers and maturities. We have avoided the types of structured products that do not meet an adequate level of transparency for good decision making. Our corporate bond industry diversification targets are based on the Bank of America Merrill Lynch U.S. Corporate Master Index, which is reasonably reflective of the mix of issuers broadly available in the market. We also target a specified level of government, agency and municipal securities in our portfolio for credit quality and additional liquidity. The weighted-average credit quality of our fixed maturity securities investment portfolio was A (Standard & Poor’s) at December 31, 2009. The percentage of fixed maturity securities below investment-grade was 5.4% and 4.9% at December 31, 2009 and 2008,
respectively. At December 31, 2009, fixed maturity securities on our watch list totaled $19.6 million in fair value and $26.0 million in amortized cost after OTTI of $5.9 million during 2009. See “Critical Accounting Policies and Estimates-Investment Valuations-Fixed Maturity Securities.” We did not have any direct exposure to sub-prime or Alt-A mortgages in our fixed maturity securities portfolio at December 31, 2009.
At December 31, 2009, our fixed maturity securities portfolio had gross unrealized capital gains of $284.8 million and gross unrealized capital losses of $41.1 million. The unrealized capital losses included $3.6 million related to noncredit losses that were reclassified from retained earnings to accumulated other comprehensive income. Our fixed maturity securities portfolio generates unrealized gains or losses primarily resulting from available interest rates that are lower or higher relative to our holdings at the reporting date. In addition, changes in the spread between the risk-free rate and market rates for any given issuer can fluctuate based on the demand for the instrument, the near-term prospects of the issuer and the overall economic climate. During 2009, the interest rate spread for several sectors of the market tightened, which was a primary driver of the increase in net unrealized capital gains during the year.
Capitalized commercial mortgage loan servicing rights associated with commercial loans serviced for other institutional investors were $7.5 million and $7.6 million at December 31, 2009 and 2008, respectively.
At December 31, 2009, there were 29 commercial mortgage loans totaling $17.3 million in our portfolio that were more than sixty days delinquent, of which 10 commercial mortgage loans with a total balance of $6.2 million were in the process of foreclosure. We had a net balance of restructured loans of $28.7 million at December 31, 2009. Our commercial mortgage loan loss allowance increased $12.8 million to $19.6 million at December 31, 2009, compared to $6.8 million at December 31, 2008, to account for probable future losses based on conditions existing at December 31, 2009. Our commercial mortgage loan delinquency rate remained low as a percentage of our total portfolio at 0.40% and 0.19% at December 31, 2009 and December 31, 2008, respectively. For 2009, 25 commercial mortgage loans from 11 different states were foreclosed or acquired through deed in lieu in the amount of $33.2 million. The foreclosure of these loans resulted in an overall loss of $8.3 million for 2009, with no individual state representing more than $1.4 million of the losses. For 2009, the value of real estate acquired as a result of this activity was $24.2 million.
The performance of our commercial mortgage loan portfolio may fluctuate in the future. However, we expect our delinquency rate will remain contained and our portfolio will continue its history of solid performance. We feel that our business approach of intensively underwriting high-quality loans will help us keep problem loans to a reasonable level. We have steadfastly avoided the types of structured products that do not meet an adequate level of transparency for good decision making. At December 31, 2009, we did not have any direct exposure to sub-prime or Alt-A mortgages in our commercial mortgage loan portfolio. When we undertake mortgage risk, we do so directly through loans that we originate ourselves rather than in packaged products such as commercial mortgage-backed securities. Given that we service the vast majority of
Financing cash flows primarily consist of policyholder fund deposits and withdrawals, borrowings and repayments on the line of credit, borrowings and repayments on long-term debt, repurchases of common stock and dividends paid on common stock. Net cash provided by financing activities was $294.0 million, $741.9 million and $261.1 million for 2009, 2008 and 2007, respectively.
The decrease in funds provided by financing cash flows for 2009 compared to 2008 was primarily due to a reduction in the level of new individual annuity deposits, resulting in a decrease of policyholder deposits net of withdrawals, and by a $34.4 million increase in cash used to repurchase shares of common stock.
The primary drivers of financing cash flows for 2008 were the growth in individual annuity deposits due to increased individual annuity sales and reduced share repurchases in 2008 compared to 2007. In 2007, proceeds from the issuance of a $300 million hybrid debt offering provided the primary contribution to proceeds from financing activities, partially offset by increased activity in our share repurchase program.
We repurchased common stock at a total cost of $59.3 million, $24.9 million and $235.6 million for 2009, 2008 and 2007, respectively. We repurchased common stock shares of 1.6 million, 0.5 million and 4.8 million during 2009, 2008 and 2007, respectively. At December 31, 2009, there were 1.3 million shares remaining under our current share repurchase program.
We maintain a $200 million senior unsecured revolving credit facility (“Facility”) that expires June 15, 2013. The Facility will remain at $200 million through June 15, 2012, and will decrease to $165 million thereafter until final maturity. Borrowings under the Facility will continue to be used to provide for working capital, for issuance of letters of credit and for general corporate purposes of the Company and our subsidiaries.
We have $300 million of 6.90%, Subordinated Debt. The Subordinated Debt has a final maturity on June 1, 2067, is non-callable at par for the first 10 years (prior to June 1, 2017) and is subject to a replacement capital covenant. The covenant limits replacement of the Subordinated Debt for the first 40 years to be redeemable after year 10 (on or after June 1, 2017) and only with securities that carry equity-like characteristics that are the same as or more equity-like than the Subordinated Debt. The principal amount of the Subordinated Debt is payable at final maturity. Interest is payable semi-annually at 6.90% in June and December for the first 10 years up to June 1, 2017, and quarterly thereafter at a floating rate equal to three-month London Interbank Offered Rate plus 2.51%. StanCorp has the option to defer interest payments for up to five years. StanCorp has not deferred interest on the Subordinated Debt. We primarily used the proceeds from the sale of the Subordinated Debt to repurchase shares of common stock and to fund the acquisition by StanCorp Real Estate, LLC (a wholly owned subsidiary) of certain real estate assets from Standard.
