<PAGE>
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.
----------------
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the Quarterly Period Ended March 31, 1999
or
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from to
Commission File Number: 1-14925
----------------
STANCORP FINANCIAL GROUP, INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C>
Oregon 93-1253576
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
</TABLE>
1100 SW Sixth Avenue, Portland, Oregon, 97204
(Address of principal executive offices)
(503) 321-7000
(Registrant's telephone number, including area code)
NONE
(Former name, former address, and former fiscal year, if changed since last
report)
----------------
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 [_] No [X]
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
As of May 28, 1999, there were 33,927,415 shares of the Registrant's common
stock, no par value, outstanding.
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
<PAGE>
INDEX
<TABLE>
<CAPTION>
Page
----
<C> <S> <C>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Unaudited Consolidated Statements of Income, Comprehensive Income
and Equity of Standard Insurance Company for the three months
ended March 31, 1999 and 1998................................... 1
Unaudited Consolidated Balance Sheets of Standard Insurance
Company at March 31, 1999 and December 31, 1998................. 2
Unaudited Consolidated Statements of Cash Flows of Standard
Insurance Company for the three months ended March 31, 1999 and
1998............................................................ 3
Notes to Unaudited Consolidated Financial Statements of Standard
Insurance Company............................................... 4
Independent Accountants' Report.................................. 10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS........................................... 11
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK....... 20
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS................................................ 21
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS........................ 21
ITEM 3. DEFAULTS UPON SENIOR DEBT........................................ 22
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.............. 22
ITEM 5. OTHER INFORMATION................................................ 22
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K................................. 22
SIGNATURES................................................................ 23
</TABLE>
i
<PAGE>
STANDARD INSURANCE COMPANY AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF INCOME,
COMPREHENSIVE INCOME AND EQUITY
(in millions)
<TABLE>
<CAPTION>
For the Three
Months Ended
March 31,
--------------
1999 1998
------ ------
<S> <C> <C>
Revenues:
Premiums...................................................... $238.6 $220.4
Net investment income......................................... 80.4 79.4
Net realized investment gains................................. 1.1 0.2
Other......................................................... 0.8 0.5
------ ------
Total....................................................... 320.9 300.5
------ ------
Benefits and expenses:
Policyholder benefits......................................... 205.4 198.5
Interest paid on policyholder funds........................... 21.3 23.0
Commissions................................................... 16.3 17.0
Operating expenses............................................ 46.4 42.0
Net increase in deferred policy acquisition costs............. (0.1) (2.2)
------ ------
Total....................................................... 289.3 278.3
------ ------
Income before Federal income taxes and extraordinary item....... 31.6 22.2
Federal income taxes............................................ 10.4 7.6
------ ------
Income before extraordinary item................................ 21.2 14.6
Extraordinary item, net of tax.................................. 2.3 0.3
------ ------
Net income...................................................... 18.9 14.3
------ ------
Other comprehensive income, net of tax:
Unrealized gains (losses) on securities available for sale.... (31.1) 0.6
Adjustment for realized gains................................. (2.0) (0.2)
------ ------
Total....................................................... (33.1) 0.4
------ ------
Comprehensive income (loss)..................................... (14.2) 14.7
Equity, beginning of period..................................... 839.3 732.0
------ ------
Equity, end of period........................................... $825.1 $746.7
====== ======
</TABLE>
See Notes to Unaudited Consolidated Financial Statements.
1
<PAGE>
STANDARD INSURANCE COMPANY AND SUBSIDIARIES
UNAUDITED CONSOLIDATED BALANCE SHEETS
(in millions)
<TABLE>
<CAPTION>
March 31, December 31,
1999 1998
--------- ------------
ASSETS
------
<S> <C> <C>
Investments:
Investment securities.................................. $2,258.4 $2,214.2
Mortgage loans......................................... 1,741.3 1,708.1
Real estate, net....................................... 90.8 93.0
Policy loans........................................... 111.9 111.0
Collateral loans....................................... 70.6 71.2
-------- --------
Total investments.................................... 4,273.0 4,197.5
Cash and cash equivalents................................ 25.0 60.4
Deferred policy acquisition costs........................ 116.5 114.9
Premiums and other receivables........................... 77.2 73.2
Federal income taxes receivable.......................... -- 8.4
Accrued investment income................................ 53.8 53.5
Property and equipment, net.............................. 65.3 65.9
Other assets............................................. 16.2 36.6
Separate account assets.................................. 719.8 668.5
-------- --------
Total.............................................. $5,346.8 $5,278.9
======== ========
LIABILITIES AND EQUITY
----------------------
Liabilities:
Future policy benefits and claims...................... $2,137.4 $2,088.9
Other policyholder funds............................... 1,430.4 1,455.5
Accrued Federal income taxes........................... 11.2 --
Deferred tax liabilities............................... 92.5 106.0
Other liabilities...................................... 130.4 120.7
Separate account liabilities........................... 719.8 668.5
-------- --------
Total liabilities.................................... 4,521.7 4,439.6
-------- --------
Commitments and Contingencies
Equity:
Retained earnings...................................... 784.0 765.1
Accumulated other comprehensive income................. 41.1 74.2
-------- --------
Total equity......................................... 825.1 839.3
-------- --------
Total.............................................. $5,346.8 $5,278.9
======== ========
</TABLE>
See Notes to Unaudited Consolidated Financial Statements.
2
<PAGE>
STANDARD INSURANCE COMPANY AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in millions)
<TABLE>
<CAPTION>
For the
Three Months Ended
March 31,
--------------------
1999 1998
--------- ---------
<S> <C> <C>
Operating:
Net income.............................................. $ 18.9 $ 14.3
Adjustments to reconcile net income to net cash provided
by operating activities:
Net realized investment gains......................... (1.1) (0.2)
Depreciation and amortization......................... 9.9 3.3
Deferral of policy acquisition costs.................. (5.4) (4.4)
Deferred income taxes................................. 4.4 (0.1)
Changes in other assets and liabilities:
Trading securities.................................... (7.2) --
Receivables and accrued investment income............. (4.3) (8.2)
Future policy benefits and claims..................... 48.6 55.6
Accrued Federal income taxes.......................... 19.6 7.8
Other, net............................................ 29.9 7.9
--------- --------
Net cash provided by operating activities........... 113.3 76.0
--------- --------
Investing:
Proceeds of investments sold, matured, or repaid:
Fixed maturity securities available for sale.......... 103.6 17.8
Mortgage loans........................................ 89.4 53.6
Other investments, net................................ 0.7 3.6
Costs of investments acquired:
Fixed maturity securities available for sale.......... (193.1) (50.2)
Mortgage loans........................................ (123.0) (99.8)
Net additions to property and equipment................. ( 1.2) (1.1)
--------- --------
Net cash used in investing activities............... (123.6) (76.1)
--------- --------
Financing:
Policyholder fund deposits.............................. 118.9 93.7
Policyholder fund withdrawals........................... (144.0) (91.1)
--------- --------
Net cash provided by (used in) financing
activities......................................... (25.1) 2.6
--------- --------
Increase (decrease) in cash and cash equivalents.......... (35.4) 2.5
Cash and cash equivalents, beginning of period............ 60.4 16.8
--------- --------
Cash and cash equivalents, end of period.................. $ 25.0 $ 19.3
========= ========
Supplemental disclosure of cash flow information:
Cash paid (refunded) during the period for:
Interest.............................................. $ 21.6 $ 23.1
Income taxes.......................................... (13.6) --
</TABLE>
See Notes to Unaudited Consolidated Financial Statements.
