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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

     
x   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
     
    FOR THE QUARTERLY PERIOD ENDED September 30, 2002 or
     
o   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
(State or other jurisdiction
of incorporation or organization)		   No. 35-1773567
(I.R.S. Employer Identification No.)
     
10689 N. Pennsylvania Street, Indianapolis, Indiana
(Address of principal executive offices)		   46280
(Zip Code)

(317) 574-6200
(Registrant’s telephone number, including area code)

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   o

As of October 31, 2002, the Registrant had 7,613,479 shares of Common Stock outstanding.

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TABLE OF CONTENTS

PART I — FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS
CONSOLIDATED STATEMENTS OF INCOME
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
CONSOLIDATED STATEMENTS OF CASH FLOWS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
ITEM 4. CONTROLS AND PROCEDURES
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
SIGNATURES
CERTIFICATION
CERTIFICATION
EX-99.1 SECTION 906 CERTIFICATION OF THE CEO
EX-99.2 SECTION 906 CERTIFICATION OF THE CFO

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STANDARD MANAGEMENT CORPORATION

INDEX

                 
            Page Number
           
Part I.  
FINANCIAL INFORMATION:
        
Item 1.  
Financial Statements
        
        Consolidated Balance Sheets
September 30, 2002 (Unaudited) and December 31, 2001 (Audited)		     3  
        Consolidated Statements of Income —
For the Three Months and Nine Months Ended September 30, 2002 and 2001 (Unaudited)		     4-5  
        Consolidated Statements of Shareholders’ Equity —
For the Nine Months Ended September 30, 2002 and 2001 (Unaudited)		     6  
        Consolidated Statements of Cash Flows —
For the Nine Months Ended September 30, 2002 and 2001
(Unaudited) 		    7  
       
Notes to Consolidated Financial Statements (Unaudited)
     8-10  
Item 2.  
Management’s Discussion and Analysis of Financial Condition and Results of Operations
     11-23  
Item 3.  
Quantitative and Qualitative Disclosures about Market Risk
     23  
Item 4.  
Controls and Procedures
     23  
Part II.  
OTHER INFORMATION:
        
Item 6.  
Exhibits and Reports on Form 8-K
     24  
       
SIGNATURES
     24  
       
Certifications Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
     25-26  

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PART I — FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
(Dollars in Thousands)

                     
        September 30   December 31
        2002   2001
       
 
        (Unaudited)   (Audited)
ASSETS
                
Investments:
                
 
Securities available for sale:
                
   
Fixed maturity securities at fair value (amortized cost $1,285,957 in 2002 and $930,831 in 2001)
   $ 1,306,226     $ 920,944  
 
Mortgage loans on real estate
     4,633       5,023  
 
Policy loans
     12,688       12,946  
 
Real estate
     3,406       4,011  
 
Equity-indexed call options
     1,411       3,545  
 
Short-term investments
     568       5,509  
 
Other invested assets
     926       776  
 
    
     
 
   
Total investments
     1,329,858       952,754  
Cash
     25,832       18,144  
Accrued investment income
     17,020       14,152  
Amounts due and recoverable from reinsurers
     39,200       41,969  
Deferred policy acquisition costs
     136,169       109,844  
Present value of future profits
     16,576       22,269  
Goodwill
     6,199       5,146  
Property and equipment (less accumulated depreciation of $3,384 in 2002 and $2,428 in 2001)
     12,599       12,148  
Other assets
     6,479       6,897  
Assets of discontinued operations
     5,450       430,330  
 
    
     
 
   
Total assets
   $ 1,595,382     $ 1,613,653  
 
    
     
 
LIABILITIES AND SHAREHOLDERS’ EQUITY
                
Liabilities:
                
 
Insurance policy liabilities
   $ 1,444,369     $ 1,065,763  
 
Accounts payable and accrued expenses
     8,629       5,935  
 
Obligations of capital lease
     884       1,152  
 
Mortgage payable
     6,796       6,900  
 
Notes payable
     14,750       19,100  
 
Deferred federal income taxes
     8,571       6,392  
 
Liabilities of discontinued operations
     1,130       417,522  
 
    
     
 
   
Total liabilities
     1,485,129       1,522,764  
 
    
     
 
Company-obligated trust preferred securities
     20,700       20,700  
Shareholders’ Equity:
                
 
Preferred stock, no par value:
                
   
Authorized 870,000 shares; none issued and outstanding
     —       —  
 
Common stock and additional paid in capital, no par value:
                
   
Authorized 20,000,000 shares; issued 9,107,557 in 2002 and 9,039,471 in 2001
     63,597       63,011  
 
Treasury stock, at cost, 1,494,078 shares in 2002 and 1,492,978 in 2001
     (7,594 )     (7,589 )
 
Accumulated other comprehensive income (loss)
     8,257       (6,172 )
 
Retained earnings
     25,293       20,939  
 
    
     
 
   
Total shareholders’ equity
     89,553       70,189  
 
    
     
 
   
Total liabilities and shareholders’ equity
   $ 1,595,382     $ 1,613,653  
 
    
     
 

See accompanying notes to consolidated financial statements

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STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME
(Unaudited, Dollars in Thousands)

                                     
        Three Months Ended   Nine Months Ended
        September 30   September 30
       
 
        2002   2001   2002   2001
       
 
 
 
Revenues:
                                
 
Premium income
   $ 1,732     $ 2,538     $ 5,955     $ 7,626  
 
Net investment income
     19,785       14,977       55,429       42,605  
 
Call option losses
     (3,049 )     (3,257 )     (10,040 )     (6,394 )
 
Net realized investment losses
     (3,672 )     (3,720 )     (12,570 )     (3,775 )
 
Policy income
     2,139       1,810       5,862       5,785  
 
Fees and other income
     392       2,096       2,100       5,556  
 
    
     
     
     
 
   
Total revenues from continuing operations
     17,327       14,444       46,736       51,403  
Benefits and expenses:
                                
 
Benefits and claims
     2,577       3,519       7,351       9,993  
 
Interest credited to interest-sensitive annuities and other financial products
     11,009       7,462       29,142       20,315  
 
Amortization
     8,325       (450 )     14,453       4,519  
 
Commission expenses
     156       906       1,188       2,880  
 
Other operating expenses
     4,002       2,777       9,114       8,606  
 
Interest expense and financing costs
     1,102       883       3,336       2,443  
 
    
     
     
     
 
   
Total benefits and expenses from continuing operations
     27,171       15,097       64,584       48,756  
 
    
     
     
     
 
Income (loss) before federal income taxes (benefits) and preferred stock dividends
     (9,844 )     (653 )     (17,848 )     2,647  
Federal income tax expense (benefits)
     (3,007 )     (375 )     (8,639 )     51  
 
    
     
     
     
 
Income (loss) from continuing operations
     (6,837 )     (278 )     (9,209 )     2,596  
Discontinued operations:
                                