State insurance departments require insurance enterprises to maintain minimum levels of capital and surplus. Our insurance subsidiaries’ target is generally to maintain capital at 300% of the Company Action Level Risk-based capital (“RBC”) required by regulators, which is 600% of the Authorized Control Level RBC required by our states of domicile. The insurance subsidiaries held capital equal to 355% of the Company Action Level RBC at December 31, 2009. At December 31, 2009, statutory capital, adjusted to exclude asset valuation reserves, for our regulated insurance subsidiaries totaled $1.33 billion.
result in increased utilization of capital beyond that which is generated by the business, and at very high levels of premium growth, we could generate the need for capital infusions. At lower levels of premium growth, additional capital produced by the business exceeds the capital utilized to meet these requirements, which can result in additional capital above our targeted RBC level. At our expected growth rate, in 2010, we anticipate generating between $150 million and $200 million of capital in excess of our 300% RBC target. In addition to the capital carried on the insurance subsidiaries, our non-insurance subsidiaries also hold capital in excess of regulatory requirements.
The following table summarizes our contractual obligations as of December 31, 2009:
The estimated payments expected to be due by period for insurance obligations reflect future estimated cash payments, for pending and future potential claims, to be made to policyholders and others for future policy benefits, policyholders’ account balances, policyholders’ dividends, and reinsurance payables. These future estimated net cash payments are based on mortality, morbidity, lapse and other assumptions comparable with our experience, consider future premium receipts on current polices in force, and assume market growth and interest crediting consistent with assumptions used in amortizing DAC and VOBA. These net cash payments are undiscounted with respect to interest and, as a result, the sum of the net cash payments shown for all years in the table of $7.38 billion exceeds the corresponding liability amount of $5.37 billion included in the Consolidated Financial Statements as of December 31, 2009. We have made significant assumptions to determine the future estimated net cash payments related to the underlying policies and contracts. Due to the significance of the assumptions used, actual net cash payments will differ, possibly materially, from these estimates.
liability amount of $4.34 billion included in the Consolidated Financial Statements as of December 31, 2009. Due to the significance of the assumptions used, actual net cash payments will differ, possibly materially, from these estimates.
In the normal course of business, we commit to fund commercial mortgage loans generally up to 90 days in advance. At December 31, 2009, we had outstanding commitments to fund commercial mortgage loans totaling $52.2 million, with fixed interest rates ranging from 6.00% to 7.75%. These commitments generally have fixed expiration dates. A small percentage of commitments expire due to the borrower’s failure to deliver the requirements of the commitment by the expiration date. In these cases, we will retain the commitment fee and good faith deposit. Alternatively, if we terminate a commitment due to the disapproval of a commitment requirement, the commitment fee and deposit may be refunded to the borrower, less an administrative fee.
The insurance obligations in the table are actuarial estimates of the cash required to meet our obligations for future policy benefits and claims. These estimates do not represent an exact calculation of our future benefit liabilities, but are instead based on assumptions, which involve a number of factors, including mortality, morbidity, recovery, the consumer price index, reinsurance arrangements and other sources of income for people on claim. Assumptions may vary by age and gender and, for individual policies, occupation class of the claimant, time elapsed since disablement, and contract provisions and limitations. 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 regulation. Changes in one or more of these factors or incorrect assumptions could cause actual results to be materially different from the information presented in the table.
Statutory results exclude federal income taxes and net capital gains and losses. GAAP results have also been presented below excluding net capital losses, which were $26.9 million, $128.8 million and $0.6 million for 2009, 2008 and 2007, respectively. The following table sets forth the difference between the statutory net gains from insurance operations before federal income taxes and net capital gains and losses (“Statutory Results”) and GAAP income before income taxes excluding net capital gains and losses (“Adjusted GAAP Results”):
The increase in Statutory Results for 2009 was primarily due to an increase in net investment income as a result of high individual annuity deposit volume for the fourth
The increase in Statutory Results compared to Adjusted GAAP Results for 2009 compared to 2008 was primarily due to favorable differences in DAC and favorable changes in reserves on a statutory basis compared to a GAAP basis. The decrease of the variance between Statutory Results and Adjusted GAAP Results for 2008 compared to 2007 was primarily due to increases in the expensing of DAC and VOBA that were offset by losses that were deferred on a statutory basis. The reserve discount rate for long term disability claims on a statutory basis was 4.50% during 2009 and 2008. The GAAP reserve discount rate ranged from 4.50% to 5.50% in 2009 and ranged from 5.00% to 5.75% in 2008.
Statutory capital adjusted to exclude asset valuation reserves for our insurance regulated subsidiaries totaled $1.33 billion and $1.23 billion at December 31, 2009 and 2008, respectively. The asset valuation reserve was $89.7 million and $78.8 million at December 31, 2009 and 2008, respectively.
The debt security was held at the beginning of the interim period of adoption,
It was not more likely than not that we would be required to sell the debt security before recovery of its amortized cost basis.
Investments, excluding fixed maturity securities and commercial mortgage loans, include real estate held for investment, derivatives and policy loans. Capital gains and losses for these investments are recognized using the specific identification method. For real estate held for investment, we record impairments when it is determined that the decline in fair value of an investment below its amortized cost is other than temporary. The impairment loss is charged to net capital gains or losses, and the cost basis of the investment is permanently adjusted to reflect the impairment.
varying from 30 to 40 years. Accumulated depreciation for real estate totaled $32.7 million and $30.1 million at December 31, 2009 and 2008, respectively. Real estate acquired in satisfaction of debt is recorded at the lower of cost or fair value, less estimated costs to sell. Real estate acquired in satisfaction of debt totaled $29.9 million and $6.2 million at December 31, 2009 and 2008, respectively.
profitability are inconsistent with our assumptions, we could be required to make adjustments to VOBA and related amortization. For the VOBA associated with the Minnesota Life block of business reinsured, the amortization period is up to 30 years and is amortized in proportion to future premiums. The VOBA associated with the TIAA transaction is amortized in proportion to expected gross profits with an amortization period of up to 20 years. VOBA totaled $30.4 million and $31.1 million at December 31, 2009 and 2008, respectively. In accordance with the adoption of new accounting guidance in 2007, the amortization period changed and the premium portion of the VOBA related to TIAA was recorded as a $10.0 million reduction to retained earnings in 2007.
that results in an after-tax benefit generally occurs as a result of actual experience or future expectations being favorable compared to previous estimates. An unlocking event that results in an after-tax charge generally occurs as a result of actual experience or future expectations being unfavorable compared to previous estimates. As a result of unlocking, the amortization schedule for future periods is also adjusted. Due to unlocking, DAC and VOBA balances decreased $1.0 million and $0.4 million for 2009 and 2008, respectively. Based on past experience, future changes in DAC and VOBA balances due to changes in underlying assumptions are not expected to be material. However, significant, unanticipated changes in key assumptions, which affect the determination of expected gross profits, may result in a large unlocking event that could have a material adverse effect on our financial position or results of operations.
