Back to GetFilings.com
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998 or
TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission file number 0-20882
STANDARD MANAGEMENT CORPORATION
(Exact name of registrant as specified in its charter)
Indiana 35-1773567
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification no.)
9100 Keystone Crossing, Indianapolis, Indiana 46240 (317) 574-6200
(Address of principal executive offices) (Telephone)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock, No
Par Value
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to
this Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates of the
Registrant, based upon the closing sale price of the Common Stock on March 15,
1999 as reported on The Nasdaq Stock Market, was approximately $42.3 million.
Shares of Common Stock held by each executive officer and director and by each
person who owns 5% or more of the outstanding Common Stock have been excluded
in that such persons may be deemed to be affiliates. This determination of
affiliate status is not necessarily a conclusive determination for other
purposes.
As of March 15, 1999, Registrant had outstanding 7,581,265 shares of Common
Stock.
Documents Incorporated by Reference:
Portions of the Registrant's definitive Proxy Statement for the Annual Meeting
of Stockholders are incorporated by reference into Part III of this Form 10-K.
PART I
AS USED IN THIS REPORT, UNLESS THE CONTEXT OTHERWISE CLEARLY REQUIRES,
"SMC", OR THE "COMPANY" REFERS TO STANDARD MANAGEMENT CORPORATION AND ITS
CONSOLIDATED SUBSIDIARIES AND "STANDARD MANAGEMENT" REFERS TO STANDARD
MANAGEMENT CORPORATION ON AN UNCONSOLIDATED BASIS. ALL FINANCIAL INFORMATION
CONTAINED IN THIS REPORT IS PRESENTED IN ACCORDANCE WITH GENERALLY ACCEPTED
ACCOUNTING PRINCIPLES ("GAAP") UNLESS OTHERWISE SPECIFIED.
ITEM 1. BUSINESS OF SMC
SMC is an international financial services holding company that directly
and through its subsidiaries develops, markets and administers profitable life
insurance, annuities and unit-linked in force business and products. A primary
component of SMC's growth relates to the acquisition of selected insurance
companies and in force life insurance and annuity businesses. Since 1993, the
Company has acquired 5 insurance companies. See "Acquisition Strategy and
Recent Acquisitions" for related information. Through its insurance
subsidiaries, the Company's operating strategy is to develop profitable
products, enhance marketing distribution channels and consolidate and
streamline management and administrative functions of acquired companies.
OPERATING SEGMENTS
The Company conducts and manages its business through the following
operating segments reflecting the geographical locations of principal insurance
subsidiaries:
DOMESTIC OPERATIONS includes the following insurance subsidiaries at
December 31, 1998:
Standard Life Insurance Company of Indiana ("Standard Life"), SMC's
principal insurance subsidiary, was organized in 1934 as an Indiana
domiciled life insurer. It is licensed to write new business or service
existing business in the District of Columbia and all states except New
York and New Jersey. Standard Life offers flexible premium deferred
annuities ("FPDAs"), equity-indexed annuities, whole and universal life
insurance and critical illness products. Standard Life also generates
cash flow and income from closed blocks of in force life insurance and
annuities. At December 31, 1998, Standard Life's statutory assets were
$572.6 million and the aggregate of its statutory capital and surplus,
asset valuation reserve ("AVR") and interest maintenance reserve ("IMR")
(its "adjusted statutory capital") was $61.9 million. The ratio of
adjusted statutory capital to its total statutory assets was 10.8% at
December 31, 1998. Standard Life has a rating of "B+" ("Very Good,
Secure") by the rating agency, A.M. Best Company, Inc. ("A.M. Best").
Dixie National Life Insurance Company ("Dixie Life"), a 99.4% owned
subsidiary of Standard Life, was organized in 1965 as a Mississippi
domiciled life insurer. Dixie Life is licensed in 22 states and markets
a variety of life insurance products throughout the mid-south offering
primarily "burial expense" policies. At December 31, 1998, Dixie Life's
statutory assets were $35.6 million, the adjusted statutory capital was
$4.0 million and the ratio of its adjusted statutory capital to its
statutory assets was 11.2%. Dixie Life has a rating of "B " ("Adequate")
by A.M. Best.
Standard Marketing Corporation ("Standard Marketing") is a wholesale
distributor of life insurance and annuity products. Through its network
of managing general agents and independent agents, Standard Marketing
distributes life insurance and annuity products for Standard Life and
Dixie Life and for a select group of unaffiliated insurance companies.
Standard Marketing earns override commission income from the sale of
these products.
Savers Marketing Corporation ("Savers Marketing") is the prior
marketing distributor of Savers Life Insurance Company ("Savers Life").
Refer to "Acquisition Strategy and Recent Acquisitions". Savers
Marketing markets Standard Life's products through financial institutions
and independent agents. Savers Marketing also receives administrative,
marketing and commission fees for services provided to unaffiliated
companies.
INTERNATIONAL OPERATIONS includes the following holding company and its
two wholly-owned insurance subsidiaries at December 31, 1998:
Standard Management International S.A., a wholly-owned subsidiary of
SMC, is a holding company organized under Luxembourg law with its
registered office in Luxembourg. At December 31, 1998, Standard
Management International, S.A. and its subsidiaries ("SMI") had $205.5
million in assets with policies in force in over 80 countries. The
majority of its business is unit-linked assurance products with a range
of policyholder directed investment choices coupled with a small death
benefit, sold through its subsidiaries.
Premier Life (Luxembourg) S.A. ("Premier Life (Luxembourg)") primarily
offers standard unit-linked products throughout the European Union. At
December 31, 1998 it had statutory capital and surplus of $6.8 million.
Premier Life (Bermuda) Ltd. ("Premier Life (Bermuda)") primarily offers
tax deferred unit-linked products in niche markets throughout the world.
At December 31, 1998 it had statutory capital and surplus of $2.1
million.
ACQUISITION STRATEGY AND RECENT ACQUISITIONS
A principal component of SMC's strategy is to grow through the
acquisition of life insurance companies and blocks of in force life insurance
and annuities. SMC regularly investigates acquisition opportunities in the life
insurance industry that complement or are otherwise strategically consistent
with its existing business. Any decision to acquire a block of business or an
insurance company will depend on a favorable evaluation of various factors. SMC
believes that availability of blocks of business in the marketplace will
continue in response to ongoing industry consolidation, risk-based capital
requirements and other regulatory and rating agency concerns. In addition, SMC
plans to market annuity and life insurance products directly as it has done in
the past. SMC currently has no plans or commitments to acquire any specific
insurance business or other material assets.
SMC has the information systems and administrative capabilities necessary
to add additional blocks of business without a proportional increase in
operating expenses. In addition, SMC has developed management techniques for
reducing or eliminating the expenses of the companies it acquires through the
consolidation of their operations with those of SMC. Such techniques include
reduction or elimination of overhead, including the acquired company's
management, staff and home office, elimination of marketing expenses and, where
appropriate, the substitution of Standard Marketing's network for the acquired
company's current distribution system, and the conversion of the acquired
company's data processing operations to SMC's system.
SMC typically acquires companies or blocks of business through the
purchase or exchange of shares. This method is also used for assumption
reinsurance transactions. SMC's acquisitions may be subject to certain
regulatory approvals, policyholder consents and stockholder approval.
The following is a list of SMC's most recent acquisitions and the terms
under which they were purchased:
On November 8, 1996, Standard Life acquired through merger Shelby Life
Insurance Company ("Shelby Life") from Delta Life and Annuity Corporation
("DLAC"), a life insurance company located in Memphis, Tennessee (the
"Shelby Merger"). The purchase price was approximately $14.7 million,
including $13.0 million in cash, 250,000 shares of restricted Common
Stock (valued at $1.3 million) and acquisition costs of $.4 million.
Financing for the Shelby Merger was provided by $10.0 million from an
Amended Revolving Line of Credit Agreement (the "Amended Credit
Agreement") and $4.0 million in subordinated convertible debt.
On March 12, 1998, SMC acquired Savers Life Insurance Company ("Savers
Life"). Each of the 1,779,908 shares of Savers Life Common Stock
outstanding was converted into 1.2 shares of SMC Common Stock plus $1.50.
Each holder of Savers Life Common Stock could elect to receive the $1.50
per share portion of the merger consideration in the form of additional
shares of SMC Common Stock. SMC issued approximately 2.2 million shares
with a value of approximately $14.9 million, paid $2.2 million in cash
and $1.5 million in acquisition costs for an aggregate purchase price of
$18.6 million. SMC increased the Amended Credit Agreement to $20.0
million as a result of the Savers Life acquisition. The acquisition of
Savers Life included its wholly-owned subsidiary Savers Marketing.
On October 30, 1998, SMC acquired Midwestern National Life Insurance
Company of Ohio, ("Midwestern Life"). SMC issued 696,453 shares of its
common stock valued at $4.6 million, increased its bank debt by $6.0
million on restructured terms by increasing the Amended Credit Agreement
to $26.0 million, and paid $2.9 million in cash and $.6 million of
acquisition costs for an aggregate purchase price of $14.1 million to
acquire Midwestern Life.
The acquisitions of Shelby Life, Savers Life and Midwestern Life were
accounted for using the purchase method of accounting and accordingly, SMC's
consolidated financial statements include the results of operations of the
acquired companies from the effective dates of their respective acquisitions.
Shelby Life was merged into Standard Life, effective November 8, 1996, while
Savers Life and Midwestern Life were merged into Standard Life effective
December 31, 1998. As a result of these mergers, Standard Life remained as the
surviving entity. Under purchase accounting, SMC allocated the total purchase
price of the assets and liabilities acquired, based on a determination of their
fair values and recorded the excess of acquisition cost over net assets
acquired as goodwill, which will be amortized on a straight-line basis over 20
- - 30 years.
MARKETING
DOMESTIC MARKETING
GENERAL: Standard Marketing was organized as a wholesale distribution
system to provide a lower cost alternative to the traditional captive agency
force. Standard Marketing and Savers Marketing have established a network of
approximately 20,000 independent general agents. These agents distribute a
full line of life insurance and annuity products issued by Standard Life and
Dixie Life and a select group of unaffiliated insurance carriers that Standard
Marketing represents. As part of its normal recruiting, Standard Marketing
selectively recruits new agents from those formerly associated with companies
acquired by SMC.
SMC believes that both agents and policy owners value the service
provided by SMC. Standard Marketing and Savers Marketing i) assist agents in
submitting and processing policy applications, ii) help ensure that issuing
insurers pay commissions on a timely basis (commissions are paid within 24
hours subsequent to receipt of policyholder's deposit), iii) assist with
licensing applications, iv) provide marketing support for its agents, and v)
can introduce agents to lead services.
STANDARD MARKETING agents offer a full portfolio of life insurance and
annuity products that Standard Marketing has selected on the basis of their
competitive position and likely consumer acceptance. Such portfolio includes
FPDAs, equity- indexed annuities, whole and universal life insurance and
critical illness products issued by Standard Life and Dixie Life, for which
Standard Marketing is the exclusive distributor, and life insurance products
issued by selected unaffiliated insurers. Standard Marketing receives override
commissions on sales by its agents, which are in addition to the commissions
paid to Standard Marketing's independent agents. The availability of override
commissions provides an economic incentive to Standard Marketing to recruit
agents who produce business. Standard Marketing's relationships with these
companies are non-exclusive and are terminable by either party upon 30 days
notice. Standard Marketing regularly evaluates the products its agents offer
to determine whether products or insurers should be added to, or deleted from,
the Standard Marketing portfolio. SMC does not insure any of the policies and
contracts Standard Marketing's agents sell for unaffiliated insurers.
Each general agent operates his own agency and is responsible for all
expenses of the agency. The general agents are compensated directly by the
issuing insurance companies, which perform all policy issuance, underwriting
and accounting functions. SMC is not dependent on any one agent or agency for
any substantial amount of its business. No single agent accounted for more
than 6% of Standard Life's annual sales in 1998, and the top twenty individual
agents accounted for approximately 42% of Standard Life's volume in 1998. At
December 31, 1998, approximately 66% of Standard Marketing's independent agents
were located in Florida, Indiana, California, Ohio, Texas, North Carolina,
Illinois, Missouri and Georgia, with the balance distributed across the
country. SMC is attempting to increase the number and geographic diversity of
its agents. In 1997, SMC began writing significant amounts of business in
California and the mid-south due to Standard Marketing's expansion efforts.
SMC does not have exclusive agency agreements with its agents and
management believes most of these agents sell products similar to those sold by
SMC for other insurance companies. This could result in a sales decline if
SMC's products were to become relatively less competitive. Standard Life's 1998
FPDA and equity indexed annuity sales increased partially due to an aggressive
marketing campaign targeted to high volume sales agents and marketing
companies. Also contributing to the increase in premiums was the continued
development of Standard Life's distribution system through marketing support
from Standard Marketing along with an aggressive program aimed at retention of
key producers and expanded geographical concentration.
SAVERS MARKETING distributes through financial institutions and independent
general agents. Savers Marketing has approximately 4,000 active brokers and
is not dependent on any one broker or agency for any substantial amount of its
business. Each broker operates independently and is responsible for all of his
or her expenses. Savers Marketing employs three Regional Managers, who are
responsible for personally initiating and maintaining direct communications
with brokers and are responsible for the recruitment and training of all new
brokers.
Savers Marketing also entered into a three-year marketing and
administrative contract with QualChoice of North Carolina ("QualChoice")
effective October 1, 1998 whereby Savers Marketing is the distribution system
for the small group product offered by QualChoice. QualChoice is an HMO in a
twenty-county area in the northwestern part of North Carolina offering HMO
insurance coverage. Savers Marketing is compensated for this effort with a
marketing fee, administrative fee and commission reimbursement for the use of
its brokers. Prior to the agreement with Savers Marketing, QualChoice was
under an agreement with Savers Life that commenced in 1996.
INTERNATIONAL MARKETING
PREMIER LIFE (LUXEMBOURG) AND PREMIER LIFE (BERMUDA), produced aggregate
new premium deposits of approximately $43 million, $22 million and $17 million
during 1998, 1997 and 1996, respectively. The increases in 1997 and 1998 relate
to renewed marketing efforts in certain European countries, particularly in
Sweden, Belgium and Italy. The countries within the European Union have been
the main contributor to these sales. Although SMC expects this to be the case
in the future, it plans to increase marketing efforts in other parts of the
world as well.
Although SMI anticipates as part of its long term plan to grow
significantly through internal sales, acquisitions of other European insurance
companies may be considered. It has designed and launched new single and
regular premium products in recent years. It is also in discussions with a
number of companies to form alliances to produce tailored products for their
markets. It is currently the intention that Premier Life (Luxembourg) will
write business within the European Union and Premier Life (Bermuda) will write
international business elsewhere in the world. The market for SMI's products is
considered to be medium to high net worth individuals who typically have in
excess of $75,000 to invest in a single premium policy and medium to high
earners who have in excess of $3,000 per annum to invest in a regular premium
savings product. The above individuals would come from a combination of
expatriates, residents of European Union countries and from other targeted
areas. The expatriate and European insurance markets are well established and
highly competitive with a large number of domestic and international groups
operating in, or going into, the same markets as SMI.
SMI's products are distributed via independent agents who have
established connections with these targeted individuals. SMI is striving to
develop into an entrepreneurial-intermediary oriented organization committed to
building long term relationships with high quality distributors, thereby
creating a niche position. SMI places the same emphasis as SMC's U.S.
insurance companies on a high level of service to intermediaries and
policyholders while striving to achieve low overhead costs.
PRODUCTS
SMC primarily markets FPDAs, equity indexed annuities, whole life,
universal and interest-sensitive life insurance policies and unit-linked
policies. The following table sets forth the amounts and percentages of net
premiums received by SMC from currently marketed products for the years ended
December 31, 1998, 1997 and 1996, respectively (in thousands). Because GAAP
generally excludes annuity and unit-linked products deposits, and premiums from
universal and interest-sensitive life insurance from premium income, and thus
does not fully reflect SMC's cash flow from new business, the premium
information contained in the following table is reported using statutory
accounting principles which includes the aforementioned items.
Year Ended December 31,
1998 1997 1996
Amount % Amount % Amount %
Currently marketed products:
FPDAs $60,086 45.8 $41,066 55.5 $37,322 58.7
Unit-linked products 42,536 32.5 21,954 29.7 16,902 26.6
Equity-indexed annuities 16,858 12.9 -- -- -- --
Universal and 5,816 4.4 5,836 7.9 5,384 8.5
interest-sensitive life
Whole life 3,282 2.5 2,349 3.2 2,546 4.0
Single premium immediate annuities 2,545 1.9 2,704 3.7 1,423 2.2
$131,123 100.0 $73,909 100.0 $63,577 100.0
Annuity sales increased in 1998 primarily due to the introduction of new
products and an increase in the agency base achieved through the recruitment of
high volume agents. Also attributable to the annuity sales increase were
larger managing general agencies and continued expansion of geographical
concentration.
The increase in deposits from unit linked products in 1998 is primarily
due to a continuation of marketing efforts in certain European countries,
particularly in Sweden, Belgium and Italy.
CURRENTLY MARKETED PRODUCTS
The individual annuity business is a growing segment of the savings and
retirement industry, which increased in sales from $1 billion in 1970 to more
than $54 billion in 1990. The individual annuity market, which is one of SMC's
primary targets, comprises 61% of those sales. As the 76 million baby boomers
born from 1946 through 1964 grow older, demand for insurance products is
expected to grow. SMC believes that those seeking adequate retirement incomes
will become less dependent on Social Security and their employers' retirement
programs and more dependent upon their own financial resources. Annuities
currently enjoy an advantage over certain other saving mechanisms because the
annuity buyer receives a tax-deferred accrual of interest on his investment
during the accumulation period.
SMI's products are sold primarily in Western Europe. SMC's gross sales
percentages by U.S. geographical region are summarized as follows:
STATE 1998 1997 1996
Indiana 17% 21% 18%
Ohio 15 10 16
North Carolina 10 4 4
Arizona 9 -- --
Florida 8 10 14
Hawaii 7 -- --
California 5 11 11
Nevada 3 2 2
Texas 3 4 4
All other states {(1)} 23 38 31
Total 100% 100% 100%
(1) No other state had gross sales greater than 6%.
STANDARD LIFE PRODUCTS
FLEXIBLE PREMIUM DEFERRED ANNUITIES ("FPDA"s) provide for an initial
deposit by an annuitant and optional additional deposits, the time and amount
of which are at the discretion of the annuitant. Standard Life credits the
account of the annuitant with earnings at interest rates that are revised
periodically by Standard Life until the maturity date. This accumulated value
is tax deferred. Revisions to interest rates on FPDAs are restricted by an
initial crediting rate guaranteed for a specific period of time and a minimum
crediting rate guaranteed for the term of the FPDA. At maturity, the annuitant
can elect a lump sum cash payment of the accumulated value or one of the
various payout options available. Standard Life's FPDAs also provide for
penalty-free partial withdrawals of up to 10% annually of the accumulation
value after the annuitant has held the FPDA for more than 12 months. In
addition, the annuitant may surrender the FPDA at any time before the maturity
date and receive the accumulated value, less any surrender charge then in
effect for that contract. To protect holders of FPDAs from a sharp reduction in
the credited interest rate after a FPDA is issued, Standard Life permits the
FPDA holder of certain annuities to surrender the annuity during a specified
period without incurring a surrender charge if the renewal crediting rate is
below a stated level. This stated level of interest is referred to as the
"bail-out rate" and is typically below the original crediting rate, but above
the minimum guaranteed crediting rate.
As of January 1, 1999, the crediting rates available on Standard Life's
currently marketed FPDAs ranged from 4.8% to 11.0%, with new issues having an
interest rate with a one year guarantee period. After the initial period, the
crediting rate may be changed periodically, subject to minimum guaranteed rates
from 3.0% to 4.0%. As of January 1, 1999, interest crediting rates after the
initial guarantee period ranged from 3.5% to 5.9%. The surrender charge is
initially 7% or 15% of the contract value depending on the product and
decreases over the applicable surrender charge period of five to thirteen
years. As of January 1, 1999, the bail out rate for Standard Life's FPDAs was
4.5%; most currently marketed products carry a bail out rate for only the first
two years after issuance. As of December 31, 1998, Standard Life had 8,962
currently marketed FPDA contracts in force.
EQUITY-INDEXED FPDAS. In response to consumers' desire for alternative
investment products with returns linked to those of common stocks, Standard
Life introduced an equity-indexed FPDA product in May 1998. This product
accounted for $16.9 million of the total premiums collected in 1998. The
annuity's contract value is equal to the premium paid increased for returns
based upon a percentage (the "participation rate") of the change in the S&P 500
Index during each year of its term, subject to a minimum guaranteed value. The
Company has the discretionary ability to annually change the participation rate
(which currently ranges from 65% to 70% plus a first-year "bonus"). The
minimum guaranteed values are equal to 85% of first year and 90% of renewal
premiums collected for FPDAs, plus interest credited at an annual rate of 3%.
The annuity provides for penalty-free withdrawals of up to 10% in each year
after the first year of the annuity's term. Other withdrawals from the product
are subject to a surrender charge of 10% in the first year, declining each
year, to zero over a 9 year period. The Company purchases Standard & Poor's
500 Index Call Options (the "S&P 500 Call Options") to hedge potential
increases to policyholder benefits resulting from increases in the S&P 500
Index to which the product's return is linked. As of December 31, 1998,
Standard Life had 617 equity-indexed contracts.
UNIVERSAL LIFE. Single premium universal life ("SPUL") policies provide
for an initial deposit (flexible premium universal life ("FPUL") for periodic
deposits), credit interest to account values and charge the account values for
mortality and administrative costs. As of January 1, 1999, the current interest
rate on new sales of SPULs and FPULs was 5.5% with a guaranteed interest rate
of 3.4%. As of December 31, 1998, Standard Life had 78 and 496 SPUL and FPUL
policies in force, respectively.
SINGLE PREMIUM IMMEDIATE ANNUITIES. Standard Life offers a single
premium immediate annuity ("SPIA") whereby an annuitant purchases an immediate
annuity with a one-time premium deposit at the time of issuance. Standard Life
begins a payout stream shortly after the time of issuance consisting of
principal value plus accumulated interest credited to such annuity. This
product credits interest based on an investment portfolio earned rate
assumption. As of December 31, 1998, Standard Life had 764 SPIA contracts in
force.
WHOLE LIFE INSURANCE. Standard Life offers two types of
non-participating whole life policies: one in face amounts up to $10,000 (which
is only issued upon conversion of other policies) and the other in face amounts
up to $50,000. Whole life insurance products involve fixed premium payments
made over time, with the stated death benefit paid in full upon the death of
the insured. The whole life policy combines the death benefit with a forced
savings plan. Premiums remain level over the life of the policy, with the
policyholder prefunding during the early years of coverage when risk of death
is low. Over time, whole life policies begin to accrue a cash value which can
be made available to the policyholder net of taxes and withdrawal penalties. As
of December 31, 1998, Standard Life had 630 currently marketed whole life
policies in force.
DIXIE LIFE PRODUCTS
Life insurance policies sold by Dixie Life in the final expense, or
burial market include fixed premium interest sensitive policies that provide
for increasing death benefits, as well as traditional whole life policies.
These policies are designed to cover expenses such as funeral, last illness,
monument and cemetery lot. The policies provide for a death benefit, generally
not in excess of $10,000, and a level premium payment. The products include a
cash value which may be borrowed by the policyholder. Dixie Life's policies
sold in other markets include interest sensitive and traditional whole life
policies and forms of term policies. The interest sensitive whole life policies
have a guaranteed interest rate of 5.5% on products marketed as of January 1,
1999. The interest sensitive and whole life policies include cash values which
may be borrowed by the policyholder. Dixie Life issues policies on both a
participating and non-participating basis. As of December 31, 1998, Dixie Life
had 597 and 22,195 individual annuities and life policies in force,
respectively. Effective January 1, 1999, SMC has decided not to sell new
business through Dixie Life.
SMI PRODUCTS
UNIT-LINKED POLICIES. SMI currently writes unit-linked life products,
which are similar to U.S. produced variable life products. Separate account
assets and liabilities are maintained primarily for the exclusive benefits of
universal life contracts and investment contracts of which the majority
represents unit-linked business, where benefits on surrender and maturity are
not guaranteed. They generally represent funds held in accounts to meet
specific investment objectives of policyholders who bear the investment risk.
Investment income and investment gains and losses within the separate accounts
accrue directly to the policyholders. The fees received by SMI for
administrative and contract holder maintenance services performed for these
separate accounts are included in SMC's statement of operations.
In the past, SMI also wrote investment contracts and universal life
policies and to a lesser extent, traditional life policies. The investment
contracts are mainly short-term single premium endowments or temporary
annuities under which fixed benefits are paid to the policyholder. The terms of
these contracts are such that SMC has relatively small morbidity or mortality
risk. The universal life contracts are mainly regular premium and single
premium endowment. The benefits payable to the policyholders are directly
linked to the investment performance of the underlying assets.
CLOSED BLOCKS
SMC also generates cash flow and income from its closed blocks of in
force life insurance and annuities. Closed blocks are blocks of in force life
insurance and annuities that are not currently being marketed by SMC. The
closed block designation does not have legal or regulatory significance and
there are no restrictions on the assets or future profits of closed blocks.
The premiums received on the closed blocks were primarily from the ordinary and
universal life business. This decline in premium income is expected as a result
of policy lapses, surrenders and expiries from closed blocks of business.
ANNUITIES. SMC's closed blocks of deferred annuities consist primarily
of FPDAs and a small amount of single premium deferred annuities ("SPDAs")
which, unlike FPDAs, do not provide for additional deposits. As of January 1,
1999, these deferred annuities had crediting rates ranging from 3.5% to 5.5%
and guaranteed minimum crediting rates ranging from 3.0% to 5.5%. The crediting
rate may be changed periodically. The contract owner is permitted to withdraw
all or part of the accumulation value. SMC's closed blocks of annuities include
payout annuities. Payout annuities consist of those annuities the benefits of
which are being paid out over a specified time period. Payout annuities cannot
be terminated by surrender or withdrawal. SMC's crediting rates on payout
annuities range from 3.0% to 6.5% and cannot be changed. At December 31, 1998,
SMC had 10,993 annuity contracts in force for closed blocks.
ORDINARY LIFE. The ordinary life policies included in SMC's closed
blocks are composed primarily of fixed premium, cash value whole life products.
In addition, they include annually renewable term policies as well as five, ten
and fifteen year level premium term policies. At December 31, 1998, SMC had
41,868 ordinary life policies in force for closed blocks.
UNIVERSAL LIFE. Certain closed blocks include universal life business.
For this business, SMC credits deposits and interest to account values and
charges the account values for mortality and administrative costs. At December
31, 1998, SMC had 6,724 universal life policies in force for the closed block
of business.
PRODUCT PROFITABILITY
The profitability of the life insurance and annuity products depend to a
significant degree on the maintenance of profit margins between investment
results from invested assets and interest credited on insurance and annuity
products. During 1998, such margins increased as a result of decreased
crediting rates on insurance and annuity products. Refer to "Investments" in
Item 1 of this report.
The long-term profitability of insurance products depends on the accuracy
of the actuarial assumptions that underlie the pricing of such products.
Actuarial calculations for such insurance products, and the ultimate
profitability of such products, are based on four major factors:
(i) persistency, (ii) mortality (iii) return on cash invested by the insurer
during the life of the policy and (iv) expenses of acquiring and administering
the policies.
The average expected remaining life of Standard Life's ordinary life
business in force at December 31, 1998 was 9.4 years. This calculation was
determined based upon SMC's actuarial models and assumptions as to expected
persistency and mortality. Persistency is the extent to which insurance
policies sold are maintained by the insured. The persistency of life insurance
and annuity products is a critical element of their profitability. However, a
surrender charge often applies in the early contract years and declines to zero
over time.
