UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
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 SEPTEMBER 30, 1996
------------------
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 1-10640
RELIASTAR FINANCIAL CORP.
--------------------------------------------------------------
(Exact name of registrant as specified in its charter)
DELAWARE 41-1620373
- --------------------------------- -----------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
20 WASHINGTON AVENUE SOUTH, MINNEAPOLIS, MINNESOTA 55401
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(Address of principal executive offices)
(Zip Code)
(612) 372-5432
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(Registrant's telephone number, including area code)
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(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 X NO
------ -------
Number of shares of common stock outstanding as of October 31, 1996 was
37,363,931.
<PAGE>
PART I-FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
RELIASTAR FINANCIAL CORP.
Condensed Consolidated Balance Sheets
(in millions)
(unaudited)
<TABLE>
<CAPTION>
SEPTEMBER 30, 1996 DECEMBER 31, 1995
------------------ -----------------
ASSETS
<S> <C> <C>
Fixed Maturity Securities, Available-for-Sale $ 9,002.7 $ 9,053.7
Equity Securities 41.0 35.9
Mortgage Loans on Real Estate 1,913.1 1,948.4
Real Estate and Leases 88.8 97.9
Policy Loans 539.4 499.8
Other Invested Assets 53.7 47.0
Short-Term Investments 126.1 131.5
------------ ------------
Total Investments 11,764.8 11,814.2
Cash 34.0 48.5
Accounts and Notes Receivable 170.8 165.3
Reinsurance Receivable 179.8 162.9
Deferred Policy Acquisition Costs 998.6 860.7
Present Value of Future Profits 222.6 192.0
Property and Equipment, Net 120.9 123.2
Accrued Investment Income 171.5 164.7
Other Assets 342.5 299.1
Participation Fund Account Assets 316.9 319.6
Assets Held in Separate Accounts 1,897.5 1,369.0
------------ ------------
TOTAL ASSETS $ 16,219.9 $ 15,519.2
============ ============
LIABILITIES
Future Policy and Contract Benefits $ 11,207.7 $ 11,033.2
Pending Policy Claims 284.6 257.7
Other Policyholder Funds 193.4 174.4
Notes and Mortgages Payable 407.4 422.3
Income Taxes 107.4 170.2
Other Liabilities 367.1 358.8
Participation Fund Account Liabilities 316.9 319.6
Liabilities Related to Separate Accounts 1,892.0 1,362.9
------------ ------------
TOTAL LIABILITIES 14,776.5 14,099.1
------------ ------------
Company-Obligated Mandatorily Redeemable Preferred
Securities Issued by a Consolidated Subsidiary 120.9 -
SHAREHOLDERS' EQUITY
10% Senior Cumulative Preferred Stock - 63.2
ESOP Convertible Preferred Stock 28.7 28.9
Note Receivable from ESOP (22.3) (23.4)
Common Stock (Shares Issued: 39.8) 541.5 566.5
Unamortized Restricted Stock Awards (2.0) (3.0)
Net Unrealized Investment Gains 89.1 246.8
Retained Earnings 756.0 647.2
Less Treasury Common Stock, at Cost (Shares Held: 1996, 2.5;
1995, 3.5) (68.5) (106.1)
------------ ------------
TOTAL SHAREHOLDERS' EQUITY 1,322.5 1,420.1
------------ ------------
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY $ 16,219.9 $ 15,519.2
============ ============
</TABLE>
See accompanying notes to condensed consolidated financial statements.
2
<PAGE>
RELIASTAR FINANCIAL CORP.
Condensed Consolidated Statements of Income
(in millions, except per share data)
(unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPTEMBER 30 NINE MONTHS ENDED SEPTEMBER 30
1996 1995 1996 1995
REVENUES
<S> <C> <C> <C> <C>
Premiums $ 205.6 $ 207.1 $ 619.2 $ 627.0
Net Investment Income 233.7 228.2 703.2 660.7
Realized Investment Gains (Losses) - (.3) 8.7 5.0
Policy and Contract Charges 61.2 55.2 181.8 161.1
Other Income 44.1 32.5 111.8 94.5
----------- ----------- ----------- -----------
Total 544.6 522.7 1,624.7 1,548.3
----------- ----------- ----------- -----------
BENEFITS AND EXPENSES
Benefits to Policyholders 314.6 328.3 966.9 981.0
Sales and Operating Expenses 111.1 90.6 312.0 265.2
Amortization of Deferred Policy Acquisition Costs
and Present Value of Future Profits 28.2 23.2 82.4 70.5
Interest Expense 7.2 7.4 21.4 19.6
Dividends and Experience Refunds to Policyholders 7.7 7.0 15.8 17.9
----------- ----------- ----------- -----------
Total 468.8 456.5 1,398.5 1,354.2
----------- ----------- ----------- -----------
Income Before Income Taxes and Net Dividends on Preferred
Securities of Subsidiary 75.8 66.2 226.2 194.1
Income Tax Expense 26.3 23.5 79.2 68.8
Net Dividends on Preferred Securities of Subsidiary 1.6 - 3.3 -
----------- ----------- ----------- -----------
Net Income $ 47.9 $ 42.7 $ 143.7 $ 125.3
=========== =========== =========== ===========
NET INCOME PER COMMON SHARE
Primary $ 1.26 $ 1.10 $ 3.74 $ 3.23
=========== =========== =========== ===========
Fully Diluted $ 1.19 $ 1.03 $ 3.53 $ 3.04
=========== =========== =========== ===========
Net Income Available to Common Shareholders $ 47.4 $ 40.6 $ 139.0 $ 119.1
=========== =========== =========== ===========
Weighted Average Shares
Common and Common Equivalent Shares (Primary) 37.7 37.0 37.2 36.9
Common Shares Assuming Maximum Dilution (Fully Diluted) 40.3 39.7 39.8 39.6
</TABLE>
See accompanying notes to condensed consolidated financial statements.
3
<PAGE>
RELIASTAR FINANCIAL CORP.
Condensed Consolidated Statements of Shareholders' Equity
(in millions, except per share data)
(unaudited)
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30
1996 1995
10% SENIOR CUMULATIVE PREFERRED STOCK
<S> <C> <C>
Beginning of Period $ 63.2 $ 63.2
Redeemed (63.2) -
------------- ------------
End of Period - 63.2
------------- ------------
ESOP CONVERTIBLE PREFERRED STOCK
Beginning of Year 28.9 29.3
Redeemed (.2) (.3)
------------- ------------
End of Period 28.7 29.0
------------- ------------
NOTE RECEIVABLE FROM ESOP
Beginning of Year (23.4) (24.6)
Repayments, Accrued or Paid 1.1 .9
------------- ------------
End of Period (22.3) (23.7)
------------- ------------
COMMON STOCK
Beginning of Year 566.5 293.4
Issued for Benefit Plans - .2
Issued for Acquisition - 265.9
Loss on Treasury Shares Reissued for Benefit Plans (2.9) (2.6)
(Loss) Gain on Treasury Shares Reissued for Acquisitions (23.9) 10.1
Tax Benefit on Stock Options Exercised 1.8 1.1
------------- ------------
End of Period 541.5 568.1
------------- ------------
UNAMORTIZED RESTRICTED STOCK AWARDS
Beginning of Year (3.0) (2.1)
Awards, Net (.1) (2.1)
Amortization of Restricted Stock Awards 1.1 .9
------------- ------------
End of Period (2.0) (3.3)
------------- ------------
NET UNREALIZED INVESTMENT GAINS (LOSSES)
Beginning of Year 246.8 (79.4)
Change for the Period (157.7) 209.2
------------- ------------
End of Period 89.1 129.8
------------- ------------
RETAINED EARNINGS
Beginning of Year 647.2 528.4
Net Income 143.7 125.3
Dividends to Shareholders:
10% Senior Cumulative Preferred Stock (Per Share: 1996, $5.00;
1995, $7.50) (3.2) (4.7)
ESOP Convertible Preferred Stock ($1.643 Per Share) (2.1) (2.1)
Common Stock (Per Share: 1996, $.81; 1995, $.725) (29.6) (26.7)
Tax Benefit on ESOP Convertible Preferred Stock Dividend .6 .6
Redemption of ESOP Convertible Preferred Stock (.6) (.6)
------------- ------------
End of Period 756.0 620.2
------------- ------------
TREASURY COMMON STOCK
Beginning of Year (106.1) (9.7)
Acquired with Acquisition - (72.7)
Reissued for Acquisitions 25.2 9.7
Acquired, Other (3.5) (50.4)
Reissued, Other 15.9 14.1
------------- ------------
End of Period (68.5) (109.0)
------------- ------------
TOTAL SHAREHOLDERS' EQUITY $ 1,322.5 $ 1,274.3
============= ============
</TABLE>
See accompanying notes to condensed consolidated financial statements.