Reserves include policy reserves for claims not yet incurred, policy reserve liabilities for our individual and group immediate annuity business and claim reserve liabilities for unpaid claims and claim adjustment expenses for claims that have been incurred or are estimated to have been incurred but not yet reported to us. These reserves totaled $5.17 billion, $5.12 billion and $5.02 billion at December 31, 2009, 2008 and 2007, respectively.
Reserves represent amounts to pay future benefits and claims. Developing the estimates for reserves (and therefore the resulting impact on earnings) requires varying degrees of subjectivity and judgment, depending upon the nature of the reserve. For most of our reserves, the calculation methodology is prescribed by various accounting and actuarial standards, although judgment is required in the determination of assumptions to use in the calculation. At December 31, 2009, these reserves represented approximately 88% of total reserves held or $4.73 billion. We also hold reserves that lack a prescribed methodology but instead are determined by a formula that we have developed based on our own experience. Because this type of reserve requires a higher level of subjective judgment, we closely monitor its adequacy. These reserves, which are primarily incurred but not reported (“IBNR”) claim reserves associated with our disability products, represented approximately 12% of total reserves held at December 31, 2009, or $631.8 million. Finally, a small amount of reserves is held based entirely upon subjective judgment. These reserves are generally set up as a result of unique circumstances that are not expected to continue far into the future and are released according to pre-established conditions and timelines. These reserves represented less than 1% of total reserves held at December 31, 2009, or $7.9 million.
The claim reserves are related to group life and group and individual disability products offered by our Insurance Services segment. The following table sets forth total claim reserves segregated between reserves associated with life versus disability products:
Claim termination rates can vary widely from quarter to quarter. The claim termination assumptions used in determining our reserves represent our expectation for claim terminations over the life of our block of business and will vary from actual experience in any one quarter. In 2009, while we have experienced some variation in our claim termination experience, we have not seen any prolonged or systemic change that would indicate a sustained underlying trend that would affect the claim termination rates used in the calculation of reserves.
We monitor the adequacy of our reserves relative to our key assumptions. In our estimation, scenarios based on reasonably possible variations in claim termination assumptions could produce a percentage change in reserves for our group insurance lines of business of approximately +/- 0.2% or $8.0 million. However given that claims experience can fluctuate widely from quarter to quarter, significant unanticipated changes in claim termination rates over time could produce a change in reserves for our group insurance lines outside of this range.
In accordance with the accounting principles related to our pension and other postretirement plans, we are required to make a significant number of assumptions in order to calculate the related liabilities and expenses each period. The major assumptions that affect net periodic benefit cost and the funded status of the plans include the weighted-average discount rate, expected return on plans assets, and rate of compensation increase.
yield of a portfolio of high-quality corporate bonds with durations that are similar to the expected distributions from the employee benefit plan.
Our discount rate assumption is reviewed annually, and we use a December 31 measurement date for each of our plans. For more information concerning our pension and postretirement plans, see Item 8, “Financial Statements and Supplementary Data-Notes to Consolidated Financial Statements-Note 11-Pension Benefits” and “-Note 12-Postretirement Benefits Other than Pensions.”
assets and liabilities. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply when the temporary differences are expected to reverse.
From time to time StanCorp or its representatives make written or oral statements, including some of the statements contained or incorporated by reference in this Annual Report on Form 10-K and in other reports, filings with the Securities and Exchange Commission, press releases, conferences or otherwise, that are other than purely historical information. These statements, including estimates, projections, statements related to business plans, strategies, objectives and expected operating results and the assumptions upon which those statements are based, are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and Section 21E of the Exchange Act, as amended. Forward-looking statements also include, without limitation, any statement that includes words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “estimates,” “seeks,” “will be,” “will continue,” “will likely result” and similar expressions that are predictive in nature or that depend on or refer to future events or conditions. Our forward-looking statements are not guarantees of future performance and involve uncertainties that are difficult to predict. They involve risks and uncertainties which may cause actual results to differ materially from the forward-looking statements including, but are not limited to, the following:
Growth of sales, premiums, annuity deposits, cash flows, assets under administration including
performance of equity investment in the separate account, gross profits and profitability.
Changes in our liquidity needs and the liquidity of assets in our investment portfolio.
Changes in the regulatory environment at the state or federal level including changes in income taxes or changes in U.S. GAAP accounting principles, practices or policies.
As discussed in Note 1 to the consolidated financial statements, on January 1, 2007, upon the adoption of new accounting guidance, the Company changed its method of accounting for the amortization of deferred acquisition costs.
StanCorp, headquartered in Portland, Oregon, is a holding company and conducts business through wholly-owned operating subsidiaries throughout the United States. Through its subsidiaries, StanCorp has the authority to underwrite insurance products in all 50 states. StanCorp operates through two segments: Insurance Services and Asset Management, each of which is described below. See “Note 3-Segments.”
Standard Insurance Company (“Standard”), the Company’s largest subsidiary, underwrites group and individual disability insurance and annuity products, group life and accidental death and dismemberment (“AD&D”) insurance, and provides group dental insurance and vision insurance, absence management services and retirement plan products. Founded in 1906, Standard is domiciled in Oregon, licensed in all states except New York, and licensed in the District of Columbia and the U.S. Territories of Guam and the Virgin Islands.
StanCorp Mortgage Investors, LLC (“StanCorp Mortgage Investors”) originates and services small, fixed-rate commercial mortgage loans for the investment portfolios of the Company’s insurance subsidiaries. StanCorp Mortgage Investors also generates additional fee income from the origination and servicing of commercial mortgage loans participated to institutional investors.
StanCorp Real Estate, LLC is a property management company that owns and manages the Hillsboro, Oregon home office properties and other properties and manages the Portland, Oregon home office properties.
StanCorp and Standard hold interests in low-income housing partnerships. These interests do not meet the requirements for consolidation under existing accounting standards, and thus our interests in the low-income housing partnerships are accounted for under the equity method of accounting. The total investment in these interests was $20.1 million and $18.8 million at December 31, 2009 and 2008, respectively.
The Company has evaluated subsequent events through the date of this filing and have concluded that there are no material subsequent events, which would require further disclosure.