3
<PAGE>
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
1. Organization and Description of Business. On April 21, 1999, pursuant to
an order approving the Plan of Reorganization dated September 28, 1998, as
amended on December 14, 1998 (the "Plan"), by the Director of the Department
of Consumer and Business Services of the State of Oregon, Standard Insurance
Company ("Standard") converted from a mutual life insurance company to a stock
life insurance company and became a wholly owned subsidiary of StanCorp
Financial Group, Inc. ("StanCorp"), an Oregon corporation organized for the
purpose of becoming the parent holding company of Standard and its non-
insurance subsidiaries. Also, on April 21, 1999, StanCorp completed an initial
public offering (the "IPO") of approximately 15.2 million shares (including
approximately 1.3 million shares sold pursuant to the underwriters' over-
allotment option) of its common stock at the IPO price of $23.75 per share.
The shares of common stock issued in the IPO were in addition to approximately
18.7 million shares of StanCorp common stock distributed to Standard
policyholders, pursuant to the Plan, in exchange for their membership
interests in Standard.
StanCorp is the holding company parent of Standard and other non-insurance
subsidiaries. Standard primarily underwrites group and individual disability,
life and annuity products and group dental insurance. Standard is domiciled in
Oregon and licensed in 49 states, the District of Columbia and the US
Territory of Guam. Standard is licensed for reinsurance only in New York.
2. Significant Accounting Policies. The accompanying unaudited consolidated
financial statements of Standard and its subsidiaries (collectively, the
"Company") have been prepared in accordance with generally accepted accounting
principles ("GAAP") for interim financial information and in conformance with
the requirements of Form 10-Q. Accordingly, they do not include all of the
information and disclosures required by GAAP for complete financial
statements. The preparation of financial statements in conformity with GAAP
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosures of contingent assets and
liabilities at the financial statement date, and the reported amounts of
revenue and expenses during the period. Actual results may differ from those
estimates. In the opinion of management, the accompanying unaudited
consolidated financial statements contain all adjustments, consisting of
normal recurring accruals, considered necessary for a fair presentation of the
Company's financial condition as of March 31, 1999 and December 31, 1998 and
the results of operations and of cash flows for the three months ended March
31, 1999 and 1998. Interim results for the three months ended March 31, 1999
are not necessarily indicative of the results that may be expected for the
year ending December 31, 1999. This report should be read in conjunction with
the Company's 1998 Annual Report included in the Registration Statement
(Registration No. 333-72521) and Prospectus of StanCorp.
3. Recently Issued Pronouncements. Effective January 1, 1999, the Company
adopted Statement of Position ("SOP") 97-3, "Accounting by Insurance and Other
Enterprises for Insurance-Related Assessments", which established accounting
guidance for state mandated guaranty assessments. The adoption of SOP 97-3 did
not have a material impact on the Company's consolidated financial statements.
Effective January 1, 1999, the Company adopted SOP 98-1, "Accounting for the
Costs of Computer Software Developed or Obtained for Internal Use", which
established accounting requirements for the capitalization of software costs
incurred for the use of the organization. The adoption of SOP 98-1 did not
have a material impact on the Company's consolidated financial statements for
the three months ended March 31, 1999. Management estimates capitalization of
approximately $2.8 million in costs of computer software developed or obtained
for internal use will result in 1999. It is expected that the amortization
period for these costs will range from three to five years.
4
<PAGE>
4. Segments. The following table sets forth selected segment information for
the periods ended March 31:
<TABLE>
<CAPTION>
Group Retirement Individual
Insurance Plans Insurance Other Total
--------- ---------- ---------- ------ --------
(in millions)
<S> <C> <C> <C> <C> <C>
Three months ended March 31,
1999:
Revenues....................... $ 248.8 $ 17.2 $ 52.5 $ 2.4 $ 320.9
Benefits and expenses:
Policyholder benefits........ 177.4 10.5 38.8 -- 226.7
Operating expenses........... 46.5 6.2 9.5 0.4 62.6
-------- -------- -------- ------ --------
Total...................... 223.9 16.7 48.3 0.4 289.3
-------- -------- -------- ------ --------
Income before Federal income
taxes
and extraordinary item........ $ 24.9 $ 0.5 $ 4.2 $ 2.0 $ 31.6
======== ======== ======== ====== ========
Total assets................... $2,085.5 $1,360.3 $1,594.5 $306.5 $5,346.8
======== ======== ======== ====== ========
Three months ended March 31,
1998:
Revenues....................... $ 225.9 $ 17.6 $ 55.4 $ 1.6 $ 300.5
Benefits and expenses:
Policyholder benefits........ 170.4 12.5 38.6 -- 221.5
Operating expenses........... 43.1 5.0 8.3 0.4 56.8
-------- -------- -------- ------ --------
Total...................... 213.5 17.5 46.9 0.4 278.3
-------- -------- -------- ------ --------
Income before Federal income
taxes
and extraordinary item........ $ 12.4 $ 0.1 $ 8.5 $ 1.2 $ 22.2
======== ======== ======== ====== ========
Total assets................... $1,782.8 $1,224.3 $1,526.1 $365.7 $4,898.9
======== ======== ======== ====== ========
</TABLE>
Total revenues include premiums, net investment income, and other income.
Benefits include policyholder benefits, interest paid on policyholder funds,
and policyholder dividends. Operating expenses include commissions, general
operating expenses, and the net increase in deferred policy acquisition costs.
5. Commitments and Contingencies. The Company has available credit lines
totaling $115.0 million, including a $100.0 million unsecured revolving line
of credit that was entered into during the first three months of 1999. The
Company is not required to maintain compensating balances, but pays a
commitment fee. Under the credit agreement, the Company is subject to
customary covenants, including limitations on indebtedness, minimum retained
earnings and minimum claims paying ability ratings. At March 31, 1999, the
Company was in compliance with all such covenants. The interest rates are
based on current market rates. At March 31, 1999, there were no outstanding
borrowings on the credit lines.
In the normal course of its business, the Company is involved in various
legal actions and other state and Federal proceedings. A number of these
actions or proceedings were pending as of March 31, 1999. In some instances,
lawsuits include claims for punitive damages and similar types of relief in
unspecified or substantial amounts, in addition to amounts for alleged
contractual liability or other compensatory damages. In the opinion of
management, the ultimate liability, if any, arising from these actions or
proceedings is not expected to have a material adverse effect on the Company's
business, financial condition or results of operations.
6. Pro Forma Financial Information. The pro forma consolidated financial
information presented below gives effect to the IPO, the reorganization of
Standard, and the establishment of a closed block (see "Management's
Discussion and Analysis of Financial Condition and Results of Operations--
Reorganization") pursuant to the Plan (hereafter collectively referred to as
the "Transaction"), as if the Transaction had occurred as of March 31, 1999
for purposes of the pro forma consolidated balance sheet information and as of
January 1, 1999 for purposes of the pro forma consolidated income statement
information.
5
<PAGE>
The pro forma balance sheet information reflects net proceeds of the IPO of
$336.9 million. Pursuant to the Plan, $194.0 million of the net proceeds has
been used to pay cash to certain eligible policyholders in exchange for their
membership interests in Standard in lieu of the distribution of common stock
(including certain eligible policyholders who expressed a preference to
receive cash in lieu of common stock) and $73.9 million has been contributed
by StanCorp to Standard to fund policy credits to be provided to certain
eligible policyholders in exchange for their membership interests in Standard
in lieu of the distribution of common stock. The pro forma balance sheet
information also reflects estimated additional nonrecurring expenses of $0.7
million related to the demutualization assumed to be incurred as of March 31,
1999.
The pro forma per share amounts are based on 33,927,415 outstanding shares
consisting of 15,209,400 shares issued in the IPO and 18,718,015 shares
distributed to eligible policyholders pursuant to the Plan.
The pro forma information is provided for informational purposes only and
should not be construed to be indicative of the Company's consolidated
financial position or its consolidated results of operations had the
Transaction been consummated on the dates assumed, and does not in any way
represent a projection or forecast of the Company's consolidated financial
position or consolidated results of operations as of any future date or for
any future period.