4
<PAGE>
RELIASTAR FINANCIAL CORP.
Condensed Consolidated Statements of Cash Flows
(in millions)
(unaudited)
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30
1996 1995
OPERATING ACTIVITIES
<S> <C> <C>
Net Income $ 143.7 $ 125.3
Adjustments to Reconcile Net Income to Net Cash Provided by
Operating Activities
Interest Credited to Insurance Contracts 370.9 369.2
Future Policy Benefits (180.4) (88.4)
Capitalization of Deferred Policy Acquisition Costs (149.0) (133.3)
Amortization of Deferred Policy Acquisition Costs 82.4 70.5
Deferred Income Taxes 14.3 8.8
Net Change in Receivables and Payables 47.5 (33.2)
Other Assets (50.2) (94.4)
Realized Investment Gains, Net (8.7) (5.0)
Other 5.7 7.9
------------- --------------
Net Cash Provided by Operating Activities 276.2 227.4
------------- --------------
INVESTING ACTIVITIES
Proceeds from Sales of Available-for-Sale Fixed Maturity Securities 161.3 148.2
Proceeds from Maturities or Repayment of Fixed Maturity Securities 675.2 516.0
Cost of Fixed Maturity Securities Acquired (1,140.8) (1,056.5)
Sales (Purchases) of Equity Securities, Net (1.0) 16.9
Proceeds of Mortgage Loans Sold, Matured or Repaid 316.7 217.2
Cost of Mortgage Loans Acquired (291.9) (256.2)
Sales of Real Estate and Leases, Net 19.0 21.6
Policy Loans Issued, Net (39.6) (60.6)
Sales of Other Invested Assets, Net .5 12.3
Sales (Purchases) of Short-Term Investments, Net 5.4 (72.0)
Net Cash Acquired with Acquisition of USLICO Corp. - 1.3
------------- --------------
Net Cash Used by Investing Activities (295.2) (511.8)
------------- --------------
FINANCING ACTIVITIES
Deposits to Insurance Contracts 855.4 967.8
Maturities and Withdrawals from Insurance Contracts (866.2) (745.4)
Retirement of Senior Cumulative Preferred Stock (63.2) -
Net Proceeds from Issuance of Preferred Securities 120.8 -
Increase in Notes and Mortgages Payable 51.3 238.3
Repayment of Notes and Mortgages Payable (66.2) (96.1)
Payments Received on Note Receivable from ESOP - .9
Issuance of Common Stock Under Stock Option and Other Plans 11.0 5.9
Dividends on 10% Senior Cumulative Preferred Stock (3.2) (4.7)
Dividends on ESOP Convertible Preferred Stock (2.1) (2.1)
Dividends on Common Stock (29.6) (26.7)
Acquisition of Treasury Common Stock (3.5) (50.4)
------------- --------------
Net Cash Provided by Financing Activities 4.5 287.5
------------- --------------
Increase (Decrease) in Cash (14.5) 3.1
Cash at Beginning of Period 48.5 20.3
------------- --------------
Cash at End of Period $ 34.0 $ 23.4
============= ==============
</TABLE>
See accompanying notes to condensed consolidated financial statements.
5
<PAGE>
RELIASTAR FINANCIAL CORP.
Notes to Condensed Consolidated Financial Statements
(unaudited)
Note 1. Basis of Presentation
The condensed consolidated financial statements have been prepared in conformity
with generally accepted accounting principles and such principles were applied
on a basis consistent with that reflected in the 1995 Annual Report filed with
the Securities and Exchange Commission (SEC) except for the accounting changes
as described in Note 2. The financial information included herein, other than
the condensed consolidated balance sheet as of December 31, 1995, has been
prepared by management without audit by independent certified public
accountants. The condensed consolidated balance sheet as of December 31, 1995
has been derived from, and does not include all the disclosures contained in the
audited consolidated financial statements for the year ended December 31, 1995.
The information furnished includes all adjustments and accruals consisting only
of normal, recurring accrual adjustments which are, in the opinion of
management, necessary for a fair statement of results for the interim period.
The results of operations for any interim period are not necessarily indicative
of results for the full year. The unaudited interim condensed consolidated
financial statements should be read in conjunction with the financial statements
and notes thereto contained in the Annual Report of ReliaStar Financial Corp.
(the Company or ReliaStar) for the year ended December 31, 1995.
Note 2. Accounting Changes
ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO
BE DISPOSED OF
Effective January 1, 1996, the Company adopted Statement of Financial Accounting
Standards (SFAS) No. 121 "Accounting for the Impairment of Long-Lived Assets and
for Long-Lived Assets to be Disposed Of." SFAS No. 121 establishes accounting
standards for the impairment of long-lived assets, certain identifiable
intangibles, and goodwill related to those assets to be held and used and for
long-lived assets and certain identifiable intangibles to be disposed of. This
Statement requires that long-lived assets and certain identifiable intangibles
to be held and used by an entity be reviewed for impairment whenever events or
changes in circumstances indicate that the carrying amount of an asset may not
be recoverable. Measurement of an impairment loss for long-lived assets and
identifiable intangibles that an entity expects to hold and use should be based
on the fair value of the asset. Long-lived assets and certain identifiable
intangibles to be disposed of must be reported at the lower of carrying amount
or fair value less cost to sell. The adoption of this standard did not have a
significant effect on the financial results of the Company.
ACCOUNTING FOR STOCK-BASED COMPENSATION
Effective January 1, 1996, the Company adopted SFAS No. 123, "Accounting for
Stock-Based Compensation." SFAS No. 123 requires expanded disclosures of
stock-based compensation arrangements with employees and encourages (but does
not require) compensation cost to be measured based on the fair value of the
equity instrument awarded. Companies are permitted, however, to continue to
apply Accounting Principles Board (APB) Opinion No. 25, which recognizes
compensation cost based on the intrinsic value of the equity instrument awarded.
The Company will continue to apply APB Opinion No. 25 to its stock-based
compensation awards to employees and directors and will disclose the required
proforma effect on net income and earnings per share in its consolidated
financial statements for the year ending December 31, 1996.
Note 3. Company-Obligated Mandatorily Redeemable Preferred Securities Issued by
a Consolidated Subsidiary
On March 29, 1996, ReliaStar Financing I (the "Subsidiary Trust"), a
consolidated wholly owned subsidiary of ReliaStar, issued $125.0 million of
8.20% Trust-Originated Preferred Securities (the "Preferred Securities"). In
connection with the Subsidiary Trust's issuance of the Preferred Securities and
the related purchase by ReliaStar of all of the Subsidiary Trust's common
securities (the "Common Securities"), ReliaStar issued to the Subsidiary Trust
$128.9 million principal amount of its 8.20% Subordinated Deferrable Interest
Notes, due March 15, 2016 (the "Junior Subordinated Debt Securities"). The sole
assets of the Subsidiary Trust are and will be the Junior
6
Subordinated Debt Securities. The interest and other payment dates on the Junior
Subordinated Debt Securities correspond to the distribution and other payment
dates on the Preferred Securities and the Common Securities. Under certain
circumstances, the Junior Subordinated Debt Securities may be distributed to
holders of Preferred Securities and holders of the Common Securities in
liquidation of the Subsidiary Trust. The Junior Subordinated Debt Securities are
redeemable at the option of ReliaStar on or after March 29, 2001, at a
redemption price of $25 per Junior Subordinated Debt Security plus accrued and
unpaid interest. The Preferred Securities and the Common Securities will be
redeemed on a PRO RATA basis to the same extent that the Junior Subordinated
Debt Securities are repaid, at $25 per Preferred Security and Common Security
plus accumulated and unpaid distributions. ReliaStar's obligations under the
Junior Subordinated Debt Securities and related agreements, taken together,
constitute a full and unconditional guarantee by ReliaStar of payments due on
the Preferred Securities. On March 29, 1996, 5,000,000 shares of Preferred
Securities were issued and all remain outstanding.