   
Income from discontinued operations (less taxes of $0, $319, $550, and $865, respectively)
     —       619       1,068       1,680  
   
Gain from the sale of discontinued operations (less taxes of $1,764 and $3,933, respectively)
     8,285       —       12,495       —  
 
    
     
     
     
 
Total income from discontinued operations
     8,285       619       13,563       1,680  
 
    
     
     
     
 
 
Net income
     1,448       341       4,354       4,276  
Preferred stock dividends
     —       (65 )     —       (318 )
 
    
     
     
     
 
Earnings available to common shareholders
   $ 1,448     $ 276     $ 4,354     $ 3,958  
 
    
     
     
     
 

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CONSOLIDATED STATEMENTS OF INCOME (continued)
(Unaudited, Dollars in Thousands)

                                     
        Three Months Ended   Nine Months Ended
        September 30   September 30
       
 
        2002   2001   2002   2001
       
 
 
 
Earnings per share – basic:
                                
 
Income (loss) from continuing operations
   $ (.90 )   $ (.03 )   $ (1.21 )   $ .35  
 
Discontinued operations:
                                
   
Income from discontinued operations
     —       .08       .14       .22  
   
Gain from the sale of discontinued operations
     1.09       —       1.64       —  
 
    
     
     
     
 
 
Total income from discontinued operations
     1.09       .08       1.78       .22  
 
    
     
     
     
 
 
Net income
     .19       .05       .57       .57  
 
Preferred stock dividends
     —       (.01 )     —       (.04 )
 
    
     
     
     
 
 
Earnings available to common shareholders
   $ .19     $ .04     $ .57     $ .53  
 
    
     
     
     
 
Earnings per share – diluted:
                                
 
Income (loss) from continuing operations
   $ (.85 )   $ (.04 )   $ (1.15 )   $ .30  
 
Discontinued operations:
                                
   
Income from discontinued operations
     —       .08       .13       .21  
   
Gain from the sale of discontinued operations
     1.03       —       1.56       —  
 
    
     
     
     
 
 
Total income from discontinued operations
     1.03       .08       1.69       .21  
 
    
     
     
     
 
 
Net income
     .18       .04       .54       .51  
 
Preferred stock dividends
     —       —       —       —  
 
    
     
     
     
 
 
Earnings available to common shareholders
   $ .18     $ .04     $ .54     $ .51  
 
    
     
     
     
 

See accompanying notes to consolidated financial statements

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CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
(Unaudited, Dollars in Thousands)

                                               
                                  Accumulated        
                  Common stock and           other        
                  additional paid   Treasury   comprehensive   Retained
          Total   in capital   stock   income (loss)   earnings
         
 
 
 
 
Balance at January 1, 2001
   $ 62,899     $ 63,019     $ (7,589 )   $ (12,008 )   $ 19,477  
Comprehensive income:
                                        
 
Net income
     4,276                               4,276  
 
Other comprehensive income:
                                        
   
Change in unrealized gain (loss) on securities, net taxes of $5,632
     11,067                       11,067          
   
Change in foreign currency translation
     (238 )                     (238 )        
 
    
                                 
     
Other comprehensive income
     10,829                                  
 
    
                                 
     
Comprehensive income
     15,105                                  
 
Issuance of common stock and warrants
     90       90                          
 
Preferred stock dividends
     (318 )                             (318 )
 
    
     
     
     
     
 
Balance at September 30, 2001
   $ 77,776     $ 63,109     $ (7,589 )   $ (1,179 )   $ 23,435  
 
    
     
     
     
     
 
Balance at January 1, 2002
   $ 70,189     $ 63,011     $ (7,589 )   $ (6,172 )   $ 20,939  
Comprehensive income:
                                        
 
Net income
     4,354                               4,354  
 
Other comprehensive income:
                                        
   
Change in unrealized gain (loss) on securities, net taxes of $6,292
    12,183                       12,183          
   
Change in foreign currency translation
     2,246                       2,246          
 
    
                                 
     
Other comprehensive income
     14,429                                  
 
    
                                 
     
Comprehensive income
     18,783                                  
 
Issuance of common stock and warrants
     837       837                          
 
Exercise of common stock options
     (251 )     (251 )                        
 
Purchase of treasury stock
     (5 )             (5 )                
 
    
     
     
     
     
 
Balance at September 30, 2002
   $ 89,553     $ 63,597     $ (7,594 )   $ 8,257     $ 25,293  
 
    
     
     
     
     
 

See accompanying notes to consolidated financial statements

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CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited, Dollars in Thousands)

                     
        Nine Months Ended
        September 30
       
        2002   2001
       
 
Operating Activities
                
Net income
   $ 4,354     $ 3,958  
Net income from discontinued operations
     (1,068 )     (1,680 )
Gain from the sale of discontinued operations
     (12,495 )     —  
Adjustments to reconcile net income to net cash provided by operating activities:
                
 
Amortization of deferred acquisition costs
     14,725       4,703  
 
Deferral of acquisition costs
     (50,487 )     (27,026 )
 
Deferred federal income taxes
     (9,297 )     896  
 
Depreciation and amortization
     1,121       2,409  
 
Insurance policy liabilities
     43,203       13,824  
 
Net realized investment losses
     12,570       3,775  
 
Accrued investment income
     (2,802 )     (1,333 )
 
Other
     1,065       2,080  
 
    
     
 
   
Net cash provided by operating activities
     889       1,606  
 
    
     
 
Investing Activities
                
Fixed maturity securities available for sale:
                
 
Purchases
     (1,310,081 )     (393,792 )
 
Sales
     871,118       200,543  
 
Maturities, calls and redemptions
     69,458       61,979  
Short-term investments, net
     6,477       (7,989 )
Other investments, net
     (2,201 )     (2,907 )
 
    
     
 
   
Net cash used by investing activities
     (365,229 )     (142,166 )
 
    
     
 
Financing Activities
                
Proceeds from the sale of discontinued operations
     25,690       —  
Net proceeds from issuance of trust preferred securities
     —       19,318  
Repayments on notes payable and mortgage payable
     (4,454 )     (11,500 )
Redemption of preferred stock
     —       (6,530 )
Premiums received on interest-sensitive and other financial products credited to policyholder account balances
     448,197       225,850  
Return of policyholder account balances on interest-sensitive annuities and other financial products
     (97,935 )     (77,069 )
Issuance of common stock and warrants
     530       90  
Dividends on preferred stock
     —       (318 )
 
    
     
 
 
Net cash provided by financing activities
     372,028       149,841  
 
    
     
 
Net increase in cash
     7,688       9,281  
Cash at beginning of period
     18,144       1,840  
 
    
     
 
Cash at end of period
   $ 25,832     $ 11,121  
 
    
     
 

See accompanying notes to consolidated financial statements.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

     The following notes should be read along with the notes to the consolidated financial statements included in the 2001 Form 10-K of Standard Management Corporation, (“we”, “our”, “Standard Management” or the “Company”).