6
<PAGE>
Unaudited Pro Forma Consolidated Balance Sheet
(in millions)
<TABLE>
<CAPTION>
At March 31, 1999
--------------------------------------------------
Standard Closed Block Transaction StanCorp
Historical Adjustments (1) Adjustments Pro Forma
---------- --------------- ----------- ---------
<S> <C> <C> <C> <C>
ASSETS
Investments
Investment securities.... $2,258.4 $(212.7) $ $2,045.7
Mortgage loans........... 1,741.3 (128.1) 1,613.2
Real estate, net......... 90.8 90.8
Policy loans............. 111.9 (91.2) 20.7
Collateral loans......... 70.6 (70.6) --
-------- ------- ------- --------
Total investments...... 4,273.0 (502.6) -- 3,770.4
Cash and cash equivalents.. 25.0 (15.9) (0.7)(2) 151.3
336.9 (3)
(194.0)(4)
Deferred policy acquisition
costs..................... 116.5 (68.8) 47.7
Premiums and other
receivables............... 77.2 (4.9) 72.3
Accrued investment income.. 53.8 (3.3) 50.5
Property and equipment,
net....................... 65.3 65.3
Other assets............... 16.2 16.2
Closed block assets........ -- 595.5 595.5
Separate account assets.... 719.8 719.8
-------- ------- ------- --------
Total Assets........... $5,346.8 $ -- $ 142.2 $5,489.0
======== ======= ======= ========
LIABILITIES AND EQUITY
Liabilities:
Future policy benefits
and claims.............. $2,137.4 $(594.8) $ 73.9 (4) $1,616.5
Other policyholder
funds................... 1,430.4 (20.4) 1,410.0
Accrued federal income
taxes................... 11.2 (0.3) 10.9
Deferred tax
liabilities............. 92.5 (14.4) 78.1
Other liabilities........ 130.4 130.4
Closed block
liabilities............. -- 629.9 629.9
Separate account
liabilities............. 719.8 719.8
-------- ------- ------- --------
Total liabilities...... 4,521.7 -- 73.9 4,595.6
-------- ------- ------- --------
Equity:
Preferred stock.......... -- --
Common stock............. -- 515.4 (5) 852.3
336.9 (3)
Accumulated other
comprehensive income...... 41.1 41.1
Retained earnings.......... 784.0 (0.7)(2) --
(267.9)(4)
(515.4)(5)
-------- ------- ------- --------
Total equity........... 825.1 -- 68.3 893.4
-------- ------- ------- --------
Total Liabilities and
Equity................ $5,346.8 $ -- $ 142.2 $5,489.0
======== ======= ======= ========
</TABLE>
7
<PAGE>
Unaudited Pro Forma Consolidated Statement of Income
(in millions except share data)
<TABLE>
<CAPTION>
For the three months ended March 31, 1999
--------------------------------------------------
Standard Closed Block Transaction StanCorp
Historical Adjustments (1) Adjustments Pro Forma
---------- --------------- ----------- -----------
<S> <C> <C> <C> <C>
Revenues:
Premiums.................. $238.6 $(18.2) $ $ 220.4
Net investment income..... 80.4 (9.4) 71.0
Net realized investment
gains.................... 1.1 1.1
Contribution from the
closed block............. -- 0.8 0.8
Other..................... 0.8 0.8
------ ------ ---- -----------
Total Revenues.......... 320.9 (26.8) -- 294.1
------ ------ ---- -----------
Benefits and expenses:
Policyholder benefits..... 205.4 (18.0) 187.4
Policyholder dividends.... 21.3 (6.3) 15.0
Commissions............... 16.3 (1.1) 15.2
Operating expenses........ 46.3 (1.4) 44.9
------ ------ ---- -----------
Total Benefits and
Expenses............... 289.3 (26.8) -- 262.5
------ ------ ---- -----------
Income before Federal income
taxes...................... 31.6 -- -- 31.6
Federal income taxes........ 10.4 -- 10.4
------ ------ ---- -----------
Income before extraordinary
item....................... $ 21.2 $ -- $-- $ 21.2
====== ====== ==== ===========
Income before extraordinary
item
per share-basic and
diluted.................... $ 0.62
Shares included in the
calculation of basic
and diluted income per
share...................... 33,927,415
</TABLE>
The following adjustments reflect the pro forma effects of the Transaction
on the pro forma consolidated financial information:
(1) The unaudited pro forma consolidated balance sheet and unaudited pro
forma consolidated statement of income reflect an allocation of assets
and liabilities to the closed block, and an allocation of the related
revenues and costs, in each case as required by the Plan. Closed block
invested assets on the unaudited pro forma consolidated balance sheet are
reflected at their March 31, 1999 carrying values. Assets allocated to
the closed block on the unaudited pro forma consolidated balance sheet
were determined based upon an actuarial model based on actual assets and
liabilities as of December 31, 1997. The liability model was developed
from Standard's policy records, with liabilities recorded at their
historical carrying value. Based on the liabilities of the closed block
policies, an estimate of the initial assets needed to fund the closed
block was made. The assets allocated to the closed block include policy
and collateral loans on the closed block policies, plus fixed maturity
securities and mortgages owned by Standard with characteristics (mix,
quality, yield and duration) which, on average, are similar to those
assets currently backing Standard's individual life insurance business.
The closed block was provisionally funded as of January 1, 1999. The
final funding will be completed during the second quarter of 1999, as
provided in the Plan. In management's opinion, the allocation of assets
and liabilities to the closed block as of the effective date is not
expected to differ materially from the allocation reflected in the
unaudited pro forma consolidated balance sheet.
The unaudited pro forma consolidated statement of income reflects revenues
and expenses of the closed block based on its provisional funding. The
closed block includes only those revenues, benefits, expenses
8
<PAGE>
and dividends considered in funding the closed block. The pre-tax
contribution from the closed block is reported as a single line item in
total revenues from continuing operations. Income tax expense applicable to
the closed block is reflected as a component of income tax expense.
Pursuant to the Plan, the assets allocated to the closed block are expected
to produce cash flows which, together with anticipated revenues from the
policies included in the closed block, are expected to be sufficient to
support certain obligations and liabilities relating to these policies. The
excess of closed block liabilities over closed block assets at the funding
date is equal to the total estimated future after tax contribution from the
closed block. The actual contribution from the closed block will be
recognized in income over the period the policies and contracts in the
closed block remain in force.
The cash flows from the assets allocated to the closed block and the
revenues from the closed block policies will be analyzed for adequacy to
fulfill closed block liabilities at least annually. If, over the period the
closed block remains in existence, the actual cumulative contribution from
the closed block is greater than the expected cumulative contribution from
the closed block, only such expected contribution will be recognized in
income, because the excess of the actual cumulative contribution from the
closed block over such expected cumulative contribution will be paid to
closed block policyholders as additional policyholder dividends. If over
such period, the actual cumulative contribution from the closed block is
less than the expected cumulative contribution from the closed block, only
such actual contribution will be recognized in income; however, dividends
could be changed, which would increase future actual contributions until
the actual cumulative contributions equal the expected cumulative
contributions. In any event, policies in the closed block will continue to
be the obligations of Standard. Should the assets of the closed block be
insufficient to satisfy the claims, Standard remains obligated to satisfy
claims on policies included in the closed block in accordance with their
terms. Management believes that the likelihood of such insufficiency is
remote.
(2) Represents the estimated additional nonrecurring expenses of $0.7 million
related to the demutualization assumed to be incurred as of the date of
the unaudited pro forma consolidated balance sheet.
(3) Represents gross proceeds of $361.2 million from the issuance of
15,209,400 shares of common stock at the initial public offering price of
$23.75 per share, less the underwriting discount and estimated offering
expenses aggregating $24.3 million.
(4) Represents the payments made in lieu of the distribution of common stock
to certain eligible policyholders, including $194.0 million paid in cash
and $73.9 million in policy credits.