Policyholders sometimes do not pay premiums, thus causing their policies
to lapse. For the years 1998, 1997 and 1996 Standard Life experienced total
policy lapses of 6.1%, 6.5% and 6.3% of total policies in force at December 31
of each year, respectively. The American Council of Life Insurance 1998 Fact
Book reported industry life insurance voluntary termination rates in 1997 of
14.9% for policies in force less than two years, 4.4% for policies in force for
two years or more and 6.1% for all policies in force.
OPERATIONS
SMC emphasizes a high level of service to agents and policyholders and
strives to achieve low overhead costs. SMC's principal administrative
departments are its financial, policyholder services and management information
services ("MIS") departments. The financial department provides accounting,
budgeting, tax, investment, financial reporting and actuarial services and
establishes cost control systems for SMC. The policyholder services department
reviews policy applications, issues and administers policies and authorizes
disbursements related to claims and surrenders. The MIS department oversees and
administers SMC's information processing systems.
SMC's administrative departments in the United States use a common
integrated system that permits efficiency and cost control. SMC's MIS system
serviced approximately 192,000 active and inactive policies at December 31,
1998 and is continually being improved to provide for growth from acquisitions
and sales.
SMI's administrative and MIS departments in Luxembourg are an autonomous
unit from the systems in the United States. SMC is in the process of improving
the MIS systems of SMI and integrating them with the U.S. systems.
INVESTMENTS
Investment activities are an integral part of SMC's business as the
investment income of SMC's insurance subsidiaries is an important part of its
total revenues. Profitability is significantly affected by spreads between
rates credited on insurance liabilities and interest earned on invested assets.
Substantially all credited rates on FPDAs may be changed at least annually. For
the year ended December 31, 1998, the weighted average interest rate credited
on SMC's interest-sensitive liability portfolio, excluding liabilities related
to separate accounts, was approximately 5.25% per annum, and the weighted
average net yield of SMC's investment portfolio for the year ended December 31,
1998 was 7.48% for an average interest spread of 223 basis points at December
31, 1998, compared to 206 basis points at December 31, 1997. The increase in
the average interest spread includes i) lower crediting rates on new and
existing FPDA business in order to meet targeted pricing spreads, offset by,
ii) deposits from FPDA sales being invested at interest rates lower than the
current portfolio rate due to a general decline in interest rates during 1998.
Increases or decreases in interest rates could increase or decrease the average
interest rate spread between investment yields and interest rates credited on
insurance liabilities, which in turn could have a beneficial or adverse effect
on the future profitability of SMC. Sales of fixed maturity securities that
result in investment gains may also tend to decrease future average interest
rate spreads. State insurance laws and regulations prescribe the types of
permitted investments and limit their concentration in certain classes of
investments.
SMC balances the duration of its invested assets with the expected
duration of benefit payments arising from insurance liabilities. The "duration"
of a security is the time-weighted present value of the security's cash flows
and is used to measure a security's price sensitivity to changes in market
interest rates. The adjusted modified duration of fixed maturities and
short-term investments for its U.S. insurance subsidiaries was 5.6 years at
December 31, 1998 and December 31, 1997.
SMC's investment strategy is guided by strategic objectives established
by the Investment Committee of the Board of Directors. SMC's major investment
objectives are to: (i) ensure adequate safety of investments and protect and
enhance capital; (ii) maximize after-tax return on investments; (iii) match the
anticipated duration of investments with the anticipated duration of policy
liabilities; and (iv) provide sufficient liquidity to meet cash requirements
with minimum sacrifice of investment yield. Consistent with its strategy, SMC
invests primarily in securities of the U.S. government and its agencies,
investment grade utilities and corporate debt securities and collateralized
mortgage obligations ("CMOs"). When opportunities arise below investment grade
securities may be purchased, however, protection against default risk is a
primary consideration. SMC has determined it will not invest more than 7% of
its bond portfolio in below investment grade securities.
The following table sets forth the quality of SMC's fixed maturity
securities as of December 31, 1998, classified in accordance with the ratings
assigned by the National Association of Insurance Commissioners ("NAIC"):
Percent of Fixed
NAIC RATING (1) MATURITY SECURITIES
1 51
2 44
Investment Grade 95
3-4 5
5-6................................... --
Below Investment Grade 5
Total fixed maturity securities 100%
(1) The NAIC assigns securities quality ratings and uniform book values
called "NAIC Designations," which are used by insurers when preparing
their annual statements. The NAIC assigns ratings to publicly traded and
privately-placed securities. The ratings assigned by the NAIC range from
Class 1 to Class 6, with a rating in Class 1 being of the highest
quality.
Conseco Capital Management Inc. ("CCM"), a wholly owned subsidiary of
Conseco, Inc., manages SMC's invested assets (other than mortgage loans, policy
loans, real estate and other invested assets), subject to the direction of
SMC's Investment Committee. In 1998, a quarterly fee equal to .035% of the
total market value of the assets under management as of the end of each quarter
was paid to CCM for its investment advisory services.
Approximately 12% of SMC's fixed maturity securities at December 31, 1998
is comprised of mortgage-backed securities which include CMOs and
mortgage-backed pass-through securities. Approximately 8% of the book value of
mortgage-backed securities in SMC's portfolio is backed by the full faith and
credit of the U.S. government as to the full amount of both principal and
interest and 85% are backed by an agency of the U.S. government (although not
by the full faith and credit of the U.S. government). SMC closely monitors the
market value of all investments within its mortgage-backed portfolio.
The following table summarizes SMC's mortgage-backed securities at
December 31, 1998 (in thousands):
Estimated Avg.
% of % of Avg. Life Term
Amortized Fixed Fair Fixed of to Final
Cost Maturities Value Maturities Investment Maturity
(In Years) (In Years)
Agency CMOs:
Planned and target amortization $39,465 7.2% $39,629 7.2% 5.7 19.9
classes
Sequential and support classes 21 -- 20 -- 0.1 22.0
Total 39,486 7.2 39,649 7.2 5.8 19.9
Non-agency CMOs:
Sequential classes 4,891 .9 4,930 .9 4.4 10.9
Total CMOs 44,377 8.1 44,579 8.1 5.7 18.9
Agency mortgage-backed pass-through
securities 22,344 4.1 22,546 4.1 2.4 15.2
Total mortgage- $66,721 12.2% $67,125 12.2% 4.6 17.7
backed securities
The market values for SMC's mortgage-backed securities were determined
from broker-dealer markets, internally developed methods and nationally
recognized statistical rating organizations.
Certain mortgage-backed securities are subject to significant prepayment
risk, since, in periods of declining interest rates, mortgages may be repaid
more rapidly than scheduled as individuals refinance higher rate mortgages to
take advantage of the lower current rates. As a result, holders of
mortgage-backed securities may receive large prepayments on their investment
which cannot be reinvested at an interest rate comparable to the rate on the
prepaying mortgages. SMC has addressed this risk of prepayment risk by
investing 59% of its mortgage-backed investment portfolio in planned and target
amortization classes. These investments are designed to amortize in a more
predictable manner by shifting the primary risk of prepayment of the underlying
collateral to investors in other tranches ("support classes"). Mortgage-backed
pass-through securities, "sequential" and support class CMOs, which comprised
the remaining 41% of the book value of SMC's mortgage-backed securities at
December 31, 1998, are more sensitive to this prepayment risk.
SEPARATE ACCOUNTS
Separate account assets and liabilities are maintained primarily for
universal life contracts of which the majority represents unit-linked business
where benefits on surrender and maturity are not guaranteed. They generally
represent funds held in accounts to meet specific investment objectives of
policyholders who bear the investment risk. Investment income and investment
gains and losses accrue directly to such policyholders.
UNDERWRITING
Premiums charged on insurance products are based in part on assumptions
about the incidence and timing of insurance claims. SMC has adopted and follows
underwriting procedures for both its whole life and universal life insurance
policies. To implement these procedures, SMC employs a professional
underwriting staff. All underwriting decisions are made in SMC's home office.
To the extent that an applicant does not meet SMC's underwriting standards for
issuance of a policy at the standard risk classifications, SMC may rate or
decline the application. Underwriting with respect to FPDAs is minimal. No
underwriting procedures are applied to Standard Life's $10,000 conversion
policy or SMI's unit-linked business.
Traditional underwriting procedures are not applied to policies acquired
in blocks. In these cases, SMC reviews the mortality experience for recent
years and compares actual experience to that assumed in the actuarial
projections for the acquired policies.
RESERVES
In accordance with applicable insurance laws, SMC's insurance
subsidiaries have established and carry as liabilities in their statutory
financial statements, actuarially determined reserves to satisfy their
respective annuity contract and life insurance policy obligations. Reserves,
together with premiums to be received on outstanding policies and interest
thereon at certain assumed rates, are calculated to be sufficient to satisfy
policy and contract obligations. The actuarial factors used in determining such
reserves are based on statutorily prescribed mortality tables and interest
rates.
The reserves in the consolidated financial statements in this report are
calculated based on GAAP and differ from those specified by the laws of the
various states and recorded in the statutory financial statements of SMC's
insurance subsidiaries. These differences arise from the use of different
mortality tables and interest rate assumptions, the introduction of lapse
assumptions into the reserve calculation and the use of the net level premium
reserve method on all insurance business. See note 1 to the consolidated
financial statements for reserve assumptions under GAAP.
To determine policy benefit reserves for its life insurance and annuity
products, SMC performs periodic studies to compare current experience for
mortality, interest and lapse rates with projected experience used in
calculating the reserves. Differences are reflected currently in earnings for
each period. SMC historically has not experienced significant adverse
deviations from its assumptions.
REINSURANCE
Consistent with the general practice of the life insurance industry, SMC
has reinsured portions of the coverage provided by its insurance products with
other insurance companies under agreements of indemnity reinsurance. The
policy risk retention limit on the life of any one individual does not exceed
$150,000.
Indemnity reinsurance agreements are intended to limit a life insurer's
maximum loss on a particular risk or to obtain a greater diversification of
risk. Indemnity reinsurance does not discharge the primary liability of the
original insurer to the insured, but it is the practice of insurers for
statutory accounting purposes (subject to certain limitations of state
insurance statutes) to account for risks which have been reinsured with other
approved companies, to the extent of the reinsurance, as though they are not
risks for which the original insurer is liable. However, under Statement of
Financial Accounting Standards No. 113 ("SFAS 113"), "Accounting and Reporting
for Reinsurance of Short-Duration and Long-Duration Contracts" these amounts
are added back to policy reserves and recorded as amounts due from reinsurers.
Reinsurance ceded on life insurance policies to unaffiliated companies by
SMC in 1998, 1997 and 1996 represented 48.9%, 51.9% and 57.6%, respectively, of
gross combined individual life insurance in force at the end of such years.
Reinsurance assumed in the normal course from unaffiliated companies by SMC in
1998, 1997 and 1996 represented .02% for all three years of net combined
individual life insurance in force excluding reinsurance from The Guardian
Insurance and Annuity Company, Inc. ("GIAC"), a subsidiary of The Guardian
Group, New York, NY.
The following is reinsurance ceded information for in force life
insurance policies at December 31, 1998 (in thousands):
% of Total
Face Value of Reinsurance Reinsurance
INSURANCE COMPANY LIFE POLICIES CEDED RECOVERABLE
Lincoln National Life 385,183 31.3% 2,546
Insurance Company
Swiss Re Life and Health 163,306 13.3% 848
Security Life of Denver 147,718 12.0% 990
Reinsured life insurance in force at December 31, 1998 is ceded to
insurers rated "A" or better by A.M. Best. SMC historically has not experienced
any material losses in collection of reinsurance receivables.
Commencing January 1, 1995, SMC began to reinsure a portion of its
annuity business. The primary purposes of the reinsurance agreement were to
limit the net loss arising from large risks, maintain SMC's exposure to loss
within capital resources and provide additional capacity for future growth.
Furthermore, these reinsurance agreements have allowed SMC to write volumes of
business that it would not otherwise have been able to write due to
restrictions based on its ratio of surplus to liabilities as determined by
regulatory authorities in the State of Florida. By reinsuring a portion of the
annuity business, the liability growth is slowed, thereby avoiding the erosion
of surplus that can occur in periods of increasing sales. If SMC's ratio of
surplus to liabilities falls below 4%, the State of Florida could prohibit SMC
from writing new business in Florida. SMC's largest annuity reinsurer at
December 31, 1998, Winterthur Life Re Insurance Company ("Winterthur"),
represented $33.7 million, or 56.4% of total reinsurance recoverable, $6.6
million of premium deposits ceded in 1998 and is rated "A" ("Excellent") by
A.M. Best. From January 1, 1996 to March 31, 1996, Standard Life ceded a 50%
quota-share portion of its annuity business. Effective April 1, 1996, Standard
Life reduced it to 25% and effective October 1, 1998, discontinued ceding its
annuity business. This reduction was possible since the surplus strain
experienced by Standard Life was not as great as originally anticipated.
Winterthur limits dividends and other transfers by Standard Life to SMC or
affiliated companies if adjusted surplus is less than 5.5% of admitted assets
or $31.5 million at December 31, 1998.
On March 18, 1996, Standard Life completed the sale of First
International to GIAC and received proceeds of $10.4 million including $1.5
million for the charter and licenses. Standard Life realized a net pretax gain
of $1.0 million and a tax benefit of $1.4 million on the sale. First
International, Standard Life and GIAC have entered into a series of reinsurance
and other agreements that include provisions for Standard Life to administer
First International policies in force at the date of sale, and for Standard
Life to continue to receive the profit stream from certain First International
policies in force effective January 1, 1996.
Effective January 1, 1996, GIAC entered into a modified coinsurance
indemnity reinsurance agreement with Standard Life with respect to Blocks I
(ordinary life policies issued in New York and New Jersey) and II (ordinary
life policies not issued in New York and New Jersey). Pursuant to this
agreement, Standard Life administers the policies in both Block I and Block II.
Under the terms of the agreement, Standard Life assumed approximately $18.8
million of reserves for Block I and Block II from GIAC as of January 1, 1996.
During 1996, Standard Life incurred and paid experience rating refunds to GIAC
on Block I for profits earned in excess of specified amounts. These refunds
were calculated and paid on a quarterly basis. As a result, the economic risks
and benefits associated with Block I remained with GIAC. Effective January 1,
1997, GIAC and Standard Life agreed to terminate the Block I agreement.
Savers Life issued and marketed medicare supplement policies in 1998
including the time period from March 12, 1998, the acquisition date of Savers
Life, through July 1, 1998, when the medicare supplement business was sold. In
connection with the sale of the Medicare supplement business, Savers Life
received an initial statutory ceding allowance of $4.2 million which was offset
by a reserve reduction of $1.6 million and write off of present value of future
profits of $2.6 million and resulted in no gain or loss for GAAP. Under the
terms of the reinsurance agreement, Savers Life will administer the Medicare
supplement business through September 1, 1999 and will receive administration
fee income as a result of this transaction. The consummation of this
transaction resulted in the Company exiting from the Medicare supplement
business it acquired with the Savers Life acquisition.
In order to write an increasing amount of new business while continuing
to meet the statutory requirements of the states in which it conducts its
insurance operations, it has been necessary for Dixie Life to utilize various
forms of surplus relief. The principal source of surplus relief has been
financial reinsurance agreements, which for GAAP purposes are treated as
financing arrangements, but for statutory accounting purposes provide reserve
reductions that, in equal amount, increase statutory surplus. Dixie Life has a
financial reinsurance agreement that entitles it to a reduction of $.9 million
to its statutory reserves at December 31, 1998, with the amount of the
reduction decreasing each quarter by the amount of profit generated to Dixie
Life by the underlying block of business.
COMPETITION
The life insurance industry is highly competitive and consists of a large
number of both stock and mutual insurance companies, many of which have
substantially greater financial resources, broader and more diversified product
lines and larger staffs than those possessed by SMC. There are approximately
2,000 life insurance companies in the United States which may offer insurance
products similar to those marketed by SMC. Competition within the life
insurance industry occurs on the basis of, among other things, i) product
features such as price and interest rates, ii) perceived financial stability of
the insurer, iii) policyholder service, iv) name recognition and v) ratings
assigned by insurance rating organizations. Additionally, when SMC bids on
companies it wishes to acquire, it typically is in competition with other
entities.
SMC must also compete with other insurers to attract and retain the
allegiance of agents. SMC believes it has been successful in attracting and
retaining agents because it has been able to offer a competitive package of
innovative products, competitive commission structures, prompt policy issuance
and responsive policyholder service. Because most annuity business written by
life companies is through agents, management believes that competition centers
more on the strength of the agent relationship rather than on the identity of
the insurer.
Competition also is encountered from the expanding number of banks,
securities brokerage firms and other financial intermediaries which are
marketing insurance products and which offer competing products such as savings
accounts and securities. In the case of banks, these insurance products are
sold for non-affiliate insurance companies in return for a sales fee. A change
in legislation may increase interest on the part of banks to begin selling
annuities or to expand their existing efforts to sell annuities. The decision
could result in a partial shift in the distribution of annuities from insurance
agents to national banks, which could have a negative impact in the Company's
sales. The Company began distributing annuities through financial institutions
as a result of the acquisition of Savers Marketing in March 1998.
The unit-linked life insurance market in Europe is highly competitive and
consists of many companies domiciled in the United Kingdom and its offshore
centers, as well as many companies in Luxembourg and Ireland which sell
products similar to those of SMI. SMI is able to develop its share of a
competitive market by developing strong relationships with high-quality
independent intermediaries and by continual innovation in the design of niche
market products.
Financial institutions, school districts, marketing companies, agents who
market insurance products and policyholders use the ratings of an insurer as
one factor in determining which insurer's annuity to market or purchase.
Standard Life and Dixie Life have a rating of "B+" and "B", respectively by
A.M. Best. A rating of "B+" is assigned by A.M. Best to companies which, in
their opinion, have achieved very good overall performance when compared to the
standards established by A.M. Best, and have a good ability to meet their
obligations to policyholders over a long period of time. A rating of "B" is
assigned by A.M. Best to companies which, in their opinion, have achieved good
overall performance when compared to the standards established by A.M. Best.
According to A.M. Best, these companies generally have an adequate ability to
meet their obligations to policyholders, but their financial strength is
vulnerable to unfavorable changes in underwriting or economic conditions. In
evaluating a company's financial and operating performance, A.M. Best reviews
the company's profitability, leverage and liquidity as well as the company's
book of business, the adequacy and soundness of its reinsurance, the quality
and estimated market value of its assets, the adequacy of its reserves and the
experience and competence of its management. A.M. Best's ratings are based upon
factors relevant to policyholders, agents, insurance brokers and intermediaries
and are not directed to the protection of investors. Generally, rating agencies
base their ratings on information furnished to them by the issuer and on their
own investigations, studies and assumptions by the rating agencies. There is
no assurance that any particular rating will continue for any given period of
time or that it will not be changed or withdrawn entirely if, in the judgment
of the rating agency, circumstances so warrant. Although a higher rating by
A.M. Best or another insurance rating organization could have a favorable
effect on Standard Life and Dixie Life's business, management believes that
Standard Life and Dixie Life are able to compete on the basis of their
competitive crediting rates, asset quality, strong relations with their
independent agents and the quality of service to their policyholders.
FEDERAL INCOME TAXATION
The life insurance and annuity products marketed and issued by Standard
Life and Dixie Life generally provide the policyholder with an income tax
advantage, as compared to other saving investments such as certificates of
deposit and bonds, in that income taxation on the increase in value of the
product is deferred until receipt by the policyholder. With other savings
investments, the increase in value is taxed as earned. Life insurance benefits,
which accrue prior to the death of the policyholder, and annuity benefits are
generally not taxable until paid and life insurance death benefits are
generally exempt from income tax. The tax advantage for life insurance and
annuity products is provided in the Internal Revenue Code ("IRC"), and is
generally followed in all states and other United States taxing jurisdictions.
Accordingly, it is subject to change by Congress and the legislatures of the
respective taxing jurisdictions.
SMC, Standard Marketing and other U.S. non-insurance subsidiaries file a
consolidated return for federal income tax purposes. Beginning in 1997,
Standard Life and Dixie Life were eligible to file a life/life consolidated
return. As such, Standard Life and Dixie Life filed a life/life consolidated
return for 1997 and plan to file a consolidated return for 1998. As of
December 31, 1998, SMC, Standard Marketing and other U.S. non-insurance
subsidiaries had consolidated net operating loss carryforwards of approximately
$9.4 million for tax return purposes which expire from 2005 to 2012.
At December 31, 1998, the Standard Life consolidated return had tax
return net operating loss carryforwards of approximately $4.1 million, which
expire in 2010 and 2018. As a result of the change in ownership of Midwestern
Life, $1.1 million of these loss carryforwards are subject to an annual
limitation of $.7 million. These carryforwards will be available to reduce the
taxable income of the Standard Life consolidated return. The change in
ownership of Savers Life and Midwestern Life will not result in additional
limitations on the use of the loss carryforwards available to Standard Life.
Standard Management International is a Luxembourg holding company which
is currently exempt from Luxembourg income tax. Premier Life (Bermuda) is
exempt from income tax until March 2016 pursuant to a decree from the Minister
of Finance. Premier Life (Luxembourg) is subject to Luxembourg income taxation
(statutory corporate rate of 37.45%) and a capital tax of approximately 1% of
its net equity. At December 31, 1998, Premier Life (Luxembourg) had accumulated
corporate income tax loss carryforwards of approximately $2.6 million, all of
which may be carried forward indefinitely. To the extent that such income is
taxable under U.S. law, it will be included in SMC's consolidated return.
INFLATION
The primary direct effect on SMC of inflation is the increase in
operating expenses. A large portion of SMC's operating expenses consists of
salaries which are subject to wage increases at least partly affected by the
rate of inflation. SMC attempts to minimize the impact of inflation on
operating expenses through programs to improve productivity.
The rate of inflation also has an indirect effect on SMC. To the extent
that the government's economic policy to control the level of inflation results
in changes in interest rates, SMC's new sales of insurance products and
investment income are affected. Changes in the level of interest rates also
have an effect on interest spreads, as investment earnings are reinvested.
FOREIGN OPERATIONS AND CURRENCY RISK
SMI policyholders invest in assets denominated in a broad range of
currencies. Policyholders effectively bear the currency risk, if any, as these
investments are matched by policyholder separate account liabilities.
Therefore, their investment and currency risk is limited to premiums they have
paid. Policyholders are not permitted to invest directly into options, futures
and derivatives.
SMI could be exposed to currency fluctuations if currencies within the
conventional investment portfolio or certain actuarial reserves are mismatched.
The assets and liabilities of this portfolio and the reserves are continually
matched by the company and at regular intervals by the independent actuary. In
addition, Premier Life (Luxembourg's) stockholder's equity is denominated in
Luxembourg francs. Premier Life (Luxembourg) does not hedge its translation
risk because its stockholder's equity will remain in Luxembourg francs for the
foreseeable future and no significant realized foreign exchange gains or losses
are anticipated. At December 31, 1998, there is an immaterial unrealized loss
from foreign currency translation.
Due to the nature of unit-linked products issued by SMI, which represent
over 94% of the SMI portfolio, the investment risk rests with the policyholder.
Investment risk for SMI exists where investment decisions are made with respect
to the remaining traditional business and for the assets backing certain
actuarial and regulatory reserves. The investments underlying these liabilities
mostly represent short term investments and fixed maturity securities which are
normally bought and/or disposed of only on the advice of independent consulting
actuaries who perform an annual exercise comparing anticipated cash flows on
the insurance portfolio with the cash flows from the fixed maturity securities.
Any resulting material foreign currency mismatches are then covered by buying
and/or selling the securities as appropriate.
REGULATORY FACTORS
SMC's insurance subsidiaries are subject to significant regulation by the
insurance regulatory authorities in the jurisdictions in which they are
domiciled and the insurance regulatory bodies in the other jurisdictions in
which they are licensed to sell insurance. The purpose of such regulation is
primarily to ensure the financial stability of insurance companies and to
provide safeguards for policyholders rather than to protect the interest of
stockholders. The insurance laws of various jurisdictions establish regulatory
agencies with broad administrative powers relating to i) the licensing of
insurers and their agents, ii) the regulation of trade practices, iii)
management agreements, iv) the types of permitted investments and maximum
concentration, v) deposits of securities, vi) the form and content of financial
statements, vii) premiums charged by insurance companies, viii) sales
literature and insurance policies, ix) accounting practices and the maintenance
of specified reserves, and x) capital and surplus. SMC's insurance
subsidiaries are required to file detailed periodic financial reports with
supervisory agencies in certain jurisdictions.
Most states have also enacted legislation regulating insurance holding
company activities including acquisitions, extraordinary dividends, terms of
surplus debentures, terms of affiliate transactions and other related matters.
The insurance holding company laws and regulations vary by state, but generally
require an insurance holding company and its insurance company subsidiaries
licensed to do business in the state to register and file certain reports with
the regulatory authorities, including information concerning capital structure,
ownership, financial condition, certain intercompany transactions and general
business operations. State holding company laws also require prior notice or
regulatory agency approval of certain material intercompany transfers of assets
within the holding company structure. Recently a number of state regulators
have considered or have enacted legislation proposing that change, and in many
cases increase, the authority of state agencies to regulate insurance companies
and holding companies. For additional information on state laws regulating
insurance company subsidiaries, refer to "Management's Discussion and Analysis
of Financial Condition and Results of Operations - Liquidity and Capital
Resources", and Note 13 to the Company's consolidated financial statements.
Under Indiana insurance law, Standard Life may not enter into certain
transactions, including management agreements and service contracts, with
members of its insurance holding company system, including Standard Management,
unless Standard Life has notified the Indiana Department of Insurance of its
intention to enter into such transactions and the Indiana Department of
Insurance has not disapproved of them within the period specified by Indiana
law. Among other things, such transactions are subject to the requirement that
their terms and charges or fees for services performed be fair and reasonable.
The Indiana insurance laws and regulations require that the statutory
surplus of Standard Life following any dividend or distribution be reasonable
in relation to its outstanding liabilities and adequate to its financial needs.
The Indiana Department of Insurance may bring an action to enjoin or rescind
the payment of a dividend or distribution by Standard Life that would cause its
statutory surplus to be unreasonable or inadequate under this standard.
Most states, including Indiana, require administrative approval of the
acquisition of 10% or more of the outstanding shares of an insurance company
incorporated in the state or the acquisition of 10% or more of the outstanding
shares of an insurance holding company whose insurance subsidiary is
incorporated in the state. The request for approval must be accompanied by
detailed information concerning the acquiring parties and the plan of
acquisition. The acquisition of 10% of such shares is generally deemed to be
the acquisition of "control" for the purpose of the holding company statutes.
However, in many states the insurance authorities may find that "control" in
fact does or does not exist in circumstances in which a person owns or controls
either a lesser or a greater amount of securities.
In some instances many state regulatory authorities require deposits of
assets for the protection of policyholders either in those states or for all
policyholders. At December 31, 1998, securities representing approximately 4%
of the book value of SMC's U.S. insurance subsidiaries' invested assets were on
deposit with various state treasurers or custodians. Such deposits must consist
of securities that comply with the standards that the particular state has
established. Assets of SMI of $6.5 million at December 31, 1998 were held by a
custodian bank approved by the Luxembourg regulatory authorities to comply with
local insurance laws.
In recent years, the NAIC and state insurance regulators have reexamined
existing laws and regulations and their application to insurance companies.
This reexamination has focused on i) insurance company investment and solvency
issues, ii) risk-based capital guidelines, iii) assumption reinsurance, iv)
interpretations of existing laws, v) the development of new laws, vi) the
interpretation of nonstatutory guidelines, vii) the standardization of
statutory accounting rules and viii) the circumstances under which dividends
may be paid. The NAIC has encouraged states to adopt model NAIC laws on
specific topics such as holding company regulations and the definition of
extraordinary dividends. It is not possible to predict the future impact of
changing state regulation on the operations of SMC.
