Washington National Insurance Company
1996 Audited GAAP Consolidated Financial Statements
Report of Independent Auditors 1
Consolidated Balance Sheet 2
Consolidated Statement of Income 3
Consolidated Statement of Cash Flows 4
Consolidated Statement of Shareholder's Equity 5
Notes to Consolidated Financial Statements 6
<PAGE>
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
Board of Directors
Washington National Insurance Company
We have audited the accompanying consolidated balance sheet
of Washington National Insurance Company as of December 31,
1996 and 1995, and the related consolidated statements of
income, shareholder's equity, and cash flows for each of the
three years in the period ended December 31, 1996. These
financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on
these financial statements based on our audits.
We conducted our audits in accordance with generally
accepted auditing standards. Those standards require that we
plan and perform the audit to obtain reasonable assurance
about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by
management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above
present fairly, in all material respects, the consolidated
financial position of Washington National Insurance Company
at December 31, 1996 and 1995, and the consolidated results
of its operations and its cash flows for each of the three
years in the period ended December 31, 1996, in conformity
with generally accepted accounting principles.
As discussed in Note C, the Company changed its method of
accounting for certain investments in debt and equity
securities in 1994.
/c/ ERNST & YOUNG LLP
Chicago, Illinois
March 7, 1997
<PAGE>
CONSOLIDATED BALANCE SHEET
(000s omitted)
<TABLE>
December 31, 1996 1995
- ----------------------------------------------------------------------------------------
<S> <S> <C> <C>
Assets Investments
Fixed maturities-Available for sale at fair
value (cost: $1,899,130; $1,953,314) $1,931,129 $2,060,710
Mortgage loans on real estate 257,635 317,249
Real estate and joint ventures 19,882 33,918
Policy loans 55,798 56,279
Other long-term 11,812 27,744
Short-term 102,720 47,920
----------------------------------------------------------------------------
Total Investments 2,378,976 2,543,820
Cash 2,987 4,852
Deferred acquisition costs 242,488 235,499
Reinsurance recoverables and prepaid premiums 109,555 49,502
Accrued investment income 31,671 32,652
Insurance premiums in course of collection 12,051 14,718
Property and equipment 13,472 18,259
Goodwill 17,679 18,385
Separate Account 39,643 51,005
Other 18,104 40,781
----------------------------------------------------------------------------
Total Assets $2,866,626 $3,009,473
- ----------------------------------------------------------------------------------------
Liabilities Policy liabilities $2,282,537 $2,363,329
General expenses and other liabilities 124,614 123,310
Mortgage payable 740 1,309
Short-term notes payable - 1,175
Income taxes (current: $562; $1,094) 13,011 31,569
Minority interest 58,478 56,381
Separate Account 39,643 51,005
----------------------------------------------------------------------------
Total Liabilities 2,519,023 2,628,078
- ----------------------------------------------------------------------------------------
Shareholder's Common stock ($5.00 par value; authorized - 5,250
Equity shares; issued and outstanding - 5,007 shares 68,274 68,274
Retained earnings 264,876 267,871
Net unrealized investment gains 14,453 45,250
----------------------------------------------------------------------------
Total Shareholder's Equity 347,603 381,395
----------------------------------------------------------------------------
Total Liabilities and Shareholder's Equity $2,866,626 $3,009,473
- ----------------------------------------------------------------------------------------
<FN>
See notes to consolidated financial statements.
</TABLE>
<PAGE>
CONSOLIDATED STATEMENT OF INCOME
(000s omitted)
<TABLE>
Year Ended December 31, 1996 1995 1994
- --------------------------------------------------------------------------------------------------
<S> <S> <C> <C> <C>
Revenues Insurance premiums and policy charges $157,568 $145,407 $136,308
Net investment income 165,690 168,715 166,157
Realized investment gains (losses) 634 (1,136) (1,425)
Other 4,447 4,342 3,978
--------------------------------------------------------------------------------------
Total Revenues 328,339 317,328 305,018
- ----------------------------------------------------------------------------------------------------
Benefits and Insurance benefits paid or provided 214,252 214,276 209,753
Expenses Insurance and general expenses 42,436 41,191 38,479
Amortization of deferred acquisition costs 22,743 23,113 20,928
--------------------------------------------------------------------------------------
Total Benefits and Expenses 279,431 278,580 269,160
- ----------------------------------------------------------------------------------------------------
Earnings Income from continuing operations
before income taxes and minority interest 48,908 38,748 35,858
Income taxes on continuing operations 16,815 11,958 10,073
Minority interest 4,497 3,566 2,937
--------------------------------------------------------------------------------------
Income From Continuing Operations 27,596 23,224 22,848
--------------------------------------------------------------------------------------
Discontinued Operations
Income (loss) from discontinued operations,
net of tax (919) 7,154 6,686
Loss on disposal, net of tax (25,080) - -
----------------------------------------------------------------------------------------
Income (Loss) From Discontinued Operations (25,999) 7,154 6,686
----------------------------------------------------------------------------------------
Net Income $ 1,597 $ 30,378 $ 29,534
- ----------------------------------------------------------------------------------------------------
<FN>
See notes to consolidated financial statements.
</TABLE>
<PAGE>
CONSOLIDATED STATEMENT OF CASH FLOWS
(000s omitted)
<TABLE>
Year Ended December 31, 1996 1995 1994
- ------------------------------------------------------------------------------------------------------
<S> <S> <C> <C> <C>
Operating Net income $ 1,597 $ 30,378 $ 29,534
Activities Adjustments to reconcile to net cash
provided by operating activities
Increase in policy liabilities 63,240 52,048 48,998
Change in reinsurance receivable (45,958) 4,058 (11,387)
Loss from discontinued operations,
net of tax 25,080 - -
Deferred acquisition costs (13,265) (11,561) (3,894)
Other, net (13,925) 14,141 18,140
----------------------------------------------------------------------------------------
Net Cash Provided by Operating Activities 16,769 89,064 81,391
- -------------------------------------------------------------------------------------------------------
Investing Proceeds from sales
Activities Fixed maturities - available for sale 209,200 308,663 113,375
Fixed maturities - held to maturity - 1,950 -
Mortgage loans, real estate, and other 31,107 4,744 18,239
Proceeds from maturities, redemptions,
and distributions
Fixed maturities - available for sale 72,996 96,188 155,684
Fixed maturities - held to maturity - 19,417 17,313
Mortgage loans, real estate, and other 69,404 46,828 58,666
Cost of purchases
Fixed maturities - available for sale (228,961) (507,084) (399,418)
Fixed maturities - held to maturity - - (5,000)
Mortgage loans, real estate, and other (9,887) (6,495) (26,068)
Change in policy loans 481 (1,911) (2,083)
Net payments on sale of discontinued
operations (11,702) - -
Purchases of property and equipment (591) (768) (2,008)
Net change in short-term investments (54,800) 3,722 15,710
-----------------------------------------------------------------------------------------
Net Cash Provided (Used) by Investing
Activities 77,247 (34,746) (55,590)
- --------------------------------------------------------------------------------------------------------
Financing Policyholder account deposits 149,924 150,469 143,627
Activities Policyholder account withdrawals (234,036) (194,006) (169,278)
Dividends to parent (11,200) (9,000) (2,975)
Repayment of mortgage payable (569) (598) (527)
----------------------------------------------------------------------------------------
Net Cash Used by Financing Activities (95,881) (53,135) (29,153)
- --------------------------------------------------------------------------------------------------------
Change in Cash Increase (Decrease) in Cash (1,865) 1,183 (3,352)
Cash at Beginning of Year 4,852 3,669 7,021
----------------------------------------------------------------------------------------
Cash at End of Year $ 2,987 $ 4,852 $ 3,669
- -------------------------------------------------------------------------------------------------------
<FN>
See notes to consolidated financial statements.