Note 4. Redemption of 10% Senior Cumulative Preferred Stock
On July 1, 1996, the Company redeemed, at par, all of the outstanding shares of
its 10% Senior Cumulative Preferred Stock. The par value of the 10% Senior
Cumulative Preferred Stock was $63.25 million. The redemption was funded with a
portion of the proceeds from the issuance of the Preferred Securities (See Note
3).
Note 5. Acquisitions
During September 1996, the Company acquired Successful Money Management
Seminars, Inc. (SMMS). SMMS, headquartered in Portland, Oregon, develops and
distributes educational materials used primarily in the presentation of seminars
to consumers on personal financial planning. The acquisition was accounted for
using the pooling-of-interests method of accounting. Prior periods were not
restated due to immateriality.
Note 6. Subsequent Event
During October 1996, the Company completed the acquisition of PrimeVest
Financial Services, Inc. (PrimeVest). PrimeVest is a full-service, third-party
marketing firm located in St. Cloud, Minnesota, which specializes in
distributing mutual funds, stocks and bonds, variable and fixed annuities, and
other financial products and services through a network of financial
institutions. The purchase price was approximately $16 million and the
acquisition will be accounted for using the purchase method of accounting.
7
<PAGE>
ITEM 2. RELIASTAR FINANCIAL CORP.
Management's Discussion and Analysis
of Financial Condition and Results of Operations
RESULTS OF OPERATIONS
Pretax results of operations by business segment are summarized below (in
millions):
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30 ENDED SEPTEMBER 30
1996 1995 1996 1995
Pretax Income (Loss) Excluding Realized
<S> <C> <C> <C> <C>
Investment Gains and Losses:
Individual Insurance $ 52.2 $ 45.7 $ 149.8 $ 128.4
Employee Benefits 12.4 11.4 34.4 33.5
Life and Health Reinsurance 11.7 11.2 35.9 33.1
Pension 3.6 2.7 11.2 8.1
Corporate and Other (4.1) (4.5) (13.8) (14.0)
------- ------- ------- -------
Pretax Operating Income 75.8 66.5 217.5 189.1
Net Pretax Realized Investment Gains (Losses) - (.3) 8.7 5.0
------- ------- ------- -------
Pretax Income Before Net Dividends
on Preferred Securities of Subsidiary 75.8 66.2 226.2 194.1
Income Tax Expense 26.3 23.5 79.2 68.8
Net Dividends on Preferred Securities of Subsidiary 1.6 - 3.3 -
------- ------- ------- -------
Net Income $ 47.9 $ 42.7 $ 143.7 $ 125.3
======= ======= ======= =======
</TABLE>
The discussion of business segment results that follows refers to the above
pretax segment results and, in each instance, amounts are before income taxes
unless otherwise noted.
INDIVIDUAL INSURANCE
The Individual Insurance segment of the Company is composed of the individual
insurance division of ReliaStar Life Insurance Company ("ReliaStar Life",
formerly Northwestern National Life Insurance Company), Northern Life Insurance
Company (Northern), United Services Life Insurance Company (USL) and ReliaStar
Bankers Security Life Insurance Company ("RBSL", formerly Bankers Security Life
Insurance Society). The North Atlantic Life Insurance Company of America was
merged into RBSL on December 28, 1995. These subsidiaries are sometimes
collectively referred to as the Insurers.
Pretax operating income for the third quarter of 1996 increased 14% to $52.2
million compared to the third quarter of 1995. Pretax operating income for the
first nine months of 1996 increased $21.4 million or 17 percent compared with
the same period in 1995. The increase in quarterly earnings is primarily due to
an increase in interest spreads and an eight percent growth in assets under
management. The average interest spread of 249 basis points in the third quarter
of 1996 increased 22 basis points compared with 227 basis points in the third
quarter of 1995. This increase in spreads reflects a 27 basis point reduction in
the average crediting rate and a 5 basis point decrease in the portfolio yield.
Year-to-date earnings also increased primarily due to the increased interest
spreads and the six percent growth in assets under management. Management
expects interest spreads in the fourth quarter of 1996 to decline from the third
quarter level. It should be noted that the interest spread calculation is an
annualized measure and can be overly influenced in a particular quarter by the
level of investment prepayment premiums, recoveries on problem investments and
other quarterly variances in the level of net investment income. For most of the
business, crediting rates on in force business are reset annually at the
beginning of the calendar year and are guaranteed for one year. Crediting rates
offered on new business can be changed at any time in response to competition
and market interest rates, and are guaranteed on most new premiums received to
the end of the calendar year.
8
EMPLOYEE BENEFITS
Pretax operating income for the third quarter of 1996, increased $1.0 million or
9% compared to the same period of 1995. Pretax operating income for the first
nine months of 1996 increased 3% to $34.4 million compared to the first nine
months of 1995. Third quarter pretax operating income increased primarily due to
more favorable group life mortality experience, more favorable group health
morbidity experience and higher net investment income. These favorable variances
were partially offset by the impact of higher operating expense ratios.
Long-term disability business continued to be profitable in the third quarter of
1996. Year-to-date pretax operating income increased primarily due to favorable
morbidity experience and higher net investment income.
LIFE AND HEALTH REINSURANCE
Pretax operating income of the Life and Health Reinsurance segment for the third
quarter of 1996 increased 4% to $11.7 million compared to the same period in
1995. Pretax operating income increased $2.8 million for the first nine months
of 1996 when compared with the same period in 1995. Segment pretax operating
income for the year-to-date and the third quarter of 1996 was higher than the
same periods in 1995 due primarily to increased earned premium, and higher net
investment income. These positive earnings variances were partially offset by a
slightly less favorable overall loss ratio as compared with 1995. Earnings in
the reinsurance business can fluctuate based upon a number of factors, including
pricing, market capacity, the availability and pricing of retrocessional
programs, loss experience and the risk profile of the book of business.
PENSION
Pretax operating income of the Pension segment for the third quarter of 1996 was
$.9 million higher than for the same period of 1995. Pretax operating income
increased $3.1 million for the nine months ended September 30, 1996 compared
with the same period in 1995. Third quarter pretax operating income from the
small employer 401(k) line of business increased to $1.3 million in 1996
compared with $.6 million in 1995. Income in the 401(k) line of business
increased primarily due to higher fee revenues attributable to growth in assets
under management. Pretax operating income in the participating pension and GIC
lines of business for the third quarter of 1996 increased $.2 million compared
with the second quarter of 1995. Year-to-date segment earnings increased $3.1
million compared with 1995 due primarily to higher fee revenues in the small
employer 401(k) line of business and higher interest margins in the
participating pension and GIC lines of business.
CORPORATE AND OTHER
The pretax operating loss for Corporate and Other for the third quarter of 1996
was $.4 million lower than for the same period of 1995. The pretax operating
loss for the first nine months of 1996 was $.2 million lower than for the same
period of 1995. The lower quarterly loss was due primarily to higher earnings in
the Company's mortgage banking subsidiary and lower losses in the Company's
mutual fund operations. The lower year-to-date losses compared to the same
period in 1995 are primarily due to lower losses in the Company's mutual fund
operations and short-term interest income on the proceeds from the issuance of
$125.0 million in Trust-Originated Preferred Securities (TOPrSsm) prior to the
redemption of $63.25 million of 10% Senior Cumulative Preferred Stock (see
FINANCIAL CONDITION - Liquidity and Capital Resources - ReliaStar Financial
Corp.). The short term interest income from the TOPrSsm proceeds was offset by
TOPrSsm dividend expense ($3.3 million) which is reported on a separate line on
the results of operations by business segment table shown on the previous page.