The NAIC, as well as Indiana and Mississippi have each adopted Risk-Based
Capital ("RBC") requirements for life and health insurance companies to
evaluate the adequacy of statutory capital and surplus in relation to
investment and insurance risks. State insurance regulators use the RBC
requirements as regulatory tools only, which aid in the identification of
insurance companies that could potentially lack sufficient capital. Regulatory
compliance is determined by a ratio (the "RBC Ratio") of the company's
regulatory total adjusted capital to its authorized control level RBC. The two
components of the RBC Ratio are defined by the NAIC. The RBC ratios which
require corrective action as follows:
LEVEL RBC RATIO CORRECTIVE ACTION
Company Action 1.5 - 2 Company is required to submit a plan
to improve its RBC Ratio
Regulatory Action 1 - 1.5 Regulators will order corrective
actions
Authorized Control 0.7 - 1 Regulators are authorized to take
control of the company
Mandatory Control less than 0.7 Regulators must take over the company
At December 31, 1998, the RBC Ratios of Standard Life and Dixie Life were
both at least two and a half times greater than the levels at which company
action is required. If these RBC Ratios should decline in the future, those
subsidiaries might be subject to increased regulatory supervision and decreased
ability to pay dividends, management fees and surplus debenture interest to
SMC.
On the basis of annual statutory statements filed with state regulators,
the NAIC calculates twelve financial ratios to assist state regulators in
monitoring the financial condition of insurance companies. A "usual range" of
results for each ratio is used as a benchmark. In the past, variances in
certain ratios of our insurance subsidiaries have resulted in inquiries from
insurance departments to which we have responded. Such inquiries did not lead
to any restrictions affecting the Company's operations.
SMC attempts to manage its assets and liabilities so that income and
principal payments received from investments are adequate to meet the cash flow
requirements of its policyholder liabilities. The cash flows of SMC's
liabilities are affected by actual maturities, surrender experience and
credited interest rates. SMC periodically performs cash flow studies under
various interest rate scenarios to evaluate the adequacy of expected cash flows
from its assets to meet the expected cash requirements of its liabilities. SMC
utilizes these studies to determine if it is necessary to lengthen or shorten
the average life and duration of its investment portfolio. Because of the
significant uncertainties involved in the estimation of asset and liability
cash flows, there can be no assurance that SMC will be able to effectively
manage the relationship between its asset and liability cash flows.
The statutory filings of SMC's insurance subsidiaries require
classifications of investments and the establishment of an Asset Valuation
Reserve ("AVR"), designed to stabilize a company's statutory surplus against
fluctuations in the market value of stocks and bonds, according to regulations
prescribed by the NAIC. The AVR consists of two main components: a "default
component" to provide for future credit-related losses on fixed income
investments and an "equity component" to provide for losses on all types of
equity investments, including real estate. The NAIC requires an additional
reserve, called the Interest Maintenance Reserve ("IMR"), which consists of the
portion of realized capital gains and losses from the sale of fixed income
securities attributable to changes in interest rates. The IMR is required to be
amortized against earnings on a basis reflecting the remaining period to
maturity of the fixed income securities sold. These regulations affect the
ability of SMC's insurance subsidiaries to reflect future investment gains and
losses in current period statutory earnings and surplus.
The amounts related to AVR and IMR for the insurance subsidiaries at
December 31, 1998 are summarized as follows (in thousands):
Maximum
AVR AVR IMR
Standard Life...........$3,987 $5,605 $14,246
Dixie Life.................252 308 155
The annual addition to the AVR for 1998 is 20% of the maximum reserve
over the accumulated balance. If the calculated reserve with current year
additions exceeds the maximum reserve amount, the reserve is reduced to the
maximum amount. For the year ended December 31, 1998, SMC's U.S. subsidiaries
each made the required contribution to the AVR.
Most jurisdictions require insurance companies to participate in guaranty
funds designed to cover claims against insolvent insurers. Insurers authorized
to transact business in these jurisdictions are generally subject to
assessments based on annual direct premiums written in that jurisdiction to pay
such claims, if any. These assessments may be deferred or forgiven under most
guaranty laws if they would threaten an insurer's financial strength and, in
certain instances, may be offset against future state premium taxes. The
incurrence and amount of such assessments have increased in recent years and
may increase further in future years. The likelihood and amount of all future
assessments cannot be reasonably estimated and are beyond the control of SMC.
As part of their routine regulatory oversight process, approximately once
every three to five years state insurance departments conduct periodic detailed
examinations ("Examinations") of the books, records and accounts of insurance
companies domiciled in their states. Standard Life underwent an Examination
during 1996 for the five-year period ended December 31, 1995 and Dixie Life
underwent an examination during 1998 for the five-year period ended December
31, 1997. The final examination reports issued by the Indiana and Mississippi
Departments of Insurance did not raise significant issues.
The federal government does not directly regulate the insurance business.
However, federal legislation and administrative policies in several areas,
including pension regulation, age and sex discrimination, financial services
regulation and federal taxation, do affect the insurance business. In
addition, legislation has been introduced from time to time in recent years
which, if enacted, could result in the federal government assuming a more
direct role in the regulation of the insurance industry.
Congressional initiatives have been introduced which are directed at
repeal of the McCarran-Ferguson Act (which exempts the "business of insurance"
from most federal laws to the extent it is subject to state regulation), and
judicial decisions have been issued which narrow the definition of "business of
insurance" for McCarran-Ferguson Act purposes. Current and proposed federal
measures may also significantly affect the insurance industry including removal
of barriers preventing banks from engaging in the insurance business.
EMPLOYEES
As of March 15, 1999, SMC had 141 employees which were comprised of the
following: Standard Life - 96 employees, SMI - 17 employees (9 of whom are
covered by a collective bargaining agreement), Standard Marketing - 10
employees, Standard Management - 10 employees and Savers Marketing - 8
employees. SMC believes that its future success will depend, in part, on its
ability to continue to attract and retain highly-skilled technical, marketing,
support and management personnel. Management believes that it has excellent
relations with its employees.
ITEM 2. PROPERTIES
DOMESTIC OPERATIONS. SMC leases approximately 31,000 square feet in an
office building located at 9100 Keystone Crossing, Indianapolis, Indiana, under
the terms of a lease which expires on June 1, 2001. SMC entered into a lease on
March 31, 1997, for approximately 16,000 square feet in a warehouse located at
2525 North Shadeland, Indianapolis, Indiana, under the terms of a lease which
expires on September 30, 1999.
Dixie Life leased approximately 1,000 square feet in an office complex
located at 855 South Pear Orchard Road, Suite 305, Ridgeland, Mississippi,
under the terms of a lease which expired on December 31, 1998. Dixie Life
leases an office service area located at 1060 East County Line Road, Ridgeland,
Mississippi, under the terms of a lease that expires on June 30, 1999.
Savers Marketing leases approximately 11,500 square feet in an office
building located at 8064 North Point Boulevard, Winston-Salem, North Carolina,
under the terms of a lease that expires on September 30, 2001.
INTERNATIONAL OPERATIONS. SMI entered into a lease on November 17, 1997
for approximately 4,500 square feet in an office building located at 13A, rue
de Bitbourg, L-1273 Luxembourg, Grand Duchy of Luxembourg, under the terms of a
lease which expires on November 16, 2003.
ITEM 3. LEGAL PROCEEDINGS
John J. Quinn resigned as an officer and director of SMC effective
April 15, 1997. On June 19, 1997, Mr. Quinn commenced an action in the
Superior Court of Marion County, Indiana, against SMC claiming that his
employment agreement contained a provision to the effect that, following a
termination of his employment with SMC under certain circumstances, Mr. Quinn
would be entitled to receive a lump sum payment equal to the amount determined
by multiplying the number of shares of SMC Common Stock subject to unexercised
stock options previously granted by SMC to Mr. Quinn on the date of
termination, whether or not such options were then exercisable, by the highest
per share fair market value of the SMC Common Stock on any day during the
six-month period ending on the date of termination. Upon payment of such
amount, such unexercised stock options would be deemed to have been surrendered
and canceled. Mr. Quinn further claims that his employment agreement contained
an additional provision that he would be entitled to receive a lump sum payment
equal to two years of annual salary, following termination of employment.
Mr. Quinn has asserted to SMC that he is entitled to a lump sum termination
payment of $1.7 million, and liquidated damages not exceeding $3.3 million, by
virtue of his voluntarily leaving SMC's employment.
SMC disputes Mr. Quinn's claims. SMC filed its Answer and Counterclaim
against Mr. Quinn on September 11, 1997. SMC's investigation since the action
was filed revealed a basis for the termination of Mr. Quinn's employment for
cause relative to after-acquired evidence. On October 14, 1997, the Board of
Directors of SMC terminated Mr. Quinn for cause effective March 15, 1997. Such
termination will also be argued by SMC as a complete defense to all claims
asserted by Mr. Quinn. The ultimate outcome of the action cannot presently be
determined. Accordingly, no provision for any liability that may result has
been made in the consolidated financial statements. Management believes that
the conclusion of such litigation will not have a material adverse effect on
SMC's consolidated financial condition.
In addition, SMC is involved in various legal proceedings in the normal
course of business. In most cases, such proceedings involve claims under
insurance policies or other contracts of SMC. The outcomes of these legal
proceedings are not expected to have a material adverse effect on the
consolidated financial position, liquidity, or future results of operations of
SMC based on SMC's current understanding of the relevant facts and law.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS
At the Company's Annual Meeting of Stockholders held on June 10, 1998,
the following individuals were elected to the Board of Directors:
Shares For Shares Withheld
John J. Dillon 6,054,707 90,508
Jerry E. Francis 6,039,211 106,004
Ronald D. Hunter 6,052,182 93,033
Edward T. Stahl 6,051,558 93,657
A total of 6,145,215 shares were present in person or by proxy at the
Annual Meeting of Stockholders.
EXECUTIVE OFFICERS
The following table sets forth information concerning each of SMC's
executive officers:
NAME AGE POSITION
Ronald D. Hunter 47 Chairman of the Board, Chief Executive Officer
and President
Raymond J. Ohlson 48 Executive Vice President and Chief Marketing Officer
Paul B. Pheffer 47 Executive Vice President, Chief Financial Officer
and Treasurer
Stephen M. Coons 57 Executive Vice President, General Counsel and Secretary
Edward T. Stahl 52 Executive Vice President and Chief Administrative
Officer
RONALD D. HUNTER Mr. Hunter has been the Chairman of the Board, Chief
Executive Officer and President of SMC since its formation in June 1989 and the
Chairman of the Board and Chief Executive Officer of Standard Life since
December 1987. Previously, Mr. Hunter held several management and sales
positions in the life insurance industry with a number of companies including
Conseco, Inc. (1981-1986), Aetna Life & Casualty Company (1978-1981), United
Home Life Insurance Company (1975-1977) and Prudential Life Insurance Company
(1972-1975).
RAYMOND J. OHLSON Mr. Ohlson has served as Executive Vice President and
director of SMC since December 1993. He has served as President and director of
Standard Marketing since August 1991. Since June 1993, Mr. Ohlson has served as
President of Standard Life. Mr. Ohlson entered the life insurance business in
1971. While still in college, Mr. Ohlson qualified for the Million Dollar Round
Table and is now a life member. He earned his CLU designation in 1980.
Mr. Ohlson owned and operated Ohlson & Associates, an independent insurance
marketing organization, from 1984 to April 1994, when the assets of Ohlson &
Associates were acquired by Standard Marketing.
PAUL ("PETE") B. PHEFFER Mr. Pheffer has been Executive Vice President,
Chief Financial Officer and Treasurer of SMC since May 1997 and director of SMC
since June 1997. Prior to joining SMC, Mr. Pheffer was Senior Vice President --
Chief Financial Officer and Treasurer of Jackson National Life Insurance
Company from 1994 to 1996 and prior to that was Senior Vice President -- Chief
Financial Officer at Kemper Life Insurance Companies from 1992 to 1994.
Mr. Pheffer, a CPA, received his MBA from the University of Chicago in 1988.
STEPHEN M. COONS Mr. Coons has been a director of SMC since August 1989.
Mr. Coons has been General Counsel and Executive Vice President of SMC since
March 1993 and has been Secretary of SMC since March 1994. He was of counsel to
the law firm of Coons, Maddox & Koeller from March 1993 to December 1996.
Prior to March 1993, Mr. Coons was a partner with the law firm of Coons &
Saint. He has been practicing law for 28 years. Mr. Coons served as Indiana
Securities Commissioner from 1978 to 1983.
EDWARD T. STAHL Mr. Stahl has been an Executive Vice President of SMC
since its formation, has been a director of SMC from July 1989 and was
appointed Chief Administrative Officer in November 1998. Mr. Stahl was
Secretary of SMC from June 1989 to March 1994. Mr. Stahl was President and
Chief Operations Officer of Standard Life from May 1988 to June 1993. He has
been a director of Standard Life since December 1987, and Executive Vice
President and Secretary since June 1993. Mr. Stahl has served in various
capacities in the insurance industry since 1966. He earned his FLMI designation
in 1981, and is a member of several insurance associations.
PART II
ITEM 5. MARKET FOR SMC COMMON STOCK AND RELATED STOCKHOLDER MATTERS
SMC Common Stock trades on NASDAQ under the symbol "SMAN." The following
table sets forth, for the periods indicated, the range of the high and low
sales prices of SMC Common Stock as reported by NASDAQ. SMC has never paid
dividends on its Common Stock. At the close of business on March 15, 1999 there
were approximately 3,046 holders of record of the outstanding shares of SMC
Common Stock. Although SMC Common Stock is traded on Nasdaq, no assurance can
be given as to the future price of or the markets for the stock.
SMC
COMMON STOCK
HIGH LOW
1997
Quarter ended March 31, 1997 6.250 4.875
Quarter ended June 30, 1997 6.000 4.625
Quarter ended September 30, 1997 7.875 5.688
Quarter ended December 31, 1997 8.375 6.500
1998
Quarter ended March 31, 1998 7.500 6.125
Quarter ended June 30, 1998 7.625 7.000
Quarter ended September 30, 1998 7.563 6.625
Quarter ended December 31, 1998 7.000 6.000
ITEM 6. SMC SELECTED HISTORICAL FINANCIAL DATA
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
The following historical financial data of SMC was derived from its audited
consolidated financial statements. This historical financial data should be
read in conjunction with "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and the SMC Consolidated Financial
Statements and related Notes.
Year Ended December 31
1998 1997 1996 1995 1994
STATEMENT OF OPERATIONS DATA:
Premium income $14,479 (d) $7,100 $10,468 (c) $5,504 $4,565
Investment activity:
Net investment income 34,580 29,516 20,871 18,517 16,057
Net realized investment gains 353 396 1,302 688 558
Total revenues 62,870 46,611 40,205 30,238 26,518
Interest expense and financing 2,955 2,381 805 118 47
costs
Total benefits and expenses 56,559 43,349 36,670 (c) 28,682 30,032
Income (loss) before income taxes,
extraordinary gain (charge) and
cumulative effect of change in 6,311 3,262 3,535 1,556 (3,514)
accounting principle
Income (loss) before extraordinary
gain
(charge) and cumulative effect 4,681 2,645 4,265 1,313 (3,436)
of change in accounting
principle
Net income (loss) 4,681 2,645 4,767 1,313 (3,436)
Operating income (a) 4,448 2,384 1,174 461 293
PER SHARE DATA:
Income (loss) per share before
extraordinary
gain (charge) and cumulative $.68 $.54 $.88 $.25 $(.62)
effect of change in accounting
principle
Net income (loss) .68 .54 .98 .25 (.62)
Net income (loss), assuming .62 .48 .91 .25 (.61)
dilution
Operating income (a) .65 .49 .24 .09 .05
Operating income, assuming .58 .43 .21 .09 .05
dilution (a)
Weighted average common shares
outstanding, assuming dilution 9,363,763 5,591,217 5,549,057 5,345,937 5,663,187
Book value per common share $8.64 $8.88 $7.95 $7.73 $4.27
Book value per common share
excluding
unrealized gain (loss) on $8.43 $8.44 $8.09 $7.23 $6.81
securities available for sale
Common shares outstanding 7,641,454 4,876,490 5,024,270 5,205,425 5,291,455
BALANCE SHEET DATA (at year end):
Invested assets $592,123 $398,782 $370,138 $280,597 $224,926
Assets held in separate accounts 190,246 148,064 128,546 122,705 94,301
Total assets 956,150 668,992 628,413 479,598 373,524
Long-term debt, notes payable and
capital lease obligations 35,000 26,141 20,697 4,191 695
Series A preferred stock 6,530 -- -- -- --
Class S preferred stock -- -- 1,757 -- --
Shareholders' equity 66,042 43,313 39,919 40,242 22,610
Shareholders' equity, excluding
unrealized gain (loss) on 64,382 41,142 40,665 37,660 36,021
securities available for sale
Ratio of debt to total 33% 38% 33% 9% 3%
capitalization (b)
NOTES TO SMC SELECTED HISTORICAL FINANCIAL DATA
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Comparison of consolidated financial information is significantly affected
by the acquisitions of Dixie Life on October 2, 1995, Shelby Life on
November 8, 1996, Savers Life on March 12, 1998, Midwestern Life on October
30, 1998 and on the disposal of First International on March 18, 1996. Refer
to the notes to the consolidated financial statements in this report for a
description of business combinations.
(a)Operating income represents income before extraordinary gains (charge),
excluding net realized investment gains (less income taxes relating to such
gains), gain on disposal of subsidiary and class action litigation and
settlements.
(b)Total capitalization is the sum of SMC's debt (long term debt, notes
payable and capital lease obligations), redeemable preferred stock and
shareholders' equity.
(c)Includes recapture of premiums ceded and an increase in benefits due to an
increase in reserves of $4.2 million due to the termination and recapture of
a reinsurance agreement with National Mutual Life Insurance Company.
(d)Includes medicare supplement premiums of $6.0 million related to the Savers
Life acquisition. This business was sold effective July 1, 1998.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion highlights the principal factors affecting the
results of operations and the significant changes in balance sheet items of SMC
on a consolidated basis for the periods listed, as well as SMC's liquidity and
capital resources. This discussion should be read in conjunction with the
accompanying Consolidated Financial Statements, related Notes and selected
historical financial data.
FORWARD-LOOKING STATEMENTS
All statements, trend analyses, and other information contained in this
Annual Report on Form 10-K or any document incorporated by reference herein
relative to markets for the Company's products and trends in the Company's
operations or financial results, as well as other statements including words
such as "anticipate," "believe," "plan," "estimate," "expect," "intend," and
other similar expressions, constitute forward-looking statements under the
Private Securities Litigation reform Act of 1995. These forward-looking
statements are subject to known and unknown risks, uncertainties and other
factors which may cause actual results to be materially different from those
contemplated by the forward-looking statements. Such factors include, but are
not limited to: (1) general economic conditions and other factors, including
prevailing interest rate levels, stock market performance and health care
inflation, which may affect the ability of the Company to sell its products,
the market value of the Company's investments and the lapse rate and
profitability of the Company's policies; (2) the Company's ability to achieve
anticipated levels of operational efficiencies at recently acquired companies,
as well as through other cost-saving initiatives; (3) customer response to new
products, distribution channels and marketing initiatives; (4) mortality,
morbidity, usage of health care services and other factors which may affect the
profitability of the Company's insurance products; (5) changes in the Federal
income tax laws and regulation which may affect the relative tax advantages of
some of the Company's products; (6) increasing competition in the sale of the
Company's products; (7) regulatory changes or actions, including those relating
to regulation of financial services affecting bank sales and underwriting of
insurance products, regulation of the sale, underwriting and pricing of
insurance products, and health care regulation affecting the Company's
supplemental health insurance products; (8) the availability and terms of
future acquisitions; and (9) the risk factors or uncertainties listed from time
to time in any document incorporated by reference herein.
GENERAL
SMC acquired Shelby Life on November 8, 1996, Savers Life on March 12, 1998
and Midwestern Life on October 30, 1998. These acquisitions were accounted for
using the purchase method of accounting. Therefore, these subsidiaries are
included in the SMC Consolidated Financial Statements commencing with their
respective acquisition effective dates.
PRODUCT PROFITABILITY. Margins on life insurance and annuity products are
affected by interest rate fluctuations. Rising interest rates would result in a
decline in the market value of assets. However, as there are positive cash
flows from renewal premiums, investment income and maturities of existing
assets, the need for early disposition of investment assets to meet operating
cash flow requirements would be unlikely. Rising interest rates would also
result in available cash flows from maturities being invested at higher
interest rates, which would help support a gradual increase in new business and
renewal interest rates on interest-sensitive products. A sharp, sudden rise in
the interest rate environment without a concurrent increase in crediting rates
could result in higher surrenders, particularly for annuities. The effect of
surrenders would be to reduce earnings over the long term. Earnings in the
period of the surrender could increase or decrease depending on whether
surrender charges were applicable and whether such charges differed from the
write-off of related deferred acquisition costs or present value of future
profits.
When interest rates fall, SMC generally attempts to adjust the credited
interest rates subject to competitive pressures. Although SMC believes that
such strategies will continue to permit it to achieve a positive spread, a
significant decline in the yield on SMC's investments could adversely affect
the results of operations and financial condition of SMC.
PURCHASED INSURANCE BUSINESS. In accordance with industry practice, when
SMC purchases additional insurance business, it assigns a portion of the
purchase price, called the present value of future profits, to the right to
receive future cash flows arising from existing insurance policies. This asset
is recorded when the business is purchased at the value of projected future
cash flows on existing policies, less a discount to present value. As future
cash flows emerge, they are treated as a recovery of this asset. Therefore, if
cash flows emerging from the purchased or recaptured business during a period
exactly equal the projections, they are offset by that period's amortization of
the cost of the policies purchased. In that event, the only income statement
effect from the purchased business is the realization of the discount that was
initially deducted from the asset to reflect its present value. Changes in the
future annual amortization of this asset are not expected to have a significant
effect on the results of operations, because the amount of amortization is
expected to be equal to the profits emerging from the purchased policies, net
of interest on the unrecovered present value of future profits balance. This
asset is amortized over the expected life of the related policies purchased.
Present value of future profits is increased for the estimated effect of
realizing unrealized investment losses and decreased for the estimated effect
of realizing unrealized investment gains.
In selecting the interest rate to calculate the discounted present value of
the projected future profits, SMC uses the risk rate of return it needs to earn
in order to invest in the business being acquired or recaptured.
In determining this required risk rate of return, SMC considers the
following factors:
The magnitude of the risks associated with each of the actuarial
assumptions used in determining expected future cash flows (as
described above).
The cost of the capital required to fund the acquisition or
recapture.
The likelihood of changes in projected future cash flows that might
occur if there are changes in insurance regulations and tax laws.
The acquired company's compatibility with other SMC activities that
may favorably affect future cash flows.
The complexity of the acquired company or recaptured business.
Recent prices (i.e., discount rates used in determining valuations)
paid by others to acquire or recapture similar blocks of business.
The discount rate selected may affect subsequent earnings in those instances
where the purchase price of the policies exceeds the value of net assets
acquired (including the value of future profits discounted at the selected
interest rate). Selection of a lower (or higher) discount rate will increase
(or decrease) the portion of the purchase price assigned to the present value
of future cash flows and will result in an offsetting decrease (or increase) in
the amount of the purchase price assigned to goodwill. The effect on subsequent
earnings caused by this variation in purchase price allocation will depend on
the characteristics of the policies purchased. For products where the profits
emerge at relatively constant levels over an extended period of time (for
example, most of SMC's immediate and deferred annuities), use of a lower rate
may result in an increase in reported earnings in the early years after an
acquisition followed by a decrease in earnings in later years. For products
where profits emerge over a shorter period of time or in amounts that decrease
over the life of the product (for example, ordinary and term life products),
selection of a lower rate will generally result in a decrease in reported
earnings in the early years after an acquisition followed by an increase in
reported earnings in later years. For SMC, the majority of the cost of policies
purchased relates to ordinary life products and the balance to deferred annuity
products.
The percentage of future expected net amortization of the beginning balance
of the present value of future profits before the effect of net unrealized
gains and losses, based on the present value of future profits at December 31,
1998 and current assumptions as to future events on all policies in force, will
be between 6% and 9% in each of the years 1999 through 2003.
SMC used a 13% discount rate to calculate the present value of future
profits on business of the Savers Life and Midwestern Life acquisitions. Each
is being amortized over 20 years based on the mix of their respective annuity
and life business.
For more information related to Purchased Insurance Business refer to Note 4
to the Consolidated Financial Statements.
PRODUCED INSURANCE BUSINESS. Insurance products generate two types of
profit streams: (i) from the excess of investment income earned over that
credited to the policyholder and (ii) from the excess of premiums received over
costs incurred for policy issuance, administration and mortality. Costs
incurred in issuing new policies are deferred and recorded as deferred
acquisition costs ("DAC"), which are amortized using present value techniques
so that profits are realized in proportion to premium revenue for certain
products and estimated gross profits for certain other products. Profits from
all of these elements are recognized over the lives of the policies; no profits
are recorded at the time the policies are issued.
Amortization of DAC was $2.7 million, $1.5 million and $1.2 million for the
years ended December 31, 1998, 1997 and 1996, respectively. The increase in
current year amortization expense resulted primarily from increased
amortization of DAC as gross profits from business sold in recent years began
to emerge. DAC is generally amortized over the expected lives of the policies,
a period of approximately 20 years, in a constant relationship to the present
value of estimated future gross profits. Interest is being accreted at the
projected crediting rate on the policies, 7% during year one, 6.5% in year two,
5.5% in year three and 5% thereafter. DAC is increased for the estimated
effect of realizing unrealized investment losses and decreased for the
estimated effect of realizing unrealized investment gains. The offset to these
amounts is recorded directly to shareholders' equity, net of taxes. Future
expected amortization of DAC for the next five years before the effect of net
realized and unrealized gains and losses, based on DAC at December 31, 1998 and
current assumptions, is as follows (in thousands):
1999 2000 2001 2002 2003
Gross amortization $5,771 $5,450 $4,940 $4,384 $3,874
Interest accreted 1,489 1,191 932 742 601
Net amortization $4,282 $4,259 $4,008 $3,642 $3,273
The amounts included in the foregoing table do not include any
amortization of DAC resulting from the sale of new products after December 31,
1998. Any changes in future annual amortization of this asset are not expected
to have a significant effect on results of operations because the amount of
amortization is expected to be proportionate to the profits from the produced
policies, net of interest on DAC.
VARIANCES BETWEEN ACTUAL AND EXPECTED PROFITS. Actual experience on
purchased and produced insurance may vary from projections due to differences
in renewal premiums collected, investment spreads, mortality costs,
persistency, administrative costs and other factors. Variances from original
projections, whether positive or negative, are included in net income as they
occur. To the extent that these variances indicate that future experience will
differ from the estimated profits reflected in the capitalization and
amortization of the cost of policies purchased or the cost of policies
produced, current and future amortization rates may be adjusted.
ACCOUNTING FOR ANNUITIES AND UNIVERSAL AND INTEREST-SENSITIVE LIFE
PRODUCTS. The Company primarily accounts for its annuity, universal and
interest-sensitive life policy deposits in accordance with Statement of
Financial Accounting Standards No. 97 ("SFAS No. 97"), "Accounting and
Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for
Realized Gains and Losses on the Sale of Investments". Under SFAS No. 97, a
benefit reserve is established at the time of policy issuance in an amount
equal to the deposits received. Thereafter, the benefit reserve is adjusted for
any additional deposits, interest credited and partial or complete withdrawals.
Revenues for annuities and universal and interest-sensitive life policies,
other than certain non-interest sensitive annuities, consist of policy charges
for surrenders and partial withdrawals, mortality and administration, and
investment income earned. Such revenues do not include the annuity, universal
and interest-sensitive life policy deposits. Expenses related to these products
include interest credited to policyowner account balances, operating costs for
policy administration, amortization of DAC and mortality costs in excess of
account balances.