</TABLE>
<PAGE>
CONSOLIDATED STATEMENT OF SHAREHOLDER'S EQUITY
(000s omitted)
<TABLE>
Year Ended December 31, 1996 1995 1994
- ----------------------------------------------------------------------------------------------------
<S> <S> <C> <C> <C>
Common Stock Balance at beginning of year $68,274 $68,274 $87,865
and Additional Subsidiary stock issuances - - (19,591)
--------------------------------------------------------------------------------
Paid-In Capital Balance at end of year 68,274 68,274 68,274
- ----------------------------------------------------------------------------------------------------
Retained Balance at beginning of year 267,871 247,550 223,848
Earnings Net income 1,597 30,378 29,534
Dividends to parent (8,100) (9,100) (5,975)
Change in unfunded pension loss 3,508 (957) 143
--------------------------------------------------------------------------------
Balance at end of year 264,876 267,871 247,550
- ----------------------------------------------------------------------------------------------------
Net Unrealized Balance at beginning of year 45,250 (56,897) (9)
Investment Effect of change in accounting principle - - 39,424
Gains (Losses) Change during year (30,797) 102,147 (96,312)
--------------------------------------------------------------------------------
Balance at end of year 14,453 45,250 (56,897)
- ----------------------------------------------------------------------------------------------------
Total Shareholder's Equity at End of Year $347,603 $381,395 $258,927
- ----------------------------------------------------------------------------------------------------
<FN>
See notes to consolidated financial statements.
</TABLE>
<PAGE>
Notes To Consolidated Financial Statements
Note A
Nature of Operations
Washington National Insurance Company (WNIC or the Company) is a
wholly owned subsidiary of Washington National Corporation (WNC).
WNIC and its indirectly owned insurance subsidiary, United
Presidential Life Insurance Company (UPI) are engaged primarily
in marketing and underwriting life insurance and annuities for
individuals and specialty health insurance for educators. Based
on assets and income, the life insurance and annuity products
account for more than eighty percent of WNIC's business. The
Company's surplus and specialty health insurance products for
educators account for the remainder.
The markets for WNIC's life insurance and annuity products
include individuals and small businesses seeking universal life
insurance and other interest-sensitive life insurance and annuity
products. The market for the Company's specialty health insurance
products for educators consist primarily of school district
employees.
The markets for the Company's discontinued operations include:
individuals without employer-sponsored insurance in need of major
medical coverage; and employers with 2 to 1,000 employees seeking
employer-sponsored health insurance and associated life insurance
and stop-loss insurance.
In November 1996, WNC signed a definitive agreement to merge with
PennCorp Financial Group, Inc. (PennCorp). The transaction, which
is subject to approval by WNC and PennCorp shareholders and
certain regulatory agencies, is expected to be completed in the
second quarter of 1997. Under the terms of the merger, the
separate corporate existence of WNC will cease and PennCorp will
continue as the surviving entity. The entities of WNIC and UPI
will continue.
Note B
Significant Accounting Policies and Practices
Basis of Presentation
The accompanying consolidated financial statements have been
prepared in accordance with generally accepted accounting
principles (GAAP) and include the accounts and operations of the
Company. Significant intercompany transactions have been
eliminated. Certain amounts applicable to prior years' financial
statements have been reclassified to conform to the 1996
presentation. Revenue and expense amounts related to the
Company's health business sold in 1996 have been reclassified to
discontinued operations (see "Discontinued Operations," Note D).
The preparation of financial statements in conformity with GAAP
requires management to make estimates and assumptions that affect
the amounts reported. Actual results could differ from these
estimates.
The Company owns a 71.3% interest in United Presidential
Corporation (UPC), the parent company of UPI, a life insurance
company domiciled in Indiana. The remaining 28.7% of UPC is owned
by WNC. The operations of UPC are consolidated in the
accompanying financial statements, with WNC's ownership of UPC
represented by a minority interest.
Investments
Fixed Maturities. Fixed maturities include bonds, redeemable
preferred stocks, and mortgage-backed securities with contractual
maturities greater than one year. All of the Company's fixed
maturities are classified as "available for sale" and are carried
at fair value. The carrying value of the Company's fixed maturity
portfolio is inversely impacted by increases and decreases in
market interest rates which may change significantly in short
time periods.
<PAGE>
In 1995, the Company transferred its $84,146,000 of "held to
maturity" fixed maturities to "available for sale" resulting in a
$5,337,000 increase to unrealized investment gains. The Company
no longer holds any fixed maturities as "held to maturity."
Mortgage Loans on Real Estate. Mortgage loans on real estate are
carried at unpaid principal balance, net of allowance for losses.
The allowance is based on estimated uncollectible amounts
considering past credit loss experience and current economic
conditions and is subject to fluctuation based on actual
experience. Loans for which the Company determines that it is
probable that all amounts due under the contractual terms will
not be collected, are deemed to be impaired and are reported at
the lower of amortized cost or fair value of the underlying
collateral, less estimated costs to sell.
Real Estate and Joint Ventures. In general, real estate
investments are considered available for sale and carried at the
lower of book or fair value less estimated costs to sell. Joint
ventures are accounted for using the equity method.
Policy Loans. Loans to policyholders are carried at the unpaid
principal balance.
Other Long-term Investments. Other long-term investments consist
of investments in equity securities reported at fair value, and
venture capital investments that are accounted for under the
equity method.
Short-term Investments. Short-term investments include
commercial paper, variable demand notes, and money market funds
and are carried at amortized cost.
Net Investment Income. Net investment income consists primarily
of interest and dividends less expenses. Interest on fixed
maturities and performing mortgage loans, adjusted for any
amortization of discount or premium, is recorded as income when
earned and includes adjustments resulting from prepayments or
expected changes in prepayments on mortgage-backed securities.
Income on impaired loans and real estate is recorded principally
on a cash basis. Income on investments accounted for under the
equity method is recognized as it becomes earned. Investment
expenses are accrued as incurred.
Realized Investment Gains and Losses. Realized investment gains
and losses are recognized using the specific identification
method and include write-downs on investments having an other-
than-temporary decline in value.
Unrealized Investment Gains and Losses Unrealized investment
gains and losses on investments carried at fair value, net of
deferred taxes and adjustments for certain deferred acquisition
costs, are recorded directly in shareholder's equity.
Depreciation
Depreciation for real estate investments and property and
equipment is based on the estimated useful life of the asset
primarily using the straight-line method. Information on
depreciation related to continuing operations follows:
<TABLE>
- -----------------------------------------------------------
Accumulated Depreciation
(000s omitted) 1996 1995
- -----------------------------------------------------------
<S> <C> <C>
Real estate investments $13,175 $12,635
Property and equipment 4,355 3,571
- -----------------------------------------------------------
</TABLE>
<TABLE>
- -----------------------------------------------------------
Depreciation Expense
(000s omitted) 1996 1995 1994
- -----------------------------------------------------------
<S> <C> <C> <C>
Real estate investments $ 940 $ 1,320 $1,453
Property and equipment 784 1,137 1,333
- -----------------------------------------------------------
</TABLE>
<PAGE>
Insurance Premiums and Policy Charges
Insurance premiums and policy charges include reinsurance
premiums assumed and are net of reinsurance ceded. Health
insurance premiums are earned on a pro rata basis over the policy
period. Premiums for traditional life insurance products are
recognized as revenues when due. Revenues for certain interest-
sensitive products consist of charges earned and assessed against
policy account balances during the period for the cost of
insurance, policy initiation fees, policy administration
expenses, and surrender charges.