(5) Represents the reclassification of retained earnings to reflect
Standard's conversion to a stock life insurance company and the
distribution of 18,718,015 shares of common stock to eligible
policyholders.
9
<PAGE>
INDEPENDENT ACCOUNTANTS' REPORT
Standard Insurance Company:
We have reviewed the accompanying consolidated balance sheet of Standard
Insurance Company and subsidiaries as of March 31, 1999, and the related
consolidated statements of income, comprehensive income and equity, and of
cash flows for the three-month periods ended March 31, 1999 and 1998. These
financial statements are the responsibility of the Company's management.
We conducted our review in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures
to financial data and of making inquiries of persons responsible for financial
and accounting matters. It is substantially less in scope than an audit
conducted in accordance with generally accepted auditing standards, the
objective of which is the expression of an opinion regarding the financial
statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that
should be made to such consolidated financial statements for them to be in
conformity with generally accepted accounting principles.
We have previously audited, in accordance with generally accepted auditing
standards, the consolidated balance sheet of Standard Insurance Company and
subsidiaries as of December 31, 1998, and the related statements of
consolidated income, comprehensive income and equity, and of cash flows for
the year then ended (not presented herein); and in our report dated February
12, 1999 (March 19, 1999 as to Note 1), we expressed an unqualified opinion on
those consolidated financial statements. In our opinion, the information set
forth in the accompanying consolidated balance sheet as of December 31, 1998
is fairly stated, in all material respects, in relation to the consolidated
balance sheet from which it has been derived.
DELOITTE & TOUCHE LLP
May 27, 1999
10
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following analysis of the consolidated financial condition and results
of operations of Standard Insurance Company should be read in conjunction with
the consolidated financial statements and related notes thereto included
herein. As used in this analysis, the "Company" means, at all times before the
effective date of the Plan of Reorganization (the "Plan"), Standard Insurance
Company and its subsidiaries, collectively, and at all times on and after such
date, StanCorp Financial Group, Inc. ("StanCorp") and its subsidiaries.
The management of the Company has made in this Form 10-Q, and from time to
time may make in its public filings and press releases as well as in oral
presentations and discussions, certain statements including statements
regarding anticipated development and expansion of the Company's business, the
effects of regulatory actions, the intent, belief, or current expectations of
the Company's management, the future operating performance of the Company and
other statements regarding matters that are not historical facts. These
statements are "forward-looking" statements as that term is defined in the
Private Securities Litigation Reform Act of 1995. Because such statements are
subject to risks and uncertainties, actual results may differ materially from
those expressed or implied by such forward-looking statements. Factors that
could cause actual results to differ materially from those expressed or
implied by such forward-looking statements include but are not limited to (i)
deterioration in morbidity, mortality, and persistency, (ii) changes in
interest rates or the condition of the national economy, (iii) changes in the
regulatory environment on the state or Federal level, (iv) competition from
other insurers and financial institutions, (v) changes in claims paying
ability ratings, (vi) adverse findings in litigation or in state or Federal
proceedings, (vii) deterioration in the experience of the closed block, and
(viii) the risks associated with Year 2000 non-compliance by StanCorp, its
subsidiaries, or third parties (including vendors and suppliers),
unanticipated costs associated with Year 2000 compliance, due to, among other
things, the inability to locate, correct and successfully test all relevant
computer codes according to schedule, the continued availability of resources
including personnel and timely and accurate responses and corrections by third
parties. Certain other factors are discussed in the StanCorp's Registration
Statement (Registration No. 333-72521) and Prospectus filed with the
Securities and Exchange Commission.
Reorganization
In December 1997, Standard's board of directors authorized management to
proceed with the development of a plan of reorganization to convert from a
mutual life insurance company to a stock life insurance company. At March 31,
1999, StanCorp was a wholly owned subsidiary of Standard formed with the
purpose of becoming an insurance holding company on the completion of
Standard's reorganization. StanCorp's assets consisted solely of $1,000 cash
received as a capital contribution from Standard. StanCorp had no further
activity until Standard's reorganization.
On April 21, 1999, StanCorp completed an initial public offering of
StanCorp's common stock, issuing 15,209,400 shares (including 1,289,400 shares
sold pursuant to the underwriters' over-allotment option) at $23.75 per share,
and received proceeds, net of IPO expenses, of $336.9 million. Of the
proceeds, $276.9 million was contributed to Standard, of which $267.9 million
was used to retire obligations arising out of Standard's conversion to a stock
life company and $9.0 million was paid in exchange for ownership of Standard's
non-insurance subsidiaries. The remaining $60.0 million has been retained by
StanCorp for general corporate purposes, which may include contributions to
Standard or to its other subsidiaries. Concurrent with the IPO, StanCorp
issued 18,718,015 shares of common stock to eligible policyholders under the
Plan in exchange for the policyholders' membership interests in Standard. The
costs incurred and expensed in the first three months of 1999 related to the
reorganization totaled $2.3 million, and are included in the financial
statements as an extraordinary item. We estimate that an additional $0.7
million in reorganization costs will be incurred in 1999.
11
<PAGE>
On the completion of its reorganization, Standard established a closed block
for the payment of future benefits, policyholder dividends and certain
expenses and taxes related to certain classes of policies. Standard allocated
to the closed block an amount of assets expected to produce cash flows which,
together with future revenues from the policies included in the closed block,
will be sufficient to support these policies, including payment of claims,
certain expenses and taxes and continuation of policyholder dividend scales in
effect for 1998, if the experience underlying such dividend scales, including
the portfolio interest rate, continues. These assets, totaling $595.5 million
at March 31, 1999, are for the benefit of the policies in the closed block.
Consolidated Results of Operations for the Three Months Ended March 31, 1999
and 1998
Premiums
Premiums, which include policy and contract charges, increased by $18.2
million, or 8.3%, to $238.6 million in the first three months of 1999 from
$220.4 million in the first three months of 1998. The increase resulted
primarily from growth in group insurance business, as evidenced by increased
group insurance premiums of $20.1 million in the first three months of 1999,
partially offset by a decline in individual insurance premiums of $2.6
million.
Net Investment Income
Net investment income increased by $1.0 million, or 1.3%, to $80.4 million
in the first three months of 1999 compared to $79.4 million in the same period
of 1998. This increase resulted from a 7.5% increase in average invested
assets, from $4.0 billion for the first three months of 1998 to $4.3 billion
for the first three months of 1999, partially offset by a decrease in net
investment yield. The net investment yield declined to 7.59% in the first
three months of 1999 compared to 8.03% in the first three months of 1998. The
primary reasons for the decrease in net investment yield were a decreasing
interest rate environment, which may or may not continue in the future, and
the decline in mortgage loans as a percentage of invested assets. Fixed
maturity securities and mortgage loans represented 52.1% and 40.2%,
respectively, of average invested assets at March 31, 1999. At March 31, 1998,
fixed maturity securities and mortgage loans represented 51.1% and 40.6%,
respectively.
Net Realized Investment Gains
Net realized investment gains were $1.1 million in the first three months of
1999 compared to $0.2 million in the first three months of 1998. Net realized
gains and losses occur primarily as a result of dispositions of the Company's
invested assets in the regular course of investment management. Sales of fixed
maturity securities in the first three months of 1999 resulted in gains of
$0.8 million, but were negligible in the first three months of 1998.
Policyholder Benefits
Policyholder benefits, including policyholder dividends and interest paid on
policyholder funds, increased by $5.2 million, or 2.3%, to $226.7 million in
the first three months of 1999 from $221.5 million for the same period in
1998. The increase related primarily to the growth in group insurance
business, partially offset by improved claims experience for group insurance
(See "--Selected Segment Information--Group Insurance Segment.") and by lower
interest credited to group annuity contracts.