Costs relating to the acquisition of new business, primarily commissions
paid to agents, which vary with and are directly related to the production of
new business, are deferred to the extent that such costs are recoverable from
future profit margins. At the time of issuance, the acquisition expenses,
approximately 13% of initial annuity premium deposits and 50% of premiums from
universal and interest-sensitive life products for SMC, are capitalized as DAC.
In accordance with SFAS No. 97, DAC with interest is amortized over the lives
of the policies in a constant relationship to the present value of estimated
future gross profits.
UNIT-LINKED PRODUCT ACCOUNTING. Separate account assets and liabilities
are maintained primarily for contracts of which the majority represents
unit-linked products where benefits on surrender and maturity are not
guaranteed. They generally represent funds held in accounts to meet specific
investment objectives of policyholders who bear the investment risk. Investment
income and investment gains and losses accrue directly to such policyholders.
SMC earns income from the investment management fee it charges on such
unit-linked contracts, which ranges from .8% to 1.2% of the value of the
underlying separate accounts. In addition, on certain contracts, SMC can
potentially earn up to a 1.7% initiation fee on new business sold.
RESULTS OF OPERATIONS BY SEGMENT FOR THE THREE YEARS ENDED DECEMBER 31, 1998:
The following tables and narratives summarize the results of our operations by
business segment.
1998 1997 1996
(Dollars in thousands)
Income before income taxes, and extraordinary charge:
Domestic operations:
Operating income $3,700 $1,146 $104
Net realized investment gains 353 396 1,302
Gain on disposal of subsidiary -- -- 886
Income before income taxes and extraordinary 4,053 1,542 2,292
gain
International operations:
Operating income 2,258 1,720 1,243
Income before income taxes and extraordinary 2,258 1,720 1,243
gain
Consolidated:
Operating income 5,958 2,866 1,347
Net investment gains 353 396 1,302
Gain on disposal of subsidiary -- -- 886
Income before income taxes and extraordinary 6,311 3,262 3,535
gain
Income tax expense (benefit) 1,630 617 (730)
Income before extraordinary gain 4,681 2,645 4,265
Extraordinary gain on early redemption of redeemable
preferred stock, net taxes of $0 -- -- 502
Net income $4,681 $2,645 $4,767
CONSOLIDATED RESULTS AND ANALYSIS
SMC's 1998 operating earnings were $4.4 million, or 58 cents per diluted
share, up 87% and 35%, respectively over 1997. Operating earnings increased as
a result of i) increased spread revenues due to an increase in weighted average
insurance liabilities (primarily due to the inclusion of Savers Life and
Midwestern Life operations), ii) favorable mortality experience, iii) fees from
administration contracts and iv) increased fees from separate accounts. The
percentage increase in operating earnings was greater than the percentage
increase in operating earnings per diluted share primarily because of the 67%
increase in weighted average diluted common shares or equivalents outstanding
during the period. This increase in weighted average shares outstanding
resulted primarily from issued shares in connection with the acquisitions of
Savers Life and Midwestern Life.
SMC's 1997 operating earnings were $2.4 million, or 43 cents per diluted
share, up 103% and 104%, respectively over 1996. Operating earnings increased
as a result of i) increased spread revenues due to an increase in weighted
average insurance liabilities (primarily due to the inclusion of Shelby Life
operations), ii) a nonproportional increase in operating expenses relative to
the increase in weighted average insurance liabilities, iii) fees from
administration contracts, and iv) decreased premium deficiency reserves.
DOMESTIC OPERATIONS:
1998 1997 1996
(Dollars in thousands)
Premiums collected:
Traditional life $8,392 $7,036 $10,376
Universal and interest-sensitive life 3,352 4,302 2,353
Subtotal - life products 11,744 11,338 12,729
FPDA's 58,111 42,251 37,963
Equity-indexed annuities 16,858 -- --
Other annuities and deposits 3,537 2,809 2,064
Subtotal - annuity products 78,506 45,060 40,027
Medicare supplement premiums 5,992 -- --
Total premiums collected $96,242 $56,398 $52,756
Life premiums $8,392 $7,036 $10,376
Health premiums 5,992 -- --
Policy income 6,529 5,512 2,551
Total policy related income 20,913 12,548 12,927
Net investment income 33,721 28,614 20,132
Other income 3,068 1,093 1,277
Total revenues (a) 57,702 42,255 34,336
Life benefits and claims 8,487 8,910 10,247
Health benefits and claims 4,823 -- --
Interest credited on interest sensitive annuities and
other financial products 19,775 16,281 11,092
Amortization 4,755 3,248 2,592
Other operating expenses 12,423 10,289 9,496
Health commissions 784 -- --
Interest expense and financing costs 2,955 2,381 805
Total benefits and expenses 54,002 41,109 34,232
Operating income before income taxes and
extraordinary gain 3,700 1,146 104
Net realized investment gains 353 396 1,302
Gain on disposal of subsidiary -- -- 886
Income before income taxes and $4,053 $1,542 $2,292
extraordinary gain
(a) Revenues exclude net investment gains, and gain on disposal of subsidiary
DOMESTIC OPERATIONS (CONTINUED):
1998 1997 1996
Number of annuity contracts in force 21,933 14,013 13,221
Interest-sensitive annuity and other
financial product reserves, net of $506,749 $350,607 $333,633
reinsurance ceded
Number of life policies in force 71,991 68,571 76,219
Life insurance in force, net of reinsurance $1,319,415 $1,178,171{ (1)} $1,367,675
ceded
(1)The decrease in life insurance in force is due to the termination and
recapture of a reinsurance agreement effective January 1, 1997. See
"Business of SMC -- Reinsurance".
GENERAL:
This segment consists of revenues earned and expenses incurred from
United States operations which includes deposits and/or income from
annuity products (primarily FPDA's), equity indexed products, universal
life products and traditional life products. The profitability for this
segment is primarily a function of its investment spread earned (i.e. the
excess of investment earnings over interest credited on annuity and
universal life deposits), persistency of the in force business, mortality
experience and operating expenses.
PREMIUM INCOME:
Life premiums were up $1.4 million or 19% in 1998, to $8.4 million.
Traditional life premiums of $1.1 million were earned from Savers Life
and Midwestern Life in 1998. The remaining increase of $.3 million is
due to premiums from existing blocks of traditional life business from
Standard Life and Dixie Life.
Health premiums for 1998 include $6.0 million of Medicare supplement
premiums that were earned from March 12, 1998, the acquisition date of
Savers Life, through July 1, 1998, the effective date of the sale of
Medicare supplement block of business.
Life premiums decreased $3.3 million or 32% in 1997, to $7.0 million.
The decrease is attributable to the recapture of premiums ceded of $4.2
million due to the termination and recapture of a reinsurance agreement
with National Mutual offset by an increase of premium income of $1.7
million earned from the inclusion of Shelby Life.
NET PREMIUM DEPOSITS:
Net premium deposits for 1998, received from the sales of FPDA's,
equity indexed annuities, interest sensitive annuities and other
financial products increased $32.5 million or 66%, to $81.9 million. The
increase relates to i) an increase in the agency base achieved through
the recruitment of high volume agents and larger managing general
agencies, ii) continued expansion of geographical concentration, iii) the
introduction of a new equity-indexed annuity product in May 1998, which
contributed $16.9 million of deposits for the period and iv) deposits
collected from Savers Life and Midwestern Life of $3.6 million.
Net premium deposits for 1997 received from the sales of FPDA's,
interest sensitive annuities and other financial products increased $7.0
million or 16%, to $49.4 million. The increase relates to i) an
aggressive marketing campaign targeting high volume marketing companies
and ii) the continued development of SMC's distribution system through
the marketing support from Standard Marketing, and iii) an increase in
the agency base achieved by expanding geographical concentrations in the
Mid-south and California.
A change in premium deposits in a single period does not directly cause
operating income to change, although continued increases or decreases in
premiums may affect the growth rate of total assets on which investment
spreads are earned.
POLICY INCOME:
Policy income represents mortality charges, administrative fees and
surrender charges.
During 1998 policy income increased $1.0 million or 18% to $6.5
million. The increase relates to $.8 million of surrender charges on
certain FPDA products of Standard Life which is primarily the result of
lowering credited rates on those products.
During 1997 policy income increased $3.0 million or 116% to $5.5
million. The increase in policy income resulted from an increase in
mortality and administrative fees of $1.8 million from the inclusion of
Shelby Life in operations for periods subsequent to November 1, 1996 and
an increase in policy surrender charges from FPDA's of $.7 million from
Standard Life.
NET INVESTMENT INCOME:
Net investment income fluctuates with changes in i) the amount of
average invested assets and ii) and the yield earned on invested assets.
During 1998 net investment income increased $5.1 million or 18%, to
$33.7 million. Average invested assets increased by $89.8 million or 23%
due to the growth in insurance liabilities from the acquisitions of
Savers Life and Midwestern Life, which contributed $4.2 million of
investment income for the period. Net investment income also increased
due to the impact from the new equity indexed product of $.6 million.
During 1997 net investment income increased $8.5 million or 42%, to
$28.6 million. Average invested assets increased by $99.0 million or 35%
due to the growth in insurance liabilities of approximately $100 million
from the acquisition of Shelby Life and increased sales of FPDA's.
The net investment yield earned on average invested assets was 7.48%,
7.77% and 7.32% for 1998, 1997 and 1996, respectively. Investment yields
fluctuate from period to period primarily due to changes in the general
interest rate environment.
OTHER INCOME:
Other income consists of fee income related to servicing blocks of
business for unaffiliated companies, experience refunds, and commission
income.
Other income for 1998 increased $2.0 million or 181%, to $3.1 million.
This increase primarily relates to $1.8 million of fee income from the
Savers Marketing Qual Choice administration agreement.
BENEFITS AND CLAIMS:
Life benefits and claims include i) paid life insurance, ii) benefits
from annuity policies that incorporate significant mortality features,
and iii) changes in future policy reserves. Throughout the Company's
history, it has experienced both periods of higher and lower benefit
claims. Such volatility is not uncommon in the life insurance industry
and, over extended periods of time, periods of higher claim experience
tend to offset periods of lower claims experience.
Health benefits and claims in 1998 include $4.8 million of Medicare
supplement benefits incurred from March 12, 1998, the acquisition date of
Savers Life through July 1, 1998, the effective date of the sale of the
Medicare supplement block of business.
Life benefits and claims in 1997 declined $1.3 million or 13%, to $8.9
million due to i) an increase in future policy reserves of $4.2 million
in 1996 related to the termination and recapture of the reinsurance
agreement with National Mutual. This decrease was somewhat offset by an
increase in benefits and claims from adverse mortality experience and
$1.2 million of additional benefits from the inclusion of Shelby Life.
INTEREST CREDITED ON INTEREST SENSITIVE ANNUITIES AND OTHER FINANCIAL PRODUCTS:
During 1998, interest credited on interest sensitive annuities and
other financial products increased $3.5 million or 21%, to $19.8
million due to i) interest credited on the insurance liabilities of
Savers Life and Midwestern Life of $2.4 million, ii) the impact from the
new equity indexed product of $.6 million and iii) interest credited on
the general growth of insurance liabilities from increased FPDA sales.
These increases were somewhat offset by a decrease in the weighted
average credited rate for the period.
During 1997 , interest credited on interest sensitive annuities and
other financial products increased $5.2 million or 47% to $16.3 million.
The increase is related to the inclusion of interest credited on Shelby
Life products of $3.7 million, increases of credited interest on new
annuity sales, the increase in the growth of policy reserves from FPDA
sales and an increase in the average credited interest rate.
The weighted average credited rate was 5.25%, 5.71% and 5.27 % in 1998,
1997 and 1996 respectively.
AMORTIZATION:
Amortization includes i) amortization related to the present value of
polices purchased from acquired insurance business ii) amortization of
deferred acquisitions costs related to capitalized costs of insurance
business sold and iii) amortization of goodwill and organizational costs.
Amortization in 1998 increased $1.5 million or 46%, to $4.8 million.
The increase in amortization expense is primarily related to deferred
policy acquisition costs and is a result of emerging gross profits from
business sold in recent years, increased surrenders and a corresponding
increase in the amortization of costs related to purchased insurance
business. Amortization expense of $.5 million related to purchased
insurance business of Savers Life and Midwestern Life.
Amortization in 1997 increased $.7 million or 25%, to $3.2 million and
related to $.6 million of present value of future profit amortization of
Shelby Life.
OTHER OPERATING EXPENSES:
Other operating expenses consist of general operating expenses,
including salaries, and commission expenses, net of deferrable amounts.
During 1998, other operating expenses increased $2.1 million or 21% ,
to $12.4 million . The majority of this increase relates to normal
operating expenses from Savers Life and Midwestern Life.
During 1997, other operating expenses increased $.8 million or 8%, to
$10.3 million. This increase relates to additional expenses as a result
of the Shelby Life acquisition in late 1996.
HEALTH COMMISSIONS:
In 1998, commission expense included $.8 million of Medicare supplement
insurance commissions incurred from March 12, 1998, the acquisition date
of Savers Life through July 1, 1998, the effective sale date of the
Medicare supplement block of business.
INTEREST EXPENSE AND FINANCING COSTS:
Interest expense and financing costs for 1998 increased $.6 million or
24%, to $3.0 million, due to increased average borrowings for the period
of $6.4 million primarily related to the acquisitions of Savers Life and
Midwestern Life. This increase was offset somewhat by a decreased
interest rate charged on the revolving line of credit.
Interest expense and financing costs for 1997 increased $1.6 million or
196% to $2.4 million. The increase resulted primarily from i) increased
borrowing of $10.0 million in November 1996 from the amended credit
agreement, ii) borrowings of $4.0 million from an unaffiliated insurance
company in connection with the acquisition of Shelby Life, iii)
additional borrowings of $5.6 million in connection with funding capital
contributions to an insurance subsidiary and, iv) the redemption of Class
S preferred stock.
NET REALIZED INVESTMENT GAINS:
Net realized investment gains fluctuate from period to period and arise
when securities are sold in response to changes in the investment
environment which provide opportunities to maximize return on the
investment portfolio without adversely affecting the quality and overall
yield.
Net realized investment gains were $ .4 million for 1998 and 1997.
INTERNATIONAL OPERATIONS:
1998 1997 1996
(Dollars in thousands)
Premiums and deposits collected:
Traditional life $95 $64 $92
Separate account deposits 42,536 21,954 16,902
Total premiums and deposits collected $42,631 $22,018 $16,994
Premium income $95 $64 $92
Net investment income 859 902 739
Separate account fees 2,120 1,521 1,462
Amortization of negative goodwill 1,388 1,388 1,388
Other income 353 85 --
Total revenues 4,815 3,960 3,681
Benefits and claims (40) (70) (430)
Other operating expenses 2,597 2,310 2,868
Total benefits and expenses 2,557 2,240 2,438
Income before income taxes and $2,258 $1,720 $1,243
extraordinary gain
Separate account contracts{ (1)} 3,070 2,329 2,484
Separate account liabilities{ (1)} $190,246 $148,064 $128,546
(1) primarily unit-linked products
GENERAL:
International operations includes revenues earned and expenses incurred
from abroad, primarily Europe, and includes fees collected on deposits
from unit-linked products. The profitability for this segment primarily
depends on the amount of separate account assets under management, the
management fee charged on those assets and expense management.
FEES FROM SEPARATE ACCOUNTS:
Fee income fluctuates in relationship to total separate account assets
and the fees earned on such assets.
During 1998, fees from separate accounts increased $.6 million or 39%,
to $2.1 million. This increase is due primarily to an increase in the
value of assets held in separate accounts of $42.2 million or 29% , to
$190.2 million. Net deposits from sales of unit-linked products by SMI
increased $20.6 million or 94%, to $42.5 million. This increase is a
continuation of expanded marketing efforts that were initiated in 1996
and 1997.
During 1997, fees from separate accounts increased due to an increase
in the value of assets held in separate accounts of $19.5 million or 15%,
to $148.1 million. Net deposits from the sales of unit-linked products
by SMI increased $5.1 million or 30%, to $22 million.
NET INVESTMENT INCOME:
Net investment income was remained unchanged at $.9 million for 1998
and 1997 on average invested assets of approximately $11.0 million.
The net yield was 7.74%, 7.57% and 6.81% for 1998, 1997 and 1996,
respectively.
AMORTIZATION OF NEGATIVE GOODWILL:
The excess cost of assets acquired over the purchase price paid for SMI
in December of 1993 of $6.9 million has been amortized over 5 years at
$1.4 million per year and is fully amortized at December 31, 1998.
BENEFITS AND CLAIMS:
Benefits and claims include changes to future policyholder benefits and
premium deficiency reserves.
During 1997, benefits and claims increased $.3 million partially due to
increased traditional life reserves.
OTHER OPERATING EXPENSES:
Other operating expenses for 1998 increased $.3 million or 12%, to $2.6
million. The increase primarily relates to an increased level of
business activity for the period. The number of separate account
contracts administered increased 32%, to 3070.
Other operating expenses for 1997 declined $.6 million or 19%, to $2.3
million. The decrease primarily related to the a favorable impact of the
US dollar relative to foreign currency.
FOREIGN CURRENCY TRANSLATION:
Although the net impact of foreign currency translation is deemed to be
immaterial, comparisons between 1998, 1997 and 1996 are impacted by the
strengthening and destrengthening of the U.S. dollar relative to foreign
currencies, primarily the Luxembourg franc. The impact of these
translations have not been quantified on individual components.
LIQUIDITY AND CAPITAL RESOURCES
LIQUIDITY OF STANDARD MANAGEMENT (PARENT COMPANY)
Standard Management is a financial services holding company whose
liquidity requirements are met through payments received from its subsidiaries.
These payments include i) interest on surplus debenture, ii) dividends, iii)
management fees and iv) rental income, which are subject to restrictions under
applicable insurance laws and are used to pay operating expenses and meet debt
service obligations. These internal sources of liquidity have been
supplemented in the past by external sources such as a revolving credit
agreements and long term debt and equity financing in the capital markets.
GENERAL: On a consolidated GAAP basis SMC reported net cash provided
by operations of $.3 million and $7.8 million for 1998 and 1997, respectively.
Although deposits received on SMC's interest-sensitive annuities and other
financial products are not included in cash flow from operations under GAAP,
such funds are available for use by SMC. Cash provided by operations plus
net deposits received, less net account balances returned to policyholders on
interest sensitive annuities and other financial products, resulted in positive
cash flow of $29.2 million and $19.6 million for 1998 and 1997, respectively.
Cash generated on a consolidated basis is available to Standard Management only
to the extent that it is generated at the Standard Management level or is
available through dividends, interest, management fees or other payments from
subsidiaries.
SMC instituted a program to repurchase its common stock in order to
increase the market value of the stock. At December 31, 1998, Standard
Management is authorized to repurchase 1.1 million additional shares of SMC
Common Stock under this program.
At February 28, 1999, Standard Management had "parent company only" cash
and short-term investments of $.4 million. These funds are available to
Standard Management for general corporate purposes. Standard Management's
"parent company only" operating expenses (not including interest expense) were
$3.1 million and $3.4 million for 1998 and 1997, respectively. In addition,
Standard Management has available $1.0 million from its Amended Credit
Agreement.
In 1998, the Company issued convertible redeemable preferred stock with a
stated value of $6.5 million. Proceeds were used to reduce the borrowings from
the Amended Credit Agreement. Holders are entitled to receive annual dividends
of $7.75 per share. Refer to Notes 7 and 10 to the consolidated financial
statements for additional information.
Standard Management anticipates the available cash from its existing
working capital, plus anticipated 1999 dividends, management fees, rental
income and interest payments on its surplus debentures receivable will be more
than adequate to meet its anticipated "parent company only" cash requirements
for 1999.
INTEREST IN SURPLUS DEBENTURES AND NOTES PAYABLE:
The following are characteristics of the Amended Credit Agreement at
December 31, 1998:
$25.0 million outstanding balance
Weighted average interest rate of 8.52%
Principal payments: $3.3 million due March 2000, $4.3 million
thereafter through March 2005
Subject to certain restrictions and covenants
Interest payments required in 1999 based on December 31, 1998 balances
will be $2.1 million
The following are characteristics of the subordinated convertible debt
agreement at December 31, 1998:
$10.0 million outstanding balance
Interest rate of 10% per annum
Due date of July 2004
Interest payments required in 1999 based on December 31, 1998 balances
will be $1.0 million
Refer to Note 5 to the consolidated financial statements for additional
information
From the funds borrowed by Standard Management pursuant to the Amended
Credit Agreement and the subordinated convertible debt agreement, $27.0 million
was loaned to Standard Life pursuant to Unsecured Surplus Debenture Agreements
("Surplus Debenture") which requires Standard Life to make quarterly interest
payments to Standard Management at a variable corporate base rate plus 2% per
annum, and annual principal payments of $1.0 million per year beginning in
2007 and concluding in 2033. The interest and principal payments are subject to
quarterly approval by the Indiana Department of Insurance, depending upon
satisfaction of certain financial tests relating to levels of Standard Life's
capital and surplus and general approval of the Commissioner of the Indiana
Department of Insurance. Standard Management currently anticipates these
quarterly approvals will be granted. Assuming the approvals are granted and the
December 31, 1998 interest rate of 9.75% continues, Standard Management will
receive interest income of $2.6 million from the Surplus Debenture in 1999.
DIVIDENDS. Dividends from Standard Life to Standard Management are
limited by laws applicable to insurance companies. As an Indiana domiciled
insurance company, Standard Life may pay a dividend or distribution from its
surplus profits, without the prior approval of the Commissioner of the Indiana
Department of Insurance, if the dividend or distribution, together with all
other dividends and distributions paid within the preceding twelve months, does
not exceed the greater of (i) net gain from operations or (ii) 10% of surplus,
in each case as shown in its preceding annual statutory financial statements.
In 1999, Standard Life can pay dividends of approximately $4.4 million without
regulatory approval.
MANAGEMENT FEES. Pursuant to a management services agreement, Standard
Life paid Standard Management $2.0 million during 1998 and $2.0 million during
1997 for certain management services related to the production of business,
investment of assets and evaluation of acquisitions. Prior to its merger into
Standard Life, Savers Life paid Standard Management $.8 million during 1998 for
certain management services pursuant to a management services agreement. In
addition, Dixie Life paid Standard Life $1.0 million during 1998 and $1.1
million during 1997 for certain management services provided. Both of these
agreements provide that they may be modified or terminated by the Indiana and
Mississippi departments of insurance in the event of financial hardship of
Standard Life or Dixie Life.
Pursuant to the management services agreement, Premier Life (Luxembourg)
paid Standard Management $.1 million during 1998 and 1997 for certain
management and administrative services. The agreement provides that it may be
modified or terminated by either Standard Management or Premier Life
(Luxembourg).
EQUIPMENT RENTAL FEES. In 1998 and 1997, Standard Management charged
subsidiaries $1.1 million per year for the use of equipment owned by Standard
Management.
LIQUIDITY OF INSURANCE OPERATIONS
U.S. INSURANCE OPERATIONS. The principal liquidity requirements of
Standard Life are its contractual obligations to policyholders, dividend, rent,
management fee and Surplus Debenture payments to Standard Management and other
operating expenses. The primary source of funding for these obligations has
been cash flow from premium income, net investment income, investment sales and
maturities and sales of FPDAs. These sources of liquidity for Standard Life
significantly exceed scheduled uses. Liquidity is also affected by unscheduled
benefit payments including death benefits and policy withdrawals and
surrenders. The amount of withdrawals and surrenders is affected by a variety
of factors such as renewal interest crediting rates, interest rates for
competing products, general economic conditions, Standard Life's A.M. Best
ratings (currently rated "B+") and events in the industry that affect
policyholders' confidence.
The policies and annuities issued by Standard Life contain provisions
that allow policyholders to withdraw or surrender their policies under defined
circumstances. These policies and annuities generally contain provisions which
apply penalties or otherwise restrict the ability of policyholders to make such
withdrawals or surrenders. Standard Life closely monitors the surrender and
policy loan activity of its insurance products and manages the composition of
its investment portfolios, including liquidity, in light of such activity.
Changes in interest rates may affect the incidence of policy surrenders
and other withdrawals. In addition to the potential effect on liquidity,
unanticipated withdrawals in a changing interest rate environment could
adversely affect earnings if SMC were required to sell investments at reduced
values to meet liquidity demands. SMC manages the asset and liability
portfolios in order to minimize the adverse earnings effect of changing market
interest rates. SMC seeks assets that have duration characteristics similar to
the liabilities that they support. SMC also prepares cash flow projections and
performs cash flow tests under various market interest rate scenarios to assist
in evaluating liquidity needs and adequacy. SMC's U.S. insurance subsidiaries
currently expect available liquidity sources and future cash flows to be
adequate to meet the demand for funds.
Statutory surplus is computed according to rules prescribed by the NAIC,
as modified by the Indiana Department of Insurance, or the state in which the
insurance subsidiaries do business. Statutory accounting rules are different
from GAAP and are intended to reflect a more conservative perspective. With
respect to new business, statutory accounting practices require that:
(i) acquisition costs (primarily commissions and policy issue costs) and
(ii) reserves for future guaranteed principal payments and interest in excess
of statutory rates, be expensed in the year the new business is written. These
items cause a reduction in statutory surplus ("surplus strain") in the year
written for many insurance products. SMC designs its products to minimize such
first-year losses, but certain products continue to cause a statutory loss in
the year written. For each product, SMC controls the amount of net new premiums
written to manage the effect of such surplus strain. SMC's long-term growth
goals contemplate continued growth in its insurance businesses. To achieve
these growth goals, SMC's U.S. insurance subsidiaries will need to increase
statutory surplus. Additional statutory surplus may be secured through various
sources such as internally generated statutory earnings, infusions by Standard
Management with funds generated through debt or equity offerings or mergers
with other life insurance companies. If additional capital is not available
from one or more of these sources, SMC believes that it could reduce surplus
strain through the use of reinsurance or through reduced writing of new
business.
Management believes that the operational cash flow of Standard Life will
be sufficient to meet its anticipated needs for 1999. As of December 31, 1998,
Standard Life had statutory capital and surplus for regulatory purposes of
$43.6 million compared to $25.9 million at December 31, 1997. The increase is
primarily due to the issuance of $14.0 million of surplus debentures in
connection with the merger of Midwestern Life and Savers Life into Standard
Life. The remaining increase is primarily due to 1998 net gain from operations
of Standard Life of $1.7 million. As the life insurance and annuity business
produced by Standard Life increases, Standard Life expects to continue to
satisfy statutory capital and surplus requirements through statutory profits,
through the continued reinsurance of a portion of its new business, and through
additional capital contributions by Standard Management. Net cash flow from
operations on a statutory basis of Standard Life, after payment of benefits and
operating expenses, was $15.8 million and $19.6 million for 1998 and 1997,
respectively. If the need arises for cash which is not readily available,
additional liquidity could be obtained from the sale of invested assets.
Effective January 1, 1999 the Company decided to no longer sell new
business through Dixie Life. All new business will instead be sold through
Standard Life. This decision is not expected to have a material effect on
operations or financial condition of the Company.
INTERNATIONAL OPERATIONS. SMI dividends are limited to its accumulated
earnings without regulatory approval. SMI and Premier Life (Luxembourg) were
not permitted to pay dividends in 1998 and 1997 due to accumulated losses.
Premier Life (Bermuda) did not pay dividends in 1998 and 1997. SMC does not
anticipate any dividends from these companies in 1999.
FACTORS THAT MAY AFFECT FUTURE RESULTS
MERGERS, ACQUISITIONS AND CONSOLIDATIONS. The U.S. insurance industry is
experiencing an increasing number of mergers, acquisitions, consolidations and
sales of certain business lines. These consolidations are largely the result
of the following:
the need to reduce costs of distribution and overhead;
the need to maintain business in force;
increased competition;
regulatory capital requirements; and
technology costs.
SMC expects this trend to continue.