Deferred Acquisition Costs (DAC)
Certain costs associated with acquiring new business are deferred
and amortized to income over time. Amortization of costs for
traditional life insurance and health products is over the
premium paying period and is based on assumptions consistent with
those used in determining policy benefit reserves. Actual results
may differ significantly from these assumptions. For certain
interest-sensitive products, costs are amortized over the
estimated life of those products in proportion to the present
value of estimated gross profits from surrender charges and
investment, mortality, and expense margins. Changes in the amount
or timing of estimated gross profits will result in adjustments
in the cumulative amortization of these costs.
To the extent that unrealized investment gains or losses on fixed
maturities would result in an adjustment of DAC had those
investment gains or losses been realized, the related unamortized
DAC is adjusted and included in shareholder's equity.
The unamortized cost of purchased insurance in force is included
in DAC and amortized in proportion to the present value of
estimated gross profits over an estimated twenty year remaining
life with interest rates ranging from 7.5% to 8.5%.
The changes in the unamortized cost of purchased insurance in
force for the years ended December 31 follow:
<TABLE>
- -------------------------------------------------------------------------------
(000s omitted) 1996 1995 1994
- -------------------------------------------------------------------------------
<S> <C> <C> <C>
Balance at beginning of year $29,130 $45,282 $41,902
Interest on unamortized balance 2,702 2,915 3,136
Amortization (6,038) (5,635) (6,026)
Effect of unrealized investment gains and losses 5,620 (13,432) 6,270
- -------------------------------------------------------------------------------
Balance at end of year $31,414 $29,130 $45,282
- -------------------------------------------------------------------------------
</TABLE>
The estimated percentage of the December 31, 1996 balance before
the effect of unrealized investment gains and losses to be
amortized over the next five years follows:
<TABLE>
- ------------------------------------------------------------------------------
1997 1998 1999 2000 2001
- ------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Percent Amortization 15.25% 14.22% 13.72% 13.48% 13.30%
- ------------------------------------------------------------------------------
</TABLE>
Policy Liabilities
Liabilities for future policy benefits for traditional life
insurance products are provided on the net level premium method.
The Company bases reserve calculations on the present value of
future net premiums, benefits, and expenses, using estimates of
future investment yields, mortality, and withdrawal rates,
adjusted to provide for possible adverse deviation. Interest rate
assumptions are graded and ranged from 4.5% to 7.5% at December
31, 1996. Withdrawal assumptions are based principally on Company
experience and vary by issue age, type of coverage, and duration.
<PAGE>
Liabilities for future policy benefits of certain interest-
sensitive products are based on policy account balances prior to
applicable surrender charges, deferred policy initiation fees
that are recognized as income over the term of the policies, and,
for certain policies, a provision for the return of cost of
insurance charges. Policy benefits and claims that are charged to
expense include benefit claims in excess of related policy
accounts incurred in the period, interest credited to policy
balances, and a provision for the return of the cost of insurance
charges. Credited interest rates for these products ranged from
4.0% to 6.75% at December 31, 1996.
Liabilities for policy and contract claims are determined using
statistical analyses and case-basis evaluations and represent
estimates of the expected cost of incurred claims. Revisions to
these estimates are recognized in the consolidated statement of
income in the period when the revisions are made.
Goodwill
The amount paid to acquire a company over the fair value of its
net assets is reported as goodwill and is being amortized on a
straight-line basis, over a thirty-five year period. The value of
goodwill is considered appropriate based on the long-term nature
of the insurance policies sold. Accumulated amortization of
goodwill was $7,450,000 and $6,744,000 at December 31, 1996 and
1995, respectively.
Separate Account
Separate Account assets and liabilities are principally carried
at fair value and represent funds that are separately
administered for annuity contracts for which the contract holders
bear the investment risk. The assets are legally segregated from
the Company's assets and are not subject to any claims that arise
from any other business of the Company. Investment income and
realized investment gains and losses accrue directly to the
contract holders and are excluded from the accompanying
consolidated statement of income.
Income Taxes
The Company files a consolidated life/nonlife federal income tax
return. The Company establishes deferred tax provisions for
temporary differences between the financial reporting basis and
the tax basis of assets and liabilities at the enacted tax rate
expected to be in effect when the temporary differences reverse.
A valuation allowance for deferred tax assets is provided for the
portion of the asset not expected to be realized.
Reinsurance
In the normal course of business, the Company minimizes its
exposure to loss by reinsuring a portion of its life insurance,
annuity, and health insurance risks with other insurance
companies. The Company's policy on claim exposure for life
insurance and annuity products is to retain a maximum of $300,000
of life insurance exposure on any one individual. The Company
retains 100% of all long-term disability and a maximum of 50% of
all long-term care claims.
For continuing operations, the Company cedes reinsurance to
entities with A. M. Best ratings of "A-" or better or to entities
required to maintain assets in an independent trust fund whose
fair value is sufficient to discharge the obligations of the
reinsurer. Reinsurance contracts do not discharge the Company
from its obligations to the policyholders.
Benefit amounts paid directly by the Company for insurance claims
covered under ceded reinsurance agreements are recorded as
reinsurance recoverables to the extent not already reimbursed.
The cost of reinsurance is accounted for over the life of the
underlying reinsured policies using assumptions consistent with
those used to account for the underlying policies.
<PAGE>
For the Company's discontinued operations, paid-claim exposure
for group insurance products is limited to $750,000 per claim for
major medical coverage and $250,000 per claim for individual stop-
loss in any one calendar year. WNIC's reinsurance for individual
health insurance claims was designed to protect the Company from
an excessive amount of claims over $250,000 on an individual
claim basis.
Note C
New Accounting Standard
Effective January 1, 1994, the Company adopted SFAS 115,
"Accounting for Certain Investments in Debt and Equity
Securities." The effect of the adoption resulted in an increase
to shareholder's equity of $39,424,000.
Note D
Discontinued Operations
In May, 1996, the Board of Directors of the Company's parent
approved a plan to dispose of the Company's health insurance
business. The Company ceased the writing of this type of business
effective November 1, 1996. The sale of the individual and small
group health insurance to Pioneer Life Insurance Company (PLIC)
closed on August 2, 1996 and provided that PLIC would purchase
the Company's individual and small group health business, through
a reinsurance transaction, for a purchase price of $19,000,000.
The $19,000,000 was received at the close of the transaction.
PLIC has assumed the risks incurred related to this business
after August 1, 1996 except for a small run-off block of New
Jersey guaranteed issue business. The Company believes it has
made adequate provisions in the accrual for the loss on the sale
for the claims incurred prior to August 1, 1996 and the risks not
assumed by PLIC.
The sale of the remaining health insurance business, the large
group business, to Trustmark Insurance Company (Mutual) closed on
October 30, 1996, through a reinsurance transaction, that
provides that the Company will receive future consideration based
on persistency. The future consideration to be received is .5% of
premiums and premium equivalents, during the first three years on
groups that renew with Trustmark. The Company has estimated this
amount to be approximately $1,300,000 based on past persistency
and premium levels. The Company has retained responsibility for
the profit or loss on this business through the next renewal date
of each group. As a result, the Company has recorded a provision
for future losses on this business in the accrual for the loss on
sale.
The transactions resulted in the Company recording an estimated
net loss of $25,080,000, net of a tax credit of $12,500,000. The
loss consists principally of the future operating losses of this
business for which the Company remains responsible after the
measurement date, employee severance costs, the cost to terminate
the Company's defined benefit pension plan, related net asset
write-offs, and other related disposal costs net of the
anticipated proceeds. The loss is an estimate due to the nature
of the transactions and may change in future periods.
Both current and previously reported operating results of the
sold business have been reported in the consolidated statement of
income as discontinued operations. As permitted, the consolidated
balance sheet has not been segregated between continuing and
discontinued operations. At December 31, 1996, the business had
remaining assets of approximately $220,444,000 consisting
primarily of invested assets and a $72,840,000 reinsurance
receivable, and liabilities of approximately $220,444,000
consisting primarily of policy liabilities.