Operating Expenses
Operating expenses, including state and local taxes, commissions and the net
increase in deferred policy acquisition costs, increased by $5.8 million, or
10.2%, to $62.6 million in the first three months of 1999 from $56.8 million
in the first three months of 1998. This growth primarily related to business
growth, including an increase in personnel. To support the current level of
business, as well as potential future business, the Company
12
<PAGE>
increased personnel 7.8% from March 31, 1999 over March 31, 1998.
Additionally, the net increase in deferred acquisition costs for the
Individual Insurance segment decreased $2.0 million over the first quarter of
1998. (See "--Selected Segment Information--Individual Insurance Segment.")
Federal Income Taxes
The effective Federal income tax rates for the first three months of 1999
and 1998 were 32.9% and 34.2%, respectively. The provisions for Federal income
taxes differ from the amounts calculated at the Federal corporate tax rate
primarily due to permanent differences, including nontaxable investment income
and tax credits.
Income before Extraordinary Item
Income before extraordinary item increased $6.6 million, or 45.2%, to $21.2
million in the first three months of 1999 from $14.6 million in the same
period of 1998.
Selected Segment Information:
The following table sets forth selected segment information for the periods
indicated:
<TABLE>
<CAPTION>
Three Months
Ended March 31,
-----------------
1999 1998
-------- --------
(in millions)
<S> <C> <C>
Revenues:
Group Insurance segment................................ $ 248.8 $ 225.9
Retirement Plans segment............................... 17.2 17.6
Individual Insurance segment........................... 52.5 55.4
Other.................................................. 2.4 1.6
-------- --------
Total revenues....................................... $ 320.9 $ 300.5
======== ========
Income before Federal income taxes and extraordinary
item:
Group Insurance segment................................ $ 24.9 $ 12.4
Retirement Plans segment............................... 0.5 0.1
Individual Insurance segment........................... 4.2 8.5
Other.................................................. 2.0 1.2
-------- --------
Total income before Federal income taxes and
extraordinary item.................................. $ 31.6 $ 22.2
======== ========
Reserves: (1)
Group Insurance segment................................ $1,444.6 $1,330.1
Retirement Plans segment............................... 625.0 631.4
Individual Insurance segment........................... 1,498.2 1,438.3
-------- --------
Total reserves....................................... $3,567.8 $3,399.8
======== ========
</TABLE>
- --------
(1) Reserves are comprised of future policy benefits and claims and other
policyholder funds.
Group Insurance Segment
The Group Insurance segment sells long and short term disability, life,
accidental death and dismemberment and dental insurance. As the largest of the
Company's three segments, group insurance premiums accounted for 88.6% and
86.8% of Standard's total premiums for the periods ended March 31, 1999 and
1998, respectively.
13
<PAGE>
The following table sets forth selected financial data for the Group
Insurance segment for the periods indicated:
<TABLE>
<CAPTION>
Three Months
Ended
March 31,
--------------
1999 1998
------ ------
(Dollars in
millions,
except as
indicated)
<S> <C> <C>
Revenues:
Premiums.................................................. $211.5 $191.4
Net investment income..................................... 36.0 34.2
Net realized investment gains (losses).................... 0.5 (0.1)
Other..................................................... 0.8 0.4
------ ------
Total revenues.......................................... 248.8 225.9
------ ------
Benefits and expenses:
Policyholder benefits..................................... 177.4 170.4
Operating expenses........................................ 46.5 43.1
------ ------
Total benefits and expenses............................. 223.9 213.5
------ ------
Income before Federal income taxes and extraordinary item... $ 24.9 $ 12.4
====== ======
Benefit ratio (% of premiums)............................... 83.9% 89.0%
Operating expense ratio (% of premiums)..................... 22.0 22.5
Life insurance in force (in billions)....................... $ 84.5 $ 78.3
</TABLE>
Premiums increased $20.1 million, or 10.5%, to $211.5 million in the first
three months of 1999 from $191.4 million in the first three months of 1998.
Approximately eighty percent of the premium growth for the periods presented
related to group accident and health insurance lines, concentrated in long
term disability insurance, with the remainder being primarily attributable to
group life insurance.
Net investment income increased $1.8 million, or 5.3%, to $36.0 million in
the first three months of 1999 from $34.2 million in the first three months of
1998. The increase for the periods presented was due substantially to an
increase of 14.9% in the average assets held by the segment, partially offset
by a decrease due to declining net investment yield.
Policyholder benefits increased by $7.0 million, or 4.1%, to $177.4 million
in the first three months of 1999 from $170.4 million for the same period in
1998. This increase was a result of offsetting factors, increasing as a result
of the growth in business for the segment, as evidenced by the 10.5% increase
in premiums, but decreasing with improvement in the benefit ratio from 89.0%
in the first three months of 1998 to 83.9% in the first three months of 1999.
The benefit ratio showed improvement in latter quarters of 1998, averaging
85.0% for the year. The first three months of 1999 were a continuation of this
improving trend. This trend may or may not continue in the future.
Operating expenses increased $3.4 million, or 7.9%, to $46.5 million in the
first three months of 1999 from $43.1 million in the first three months of
1998. The increase primarily related to the growth in business. The operating
expense ratio for the first three months of 1999 and 1998 were 22.0% and
22.5%, respectively.
Income before Federal income taxes and extraordinary item for the segment
increased by $12.5 million to $24.9 million in the first three months of 1999
from $12.4 million in the same period of 1998. The increase was primarily due
to the improvement in the benefit ratio.
Retirement Plans Segment
The Retirement Plans segment offers full-service 401(k) and other pension
plan products and services.
14
<PAGE>
The following table sets forth selected financial data for the Retirement
Plans segment for the periods indicated:
<TABLE>
<CAPTION>
Three Months
Ended
March 31,
------------------
1999 1998
-------- --------
(Dollars in
millions)
<S> <C> <C>
Revenues:
Premiums............................................. $ 4.7 $ 4.0
Net investment income................................ 12.3 13.6
Net realized investment gains (losses)............... 0.2 --
-------- --------
Total revenues..................................... 17.2 17.6
-------- --------
Benefits and expenses:
Policyholder benefits................................ 10.5 12.5
Operating expenses................................... 6.2 5.0
-------- --------
Total benefits and expenses........................ 16.7 17.5
-------- --------
Income before Federal income taxes and extraordinary
item.................................................. $ 0.5 $ 0.1
======== ========
Operating expense ratio (% of total revenues).......... 36.0% 28.4%
Assets under management:
General account...................................... $ 623.2 $ 641.5
Separate account..................................... 719.8 567.0
-------- --------
Total.............................................. $1,343.0 $1,208.5
======== ========
</TABLE>
Revenues are derived from premiums, which consist of charges for
administrative services on assets managed in both the general account and
separate account, and interest income on assets managed in the general
account. Premiums increased by $0.7 million, or 17.5%, to $4.7 million in the
first three months of 1999 from $4.0 million in the same period in 1998. The
increase resulted primarily from growth in assets under management. Net
investment income decreased $1.3 million, or 9.6%, to $12.3 million in the
first three months of 1999 from $13.6 million in the first three months of
1998. The decline was due primarily to a decline in the net investment yield,
but also resulted from a 2.9% decrease in assets under management in the
general account caused by contractholder withdrawals and transfers to separate
account contracts offered by the Company.
Policyholder benefits, which include interest credited to policyholders,
decreased $2.0 million, or 16%, to $10.5 million in the first three months of
1999 from $12.5 million in the first three months of 1998. The decrease
primarily was due to a decrease in the rates credited to policyholders,
reflecting the Company's active management of the targeted interest rate
spread. The profitability of the Retirement Plans segment is, in part,
dependent on the maintenance of targeted interest rate spreads.