     Standard Management is a financial services holding company that develops, markets and/or administers, through several subsidiaries, annuity and life insurance products domestically and unit-linked assurance products, which are investment products with a nominal death benefit, internationally.

Note 1 — Basis of Presentation

     Our unaudited, consolidated financial statements reflect normal recurring adjustments that are necessary to present fairly our financial position and results of operations on a basis consistent with that of our prior audited consolidated financial statements. As permitted by rules and regulations of the Securities and Exchange Commission applicable to quarterly reports on Form 10-Q, we have condensed or omitted certain information and disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles (“GAAP”). We have also reclassified certain amounts from the prior periods to conform to the 2002 presentation. These reclassifications have no effect on net income or shareholders’ equity. Results for interim periods are not necessarily indicative of the results that may be expected for a full year.

     The nature of the insurance business requires us to make estimates and assumptions that affect the amounts reported in our consolidated financial statements and accompanying notes. For example, we use significant estimates and assumptions in calculating deferred policy acquisition costs, present value of future profits, goodwill, future policy benefits and deferred federal income taxes. If future experience differs from these estimates and assumptions, our financial statements could be materially affected.

Recently Issued Professional Accounting Standards

     In June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”). SFAS 142 is effective for fiscal years beginning after December 15, 2001. Under the new rules, goodwill and indefinite lived intangible assets are no longer amortized, but are subject to impairment tests conducted at least annually in accordance with the new standard. Intangible assets that do not have indefinite lives continue to be amortized over their estimated useful lives. We adopted SFAS 142 on January 1, 2002.

     Goodwill is tested for impairment using a two step process prescribed in SFAS 142. The first step is a screen for potential impairment, while the second step measures the amount of the impairment, if any. In compliance with the transition provision of SFAS 142, we completed the first step of the transitional goodwill impairment test during the second quarter of 2002. A discounted cash flow model was used to assess the goodwill of the reporting units. The results indicate it is likely that a portion of the goodwill related to the domestic insurance operations will be impaired using the impairment test required by SFAS 142. An impairment that is required to be recognized will be reflected as the cumulative effect of a change in accounting principle. We have not yet determined the amount of the potential impairment loss.

     For the three months ended September 30, 2001, on a SFAS 142 comparable basis, our net income, basic net income per share and diluted net income per share would have been $.4 million, $.05 and $.05, which includes the elimination of amortization of $.1 million or $.01 per share.

     For the nine months ended September 30, 2001, on a SFAS 142 comparable basis, our net income, basic net income per share and diluted net income per share would have been $4.5 million, $.59 and $.54, respectively, which includes the elimination of amortization of $.2 million or $.01 per share.

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Note 2 — International Operations

     On May 24, 2002, we signed an agreement to sell 100% of the shares of Premier Life (Luxembourg) S.A. and the portfolio of Premier’s business in Bermuda (collectively our International Operations) to Winterthur Life, a division of Credit Suisse Group for a sale price of approximately $27.7 million (the “Transaction”). The sales price was determined through arms-length negotiations.

     On August 14, 2002, we closed the sale of our Bermuda business and received net proceeds of $8.2 million. We recorded a gain on sale, net of related costs, of $4.2 million in our second quarter 2002 financial statements. In connection with this closing, a purchase price disagreement of $1.0 million exists related to the assets which remain supporting our Bermuda shareholder’s equity. We are vigorously contesting the disagreement and anticipate a favorable outcome.

     On September 17, 2002, we closed the sale of Premier Life (Luxembourg) S.A. and received net proceeds of $16.7 million. We recorded a gain on sale, net of related costs, of $8.3 million in our third quarter 2002 financial statements.

     The disposition of our international operations segment represents a disposal of a segment under SFAS 144, Accounting for the Impairment and Disposal of Long-Lived Assets. Accordingly, the revenues, costs and expenses, assets and liabilities, and cash flows of this segment have been segregated in the Consolidated Balance Sheets, Consolidated Statements of Income and Consolidated Statements of Cash Flows.

Note 3 — Mortgage Payable, Notes Payable and Trust Preferred Securities

     Our mortgage payable, notes payable and trust preferred securities were as follows (dollars in thousands):

                           
      Interest   September 30   December 31
      Rate   2002   2001
     
 
 
Mortgage payable
     7.38 %   $ 6,796     $ 6,900  
 
            
     
 
Notes payable:
                        
 
Borrowings under revolving credit agreements
     5.05 %(1)   $ 3,750     $ 8,100  
 
Senior subordinated notes
     10.00 %     11,000       11,000  
 
            
     
 
 
           $ 14,750     $ 19,100  
 
            
     
 
Trust preferred securities
     10.25 %   $ 20,700     $ 20,700  
 
            
     
 

(1)   Current weighted average rate at September 30, 2002.

Note 4 — Net Unrealized Gain (Loss) on Securities Available for Sale

     The components of unrealized gain (loss) on securities available for sale in shareholders’ equity are summarized as follows (in thousands):

                     
        September 30   December 31
        2002   2001
       
 
Fair value of securities available for sale
   $ 1,306,226     $ 920,944  
Amortized cost of securities available for sale
     1,285,957       930,831  
 
    
     
 
   
Gross unrealized gain (loss) on securities available for sale
     20,269       (9,887 )
Adjustments for:
                
 
Deferred policy acquisition costs
     (4,924 )     2,468  
 
Present value of future profits
     (2,876 )     1,410  
 
Deferred federal income taxes
     (4,212 )     2,080  
 
    
     
 
   
Net unrealized gain (loss) on securities available for sale
   $ 8,257     $ (3,929 )
 
    
     
 

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Note 5 — Earnings Per Share

     A reconciliation of income and shares used to calculate basic and diluted earnings per share is as follows (dollars in thousands):

                                   
      Three Months Ended   Nine Months Ended
      September 30   September 30
     
 
      2002   2001   2002   2001
     
 
 
 
Income (loss):
                                
Income (loss) from continuing operations before income taxes
   $ (9,844 )   $ (653 )   $ (17,848 )   $ 2,647  
Federal income taxes expense (benefits)
     (3,007 )     (375 )     (8,639 )     51  
 
    
     
     
     
 
Income (loss) from continuing operations
     (6,837 )     (278 )     (9,209 )     2,596  
Discontinued operations:
                                
 
Income from discontinued operations (less taxes of $0, $319, $550 and $865, respectively)
     —       619       1,068       1,680  
 
Gain from the sale of discontinued operations (less taxes of $1,764 and $3,933, respectively)
     8,285       —       12,495       —  
 
    
     
     
     
 
Total discontinued operations
     8,285       619       13,563       1,680  
 
    
     
     
     
 
Net income
     1,448       341       4,354       4,276  
Preferred stock dividends
     —       (65 )     —       (318 )
 
    
     