FOREIGN CURRENCY RISK. SMI policyholders invest in assets denominated in
a wide range of currencies. As policyholders are not permitted to invest
directly in options, futures and derivatives, their investment and currency
risk is limited to premiums they have paid. Although policyholders effectively
bear the currency risk, SMI could be exposed to currency fluctuations if
currencies within the conventional investment portfolio or certain actuarial
reserves are mismatched. In order to minimize this risk, SMI continually
matches the assets and liabilities of the portfolio and the reserves. In
addition, Premier Life (Luxembourg) shareholder's equity is denominated in
Luxembourg francs. Premier Life (Luxembourg) does not hedge currency risk
because its shareholder's equity will remain in Luxembourg francs for the
foreseeable future, thus, no significant realized foreign exchange gains or
losses are anticipated. At December 31, 1998, there was an immaterial
unrealized loss from foreign currency.
EURO CURRENCY. Effective January 1, 1999, the eleven participating
European member union countries established fixed conversion rates between
their legal currencies and the euro. The legal currencies in those countries
will continue to be used as legal tender through January 1, 2002. Subsequent
to this date, the legal currencies will be canceled and euro bills and coins
will be used for cash transactions in the participating countries. During this
three year dual-currency environment, conversion rates between the legal
currencies will no longer be computed directly between one another. Instead, a
special "triangulation" procedure must be followed by first converting one
legal currency into its euro equivalent and then converting the euro equivalent
into the other legal currency. Although the Company has not initiated an
analysis plan for the euro conversion, SMC does not expect it to have a
material impact on its operations or financial condition.
POSSIBILITY OF FUTURE DILUTION OF OWNERSHIP AND VOTING POWER. The SMC
Board of Directors has the authority to issue up to .9 million additional
shares of preferred stock and 12.4 million additional shares of common stock.
The board's authority under SMC's charter typically does not require
stockholder approval unless it is otherwise required for a particular
transaction. Although SMC is not currently involved in any life insurance
acquisitions, the Company regularly investigates such opportunities and could
issue additional shares of SMC common or preferred stock in connection with an
acquisition.
UNCERTAINTIES REGARDING INTANGIBLE ASSETS. Included in SMC's December
31, 1998 financial statements are certain assets that are primarily valued ,
for financial statement purposes, on the basis of management assumptions.
These assets include items such as:
deferred acquisition costs;
present value of future profits;
costs in excess of net assets acquired; and
organization and deferred debt issuance costs.
The value of these assets reflected in the December 31, 1998 balance
sheet total $67.6 million or 7.1% of SMC's assets. SMC has established
procedures to periodically review the assumptions used to value these assets
and determine the need to make adjustments of such values in SMC's consolidated
financial statements. SMC has determined that the assumptions used in the
initial valuation of the assets are consistent with the current operations of
SMC as of December 31, 1998.
REGULATORY ENVIRONMENT. Currently, prescribed or permitted statutory
accounting principles ("SAP") may vary between states and between companies.
The NAIC is in the process of codifying SAP to promote standardization of
methods utilized throughout the industry. Completion of this project might
result in changes in statutory accounting practices for SMC's insurance
subsidiaries; however, it is not expected that such changes would materially
affect SMC's insurance subsidiaries' statutory capital requirements.
FINANCIAL SERVICES DEREGULATION. The United States Congress is currently
considering a number of legislative proposals intended to reduce or eliminate
restrictions on affiliations among financial services organizations. Proposals
are extant which would allow banks to own or affiliate with insurers and
securities firms. An increased presence of banks in the life insurance and
annuity businesses may increase competition in these markets. The Company
cannot predict the impact of these proposals on the earnings of the Company.
IMPACT OF YEAR 2000. The Company updated its main operating computer
systems in 1995 with Year 2000 ready systems at a cost of $.5 million. Since
that time the Company has completed modifications or conversions of other
portions of its software, hardware and imbedded chip technology so that its
computer systems will function properly with respect to dates in the year 2000
and thereafter. The Company believes that with such modifications and
conversions, the Year 2000 issue will not pose significant operational problems
for its computer systems. The total cost of the Year 2000 project is $.6
million including the $.5 million previously discussed. These costs are not
material to the Company's financial statements and were funded through
operating cash flows.
The Company is currently assessing the risks associated with their
external business relationships, including those with agents and financial
institutions. The Company has been informed by approximately 50% of their
external business partners that they are or will be Year 2000 ready sometime
in 1999. The Company is still accumulating data from the remaining business
partners, which it hopes to have concluded by mid 1999.
The Company also assessed what contingency plans will be needed, if any,
of its critical systems or those of external business relationships that are
not Year 2000 ready after December 31, 1999. The Company does not currently
anticipate such a situation, but the consideration of a contingency plan will
continue to evolve as new information becomes available.
The failure to correct a Year 2000 problem could result in an
interruption, or failure of, a number of normal business activities or
operations. However, management has concluded that the Year 2000 issue will
not materially affect future financial results, or cause reported financial
information to be nonindicative of future operating results or financial
condition.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company seeks to invest available funds in a manner that will
maximize shareholder value and fund future obligations to policyholders and
debtors, subject to appropriate risk considerations. Many of the Company's
products incorporate surrender charges, market interest rate adjustments or
other features to encourage persistency. Approximately 75% of the total
insurance liabilities at December 31, 1998 had surrender penalties or other
restrictions and approximately 9% are not subject to surrender.
The Company also seeks to maximize the total return on its investments
through active investment management. Accordingly, the Company has determined
that the entire portfolio of fixed maturity securities is available to be sold
in response to: (i) changes in market interest rates; (ii) changes in relative
values of individual securities and asset sectors; (iii) changes in prepayment
risks; (iv) changes in credit quality outlook for certain securities; (v)
liquidity needs; and (vi) other factors.
Profitability of many of the Company's products is significantly affected
by the spreads between interest yields on investments and rates credited on
insurance liabilities. Although substantially all credited rates on annuity
products may be changed annually (subject to minimum guaranteed rates), changes
in competition and other factors, including the impact of the level of
surrenders and withdrawals, may limit the ability to adjust or to maintain
crediting rates at levels necessary to avoid narrowing of spreads under certain
market conditions. As of December 31, 1998, the average yield, computed on the
cost basis of the investment portfolio, was 7.48%, and the average interest
rate credited or accruing to total insurance liabilities was 5.25%, excluding
interest bonuses guaranteed for the first year of the annuity contract only.
Computer models were used to perform simulations of the cash flows
generated from the Company's existing business under various interest rate
scenarios. These simulations measured the potential gain or loss in fair value
of interest rate-sensitive financial instruments. With such estimates, the
Company seeks to closely match the duration of assets to the duration of
liabilities. When the estimated durations of assets and liabilities are
similar, exposure to interest rate risk is minimized because a change in the
value of assets should be largely offset by a change in the value of
liabilities. At December 31, 1998, the adjusted modified duration of fixed
maturity securities and short-term investments was approximately 5.6 years, and
the duration of insurance liabilities was approximately 4.1 years.
If interest rates were to increase by 10% from their December 31, 1998
levels, the Company's fixed maturity securities and short-term investments (net
of the corresponding changes in the values of cost of policies purchased, cost
of policies produced and insurance liabilities) would decline in fair value by
approximately $3.5 million.
The calculations involved in the Company's computer simulations
incorporate numerous assumptions, require significant estimates and assume an
immediate change in interest rates without any management of the investment
portfolio in reaction to such change. Consequently, potential changes in the
value of our financial instruments indicated by the simulations will likely be
different from the actual changes experienced under given interest rate
scenarios, and the differences may be material. Because the Company's
investments and liabilities are actively managed, actual losses could be less
than those estimated above.
ITEM 8.CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and supplementary data required with respect to
this Item 8 are listed in Item 14(a)(1) and included in a separate section of
this report.
ITEM 9.CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
The Registrant will file a definitive proxy statement pursuant to
Regulation 14A of the Securities Exchange Act of 1934 in connection with the
Company's 1999 Annual Meeting of Shareholders, (the "Proxy Statement") not
later than 120 days after the end of the fiscal year covered by this report,
and certain information included therein is incorporated herein by reference.
Only those sections of the Proxy Statements which specifically address the
items set forth herein are incorporated by reference. Such incorporation does
not include the Compensation Committee Report or the Performance Graph included
in the Proxy Statement.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information concerning SMC's directors required by this item is
incorporated by reference to SMC's Proxy Statement.
The information concerning SMC's executive officers required by this Item
is incorporated by reference herein to the section in Part I, entitled
"Executive Officers."
The information regarding compliance with Section 16 of the Securities
and Exchange Act of 1934 is to be set forth in the Proxy Statement and is
hereby incorporated by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated by reference to
SMC's Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is incorporated by reference to
SMC's Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIP AND RELATED TRANSACTIONS
The information required by this Item is incorporated by reference to
SMC's Proxy Statement.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)(1) and (2) The response to this portion of Item 14 is submitted as a
separate section of this report.
(a)(3) List of Exhibits:
Exhibit
NUMBER DESCRIPTION OF DOCUMENT
2.1 Amended and Restated Agreement and Plan of Merger dated as of
December 9, 1997 among SMC, SAC and Savers Life. (incorporated by
reference to SMC's Registration Statement on Form S-4 (Registration
No. 333-43023)).
2.2 Stock Purchase Agreement dated as of June 4, 1998 by and among SMC and
MC Equities, Inc. (incorporated by reference to SMC's Form 8-K
(Registration No. 0-20882)).
2.3 First Amendment to Stock Purchase Agreement dated as of July 1, 1998
by and among SMC and MC Equities, Inc. (incorporated by reference to
SMC's Form 8-K (Registration No. 0-20882)).
2.4 Second Amendment to Stock Purchase Agreement dated as of July 23, 1998
by and among SMC and MC Equities, Inc. (incorporated by reference to
SMC's Form 8-K (Registration No. 0-20882)).
2.5 Third Amendment to Stock Purchase Agreement dated as of October 8,
1998 by and among SMC and MC Equities, Inc. (incorporated by reference
to SMC's Form 8-K (Registration No. 0-20882)).
3.1 Amended and Restated Articles of Incorporation, as amended
(incorporated by reference to SMC's Annual Report on Form 10-K (File
No. 0-20882) for the year ended December 31, 1996).
3.2 Amended and Restated Bylaws of SMC as amended (incorporated by
reference to SMC's Registration Statement on Form S-1 (Registration
No. 33-53370) as filed with the Commission on January 27, 1993 and to
Exhibit 3 of SMC's Quarterly Report on Form 10-Q (File No. 0-20882)
for the quarter ended September 30, 1994).
4.1 Form of Senior Note Agreement Warrant (incorporated by reference to
SMC's Registration Statement on Form S-1 (Registration No. 33-53370)).
4.2 Form of Oppbridge Partners Warrant (incorporated by reference to SMC's
Registration Statement on Form S-1 (Registration No. 33-53370)).
4.3 Registration Rights Agreement, dated as of May 3, 1990 among SMC,
Howard T. Cohn and Joseph J. Piazza and the first amendment thereto,
dated June 4, 1990 (incorporated by reference to SMC's Registration
Statement on Form S-1 (Registration No. 33-53370).
4.4 Amended and Restated Registration Rights Agreement dated as of April
15, 1997 by and between SMC and Fleet National Bank.
4.5 Form of Fleet National Bank Warrant.
Exhibit
NUMBER DESCRIPTION OF DOCUMENT
4.6 Form of President's Club Warrant (incorporated by reference to SMC's
Annual Report on Form 10-K (File No. 0-20882)).
4.7 Registration Rights Agreement dated as of November 8, 1996 by and
between SMC and Conseco Variable Insurance Company (formerly Great
American Reserve Insurance Company) (incorporated by reference to
SMC's Quarterly Report on Form 10-Q (File No. 0-20882) for the quarter
ended September 30, 1996).
4.8 Form of Sand Brothers & Company, Ltd. Warrant (incorporated by
reference to SMC's Annual Report on Form 10-K (File No. 0-20882) for
the year ended December 31, 1997).
9 Voting Trust Agreement dated as of November 8, 1996 among Delta Life
and Annuity Company, Messrs. Ronald D. Hunter and Allen O. Jones, Jr.,
as Voting Trustees, and SMC (incorporated by reference to SMC's
Registration Statement on Form S-4 (Registration No. 333-35447)).
10.1 Amended Advisory Agreement, dated as of August 1, 1991, between
SMC and Conseco Capital Management, Inc., as amended, April 17,
1995 (incorporated by reference to SMC's Annual Report on
Form 10-K (File No. 0-20882) for the year ended December 31,
1996).
10.2 Second Amended and Restated Employment Contract by and between
SMC and Ronald D. Hunter, dated and effective, as amended,
April 3, 1995 (incorporated by reference to SMC's Quarterly
Report on Form 10-Q (File No. 0-20882) for the quarter ended
June 30, 1995).
10.3 Second Amended and Restated Employment Contract by and between
SMC and Edward T. Stahl, dated and effective, as amended,
April 3, 1995 (incorporated by reference to SMC's Quarterly
Report on Form 10-Q (File No. 0-20882) for the quarter ended
June 30, 1995).
10.4 Second Amended and Restated Employment contract by and between
SMC and Raymond J. Ohlson, dated and effective, as amended,
April 3, 1995 (incorporated by reference to SMC's Quarterly
Report on Form 10-Q (File No. 0-20882) for the quarter ended
June 30, 1995).
10.5 First Amended and Restated Employment Contract by and between
SMC and Stephen M. Coons dated and effective, April 3, 1995
(incorporated by reference to SMC's Quarterly Report on
Form 10-Q (File No. 0-20882) for the quarter ended June 30,
1995).
10.6 Indemnification Agreement between SMC and Stephen M. Coons and
Coons & Saint, dated August 1, 1991 (incorporated by reference
to SMC's Registration Statement on Form S-1 (Registration
No. 33-53370) as filed with the Commission on January 27, 1993).
10.7 Standard Management Corporation Amended and Restated 1992 Stock
Option Plan (incorporated by reference to the Company's
Registration Statement on Form S-4 (Registration No. 333-35447)
as filed with the Commission on September 11, 1997.
10.8 Lease by and between Standard Life and WRC Properties, Inc.,
dated February 27, 1991 (incorporated by reference to SMC's
Registration Statement on Form S-1 (Registration No. 33-53370)
as filed with the Commission on January 27, 1993).
10.9 Management Service Agreement between Standard Life and SMC dated
August 1, 1992, as amended on January 1, 1997 and as further
amended on January 1, 1999.
10.10 Agreement for Assumption Reinsurance between the National
Organization Of Life and Health Insurance Guaranty Associations
and Standard Life, concerning, The Midwest Life Insurance
Company In Liquidation effective June 1, 1992 (incorporated by
reference to SMC's Registration Statement on Form S-1
(Registration No. 33-53370) as filed with the Commission on
January 27, 1993).
10.11 Reinsurance Agreement between Standard Life and Swiss Re Life
and Health effective May 1, 1975 (incorporated by reference to
SMC's Registration Statement on Form S-1 (Registration
No. 33-53370) as filed with the Commission on January 27, 1993).
Exhibit
NUMBER DESCRIPTION OF DOCUMENT
10.12 Reinsurance Agreement between Firstmark Standard Life Insurance
Company and Swiss Re Life and Health effective February 1, 1984
(incorporated by reference to SMC's Registration Statement on
Form S-1 (Registration No. 33-53370) as filed with the
Commission on January 27, 1993).
10.13 Reinsurance Contract between First International and Standard
Life dated July 10, 1992 (incorporated by reference to SMC's
Registration Statement on Form S-1 (Registration No. 33-53370)
as filed with the Commission on January 27, 1993).
10.14 Amended Reinsurance Agreement between Standard Life and
Winterthur Life Re Insurance Company effective January 1, 1995
(incorporated by reference to SMC's Annual Report on Form 10-K
(File No. 0-20882) for the year ended December 31, 1996).
10.15 Management Service Agreement between Premier Life (Luxembourg)
and SMC dated September 30, 1994 (incorporated by reference to
SMC's Annual Report on Form 10-K (File No. 0-20882) for the year
ended December 31, 1994).
10.16 Assignment of Management Contract dated October 2, 1995 of
Management Contract dated January 1, 1987 between DNC and Dixie
Life to Standard Life (incorporated by reference to SMC's Annual
Report on Form 10-K (File No. 0-20882) for the year ended
December 31, 1996).
10.17 Automatic Indemnity Reinsurance Agreement between First
International and The Guardian Insurance & Annuity Company, Inc.
dated and effective January 1, 1996 (incorporated by reference
to SMC's Annual Report on Form 10-K (File No. 0-20882) for the
year ended December 31, 1996).
10.18 Indemnity Retrocession Agreement between The Guardian
Insurance & Annuity Company, Inc. and Standard Life dated and
effective January 1, 1996 (incorporated by reference to SMC's
Annual Report on Form 10-K (File No. 0-20882) for the year ended
December 31, 1996).
10.19 Automatic Indemnity Reinsurance Agreement between The Guardian
Insurance & Annuity Company, Inc. and Standard Life dated and
effective January 1, 1996 (incorporated by reference to SMC's
Annual Report on Form 10-K (File No. 0-20882) for the year ended
December 31, 1996).
10.20 Administrative Services Agreement between First International
and Standard Life dated and effective March 18, 1996
(incorporated by reference to SMC's Annual Report on Form 10-K
(File No. 0-20882) for the year ended December 31, 1996).
10.21 Amendment No. 1 to Amended and Restated Revolving Line of Credit
Agreement dated as of March 10, 1998 between SMC and Fleet
National Bank. (Incorporated by reference to SMC's Quarterly
Report on Form 10-Q (File No. 0-20882)).
10.22 Amended and Restated Note Agreement dated as of March 10, 1998
between SMC and Fleet National Bank in the amount of
$20,000,000.(Incorporated by reference to SMC's Quarterly Report
on Form 10-Q (File No. 0-20882)).
10.23 Amended and Restated Pledge Agreement dated as of March 10, 1998
between SMC and Fleet National Bank. (Incorporated by reference
to SMC's Quarterly Report on Form 10-Q (File No. 0-20882)).
10.24 Revised Service Contract Agreement dated as of October 16, 1995
and effective January 1, 1995 between Standard Life and Standard
Marketing (incorporated by reference to SMC's Annual Report on
Form 10-K (File No. 0-20882) for the year ended December 31,
1996).
10.25 Note Agreement dated as of November 8, 1996, as amended and
restated on June 30, 1997, by and between SMC and Conseco
Variable Insurance Company in the amount of $4,371,573
(incorporated by reference to SMC's Quarterly Report on
Form 10-Q (File No. 0-20882) for the quarter ended June 30,
1997).
10.26 Surplus Debenture dated as of November 8, 1996 by and between
SMC and Standard Life in the amount of $13,000,000 (incorporated
by reference to SMC's Quarterly Report on Form 10-Q (File
No. 0-20882) for the quarter ended September 30, 1996).
10.27 Portfolio Indemnify Reinsurance Agreement between Dixie Life and
Cologne Life Reinsurance Company dated and effective December
31, 1997 (incorporated by reference to SMC's Annual Report on
Form 10-K (File No. 0-20882) for the year ended December 31,
1996).
Exhibit
NUMBER DESCRIPTION OF DOCUMENT
10.28 Note Agreement dated as of June 30, 1997 between SMC, Conseco
Health Insurance Company (formerly Capitol American Life
Insurance Company) and Conseco Senior Health Insurance Company
(formerly Transport Life Insurance Company) in the amount of
$5,628,427 (incorporated by reference to SMC's Quarterly Report
on Form 10-Q (File No. 0-20882) for the quarter ended June 30,
1997).
10.29 Senior Subordinated Convertible Note dated as of June 30, 1997
between SMC and Conseco Health Insurance Company in the amount
of $3,628,427 (incorporated by reference to SMC's Quarterly
Report on Form 10-Q (File No. 0-20882) for the quarter ended
June 30, 1997).
10.30 Senior Subordinated Convertible Note dated as of June 30, 1997
between SMC and Conseco Senior Health Insurance Company in the
amount of $2,000,000 (incorporated by reference to SMC's
Quarterly Report on Form 10-Q (File No. 0-20882) for the quarter
ended June 30, 1997).
10.31 Coinsurance Agreement effective as of July 1, 1997 by and
between Savers Life and World Insurance Company (incorporated by
reference to SMC's Registration Statement on Form S-4
(Registration No. 333-35447)).
10.32 Amendment I to the Guardian Indemnity Retrocession Agreement
effective as of January 1, 1996 by and between The Guardian
Insurance and Annuity Company and Standard Life (incorporated by
reference to SMC's Registration Statement on Form S-4
(Registration No. 333-35447)).
10.33 Promissory Note from Ronald D. Hunter to SMC in the amount of
$775,500 executed October 28, 1997 (incorporated by reference to
SMC's Quarterly Report on Form 10-Q (File No. 0-20882) for the
quarter ended September 30, 1997).
10.34 Reinsurance Agreement between Standard Life and Life Reassurance
Corporation of America effective September 1, 1997.
10.35 Reinsurance Agreement between Standard Life and Business Men's
Assurance Company of America effective September 1, 1997.
10.36 Management Services Agreement between Savers Life and SMC dated
March 11, 1998 (incorporated by reference to SMC's Quarterly
Report on Form 10-Q (File No. 0-20882) for the quarter ended
June 30, 1998).
10.37 Indemnity Reinsurance Agreement between Standard Life and the
Mercantile and General Life Reassurance Company of America dated
March 30, 1998 and effective June 1, 1997 (incorporated by
reference to SMC's Quarterly Report on Form 10-Q (File No. 0-
20882) for the quarter ended June 30, 1998).
10.38 Certificate of Designations for Series A Convertible Redeemable
Preferred Stock (incorporated by reference to SMC's Quarterly
Report on Form 10-Q (File No. 0-20882) for the quarter ended
June 30, 1998).
10.39 Quota Share Reinsurance Agreement between Savers Life and the
Oxford Life Insurance Company dated September 24, 1998 and
effective July 1, 1998 (incorporated by reference to SMC's
Quarterly Report on Form 10-Q (File No. 0-20882) for the quarter
ended September 30, 1998).
10.40 Addendum No. 5 to Reinsurance Agreement between Standard Life
Insurance Company of Indiana and Winterthur Life Re Insurance
Company dated August 20, 1998 and effective October 1, 1998
(incorporated by reference to SMC's Quarterly Report on Form 10-
Q (File No. 0-20882) for the quarter ended September 30, 1998).
10.41 Employment Agreement between Robert B. Neal and Standard
Management Corporation dated October 2, 1998 and effective
October 2, 1998 (incorporated by reference to SMC's Quarterly
Report on Form 10-Q (File No. 0-20882) for the quarter ended
September 30, 1998).
10.42 Articles of Merger of Savers Life into Standard Life effective
as of December 31, 1998 and approved by the Indiana Department
of Insurance December 29, 1998.
Exhibit
NUMBER DESCRIPTION OF DOCUMENT
10.43 Plan and Agreement of Merger of Savers Life into Standard Life
effective as of December 31, 1998 dated October 30, 1998.
10.44 Articles of Merger of Midwestern Life into Standard Life
effective as of December 31, 1998 and approved by the Indiana
Department of Insurance December 29, 1998.
10.45 Plan and Agreement of Merger of Midwestern Life into Standard
Life effective as of December 31, 1998 dated October 30, 1998.
10.46 Amended and Restated note Agreement dated as of September 24,
1998 between SMC and Fleet National Bank in the amount of
$26,000,000.
10.47 Amendment No. 2 to Amended and Restated Revolving Line of Credit
Agreement dated as of September 24, 1998 between SMC and Fleet
National Bank.
10.48 Amended and Restated Registration Rights Agreement dated as of
August 19, 1998 between SMC and Fleet National Bank.
10.49 Amended and Restated Pledge Agreement dated as of September 23,
1998, between SMC and Fleet National Bank.
10.50 Warrant to purchase common stock of SMC dated August 19, 1998
entitling Fleet National Bank to purchase 20,000 shares.
10.51 Guaranty dated October 1, 1998 made by SMC in favor of Fleet
National Bank.
10.52 Surplus debenture dated as of December 31, 1998 by and between
SMC and Standard Life in the amount of $8.0 million.
10.53 Surplus debenture dated as of December 31, 1998 by and between
SMC and Standard Life in the amount of $6.0 million.
21 List of Subsidiaries of SMC
23.1 Consent of Ernst & Young LLP
23.2 Consent of KPMG Audit
24 Powers of Attorney
27 Financial Data Schedule, which is submitted electronically pursuant to
Regulation S-K to the Securities and Exchange Commission for
information only and not filed.
The following is a list of each management contract or compensatory plan or
arrangement required to be filed as an exhibit to this report.
EXHIBIT
NUMBER
10.9
10.42
10.43
10.44
10.45
10.46
10.47
10.48
10.49
10.50
10.51
10.52
10.53
(b) Reports on Form 8-K filed during the fourth quarter of 1998.
A report on Form 8-K was filed with the Commission to report under Item 5
the signing of the Third Amendment to the Stock Purchase Agreement dated as of
October 8, 1998 to purchase Midwestern National Life Insurance Company of Ohio.
A report on Form 8-K was filed with the Commission to report under Item 2
the purchase of Midwestern National Life Insurance Company of Ohio dated as of
November 13, 1998.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.
Date: March 30, 1999
STANDARD MANAGEMENT CORPORATION
/S/ RONALD D. HUNTER
Ronald D. Hunter
Chairman, President and
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below on March 30, 1999 by the following persons on
behalf of the Registrant and in the capacities indicated.
/S/ RONALD D. HUNTER
Ronald D. Hunter Chairman, President and Chief Executive Officer
(Principal Executive Officer)
*
Paul B. Pheffer Director, Executive Vice President,
Treasurer and Chief Financial Officer
(Principal Financial Officer)
*
Gerald R. Hochgesang Senior Vice President -- Finance
(Principal Accounting Officer)
*
Raymond J. Ohlson Director
*
Edward T. Stahl Director
*
Stephen M. Coons Director
*
Martial R. Knieser Director
*
Robert A. Borns Director
*
John J. Dillon Director
*
Jerry E. Francis Director
*By: /s/ RONALD D. HUNTER
Ronald D. Hunter
Attorney-in-Fact
ANNUAL REPORT ON FORM 10-K
ITEM 8, ITEM 14(a)(1) AND (2),(c) AND (d)
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
LIST OF FINANCIAL STATEMENTS
and
FINANCIAL STATEMENT SCHEDULES
CERTAIN EXHIBITS
FINANCIAL STATEMENT SCHEDULES
Year Ended December 31, 1998
STANDARD MANAGEMENT CORPORATION
INDIANAPOLIS, INDIANA
STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
INDEX TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS
AND FINANCIAL STATEMENT SCHEDULES
PAGE
AUDITED CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Auditors F-2
Consolidated Balance Sheets as of December 31, 1998 and 1997 F-4
Consolidated Statements of Income for the Years Ended
December 31, 1998, 1997 and 1996 F-5
Consolidated Statements of Shareholders' Equity for the Years Ended
December 31, 1998, 1997 and 1996 F-6
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1998, 1997 and 1996 F-8
Notes to Consolidated Financial Statements F-9
FINANCIAL STATEMENT SCHEDULES
The following consolidated financial statement schedules are included in this
report and should be read in conjunction with the Audited Consolidated
Financial Statements.
Schedule II -- Condensed Financial Information of Registrant
(Parent Company) for the Years Ended December 31, 1998, 1997 and 1996 F-32
Schedule IV -- Reinsurance for the Years Ended
December 31, 1998, 1997 and 1996 F-36
Schedules not listed above have been omitted because they are not applicable or
are not required, or because the required information is included in the
Audited Consolidated Financial Statements or related Notes.