Revenues for the discontinued operations were $268,746,000,
$379,066,000, and $351,609,000 in 1996, 1995, and 1994,
respectively.
<PAGE>
Note E
Policy Liabilities
Detail of WNIC's policy liabilities at December 31 follows:
<TABLE>
- ----------------------------------------------------------
(000s omitted) 1996 1995
- ----------------------------------------------------------
<S> <C> <C>
Future policy benefits
Annuities $1,144,935 $1,228,947
Life 865,155 837,990
Policy and contract claims 212,074 219,755
Unearned premiums 37,633 37,382
Other 22,740 39,255
- ----------------------------------------------------------
Total policy liabilities $2,282,537 $2,363,329
- ----------------------------------------------------------
</TABLE>
Activity in the liability for short duration unpaid claims and
short duration claim adjustment expense reported in continuing
operations (included in policy and contract claims and a
component of general expenses and other liabilities) follows:
<TABLE>
- ----------------------------------------------------------
(000s omitted) 1996 1995 1994
- ----------------------------------------------------------
<S> <C> <C> <C>
Balance at January 1 $59,417 $58,333 $55,137
Incurred relating to:
Current year 55,978 53,247 54,395
Prior years 1,970 988 (3,400)
- ----------------------------------------------------------
Total incurred 57,948 54,235 50,995
- ----------------------------------------------------------
Paid relating to:
Current year 23,375 23,436 22,727
Prior years 31,423 29,715 25,072
- ----------------------------------------------------------
Total paid 54,798 53,151 47,799
- ----------------------------------------------------------
Net balance at December 31 $62,567 $59,417 $58,333
- ----------------------------------------------------------
</TABLE>
<PAGE>
Note F
Investments
Fixed Maturities
A comparison of amortized cost to fair value of fixed maturity
investments by category at December 31 follows:
<TABLE>
- -----------------------------------------------------------------------------------------------------------------
Amortized Gross Unrealized Fair
(000s omitted) Cost Gains Losses Value
- -----------------------------------------------------------------------------------------------------------------
<C> <C> <C> <C>
<CAPTION> 1996
- -----------------------------------------------------------------------------------------------------------------
<S>
United States government obligations $ 70,150 $ 1,604 $ 536 $ 71,218
Obligations of states and political subdivisions 78,993 2,426 350 81,069
Public utilities 149,986 2,567 2,408 150,145
Industrial and miscellaneous 1,000,227 33,921 9,070 1,025,078
Mortgage-backed securities 575,902 9,385 6,842 578,445
Other 23,872 1,376 74 25,174
- -----------------------------------------------------------------------------------------------------------------
Total fixed maturities $1,899,130 $ 51,279 $19,280 $1,931,129
- -----------------------------------------------------------------------------------------------------------------
<CAPTION> 1995
- -----------------------------------------------------------------------------------------------------------------
United States government obligations $ 75,750 $ 4,860 $66 $ 80,544
Obligations of states and political subdivisions 78,824 3,685 89 82,420
Public utilities 147,206 8,216 296 155,126
Industrial and miscellaneous 989,348 71,124 2,510 1,057,962
Mortgage-backed securities 634,236 19,404 627 653,013
Other 27,950 3,695 - 31,645
- -----------------------------------------------------------------------------------------------------------------
Total fixed maturities $1,953,314 $110,984 $ 3,588 $2,060,710
- -----------------------------------------------------------------------------------------------------------------
</TABLE>
During 1995, the Company sold one "held to maturity" investment
with an amortized cost of $2,000,000. The sale, which resulted in
a realized investment loss of $50,000, was made as a result of
significant deterioration of the bond issuer's creditworthiness.
The amortized cost and fair value of fixed maturities at December
31, 1996, by contractual maturity, follow. Expected maturities
differ from contractual maturities as borrowers may have the
right to call or prepay obligations with or without penalties. In
addition, corporate requirements may result in sales before
maturity.
<TABLE>
- ------------------------------------------------------------
Amortized Fair
(000s omitted) Cost Value
- ------------------------------------------------------------
<S> <C> <C>
Due in 1997 $ 23,091 $ 23,349
Due in 1998 - 2001 223,938 229,792
Due in 2002 - 2006 453,073 462,647
Due after 2006 623,126 636,896
Mortgage-backed securities 575,902 578,445
- ------------------------------------------------------------
Total fixed maturities $1,899,130 $1,931,129
- ------------------------------------------------------------
</TABLE>
<PAGE>
Mortgage Loans on Real Estate
Mortgage loan diversification at December 31, 1996 is as follows:
<TABLE>
- ------------------------------------------------------------
Carrying % of
(000s omitted) Value Total
- ------------------------------------------------------------
<S> <C> <C>
Property type
Retail $155,054 60.2%
Office 28,307 11.0
Industrial 22,097 8.6
Medical 16,610 6.4
Multi-family residential 11,309 4.4
All other (1) 24,258 9.4
- ------------------------------------------------------------
Total $257,635 100.0%
- ------------------------------------------------------------
Geographic distribution
California $ 42,760 16.6%
Illinois 33,754 13.1
Florida 29,463 11.4
Indiana 29,189 11.3
Texas 17,666 6.9
North Carolina 16,231 6.3
Virginia 14,062 5.5
All other (1) 74,510 28.9
- ------------------------------------------------------------
Total $257,635 100.0%
- ------------------------------------------------------------
</TABLE>
(1) No holdings in any other property
type or state exceed $10,000,000.
Information on mortgage loan maturities at December 31, 1996
follows:
<TABLE>
- ---------------------------------------------------------------------
Scheduled
Principal Balloon
(000s Omitted) Payments Payments Total
- ---------------------------------------------------------------------
<S> <C> <C> <C>
1997 $ 10,724 $ 29,096 $ 39,820
1998 11,691 6,847 18,538
1999 12,544 4,699 17,243
2000 13,083 5,051 18,134
2001 13,218 20,310 33,528
Due after 2001 70,362 60,010 130,372
- ---------------------------------------------------------------------
Total $131,622 $126,013 $257,635
- ---------------------------------------------------------------------
</TABLE>
Information on mortgage loan impairment for the years ended
December 31 follows:
<TABLE>
- -------------------------------------------------------------------------------------
(000s omitted) 1996 1995
- -------------------------------------------------------------------------------------
<S> <C> <C>
Non-impaired loans (net of allowance: $6,721; $7,171) $248,217 $306,847
Impaired loans (without allowance) 9,418 7,640
Impaired loans (net of allowance: $_; $135) - 2,762
- -------------------------------------------------------------------------------------
Total mortgage loans $257,635 $317,249
- -------------------------------------------------------------------------------------
Average investment in impaired mortgage loans $ 9,641 $ 5,812
Income recognized on impaired mortgage loans 584 732
Income received on impaired mortgage loans 534 714
- -------------------------------------------------------------------------------------
</TABLE>
<PAGE>
A rollforward of the allowance for mortgage loan losses follows:
<TABLE>
- ------------------------------------------------------------------------
(000s omitted) 1996 1995 1994
- ------------------------------------------------------------------------
<S> <C> <C> <C>
Balance at January 1 $7,306 $ 8,032 $12,031
Additions - 400 1,501
Deductions (585) (1,126) (5,500)
- ------------------------------------------------------------------------
Balance at December 31 $6,721 $ 7,306 $ 8,032
- ------------------------------------------------------------------------
</TABLE>
Realized Investment Gains and Losses
Details of realized investment gains (losses) for the years ended
December 31 follow:
<TABLE>
- -----------------------------------------------------------------------
(000s omitted) 1996 1995 1994
- -----------------------------------------------------------------------
<S> <C> <C> <C>
Fixed maturities
Gross gains $ 4,054 $ 7,257 $ 2,026
Gross losses (3,524) (7,740) (3,760)
- -----------------------------------------------------------------------
Total fixed maturities 530 (483) (1,734)
Mortgage loans on real estate 101 (52) (82)
Equity securities 355 (192) 1,447
Real estate and other (352) (409) (1,056)
- -----------------------------------------------------------------------
Realized investment
gains (losses) $ 634 $(1,136) $(1,425)
- -----------------------------------------------------------------------
</TABLE>
Investment Income
Major sources of net investment income from continuing operations
for the years ended December 31 follow:
<TABLE>
- -----------------------------------------------------------------------
(000s omitted) 1996 1995 1994
- -----------------------------------------------------------------------
<S> <C> <C> <C>
Fixed maturities $139,039 $138,998 $134,866
Mortgage loans on real estate 25,668 27,981 32,008
Real estate and other 5,108 7,103 8,181
Policy loans 3,828 3,643 3,459
Short-term 2,704 2,930 2,091
- -----------------------------------------------------------------------
Gross investment income 176,347 180,655 180,605
Investment expenses 10,657 11,940 14,448
- -----------------------------------------------------------------------
Net investment income $165,690 $168,715 $166,157
- -----------------------------------------------------------------------
</TABLE>
Investment expenses consist primarily of real estate and
portfolio management expenses.