Offsetting the favorable variances are lower year-to-date earnings of the
Company's mortgage banking subsidiary resulting from gains of $4.8 million
recognized in the first quarter of 1995 from bulk sales of mortgage servicing
rights. There have been no such sales in 1996.
9
<PAGE>
REALIZED INVESTMENT GAINS AND LOSSES
The sources of the pretax realized investment gains (losses) were as follows (in
millions):
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30 ENDED SEPTEMBER 30
1996 1995 1996 1995
Net Gains (Losses) on Sales of Investments
<S> <C> <C> <C> <C>
Fixed Maturity Securities $ (3.5) $ .4 $ 2.5 $ 2.5
Equity Securities 1.6 - 1.7 9.2
Mortgage Loans 0.1 - 0.1 -
Foreclosed Real Estate .3 .7 .6 .4
Real Estate 2.0 .9 2.7 1.6
Other 1.6 2.0 7.3 1.6
------- ------ ------ -------
2.1 $ 4.0 14.9 15.3
------- ------ ------ -------
Provision for Losses on Investments
Fixed Maturity Securities - (1.4) (1.1) (3.0)
Equity Securities - - - (.1)
Mortgage Loans (.7) (.6) (1.9) (3.0)
Foreclosed Real Estate (1.3) (2.3) (2.7) (4.2)
Real Estate (.1) - (.5) -
-------- ------ ------- ------
(2.1) (4.3) (6.2) (10.3)
------- ------ ------ -------
Net Pretax Realized Investment Gains (Losses) $ - $ (.3) $ 8.7 $ 5.0
======= ====== ====== =======
</TABLE>
Gross realized gains and losses from the sale of available-for-sale fixed
maturity securities were as follows (in millions):
NINE MONTHS
ENDED SEPTEMBER 30
1996 1995
Gross Realized Gains $ 6.1 $ 5.7
Gross Realized Losses $ (3.6) $ (3.2)
The Company establishes allowances and writes down the value of specific assets
based upon its continuing review of individual problem investments. The
Company's practice of recording allowances and write-downs based upon a review
of individual problem assets results in fluctuations in the level of the
provision for losses on investments reported in each period. The provision for
losses on investments is affected to a significant degree by general economic
conditions and the status of the real estate market. While the Company believes
it has set aside appropriate reserves and allowances for problem investments,
subsequent economic and market conditions may require the establishment of
additional reserves.
DISCONTINUED OPERATIONS
In connection with the March 1992 sale of Chartwell Re Corporation (Chartwell),
the Company and the acquiring company entered into a separate reciprocal reserve
indemnification agreement with respect to the adequacy of the loss and loss
adjustment expense reserves of Chartwell. On June 28, 1996 a final settlement of
the reserve indemnification agreement was reached. The Company's previous
accruals for this liability were adequate.
ACQUISITIONS
During September 1996, the Company acquired Successful Money Management
Seminars, Inc. (SMMS). SMMS, headquartered in Portland, Oregon, develops and
distributes educational materials used primarily in the presentation of seminars
to consumers on personal financial planning. The acquisition was accounted for
using the pooling-of-interests method of accounting. Prior periods were not
restated due to immateriality.
10
During October 1996, the Company completed the acquisition of PrimeVest
Financial Services, Inc. (PrimeVest). PrimeVest is a full-service, third-party
marketing firm located in St. Cloud, Minnesota, which specializes in
distributing mutual funds, stocks and bonds, variable and fixed annuities and
other financial products and services through a network of financial
institutions. The purchase price was approximately $16 million and the
acquisition will be accounted for using the purchase method of accounting.
FINANCIAL CONDITION
LIQUIDITY AND CAPITAL RESOURCES - RELIASTAR FINANCIAL CORP.
ReliaStar, as parent, is dependent upon dividends, interest and payments for
other charges received from its subsidiaries to pay dividends to shareholders,
service its debt and pay other obligations. The payment of dividends, interest
or other charges by the Insurers is subject to restrictions imposed by
applicable insurance laws and regulations.
The payment of future dividends by ReliaStar will be largely dependent upon the
ability of ReliaStar Life to pay dividends to it. Under Minnesota insurance law
regulating the payment of dividends by ReliaStar Life, any such payment must be
in an amount deemed prudent by ReliaStar Life's board of directors and, unless
otherwise approved by the Commissioner of the Minnesota Department of Commerce
(the Commissioner), must be paid solely from the adjusted earned surplus of
ReliaStar Life. Adjusted earned surplus means the earned surplus as determined
in accordance with statutory accounting practices (unassigned funds) less 25% of
the amount of such earned surplus which is attributable to net unrealized
capital gains. Further, without approval of the Commissioner, ReliaStar Life may
not pay in any calendar year any dividend which, when combined with other
dividends paid within the preceding 12 months, exceeds the greater of (i) 10% of
ReliaStar Life's statutory surplus at the prior year-end or (ii) 100% of
ReliaStar Life's statutory net gain from operations (not including realized
capital gains) for the prior calendar year. For 1996, the amount of dividends
which can be paid by ReliaStar Life without Commissioner approval is $117.7
million.
On December 18, 1995, the Company filed a shelf registration statement with the
Securities and Exchange Commission for the issuance of up to $250.0 million of
debt or equity securities. This filing replaced and superseded the unused
portion ($140.0 million) of a previous shelf registration. On March 27, 1996 the
Company sold $125.0 million of 8.20% TOPrSsm. The Company used the proceeds from
this offering to redeem, at par, all of the outstanding shares of its 10% Senior
Cumulative Preferred Stock on July 1, 1996, repay short-term bank debt and for
general corporate purposes.
LIQUIDITY AND CAPITAL RESOURCES - INSURERS
Liquidity for life insurance companies is measured by their ability to pay
scheduled contractual benefits, pay operating expenses and fund investment
commitments. Sources of liquidity include scheduled and unscheduled principal
and interest payments on investments, premium payments and deposits and the sale
of liquid investments. These sources of liquidity for the Insurers significantly
exceed scheduled uses.
Liquidity is also affected by unscheduled benefit payments, including death
benefits, benefits under insured accident and health policies and contract
withdrawals and surrenders. The amount of withdrawals and surrenders is affected
by a variety of factors such as credited interest rates for competing products,
general economic conditions, the Insurers' claims paying ratings and events in
the industry which affect policyholders' confidence.
The Insurers' investment portfolios represent a significant source of liquid
assets. As of September 30, 1996, the Insurers' investment portfolio included
$6.6 billion (41% of total assets) of short-term investments and investment
grade marketable bonds. The September 30, 1996 investment portfolio also
included $2.0 billion of investment grade privately placed bonds which, while
not publicly traded, are a source of liquidity.
The policies and annuities issued by the Individual Insurance segment contain
provisions which allow contractholders to withdraw or surrender their contracts
under defined circumstances. These policies and annuities generally contain
provisions which apply penalties or otherwise restrict the ability of
contractholders to make unscheduled withdrawals or surrenders. The Insurers
closely monitor the surrender and policy loan activity of their insurance
products and manage the composition of their investment portfolios, including
liquidity, in light of
11
such activity. The Insurers have not experienced any material changes in
withdrawal and surrender activity attributable to their individual insurance
products which would have a material effect on liquidity.
Changes in interest rates may affect the incidence of policy surrenders and
other withdrawals. In addition to the potential impact on liquidity,
unanticipated withdrawals in a changed interest rate environment could adversely
affect earnings if the Company were required to sell investments at reduced
values in order to meet liquidity demands. The Company manages the asset and
liability portfolios in order to minimize the adverse earnings impact of
changing market interest rates. The Company seeks assets which have duration
characteristics similar to the liabilities which they support. The Company also
uses derivative instruments, such as interest rate swaps and futures contracts,
to adjust the duration of the asset and liability portfolios (see INVESTMENTS
Derivative Financial Instruments). The Company closely monitors its derivative
usage and has procedures in place to manage counter-party risks and related
exposures.