REPORT OF INDEPENDENT AUDITORS
Shareholders and Board of Directors
Standard Management Corporation
We have audited the accompanying consolidated balance sheets of Standard
Management Corporation and subsidiaries as of December 31, 1998 and 1997, and
the related consolidated statements of income, shareholders' equity and cash
flows for each of the three years in the period ended December 31, 1998. Our
audits also included the financial statement schedules listed in the Index at
Item 14(a). These financial statements and schedules are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements and schedules based on our audits. We did not audit the
consolidated balance sheets at September 30, 1998 and 1997 or the consolidated
statements of operations, shareholder's equity and cash flows for the three
years ended September 30, 1998 of Standard Management International S.A. and
subsidiaries, a wholly owned subsidiary group, which financial statements
reflect assets totaling approximately 22% and 24% of the Company's consolidated
assets at December 31, 1998 and 1997 and revenues totaling approximately 8%, 8%
and 9% of consolidated revenues for each of the three years in the period ended
December 31, 1998. Those financial statements, which as explained in Note 1,
are included in the Company's consolidated balance sheets at December 31, 1998
and 1997, and the Company's consolidated statements of income, shareholders'
equity and cash flows for each of the three years in the period ended December
31, 1998, were audited by other auditors whose report has been furnished to us,
and our opinion, insofar as it relates to the data included for Standard
Management International S.A., is based solely on the report of other auditors.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits and the report of other
auditors provide a reasonable basis for our opinion.
In our opinion, based on our audits and the report of other auditors, the
financial statements referred to above present fairly, in all material
respects, the consolidated financial position of Standard Management
Corporation and subsidiaries at December 31, 1998 and 1997, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 1998, in conformity with generally
accepted accounting principles. Also, in our opinion, the related financial
statement schedules, when considered in relation to the basic financial
statements taken as a whole, present fairly in all material respects the
information set forth therein.
Ernst & Young LLP
Indianapolis, Indiana
February 18, 1999
REPORT OF INDEPENDENT AUDITORS
Shareholders and Board of Directors
Standard Management International, S.A.
We have audited the consolidated balance sheets of Standard Management
International S.A. and subsidiaries as at September 30, 1998 and 1997 and the
related consolidated statements of operations, shareholder's equity and cash
flows for each of the three years in the period ended September 30, 1998 (none
of which aforementioned financial statements are separately presented herein).
These consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion the financial statements referred to above present fairly, in
all material aspects, the consolidated financial position of Standard
Management International S.A. and subsidiaries as at September 30, 1998 and
1997, and the consolidated results of their operations and their cash flows for
each of the three years in the period ended September 30, 1998 in conformity
with generally accepted accounting principles in the United States of America.
Luxembourg City, Luxembourg
February 18, 1999
KPMG Audit
STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
December 31
1998 1997
ASSETS
Investments:
Securities available for sale:
Fixed maturity securities, at fair value (amortized cost: 1998 - $551,312 $372,576
$547,115; 1997 - $367,372)
Equity securities, at fair value (cost: 1998 - $1,498; 1997 - $55) 1,316 52
Mortgage loans on real estate 8,578 375
Policy loans 15,019 9,495
Real estate 3,435 2,163
Other invested assets 837 779
Short-term investments 11,626 13,342
Total investments 592,123 398,782
Cash 13,591 4,165
Accrued investment income 9,563 6,512
Amounts due and recoverable from reinsurers 76,897 61,596
Deferred policy acquisition costs 32,946 21,435
Present value of future profits 28,793 20,537
Excess of acquisition cost over net assets acquired 5,886 2,445
Federal income tax recoverable 1,059 1,854
Other assets 5,046 3,602
Assets held in separate accounts 190,246 148,064
Total assets $956,150 $668,992
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Insurance policy liabilities $638,435 $439,390
Accounts payable and accrued expenses 12,277 6,349
Notes payable 35,000 26,000
Deferred federal income taxes 7,620 4,488
Excess of net assets acquired over acquisition cost -- 1,388
Liabilities related to separate accounts 190,246 148,064
Total liabilities 883,578 625,679
Series A convertible redeemable preferred stock, par value $100 per share:
authorized 130,000 shares; 65,300 shares issued and outstanding in 1998 6,530 --
Shareholders' Equity:
Preferred stock, no par value:
authorized 870,000 shares; none issued and outstanding -- --
Common stock, no par value:
authorized 20,000,000 shares; outstanding 1998-7,641,454; 1997- 60,586 40,646
4,876,490
Treasury stock (6,220) (4,572)
Accumulated other comprehensive income:
Unrealized gain on securities available for sale (net taxes of: 1998 - 1,660 2,171
$765; 1997 - $1,094)
Unrealized gain on other investments (net taxes of: 1998 - $12) 23 --
Foreign currency translation adjustment (net taxes (benefits) of: 1998 4 (473)
- $2; 1997 - $(244))
Retained earnings 9,989 5,541
Total shareholders' equity 66,042 43,313
Total liabilities and shareholders' equity $956,150 $668,992
See accompanying notes to consolidated financial statements.
STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Year Ended December 31
1998 1997 1996
Revenues:
Life premiums $8,487 $7,100 $10,468
Health premiums 5,992 -- --
Net investment income 34,580 29,516 20,871
Net realized investment gains 353 396 1,302
Gain on disposal of subsidiaries -- -- 886
Policy income 6,529 5,512 2,551
Amortization of excess of net assets acquired over 1,388 1,388 1,388
acquisition cost
Fees from separate accounts 2,120 1,521 1,462
Other income 3,421 1,178 1,277
Total revenues 62,870 46,611 40,205
Benefits and expenses:
Life benefits and claims 8,447 8,840 9,817
Health benefits and claims 4,823 -- --
Interest credited on interest-sensitive annuities and
other 19,775 16,281 11,092
financial products
Amortization 4,755 3,248 2,592
Other operating expenses 15,020 12,599 12,364
Health commissions 784 -- --
Interest expense and financing costs 2,955 2,381 805
Total benefits and expenses 56,559 43,349 36,670
Income before federal income taxes, extraordinary gain and
preferred stock 6,311 3,262 3,535
dividends
Federal income tax expense (benefit) 1,630 617 (730)
Income before extraordinary gain and preferred stock 4,681 2,645 4,265
dividends
Extraordinary gain on early redemption of redeemable
preferred stock, -- -- 502
net taxes of $0
Net income 4,681 2,645 4,767
Preferred stock dividends 180 97 208
Earnings available to common shareholders $4,501 $2,548 $4,559
Earnings per common share:
Income before extraordinary gain and preferred stock $.68 $.54 $.88
dividends
Extraordinary gain -- -- .10
Net income .68 .54 .98
Preferred stock dividends .03 .02 .04
Earnings available to common shareholders $.65 $.52 $.94
Earnings per common share - assuming dilutions:
Income before extraordinary gain and preferred stock $.62 $.48 $.82
dividends
Extraordinary gain -- -- .09
Net income .62 .48 .91
Preferred stock dividends .02 .01 .04
Earnings available to common shareholders - assuming $.60 $.47 $.87
dilutions
See accompanying notes to consolidated financial statements.
STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(DOLLARS IN THOUSANDS)
Accumulated
Other
Common Treasury Comprehensive Retained
Total Stock Stock Income Earnings
Balance at January 1, 1996 $40,242 $39,808 $(2,621) $ 3,741 $(686)
Comprehensive income, net of tax:
Net income 4,767 4,767
Other comprehensive income:
Change in unrealized gain (loss) of
securities (3,328) (3,328)
(net taxes (benefits) of
$(1,714))
Change in foreign currency (net
taxes(benefits) (468) (468)
of $(241))
Other comprehensive income (3,796)
Total comprehensive income 971
Issuance of common stock 100 100
Common stock dividends 850 850
Issuance of common stock warrants 285 285
Repurchase of common stock warrants (600) (600)
Gain on reissuance of treasury stock
in connection with purchase of Shelby 38 38
Life
Treasury stock acquired (2,126) (2,126)
Reissuance of treasury stock in connection
with 6 6
exercise of stock options
Reissuance of treasury stock in connection
with 1,213 1,213
purchase of Shelby Life
Common stock dividend, plus cash in lieu
of fractional shares (850) (850)
Loss on reissuance of treasury stock (2) (2)
Preferred stock dividends (208) (208)
Balance at December 31, 1996 39,919 40,481 (3,528) (55) 3,021
Comprehensive income, net of tax:
Net income 2,645 2,645
Other comprehensive income:
Change in unrealized gain (loss) of
securities 2,917 2,917
(net taxes of $1,503)
Change in foreign currency (net
taxes (benefits) OF $(600)) (1,164) (1,164)
Other comprehensive income 1,753
Total comprehensive income 4,398
Issuance of common stock warrants 165 165
Treasury stock acquired (1,079) (1,079)
Reissuance of treasury stock in connection
with exercise of stock options 35 35
Loss on reissuance of treasury stock (28) (28)
Preferred stock dividends (97) (97)
Balance at December 31, 1997 43,313 40,646 (4,572) 1,698 5,541
(continued on following page)
See accompanying notes to consolidated financial statements.
STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (CONTINUED)
(DOLLARS IN THOUSANDS)
Accumulated
Other
Common Stock Treasury Comprehensive Retained
Total Stock Income Earnings
Balance at December 31, 1997 (carried forward
from prior page) 43,313 40,646 (4,572) 1,698 5,541
Comprehensive income, net of tax:
Net income 4,681 4,681
Other comprehensive income:
Change in unrealized gain (loss) of
securities (488) (488)
(net taxes (benefits) of $(251))
Change in foreign currency (net taxes of 477 477
$246)
Other comprehensive income (11)
Total comprehensive income 4,670
Issuance of common stock for Savers Life 15,024 15,024
acquisition
Issuance of common stock for Midwestern Life
acquisition 4,614 4,614
Issuance of common stock warrants 64 64
Issuance of common stock in connection with
exercise of stock warrants 233 234 (1)
Treasury stock acquired (1,702) (1,702)
Conversion of preferred stock into common 4 4
stock
Reissuance of treasury stock in connection
with exercise of stock options 2 54 (52)
exercise of stock options
Preferred stock dividends (180) (180)
Balance at December 31, 1998 $66,042 $60,586 $(6,220) $1,687 $9,989
See accompanying notes to consolidated financial statements.
STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
Year Ended December 31
1998 1997 1996
OPERATING ACTIVITIES
Net income $4,681 $2,645 $4,767
Adjustments to reconcile net income to net cash provided by
operating activities:
Amortization of deferred policy acquisition costs 2,658 1,456 1,221
Policy acquisition costs deferred (13,542) (7,005) (6,400)
Deferred federal income taxes 957 1,187 158
Depreciation and amortization 1,209 1,085 544
Insurance policy liabilities 6,400 9,441 4,785
Net realized investment gains (353) (396) (1,302)
Accrued investment income (1,451) (314) (770)
Extraordinary gain on early redemption of redeemable -- -- (502)
preferred stock
Other (290) (335) (775)
Net cash provided by operating activities 269 7,764 1,726
FINANCING ACTIVITIES
Issuance of common stock, net 19,638 -- --
Borrowings, net of debt issuance costs of $206, $70 and $208
in 1998, 1997 11,794 5,558 16,792
and 1996, respectively
Repayments on long-term debt and obligations under capital (3,141) (543) (491)
lease
Premiums received on interest-sensitive annuities and other
financial products credited 81,858 49,362 42,347
to policyholder account balances, net of premiums ceded
Return of policyholder account balances on interest-sensitive
annuities and other financial products, net of premiums ceded (52,934) (37,477) (17,356)
Issuance of Series A redeemable preferred stock 6,389 -- --
Redemption of preferred stock -- (1,855) (949)
Repurchase of common stock warrants -- -- (600)
Proceeds from common and treasury stock sales 234 138 100
Purchase of common stock for treasury (1,647) (1,079) (2,126)
Net cash provided by financing activities 62,191 14,104 37,717
INVESTING ACTIVITIES
Fixed maturity securities available for sale:
Purchases (261,744) (205,976) (249,638)
Sales 162,503 161,891 194,244
Maturities, calls and redemptions 32,570 28,380 10,254
Short-term investments, net 44,460 (4,925) 11,890
Other investments, net 320 (2,186) (551)
Purchase of Savers Life Insurance Company, less cash acquired (18,039) -- --
of $518
Purchase of Midwestern National Life Insurance Company of
Ohio, less cash (13,104) -- --
acquired of $1,026
Purchase of Shelby Life Insurance Company, less cash acquired -- -- (14,618)
of $32
Dividends paid by Shelby Life Insurance Company to former -- -- (3,000)
parent
Proceeds from sale of First International Life Insurance
Company, less cash transferred -- -- 11,327
to seller of $265
Net cash used by investing activities (53,034) (22,816) (40,092)
Net increase (decrease) in cash 9,426 (948) (649)
Cash at beginning of year 4,165 5,113 5,762
Cash at end of year $13,591 $4,165 $5,113
See accompanying notes to consolidated financial statements.
STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION
Standard Management Corporation ("Standard Management") is an international
financial services holding company, which directly and through its subsidiaries
i) acquires and manages in force life insurance and annuity business, ii)
issues and distributes life insurance and annuity products, and iii) offers
unit-linked assurance products through its international subsidiaries.
Standard Management's active subsidiaries at December 31, 1998 include:
(i) Standard Life Insurance Company of Indiana ("Standard Life") and its
subsidiary, Dixie National Life Insurance Company ("Dixie Life"), (ii) Standard
Management International, S.A. and its subsidiaries ("SMI"), Premier Life
(Luxembourg) S.A. ("Premier Life (Luxembourg)") and Premier Life (Bermuda) Ltd.
("Premier Life (Bermuda)"), (iii) Standard Marketing Corporation ("Standard
Marketing") and (iv) Savers Marketing Corporation ("Savers Marketing").
BASIS OF PRESENTATION
The accompanying consolidated financial statements of Standard Management
and its subsidiaries (the "Company" or "SMC") have been prepared in conformity
with generally accepted accounting principles ("GAAP") and include the accounts
of the Company since acquisition or organization. All significant intercompany
balances and transactions have been eliminated.
The fiscal year end for SMI is September 30. To facilitate reporting on the
consolidated level, the fiscal year end for SMI was not changed and the
consolidated balance sheets and statements of operations for SMI at
September 30, 1998 and 1997 and for each of the three years in the period ended
September 30, 1998, are included in the Company's consolidated balance sheets
at December 31, 1998 and 1997 and for each of the three years in the period
ended December 31, 1998.
USE OF ESTIMATES
The nature of the Company's insurance businesses requires management to make
estimates and assumptions that affect the amounts reported in the consolidated
financial statements and accompanying notes. Such estimates and assumptions
could change in the future as more information becomes known, which could
impact the amounts disclosed in this report.
INVESTMENTS
The Company classifies its fixed maturity and equity securities as available
for sale and, accordingly, such securities are carried at fair value. Fixed
maturity securities include bonds and redeemable preferred stocks. Changes in
fair values of securities available for sale, after adjustment for deferred
policy acquisition costs, present value of future profits and deferred income
taxes, are reported as unrealized gains or losses directly in shareholders'
equity and, accordingly, have no effect on net income. The deferred policy
acquisition costs and present value of future profits adjustments to the
unrealized gains or losses represent valuation adjustments or reinstatements of
these assets that would have been required as a charge or credit to operations
had such unrealized amounts been realized.
The cost of fixed maturity securities is adjusted for amortization of
premiums and discounts. The amortization is provided on a constant effective
yield method over the life of the securities and is included in net investment
income.
Mortgage-backed and other collateralized securities, classified as fixed
maturity securities in the consolidated balance sheets, are comprised
principally of obligations backed by an agency of the United States government
(although generally not by the full faith and credit of the United States
government). The Company has reduced the risk normally associated with these
investments by primarily investing in highly rated securities and in those that
provide more predictable prepayment patterns. The income from these securities
is recognized using a constant effective yield based on anticipated prepayments
and the estimated economic life of the securities. When actual prepayments
differ significantly from anticipated prepayments, the income recognized is
adjusted currently to match that which would have been recorded had the
effective yield been applied since the acquisition of the security. This
adjustment is included in net investment income.
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Mortgage loans on real estate and policy loans are carried at unpaid
principal balances and are generally collateralized. Real estate investments,
which the Company has the intent to hold for the production of income, are
carried at cost, less accumulated depreciation. Short-term investments are
carried at amortized cost, which approximates fair value.
NET REALIZED INVESTMENT GAINS OR LOSSES
Net realized investment gains and losses are calculated using the specific
identification method and included in the consolidated statements of income.
If the values of investments decline below their amortized cost and this
decline is considered to be other than temporary, the amortized cost of these
investments is reduced to net realizable value and the reduction is recorded as
a realized loss.
FUTURE POLICY BENEFITS
Liabilities for future policy benefits for deferred annuities and universal
life policies are equal to full account value that accrues to the policyholder
(cumulative premiums less certain charges, plus interest credited) with rates
ranging from 4.8% to 11% in 1998 and 4.5% to 12% in 1997.
Future policy benefits for traditional life insurance contracts are computed
using the net level premium method on the basis of assumed investment yields,
mortality and withdrawals which were appropriate at the time the policies were
issued. Assumed investment yields are based on interest rates ranging from 6.5%
to 7.5%. Mortality is based upon various actuarial tables, principally the
1965-1970 Select and Ultimate Table. Withdrawals are based upon Company
experience and vary by issue age, type of coverage, and duration.
RECOGNITION OF INSURANCE POLICY REVENUE AND RELATED BENEFITS AND EXPENSES
Revenue for interest-sensitive annuity contracts consists of policy charges
for surrenders and investment income earned. Premiums received for these
annuity contracts are reflected as premium deposits and are not recorded as
revenues. Expenses related to these annuities include interest credited to
policyholder account balances. Revenue for universal life insurance policies
consists of policy charges for the cost of insurance, policy administration
charges, surrender charges and investment income earned during the period.
Expenses related to universal life policies include interest credited to
policyholder account balances and death benefits incurred in excess of
policyholder account balances.
Traditional life insurance and immediate annuity premiums are recognized as
premium revenue when due over the premium paying period of the policies.
Benefits are charged to expense in the period when claims are incurred and are
associated with related premiums through changes in reserves for future policy
benefits which results in the recognition of profit over the premium paying
period of the policies.
REINSURANCE
Premiums, annuity policy charges, benefits and claims, interest credited and
amortization expense are reported net of reinsurance ceded and are accounted
for on a basis consistent with those used in accounting for the original
policies issued and the terms of the reinsurance contracts.
SEPARATE ACCOUNTS
The majority of the balance represents i) unit-linked business, where
benefits on surrender and maturity are not guaranteed, and ii) investment
contracts which pay fixed benefits to the policyholder and have minimal
mortality risk. Separate accounts generally represent funds maintained in
accounts to meet specific investment objectives of policyholders who bear the
investment risk. The Company records the related liabilities at amounts equal
to the underlying assets. Investment income and investment gains and losses
accrue directly to such policyholders. The assets of each account are
segregated and are not subject to claims that arise out of any other business
of the Company. Deposits, net investment income and realized gains and losses
on separate accounts assets are not reflected in the consolidated statements of
income.
STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
FOREIGN CURRENCY TRANSLATION
The Company's foreign subsidiaries' balance sheets and statements of income
are translated at the year end exchange rates and average exchange rates for
the year, respectively. The resulting unrealized gain or loss adjustment from
the translation to U.S. dollars is recorded in the foreign currency translation
adjustment as a separate component of accumulated other comprehensive income.
Foreign exchange gains or losses relating to policyholders' funds in separate
accounts are allocated to the relevant separate account.
INCOME TAXES
Deferred tax assets and liabilities are recognized for the estimated future
tax consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities are measured using enacted tax rates
in effect for the year in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period in which the change
is enacted.
Standard Life and Dixie Life filed a life/life consolidated return for 1997
and plan to file a consolidated return for 1998. SMC, Standard Marketing and
other U.S. non-insurance subsidiaries are taxed as regular corporations and
file a consolidated return. SMC and its U.S. non-insurance subsidiaries were
eligible to consolidate with Standard Life for income tax purposes beginning in
1996, but do not currently plan to do so.
SMI is incorporated as a holding company in the Grand Duchy of Luxembourg
and, accordingly, is not currently subject to taxation on income or capital
gains. SMI is subject to an annual capital tax which is calculated on the
nominal value of the statutory shareholder's equity at an annual rate of .20%.
Premier Life (Luxembourg) is a normal commercial taxable company and is subject
to income tax at regular corporate rates (statutory corporate rate of 37.45%),
and annual capital taxes amounting to approximately 1% of its net equity.
Premier Life (Bermuda) is exempt from taxation on income until March 2016
pursuant to a decree from the Minister of Finance in Bermuda. To the extent
that such income is taxable under U.S. law, such income will be included in
SMC's consolidated return.
PRESENT VALUE OF FUTURE PROFITS
Present value of future profits is recorded in connection with acquisitions
of insurance companies or a block of policies. The initial value is based on
the actuarially determined present value of the projected future gross profits
from the in-force business acquired. In selecting the interest rate to
calculate the discounted present value of the projected future gross profits,
the Company uses the risk rate of return believed to best reflect the
characteristics of the purchased policies, taking into account the relative
risks of such policies, the cost of funds to acquire the business and other
factors. The value of in force insurance purchased is amortized on a constant
yield basis over its estimated life from the date of acquisition in proportion
to the emergence of profits over a period of approximately 20 years. For
acquisitions the Company made on or before November 19, 1992, the Company
amortizes the asset with interest at the same discount rate used to determine
the present value of future profits at the date of purchase. For acquisitions
after November 19, 1992, the Company amortizes the asset using the interest
rate credited to the underlying policies.
DEFERRED POLICY ACQUISITION COSTS
Costs relating to the production of new business (primarily commissions and
certain costs of marketing, policy issuance and underwriting) are deferred and
included in the deferred policy acquisition cost asset to the extent that such
costs are recoverable from future related policy revenues. For
interest-sensitive annuities and other financial products, deferred policy
acquisition costs, with interest, are amortized over the lives of the policies
and products in a constant relationship to the present value of estimated
future gross profits, discounted using the interest rate credited to the
policy. Traditional life insurance deferred policy acquisition costs are being
amortized over the premium-paying period of the related policies using
assumptions consistent with those used in computing policy benefit reserves.
STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The Company reviews the recoverability of the carrying value of the deferred
policy acquisition costs each year. For interest-sensitive annuities and other
financial products, the Company considers estimated future gross profits in
determining whether the carrying value is appropriate; for other insurance
products, the Company considers estimated future premiums. In all cases, the
Company considers expected mortality, interest earned and crediting rates,
persistency and expenses. Amortization is adjusted retrospectively for
interest-sensitive annuities and other financial products when estimates of
future gross profits to be realized are revised.
EXCESS OF ACQUISITION COST OVER NET ASSETS ACQUIRED
The excess of the cost to acquire purchased companies over the fair value of
net assets acquired is being amortized on a straight-line basis over periods
that generally correspond with the benefits expected to be derived from the
acquisitions, usually 20 to 40 years. Accumulated amortization was $.6 million
and $.4 million at December 31, 1998 and 1997, respectively. The Company
continually monitors the value of excess of acquisition cost over net assets
acquired ("goodwill") based on estimates of future earnings. If it determines
that goodwill has been impaired, the carrying value is reduced with a
corresponding charge to expense.
EXCESS OF NET ASSETS ACQUIRED OVER ACQUISITION COST
The excess of the net assets acquired over the cost to acquire purchased
companies ("negative goodwill"), after reducing the basis in property and
equipment and other noncurrent assets to zero, is being amortized into earnings
on a straight-line basis over a five year period. Accumulated amortization was
$6.6 million and $5.2 million at December 31, 1998 and 1997, respectively.
STOCK OPTIONS
The Company recognizes compensation expense for its stock option plan using
the intrinsic value method of accounting. Under the terms of the intrinsic
value method, compensation cost is the excess, if any, of the quoted market
price of the stock at the grant date, or other measurement date, over the
amount an employee must pay to acquire the stock. Under the Company's stock
option plans, no expense is recognized since the exercise price equals or
exceeds the market price at the measurement date.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
As of January 1, 1998, the Company adopted SFAS No. 130, "Reporting
Comprehensive Income." SFAS No. 130 establishes new rules for the reporting
and display of comprehensive income and its components; however, the adoption
of SFAS No. 130 had no impact on the Company's net income or shareholders'
equity. The adoption of SFAS No. 130 requires unrealized gains or losses on
the Company's securities and foreign currency translation adjustments to be
included in other comprehensive income, which is a separate component of
shareholders' equity. Prior year financial statements have been reclassified
to conform to the requirements of SFAS No. 130. Comprehensive income excludes
net realized investment gains of $.7 million (after income taxes of $.3
million).
In June 1997, the Financial Accounting Standards Board ("FASB) issued SFAS
No. 131, "Disclosures about Segments of an Enterprise and Related Information."
SFAS No. 131 supersedes SFAS No. 14 "Financial Reporting for Segments of a
Business Enterprise" and defines financial and descriptive information about a
company's operating segments that is to be disclosed in the financial
statements. SFAS No. 131 is effective for financial statements issued for
fiscal years beginning after December 15, 1997 and was adopted by the Company
in the first quarter of 1998. The Company considers its domestic and
international operations to be its operating segments. See Note 14.
In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 133, "Accounting for Derivative Instruments and Hedging Activities" which
is required to be adopted in years beginning after June 15, 1999. The
Statement permits early adoption as of the beginning of any fiscal quarter
after its issuance. The Company adopted the Statement effective July 1, 1998.
There was no material income statement impact due to the adoption of FASB 133.
See Note 15.
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Statement of Position 97-3, "Accounting by Insurance and Other Enterprises
for Insurance-Related Assessments" ("SOP 97-3") was issued by the American
Institute of Certified Public Accountants in December 1997 and provides
guidance for determining when an insurance company or other enterprise should
recognize a liability for guaranty-fund assessments and guidance for measuring
the liability. The statement is effective for 1999 financial statements with
early adoption permitted. The adoption of this statement is not expected to
have a material effect on the Company's financial statements.
RECLASSIFICATIONS
Certain amounts in the 1997 and 1996 consolidated financial statements and
notes have been reclassified to conform with the 1998 presentation. These
reclassifications had no effect on previously reported shareholders' equity or
net income in the periods presented.
2. ACQUISITIONS
On March 12, 1998, SMC acquired Savers Life Insurance Company ("Savers
Life"). Each of the 1,779,908 shares of Savers Life Common Stock outstanding
was converted into 1.2 shares of SMC Common Stock plus $1.50. Each holder of
Savers Life Common Stock could elect to receive the $1.50 per share portion of
the merger consideration in the form of additional shares of SMC Common Stock.
SMC issued approximately 2.2 million shares with a value of approximately $14.9
million and paid $2.2 million in cash and $1.5 million in acquisition costs for
an aggregate purchase price of $18.6 million to acquire Savers Life. SMC
increased the Amended and Restated Revolving Line of Credit Agreement (the
"Amended Credit Agreement") to $20.0 million to finance the acquisition of
Savers Life.
On October 30, 1998, SMC acquired Midwestern National Life Insurance Company
of Ohio ("Midwestern Life"). SMC issued 696,453 shares of its common stock
valued at $4.6 million, increased its bank debt by $6.0 million on restructured
terms by increasing the Amended Credit Agreement to $26.0 million, and paid
$2.9 million in cash and $.6 million of acquisition costs for an aggregate
purchase price of $14.1 million to acquire Midwestern Life.
The acquisitions of Savers Life and Midwestern Life were accounted for using
the purchase method of accounting and accordingly, SMC's consolidated financial
statements include the results of operations of the acquired companies from the
effective dates of their respective acquisitions. Under purchase accounting,
SMC allocated the total purchase price of the assets and liabilities acquired,
based on a determination of their fair values and recorded the excess of
acquisition cost over net assets acquired as goodwill, which will be amortized
on a straight line basis over 30 years and 20 years for Savers Life and
Midwestern Life, respectively. SMC merged Savers Life and Midwestern Life into
Standard Life effective December 31, 1998, with Standard Life as the surviving
entity.
STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. ACQUISITIONS (CONTINUED)
The following schedule summarizes the assets acquired and the liabilities
assumed with the Savers Life and Midwestern Life acquisitions described above
(in thousands):
Savers Midwestern
Life Life
Assets acquired:
Fixed maturity securities $ 7,055 $ 99,243
Equity securities 2,840 174
Mortgage loans on real estate 6,273 223
Real estate 1,639 --
Policy loans 9 6,480
Short term investments 42,745 --
Cash 518 1,026
Present value of future profits 5,960 6,999
Other assets 7,944 9,671
Total assets acquired 74,983 123,816
Liabilities assumed:
Policy reserves 58,680 100,497
Deferred federal income taxes -- 3,073
Other liabilities 1,386 6,141
Total liabilities assumed 60,066 109,711
Net assets acquired 14,917 14,105
Excess of acquisition cost over net
assets acquired 3,640 25
Total purchase price $ 18,557 $ 14,130
The following are supplemental unaudited pro forma consolidated results of
operations of the Company as if the acquisitions of Savers Life and Midwestern
Life had occurred on January 1, 1997. The following amounts are based upon
certain assumptions and estimates which the Company believes are reasonable and
do not reflect any benefit from savings which might be achieved from combined
operations. The amounts are not necessarily indicative of the results of
operations had these transactions occurred on January 1, 1997, or the results
of future operations (in thousands, except per share amounts):
Year Ended
DECEMBER 31
1998 1997
Revenues $80,710 $95,883
Earnings available to common shareholders 2,657 3,842
Earnings per share .34 .49
Earnings per share, assuming dilution .32 .46
STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. INVESTMENTS
The amortized cost, gross unrealized gains and losses and estimated fair
value of securities available for sale are as follows (in thousands):
December 31, 1998
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
Securities available for sale:
Fixed maturity securities:
United States Treasury securities and
obligations of United States $34,635 $606 $53 $35,188
government agencies
Obligations of states and political 3,337 141 -- 3,478
subdivisions
Foreign government securities 46,872 616 4,541 42,947
Utilities 23,316 662 74 23,904
Corporate bonds 366,348 10,965 4,498 372,815
Mortgaged-backed securities 66,721 716 312 67,125
Redeemable preferred stock 5,886 8 39 5,855
Total fixed maturity securities 547,115 13,714 9,517 551,312
Equity securities 1,498 9 191 1,316
Total securities available for sale $548,613 $13,723 $9,708 $552,628
December 31, 1997
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
Securities available for sale:
Fixed maturity securities:
United States Treasury securities and
obligations of United States $27,613 $174 $90 $27,697
government agencies
Obligations of states and political 3,790 204 26 3,968
subdivisions
Foreign government securities 30,558 497 3,296 27,759
Utilities 26,606 534 109 27,031
Corporate bonds 223,958 8,140 1,609 230,489
Mortgaged-backed securities 51,266 657 60 51,863
Redeemable preferred stock 3,581 188 -- 3,769
Total fixed maturity securities 367,372 10,394 5,190 372,576
Equity securities 55 -- 3 52
Total securities available for sale $367,427 $10,394 $5,193 $372,628
The estimated fair values for fixed maturity securities are based on quoted
market prices, where available. For fixed maturity securities not actively
traded, fair values are estimated using values obtained from independent
pricing services, or by discounting expected future cash flows using a current
market rate applicable to the coupon rate, credit rating, and maturity of the
investments.
STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. INVESTMENTS (CONTINUED)
The amortized cost and estimated fair value of fixed maturity securities at
December 31, 1998 by contractual maturity are shown below (in thousands).
Actual maturities will differ from contractual maturities because borrowers may
have the right to call or prepay obligations with or without call or prepayment
penalties and because most mortgage-backed securities provide for periodic
payments throughout their lives.
Amortized Fair
COST VALUE
Due in one year or less $ 3,636 $ 3,651
Due after one year through five years 92,862 93,959
Due after five years through ten years 163,869 163,208
Due after ten years 214,141 217,514
Subtotal 474,508 478,332
Redeemable preferred stock 5,886 5,855
Mortgage-backed securities 66,721 67,125
Total fixed maturity securities $547,115 $551,312
The Company maintains a highly-diversified investment portfolio with
limited concentration of financial instruments in any given region, industry or
economic characteristic. At December 31, 1998, the Company held no investments
in any entity in excess of 10% of shareholders' equity other than asset-backed
securities and investments issued or guaranteed by the U.S. government or a
U.S. government agency, all of which were classified as fixed maturity
securities available for sale.
Net investment income was attributable to the following (in thousands):
Year Ended December 31
1998 1997 1996
Fixed maturity securities $30,484 $27,151 $19,865
Common stocks 46 -- --
Mortgage loans on real estate 679 123 309
Policy loans 654 618 447
Real estate 135 58 65
Short-term investments and other 3,291 2,098 602
Gross investment income 35,289 30,048 21,288
Less: investment expenses 709 532 417
Net investment income $34,580 $29,516 $20,871
Net realized investment gains arose from the following (in thousands):
Year Ended December 31
1998 1997 1996
Fixed maturity securities available for sale:
Gross realized gains $2,570 $2,209 $2,111
Gross realized losses 2,074 1,695 913
Net 496 514 1,198
Real estate -- 26 --
Other gains (losses) (143) (144) 104
Net realized investment gains $353 $396 $1,302
3. INVESTMENTS (CONTINUED)
Life insurance companies are required to maintain certain amounts of
assets with state or other regulatory authorities. At December 31, 1998 fixed
maturity securities of $20.9 million and cash and short-term investments of
$2.5 million were held on deposit by various state regulatory authorities in
compliance with statutory regulations. Additionally, fixed maturity securities
of $.3 million and short-term investments of $6.2 million of SMI were held by a
custodian bank approved by the Luxembourg regulatory authorities to comply with
local insurance laws.
4. DEFERRED POLICY ACQUISITION COSTS AND PRESENT VALUE OF FUTURE PROFITS
The activity related to the deferred policy acquisition costs of business
produced is summarized as follows (in thousands):
Year Ended December 31
1998 1997 1996
Balance, beginning of year $21,435 $18,309 $10,054
Additions 13,542 7,005 6,400
Amortization (2,658) (1,456) (1,221)
Adjustment relating to net unrealized (gain)
loss on securities available for sale 627 (2,423) 3,076
Balance, end of year $32,946 $21,435 $18,309
The activity related to the present value of future profits of the business acquired is
summarized as follows (in thousands):
Year Ended December 31
1998 1997 1996
Balance, beginning of year $20,537 $23,806 $15,246
Amounts related to acquisitions and disposals 10,401 (1,374) 9,615
Interest accreted on unamortized balance 4,223 3,178 2,563
Gross amortization during the year (6,088) (4,844) (3,812)
Adjustments relating to net unrealized (gain)
loss on securities available for sale (280) (229) 194
Balance, end of year $28,793 $20,537 $23,806
The percentages of future expected net amortization of the beginning
balance of the present value of future profits, before the effect of net
unrealized gains and losses, will be between 6% and 9% in each of the years
1999 through 2003. Future net amortization is based on the present value of
future profits at December 31, 1998 and current assumptions as to future events
on all policies in force.
The discount rate used to calculate the present value of future profits
reflected in the Company's consolidated balance sheets at December 31, 1998,
ranged from 7.5% to 18%. The Company used a 13% discount rate to calculate the
present value of future profits on the Savers Life and Midwestern Life
acquisitions.
STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. NOTES PAYABLE
Notes payable were as follows (in thousands):
Interest December 31
Rate
1998 1997
Borrowings under revolving credit agreements 8.52%{ (1)} $25,000 $16,000
Senior subordinated convertible notes 10.00% 10,000 10,000
$35,000 $26,000
(1) Current weighted average rate at December 31, 1998.
BORROWINGS UNDER REVOLVING CREDIT AGREEMENTS
Standard Management has outstanding borrowings at December 31, 1998
pursuant to the Amended Credit Agreement that provides for it to borrow up to
$26.0 million in the form of a seven-year reducing revolving loan arrangement.
Standard Management has agreed to pay a non-use fee of .50% per annum on the
unused portion of the commitment. In connection with the original and Amended
Credit Agreement, SMC issued warrants to the bank to purchase 93,500 shares of
Common Stock. Borrowings under the Amended Credit Agreement may be used for
contributions to surplus of insurance subsidiaries, acquisition financing and
repurchases of Common Stock. The debt is secured by a Pledge Agreement of all
of the issued and outstanding shares of Common stock of Standard Life and
Standard Marketing. Interest on the borrowings under the Amended Credit
Agreement is determined, at the option of SMC, to be: (i) a fluctuating rate of
interest to the corporate base rate announced by the bank periodically, plus 1%
per annum, or (ii) a rate at LIBOR plus 3.25%. The repayment schedule of the
$25.0 million includes $3.3 million due March 2000 and $4.3 million each year
thereafter to March 2005. Indebtedness incurred under the Amended Credit
Agreement is subject to certain restrictions and covenants including, among
other things, certain minimum financial ratios, minimum consolidated equity
requirements for SMC, positive net income, minimum statutory surplus
requirements for the Company's insurance subsidiaries and certain limitations
on acquisitions, additional indebtedness, investments, mergers, consolidations
and sales of assets.
SMI has an unused line of credit of $1.7 million, with no borrowings in
connection with this line of credit in 1998 or 1997.
SENIOR SUBORDINATED CONVERTIBLE NOTES
In connection with the acquisition of Shelby Life, Standard Management
borrowed $4.0 million from an insurance company pursuant to a subordinated
convertible debt agreement which was due in December 2003. At June 30, 1997,
this subordinated convertible debt agreement was amended to the principal
amount of $4.4 million which is due July 2004, unless previously converted, and
requires interest payments in cash on January 1 and July 1 of each year at 10%
per annum. At June 30, 1997, Standard Management borrowed an additional $5.6
million from the insurance company pursuant to another subordinated convertible
debt agreement (collectively, the "Notes"), which is due July 2004 unless
previously converted, and also requires interest payments in cash on January 1
and July 1 of each year at 10% per annum. Proceeds from the additional
borrowings were used for contributions to surplus of insurance subsidiaries of
$2.4 million, redemption of Class S Preferred Stock of approximately $1.8
million (SEE NOTE 7), and other general corporate purposes. The Notes are
convertible at any time at the option of the noteholders into SMC Common Stock
at the rate of $5.747 per share. The Notes may be prepaid in whole or in part
at the option of Standard Management commencing on July 1, 2000 at redemption
prices equal to 105% of the principal amount (plus accrued interest) and
declining to 102% of the principal amount plus accrued interest. The Notes may
be prepaid prior to July 1, 2000 at a redemption price equal to 101% of the
principal amount (plus accrued interest) under certain limited circumstances.
The Notes are subject to certain restrictions and covenants substantially
similar to those in the Amended Credit Agreement.
INTEREST PAID
Cash paid for interest was $2.7 million, $1.5 million, and $.4 million in
1998, 1997 and 1996, respectively.
STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. INCOME TAXES
The components of the federal income tax expense (benefit), applicable to
pre-tax income before extraordinary gains, were as follows (in thousands):
Year Ended December 31
1998 1997 1996
Current taxes (benefit) $673 $(570) $(888)
Deferred taxes 957 1,187 158
$1,630 $617 $(730)
The effective tax rate on pre-tax income before extraordinary gain is
lower than the statutory corporate federal income tax rate as follows (in
thousands):
Year Ended December 31
1998 1997 1996
Federal income tax expense at statutory rates (34%) $2,146 $1,109 $1,202
Nonrecognition of losses in SMC consolidated return and
in foreign subsidiaries -- 314 543
Amortization of excess of net assets acquired over (472) (472) (472)
acquisition cost
Tax benefit from disposal of subsidiary -- -- (1,420)
Tax benefits from capital loss carryforwards not -- (200) --
previously recognized
Release of reserve for tax adjustments -- (100) (325)
Other items, net (44) (34) (258)
Federal income tax expense (benefit) $1,630 $617 $(730)
Effective tax rate 26% 19% (21)%
The Company recovered $1.7 million, $1.3 million and $.1 million in federal
income taxes in 1998, 1997 and 1996, respectively, and paid federal income
taxes of $.7 million, $.2 million and $.9 million in 1998, 1997 and 1996,
respectively.
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for tax return purposes. Significant temporary
differences included in the Company's deferred tax assets (liabilities) are as
follows (in thousands):
December 31
1998 1997
Deferred income tax assets:
Future policy benefits $12,338 $9,368
Capital and net operating loss carryforwards 5,556 6,123
Other-net 1,567 1,126
Gross deferred tax assets 19,461 16,617
Valuation allowance for deferred tax assets (9,023) (6,962)
Deferred income tax assets, net of valuation allowance 10,438 9,655
Deferred income tax liabilities:
Unrealized gain on securities available for sale (2,514) (1,820)
Present value of future profits (9,791) (6,983)
Deferred policy acquisition costs (5,753) (5,340)
Total deferred income tax liabilities (18,058) (14,143)
Net deferred income tax liabilities $(7,620) $(4,488)
STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. INCOME TAXES (CONTINUED)
The Company is required to establish a "valuation allowance" for any portion
of its deferred tax assets which are unlikely to be realized. The valuation
allowance for deferred tax assets includes $1.0 million at December 31, 1998
with respect to corporate income tax loss carryforwards of Standard Management
International, S.A. which, if recognized in the future, will result in an
addition to negative goodwill and be amortized into income over its remaining
life. The valuation allowance for deferred tax assets includes $1.8 million at
December 31, 1998 with respect to deferred tax assets at the date of
acquisition and net tax operating loss carry forwards of Dixie Life and Shelby
Life which, if recognized in the future, will result in a reduction to goodwill
and be amortized into income over its remaining life by reducing goodwill
amortization expense.
As of December 31, 1998, Standard Management and its noninsurance
subsidiaries had consolidated net operating loss carryforwards of approximately
$9.4 million for tax return purposes which expire from 2005 through 2012.
These carryforwards will only be available to reduce the taxable income of
Standard Management. At December 31, 1998, the Standard Life consolidated
return had net operating loss carryforwards of approximately $4.1 million which
expire in 2010 and 2018. As a result of the change in ownership of Midwestern
Life, $1.1 million of these loss carryforwards are subject to an annual
limitation of $.7 million. These carryforwards will only be available to
reduce the taxable income of the Standard Life consolidated return. At
December 31, 1998, Premier Life (Luxembourg) had accumulated corporate income
tax loss carryforwards of approximately $2.6 million, all of which may be
carried forward indefinitely.
The Internal Revenue Service has completed its examination of the Company
for years through 1993 in 1996. All adjustments to taxable income determined by
completed examinations, which were not material, have reduced the net operating
loss carryforwards. Upon completion of the examination, a tax reserve for
adjustments of $.3 million was released and recorded in income in 1996. In
1997, the Internal Revenue Service completed its examination of Standard Life
through 1996. All adjustments including a tax benefit from previously expired
capital loss carryforwards were settled during 1997 resulting in a net tax
benefit of approximately $.2 million during 1997 and upon completion of the
examination, a tax reserve for adjustments of $.1 million was released into
income in 1997.
7. SHAREHOLDERS' EQUITY
REDEEMABLE PREFERRED STOCK
Shareholders have authorized 1,000,000 shares of Preferred Stock. Other
terms, including preferences, voting and conversion rights, may be established
by the Board of Directors.
In 1995, 300,000 shares of the authorized preferred stock were designated as
Class S cumulative convertible redeemable preferred stock ("Class S preferred
stock"). In February 1996 these shares were issued at a par value of $10.00
per share. The Company repurchased and retired 140,111 of these shares at a
cost of $1.0 million in 1996, which resulted in an extraordinary gain of $.5
million. Effective August 1997, SMC redeemed the remaining Class S preferred
stock for $1.8 million.
In 1998, 130,000 shares of the authorized preferred stock were designated as
Series A convertible redeemable preferred stock ("Series A preferred stock").
The Company issued 65,300 shares with a stated value of $6.5 million ($100 per
share) in 1998. The following, among other things, are characteristics of the
Series A preferred stock:
The holders are entitled to cumulative annual dividends of $7.75 per
share (payable quarterly).
Conversion into 11.767 shares of SMC common stock per share of Series A
preferred stock.
Redeemable on July 1, 2003.
Redemption by the Company may occur at 105% of stated value beginning
July 1, 1999 and decreasing 1% per year to 100% at July 1, 2003.
There are no voting rights attached to these shares.
STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. SHAREHOLDERS' EQUITY (CONTINUED)
COMMON STOCK
The Company repurchased 308,465, 154,903, and 431,026 shares of Common
Stock for $1.7 million, $1.1 million, and $2.1 million in 1998, 1997 and 1996,
respectively under its stock repurchase program. At December 31, 1998, the
Company was authorized to purchase an additional 1,057,179 shares under this
program.
The following table represents outstanding warrants to purchase Common Stock
as of December 31, 1998:
Exercise Warrants
ISSUE DATE EXPIRATION DATE PRICE OUTSTANDING
June 1989 December 1999 $3.5216 229,430
January 1994 January 1999 7.8571 42,000
November 1995 November 2002 4.5238 31,500
July 1996 July 2003 4.3750 30,000
September 1996 September 1999 5.5000 16,500
April 1997 April 2004 5.1250 12,000
July 1997 July 2000 5.7500 75,000
September 1997 September 2000 7.5000 15,000
February 1998 August 2000 8.2500 50,000
October 1998 October 2001 8.0000 75,000
October 1998 October 2001 7.1250 20,000
596,430
CHANGES IN SHARES OF COMMON STOCK AND TREASURY STOCK
The following table represents changes in the number of common and
treasury shares as of December 31:
1998 1997 1996
Common Stock:
Balance, beginning of year 5,752,499 5,752,499 5,459,573
Issuance of common stock 3,049,814 -- 20,000
5% common stock dividend -- -- 272,926
Balance, end of year 8,802,313 5,752,499 5,752,499
Treasury Stock:
Balance, beginning of year (876,009) (728,229) (502,025)
Treasury stock acquired (308,465) (154,903) (431,026)
5% common stock dividend -- -- (46,402)
Reissuance of treasury stock in
connection with exercise of
stock options 23,615 7,123 1,224
Reissuance of treasury stock in
connection with purchase of
Shelby Life -- -- 250,000
Balance, end of year (1,160,859) (876,009) (728,229)
STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. SHAREHOLDERS' EQUITY (CONTINUED)
UNREALIZED GAIN ON SECURITIES
The components of the balance sheet caption "Unrealized gain on securities
available for sale" in shareholders' equity are summarized as follows (in
thousands):
December 31
1998 1997
Fair value of securities available for sale $552,628 $372,628
Amortized cost of securities available for sale 548,613 367,427
Gross unrealized gain on securities available for sale 4,015 5,201
Adjustments for:
Deferred policy acquisition costs (1,101) (1,727)
Present value of future profits (489) (209)
Deferred federal income tax liability (765) (1,094)
Net unrealized gain on securities available for sale $1,660 $2,171
8. STOCK OPTION PLAN
SMC has a non-qualified Stock Option Plan (the "Plan") under which
2,500,000 shares of Common Stock are reserved for grants of stock options to
employees and directors. The purchase price per share specified in any Plan
option must be at least equal to the fair market value of common stock at the
grant date. Options generally become exercisable over a three-year period and
have a term of 10 years. The Plan is administered by the Board of Directors and
officers of SMC. The terms of the options, including the number of shares and
the exercise price, are subject to the sole discretion of the Board of
Directors. A total of 490,533 shares are available for future issuance for the
Plan as of December 31, 1998.
SFAS No. 123 entitled "Accounting for Stock-Based Compensation" issued in
October 1995, was adopted by the Company as of December 31, 1997. The
provisions of SFAS No. 123 allows companies to either expense the estimated
fair value of stock options or to continue their current practice and disclose
the pro forma effects on net income and earnings per share had the fair value
of the options been expensed. The Company has elected to continue its practice
of recognizing compensation expense for its Plan using the intrinsic value
based method of accounting and to provide the required pro forma information.
Had compensation cost for the Plan been determined based on the fair value at
the grant date for awards under the Plan consistent with the provisions of SFAS
No. 123, the Company's pro forma net income and pro forma earnings per share
would have been the following (in thousands, except per share amounts):
Year Ended December 31
1998 1997 1996
Net income $3,094 $623 $3,227
Earnings per share .43 .11 .62
Earnings per share, assuming dilution .43 .11 .60
The fair value of each option grant is estimated on the date of grant
using the Black-Scholes option-valuation model with the following
weighted-average assumptions :
1998 1997 1996
Risk-free interest rates 5.6% 5.7% 5.9%
Volatility factors .55 .37 .49
Weighted average expected life 7 years 7 years 7 years
STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. STOCK OPTION PLAN (CONTINUED)
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferrable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in
subjective assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not provide a reliable single
measure of the fair value of its employee stock options. Because SFAS No. 123
is effective only for awards granted after January 1, 1995, the pro forma
disclosures provided may not be representative of the effects on reported net
income for future years.
A summary of the Company's stock option activity and related information
for the years ended December 31, 1998, 1997 and 1996 is as follows:
1998 1997 1996
Weighted- Weighted- Weighted-
Average Average Average
Exercise Exercise Exercise
Price Price Price
Shares Shares Shares
Options outstanding, beginning 1,916,820 $6.08 1,446,169 $5.98 1,164,720 $6.46
of year
Exercised (97,988) 5.23 (17,300) 4.52 (1,224) 3.57
Granted 79,950 6.94 685,000 6.29 769,122 6.14
Expired or forfeited (7,495) 6.75 (197,049) 4.30 (486,449) 7.56
Options outstanding, end of 1,891,287 6.15 1,916,820 6.08 1,446,169 5.98
year
Options exercisable, end of 1,664,153 1,467,185 1,097,028
year
Weighted-average fair value of
options granted during $ 4.42 $ 3.10 $ 3.62
the year
Information with respect to stock options outstanding at December 31,
1998 is as follows:
Options Outstanding Options Exercisable
Weighted- Weighted- Weighted-
Range of Average Average Average
Exercise Number Remaining Exercise Number Exercise
Prices Outstanding Contractual Price Exercisable Price
Life
(years)
$3-5 348,988 7 $4.40 318,988 $4.36
5-7 988,867 8 6.03 811,733 5.93
7-9 534,532 7 7.42 514,532 7.41
9-11 18,900 5 9.40 18,900 9.40
1,891,287 1,664,153
STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. REINSURANCE
The Company's insurance subsidiaries have entered into reinsurance
agreements with non-affiliated companies to limit the net loss arising from
large risks, maintain their exposure to loss within capital resources, provide
additional capacity for future growth and enter into sharing arrangements. The
maximum amount of life insurance retained on any one life ranges from $30,000
to $150,000. Amounts of standard risk in excess of that limit are reinsured.
Reinsurance premiums ceded to other insurers were $17.0 million, $4.8
million, and $2.2 million in 1998, 1997 and 1996, respectively. Reinsurance
ceded has reduced benefits and claims incurred by $10.5 million, $5.4 million,
and $6.2 million in 1998, 1997 and 1996, respectively. A contingent liability
exists to the extent any of the reinsuring companies are unable to meet their
obligations under the reinsurance agreements. To minimize exposure to
significant losses from reinsurance insolvencies, the Company evaluates the
financial condition of its reinsurers and monitors concentrations of credit
risk arising from similar geographic regions, activities or economic
characteristics of the reinsurers. Based on its periodic reviews of these
companies, the Company believes the assuming companies are able to honor all
contractual commitments under the reinsurance agreements.
At December 31, 1998 the Company's largest annuity reinsurer, which is
rated "A" (Excellent) by A.M. Best, represented $33.7 million, or 56.3% of
total reinsurance recoverable and $6.5 million of premium deposits ceded. From
January 1, 1996 to March 31, 1996, approximately 50% of Standard Life's annuity
business was ceded. Effective April 1, 1996, Standard Life reduced it to 25%
and effective October 1, 1998, discontinued ceding its annuity business.
On July 1, 1998, Savers Life's medicare supplement business was sold to
Oxford Life Insurance Company through a quota share reinsurance agreement.
Under the terms of the reinsurance agreement, Savers Life will administer the
medicare supplement business through July 1, 1999 and will receive
administration fee income. Effective December 31, 1998, Standard Life replaced
Savers Life as a party to this reinsurance agreement and became responsible for
the administration of the Medicare Supplement business.
10. RELATED PARTY TRANSACTIONS
On October 28, 1997, SMC made an interest-free loan to an officer and
director of SMC, in the amount of $778,000, representing a new loan in the sum
of $438,000 and consolidation of an existing loan. The principal balance of
the loan was $778,000 at December 31, 1998 and 1997. Repayment is due within
10 days of the officer's voluntary termination or resignation as an officer of
SMC. In the event of a termination of the officer's employment with SMC
following a change in control, the loan is deemed to be forgiven.
On September 2, 1998, SMC made a loan to a director of SMC, in the amount
of $120,000 with an interest rate of prime plus 1%. At December 31, 1998, the
principal balance of the loan was $58,500.
SMC entered into a covenant not to compete agreement with a former
officer and director in February 1997, effective July 1, 1996, the date his
employment agreement terminated. In accordance with the covenant not to compete
agreement, the officer and director received payments of $275,000 and $125,000
in 1997 and 1998, respectively, and will receive $100,000 in 1999.
SMC is a guarantor on a $70,000 loan to a director and officer. The
guaranty will be effective until the earlier of repayment of the loan or
June 25, 1999.
Certain officers and directors purchased 31,000 shares, or $3.1 million
of the Series A preferred stock as described in
Note 7. These shares were purchased in connection with a loan agreement of
$2.6 million which the Company has guaranteed.
STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. COMMITMENTS AND CONTINGENCIES
LEASE COMMITMENTS
The Company rents office and storage space under noncancellable operating
leases. The Company incurred rent expense for operating leases of $1.0 million,
$.9 million, and $1.0 million in 1998, 1997 and 1996, respectively. Pursuant to
the terms of a lease agreement effective June 1, 1991, Standard Life has agreed
to lease office space for a ten year period. After the initial ten year lease
period, Standard Life may continue to lease the premises on a month to month
basis at a rental of 125% of the prevailing market rate for the leased premises
in effect at that time.
Future required minimum rental payments, by year and in the aggregate,
under operating leases as of December 31, 1998, are as follows (in thousands):
1999 $ 913
2000 805
2001 429
2002 128
2003 128
Thereafter 16
Total minimum lease payments $2,419
EMPLOYMENT AGREEMENTS
Certain officers are employed pursuant to executive employment agreements
that create certain liabilities in the event of the termination of the covered
executives following a change in control of the Company. The commitment under
these agreements is approximately three times their current annual salaries.
Additionally, following termination from the Company due to a change in
control, each executive is entitled to receive a lump sum payment equal to all
unexercised stock options granted multiplied by the highest per share fair
market value during the six month period ending on the date of termination.
There were unexercised options outstanding to these executives to buy 1,327,880
shares at December 31, 1998.
12. LITIGATION
An officer and director of SMC resigned effective April 15, 1997. On
June 19, 1997, this former officer commenced an action in the Superior Court of
Marion County, Indiana against SMC claiming that his employment agreement
contained a provision to the effect that, following a termination of his
employment with SMC under certain circumstances, he would be entitled to
receive certain benefits. This former officer has asserted to SMC that he is
entitled to a lump sum termination payment of $1.7 million and liquidated
damages not exceeding $3.3 million by virtue of his voluntarily leaving SMC's
employment. SMC disputes those claims. SMC filed its Answer and Counterclaim
on September 11, 1997. SMC's investigation since the action was filed revealed
a basis for the termination of employment of the former officer for cause
relative to after-acquired evidence. On October 14, 1997, the Board of
Directors of SMC terminated the former officer for cause effective March 15,
1997. Such termination will also be argued by SMC as a complete defense to all
claims asserted by the former officer. The ultimate outcome of the action
cannot presently be determined. Accordingly, no provision for any liability
that may result has been made in the consolidated financial statements.
Management believes that the conclusion of such litigation will not have a
material adverse effect on SMC's consolidated financial condition.