     
     
 
Earnings available to common shareholders
   $ 1,448     $ 276     $ 4,354     $ 3,958  
 
    
     
     
     
 
Shares:
                                
Weighted average shares outstanding for basic earnings per share
     7,613,479       7,545,156       7,611,629       7,545,156  
Effect of dilutive securities:
                                
 
Stock options
     196,003       166,180       197,369       81,676  
 
Stock warrants
     215,997       218,065       210,335       133,802  
 
Preferred stock
     —       —       —       512,157  
 
    
     
     
     
 
 
Dilutive potential common shares
     412,000       384,245       407,704       727,635  
 
    
     
     
     
 
Weighted average shares outstanding for diluted earnings per share
     8,025,479       7,929,401       8,019,333       8,272,791  
 
    
     
     
     
 

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

General

     The following discussion highlights the material factors affecting the results of operations and the significant changes in balance sheet items. Notes to the consolidated financial statements included in this report and the notes to the consolidated financial statements included in our Form 10-K for the year ended December 31, 2001 should be read in conjunction with both sets of consolidated financial statements.

Comparison of the Three Month and Nine Month Periods Ended September 30, 2002 and September 30, 2001:

     The following tables and narratives summarize the results of operations by operating segment (dollars in thousands):

                                     
        Three Months Ended   Nine months Ended
        September 30   September 30
       
 
        2002   2001   2002   2001
       
 
 
 
Operating income (loss) before income taxes:
                                
 
Operating income (loss) from continuing operations
   $ (7,732 )   $ 1,396     $ (6,838 )   $ 4,752  
 
Taxes (benefits) related to operating income from continuing operations
     (2,630 )     29       (5,236 )     365  
 
    
     
     
     
 
   
Operating income after taxes (benefits) from continuing operations
     (5,102 )     1,367       (1,602 )     4,387  
 
    
     
     
     
 
 
Consolidated realized investment losses before tax benefits
     (2,112 )     (2,049 )     (11,010 )     (2,105 )
 
Tax benefits related to realized investment losses
     (377 )     (404 )     (3,403 )     (314 )
 
    
     
     
     
 
   
Consolidated realized investment losses after tax benefits
     (1,735 )     (1,645 )     (7,607 )     (1,791 )
 
    
     
     
     
 
   
Income (loss) from continuing operations
   $ (6,837 )   $ (278 )   $ (9,209 )   $ 2,596  
Discontinued operations:
                                
 
Operating income from discontinued operations (less taxes of $0, $319, $550, and $865, respectively)
     —       619       1,068       1,680  
 
Gain from the sale of discontinued operations (less taxes of $1,764 and $3,933, respectively)
     8,285       —       12,495       —  
 
    
     
     
     
 
   
Total discontinued operations
     8,285       619       13,563       1,680  
 
    
     
     
     
 
   
Net income
   $ 1,448     $ 341     $ 4,354     $ 4,276  
 
    
     
     
     
 

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Consolidated Results and Analysis:

Quarterly analysis:

Net income for the third quarter of 2002 was $1.4 million, or $.18 per diluted share compared to $.3 million or $.04 per diluted share in the third quarter 2001. Positively impacting net income per diluted share was the sale of Premier Life (Luxembourg) S.A. resulting in a net gain of $1.03. Negatively impacting net income per diluted share was $.64 from the accelerated amortization of deferred acquisition costs on fixed annuity products, $.06 associated with the write off and legal costs related to the recovery of an agency receivable balance, $.05 of operating expenses associated with the costs of new marketing initiatives, and $.04 from FAS 133 adjustment related to declining treasury yields. The third quarter 2001 results were positively affected by $.06 per diluted share due to a lower effective tax rate resulting from the utilization of net operating loss carryforwards.

Domestic Operations (Continuing Operations) dollars in thousands:

                                     
        Three Months Ended   Nine Months Ended
        September 30   September 30
       
 
        2002   2001   2002   2001
       
 
 
 
Premiums and Deposits Collected:
                                
 
Traditional life
   $ 1,732     $ 2,538     $ 5,955     $ 7,626  
 
    
     
     
     
 
 
Deferred annuities
     76,478       49,022       247,475       118,787  
 
Single premium immediate annuities and other deposits
     33,352       23,909       114,562       57,540  
 
Equity-indexed annuities
     31,190       16,034       85,697       49,055  
 
Universal and interest-sensitive life
     151       152       453       468  
 
    
     
     
     
 
   
Subtotal — interest sensitive and other financial products
     141,171       89,117       448,187       225,850  
 
    
     
     
     
 
 
Total premiums and deposits collected
   $ 142,903     $ 91,655     $ 454,142     $ 233,476  
 
    
     
     
     
 
Statement of Operations:
                                
Premium income
   $ 1,732     $ 2,538     $ 5,955     $ 7,626  
Policy income
     2,139       1,810       5,862       5,785  
 
    
     
     
     
 
 
Total policy related income
     3,871       4,348       11,817       13,411  
Net investment income
     19,785       14,977       55,429       42,605  
Call option losses
     (3,049 )     (3,257 )     (10,040 )     (6,394 )
Fees and other income
     392       2,096       2,100       5,556  
 
    
     
     
     
 
 
Total revenues
     20,999       18,164       59,306       55,178  
Benefits and claims
     2,577       3,519       7,351       9,993  
Interest credited to interest sensitive annuities and other financial products
     11,009       7,462       29,142       20,315  
Amortization
     9,885       1,221       16,013       6,189  
Commission expenses
     156       906       1,188       2,880  
Other operating expenses
     4,002       2,777       9,114       8,606  
Interest expense and financing costs
     1,102       883       3,336       2,443  
 
    
     
     
     
 
 
Total benefits and expenses
     28,731       16,768       66,144       50,426  
 
    
     
     
     
 
 
Operating income (loss) before income taxes
     (7,732 )     1,396       (6,838 )     4,752  
Net realized investment losses, net of related costs
     (2,112 )     (2,049 )     (11,010 )     (2,105 )
 
    
     
     
     
 
 
Income (loss) before income taxes
   $ (9,844 )   $ (653 )   $ (17,848 )   $ 2,647  
 
    
     
     
     
 

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General: Our domestic operations (continuing operations) segment consists of revenues earned and expenses incurred from our United States operations. Our domestic products include deferred annuities, single premium immediate annuities and equity-indexed annuities. The profitability of this segment is primarily a function of net investment spread (the difference between the investment income earned on our investments less the interest we credit to our policyholders), persistency of our in force business, mortality experience and management of our operating expenses.

Quarterly analysis compares the three month period ending September 30, 2002 to the three month period ending September 30, 2001.

Year-to-date analysis compares the nine month period ending September 30, 2002 to the nine month period ending September 30, 2001.