Statutory surplus is computed according to rules prescribed by the National
Association of Insurance Commissioners (NAIC), as modified by each Insurer's
state of domicile. Statutory accounting rules are different from GAAP and are
intended to reflect a more conservative perspective by, for example, requiring
immediate recognition of selling expenses. The Company's long-term growth goals
contemplate continued growth in its insurance businesses. To achieve these
growth goals, the Insurers will need to increase their statutory surplus.
Additional statutory surplus may be secured through various sources such as
internally generated statutory earnings, equity sales by a subsidiary or equity
infusions by the Company with funds generated through debt or equity offerings.
The state of domicile of each of the Insurers imposes minimum risk-based capital
requirements on insurance enterprises. The formulas for determining the amount
of risk-based capital specify various weighting factors that are applied to
financial balances or various levels of activity based on the perceived degree
of risk. Regulatory compliance is determined by a ratio of a company's
regulatory total adjusted capital, as defined, to its authorized control level
risk-based capital, as defined. Companies below specific trigger points or
ratios are classified within certain levels, each of which requires specified
corrective action. The risk-based capital ratio of each of the Insurers
significantly exceeds the ratios at which regulatory corrective action would be
required.
CONSOLIDATED CASH FLOWS
The Company's cash balance at September 30, 1996 was $34.0 million. During the
first nine months of 1996, net cash provided by operating and financing
activities was $276.2 million and $4.5 million, respectively, which was offset
by net cash used by investing activities of $295.2 million.
The $276.2 million of net cash provided by operating activities was primarily
the result of positive cash flow from premiums and investment income receipts in
excess of cash outflows for insurance benefits and sales and operating expenses.
Net cash provided by financing activities of $4.5 million was primarily the
result of positive cash flow from the net proceeds from the issuance of the
TOPrSsm securities offset by the redemption of the 10% Senior Cumulative
Preferred Securities and dividends on common stock.
INVESTMENTS
The investment strategy for the Company is designed to maintain the overall
quality of the portfolios, to maintain an appropriate liquidity position, to
assure appropriate asset/liability structures, to achieve asset type
diversification and to avoid issuer concentration.
The Company intends to direct most of its investment cash flow in 1996 to the
acquisition of investment grade marketable and privately placed bonds. The
marketable bonds category includes both corporate issues and structured finance
securities such as collateralized mortgage obligations (CMOs) and other
mortgage-backed securities. The Company will make new investments in commercial
mortgages and below investment grade bonds subject to overall limitations.
The assets held by each of the Insurers are legally segregated and support only
their respective contractual obligations. The investment portfolios of each
Insurer are structured to reflect the characteristics of the liabilities which
they support. The Company internally allocates assets within ReliaStar Life, USL
and RBSL to facilitate
12
segment asset/liability matching. These segment allocations are solely for
portfolio management purposes, and generally all of the assets allocated to a
segment are available to satisfy the respective liabilities of all segments.
Assets within these portfolios are selected to provide compatible duration, cash
flow and return characteristics. All of the investments in the Insurers'
portfolios are subject to diversification, quality and reserving requirements of
state laws regulating the Insurers.
The following table provides information regarding the composition of the
Company's invested assets as of the indicated dates:
<TABLE>
<CAPTION>
SEPTEMBER 30, 1996 DECEMBER 31, 1995
(In Millions) AMOUNT PERCENT AMOUNT PERCENT
<S> <C> <C> <C> <C>
Investment Grade Bonds:
Marketable $ 6,464.8 55.0% $ 6,551.5 55.5%
Private Placements 2,035.7 17.3 2,062.1 17.4
---------- ------ ----------- ------
Subtotal 8,500.5 72.3 8,613.6 72.9
Below Investment Grade Bonds:
Marketable 254.9 2.1 198.8 1.7
Private Placements 245.3 2.1 239.3 2.0
----------- ------- ------------ -------
Subtotal 500.2 4.2 438.1 3.7
Equity Securities 41.0 .3 35.9 .3
Commercial Mortgages 1,406.7 12.0 1,465.0 12.4
Mortgages, Residential and Other 506.4 4.3 483.4 4.1
Real Estate 88.8 .7 97.9 .8
Short-Term Investments 126.1 1.1 131.5 1.1
Other 595.1 5.1 548.8 4.7
----------- ------- ----------- -------
Total Invested Assets $11,764.8 100.0% $11,814.2 100.0%
========= ===== ========= =====
</TABLE>
FIXED MATURITY SECURITIES
The amount invested in fixed maturity securities as of September 30, 1996 and
December 31, 1995, was $9.0 billion and $9.1 billion, respectively. The average
marketable and private placement bond investments in a single corporate issuer
(excluding structured finance securities such as CMOs, mortgage-backed pass
throughs and asset-backed securities) as of September 30, 1996 were $9.3 million
and $7.6 million, respectively.
All of the Company's marketable and privately placed bonds are required to be
evaluated by the Securities Valuation Office (SVO) of the NAIC. The SVO
evaluates the investments of insurers for regulatory reporting purposes and
assigns securities to one of six investment categories. The NAIC's categories
closely follow the public rating agencies' definition for marketable bonds. NAIC
categories 1 and 2 include bonds considered investment grade (BBB or higher) by
the public rating agencies. Categories 3 through 6 are referred to as below
investment grade (BB or lower).
As of September 30, 1996, the weighted average book yields of the Company's
investment grade portfolio and below investment grade portfolio were 7.8% and
9.0%, respectively. The weighted average book yield is not necessarily
reflective of the net investment income ultimately realized by the Company.
Investments with greater credit risk have a greater risk of default than
investment grade securities, and, accordingly, some of the incremental book
yield of the below investment grade portfolio may not be realized.
13
<PAGE>
The following tables identify the amortized cost and the fair value of the
Company's fixed maturity securities with respect to each NAIC credit
classification as of the indicated dates (in millions):
<TABLE>
<CAPTION>
SEPTEMBER 30, 1996
- ----------------------------------------------------------------------------------------------------------
MARKETABLES PRIVATE PLACEMENTS
NAIC AMORTIZED GROSS UNREALIZED FAIR AMORTIZED GROSS UNREALIZED FAIR
---------------- ----------------
RATING COST GAINS (LOSSES) VALUE COST GAINS (LOSSES) VALUE
- ------ ---- ----- -------- ----- ---- ----- -------- -----
<C> <C> <C> <C> <C> <C> <C> <C> <C>
1 $4,699.5 $155.1 $(33.3) $4,821.3 $ 766.1 $23.3 $ (5.5) $ 783.9
2 1,599.6 57.0 (13.1) 1,643.5 1,223.7 35.5 (7.4) 1,251.8
3 229.4 4.9 (3.2) 231.1 158.7 4.9 (1.6) 162.0
4 21.2 .3 (.9) 20.6 39.3 .7 (.5) 39.5
5 3.9 .2 (.9) 3.2 46.0 .3 (3.2) 43.1
6 - - - - .7 - - .7
Redeemable
Preferred
Stock .5 - - .5 1.6 - (.1) 1.5
-------- ------- ------- --------- --------- ----- ------- --------
Total $6,554.1 $217.5 $(51.4) $6,720.2 $2,236.1 $64.7 $(18.3) $2,282.5
======== ====== ====== ======== ======== ===== ====== ========
<CAPTION>
DECEMBER 31, 1995
MARKETABLES PRIVATE PLACEMENTS
NAIC AMORTIZED GROSS UNREALIZED FAIR AMORTIZED GROSS UNREALIZED FAIR
---------------- ----------------
RATING COST GAINS (LOSSES) VALUE COST GAINS (LOSSES) VALUE
- ------ ---- ----- -------- ----- ---- ----- -------- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
1 $4,578.5 $ 309.7 $ (8.3) $4,879.9 $ 810.2 $ 59.9 $ (1.0) $ 869.1
2 1,546.9 126.6 (1.9) 1,671.6 1,113.9 79.4 (.3) 1,193.0
3 175.7 8.4 (2.6) 181.5 143.5 7.2 (3.0) 147.7
4 17.1 .5 (2.2) 15.4 22.3 1.0 (.1) 23.2
5 2.0 .1 (.2) 1.9 72.4 .8 (5.6) 67.6
6 - - - - .8 - - .8
Redeemable
Preferred
Stock .5 - - .5 1.6 - (.1) 1.5
------------- --------- ---------- --------- --------- --------- -------- --------
Total $6,320.7 $445.3 $(15.2) $6,750.8 $2,164.7 $148.3 $(10.1) $2,302.9
======== ====== ====== ======== ======== ====== ====== ========
</TABLE>
The amortized cost and fair value of fixed maturity securities by contractual
maturity are shown below. Expected maturities will differ from contractual
maturities because borrowers may have the right to call or prepay obligations
with or without call or prepayment penalties (in millions).
