To support enhanced investment in customer service systems technology and processes in each of the Company’s businesses in 2005, we expect operating expenses as a percentage of premiums to exceed historical levels.
Sales. In 2003 and the first half of 2004, sales for this segment decreased as a result of competitive pressure in the market, including the effects of decreasing interest rates and their effect on our pricing competitiveness (see Item 1, “Business-Competition”). During 2004, we reviewed our pricing and lowered rates for our group insurance products in select market segments and industries in order to compete more effectively for new business. We also realigned our compensation plan for field representatives and are continuing to enhance our product offerings. Through these actions we are better using our market data to focus on customers, industries, and sectors where we can be more competitive and still reach our return objectives. As a result, sales reached record highs in the second half of 2004, and annual sales for 2004 were 25.1% higher than 2003.
Our fixed maturity securities portfolio had gross unrealized capital gains of $225.8 million and gross unrealized capital losses of $8.9 million at December 31, 2004. Unrealized losses primarily result from holding fixed maturity securities with interest rates lower than those currently available. Bonds on our credit quality watch list totaled approximately $1.2 million in carrying value at December 31, 2004. Should the credit quality of our fixed maturity securities decline, there could be a material adverse effect on the Company’s business, financial position, results of operations or cash flows.
Statutory accounting practices differ in some respects from GAAP. The principal statutory practices which differ from GAAP are: a) bonds and commercial mortgage loans are reported principally at amortized cost; b) asset valuation and
IMR 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; i) deferred tax assets, net of deferred tax liabilities, are included in the regulatory financial statements but are limited to those deferred tax assets that will be realized within one year; and j) surplus notes are included in capital and surplus.
Real estate held for investment is stated at cost less accumulated depreciation. Depreciation generally is provided on the straight-line method, with property lives varying from 30 to 40 years. Accumulated depreciation totaled $29.8 million and $29.6 million at December 31, 2004 and 2003, respectively. Real estate acquired in satisfaction of debt is held for sale. It is recorded at the lower of cost or fair value less estimated costs to sell and depreciated consistently with real estate held for investment.
In particular, our group and individual long term disability reserves are sensitive to assumptions regarding the following factors:
Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations. Callable bonds represent 1.87%, or $82.5 million, of our investment securities.
Effective October 1, 2002, Standard entered into a reinsurance agreement with TIAA.
StanCorp had a 50% interest in a real estate joint venture. During 2003, we fully guaranteed the existing debt of the entity, and therefore, effective December 31, 2003, we consolidated the entity and its $15.2 million of debt was included in other long-term borrowings. At December 31, 2004, the real estate joint venture was dissolved, the other long-term borrowings were repaid, and the related net assets were distributed.
Subsequent to the terrorist events of September 11, 2001, the availability of reinsurance for catastrophe coverage became less certain and more expensive. Accordingly, we entered into a catastrophe reinsurance pool with other insurance companies. This pool spreads catastrophe losses on group life and AD&D over approximately 35 participating members. The annual fees paid by the Company to participate in the pool and claims to date have been minor. As a member of the pool, we are exposed to potential losses experienced by other participating members of approximately $65 million for a single event for losses submitted by a single company, and approximately $160 million for a single event for losses submitted by multiple companies. If we had been a member of the pool on September 11, 2001, the estimated pre-tax charges related to the terrorist events would have been approximately $15 million compared to pre-tax charges of $5 million incurred. The Company’s percentage share of losses experienced by pool members will change over time as it is a function of our group life and AD&D in force relative to the total group life and AD&D in force for all pool participants. The reinsurance pool does not exclude war or nuclear, biological and chemical acts of terrorism.
based on the federal funds rate, the bank’s prime rate, or the London Interbank Offered Rate at the time of borrowing plus an incremental basis point charge that varies by agreement, type of borrowing, and the amount outstanding on the lines. At December 31, 2004, we were in compliance with all covenants under the credit agreements and have no outstanding balance on the lines of credit. We currently have no commitments for standby letters of credit, standby repurchase obligations, or other related commercial commitments under the credit agreements.
The Company has certain software maintenance, licensing, and telecommunications commitments that expire in various years through 2011, with renewal options for a two-year period. Future minimum payments under these commitments are 2005, $2.4 million; 2006, $2.0 million; 2007, $1.1 million; 2008, $0.1 million and 2009, $0.1 million. Total expense for these agreements was $0.8 million, $0.9 million and $1.2 million for the years ended December 31, 2004, 2003, and 2002, respectively.