Premium deposits consist of deposits from our deferred annuities, single premium immediate annuities, equity-indexed annuities, and other financial products that do not incorporate significant mortality features. For GAAP, these premium deposits are not shown as premium income in the income statement. A change in premium deposits in a single period does not directly cause our operating income to change, although continued increases or decreases in premiums may affect the growth rate of assets on which investment spreads are earned.

Quarterly analysis:

•   Premium deposits for the third quarter of 2002 increased $52.1 million or 58%, to $141.2 million, compared to the same period in 2001. Deferred annuity deposits increased $27.5 million or 56%, to $76.5 million. Single premium immediate annuity deposits increased $9.4 million or 39%, to $33.4 million. Equity-indexed annuities increased $15.2 million or 95%, to $31.2 million.

Year-to-date analysis:

•   Premium deposits for the first nine months of 2002 increased $222.3 million or 98%, to $448.2 million, compared to the same period in 2001. Deferred annuity deposits increased $128.7 million or 108%, to $247.5 million. Single premium immediate annuity deposits increased $57.0 million or 99%, to $114.6 million. Equity-indexed annuities increased $36.6 million or 75%, to $85.7 million.
 
    Premium deposits increased in the 2002 period primarily due to an expanded distribution force, an enhanced product portfolio, and increased industry wide fixed annuity sales.

Premium income consists of premiums earned from 1) traditional life products and 2) annuity products that incorporate significant mortality features.

Quarterly analysis:

•   Premium income for the third quarter of 2002 decreased by $.8 million or 32%, to $1.7 million compared to the same period in 2001.

Year-to-date analysis:

•   Premium income for the first nine months of 2002 decreased $1.7 million or 22%, to $6.0 million compared to the same period in 2001.
 
    Premium income in 2002 declined because effective August 2001, we suspended the active marketing of our life products indefinitely. We continue, however, to manage our existing life insurance business, which includes renewal premiums.

Policy income represents 1) mortality income and administrative fees earned on universal life products and 2) surrender income earned on terminated universal life and annuity policies.

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Quarterly analysis:

•   Policy income, in the third quarter of 2002, increased $.3 million or 18%, to $2.1 million compared to the same period in 2001.

Year-to-date analysis:

•   Policy income for the first nine months of 2002 increased $.1 million or 1%, to $5.9 million compared to the same period in 2001.
 
    The increase in policy income is primarily due to additional surrender income in the quarterly and year-to-date periods.

Net investment income includes interest earned on invested assets which fluctuates with changes in 1) the amount of average invested assets supporting insurance liabilities and 2) the average yield earned on those invested assets.

Quarterly analysis:

•   Net investment income for the third quarter of 2002 increased by $4.8 million or 32%, to $19.8 million compared to the same period in 2001. Net investment income increased as a result of a $386.2 million or 44% increase in weighted average invested assets for the period.
 
•   The net investment yields earned on average invested assets were 6.28% and 6.97% for the third quarter of 2002 and 2001, respectively.

Year-to-date analysis:

•   Net investment income for the first nine months of 2002 increased $12.8 million or 30%, to $55.4 million compared to the same period in 2001. Net investment income increased as a result of a $317.3 million or 39% increase in weighted average invested assets for the period.
 
•   The net investment yields earned on average invested assets were 6.54% and 6.98% for the first nine months of 2002 and 2001, respectively.
 
    Net investment income for 2002 was unfavorably impacted from defaulted bonds and lower earned rates on current year investment purchases.

Call option losses relate to equity-indexed products that are hedged with call options to limit risk against unusually high crediting rates from favorable returns in the equity market. The market value of these options fluctuate from period to period and are substantially offset by amounts credited to policyholder account balances.

Quarterly analysis:

•   Call option losses for the third quarter of 2002 decreased by $.2 million to $3.0 million compared to the same period in 2001.

Year-to-date analysis:

•   Call option losses for the first nine months of 2002 increased by $3.6 million to $10.0 million compared to the same period in 2001.
 
    Call option losses in 2002 were due to a decline in the market value of our call options as a result of changes in the S & P 500 Index.

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See also “Interest credited to interest sensitive annuities and other financial products” for information regarding the impact of our equity-indexed products.

Fees and other income consist of fee income related to servicing unaffiliated blocks of business, experience refunds and commission income.

Quarterly analysis:

•   Fees and other income in the third quarter of 2002 decreased $1.7 million or 81%, to $.4 million. This decrease includes a decline of $1.3 million in commission income.

Year-to-date analysis:

•   Fees and other income for the first nine months of 2002 decreased $3.5 million or 62%, to $2.1 million. This decrease includes a decline of $2.6 million in commission income.
 
    The decline in commission income in 2002 was due to the termination of a marketing and administration contract. This decrease is substantially offset by a decline in related commission expense.

Benefits and claims include 1) mortality experience, 2) benefits from other policies that incorporate significant mortality features and 3) changes in future policy reserves. Throughout our history, we have experienced periods of higher and lower benefit claims. This volatility is not uncommon in the life insurance industry and, over extended periods of time, periods of higher claims experience tend to offset periods of lower claim experience.

Quarterly analysis:

•   Benefits and claims for the third quarter of 2002 decreased $.9 million or 27%, to $2.6 million compared to the same period in 2001.

Year-to-date analysis:

•   Benefits and claims for the first nine months of 2002 decreased $2.6 million or 26%, to $7.4 million compared to the same period in 2001.
 
    Benefits and claims declined in 2002 due to favorable mortality experience, and less traditional life business from our decision to suspend active marketing of life products.

Interest credited to interest sensitive annuities and other financial products represents interest credited to insurance liabilities of the deferred annuities, single premium immediate annuities, equity-indexed annuities and other financial products. This expense fluctuates with changes in 1) the average interest-sensitive insurance liabilities, 2) the average credited rate on those liabilities and 3) the market value fluctuations of call options.

Quarterly analysis:

•   During the third quarter of 2002, interest credited increased $3.5 million to $11.0 million, an increase of 48% compared to the same period in 2001. This increase is primarily due to a 53%, or $439.5 million, increase in average interest sensitive liabilities offset by a decrease in weighted average credited rates from 5.39% to 4.52%.
 
    In addition to these items, credited interest on equity-indexed products increased by $.6 million as a result of equity market improvements, offset by a $.5 million decrease in the reserve for future equity benefits.

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Year-to-date analysis:

•   During the first nine months of 2002, interest credited increased $8.8 million to $29.1 million, an increase of 43% compared to the same period in 2001. This increase is primarily due to a 43%, or $324.0 million, increase in average interest sensitive liabilities, offset by a decrease in weighted average credited rates from 5.31% to 4.86%.
 
    In addition to these items, credited interest on equity-indexed products increased $2.5 million as a result of equity market improvements.

Amortization includes 1) amortization related to the present value of our policies purchased from our acquired insurance business, 2) amortization of deferred acquisition costs (“DAC”) related to capitalized costs of our insurance business sold, and 3) amortization of goodwill for the 2001 period.