<TABLE>
<CAPTION>
SEPTEMBER 30, 1996 DECEMBER 31, 1995
--------------------- -------------------
AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE
<S> <C> <C> <C> <C>
Due in One Year or Less $ 141.5 $ 142.8 $ 123.1 $ 122.8
Due After One Year Through Five Years 2,947.1 3,014.7 2,497.4 2,634.3
Due After Five Years Through Ten Years 2,531.9 2,599.9 2,750.4 2,965.4
Due After Ten Years 1,013.4 1,049.1 1,056.5 1,172.9
Mortgage-Backed/Structured Finance
Securities 2,156.3 2,196.2 2,058.0 2,158.3
--------- --------- --------- ---------
Total $8,790.2 $9,002.7 $8,485.4 $9,053.7
======== ======== ======== ========
</TABLE>
The fair values for the marketable bonds are based upon the quoted market prices
for bonds actively traded. The fair values for marketable bonds without an
active market, are obtained through several commercial pricing services which
provide the estimated fair values. Fair market values for privately placed bonds
which are not considered problems are determined utilizing a commercially
available pricing model. The model considers the current level of risk-free
interest rates, current corporate spreads, the credit quality of the issuer and
cash flow characteristics of the security. Utilizing these data, the model
generates estimated market values which the Company considers reflective of the
fair value of each privately placed bond. Fair values for privately placed bonds
14
which are considered problems are determined through consideration of factors
such as the net worth of borrower, the value of collateral, the capital
structure of the borrower, the presence of guarantees and the Company's
evaluation of the borrower's ability to compete in the relevant market (see
Problem Investments).
Fair values of fixed income securities fluctuate due to a number of factors,
including the market level of interest rates, fluctuations in the corporate
spreads over the risk-free rate and changes in the credit quality of specific
investments.
The Company's marketable and private placement bond portfolios were diversified
by industry (based upon amortized cost) as of the indicated dates as set forth
in the following table:
<TABLE>
<CAPTION>
PERCENT OF MARKETABLE PERCENT OF PRIVATE
BOND PORTFOLIO PLACEMENT PORTFOLIO
SEPTEMBER 30 DECEMBER 31 SEPTEMBER 30 DECEMBER 31
1996 1995 1996 1995
---- ---- ---- ----
<S> <C> <C> <C> <C>
Basic Material 6.7% 4.2% 9.5% 7.1%
Consumer Non-Cyclical 5.8 5.8 17.7 18.4
Consumer Products/Services 7.0 6.9 19.9 18.9
Energy 6.1 6.4 7.0 7.1
Financial Services 19.4 17.9 17.2 16.3
Government 3.8 4.4 .8 1.0
Industrial 3.7 6.3 8.9 11.4
Mortgage Backed/Structured
Finance Securities 32.4 31.9 1.6 1.4
Real Estate .2 .1 1.4 1.6
Retailing 2.4 2.6 6.3 6.4
Technology 2.5 2.4 3.8 4.6
Utilities 10.0 11.1 5.9 5.8
------ ------ ------- -------
Total 100.0% 100.0% 100.0% 100.0%
===== ===== ===== =====
</TABLE>
BELOW INVESTMENT GRADE INVESTMENTS
Issuers of below investment grade debt frequently have relatively high levels of
indebtedness and are more sensitive to adverse economic conditions, such as
recession or increasing interest rates, than are issuers of investment grade
securities.
The largest investment in below investment grade bonds of any one borrower was
approximately two-tenths of one percent of invested assets at September 30,
1996. The largest investment in below investment grade bonds of any one industry
grouping was approximately 2.2% of invested assets at September 30, 1996.
Concentrations of the portfolio in below investment grade bonds are regularly
analyzed and adjusted as appropriate.
15
<PAGE>
MORTGAGE-BACKED SECURITIES
The Company's investment policy permits the acquisition of mortgage-backed
securities and collateralized mortgage obligations (collectively referred to as
MBS securities) provided that the Company's aggregate investment in MBS
securities shall not exceed 50% of its statutory assets and the Company shall
not acquire any interests in residual, interest only, principal only or inverse
floater tranches of MBS securities. The Company's investment strategy has been
to invest primarily in actively traded MBS securities which are structured to
reduce prepayment risk as compared to direct investments in the underlying
mortgage collateral. The amortized cost and estimated fair value of investments
in MBS securities categorized by interest rates on the underlying collateral
were comprised of the following (in millions):
SEPTEMBER 30, 1996
---------------------------
AMORTIZED
COST FAIR VALUE
Adjustable Rate Pass Through MBS Securities:
Below 5% $ 34.9 $ 35.1
5% - 6% 168.6 168.9
6% - 7% 328.4 329.1
Above 7% 41.5 41.7
Fixed Rate Pass Through MBS Securities:
Below 8% 6.5 6.9
8% - 9% 9.4 10.0
Above 9% 313.2 318.0
Planned Amortization Class MBS Securities:
Below 7% 344.9 357.5
7% - 8% 119.1 124.6
8% - 9% 21.9 22.5
Above 9% 197.1 199.0
Other MBS Securities:
Below 7% 92.1 97.2
7% - 8% 20.5 21.7
8% - 9% 12.9 13.4
----------- -----------
Total MBS Securities $1,711.0 $1,745.6
======== ========
The Company invests in asset-backed securities in addition to the MBS securities
described above. As of September 30, 1996, the Insurers held asset-backed
securities with an amortized cost of $445.3 million and a fair value of $450.6
million.
MORTGAGE LOANS
The Company's commercial mortgage loans generally range in size from $1.5 to
$11.0 million, with the average commercial mortgage loan investment as of
September 30, 1996 being approximately $2.1 million.
16
<PAGE>
The commercial mortgage loan portfolio diversification by property type and
geographic region of the country was as follows:
PROPERTY TYPE
------------------------------
SEPTEMBER 30 DECEMBER 31
1996 1995
---- ----
Office 25.6% 30.0%
Industrial 24.2 26.2
Special Purpose 19.0 17.1
Retail 14.6 12.8
Apartment 13.5 9.4
Hotel/Motel 3.1 4.5
------- -------
Total 100.0% 100.0%
===== =====
GEOGRAPHIC REGION
------------------------------
SEPTEMBER 30 DECEMBER 31
1996 1995
---- ----
Midwest 33.3% 32.5%
Pacific 30.4 30.7
Southeast 17.9 18.9
Northeast 7.4 5.9
Mountain 6.4 7.1
Southwest 4.6 4.9
------- ---
Total 100.0% 100.0%
===== =====
The weighted average yield of the commercial mortgage loan portfolio as of
September 30, 1996 was 8.8%. The weighted average maturity of these loans was
5.7 years.
The principal balance of commercial mortgage loans with scheduled maturities
during the remainder of 1996 and for the year ending December 31, 1997 is $135.2
million and $157.8 million, respectively. Of the $202.0 million of commercial
mortgage loans with maturities scheduled during 1995, approximately 57% were
paid in full at or near the scheduled maturity date. Approximately 3% of the
commercial mortgage loans with maturities scheduled during 1995 were declared to
be in default. Approximately 40% of the commercial mortgage loans with
maturities scheduled during 1995 were rewritten by the Company at current market
terms and conditions.