The Company’s consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and require the Company to make estimates and assumptions that affect reported amounts of assets and liabilities and disclosures of contingent assets and contingent liabilities at the dates of the financial statements
and the reported amounts of revenues and expenses during the reporting periods. The estimates most susceptible to material changes due to significant judgment (the “critical accounting policies”) are those used in determining investment valuations, deferred acquisition costs (“DAC”), value of business acquired (“VOBA”) and other intangible assets, goodwill, the reserves for future policy benefits and claims, pension and postretirement benefit plans and the provision for income taxes. The results of these estimates are critical because they affect our profitability and may affect key indicators used to measure the Company’s performance. These estimates have a material effect on our results of operations and financial condition.
Our intent to sell or whether it is more likely than not we will be required to sell a fixed maturity security before recovery of the security’s cost basis through the evaluation of facts and circumstances including but not limited to, decisions to rebalance our portfolio, current cash flow needs and sales of securities to capitalize on favorable pricing.
If it is determined an other-than-temporary impairment (“OTTI”) exists, the Company separates the OTTI of debt securities into an OTTI related to credit loss and an OTTI related to noncredit loss. The OTTI related to credit loss represents the portion of losses equal to the difference between the present value of expected cash flows, discounted using the pre-impairment yields, and the amortized cost basis. All other changes in value represent the OTTI related to noncredit loss. The OTTI related to
At December 31, 2009, the Company’s fixed maturity securities watch list totaled $19.6 million in fair value and $26.0 million at amortized cost after OTTI had been taken. The Company records OTTI related to credit loss of $5.9 million for 2009. There was no OTTI related to noncredit loss for 2009. The Company will continue to evaluate our holdings. However, the Company currently expects the fair values of our investments to recover either prior to their maturity dates or upon maturity. Should the credit quality of the Company’s fixed maturity securities significantly decline, there could be a material adverse effect on the Company’s business, financial position, results of operations or cash flows.
The Company recorded a cumulative effect adjustment of $2.3 million, net of tax, for the portion of OTTI related to debt security noncredit loss for the period prior to April 1, 2009. The Company met the following criteria in order to record the cumulative effect adjustment:
The Company did not have any direct exposure to sub-prime or Alt-A mortgages in our fixed maturity securities portfolio at December 31, 2009. Fixed maturity securities are classified as available-for-sale and are carried
Commercial mortgage loans are stated at amortized cost less a loan loss allowance for potentially uncollectible amounts. The commercial mortgage loan loss allowance is estimated based on evaluating known and inherent risks in the loan portfolio and consists of a general loan loss allowance and a specific loan loss allowance. The general loan loss allowance is based on the Company’s analysis of factors including changes in the size and composition of the loan portfolio, actual loan loss experience and individual loan analysis. A specific loan loss allowance is set up when a loan is considered to be non-performing. The Company defines a non-performing loan as a loan that is not performing to the contractual terms of the loan agreement and for which the Company believes there is a probability of loss on the loan. In addition, the Company evaluates the loss to dispose of the property, any significant out of pocket expenses the loan may incur, the loan-to-value ratio, and other quantitative information management has concerning the loan. Loans that are deemed uncollectible are generally written off against the allowance, and recoveries, if any, are credited to the allowance. The Company’s loan loss allowance for commercial mortgage loans was $19.6 million and $6.8 million for December 31, 2009 and December 31, 2008, respectively. The Company did not have any direct exposure to sub-prime or Alt-A mortgages in its commercial mortgage loan portfolio at December 31, 2009.
basis of the investment is permanently adjusted to reflect the impairment.
Derivative instruments are carried at fair value, and valuation adjustments for derivatives are reported as a component of net investment income. See “Note 7-Derivative Financial Instruments.”
StanCorp adopted the fair value measurements accounting pronouncement beginning January 1, 2008. See “Note 4-Fair Value of Financial Instruments.”
The Company’s individual deferred annuities and group annuity products are classified as investment contracts. DAC related to these products is amortized over the life of related policies in proportion to expected gross profits. For the Company’s individual deferred annuities, DAC is generally amortized over 30 years with approximately 55%
and 95% expected to be amortized by years 5 and 15, respectively. DAC for group annuity products is amortized over 10 years with approximately 65% expected to be amortized by year five.
VOBA primarily represents the discounted future profits of business assumed through reinsurance agreements. We have established VOBA for a block of individual disability business assumed from Minnesota Life Insurance Company (“Minnesota Life”) and a block of group disability and group life business assumed from Teachers Insurance and Annuity Association of America (“TIAA”). VOBA is generally amortized in proportion to future premiums for group and individual disability insurance products and group life products. However, a portion of the VOBA related to the TIAA transaction associated with an in force block of group long term disability claims for which no ongoing premium is received is amortized in proportion to expected gross profits. If actual premiums or future profitability are inconsistent with our assumptions, the Company could be required to make adjustments to VOBA and related amortization. For the VOBA associated with the Minnesota Life block of business reinsured, the amortization period is up to 30 years and is amortized in proportion to future premiums. The VOBA associated with the TIAA transaction is amortized in proportion to expected gross profits with an amortization period of up to 20 years. VOBA totaled $30.4 million and $31.1 million at December 31, 2009 and 2008, respectively. In accordance with the adoption of new accounting guidance in 2007, the amortization period changed and the premium portion of the VOBA related to TIAA was recorded as a $10.0 million reduction to retained earnings in 2007.
The Company’s other intangible assets are subject to amortization and consist of certain customer lists and a marketing agreement. Customer lists were obtained in connection with acquisitions and have a combined estimated weighted-average remaining life of approximately 9.3 years. A marketing agreement accompanied the Minnesota Life transaction and provides access to Minnesota Life agents, some of whom now market Standard’s individual disability insurance products. The amortization period for the Minnesota Life marketing agreement is up to 25 years. Other intangible assets totaled $55.8 million and $54.2 million at December 31, 2009 and 2008, respectively.
performed a step one test, as of December 31, 2009, in which the carrying value of tested assets was compared to the assets’ fair value. Fair value is measured using a combination of the income approach and the market approach. The income approach consists of utilizing the discounted cash flow method that incorporates the Company’s estimates of future revenues and costs, discounted using a market participant weighted-average cost of capital. The Company’s estimates used in the income approach were consistent with the plans and estimates used to manage its operations. The market approach utilizes multiples of profit measures in order to estimate the fair value of the assets. As the income approach more closely aligns with how the Company internally evaluates and manages its business, the Company weighted the income approach more heavily than the market approach in determining the fair value of the assets. However, the Company did perform testing to ensure that both models were providing reasonably consistent results. Additionally, the Company performed sensitivity analysis on the key input factors in these models to determine whether any input factor or combination of factors moving moderately in either direction would change the results of these tests. Through the performance of these tests, the Company concluded that goodwill was not impaired as of December 31, 2009.