At December 31, 1996, the carrying value of investments that
produced no income for the previous twelve month period was
$4,124,000 or less than 1% of invested assets.
<PAGE>
Unrealized Investment Gains and Losses
The following table details the net unrealized investment gains
and losses included in shareholder's equity:
<TABLE>
- -----------------------------------------------------------------------
(000s omitted) 1996 1995
- -----------------------------------------------------------------------
<S> <C> <C>
Gross unrealized gains $53,692 $112,849
Gross unrealized losses (20,039) (4,316)
DAC (8,115) (37,700)
Deferred income taxes (8,930) (21,035)
Minority interest (2,155) (4,548)
- -----------------------------------------------------------------------
Net unrealized investment gains $14,453 $ 45,250
- -----------------------------------------------------------------------
</TABLE>
The change in gross unrealized net gains and losses for fixed
maturity investments was $(75,397,000), $226,872,000, and
$(201,808,000) in 1996, 1995, and 1994, respectively.
Non-Cash Investing Activities
During 1996, 1995, and 1994, non-cash investing activities
totaled $8,461,000, $10,707,000, and $4,009,000, respectively,
and consisted of real estate acquired through foreclosure of
fixed maturities and mortgage loans on real estate, purchase
money mortgages, and venture capital distributions of common
stock.
Note G
Defined Benefit and Contribution Plans
Retirement Plans
The Company has three qualified defined contribution retirement
plans: a non-contributory money-purchase retirement plan, a non-
contributory discretionary profit sharing plan, and a
contributory 401(k) plan. The plans cover substantially all
employees who have met the prescribed requirements for
participation. The Company contribution to the money-purchase
retirement plan is 3% of each employee's compensation plus an
additional 3% of compensation in excess of the Social Security
wage base. The Company contribution to the profit sharing plan is
at the discretion of both WNIC's and UPI's Boards of Directors in
consultation with WNC's Board of Directors. Employees may
contribute up to 12% of compensation to the 401(k) plan. The
Company matches employee contributions dollar for dollar up to a
maximum of 3% of compensation. The net pension expense for
continuing operations for the defined contribution plans in 1996,
1995, and 1994 was $1,633,000, $1,237,000, and $928,000,
respectively. As a result of the Company's decision to dispose of
the health business in 1996, the plans are considered partially
terminated under present income tax law. The affect of the
partial termination is an accelerated vesting schedule which
vests at 100% those employees who leave the Company under certain
conditions on or after August 1, 1996. Active employees who
remain with the Company are not 100% vested until they meet the
service requirements of the plans.
The Company has a non-qualified supplemental retirement plan
under which benefits are paid to certain employees equal to the
amounts by which the qualified plan benefits are reduced due to
provisions of the Internal Revenue Code (IRC). At both December
31, 1996 and 1995, the unfunded liability for the supplemental
retirement plan was not material. This Plan will be terminated at
the completion of the merger with PennCorp and the benefits
distributed to the participants.
The Company has two defined benefit retirement plans, the
Washington National Retirement Plan ("WNIC Plan") and the United
Presidential Corporation Employees' Retirement Plan ("UPI Plan")
both of which cover certain grandfathered employees and agents.
Benefits are based principally on years of service and
compensation. In connection with the Company's disposal of the
health business, the WNIC Plan was terminated on October 1, 1996.
The Company is committed to fund amounts sufficient to meet all
benefit obligations under the WNIC Plan which are not covered by
plan assets. The distribution of
<PAGE>
plan assets to participants will
occur through the first half of 1997. The UPI Plan has been
amended to terminate the accrual of future benefits. The funding
policy is to contribute annually at least the minimum amounts
required by the IRC.
The components of net periodic pension income reported in income
from continuing operations for the defined benefit plans for the
years ended December 31 follow:
<TABLE>
- -------------------------------------------------------------------------------------
(000s omitted) 1996 1995 1994
- -------------------------------------------------------------------------------------
<S> <C> <C> <C>
Interest cost on projected benefit obligations $ 1,773 $ 1,734 $ 1,824
Actual return on plan assets (2,838) (3,419) (419)
Net amortization and deferral 176 1,118 (2,054)
- -------------------------------------------------------------------------------------
Net periodic pension income $ (889) $ (567) $ (649)
- -------------------------------------------------------------------------------------
</TABLE>
The funded status and the amounts reported in WNIC's Consolidated
Balance Sheet as part of other liabilities for the defined
benefit plans at December 31 follow:
<TABLE>
- -----------------------------------------------------------------------------------------------
(000s omitted) 1996 1995
- -----------------------------------------------------------------------------------------------
<S> <C> <C>
Actuarial present value of accumulated benefit obligations:
Vested $(24,005) $(26,501)
Non-vested (81) (78)
- -----------------------------------------------------------------------------------------------
Accumulated benefit obligations $(24,086) $(26,579)
- -----------------------------------------------------------------------------------------------
Projected benefit obligations $(24,086) $(26,579)
Plan assets at fair value 24,624 25,482
- -----------------------------------------------------------------------------------------------
Plan assets in excess of (less than) projected benefit obligations $ 538 $ (1,097)
- -----------------------------------------------------------------------------------------------
Comprised of:
Prepaid pension cost $ 4,389 $ 3,190
Unrecognized actuarial net loss (6,464) (8,207)
Unrecognized transition asset 2,613 3,920
- -----------------------------------------------------------------------------------------------
Total $ 538 $ (1,097)
- -----------------------------------------------------------------------------------------------
</TABLE>
In addition, WNIC's Consolidated Balance Sheet includes an
accrual of $3,500,000 for the estimated funding for the
termination of the WNIC Plan.
Plan assets are invested principally in mutual funds, stocks, and
venture capital funds. The WNIC Plan held 415,564 shares of WNC
Common and 17,108 shares of WNC Preferred Stock at both December
31, 1996 and 1995 with a fair market value of $12,322,000 and
$12,408,000, respectively. Dividends of $492,000 were received on
the WNC Common and Preferred Stock in both 1996 and 1995. No WNC
shares were purchased or sold during 1996 or 1995. The Company
will repurchase the shares from the WNIC Plan in 1997 in
connection with the distribution of plan assets to participants.