Quarterly analysis:

•   Amortization for the third quarter of 2002 was $10.0 million, an increase of $8.7 million compared to the same period in 2001. This increase primarily relates to a $7.8 million acceleration of DAC amortization due to DAC unlocking.

Year-to-date analysis:

•   Amortization for the first nine months of 2002 was $16.0 million, an increase of $9.8 million compared to the same period in 2001. This increase reflects a $2.0 million increase from the recognition of additional gross profits from increased sales of annuity products during recent periods and a $7.8 million increase related to DAC unlocking.
 
    Acquisition costs for deferred annuity contracts and equity indexed annuity contracts are required to be amortized over the lives of the contracts in relation to the incidence of estimated gross profits. Estimated gross profits on fixed and equity indexed annuity contracts include investment spread, surrender income, expense margins, and realized investment gains/losses. Gross profit estimates are evaluated regularly, with historical gross profit estimates adjusted to actual results and projected gross profit estimates updated to reflect current expectations. DAC amortization is adjusted both retrospectively and prospectively (“unlocked”) in accordance with the revised profit stream, and retrospective adjustments are reported in the current reporting period. DAC unlocking in the current period created a charge to earnings of $7.8 million.

Commission expenses represent commission expenses, net of deferrable amounts.

Quarterly analysis:

•   Commission expenses decreased $.7 million to $.2 million.

Year-to-date analysis:

•   Commission expenses decreased by $1.7 million to $1.2 million.
 
    Commission expenses declined in 2002 due to the termination of a marketing and administration contract in 2002.

Other operating expenses consist of general operating expenses, including salaries, net of deferrable amounts.

Quarterly analysis:

•   Other operating expenses for the third quarter of 2002 increased $1.2 million to $4.0 million compared to the same period in 2001.

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Year-to-date analysis:

•   Other operating expenses for the first nine months of 2002 increased $.5 million to $9.1 million compared to the same period in 2001.

The increase in other operating expenses is primarily due to increased legal expenses, costs associated with new marketing initiatives, and the elimination of management fees from our international operations.

Interest expense and financing costs represents interest expense incurred and the amortization of related debt issuance costs.

Quarterly analysis:

•   Interest expense and financing costs increased by $.2 million or 25%, to $1.1 million for the third quarter of 2002 compared to the same period for 2001. Average borrowings increased $11.5 million to $46.0 million in the 2002 period and included the impact of our trust preferred offering and our mortgage payable.
 
    The interest rate incurred on average borrowings were 9.58% and 10.25% for the third quarter of 2002 and 2001, respectively.

Year-to-date analysis:

•   Interest expense and financing costs increased by $.9 million or 37%, to $3.3 million. Average borrowings increased $15.3 million to $46.2 million in the 2002 period and included the impact of our trust preferred offering and our mortgage payable.
 
    The interest rate incurred on average borrowings were 9.64% and 10.56% for the first nine months of 2002 and 2001, respectively.

Net realized investment losses, net of related costs fluctuate from period to period and generally arise when securities are sold in response to changes in the investment environment. Realized investment losses can affect the timing of the amortization of deferred acquisition costs and the present value of future profits.

Quarterly analysis:

•   Net realized investment losses, net of related costs were $2.1 million in the third quarter of 2002 and included portfolio write-downs of $5.0 million of corporate bonds. These write-downs were partially offset by net realized gains from the sale of corporate and agency bonds, and amortization of $1.6 million.

Year-to-date analysis:

•   Net realized investment losses, net of related costs were $11.0 million in the first nine months of 2002, and included portfolio write-downs of $12.7 million of corporate bonds and collateral bond obligations offset by net realized gains from the sale of corporate and agency bonds, and amortization of $1.6 million.
 
    Approximately 96% of our fixed maturity securities are classified as investment grade at September 30, 2002.

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International Operations (Discontinued Operations) dollars in thousands:

                                     
        Three Months Ended   Nine Months Ended
        September 30   September 30
       
 
        2002   2001   2002   2001
       
 
 
 
Premiums and Deposits Collected:
                                
 
Traditional life
   $ —     $ 25     $ 18     $ 146  
 
Separate account deposits
     —       8,047       32,384       61,888  
 
    
     
     
     
 
   
Total premiums and deposits collected
   $ —     $ 8,072     $ 32,402     $ 62,034  
 
    
     
     
     
 
Statement of Operations:
                                
Premium income
   $ —     $ 25     $ 18     $ 146  
Net investment income
     —       138       103       418  
Separate account fees
     —       2,474       3,569       6,728  
 
    
     
     
     
 
   
Total revenues
     —       2,637       3,690       7,292  
Benefits and claims
     —       9       (186 )     (59 )
Amortization
     —       853       272       2,017  
Commission expenses
     —       (25 )     97       46  
Other operating expenses
     —       863       1,889       2,743  
 
    
     
     
     
 
   
Total benefits and expenses
     —       1,700       2,072       4,747  
 
    
     
     
     
 
   
Income before income taxes
   $ —     $ 937     $ 1,618     $ 2,545  
 
    
     
     
     
 

General: Our international operations (discontinued operations) include revenues earned and expenses incurred from abroad, primarily Europe, and include fees collected on our deposits from unit-linked assurance products. The profitability of this segment primarily depends on the amount of separate account assets under management, the management fee charged on those assets and management of our operating expenses.

Quarterly analysis generally compares the three month period ending September 30, 2002 to the three month period ending September 30, 2001, however, effective September 17, 2002 we concluded the sale of our international operations. In accordance with the sale agreement we do not reflect international operation activity in our financial statements subsequent to June 30, 2002. Therefore, quarterly analysis is not applicable for the three months ended September 30, 2002.

Year-to-date analysis compares the six month period ending September 30, 2002 to the nine month period ending September 30, 2001. Explanations provided include substantive information regarding our international operations and reflect six months of activity in the 2002 period compared to nine months of activity in the 2001 period.

Separate account deposits consist of deposits from our unit-linked assurance products. For GAAP these separate account deposits are not shown as premium income in the income statement. A change in separate account deposits in a single period does not directly cause our operating income to change, although continued increases or decreases in separate account deposits may affect the growth rate of separate account assets on which fees are earned.

Year-to-date analysis:

•   Separate account deposits for the 2002 period, decreased $29.5 million or 48%, to $32.4 million compared to the same period in 2001.

The decrease in deposits in 2002 is primarily due to the volatile global equity environment.

Net investment income represents income earned on our corporate assets such as cash, short-term investments and fixed securities. Standard Management International is required to hold a certain level of cash and short-term investments in order to comply with local insurance laws.

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Year-to-date analysis:

•   Net investment income for the 2002 period decreased $.3 million or 75%, to $.1 million compared to the same period in 2001. Corporate assets averaged $5.3 million and $13.3 million for the nine month period ending September 30, 2002 and 2001, respectively.
 