Operating expenses increased by $1.2 million, or 24%, to $6.2 million in the
first three months of 1999 from $5.0 million in the first three months of
1998. Management expects the rate of expense growth to continue to outpace
revenue growth for the remainder of 1999. During the first three months of
1999, a new field office was opened, with associated operating costs of $0.2
million, and management plans to open 4 additional offices in 1999. The impact
on operating expenses of all offices opened in 1999 is projected to be
approximately $1.4 million. Management expects that the new offices will
contribute to increased market share by 2001, resulting in significant premium
growth with operating expenses remaining fairly stable. This expectation is
supported by the segment's decision to focus on administering a single type of
plan. In the fourth quarter of 1997, the segment began converting existing
traditional plans, which allow quarterly investment directives by the
employers and participants, to daily plans, which allow daily investment
directives, and to exit the traditional business. Daily plans are believed to
be more attractive to customers. Management expects the conversion to be
completed or the traditional plans discontinued by December 31, 1999. Although
the efficiencies and cost savings of the strategy cannot be readily estimated,
management believes that future expense savings will be realized.
15
<PAGE>
Income before Federal income taxes and extraordinary item for the Retirement
Plans segment in the first three months of 1999 and 1998 was $0.5 million and
$0.1 million, respectively.
Individual Insurance Segment
The Individual Insurance segment sells life insurance, disability insurance,
fixed annuities and other insurance products to individuals. For the
individual insurance market, a growing percentage of consumers are now
reaching 45 years of age or older and are shifting their focus from loss
avoidance to asset accumulation, and the strong stock market has increased
competition from investments in other than traditional individual life
insurance and fixed annuities such as variable life and variable annuity
products. The following table sets forth selected financial data for the
Individual Insurance segment for the periods indicated:
<TABLE>
<CAPTION>
Three Months Ended
March 31,
----------------------
1999 1998
---------- ----------
(Dollars in millions
except as indicated)
<S> <C> <C>
Revenues:
Premiums......................................... $ 22.4 $ 25.0
Net investment income............................ 29.7 30.5
Net realized investment gains (losses)........... 0.4 (0.1)
---------- ----------
Total revenues................................. 52.5 55.4
---------- ----------
Benefits and expenses:
Policyholder benefits............................ 38.8 38.6
Operating expenses............................... 9.5 8.3
---------- ----------
Total benefits and expenses.................... 48.3 46.9
---------- ----------
Income before Federal income taxes and
extraordinary item................................ $ 4.2 $ 8.5
========== ==========
Operating expense ratio (% of premiums)............ 42.4% 33.2%
Life insurance in force (in billions).............. $ 7.9 $ 7.8
</TABLE>
Premiums decreased $2.6 million, or 10.4%, to $22.4 million in the first
three months of 1999 from
$25.0 million in the same periods of 1998. The decrease resulted, in part,
from declining demand due to the maturing individual insurance market. The
balance of the decrease related to typical fluctuations in quarterly premiums
for this segment. Premiums were $25.0 million, $22.7 million, $22.0 million
and $24.5 million for the first, second, third and fourth quarters of 1998,
respectively. These fluctuations are due, in part, to the sale of single
premium products, variations in sales volume and fluctuations in reinsurance
activity.
Policyholder benefits remained relatively stable at $38.8 million in the
first three months of 1999 compared to $38.6 million for the first three
months of 1998. Operating expenses increased $1.2 million, or 14.5%, to
$9.5 million in the first three months of 1999 compared to $8.3 million in the
first three months of 1998. The increase consisted of $2.0 million related to
net deferred policy acquisition costs, offset in part by a $0.9 million
decrease in commissions expense, which was primarily due to decreased
premiums. The deferral and amortization of policy acquisition costs involves
the use of estimates which management revises when appropriate. As the result
of revisions to estimates in the first quarter of 1999, expense related to net
deferred policy acquisition costs increased $2.0 million over the first
quarter of 1998.
Income before Federal income taxes and extraordinary item for the Individual
Insurance segment was $4.2 million and $8.5 million for the three months ended
March 31, 1999 and 1998, respectively.
16
<PAGE>
Other
Other includes primarily mortgage lending and real estate management
subsidiaries and real estate investments. Income before Federal income taxes
and extraordinary item for the three months ended March 31, 1999 and 1998 was
$2.0 million and $1.2 million, respectively. The income primarily related to
the fees earned by the mortgage subsidiary for servicing and originating
loans. Income earned as a result of servicing and originating mortgage loans
totaled $1.6 million and $1.0 million, respectively, for the three months
ended March 31, 1999 and 1998.
Liquidity and Capital Resources
Following the effective date of the Plan, Standard became a wholly owned
subsidiary and the principal asset of StanCorp. StanCorp's ability to pay
dividends to its shareholders and meet its obligations substantially depends
upon the receipt of dividends from Standard. In the future, dividends from the
non-insurance subsidiaries may also become significant sources of funds for
StanCorp.
Standard's ability to pay dividends to StanCorp is regulated under Oregon
law. Under Oregon law, Standard may pay dividends only from the earned surplus
arising from its business. It also must receive the prior approval of the
Director of the Oregon Department of Consumer and Business Services (the
"Director") to pay a dividend, if such dividend would exceed certain statutory
limitations. The current statutory limitation is the greater of (a) 10 percent
of Standard's combined capital and surplus as of December 31, of the preceding
year and (b) the net gain from operations after dividends to policyholders and
Federal income taxes and before capital gains or losses for the twelve-month
period ending on the December 31 last preceding, in each case determined under
statutory accounting practices. Oregon law gives the Director broad discretion
to disapprove requests for dividends in excess of these limits. Based on its
statutory results, Standard will be permitted to pay up to $93.9 million in
dividends to StanCorp in 1999 without obtaining the Director's approval. These
limitations on dividends do not apply to any dividends to StanCorp from the
non-insurance subsidiaries.
Operating Cash Flows. Operating cash inflows consist primarily of premiums
and annuity deposits. Operating cash outflows consist primarily of benefits to
policyholders and beneficiaries, operating expenses, commissions and taxes.
Investing Cash Flows. Investing cash inflows consist primarily of investment
income and the proceeds from sales or maturities of investments. Investing
cash outflows consist primarily of payments for investments acquired. Since
future benefit payments are primarily intermediate and long-term obligations,
Standard's investments are predominantly intermediate and long-term fixed-rate
instruments, such as fixed maturity securities and mortgage loans, which are
expected to provide sufficient cash flow to cover these obligations. The
nature and quality of various types of investments purchased by Standard must
comply with statutes and regulations imposed by Oregon and other states in
which Standard is licensed.
It is management's objective to generally align the cash flow
characteristics of assets and liabilities to ensure that Standard's financial
obligations can be met under a wide variety of economic conditions. Most of
Standard's policy liabilities result from participating individual life
insurance products and other life insurance and annuity products on which
interest rates can be adjusted periodically, long term disability reserves
that have proven to be very stable over time, and separate account products.
Annual cash flow scenario testing is employed to assess interest rate risk and
to permit Standard's investment policy to be modified whenever necessary to
address changing economic environments. See "--Interest Rate Risk Management".
Management believes that historically its liquidity, capital resources and
results of operations have not been materially affected by any failure to
align the cash flow characteristics of Standard's assets and liabilities.
The Company's mortgage loan portfolio represented 40.2% of total general
account invested assets at March 31, 1999. Policyholders or claimants cannot
withdraw Standard's large block of disability reserves and claim payments are
issued monthly over periods that may extend for many years. This holding of
stable long-term reserves makes it possible for Standard to allocate a greater
portion of its assets to long-term commercial
17
<PAGE>
mortgage loans than many other life insurance companies. At March 31, 1999,
the Company had outstanding commitments to fund or acquire various assets,
generally mortgage loans with interest rates ranging from 7.25% to 8.50%,
totaling $121.3 million. The Company's capital expenditures are estimated to
be $10.3 million for the remainder of 1999.
The following table sets forth selected liquidity characteristics for
policyholder reserves and deposit fund liabilities.