The actuarial assumptions used to measure the projected benefit
obligations include:
<TABLE>
- ---------------------------------------------------------------------------------------
1996 1995 1994
- ---------------------------------------------------------------------------------------
<S> <C> <C> <C>
Weighted-average discount rate 7.0% 7.0% 7.5%
Weighted-average expected rate of return on plan assets 7.6% 7.6% 7.6%
- ---------------------------------------------------------------------------------------
</TABLE>
<PAGE>
The UPI Plan and the WNIC Plan (prior to the WNIC's Plan
termination) transition asset is being amortized over a fourteen-
year period. Actuarial gains and losses are deferred and then
amortized over a fourteen-year period when the cumulative
deferred amounts exceeded certain limits.
Postretirement Benefit Plan
In addition to the Company's retirement programs, a contributory
group life and medical insurance plan is provided to certain
eligible retirees and certain grandfathered active employees who
have met a combination of age and service requirements (the
Plan). The Plan pays a stated percentage of most medical
expenses, reduced for deductibles and payments made by government
programs or other group coverage. Active employees who are not
included in the grandfathered group are eligible for $10,000 of
life insurance benefits under the Plan after reaching a
combination of age and service requirements.
In 1993, the Company established a Voluntary Employees'
Beneficiary Association (VEBA) trust under section 501(c)(9) of
the IRC for the purpose of paying out postretirement benefits to
plan participants. The VEBA is funded annually, based on the
difference between the net periodic postretirement benefit
expense as measured by statutory accounting rules and the retiree
medical claims incurred during the respective periods, subject to
certain IRC limitations. Assets of the VEBA trust were invested
in a short- term government money market fund and corporate
demand notes at December 31, 1996.
The components of net periodic postretirement benefit expense for
continuing operations for the years ended December 31 follow:
<TABLE>
- ------------------------------------------------------------------------------
(000s omitted) 1996 1995 1994
- ------------------------------------------------------------------------------
<S> <C> <C> <C>
Interest cost $1,657 $1,537 $1,654
Service cost 53 40 46
Return on plan assets (234) (181) (23)
Net amortization and deferral 51 68 188
- ------------------------------------------------------------------------------
Net periodic postretirement benefit expense $1,527 $1,464 $1,865
- ------------------------------------------------------------------------------
</TABLE>
The funded status of the plan and the amount recognized in WNIC's
Consolidated Balance Sheet as part of other liabilities at
December 31 follow:
<TABLE>
- -------------------------------------------------------------------------------------------------
(000s omitted) 1996 1995
- -------------------------------------------------------------------------------------------------
<S> <C> <C>
Accumulated postretirement benefit obligation
Retirees, dependents, and disabled participants $(22,024) $(27,578)
Fully eligible active plan participants (680) (997)
Other active plan participants (263) (1,048)
- -------------------------------------------------------------------------------------------------
Total accumulated postretirement benefit obligation (22,967) (29,623)
Fair value of plan assets 6,568 4,516
- -------------------------------------------------------------------------------------------------
Accumulated postretirement benefit obligation in excess of plan assets $(16,399) $(25,107)
- -------------------------------------------------------------------------------------------------
Comprised of
Accrued postretirement benefit expense $(21,700) $(23,074)
Unrecognized actuarial net gain (loss) 5,134 (2,215)
Unrecognized prior service cost 167 182
- -------------------------------------------------------------------------------------------------
Total $(16,399) $(25,107)
- -------------------------------------------------------------------------------------------------
</TABLE>
<PAGE>
The actuarial assumptions used to measure the postretirement
benefit obligation include:
<TABLE>
- -------------------------------------------------------------------------------
1996 1995 1994
- -------------------------------------------------------------------------------
<S> <C> <C> <C>
Weighted-average discount rate 7.25% 7.00% 7.50%
Weighted-average after-tax expected rate of
return on plan assets 4.60% 4.60% 4.60%
Estimated income tax rate 34.00% 34.00% 34.00%
- -------------------------------------------------------------------------------
</TABLE>
The health care cost trend rate in 1996 was 11.1% for pre-age 65
and 9.3% for post-age 65 participants, graded evenly to 5.0% in
13 years. The health care trend rate used in 1995 was 11.5% for
pre-age 65 and 9.7% for post-age 65 participants, graded evenly
to 5.0% in 14 years. The health care cost trend rate assumption
has a significant effect on the amounts reported. Increasing the
trend rate by 1% per year would increase the accumulated
postretirement benefit obligation by $1,939,000 at December 31,
1996 and the aggregate of the service and interest cost
components of net periodic postretirement benefit expense by
$197,000 in 1996.
Note H
Reinsurance
The effect of reinsurance on insurance premiums and policy
charges earned from continuing operations for the years ended
December 31 follows:
<TABLE>
- ------------------------------------------------------------------------
(000s omitted) 1996 1995 1994
- ------------------------------------------------------------------------
<S> <C> <C> <C>
Direct premiums and policy charges $206,659 $198,803 $193,181
Premiums ceded (49,091) (53,396) (56,873)
- ------------------------------------------------------------------------
Net premiums and policy charges $157,568 $145,407 $136,308
- ------------------------------------------------------------------------
</TABLE>
Reinsurance benefits ceded from continuing operations were
$19,837,000, $19,619,000, and $19,134,000, in 1996, 1995, and
1994, respectively.
At December 31, 1996, approximately 66% of WNIC's total
reinsurance recoverables related to the Company's discontinued
operations. Of the 66%, 85% was from PLIC as a result of the sale
of the individual and small group business and 12% was due from
UNUM Life Insurance Company. Of WNIC's total reinsurance
recoverables, 21% were due from Combined Insurance Company of
America.
The Company uses yearly renewable term reinsurance at its
insurance subsidiary to maintain statutory profitability and
other statutory financial requirements while sustaining growth.
The cumulative contribution to statutory basis capital and
surplus from this reinsurance was $8,018,000 and $8,202,000 at
December 31, 1996 and 1995, respectively. These transactions do
not materially impact the Company's GAAP financial statements.
<PAGE>
Note I
Income Taxes
Components of WNIC's deferred tax liabilities and assets at
December 31 follow:
<TABLE>
- -------------------------------------------------------------------------
(000s omitted) 1996 1995
- -------------------------------------------------------------------------
<S> <C> <C>
Deferred tax liabilities:
DAC $76,641 $ 75,789
Unrealized investment gains 11,288 33,768
Accrued bond discount 1,791 1,630
Joint ventures and venture capital investments 1,781 2,150
Other 871 1,739
- -------------------------------------------------------------------------
Total deferred tax liabilities 92,372 115,076
Deferred tax assets:
Policy liability adjustments 57,469 65,576
Liabilities for employee benefits 12,741 13,723
Realized investment losses 8,276 5,718
Net liabilities related to discontinued business 4,924 -
Other 4,286 4,672
- -------------------------------------------------------------------------
Total deferred tax assets 87,696 89,689
Valuation allowance (7,773) (5,088)
- -------------------------------------------------------------------------
Deferred tax assets, net of valuation allowance 79,923 84,601
- -------------------------------------------------------------------------
Net deferred tax liabilities $12,449 $ 30,475
- -------------------------------------------------------------------------
</TABLE>
Other than capital gain or loss items, the nature of WNIC's
deferred tax assets and liabilities is such that the general
reversal pattern for these temporary differences is expected to
result in a full realization of WNIC's deferred tax assets.
At December 31, 1996, WNIC had capital loss carryforwards for tax
return purposes of $110,000, which will expire in 2000. For
financial reporting purposes, a valuation allowance has been
recognized to offset the deferred tax assets related to those
carryforwards, investment loss reserves, and other capital loss-
related deferred tax assets not expected to be realized. The
valuation allowance increased by $2,685,000 in 1996 and decreased
by $10,510,000 in 1995.
Prior to 1984, the Company was required to accumulate certain
untaxed amounts in a memorandum "policyholders' surplus account."