Separate account assets and liabilities represent segregated funds held for the exclusive benefit of contract holders. The activities of the account primarily relate to contract holder-directed 401(k) contracts. Standard charges the separate account with asset management and plan administration fees associated with the contracts. Separate account assets are carried at fair value and separate account liabilities are carried at the amount of the related assets.
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. 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 and considerations concerning a number of factors, which include:
Other policyholder funds are liabilities for investment-type contracts and are based on the policy account balances including accumulated interest. Other policyholder funds include amounts related to advanced premiums, premiums on deposit and experience rated liabilities totaling $431.6 million and $419.6 million at December 31, 2009 and 2008, respectively.
The Company files a U.S. consolidated income tax return that includes all subsidiaries. The Company’s U.S. income tax is calculated using regular corporate income tax rates on a tax base determined by laws and regulations administered by the Internal Revenue Service (“IRS”). The Company also files corporate income tax returns in various states. The provision for income taxes includes amounts currently payable and deferred amounts that result from temporary differences between financial reporting and tax bases of assets and liabilities. Deferred tax assets and
The effects on certain provisions of FASB Interpretation No. (“FIN”) 46(R), Consolidation of Variable Interest Entities, codified in ASU Topic 810, as a result of the elimination of the qualifying special-purpose entity concept in SFAS No. 166, Accounting for Transfers of Financial Assets-an amendment of FASB Statement No. 140, codified in ASU Topic 860.
ASU No. 17 is effective as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period, and for interim and annual reporting periods thereafter. Earlier adoption of ASU No. 17 is prohibited. This standard is expected to be added to the FASB codification by its effective date. The Company does not expect the adoption of ASU No. 17 to have a material effect on its consolidated financial statements.
The fair value hierarchy prioritizes the inputs to valuation techniques used to measure fair value into three broad levels: Level 1 inputs are based upon quoted prices in active markets for identical assets or liabilities that the Company can access at the measurement date. Level 2 inputs are based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and
The Company did not elect to measure and record commercial mortgage loans, policy loans, other policyholders funds that are investment-type contracts, and long-term debt at fair value on the consolidated balance sheets.
or performs independent valuations on a case-by-case basis of inputs and assumptions similar to those used by the pricing service. Although the Company does identify differences from time to time as a result of these validation procedures, the Company did not make any significant adjustments as of December 31, 2009 or December 31, 2008.
S&P 500 index options and certain available-for-sale fixed maturity securities were valued using Level 3 inputs and are included in the corporate bonds category in the table below. The available-for-sale fixed maturity security bonds in Level 3 were valued using matrix pricing, independent broker quotes and other market standard valuation methodologies. These values utilized inputs that were not observable or could not be derived principally from, or corroborated by, observable market data. These inputs included assumptions regarding liquidity, estimated future cash flows, and discount rates. Unobservable inputs to these valuations are based on management’s judgment or estimation obtained from the best sources available. The Company’s valuations maximize the use of observable inputs, which include an analysis of securities in similar sectors with comparable maturity dates and bond ratings. Broker quotes are validated by management for reasonableness in conjunction with information obtained from matrix pricing and other sources.
The valuation technique used to determine the fair value of index-based interest guarantees is the income approach. The liability is the present value of future cash flows attributable to the projected index growth in excess of cash flows driven by fixed interest rate guarantees for the indexed annuity product. Level 3 assumptions for policyholder behavior and future index interest rate declarations significantly impact the calculation.
Changes to the fair value of fixed maturity securities were recorded to other comprehensive income. Changes to the fair value of the S&P 500 index options were recorded to net investment income. Changes in the fair value of the index-based interest guarantees were recorded as interest credited. The interest credited amount for 2009 also included a change in the Level 3 actuarial assumptions that contributed $2.4 million of negative interest to the balance.
Certain assets and liabilities are measured at fair value on a nonrecurring basis such as non-performing commercial mortgage loans with specific reserves and real estate acquired through commercial mortgage loan foreclosures.
The commercial mortgage loans with specific reserves and real estate owned are valued using Level 3 measurements. These measurements include appraisals and a valuation of the market value of the asset using general underwriting procedures. These Level 3 inputs are reviewed for reasonableness by management and evaluated on a quarterly basis. For further discussion of commercial mortgage loans with specific reserves, see “Note 6-Commercial Mortgage Loans, Net.”
The following tables set forth the amortized cost and fair value of available-for-sale investment securities at December 31:
The following table sets forth the contractual maturities of available-for-sale investment securities at December 31:
The following table sets forth net investment income summarized by type of investment for the years ended December 31:
The following table sets forth the gross unrealized losses and fair value of investments, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2009:
on management’s evaluation of the securities and the Company’s intent to sell or whether it is more likely than not the Company will be required to sell the securities, none of the unrealized losses summarized in this table are considered other-than-temporary. In comparing December 31, 2009, to December 31, 2008, the significant decrease in the number and amount of securities with an unrealized loss position was primarily due to an overall economic improvement in the securities’ markets that affected multiple economic sectors.
Commercial mortgage loans foreclosed were $33.2 million and $6.8 million for 2009 and 2008, respectively. Assets transferred to real estate were $24.2 million and $6.2 million for 2009 and 2008, respectively, after charges against the allowance. At December 31, 2009 and 2008, we had commercial mortgage loans totaling $17.3 million and $7.8 million, respectively, which were more than sixty days delinquent, and of these amounts, $6.2 million and $3.9 million, respectively, were in the process of foreclosure. We had a net balance of restructured loans of $28.7 million at December 31, 2009. For 2009, 25 commercial mortgage loans from 11 different states were foreclosed or acquired through deed in lieu in the amount of $33.2 million. The foreclosure of these loans resulted in an overall loss of $8.3 million for 2009, with no individual state representing more than $1.4 million of the losses. For 2009, the value of real estate acquired as a result of this activity was $24.2 million.
interest guarantees are discounted back to the date of the balance sheet using current market indicators for future interest rates, option costs and actuarial estimates for policyholder lapse behavior and management’s discretion in setting renewal index-based guarantees. The interest credited to policyholders relating to the change in the fair value of the index-based interest guarantees decreased $0.4 million for 2009, compared to a decrease of $9.2 million for 2008. The decrease for 2009 and 2008 was primarily due to fluctuations of the S&P 500 index and the discount rates used to value the derivatives during those periods.