The Company invests in individual and pools of individual residential mortgage
loans in addition to the structured finance securities backed by residential
mortgages (see Fixed Maturity Securities). As of September 30, 1996 and December
31, 1995, the Insurers held $504.5 million and $480.8 million, respectively, of
non-securitized residential mortgage loans.
UNREALIZED INVESTMENT GAINS (LOSSES)
Debt and equity securities classified as available-for-sale are carried at fair
value on the condensed consolidated balance sheets with unrealized gains and
losses excluded from income and reported as a separate component of
shareholders' equity.
The September 30, 1996 balance of shareholders' equity was increased by $89.1
million (comprised of net unrealized appreciation in the carrying value of the
securities of $215.8 million, reduced by $78.8 million of related adjustments to
deferred policy acquisition costs and present value of future profits and $47.9
million in deferred income taxes) to reflect the net unrealized gain on
securities classified as available-for-sale.
Changes in net unrealized gains or losses are primarily the results of
fluctuations in market interest rates which impact the market value of fixed
interest rate securities. The change in market value of the Company's fixed
maturity securities is not expected to have a significant effect on results of
operations or liquidity because: 1) the Company has the present intent and
practice to hold most of its available-for-sale fixed maturity securities to
17
maturity and 2) the Company's asset/liability management activity is designed to
monitor and adjust for the effects of changes in market interest rates.
DERIVATIVE FINANCIAL INSTRUMENTS
The Company has an established program prescribing the use of derivatives in its
asset/liability management activity. The investment policy of each of the
Insurers expressly precludes the use of such instruments for speculative
purposes. The policy details permissible uses and instruments and contains
accounting and management controls designed to assure compliance with these
policies. The Company is not a party to leveraged derivatives.
The insurance liabilities of the Company are sensitive to changes in market
interest rates. The Company has established procedures for evaluating these
liabilities and structures investment asset portfolios with compatible
characteristics. Investment assets are selected which provide yield, cash flow
and interest rate sensitivities appropriate to support the insurance products.
The Company uses interest rate swaps and interest rate futures as part of this
asset/liability management program. The Company has acquired a significant
amount of certain shorter duration investments, such as floating rate or
adjustable rate investments. Acquisition of these assets shortens the duration
of an asset portfolio. The Company uses interest rate swaps to extend the
duration of these portfolios as an alternative to purchasing longer duration
investments.
The Company uses duration analysis to estimate the amount of sensitivity to
market interest rate changes. Duration of a bond or portfolio can be thought of
as the life in years of a notional zero-coupon bond whose fair value would
change by the same amount in response to any change in market interest rates.
The following table sets forth the asset duration, portfolio duration and target
duration for the investment portfolio of each business segment. The portfolio
duration includes the duration impact added by interest rate swaps and interest
rate futures contracts. Target durations are determined by the Company based
upon the subjective evaluation of a number of characteristics of the
liabilities, including such factors as the ability of the Company to modify
interest crediting rates, the presence and magnitude of surrender charges,
historical and projected lapse experience, the level of market interest rates
and competition.
SEPTEMBER 30, 1996
----------------------------------------------
ASSET PORTFOLIO TARGET
DURATION DURATION DURATION
Individual Insurance 3.86 4.08 3.5 - 5.0
Employee Benefits 3.36 3.78 3.5 - 8.0
Life and Health Reinsurance 3.99 4.13 3.5 - 8.0
Pension 2.58 3.30 2.5 - 3.5
At September 30, 1996, the Company had 71 interest rate swap contracts in effect
with an aggregate notional amount of $1.14 billion. At December 31, 1995, the
Company had 73 interest rate swap contracts in effect with an aggregate notional
amount of $1.22 billion. During the nine months ended September 30, 1996, three
new interest rate swap contracts were entered into with a notional amount of
$50.0 million and five interest rate swap contracts matured with a notional
amount of $135.0 million. There were no terminations of interest rate swaps
prior to maturity during the nine months ended September 30, 1996. The Company
has no deferred gains or losses at September 30, 1996 related to swap contracts
terminated early. The estimated fair value of the interest rate swap contracts
in effect at September 30, 1996 was an unrealized gain of $5.6 million.
The following table details the characteristics of the Company's interest rate
swap portfolio at September 30, 1996. All of the contracts described below are
standard contracts whereby the Company pays a floating rate of interest
(generally based upon the LIBOR rate as determined from time to time) and
receives a fixed rate (generally a specified contract rate).
18
<PAGE>
NOTIONAL RANGE OF FIXED
(In Millions) AMOUNT RATES RECEIVED
Maturing in One Year or Less $ 135.0 6.68-9.30%
Maturing After One Year Through Three Years 360.0 5.17-8.68
Maturing After Three Years Through Five Years 552.5 5.34-7.55
Maturing After Five Years Through Seven Years 90.0 6.68-8.18
-----------
Total Notional Amount $1,137.5
========
The Company closely monitors the effect of the swap position on reported income.
The Company's investment portfolio includes a substantial amount of floating
rate investments. Changes in market interest rates have an opposite (and
approximately offsetting) effect on the reported income from the swap portfolio.
Accordingly, the reported investment income (or losses) attributable to the
Company's swap position will be approximately offset by the changed investment
income of the Company's floating or adjustable rate investments in a changing
rate environment. At September 30, 1996 the Company held $1.32 billion of
adjustable rate invested assets, short-term investments and cash.
The Company also enters into futures contracts, which are contracts for delayed
delivery of securities or money market instruments in which the seller agrees to
make delivery at a specified future date of a U.S. Treasury Bond at a specified
price or yield. These contracts are entered into to manage interest rate risk of
the Company's GIC operations. The contracts that the Company has entered into
are exchange traded and marked to market daily. The contract value of these
futures contracts at September 30, 1996 was $75.3 million.
PROBLEM INVESTMENTS
The Company classifies invested assets of the Insurers as problem investments
where: (i) an asset is delinquent in a required payment of principal or
interest; (ii) an asset is the subject of a foreclosure action or the borrower
is in bankruptcy; (iii) a loan has been restructured; or (iv) a loan has been
foreclosed and the collateral is owned (Problem Investments). The Company
reports a mortgage loan as delinquent when a required payment of principal or
interest is sixty days past due. Fixed maturity securities are reported as
delinquent following the contractual grace period allowed for any required
payment of principal or interest. The Company generally considers a loan as
restructured when one or more of the following terms is changed for the benefit
of the borrower: (i) interest rate for a specified period of time or for the
life of the loan; (ii) maturity date; (iii) the principal face amount or timing
of principal repayments on a contingent or absolute basis; or (iv) amount or
timing of payment of accrued interest.
In addition to the risk of loss of principal, the Company's Problem Investments
reduce investment income because some are not producing income and others are
producing income at rates below those agreed upon when the loans were initially
made. For restructured loans for the nine months ended September 30, 1996, the
gross interest income that would have been recorded had such loans been current
in accordance with their original terms was $2.7 million compared with actual
interest recorded of $2.3 million. The Company does not accrue interest on
Problem Investments when management believes the likelihood of collection of
principal or interest is doubtful.
The amortized cost of Problem Investments, net of related write-offs and
allowances and non-recourse debt, as of the indicated dates was as follows (in
millions):
SEPTEMBER 30 DECEMBER 31
1996 1995
Fixed Maturity Securities 1 $ 22.0 $ 23.9
Commercial Mortgage Loans 28.9 21.9
Residential and Other Mortgage Loans 5.6 8.1
Investment Real Estate 2 12.3 14.9
Foreclosed Real Estate 47.8 50.2
-------- -------
Total $116.6 $119.0
====== ======
1 All problem fixed maturity securities were private placements.
2 The amounts shown represent real estate acquired as an investment which the
Company has determined to be Problem Investments.