Under the Tax Reform Act of 1984, the "policyholders' surplus
account" balances were capped at December 31, 1983 and taxed only
to the extent distributed to shareholders or when they exceed
certain prescribed limits. The Company does not intend to make
any taxable distributions or to exceed the prescribed limits in
the foreseeable future; therefore, no income tax provision has
been made for those purposes. However, if such taxes were
assessed, the amount of tax payable would be approximately
$19,922,000. At December 31, 1996, the combined "policyholders'
surplus account" of the Company approximates $57,000,000.
Under current and prior law, income of the Company taxed on a
current basis is accumulated in a shareholder's surplus account
and can be distributed without tax to WNC. At December 31, 1996,
this shareholder's surplus was $279,711,000.
<PAGE>
The following reconciles the difference between actual tax
expense and the amounts obtained by applying the statutory
federal income tax rate of 35%:
<TABLE>
- ---------------------------------------------------------------------------------------
(000s omitted) 1996 1995 1994
- ---------------------------------------------------------------------------------------
<S> <C> <C> <C>
Income tax at statutory rate applied to income from
continuing operations before income taxes $15,544 $12,314 $11,522
Tax expense not recognized on certain GAAP-basis
capital gains or losses (920) (1,484) (2,179)
Investment income not taxed (286) (299) (452)
Merger related expenses 544 - -
Amortization of purchase accounting adjustments 247 247 247
Other 1,686 1,180 935
- ---------------------------------------------------------------------------------------
Income tax expense from continuing operations 16,815 11,958 10,073
- ---------------------------------------------------------------------------------------
Comprised of:
Current expense 15,023 9,914 7,260
Deferred expense 1,792 2,044 2,813
- ---------------------------------------------------------------------------------------
Income tax expense from continuing operations 16,815 11,958 10,073
- ---------------------------------------------------------------------------------------
Income tax expense (benefit) from discontinued operations (13,088) 3,567 2,989
- ---------------------------------------------------------------------------------------
Total income tax expense $ 3,727 $15,525 $13,062
- ---------------------------------------------------------------------------------------
</TABLE>
Deferred income taxes (benefits) of $(11,526,000), $45,045,000,
and $(24,451,000) have been provided in 1996, 1995, and 1994,
respectively, which are recorded as a direct charge to
shareholder's equity rather than net income. These taxes
primarily relate to the change in net unrealized investment gains
and losses.
Income taxes paid by WNIC were $10,759,000, $12,969,000, and
$8,120,000 in 1996, 1995, and 1994, respectively.
The Internal Revenue Service is currently examining the Company's
tax returns for 1992 through 1994.
Note J
Commitments and Contingencies
Leases
WNIC has noncancelable operating leases primarily for office
space and office equipment, the most significant of which is a
twenty-year lease of the Company's home office building with a
related party as lessor. Future minimum lease payments required
under operating leases that have initial or remaining
noncancelable lease terms in excess of one year at December 31,
1996 follow:
<TABLE>
- ---------------------------------------------
<CAPTION>
(000s omitted)
- ---------------------------------------------
<C> <C>
1997 $ 6,393
1998 5,084
1999 4,247
2000 3,925
2001 3,620
Thereafter 40,952
- ---------------------------------------------
Total minimum lease commitments $64,221
- ---------------------------------------------
</TABLE>
Of the above future minimum lease commitments, $6,378,000 has
been accrued for as part of the loss on sale of discontinued
operations.
<PAGE>
Rental expenses for continuing operations were $2,658,000,
$3,348,000, and $2,893,000, in 1996, 1995, and 1994,
respectively.
As a result of the proposed merger with PennCorp, the Company is
exploring the subleasing of its home office building. A sublease
could result in a charge to earnings in future periods.
Financial Guarantees
The Company has entered into certain financial guarantees. A
financial guarantee is a conditional commitment to guarantee the
payment of an obligation by an unrelated entity to a third party
and has off-balance sheet credit risk. The exposure to credit
risk is represented by the amount the Company would be required
to pay under certain circumstances.
At December 31, 1996 the Company had three financial guarantees
totaling $11,460,000 with related letters of credit totaling
$2,104,000 and a construction completion guarantee. At December
31, 1995 the Company had three financial guarantees totaling
$11,600,000, related letters of credit of $2,133,000 and a
construction completion guarantee. The Company feels it has
adequate reserves for related potential losses.
Litigation
WNIC and certain affiliated companies have been named in various
pending legal proceedings considered to be ordinary routine
litigation incidental to the business of such companies. A number
of other legal actions have been filed which demand compensatory
and punitive damages aggregating material dollar amounts. WNIC
believes that such suits are substantially without merit and that
valid defenses exist. WNIC's management and its chief legal
officer are of the opinion that such litigation will not have a
material effect on WNIC's results of operations or consolidated
financial position. The amount involved in any proceeding, or
group of proceedings presenting in large degree the same issues,
does not exceed the materiality standard for disclosure contained
in Instruction 2 to Item 103 of Regulation S-K.
In June 1996, the estate of a retired employee filed a lawsuit in
the United States District Court for the Northern District of
Illinois against WNIC, WNIC's parent, WNC, and the three
individual trustees of the Washington National Insurance Company
Home Office Group Insurance Plan (the Plan), and the Plan. The
plaintiff purports to represent a class consisting of eligible
retirees under the Plan who retired before January 1, 1992.
This complaint, brought under the Employee Retirement Income
Security Act, centers around a January 1992 amendment to the Plan
which resulted in a different coordination of benefits with
Medicare. Also, at that time the retirees were first required to
contribute a portion of their premium, whereas previously the
Company paid 100% of retiree medical premium. Plaintiff seeks
certification of the class, permanent no-cost retiree medical
benefits, an accounting and repayment of premium contributions,
attorney fees, costs and expenses, plus other appropriate
equitable relief. Plaintiff utilizes several theories of
recovery, namely, promissory estoppel, equitable estoppel,
negligent misrepresentation, breach of fiduciary duty, and
entitlement.
WNIC, WNC and the individual trustees believe that valid defenses
exist and intend to contest vigorously the allegations made in
the complaint.
<PAGE>
State Guaranty Funds
Under insolvency or guaranty laws in most states in which the
Company operates, insurers can be assessed for policyholder
losses incurred by insolvent insurance companies. At present,
most insolvency or guaranty laws provide for assessments based on
the amount of insurance underwritten in a given jurisdiction. The
Company paid $1,137,000, $1,934,000, and $2,850,000 in state
guaranty fund assessments in 1996, 1995, and 1994, respectively,
and had accrued liabilities of $4,483,000 and $3,478,000 for
estimated future assessments at December 31, 1996 and 1995,
respectively.
For 1996, $327,000 and $1,606,000 of the above paid and accrued
guaranty fund assessments, respectively, relate to the
discontinued operations.
The Company's accounting policy with regard to payments to state
guaranty funds is to treat as assets any such payments in those
states where current law allows an offset against future premium
taxes if the Company expects to utilize the asset. At December
31, 1996 and 1995, other assets included $2,799,000 and
$5,226,000, respectively, of deferred payments to state guaranty
funds. Generally, these amounts will be used to offset future
premium tax payments over periods from five to ten years. Under
certain circumstances, including changes in state laws and a
change in the Company's product mix, such amounts might become
unrecoverable.
Note K
Mortgage Payable and Credit Arrangements
Mortgage Payable
Mortgage payable of $740,000 at December 31, 1996 consisted of a
mortgage on investment real estate with an interest rate of 6.5%
that matures in July, 1997. The property is pledged as
collateral with a carrying value of $6,753,000 at December 31,
1996.
Interest paid on borrowings by WNIC was $71,000, $110,000, and
$146,000, in 1996, 1995, and 1994, respectively.
Credit Arrangements
WNIC has a $10,000,000 short-term line of credit available with
one bank which is also available to WNC and which was unused at
December 31, 1996. The line of credit arrangement is renewable
annually, but credit can be withdrawn at the bank's option.