The following table sets forth the fair value of the Company’s derivative assets (See “Note 4-Fair Value of Financial Instruments” for additional fair value information) as of December 31:
The following table sets forth the amount of gain or loss recognized in earnings from the change in fair value of the Company’s derivative assets and liabilities for December 31:
the S&P 500 index. The maximum credit risk is calculated using the cap strike price within the Company’s index option contracts less the floor price, multiplied by the notional amount of the contracts.
The following table sets forth the fair value of the Company’s derivative assets and its maximum credit risk exposure related to its derivatives at December 31, 2009:
8. LIABILITY FOR UNPAID CLAIMS, CLAIM ADJUSTMENT EXPENSES AND OTHER POLICYHOLDER FUNDS
The liability for unpaid claims, claim adjustment expenses and other policyholder funds includes liabilities for insurance offered on products such as group long term and short term disability, individual disability, group dental, group vision and group AD&D. The liability for unpaid claims and claim adjustment expenses is established when a claim is incurred or is estimated to have been incurred but not yet reported to us and, as prescribed by GAAP, equals our best estimate of the present value of the liability of future unpaid claims and claim adjustment expenses. This liability is included in future policy benefits and claims in the consolidated balance sheets. The following table sets forth the change in the liabilities for unpaid claims and claim adjustment expenses for the years ended December 31:
On May 29, 2007, the Company completed a public debt offering of $300 million of junior subordinated debentures (“Subordinated Debt”) with an interest rate of 6.90%. The Subordinated Debt has a final maturity on June 1, 2067, is non-callable at par for the first 10 years (prior to June 1, 2017) and is subject to a replacement capital covenant. The covenant limits replacement of the Subordinated Debt for the first 40 years to be redeemable after year 10 (on or after June 1, 2017) and only with securities that carry equity-like characteristics that are the same as or more equity like than the Subordinated Debt. The principal amount of the Subordinated Debt is payable at final maturity. Interest is payable semi-annually at 6.90% in June and December for the first 10 years up to June 1, 2017, and quarterly thereafter at a floating rate equal to three-month LIBOR plus 2.51%. StanCorp has the option to defer interest payments for up to five years. StanCorp is currently not deferring interest on the Subordinated Debt.
The Company is carrying forward net operating losses of $45.4 million that originated in StanCorp and certain subsidiaries. The losses will be used in future years to offset taxable income from those entities to the degree allowed by the Internal Revenue Code. If unutilized, these losses would expire between the years 2023 and 2029. In addition, the Company is carrying forward a $55.4 million federal net operating loss from a business acquisition. This carryforward is subject to limitations under IRS Section 382, which potentially reduces the annual amount that may be utilized. This carryforward will expire between 2019 and 2024. In addition, as a result of this business acquisition, the Company has approximately $1 million of various state net operating loss carryforwards that expire at various dates through 2029.
The Company did not have any material unrecognized tax benefits in 2009 and 2008. It is the Company’s accounting policy to record income tax interest and penalties in the income tax provision. See “Note 1-Summary of Significant Accounting Policies-Income Taxes.”
In September 2008, the compensation and organization committee of the board of directors of StanCorp approved an amendment to the employee pension plan that also had the effect of modifying the terms of the non-qualified supplemental retirement plan (“non-qualified plan”), which covers eligible executive officers. The amendment became effective January 1, 2009. Under the employee pension plan and the non-qualified plan, a participant is entitled to a normal retirement benefit once the participant reaches age 65. Prior to the amendment, a participant could also receive a normal, unreduced retirement benefit once the participant reached age 60 and the sum of his or her age plus years of service was at least 90. The amendment eliminates the requirement that a participant reach age 60 in order to receive an unreduced early retirement benefit, thereby making a participant eligible for this unreduced benefit once the sum of his or her age plus years of service is at least 90.
The Company recognizes the funded or underfunded status of the pension plans as an asset or liability on the balance sheet. This is measured as the difference between the plan assets at fair value and the projected benefit obligation as of the year-end balance sheet date. At December 31, 2009, a liability of $30.5 million was reflected on the balance sheet.
The following table sets forth the projected and accumulated benefit obligations and the fair value of assets for our pension plans at December 31:
The Company recognizes as a component of accumulated other comprehensive income or loss, net of tax, the actuarial gains or losses, prior service costs or credits, and transition assets that have not yet been recognized as components of net periodic benefit cost. The following table sets forth the amounts recognized in accumulated other comprehensive loss at December 31:
The following table sets forth the components of net periodic benefit cost, other changes in plan assets and benefit obligations recognized in other comprehensive loss, and obligation assumptions used in the measurement of the benefit obligations for the years ended December 31:
The investment goal of the employee pension plan is to produce long-run portfolio returns that are consistent with reasonable contribution rates and a well-funded plan. To manage the overall risk of the portfolio, the portfolio is reviewed quarterly and rebalanced as necessary to keep the allocation of debt and equity securities within target allocation tolerance levels. The equity securities include pooled separate account funds comprised of large cap growth, large cap blend, large cap value, mid cap blend and foreign mutual funds and are diversified across investment strategies. The employee pension plan held no StanCorp equity securities as plan assets at December 31, 2009 and 2008. The plan invests in a stable asset fund comprised of debt securities represented by a Deposit Administration Contract with Standard. Standard maintains the contributions in an unallocated fund, whose assets are invested with other assets in the general account of Standard. The account is credited with earnings on the underlying investments and charged for plan withdrawals and administrative expenses charged by Standard Retirement Services. The stable asset fund contract may subject the plan to concentrations of risk as its contract value is dependent on the ability of Standard to honor its contractual commitments. There are no reserves against contract value for credit risk of Standard or otherwise.
The following table sets forth the estimated fair values of assets and liabilities measured and recorded at fair value on a recurring basis at December 31, 2009:
Eligible employees are covered by one of two qualified deferred compensation plans sponsored by Standard and Standard Retirement Services under which a portion of the employee contribution is matched. Employees not eligible for the employee pension plan are eligible for an additional non-elective employer contribution. Contributions to the plan for 2009, 2008 and 2007 were $10.5 million, $10.2 million and $8.8 million, respectively.