•   The net investment yields earned on average invested assets were 2.58% and 4.27% for the 2002 and 2001 periods, respectively.

Corporate assets consist primarily of cash and short-term investments.

Fees from separate accounts represent the net fees earned on our unit-linked assurance products. The fees include asset based administrative fees, premium based administrative fees and the amortization of front end loads (deferred revenue) into income. Asset based fees fluctuate in relation to separate account assets, and premium based fees fluctuate in relation to premium collections for certain products. Deferred revenue amortization fluctuates subject to mandated amortization rules.

Year-to-date analysis:

•   Fees from separate accounts for the 2002 period decreased $3.2 million or 47%, to $3.6 million compared to the same period in 2001. Average separate account assets decreased $192.5 million or 41% to $280.2 million. Fees were unfavorably impacted by $.7 million due to changes in the value of foreign currencies relative to the United States dollar.

Amortization includes the amortization of deferred acquisition costs, such as sales commissions and other costs, directly related to selling new business and foreign exchange translation.

Year-to-date analysis:

•   Amortization for the 2002 period decreased $1.7 million or 87%, to $.3 million compared to the same period in 2001. This decrease is partially related to the favorable impact of $.8 million from changes in the value of foreign currencies relative to the United States dollar. Excluding the impact of foreign currencies, amortization decreased $.9 million in the 2002 period primarily due to less fees from separate accounts.

Commission expenses represent commission expenses, net of deferrable amounts.

Year-to-date analysis:

•   Commission expenses were $97 thousand and $46 thousand for the 2002 and 2001 periods, respectively.

Due to the nature of our business, most incurred commissions are deferred.

Other operating expenses consist of general operating expenses, including salaries, net of deferrable amounts.

Year-to-date analysis:

•   Other operating expenses were $1.9 million and $2.8 million for the 2002 and 2001 periods, respectively.

Foreign currency translation comparisons between 2002 and 2001 are impacted by the strengthening and weakening of the United States dollar relative to foreign currencies, primarily the Euro. The impact of these translations has been quantified on fees from separate accounts and amortization.

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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 our subsidiaries. These payments have included 1) surplus debenture interest, 2) dividends, 3) management fees, 4) equipment rental fees, 5) lease income and 6) allocation of taxes through a tax sharing agreement, all of which are subject to restrictions under applicable insurance laws and are used to pay our operating expenses and meet our debt service obligations. These internal sources of liquidity have been supplemented in the past by external sources such as revolving credit agreements and long-term debt and equity financing in the capital markets.

Potential Cash Available in 2002

     We anticipate that available cash from our existing working capital, surplus debenture interest, dividends, management fees, equipment rental fees and lease income will be more than adequate to meet our anticipated parent company cash requirements in 2002. The following describes our potential sources of cash in 2002.

     Surplus Debenture Interest. We loaned $27.0 million to Standard Life Insurance Company of Indiana (“Standard Life”) pursuant to unsecured surplus debenture agreements (“surplus debentures”) which requires Standard Life to make quarterly interest payments 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. We currently anticipate these quarterly approvals will be granted. Assuming the approvals are granted and the September 30, 2002 interest rate of 6.75% continues, we expect to receive interest income of $1.8 million from the surplus debentures in 2002.

     Dividends paid from Standard Life 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 1) net gain from operations or 2) 10% of surplus, in each case as shown in its preceding annual statutory financial statements. In 2001, we received dividends of $1.6 million and $.5 million from Standard Life and Savers Marketing, respectively. In 2002, we could receive dividends of approximately $4.4 million from Standard Life.

     Management Fees. Pursuant to a management services agreement, Standard Life paid $3.6 million during 2001 for certain management services related to the production of business, investment of assets and evaluation of acquisitions. In addition, Dixie National Life Insurance Company (“Dixie Life’) paid Standard Life $1.1 million in 2001, respectively, for certain management services provided. Both of these agreements provide that they may be modified or terminated by the applicable Departments of Insurance in the event of financial hardship of Standard Life or Dixie Life. In 2002, we expect to receive management fees of $3.6 million from Standard Life.

     Pursuant to the management services agreement, Premier Life (Luxembourg) paid $1.2 million during 2001 for certain management, technical support and administrative services. In 2002, we expect to receive management fees of $.4 million from Premier Life (Bermuda) and $.1 million from Premier Life (Luxembourg). These fees were terminated upon the sale of our international operations.

     Equipment Rental Fees. In 2001 we charged subsidiaries $1.1 million for the use of our equipment. In 2002, we expect to receive $1.1 million of equipment rental fees from Standard Life.

     Lease Income. Effective January 1, 2002, we entered into a lease agreement with Standard Life who leases approximately 43,000 square feet of our office space located at 10689 North Pennsylvania Street. In 2002, we expect to receive lease income of $.8 million from Standard Life.

     Tax Sharing Payments. Effective January 1, 2000 we entered into a tax sharing agreement with Savers Marketing Corporation (“Savers Marketing”) and Standard Management International S.àr.l. (“Standard Management International”) that allocates the consolidated federal income tax liability. During 2001, Savers Marketing and Standard Management International paid $.5 million and $.8 million, respectively, in accordance with this agreement. We do not expect tax sharing payments in 2002 to be material.

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Estimated Cash Required in 2002

     The following are the characteristics of our mortgage payable, notes payable and trust preferred securities, including estimated required payments in 2002.

     Mortgage Payable:

     The following are characteristics of our mortgage payable agreement at September 30, 2002:

•   outstanding balance of $6.8 million;
 
•   interest rate of 7.38% per annum;
 
•   principal and interest payments: $56 thousand per month through December 2011;
 
•   interest payments required in 2002 based on current balances will be $.5 million;
 
•   note may be prepaid on or before January 2005 at 105% and declining to 101% after December 2008.

     Notes Payable:

     The following are characteristics of our amended credit agreement at September 30, 2002:

•   outstanding balance of $3.75 million;
 
•   weighted average interest rate of 5.05%;
 
•   principal payments: $.6 million and $3.75 million paid in March 2002 and September 2002, respectively. The remaining principal payment of $3.75 million is due in August 2003.
 
•   subject to certain restrictions and financial and other covenants;
 
•   interest payments required in 2002 based on current balances will be $.3 million.

     The following are characteristics of our subordinated debt agreement at September 30, 2002:

•   outstanding balance of $11.0 million;
 
•   interest rate is greater of 1) 10% per annum or 2) six month London Inter-Bank Offered Rate (“LIBOR”) plus 1.5%;
 
•   due October 2007;
 
•   interest payments required in 2002 based on current balances will be $1.1 million.

     Trust Preferred Securities:

     The following are characteristics of our trust preferred securities at September 30, 2002:

•   outstanding balance of $20.7 million;
 
•   annual distribution rate of 10.25%; distributions may be deferred up to 20 consecutive quarters;
 
•   matures August 9, 2031;
 
•   may be redeemed on or after August 9, 2006 at $10 per security plus accumulated and unpaid distributions;
 
•   distributions required in 2002 based on current balances will be $2.1 million;
 
•   distributions are classified as interest expense.