In addition, the Company is involved in various legal proceedings in the
normal course of business. In most cases, such proceedings involve claims under
insurance policies or other contracts of the Company. The outcomes of these
legal proceedings are not expected to have a material adverse effect on the
consolidated financial position, liquidity or future results of operations of
the Company based on the Company's current understanding of the relevant facts
and law.
STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
13. STATUTORY ACCOUNTING INFORMATION OF SUBSIDIARIES
The Company's U.S. life insurance subsidiaries maintain their records in
conformity with statutory accounting practices prescribed or permitted by state
insurance regulatory authorities. Statutory accounting practices differ in
certain respects from GAAP. In consolidation, adjustments have been made to
conform the Company's domestic subsidiaries' accounts with GAAP.
The Company's U.S. life insurance subsidiaries had consolidated statutory
capital and surplus of $43.6 million and $25.9 million at December 31, 1998 and
1997, respectively, after elimination of subsidiaries intercompany accounts.
Consolidated net income of the Company's life insurance subsidiaries on a
statutory basis, after elimination of subsidiaries intercompany accounts was
$1.7 million, $1.8 million, and $3.3 million for the years ended December 31,
1998, 1997 and 1996, respectively. Minimum statutory capital and surplus
required by the Indiana Insurance Code was $.5 million as of December 31, 1998.
"Prescribed" statutory accounting practices include a variety of
publications of the National Association of Insurance Commissioners ("NAIC"),
as well as state laws, regulations, and general administrative rules.
"Permitted" statutory accounting practices encompass all accounting practices
that are not prescribed; such practices may differ from state to state, may
differ from company to company within a state and may change in the future. The
NAIC currently is in the process of codifying statutory accounting practices,
the result of which is expected to constitute the only source of "prescribed"
statutory accounting practices. Accordingly, that project, which is expected to
be adopted by states with an implementation date of January 1, 2001, will
likely change, to some extent, prescribed statutory accounting practices, and
may result in changes to the accounting practices that insurance enterprises
use to prepare their statutory financial statements.
Effective December 31, 1998, Standard Life strengthened policy reserves
by $.3 million pursuant to the statutory Actuarial Guideline 33. Standard Life
received permission from the Indiana Department of Insurance Commissioner to
grade in the remaining effect of Actuarial Guideline 33 in 1999 and 2000. This
permitted accounting practice increased statutory surplus by $.7 million at
December 31, 1998.
Policy reserves for Dixie Life's fixed premium universal life policies
were calculated according to the Commissioners' Reserve Valuation Method
("CRVM") for traditional whole life policies. This differs from prescribed
statutory accounting practices. Effective October 2, 1995, Dixie Life received
permission from the Mississippi Insurance Department to strengthen the reserves
for these policies by using the CRVM methodology as modified by the Universal
Life Model Regulation. This reserve strengthening was recorded quarterly
through September 30, 1998.
From the funds borrowed by SMC pursuant to the Amended Credit Agreement
and the subordinated convertible debt agreement, $27.0 million ($13.0 million
at December 31, 1997) was loaned to Standard Life pursuant to an Unsecured
Surplus Debenture Agreement ("Surplus Debenture") which requires Standard Life
to make quarterly interest payments to SMC at a variable corporate base rate
plus 2% per annum, and annual principal payments of $1.0 million per year
beginning in 2007 and concluding in 2033. As required by state regulatory
authorities, the balance of the surplus debenture at December 31, 1998 and 1997
of $27.0 million and $13.0 million, respectively, is classified as a part of
capital and surplus of Standard Life. The interest and principal payments are
subject to quarterly approval by the Indiana Department of Insurance, depending
upon satisfaction of certain financial tests relating to levels of Standard
Life's capital and surplus and general approval of the Commissioner of the
Indiana Department of Insurance.
SMC's ability to pay operating expenses and meet debt service obligations
is partially dependent upon the amount of dividends received from Standard
Life. Standard Life's ability to pay cash dividends to SMC is, in turn,
restricted by law or subject to approval by the insurance regulatory
authorities of Indiana. Dividends are permitted based on, among other things,
the level of the preceding year statutory surplus and net income. In 1997 and
1996, Standard Life paid dividends of $1.6 million and $1.0 million,
respectively, to SMC. During 1999, Standard Life can pay dividends of $4.4
million without regulatory approval; Standard Life must notify the Indiana
regulatory authorities of the intent to pay dividends at least thirty days
prior to payment.
State insurance regulatory authorities impose minimum risk-based capital
requirements on insurance enterprises that were developed by the NAIC. The
formulas for determining the amount of risk-based capital ("RBC") specify
various weighting factors that are applied to financial balances or various
levels of activity based on the perceived degree of investment and insurance
risks. Regulatory compliance is determined by a ratio (the "Ratio") of the
enterprise's regulatory total adjusted capital, as defined by the NAIC, to its
authorized control level RBC, as defined by the NAIC. Enterprises below
specific trigger points or ratios are classified within certain levels, each of
which requires specified corrective action. At December 31, 1998, the RBC
Ratios of Standard Life and Dixie Life were both at least two and a half times
greater than the levels at which company action is required.
STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
13. STATUTORY ACCOUNTING INFORMATION OF SUBSIDIARIES (CONTINUED)
The statutory capital and surplus for Premier Life (Luxembourg) was $6.8
million and $7.3 million at fiscal years ended 1998 and 1997, respectively, and
minimum capital and surplus under local insurance regulations was $2.9 million
at fiscal years ended 1998 and 1997. The statutory capital and surplus for
Premier Life (Bermuda) was $2.1 million and $1.4 million at fiscal years ended
1998 and 1997, respectively, and minimum capital and surplus under local
insurance regulations was $.3 million at fiscal years ended 1998 and 1997. SMI
dividends are limited to its accumulated earnings without regulatory approval.
SMI and Premier Life (Luxembourg) were not permitted to pay dividends under
Luxembourg law in 1998 and 1997 due to accumulated losses.
14. OPERATIONS BY BUSINESS SEGMENT
In 1998, the Company adopted SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information." Under this new pronouncement,
effective for financial statements issued for fiscal years beginning after
December 15, 1997, a company must provide disclosures about operating segments
on the same basis it uses internally to evaluate the performance of its
operations and allocate its resources. The Company identified the following
two operating segments which are the primary components of its business.
DOMESTIC OPERATIONS includes revenues earned and expenses incurred from
United States operations and includes deposits and/or income from annuity
products (primarily FPDA's), equity indexed products, universal life products
and traditional life products. The profitability for this segment primarily
depends on the investment spread earned (annuities and universal life), the
persistency of the in-force business, claim experience and expense management.
INTERNATIONAL OPERATIONS includes revenues earned and expenses incurred
from abroad, primarily Europe, and includes fees collected on deposits from
unit-linked products. The profitability for this segment primarily depends on
the amount of separate account assets under management, the management fee
charged on those assets and expense management.
The accounting policies of the segments are the same as described in Note
1 (Summary of Significant Accounting Policies).
The following segment presentation contains the same operating data and
results the Company uses to evaluate the performance of the business and
provides reconciliations to consolidated totals (in thousands):
Year Ended December 31
1998 1997 1996
Revenues:
Domestic $58,055 $42,651 $36,524
International 4,815 3,960 3,681
Consolidated Revenues $62,870 $46,611 $40,205
Net Investment Income:
Domestic $33,721 $28,614 $20,132
International 859 902 739
Consolidated Net Investment Income $34,580 $29,516 $20,871
Interest Credited on Interest Sensitive Annuities
and Other $19,775 $16,281 $11,092
Financial Products (All Domestic)
Pre-tax Income:
Domestic $4,053 $1,542 $2,292
International 2,258 1,720 1,243
Consolidated Pre-tax Income $6,311 $3,262 $3,535
Assets:
Domestic $750,683 $508,476 $486,576
International 205,467 160,516 141,837
Consolidated Assets $956,150 $668,992 $628,413
15. DERIVATIVE FINANCIAL INSTRUMENTS
In May 1998, Standard Life began offering equity-indexed annuity
products which provide a base rate of return with a higher potential return
linked to the performance of a broad-based equity index. The Company buys
Standard & Poor's 500 Index Call Options (the "S&P 500 Call Options") in an
effort to hedge potential increases to policyholder benefits resulting from
increases in the S&P 500 Index to which the product's return is linked. The
cost of the S&P 500 Call Options is included in the pricing of the equity-
indexed annuity products. The changes in the values of the S&P 500 Call
Options are reflected in net investment income and fluctuate in relation to
changes in policyholder account balances for these annuities. Premiums paid to
purchase these instruments are deferred and amortized over their term.
At December 31, 1998, net investment income included $.6 million related
to changes in the fair value of the S&P 500 Call Options. Such investment
income was substantially offset by amounts credited to financial products. The
fair value of the S&P 500 Call Options was $1.8 million at December 31, 1998.
If the counterparts of the aforementioned financial instruments do not
meet their obligations, the Company may have to recognize a loss. The Company
limits its exposure to such a loss by diversifying among several counterparties
believed to be strong and creditworthy. At December 31, 1998, all of the
counterparties were rated "A" or higher by Standard & Poor's Corporation.
16. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following discussion outlines the methods and assumptions used by the
Company in estimating its fair value disclosures for its financial instrument
assets and liabilities. Because fair values for all balance sheet items are
not required to be disclosed pursuant to SFAS No. 107, "Disclosures about Fair
Values of Financial Instruments", the aggregate fair value amounts presented
herein do not necessarily represent the underlying value of the Company;
likewise, care should be exercised in deriving conclusions about the Company's
business or financial condition based on the fair value information presented
herein.
FIXED MATURITY SECURITIES: Fair values for fixed maturity securities are
based on quoted market prices from broker-dealers, where available. For fixed
maturity securities not actively traded, fair values are estimated using values
obtained from independent pricing services, or, in the case of private
placements, are estimated by discounting the expected future cash flows using
current market rates applicable to the coupon rate, credit rating and maturity
of the investments.
EQUITY SECURITIES: The fair values for equity securities are based on
the quoted market prices.
DERIVATIVE SECURITIES: The fair values for derivative securities are
based on internal methods developed by our investment advisor.
MORTGAGE LOANS AND POLICY LOANS: The estimated fair values for mortgage
loans and policy loans are estimated using discounted cash flow analyses and
interest rates currently being offered for similar loans to borrowers with
similar credit ratings.
ASSETS AND LIABILITIES HELD IN SEPARATE ACCOUNTS: Fair values for the
assets held in separate accounts are determined from broker-dealers or
valuations supplied by internationally recognized statistical rating
organizations. The separate account liability represents the Company's
obligations to policyholders and approximates fair value.
INSURANCE LIABILITIES FOR INVESTMENT CONTRACTS: Fair values for the
Company's liabilities under investment-type insurance contracts are estimated
using discounted cash flow calculations, based on interest rates currently
being offered for similar contracts with maturities consistent with those
remaining contracts being valued. The estimated fair value of the liabilities
for investment contracts was approximately equal to its carrying value at
December 31, 1998 and 1997. This is due to i) credited rates on the vast
majority of account balances approximating current rates paid on similar
investments and ii) rates not generally being guaranteed beyond one year.
INSURANCE LIABILITIES FOR NON-INVESTMENT CONTRACTS: Fair value
disclosures for the Company's reserves for insurance contracts other than
investment-type contracts are not required and have not been determined by the
Company. However, the Company closely monitors the level of its insurance
liabilities and the fair value of reserves under all insurance contracts are
taken into consideration in the Company's overall management of interest rate
risk.
NOTES PAYABLE: The Company believes the fair value of its variable rate
long-term debt was equal to its carrying value at December 31, 1998 and 1997.
The Company negotiated the terms of its Amended Credit Agreement with its
lenders in November 1996. Those negotiations were based on the financial
condition of the Company and market conditions at that time. The financial
condition of the Company has not changed significantly since the negotiations,
and although market conditions
16. FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
have changed, the Company pays a variable rate of interest on the debt which
reflects the change in market conditions. The fair value of the subordinated
convertible debt is based on quoted market prices for the amount of shares
convertible.
The carrying amount of all other financial instruments approximates their
fair values.
The fair value of the Company's financial instruments is shown below
using a summarized version of the Company's assets and liabilities at December
31, 1998 and 1997 (in thousands). Refer to Note 3 for additional information
relating to the fair value of investments.
December 31
1998 1997
Fair Carrying Fair Carrying
Value Amount Value Amount
Assets:
Investments:
Securities available for sale:
Fixed maturity securities $551,312 $551,312 $372,576 $372,576
Equity securities 1,316 1,316 52 52
Mortgage loans on real estate 8,856 8,578 377 375
Policy loans 14,295 15,019 8,978 9,495
Other invested assets 837 837 779 779
Short-term investments 11,626 11,626 13,342 13,342
Cash 13,591 13,591 4,165 4,165
Assets held in separate accounts 190,246 190,246 148,064 148,064
Liabilities:
Insurance liabilities for 506,749 506,749 350,607 350,607
investment contracts
Notes payable 37,180 35,000 27,419 26,000
Liabilities related to separate 190,246 190,246 148,064 148,064
accounts
STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
17. EARNINGS PER SHARE
A reconciliation of the numerator and denominator of the earnings per
share computation is as follows (dollars in thousands, except per share
amounts):
1998 1997 1996
Numerator:
Income before extraordinary gain and preferred stock $4,681 $2,645 $4,265
dividends
Extraordinary gain on early redemption of redeemable -- -- 502
preferred stock
Preferred stock dividends (180) (97) (208)
Numerator for basic earnings per share -
Income available to common shareholders 4,501 2,548 4,559
Effect of dilutive securities:
Preferred stock dividends 180 97 208
14% subordinated convertible debt -- -- 82
10% subordinated convertible debt 1,000 -- --
1,180 97 290
Numerator for diluted earnings per share -
Income available to common shareholders after $5,681 $2,645 $4,849
assumed conversions
Denominator:
Denominator for basic earnings per share - weighted - 6,846,335 4,948,302 4,856,316
average shares
Effect of dilutive securities:
Stock options 263,636 182,615 24,311
Stock warrants 211,989 230,285 108,062
Class S convertible preferred stock -- 230,015 393,701
14% subordinated convertible debt -- -- 166,667
10% subordinated convertible debt 1,740,038 -- --
Series A convertible preferred stock 301,765 -- --
Dilutive potential common shares 2,517,428 642,915 692,741
Denominator for diluted earnings per share - adjusted
weighted -average shares and assumed conversions 9,363,763 5,591,217 5,549,057
Basic earnings per share $.65 $.52 $.94
Diluted earnings per share $.60 $.47 $.87
The Notes convertible in 1997 (SEE NOTE 5) were not included in the
computation of diluted earnings per share in 1997 due to their antidilutive
effect.
STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
18. QUARTERLY FINANCIAL DATA (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Earnings per common and common equivalent share for each quarter are
computed independently of earnings per share for the year. Due to the
transactions affecting the weighted average number of shares outstanding in
each quarter and due to the uneven distribution of earnings during the year,
the sum of the quarterly earnings per share may not equal the earnings per
share for the year.
1998 Quarters
First Second Third Fourth
Total revenues $11,675 $19,798 $13,887 $17,510
Components of net income:
Operating income $734 $1,276 $1,120 $1,317
Net realized investment gain 14 17 18 185
Net income $748 $1,293 $1,138 $1,502
Net income per common share $.14 $.18 $.16 $.20
Net income per common share, assuming
dilution $.13 $.16 $.15 $.17
1997 Quarters
First Second Third Fourth
Total revenues $11,998 $11,342 $11,615 $11,656
Components of net income:
Operating income $528 $661 $537 $658
Net realized investment gains 115 21 53 72
Net income $643 $682 $590 $730
Net income per common share $.13 $.14 $.12 $.15
Net income per common share, assuming
dilution $.11 $.12 $.11 $.13
Reporting the results of insurance operations on a quarterly basis
requires the use of numerous estimates throughout the year, primarily in the
computation of reserves, amortization of deferred policy acquisition costs and
present value of future profits, and the effective rate for income taxes. It
is the Company's practice to review estimates at the end of each quarter and,
if necessary, make appropriate adjustments, with the effect of such adjustments
being reported in current operations. Only at year-end is the Company able to
assess the accuracy of its previous quarterly estimates. The Company's fourth
quarter results include the effect of the difference between previous estimates
and actual year-end results. Therefore, the results of an interim period may
not be indicative of the results of the entire year.
STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SCHEDULE II -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT
STANDARD MANAGEMENT CORPORATION
(PARENT COMPANY)
CONDENSED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
December 31
1998 1997
ASSETS
Investments:
Investment in subsidiaries $77,382 $52,005
Surplus debenture due from Standard Life 27,000 13,000
Fixed maturity securities, at fair value (amortized cost $900) 900 --
Equity securities available for sale, at fair value (amortized 28 2
cost: 1998 - $20; 1997 -$5)
Real estate 122 130
Notes receivable from officers and directors 837 778
Short-term investments, at cost, which approximates fair value -- 79
106,279 65,994
Cash 940 1,327
Property and equipment, less accumulated depreciation of $2,038 in 1998 862 879
and $1,636 in 1997
Note receivable from affiliate 2,858 2,858
Amounts receivable from subsidiaries 2,338 1,212
Other assets 1,229 1,892
Total assets $113,350 $74,162
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Obligations under capital lease $ -- $141
Notes payable 35,000 26,000
Note payable to affiliate 2,858 2,858
Amounts due to subsidiaries 850 397
Other liabilities 2,070 1,453
Total liabilities 40,778 30,849
Class A cumulative convertible redeemable preferred stock, par value $100
per share:
authorized 130,000 shares; issued and outstanding 65,300 shares in 1998 6,530 --
Shareholders' Equity:
Preferred stock, no par value:
Authorized 870,000 shares; none issued and outstanding -- --
Common stock, no par value:
Authorized 20,000,000 shares; outstanding 1998 - 7,641,454; 1997 60,586 40,646
- 4,876,490
Treasury stock, at cost, 1,160,854 shares in 1998 and 876,009 shares in (6,220) (4,572)
1997
Accumulated other comprehensive income:
Unrealized gain (loss) on securities of subsidiaries 1,683 2,171
Foreign currency translation adjustment of subsidiaries 4 (473)
Retained earnings 9,989 5,541
Total shareholders' equity 66,042 43,313
Total liabilities and shareholders' equity $113,350 $74,162
See accompanying notes to condensed financial statements.
STANDARD MANAGEMENT CORPORATION
(PARENT COMPANY)
CONDENSED STATEMENTS OF INCOME
(DOLLARS IN THOUSANDS)
Year Ended December 31
1998 1997 1996
Revenues:
Net investment income (loss) $(26) $-- $32
Interest income from subsidiaries 1,709 1,519 357
Net realized investment losses (100) -- --
Loss on disposal of subsidiary -- -- (156)
Other income 118 154 135
Rental income from subsidiaries 995 1,145 853
Management fees from subsidiaries 2,850 2,100 1,905
Total revenues 5,546 4,918 3,126
Expenses:
Other operating expenses 3,134 3,420 3,470
Interest expense and financing costs 2,850 2,367 799
Interest expense on note payable to affiliate 160 162 161
Total expenses 6,144 5,949 4,430
Income (loss) before federal income taxes, equity
in earnings
of consolidated subsidiaries, extraordinary gain (598) (1,031) (1,304)
and preferred stock dividends
Federal income tax expense (credit) 30 (76) --
Income (loss) before equity in earnings of
consolidated subsidiaries, extraordinary gain
and preferred stock dividends (628) (955) (1,304)
Equity in earnings of consolidated subsidiaries 5,309 3,600 5,569
Income before extraordinary gain and preferred 4,681 2,645 4,265
stock dividends
Extraordinary gain on early redemption of
redeemable preferred stock, net taxes of $0 -- -- 502
Net income 4,681 2,645 4,767
Preferred stock dividends 180 97 208
Earnings available to common shareholders $4,501 $2,548 $4,559
See accompanying notes to condensed financial statements.
STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
STANDARD MANAGEMENT CORPORATION
(PARENT COMPANY)
CONDENSED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
Year Ended December 31
1998 1997 1996
OPERATING ACTIVITIES
Net income $4,681 $2,645 $4,767
Adjustments to reconcile net income to net cash
provided by operating activities:
Amortization of deferred debt issuance costs 97 71 32
Depreciation and amortization 439 646 564
Equity in earnings of subsidiaries (5,309) (3,600) (5,569)
Accrued interest payable 197 435 320
Other liabilities (38) 79 192
Dividend from Standard Life -- 1,600 1,000
Extraordinary gain -- -- (502)
Other (483) (370) 165
Net cash provided (used) by operating (416) 1,506 969
activities
FINANCING ACTIVITIES
Issuance of common stock, net 19,638 -- --
Borrowings, net of debt issuance costs of $206, $70 and
$208 in 1998, 1997 and 1996, respectively 11,794 5,558 16,792
Repayments on long-term debt and obligations under (3,141) (543) (491)
capital lease
Issuance of convertible preferred stock net of issuance
costs of $141 in 1998 6,389 -- --
Reissuance of treasury stock in connection with
exercise of stock options and warrants 234 -- --
Redemption of redeemable preferred stock -- (1,855) (949)
Repurchase of stock warrants -- -- (600)
Proceeds from common and treasury stock sales -- 138 100
Purchase of common stock for treasury (1,672) (503) (2,126)
Net cash provided by financing activities 33,242 2,795 12,726
INVESTING ACTIVITIES
Investments, net (1,685) (1,035) 197
Purchase of property and equipment, net (385) (439) (246)
Surplus debenture contributed to Standard Life -- -- (13,000)
Capital contribution to Standard Life -- (2,400) --
Purchase of Savers Life, less cash acquired of $518 (18,039) -- --
Purchase of Midwestern Life, less cash acquired of (13,104) -- --
$1,026
Net cash used by investing activities (33,213) (3,874) (13,049)
Net increase (decrease) in cash (387) 427 646
Cash at beginning of year 1,327 900 254
Cash at end of year $940 $1,327 $900
See accompanying notes to condensed financial statements.
STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SCHEDULE II--CONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONTINUED)
STANDARD MANAGEMENT CORPORATION
(PARENT COMPANY)
NOTES TO CONDENSED FINANCIAL STATEMENTS
DECEMBER 31, 1998
1. BASIS OF PRESENTATION
For purposes of these condensed financial statements, Standard Management
Corporation ("SMC") carries its investments in subsidiaries at cost plus equity
in undistributed earnings of subsidiaries since date of acquisition. Net income
of its subsidiaries is included in income using the equity method. These
condensed financial statements should be read in conjunction with SMC's
consolidated financial statements included elsewhere in this document.
2. DIVIDENDS FROM SUBSIDIARIES
SMC received a cash dividend from subsidiaries of $1.6 million and $1.0
million in 1997 and 1996, respectively.
STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SCHEDULE IV -- REINSURANCE
STANDARD MANAGEMENT CORPORATION
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS IN THOUSANDS)
Percentage
Ceded to Assumed of Amount
Gross Other from Other Assumed
Amount Companies Companies Net Amount to Net
YEAR ENDED DECEMBER 31, 1998
Life insurance in force $2,520,340 $1,231,533 $217 $1,289,024 0.02%
Premiums:
Life insurance and annuities $13,160 $4,705 $-- $8,455
Accident and health insurance 18,333 12,341 -- 5,992
Supplementary contract and other
funds on deposit 32 -- -- 32
Total premiums $31,525 $17,046 $-- $14,479
YEAR ENDED DECEMBER 31, 1997
Life insurance in force $2,447,782 $1,269,848 $237 $1,178,171 0.02%
Premiums:
Life insurance and annuities $11,735 $4,821 $-- $6,914
Accident and health insurance 17 -- -- 17
Supplementary contract and other
funds on deposit 169 -- -- 169
Total premiums $11,921 $4,821 $-- $7,100
YEAR ENDED DECEMBER 31, 1996
Life insurance in force $3,000,763 $1,633,340 $252 $1,367,675 0.02%
Premiums:
Life insurance and annuities $11,862 $2,152 $-- $9,710
Accident and health insurance 21 -- -- 21
Supplementary contract and other
funds on deposit 737 -- -- 737
Total premiums $12,620 $2,152 $-- $10,468
STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
EXHIBIT 21
SUBSIDIARIES OF STANDARD MANAGEMENT CORPORATION
STATE
PERCENTAGE OF OR COUNTRY IN
NAME OF SUBSIDIARY OUTSTANDING WHICH ORGANIZED
Standard Life Insurance Company of Indiana 100% Indiana
Dixie National Life Insurance Company 99.4% Mississippi
Standard Marketing Corporation 100% Indiana
Savers Marketing Corporation 100% North Carolina
Standard Marketing International, Ltd. 100% Bermuda
Standard Investor Services Corporation 100% Indiana
Standard Administrative Services, Inc. 100% Indiana
Standard Management International S.A. 100% Luxembourg
Premier Life (Luxembourg) S.A. 100% Luxembourg
Premier Life (Bermuda) Limited 100% Bermuda
Standard Development, LLC 100% Indiana
STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
EXHIBIT 23.1
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration
Statement (Form S-8 No. 33-92906) pertaining to the Second Amended and Restated
Stock Option Plan of Standard Management Corporation, the Registration
Statement (Form S-8 No. 333-41119) pertaining to the Amended and Restated Stock
Option Plan of Standard Management Corporation and the Registration Statement
(Form S-8 No. 333-41117) pertaining to the Standard Management Corporation
Savings Plan, of our report dated February 18, 1999, with respect to the
consolidated financial statements and schedules of Standard Management
Corporation and subsidiaries included in the Annual Report (Form 10-K) for the
year ended December 31, 1998.
Ernst & Young LLP
Indianapolis, Indiana
March 30, 1999
STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
EXHIBIT 23.2
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statement
(Form S-8 No. 33-92906) pertaining to the Second Amended and Restated Stock
Option Plan of Standard Management Corporation, the Registration Statement
(Form S-8 No. 333-41119) pertaining to the Amended and Restated Stock Option
Plan of Standard Management Corporation and the Registration Statement (Form S-
8 No. 333-41117) pertaining to the Standard Management Corporation Savings
Plan, of our report dated February 18, 1999, with respect to the consolidated
financial statements of Standard Management International S. A. and
subsidiaries included in the Annual Report (Form 10-K) for the year ended
December 31, 1998 of Standard Management Corporation.
KPMG Audit
Luxembourg
March 30, 1999
STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
EXHIBIT 24
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each of the undersigned persons
whose signature appear immediately below, does hereby constitute and appoint
Ronald D. Hunter and Stephen M. Coons, each with full power to act alone, his
true and lawful attorney-in-fact and agent, with full power of substitution and
resubstitution, for him and in his name, place and stead, in any and all
capacities, to sign on behalf of the undersigned an Annual Report on Form 10-K
("Form 10-K") under the Securities Exchange Act of 1934, as amended (the
"Exchange Act"), granting unto said attorney-in-fact and agent full power and
authority to do and perform each and every act and thing requisite and
necessary to be done, as fully to all intents and purposes as the undersigned
might or could do in person, hereby ratifying and confirming all that said
attorneys-in-fact and agent, or his substitute lawfully do or cause to be done
by virtue hereof.
IN WITNESS WHEREOF, I have hereunto set my hand this 30th day of March,
1999.
/S/ RONALD D. HUNTER /S/ PAUL B. PHEFFER
Ronald D. Hunter Paul B. Pheffer
/S/ GERALD R. HOCHGESANG /S/ RAYMOND J. OHLSON
Gerald R. Hochgesang Raymond J. Ohlson
/S/ EDWARD T. STAHL /S/ STEPHEN M. COONS
Edward T. Stahl Stephen M. Coons
/S/ MARTIAL R. KNIESER /S/ ROBERT A. BORNS
Martial R. Knieser Robert A. Borns
/S/ JOHN J. DILLON /S/ JERRY E. FRANCIS
John J. Dillon Jerry E. Francis
STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)