Policyholder Reserves and Deposit Fund Liabilities--
Liquidity Characteristics
<TABLE>
<CAPTION>
At March 31,
------------------------------
1999 1998
-------------- --------------
% of % of
Amount Total Amount Total
-------- ----- -------- -----
(Dollars in millions)
<S> <C> <C> <C> <C>
Subject to Discretionary Withdrawal:
At fund balance or with market value
adjustment or surrender charge of less
than 5%................................. $ 682.4 19.1% $ 709.6 20.9%
At fund balance, with market value
adjustment or surrender charge of 5% or
more.................................... 557.3 15.6 581.3 17.1
-------- ----- -------- -----
Total subject to discretionary
withdrawal............................ 1,239.7 34.7 1,290.9 38.0
Not subject to withdrawal.................. 2,328.1 65.3 2,108.9 62.0
-------- ----- -------- -----
Total.................................. $3,567.8 100.0% $3,399.8 100.0%
======== ===== ======== =====
</TABLE>
Financing. The Company has available lines of credit totaling $115.0
million, including a $100.0 million revolving line of credit that was entered
into during the first three months of 1999. Under that credit agreement, the
Company is subject to customary covenants, including limitations on
indebtedness, minimum retained earnings and minimum claims paying ability
ratings. Such covenants could have the effect of limiting StanCorp's ability
to pay dividends to its shareholders.
Interest Rate Risk Management
Standard manages interest rate risk, in part, through asset/liability
duration analyses. As part of this strategy, detailed actuarial models of the
cash flows associated with each type of insurance liability and the financial
assets related to these reserves are generated under various interest rate
scenarios. These actuarial models include those used to support the
unqualified statutory Statement of Actuarial Opinion, required by insurance
regulators, which states that according to presently accepted actuarial
standards of practice, and in light of the assets held, Standard's current
reserves and related items tested to support that opinion make adequate
provision for the anticipated cash flows required by Standard's contractual
obligations and related expenses.
The Company has not used derivatives, such as interest rate swaps, currency
swaps, futures or options, to manage interest rate risk or for speculative
purposes, but may use such instruments to manage interest rate risk in the
future. In the normal course of business, the Company commits to fund mortgage
loans generally up to 60 days in advance.
Year 2000
The Year 2000 issue is the result of computer programs that were written
using two digits rather than four to define the applicable year. Any of the
Company's computer programs that include date sensitive software may recognize
a date using "00" as the year 1900 rather than the year 2000. This could
result in a system failure or miscalculations causing disruption of
operations, including, among other things, a temporary inability to process
transactions and engage in normal business activities.
18
<PAGE>
Based on an assessment, the Company determined a need to modify, upgrade or
replace significant portions of its software so that its computer systems will
function properly beyond December 31, 1999. Management believes that with
modifications to existing software and hardware and conversions to new
software and hardware, the Year 2000 issue will be mitigated. However, if such
modifications and conversions are not made, or are not completed on a timely
basis, the Year 2000 issue could have a material adverse effect on the
Company's business, financial condition and results of operations.
The Company has assessed its computer hardware for Year 2000 readiness. The
hardware is generally compliant, with the exception of a few personal
computers, which are being replaced in the normal course of business. In
addition, the Company has assessed its non-information technology systems and
has found them to be Year 2000 ready.
The Company has established milestone dates for each of the critical
subprojects that comprise the Company's master year 2000 plan. These milestone
dates are key events for determining whether the remediation or replacement of
a critical system will be completed successfully and on time. If any milestone
date is missed, the Company will commence the development of a contingency
plan that will either remediate or replace the system that the subproject was
designed to bring into compliance. As of March 31, 1999, all subprojects have
progressed through identified milestones, and as the result of this progress,
no contingency plans were initiated during the three months ended March 31,
1999. There can be no guarantee that the Company's method of developing
contingency plans or the contingency plans themselves, if required, will
prevent the Year 2000 issue from having a material adverse effect on the
Company's business, financial condition and results of operations.
The Company is using both internal and external resources to reprogram,
upgrade or replace and test its software and hardware for Year 2000 readiness.
The Company plans to complete the Year 2000 project for all business-critical
applications no later than June 30, 1999. At that time, management believes,
the Year 2000 issue will be mitigated. Based on presently available
information, the Company estimates the total remaining cost at March 31, 1999
of the Year 2000 project to be approximately $1.4 million. These costs are
being funded through operating cash flows and expensed as incurred. Through
March 31, 1999, the Company has incurred and expensed approximately $13.4
million related to assessment and remediation or replacement in connection
with the Year 2000 project.
The costs of the Year 2000 project and the date on which the Company plans
to complete the Year 2000 modifications are based on management's estimates,
which were derived using various assumptions regarding future events,
including the continued availability of certain resources, third-party
modification plans and other factors. Actual results could differ materially
from these estimates. Specific factors that might cause such material
differences include, but are not limited to, the availability and cost of
personnel trained in this area, the ability to locate and correct all relevant
computer codes, supplier and large customer compliance and similar
uncertainties.
The Company has initiated formal communications with all of its significant
suppliers and large customers to determine the extent to which Standard is
vulnerable to those third parties' failure to remediate their own Year 2000
issues. A majority of the Company's significant suppliers have given
assurances that they are, or will be, Year 2000 compliant by December 31,
1999. The Company continues to monitor significant suppliers. If it does not
receive adequate assurances of Year 2000 compliance from its significant
suppliers by June 30, 1999, the Company will seek alternative suppliers, if
available. The Company has also received adequate assurances that its major
customers that have systems that connect with the Company's systems are, or
will be, Year 2000 compliant by December 31, 1999. While management believes
that it is not at significant risk that its significant suppliers and large
customers will not be Year 2000 compliant, there can be no guarantee that the
hardware and software of other companies, governmental agencies or other
entities on which the Company relies will be converted on a timely basis, or
that a failure to convert by another entity, or a conversion that is
incompatible with the Company's hardware and software, would not have a
material adverse effect on the Company's business, financial condition or
results of operations.
19
<PAGE>
Litigation
In the normal course of its business, the Company is involved in various
legal actions and other state and federal proceedings. A number of these
actions or proceedings were pending as of March 31, 1999. In some instances,
lawsuits include claims for punitive damages and similar types of relief in
unspecified or substantial amounts, in addition to amounts for alleged
contractual liability or other compensatory damages. In the opinion of
management, the ultimate liability, if any, arising from these actions or
proceedings is not expected to have a material adverse effect on the Company's
business, financial condition or results of operation.
Recently Issued Pronouncements
Effective January 1, 1999, the Company adopted Statement of Position ("SOP")
97-3, "Accounting by Insurance and Other Enterprises for Insurance-Related
Assessments", which establishes accounting guidance for state mandated
guaranty assessments. The adoption of SOP 97-3 did not have a material impact
on the Company's consolidated financial statements in the first three months
of 1999.
Effective January 1, 1999, the Company adopted SOP 98-1, "Accounting for the
Costs of Computer Software Developed or Obtained for Internal Use", which
establishes accounting requirements for the capitalization of software costs
incurred for the use of the organization. The adoption of SOP 98-1 did not
have a material impact on the Company's consolidated financial statements in
the first three months of 1999. Management estimates capitalization of
approximately $2.8 million in costs of computer software developed or obtained
for internal use will result in 1999. It is expected that the amortization
period for these costs will approximate three to five years.
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There have been no material changes in reported interest rate risks faced by
the Company since the end of the most recent fiscal year.