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     General: On a consolidated basis we reported net cash provided by operations of $.9 million and $1.6 million for the first nine months of 2002 and 2001, respectively. At September 30, 2002, we had “parent company only” cash and short-term investments of $4.1 million which are available for general corporate purposes. Annual parent company operating expenses (not including interest expense) were $4.3 million and $4.5 million for 2001 and 2000, respectively.

Liquidity of Insurance Operations

     United States Insurance Operations (Continuing Operations). The principal liquidity requirements of Standard Life are its 1) contractual obligations to policyholders, 2) surplus debenture interest, dividends, management fees and rental fees to Standard Management and 3) 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 annuity products. These sources of liquidity for Standard Life significantly exceed scheduled uses. Liquidity is also affected by unscheduled benefit payments including death benefits, 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 rating and events in the industry that affect policyholders’ confidence.

     Certain 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 activity of its insurance products and manages the composition of its investment portfolios, including liquidity, to ensure it has sufficient cash resources in light of such activity.

     Changes in interest rates may affect our 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 our earnings if we were required to sell investments at reduced values to meet liquidity demands. We manage our asset and liability portfolios in order to minimize the adverse earnings effect of changing market interest rates. We seek assets that have duration characteristics similar to the liabilities that they support. We also prepare cash flow projections and perform cash flow tests under various market interest rate scenarios to assist in evaluating liquidity needs and adequacy. Our United States 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 National Association of Insurance Commissioners as modified by the Indiana Department of Insurance, or the state in which our 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: 1) acquisition costs (primarily commissions and policy issue costs) and 2) 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 or surplus strain in the year written for many insurance products. We design our products to minimize such first-year losses, but certain products continue to cause a statutory loss in the year written. For each product, we control the amount of net new premiums written to manage the effect of such surplus strain. Our long-term growth goals contemplate continued growth in our insurance businesses. To achieve these growth goals, our United States insurance subsidiaries will need to increase statutory surplus. Additional statutory surplus may be secured through various sources such as internally generated statutory earnings, infusions with funds generated through our debt or equity offerings, or mergers with other life insurance companies. If additional capital is not available from one or more of these sources, we believe that we could reduce surplus strain through the use of reinsurance or through reduced writing of new business.

     We believe that the operational cash flow of Standard Life will be sufficient to meet our anticipated needs for 2002. As of September 30, 2002, Standard Life had statutory capital and surplus for regulatory purposes of $57.8 million. As the annuity business produced by Standard Life increases, Standard Life expects to satisfy statutory capital and surplus requirements through statutory profits 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 $335.7 million and $149.2 million for the first nine months of 2002 and 2001, respectively. If the need arises for cash, which is not readily available, additional liquidity could be obtained from the sale of invested assets.

International Operations (Discontinued Operations). Standard Management International and Premier Life (Luxembourg) were not permitted to pay dividends in 2001 due to accumulated losses.

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Forward-looking Statements

     All statements, trend analyses, and other information contained in this quarterly report on Form 10-Q or any document incorporated by reference herein relative to markets for our products and trends in our 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:

•   general economic conditions and other factors, including prevailing interest rate levels, stock market performance which may affect the ability to sell our products, the market value of our investments and the lapse rate and profitability of our policies;
 
•   customer response to new products, distribution channels and marketing initiatives;
 
•   mortality, morbidity and other factors which may affect the profitability of our insurance products;
 
•   changes in the Federal income tax laws and regulation which may affect the relative tax advantages of some of our products;
 
•   increasing competition in the sale of our products;
 
•   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;
 
•   the availability and terms of future acquisitions; and
 
•   the risk factors or uncertainties listed from time to time in any document incorporated by reference herein.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     Our market risks and the way they are managed are summarized in our discussion and analysis of financial condition and results of operations in our December 31, 2001 Form 10-K. There have been no material changes in 2002 to these risks or the management of these risks.

ITEM 4. CONTROLS AND PROCEDURES

     Our Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-4c under the Securities Exchange Act of 1934) as of a date within 90 days of the filing date of this Quarterly Report on Form 10-Q (the “Evaluation Date”). They have concluded that, as of the Evaluation Date, our disclosure controls and procedures were adequate and effective. There were no significant changes in our internal controls or in other factors that could significantly affect disclosure controls and procedures subsequent to the Evaluation Date.

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PART II. OTHER INFORMATION

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.

(a)  Exhibits

     
99.1   Certification of Chief Executive Officer, pursuant to 18 U.S.C. Section 1350.
99.2   Certification of Chief Financial Officer, pursuant to 18 U.S.C. Section 1350.

(b)  Reports on Form 8-K

     On August 30, 2002, we filed a Current Report on Form 8-K reporting the unaudited pro forma consolidated balance sheet as of June 30, 2002, and the unaudited pro forma consolidated statements of income for the six month period ended June 30, 2002 and the year ended December 31, 2001 giving effect to the sale of our Bermuda operations to Winterthur Life, a division of Credit Suisse Group.

     On October 2, 2002 we filed a Current Report on Form 8-K reporting the unaudited pro forma consolidated balance sheet as of June 30, 2002, and the unaudited pro forma consolidated statements of income for the six month period ended June 30, 2002 and the year ended December 31, 2001, giving effect to the sale of our Premier Life (Luxembourg) S.A. business to Winterthur Life, a division of Credit Suisse Group.

SIGNATURES

     Pursuant to the requirements 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.

         
Dated: October 31, 2002        
         
    STANDARD MANAGEMENT CORPORATION
(Registrant)
 
    By:   /s/ RONALD D. HUNTER
       
        Ronald D. Hunter
Chairman of the Board and Chief Executive Officer
(Principal Executive Officer)
         
    By:   /s/ GERALD R. HOCHGESANG
       
        Gerald R. Hochgesang
Senior Vice President and Treasurer
(Chief Accounting Officer)

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CERTIFICATION

I, Ronald D. Hunter, certify that:

1.     I have reviewed this quarterly report on Form 10-Q of Standard Management Corporation;

2.     Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

3.     Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

4.     The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

  a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
 
  b) evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and
 
  c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5.     The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

  a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and
 
  b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

6.     The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Date: October 31, 2002

/s/ Ronald D. Hunter

Ronald D. Hunter
Chairman and Chief Executive Officer

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CERTIFICATION

I, Paul B. “Pete” Pheffer, certify that:

1.     I have reviewed this quarterly report on Form 10-Q of Standard Management Corporation;

2.     Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

3.     Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

4.     The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

  a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
 
  b) evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and
 
  c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5.     The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

  a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and
 
  b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

6.     The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Date: October 31, 2002

/s/Paul B. “Pete” Pheffer

Paul B. “Pete” Pheffer
President and Chief Financial Officer

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