Eligible executive officers, directors, agents and group producers may participate in one of several non-qualified deferred compensation plans under which a portion of the deferred compensation for participating executive officers, agents and group producers is matched. The liability for the plans was $9.9 million and $8.9 million at December 31, 2009 and 2008, respectively.
The Company uses a December 31 measurement date for the postretirement benefit plan. The following table sets forth a reconciliation of the changes in the postretirement benefit plan’s accumulated benefit obligation, fair value of assets and the funded status for the years ended December 31:
The projected discounted cash flow obligation for the postretirement benefit plan was $50.9 million and $42.1 million at December 31, 2009 and 2008, respectively.
The following table sets forth expected benefit payments for the Company’s postretirement benefit plan for the years indicated:
Postretirement benefit plan assets are recorded at fair value and are disclosed below using a three-level hierarchy. See “Note 4-Fair Value of Financial Instruments” for additional fair value information. As there was not an active market for the Company’s municipal bond holdings at December 31, 2009, the municipal bonds were valued using Level 2 measurements.
have been issued under the 2002 Plan. The Company’s ESPP allows eligible employees to purchase StanCorp common stock at a discount. The ESPP is described later in this note.
The Company has provided three types of share-based compensation pursuant to the 2002 Plan: option grants, stock award grants, and stock retainer fees to directors.
Options are granted to directors, officers and certain non-officer employees. Directors typically receive annual grants in amounts determined by the nominating and corporate governance committee of the board of directors and executive officers typically receive annual grants in amounts determined by the organization and compensation committee of the board of directors. Officers may also receive options when hired or promoted to an officer position. In addition, the chief executive officer has authority to award a limited number of options at his discretion to non-executive officers and other employees. Options are granted with an exercise price equal to the market closing price of the Company’s common stock on the date of grant. Directors’ options vest in one year with other options generally vesting in four equal installments on the first four anniversaries of the grant date. Option awards to certain officers vest immediately upon a change of control of the Company as defined in the change of control agreement. Options generally expire 10 years from the grant date.
The fair value of each option award granted under the share-based compensation plans was estimated using the Black-Scholes option pricing model as of the grant date using the assumptions noted in the following table. The Black-Scholes model uses the expected term as an input with the calculated option value varying directly with the length of time until exercise. The Company bases its estimate of the expected term on an analysis of the historical exercise experience of similar options granted to similar employee or director groups. The expected term given below represents the weighted-average expected term of options granted. Expected stock price volatility is based on the volatility of the Company’s common stock price over the prior period equal in duration to the expected term. The dividend rate is the rate expected to be paid over the
In years prior to 2007, the performance-based stock awards consisted of restricted shares (60%) and cash performance units (40%), which represent a right to receive cash equal to the value of one share of common
stock. The restricted shares and cash performance units were subject to forfeiture if continued employment and financial performance criteria were not met.
In December 2006, the organization and compensation committee of the board of directors of StanCorp approved a revised form of long-term incentive award agreement to be used in connection with future grants of performance-based stock awards to officers (“Performance Shares”). Under the new agreement, Performance Share grants represent the maximum number of shares issuable to the designated officers and are generally granted two years before the beginning of the performance period. The
actual number of shares issued at the end of the performance period is based on satisfaction of employment and financial performance conditions, with a portion of the shares withheld to cover required tax withholding. The new agreement replaced the restricted shares and cash performance unit arrangement previously used.
Prior to May 7, 2007, Company common stock was used pursuant to the 1999 Plan and the 2002 Plan to pay a portion of the retainer fees to members of the Company’s board of directors. Total retainer fees were fixed in dollars. Directors received one-third of the retainer fees in common stock and received the remainder in cash. The number of shares issued varied according to the market
value of the common stock on the date of the issue. The shares were fully vested when issued.
On November 6, 2006, the board of directors of the Company approved a director compensation schedule that became effective May 7, 2007. Each director who was not an employee of the Company received cash retainer fees. Additionally, each director received 1,000 shares of Company common stock annually beginning on the day preceding the annual shareholders meeting in 2008.
On February 9, 2009, the board of directors of the Company approved a new director compensation schedule that became effective May 4, 2009. Under the new schedule, each director who is not an employee of the Company receives cash retainer fees and Company common stock with a fair value equal to $50,000 based on the Company’s closing common stock price on the day of the annual shareholders meeting. On November 9, 2009, the board of directors of the Company approved a director compensation schedule that updated the annual board retainer fees and eliminated committee meeting fees effective January 1, 2010.
The number of director shares issued was 10,339, 9,820 and 1,292 for 2009, 2008 and 2007, respectively. The weighted-average fair value per share for the shares issued was $28.19, $53.22 and $46.36 for the same periods, respectively.
The Company’s ESPP allows eligible employees to purchase StanCorp common stock at a 15% discount off the lesser of the fair market value of the common stock on either the commencement date of each six-month offering period or the end-of-the-period purchase date. Under the terms of the plan, each eligible employee may elect to have up to 10% of the employee’s gross total cash compensation for the period withheld to purchase StanCorp common stock. Within the ESPP, no employee may purchase StanCorp common stock having a fair market value in excess of $25,000 in any calendar year. Of the 2.0 million shares authorized for this plan, 0.5 million remain available at December 31, 2009.
The Company’s compensation cost for the ESPP is measured as the sum of the value of the 15% discount and the value of the embedded six-month option. The value of the discount is equal to 15% of the fair market value of the purchase price of the common stock. The value of the embedded option is calculated using the Black-Scholes option pricing model using the assumptions noted in the
The Company manages the insurance risk through sound product design and underwriting, effective claims management, disciplined pricing, distribution expertise, broad diversification of risk by customer geography, industry, size and occupation, maintenance of a strong financial position, maintenance of reinsurance and risk pool arrangements, and sufficient alignment of assets and liabilities to meet financial obligations.