20
<PAGE>
PART II. OTHER INFORMATION
ITEM 1: LEGAL PROCEEDINGS
On April 26, 1999 Standard received notice from the San Francisco office of
the U.S. Department of Labor ( the "DOL") that it was conducting an
investigation with respect to Standard's employee benefit plan clients
pursuant to Section 504(a)(1) of the Employee Retirement Income Security Act
of 1974 ("ERISA"), to determine whether any person has violated or is about to
violate any provision of Title I of ERISA. Standard and certain of its
employee benefit plan clients are subject to ERISA in connection with, among
other things, certain policies sold by Standard's Group Insurance segment. The
notice included a subpoena that certain documents and records be provided to
the DOL. Standard intends to cooperate fully with the DOL.
To date, no claims or charges have been asserted against Standard as a
result of the investigation and the DOL states that its investigation should
not be construed as an indication that any violations of ERISA have occurred
or as a reflection upon any person involved. Management believes that
Standard's business practices comply in all material respects with ERISA and
that the investigation will not have a material adverse effect on its
business, financial condition or results of operations.
In the normal course of its business, the Company is involved in various
legal actions and other state and Federal proceedings. A number of these
actions or proceedings were pending as of March 31, 1999. In some instances,
lawsuits include claims for punitive damages and similar types of relief in
unspecified or substantial amounts in addition to amounts for alleged
contractual liability or other compensatory damages. In the opinion of
management, the ultimate liability, if any, arising from these actions or
proceedings is not expected to have a material adverse effect on the Company's
business, financial condition or results of operations.
ITEM 2: CHANGES IN SECURITIES AND USE OF PROCEEDS
On April 15, 1999, the Securities and Exchange Commission declared effective
StanCorp's Registration Statement on Form S-1 (No. 333-72521), as amended,
relating to the IPO. The managing underwriters for the U.S. offering were
Goldman, Sachs & Co., Donaldson, Lufkin & Jenrette Securities Corporation and
Morgan Stanley & Co. Incorporated, and the managing underwriters for the
international offering were Goldman Sachs International, Donaldson, Lufkin &
Jenrette International and Morgan Stanley & Co. International Limited
(collectively, the "Underwriters"). The IPO commenced on April 15, 1999, and
terminated upon the sale of all the 15,209,400 shares of common stock
(including 1,289,400 shares sold pursuant to the Underwriters' over-allotment
option) which were registered for sale. The aggregate offering price of the
securities sold was $361,223,250 (including $30,623,250 of proceeds from the
exercise of the Underwriters' over-allotment option). The Company incurred the
following estimated expenses in connection with the IPO:
<TABLE>
<S> <C>
Underwriting discounts and commissions.......................... $21,597,348
Other expenses (legal and accounting fees, printing and
engraving expenses, filing and listing fees, transfer agent and
registrar fees and miscellaneous).............................. 2,702,652
-----------
Total....................................................... $24,300,000
===========
</TABLE>
The net proceeds to the Company from the IPO, after deducting the foregoing
expenses, were approximately $336,900,000. In connection with the IPO, the
Company did not make any direct or indirect payments to directors or officers
of the Company, except in their capacity of policyholders, or, to the
Company's knowledge, to their associates; to persons owning 10% or more of any
class of equity securities of StanCorp; or to affiliates of the Company.
Approximately $60,000,000 of the proceeds were retained by StanCorp, and the
balance of approximately $276,900,000 million was contributed to Standard.
21
<PAGE>
Of the net proceeds contributed by StanCorp to Standard, $73.9 million was
used to fund policy credits required to be credited to certain eligible
policyholders pursuant to the Plan, $194.0 million was used to pay all of the
cash to certain eligible policyholders who are to receive cash as described in
the Plan (including certain eligible policyholders who expressed a preference
to receive cash), and $9.0 million was paid in connection with the
distribution of Standard's non-insurance subsidiaries to StanCorp, as required
by the Plan.
The net proceeds retained by StanCorp are expected to be used for general
corporate purposes of the consolidated entity.
ITEM 3: DEFAULTS UPON SENIOR DEBT
None
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5: OTHER INFORMATION
None
ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibit Index
3(i). Articles of Incorporation. An amendment to StanCorp Financial
Group, Inc.'s Articles of Incorporation was included in StanCorp's 8-K,
filed on May 7, 1999 and is incorporated by this reference.
15. Letter re: Unaudited interim financial statements
27. Financial Data Schedules
(b) No report on Form 8-K was filed by the Company with the Securities and
Exchange Commission during the three months ended March 31, 1999.
Subsequently, the Company filed with the Securities and Exchange
Commission a Form 8-K on May 5, 1999, which discussed the Company's
consolidated financial results for the first quarter of 1999 and a
pending investigation by the U.S. Department of Labor, which management
believes will have no material adverse effect on the Company's
business, financial conditions or results of operations. On May 7,
1999, the Company filed another Form 8-K which disclosed the
implementation of StanCorp's Shareholder Rights Plan and the amendment
to StanCorp's Articles of Incorporation to include a class of preferred
stock.
22
<PAGE>
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.
Date: June 1, 1999 /s/ Eric E. Parsons
By: _____________________________
Eric E. Parsons
Senior Vice President
and Chief Financial Officer
(Principal Financial Officer)
Date: June 1, 1999 /s/ Patricia J. Brown
By: ______________________________
Patricia J. Brown
Assistant Vice President
Controller and Treasurer
(Principal Accounting Officer)
23
<PAGE>
EXHIBIT 15
Standard Insurance Company
Portland, Oregon
We have made a review, in accordance with standards established by the American
Institute of Certified Public Accountants, of the unaudited interim financial
information of Standard Insurance Company and subsidiaries for the periods ended
March 31, 1999 and 1998, as indicated in our report dated May 27, 1999; because
we did not perform an audit, we expressed no opinion on that information.
We are aware that our report referred to above, which is included in your
Quarterly Report on Form 10-Q for the quarter ended March 31, 1999, is
incorporated by reference in Registration Statement No. 333-72521 on Form S-8.
We also are aware that the aforementioned report, pursuant to Rule 436(c) under
the Securities Act of 1933, is not considered a part of the Registration
Statement prepared or certified by an accountant or a report prepared or
certified by an accountant within the meaning of Sections 7 and 11 of that Act.
DELOITTE & TOUCHE LLP
Portland, Oregon
May 27, 1999
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 7
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM UNAUDITED
INTERIM CONSOLIDATED FINANCIAL STATEMENTS OF STANDARD INSURANCE COMPANY AND ITS
SUBSIDIARIES AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> MAR-31-1999
<DEBT-HELD-FOR-SALE> 2,258,100
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 300
<MORTGAGE> 1,741,300
<REAL-ESTATE> 90,800
<TOTAL-INVEST> 4,273,000
<CASH> 25,000
<RECOVER-REINSURE> 30,800
<DEFERRED-ACQUISITION> 116,500
<TOTAL-ASSETS> 5,346,800
<POLICY-LOSSES> 2,038,300
<UNEARNED-PREMIUMS> 0
<POLICY-OTHER> 99,100
<POLICY-HOLDER-FUNDS> 1,430,400
<NOTES-PAYABLE> 0
0
0
<COMMON> 0
<OTHER-SE> 825,100
<TOTAL-LIABILITY-AND-EQUITY> 5,346,800
238,600
<INVESTMENT-INCOME> 80,400
<INVESTMENT-GAINS> 1,100
<OTHER-INCOME> 800
<BENEFITS> 205,400
<UNDERWRITING-AMORTIZATION> (100)<F1>
<UNDERWRITING-OTHER> 0
<INCOME-PRETAX> 31,600
<INCOME-TAX> 10,400
<INCOME-CONTINUING> 21,200
<DISCONTINUED> 0
<EXTRAORDINARY> 2,300
<CHANGES> 0
<NET-INCOME> 18,900
<EPS-BASIC> 0
<EPS-DILUTED> 0
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 0
<CUMULATIVE-DEFICIENCY> 0
<FN>
<F1>THIS ITEM CONTAINS THE AMOUNTS OF DEFERRED AND AMORTIZED POLICY ACQUISITION
COSTS FOR THE PERIOD.
</FN>
</TABLE>