In addition, WNIC has four letters of credit with varying terms
and conditions totaling $2,184,000. As of December 31, 1996, the
entire amount was unused.
Note L
Statutory Financial Information
WNIC and UPI prepare statutory financial statements in accordance
with accounting principles and practices prescribed or permitted
by the insurance department of the applicable state of domicile.
Prescribed statutory accounting practices currently include state
laws, regulations, and general administrative rules applicable to
all insurance enterprises domiciled in a particular state, as
well as practices described in National Association of Insurance
Commissioners' publications. Permitted practices include
practices not prescribed, but allowed, by the domiciliary state
insurance department. The prescribed and permitted statutory
accounting practices differ from GAAP.
<PAGE>
Current statutory practice does not address reserves for certain
endowment features of several life insurance products marketed by
the Company which uses a practice permitted by its state of
domicile and discounts the future benefit using mortality and
interest rate assumptions.
A summary of statutory net income and capital and surplus as of
and for the years ended December 31 follows:
<TABLE>
- -------------------------------------------------------------------
(000s omitted) 1996 1995 1994
- -------------------------------------------------------------------
<S> <C> <C> <C>
Statutory net income $ 19,482 $ 18,278 $ 18,633
Statutory capital and surplus 240,034 231,930 221,270
- -------------------------------------------------------------------
</TABLE>
Dividends To Parent
The amount of dividends available for distribution without prior
regulatory approval is limited by regulatory restrictions. This
amount is the greater of: a) 10% of WNIC's and UPI's statutory
capital and surplus as of the preceding year end; or b) WNIC's or
UPI's statutory net income from operations for the preceding
year. WNIC is permitted a maximum of $21,544,000 in dividend
distributions to WNC in 1997 without the prior approval of
regulatory authorities. UPI is permitted to pay $8,568,000 in
dividends ($6,109,000 to WNIC and $2,459,000 to WNC) without
prior regulatory approval. WNIC paid dividends of $11,200,000 to
WNC in 1996. There were no dividends paid by UPI. In connection
with the pending merger, the Illinois Insurance Department has
approved WNIC's request to pay an extraordinary dividend of
$75,000,000 in 1997.
<PAGE>
Note M
Fair Value of Financial Instruments
The fair values of certain financial instruments along with their
corresponding carrying values at December 31, 1996, and 1995
follow. As the fair value of all WNIC's assets and liabilities is
not presented, this information in the aggregate does not
represent the underlying value of WNIC. WNIC does not have any
financial instruments held or issued for trading purposes.
<TABLE>
- -------------------------------------------------------------------------------------------------
1996 1995
-------------------- ---------------------
Fair Carrying Fair Carrying Valuation
(000s omitted) Value Value Value Value Method
- -------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Financial assets
Fixed maturities $1,931,129 $1,931,129 $2,060,710 $2,060,710 (1)
Equity securities 1,745 1,745 1,994 1,994 (1)
Mortgage loans on real estate 271,965 257,635 336,366 317,249 (2)
Policy loans 54,258 55,798 53,665 56,279 (3)
Cash and short-term investments 105,707 105,707 52,772 52,772 (4)
Investment proceeds receivable 1,092 1,092 2,289 2,289 (4)
Accrued investment income 31,671 31,671 32,652 32,652 (4)
Separate Account investment - - 11,840 11,840 (4)
Financial liabilities
Investment-type insurance contracts 1,043,707 1,070,581 1,131,665 1,161,263 (3)
Mortgage payable 757 740 1,328 1,309 (2)
Short-term borrowings - - 1,175 1,175 (4)
Off-balance sheet guarantees
Real estate developments 110 - 157 - (5)
- -------------------------------------------------------------------------------------------------
(1)Fair values are based on publicly quoted market prices at
the close of trading on the last business day of the year. In
cases where publicly quoted market prices are not available,
fair values are based on estimates using values obtained from
independent pricing services or, in the case of private
placements, by discounting expected future cash flows using a
current market rate applicable to the yield, credit quality,
and maturity of the investments.
(2)Fair values are estimated using discounted cash flow
analyses based on interest rates currently being offered for
similar loans to borrowers with similar credit ratings. A
pricing cap is put on mortgage loans that carry significant
above-market interest rate yields to reflect the prepayment
risk.
(3)Fair values are estimated using discounted cash flow
calculations based on interest rates currently being offered
for similar contracts with similar maturities.
(4)Carrying value approximates fair value.
(5)Fair values are based on estimates of fees to guarantee
similar developments. In addition, the Company has a
construction completion guarantee pertaining to a joint
venture investment. The Company does not feel that estimating
a fair value for the instrument is practicable due to the
inability to estimate cash flows. See Note J for further
discussion of guarantees.
</TABLE>
<PAGE>
Note N
Segment Information
WNIC has two business segments: insurance operations and
corporate and other. Prior to the sale of the Company's health
business, the Company had three business segments (see Note D).
The corporate and other segment includes realized investment
gains and losses and operations that do not specifically support
the insurance operations. Assets not individually identifiable by
segment are allocated, generally, based on the amount of segment
liabilities. Depreciation expense and capital expenditures are
not material. Revenues, pretax income from continuing operations,
and assets by segment for the years ended and at December 31
follow:
<TABLE>
- -----------------------------------------------------------------------------------------
(000s omitted) 1996 1995 1994
- -----------------------------------------------------------------------------------------
<S> <C> <C> <C>
Revenues from continuing operations (1)
Insurance operations $ 318,092 $ 309,054 $ 299,105
Corporate and other 10,247 8,274 5,913
- -----------------------------------------------------------------------------------------
Consolidated total $ 328,339 $ 317,328 $ 305,018
- -----------------------------------------------------------------------------------------
Pretax income(loss) from continuing operations (1)
Insurance operations $ 44,361 $ 37,794 $ 34,397
Corporate and other 50 (2,612) (1,476)
- -----------------------------------------------------------------------------------------
Consolidated total $ 44,411 $ 35,182 $ 32,921
- -----------------------------------------------------------------------------------------
Assets
Insurance operations $2,431,614 $2,512,050 $2,345,240
Corporate and other 214,568 210,267 210,871
Discontinued operations 220,444 287,156 250,246
- -----------------------------------------------------------------------------------------
Consolidated total $2,866,626 $3,009,473 $2,806,357
- -----------------------------------------------------------------------------------------
(1) Prior year amounts have been reclassified to reflect the
discontinued operations of the health business.
</TABLE>
Actuarial estimates are used in determining certain policy
liabilities and deferred acquisition costs which in turn effect
the reported profitability of the insurance operations segment.
Actual results can differ materially from these actuarial
estimates. In addition, changes in these estimates, where
required, may have a significant effect on reported net income,
especially in the year of the change.
The profits of the insurance operations segment are highly
dependent on interest rate spreads, which is the difference
between the amount earned on investments and the amount credited
to policyholders. Increases in market interest rates could result
in the need to credit higher rates to policyholders without a
comparable increase in the rate earned on the Company's invested
assets; they could also result in customers surrendering their
policies to obtain higher rates from other insurance companies or
alternative products. Decreases in market interest rates could
result in inadequate spreads due to the inability to lower
credited rates below certain minimum guarantees as to such rates.
The profitability of most of the Company's products depends on
the ability to attract and retain customers at a price level
sufficient to cover the various expenses incurred by the Company.
The nature of these products is such that customers can in most
cases easily transfer to other insurance carriers offering more
attractive coverage. The profitability of the products may change
over time depending on the degree of competition in the markets
for such products.
<PAGE>
The registrant hereby incorporates by reference the March 1, 1997
Fundamental Investors Prospectus, file number
811-32, filed with the Commission on April 28, 1997.