Standard participates in a reinsurance and third party administration arrangement with Northwestern Mutual Life Insurance Company (“Northwestern Mutual”) under which Northwestern Mutual group long term and short term disability products are sold using Northwestern Mutual’s agency distribution system. Generally, Standard assumes 60% of the risk and receives 60% of the premiums for the policies issued. If Standard were to become unable to meet its obligations, Northwestern Mutual would retain the reinsured liabilities. Therefore, in accordance with an agreement with Northwestern Mutual, Standard established a trust for the benefit of Northwestern Mutual with the market value of assets in the trust equal to Northwestern Mutual’s reinsurance receivable from Standard. The market value of assets required to be maintained in the trust at December 31, 2009, was $225.9 million. Premiums assumed by Standard for the Northwestern Mutual business accounted for 3% of the Company’s total premiums for each of the three years 2009, 2008 and 2007. In addition to assuming risk, Standard provides product design, pricing, underwriting, legal support, claims management and other administrative services under the arrangement.
Recoveries recognized under reinsurance agreements were $75.2 million, $64.0 million and $60.8 million for 2009, 2008 and 2007, respectively. Amounts recoverable from reinsurers were $935.0 million and $944.0 million at December 31, 2009 and 2008, respectively. Of these amounts, $792.7 million and $799.6 million were from the reinsurance transaction with Protective Life Insurance Company (“Protective Life”) effective January 1, 2001. See “Note 15-Reinsurance of Blocks of Business.”
Other operating expenses include operating expenses, commissions and bonuses, interest expense, premium taxes, and the net increase in DAC, VOBA and other intangibles.
Statutory accounting practices differ in some respects from GAAP. The principal statutory practices that differ from GAAP are: a) bonds and commercial mortgage loans are reported principally at adjusted carrying value; b) asset valuation and the interest maintenance reserves are provided as prescribed by the NAIC; c) certain assets designated as non-admitted, principally deferred tax assets, furniture, equipment, and unsecured receivables are not recognized as assets, resulting in a charge to statutory surplus; d) annuity considerations with life contingencies, or purchase rate guarantees, are recognized as revenue when received; e) reserves for life and disability policies and contracts are reported net of ceded reinsurance and calculated based on statutory requirements, including required discount rates; f) commissions, including initial commissions and expense allowance paid for reinsurance assumed, and other policy acquisition expenses are expensed as incurred; g) initial commissions and expense allowance received for a block of reinsurance ceded net of taxes are reported as deferred gains in surplus and recognized as income in subsequent periods; h) federal income tax expense includes current income taxes defined as current year estimates of federal income taxes and tax contingencies for current and all prior years and amounts incurred or received during the year relating to prior periods, to the extent not previously provided; and i) deferred tax assets, net of deferred tax liabilities, that will be realized within three years, are considered admitted assets and are included in the regulatory financial statements in accordance with SSAP No. 10R-Income Taxes-Revised, A Temporary Replacement of SSAP No. 10. Standard and The Standard Life Insurance Company of New York are subject to statutory restrictions that limit the maximum amount of dividends and distributions that they could declare and pay to StanCorp without prior approval of the states in which the subsidiaries are domiciled.
State insurance departments require insurance enterprises to adhere to minimum Risk-based capital (“RBC”) requirements promulgated by the NAIC. At December 31, 2009 and 2008, the insurance subsidiaries’ capital levels were significantly in excess of that which would require corrective action by the insurance subsidiaries or regulatory agencies. The Authorized Control Level RBC was $187.9 million and $196.1 million at December 31, 2009 and 2008, respectively.
The following table reconciles the statutory capital and surplus of the insurance subsidiaries based on statutory filings with applicable insurance regulatory authorities to the Company’s GAAP equity at December 31:
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 maintains a $200 million senior unsecured revolving credit facility (“Facility”). The Facility will remain at $200 million through June 15, 2012, and will decrease to $165 million thereafter until final maturity on June 15, 2013. Borrowings under the Facility will continue to be used to provide for the working capital and general corporate purposes of the Company and its subsidiaries and the issuance of letters of credit.
Under the agreement, StanCorp is subject to customary covenants that take into consideration the impact of material transactions, changes to the business, compliance with legal requirements and financial performance. The two financial covenants are based on the Company’s total debt to total capitalization ratio and consolidated net worth. The Facility is subject to performance pricing based upon the Company’s total debt to total capitalization ratio and includes interest based on a Eurodollar margin, plus facility and utilization fees. At December 31, 2009, StanCorp was in compliance with all covenants under the Facility and had no outstanding balance on the Facility.
The Company leases certain buildings and equipment under non-cancelable operating leases that expire in various years through 2020, with renewal options for periods ranging from three to twelve years. Future minimum payments under the leases are 2010, $13.8 million; 2011, $11.1 million; 2012, $9.1 million; 2013, $5.2 million; 2014, $1.5 million and thereafter, $0.8 million. Total rent expense was $23.5 million, $16.0 million and $15.8 million for the years ended December 31, 2009, 2008 and 2007, respectively.
In the normal course of business, the Company commits to fund commercial mortgage loans generally up to 90 days in advance. At December 31, 2009, the Company had outstanding commitments to fund commercial mortgage loans totaling $52.2 million, with fixed interest rates ranging from 6.00% to 7.75%. These commitments generally have fixed expiration dates. A small percentage of commitments expire due to the borrower’s failure to deliver the requirements of the commitment by the expiration date. In these cases, the Company will retain the commitment fee and good faith deposit. Alternatively, if we terminate a commitment due to the disapproval of a commitment requirement, the commitment fee and deposit may be refunded to the borrower, less an administrative fee.
Purchase obligations were 2010, $1.4 million; 2011, $0.6 million; and 2012, $0.2 million. Purchase obligations were related to non-cancelable telecommunication obligations, software maintenance agreements and other contractual obligations.
From time to time, the board of directors has authorized share repurchase programs. Share repurchases are made in the open market or in negotiated transactions in compliance with the safe harbor provisions of Rule 10b-18 under regulations of the Securities Exchange Act of 1934. Execution of the share repurchase program is based upon management’s assessment of market conditions for its common stock, other potential growth opportunities or priorities for capital use. On November 9, 2009, the board of directors authorized a share repurchase program of up to 2.0 million shares of StanCorp common stock, which expires December 31, 2011. The November 2009 repurchase program took effect upon the completion of the previous share repurchase program. On February 8, 2010, the board of directors authorized an additional share repurchase program of up to 3.0 million shares of StanCorp common stock. The February 2010 repurchase program will take effect upon the completion of the November 2009 repurchase program and also expires on December 31, 2011.
5,584 shares of common stock from executive officers and directors to cover tax liabilities of these officers and directors resulting from the release of performance-based shares and retention-based shares at a total cost of $0.2 million for a volume weighted-average price of $31.34 per common share. Repurchases are made at market prices on the transaction dates.