19
The amortized cost of Problem Investments in the preceding table reflects
reductions for write-offs and allowances taken by the Company. The cumulative
amounts of such write-offs and allowances on problem invested assets of the
Insurers on the condensed consolidated balance sheets as of the indicated dates
were as follows (in millions):
SEPTEMBER 30 DECEMBER 31
1996 1995
Fixed Maturity Securities $ 9.1 $ 8.0
Commercial Mortgage Loans 9.0 10.9
Residential and Other Mortgage Loans .7 .4
Investment Real Estate - 1.0
Foreclosed Real Estate 27.1 29.3
The amount of Problem Investments is affected to a significant degree by
economic conditions and the status of the real estate markets. While the Company
believes it has set aside appropriate reserves and allowances for Problem
Investments, subsequent economic and market conditions may require the
establishment of additional reserves.
The Company establishes the carrying value of all Problem Investments. For
problem marketable securities, the fair value is the quoted market value. For
problem private placement debt securities, the fair value is determined through
consideration of factors such as the net worth of the borrower, the value of
collateral, the capital structure of the borrower, the presence of guarantees
and the Company's evaluation of the borrower's ability to compete in the
relevant market.
For problem and potential problem securities, the Company determines whether a
decline in fair value below the amortized cost is other than temporary. If the
decline in fair value is determined to be other than temporary, the Company
writes down the cost basis to fair value and the amount of the write-down is
recorded as a realized loss. Subsequent changes in the fair value of problem
available-for-sale securities which are determined to be temporary are reflected
directly in equity as unrealized gains or losses.
Fair value for problem real estate and problem mortgage loans is determined
taking into consideration one or more of the following factors, depending on the
circumstances for each property, including: (i) property valuation techniques
utilizing discounted cash flows at the time of stabilization including capital
expenditures and stabilization costs; (ii) sales of comparable properties; (iii)
geographic location of the property and related market conditions; and (iv)
disposition costs. In many instances, there is not an active market for such
properties. Therefore, the fair value determined by the Company may be greater
than the price which may be realized if the Company were forced to liquidate
such properties on an immediate sale basis. If fair value of a problem mortgage
loan or real estate investment is less than the carrying value, the Company
records a write-off or an increase in the allowance for uncollectible amounts.
Foreclosed properties are actively managed by the Company in order to maximize
net realizable value. The Company has the intent and ability to hold these
assets until appropriate sales opportunities arise.
The following tables set forth the distribution of problem commercial mortgage
loans by property type and geographic region as of the indicated dates:
PROPERTY TYPE
SEPTEMBER 30 DECEMBER 31
1996 1995
---- ----
Office 64.1% 72.8%
Industrial 19.7 18.1
Retail 13.3 6.1
Hotel/Motel 2.9 3.0
------- -------
Total 100.0% 100.0%
===== =====
20
<PAGE>
GEOGRAPHIC REGION
SEPTEMBER 30 DECEMBER 31
1996 1995
---- ----
Midwest 44.1% 39.2%
Southeast 21.8 28.4
Pacific 22.3 28.0
Southwest 5.3 3.4
Northeast 2.2 -
Mountain 4.3 1.0
------- -------
Total 100.0% 100.0%
===== =====
The Company also monitors its portfolios in an attempt to identify loans which
are not currently classified as Problem Investments, but where the Company has
knowledge which causes it to have serious doubts as to the ability of borrowers
to comply with the present loan repayment terms. These loans (Potential Problem
Investments) are subject to increased scrutiny and review by the Company. The
amounts of private placements and mortgage loan Potential Problem Investments
were $11.6 million and $44.9 million, respectively at September 30, 1996.
KNOWN TRENDS AND UNCERTAINTIES WHICH MAY AFFECT FUTURE REPORTED RESULTS
HEALTH CARE MARKETPLACE ENVIRONMENT
The market place for the provision of health care employee benefits is changing
in response to legislative and regulatory initiatives and a market trend toward
capitated and managed care plans. The Company has determined that it will not
seek to directly provide capitated plans, but, rather will market plans
maintained by third party managed care organizations through a series of
strategic alliances in selected markets. The Company intends to jointly market
its group life coverage with its strategic partners in these markets. The
Company expects that its book of insured health and health related business will
decline over the next several years and the Company does not expect significant
new sales of insured health and health related products. The Company cannot
predict the impact that these market developments will have on future reported
earnings. Excluding the earnings of the USL and RBSL operations acquired in
1995, the health insurance and managed care businesses have, over the past three
years, on average, represented approximately 10% of the Company's after tax
earnings.
GUARANTY ASSOCIATION ASSESSMENTS
The Insurers are subject to state guaranty association assessments in all states
in which they are admitted. Generally these associations guarantee specified
amounts (commonly $100,000 of surrender values or $300,000 of other benefits)
payable to residents of the state under policies of insolvent insurers. State
laws vary widely on coverage (and inclusion in the assessment base) of GICs.
Most state laws permit assessments or some portion thereof to be credited
against future premium taxes. However, several states do not permit such a
credit. While the Company believes that it has accrued appropriate amounts based
upon currently available information, the Company could be subject to additional
future assessments in amounts which may be material.
LITIGATION
The Company is a defendant in a number of lawsuits arising out of the normal
course of the business of the Insurers. While the nature and amount of the
Company's outstanding litigation has been fairly constant over the past several
years, some life insurers have recently been subjected to significant punitive
damages awards in certain jurisdictions. While the Company is not aware of any
actions or allegations which should reasonably give rise to any punitive damages
liability, it is possible that the Company could be subjected to such a claim in
an amount which could be material.
21
<PAGE>
Part II-Other Information
RELIASTAR FINANCIAL CORP.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
(11) Statement re Computation of Per Share Earnings
(27) Financial Data Schedule
(b) Reports on Form 8-K:
None
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.
Dated NOVEMBER 12, 1996
--------------------
RELIASTAR FINANCIAL CORP.
/S/ WAYNE R. HUNEKE
----------------------
by Wayne R. Huneke
Senior Vice President, Chief Financial Officer
and Treasurer
23
<PAGE>
ReliaStar Financial Corp. EXHIBIT 11
Computation of Earnings Per Share
(in millions, except per share amounts)
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30 ENDED SEPTEMBER 30
1996 1995 1996 1995
EARNINGS:
Primary:
<S> <C> <C> <C> <C>
Net Income, as Reported $ 47.9 $ 42.7 $ 143.7 $ 125.3
Dividends on ESOP Convertible Preferred Stock (.7) (.7) (2.1) (2.1)
Tax Benefit on Unallocated ESOP Dividends .2 .2 .6 .6
Dividends on 10% Senior Cumulative Preferred Stock - (1.6) (3.2) (4.7)
----------- ----------- ----------- -----------
Net Income, As Adjusted $ 47.4 $ 40.6 $ 139.0 $ 119.1
=========== =========== =========== ===========
Fully Diluted:
Net Income, as Reported $ 47.9 $ 42.7 $ 143.7 $ 125.3
Additional Compensation Expense due to Assumed
Conversion of ESOP Convertible Preferred Stock - - - (.2)
Dividends on 10% Senior Cumulative Preferred Stock - (1.6) (3.2) (4.7)
----------- ----------- ----------- -----------
Net Income, as Adjusted $ 47.9 $ 41.1 $ 140.5 $ 120.4
=========== =========== =========== ===========
SHARES:
Primary:
Weighted Average Common Shares Outstanding, Unadjusted 37.3 36.4 36.7 36.3
Dilutive Effect of Outstanding Stock Options .4 .6 .5 .6
----------- ----------- ----------- -----------
Weighted Average Common Shares, as Adjusted 37.7 37.0 37.2 36.9
=========== =========== =========== ===========
Fully Diluted:
Weighted Average Common Shares Outstanding, Unadjusted 37.3 36.4 36.7 36.3
Dilutive Effect of:
ESOP Convertible Preferred Stock 2.5 2.6 2.6 2.6
Outstanding Stock Options .5 .7 .5 .7
----------- ----------- ----------- -----------
Weighted Average Common Shares, as Adjusted 40.3 39.7 39.8 39.6
=========== =========== =========== ===========
NET INCOME PER COMMON SHARE:
Primary $ 1.26 $ 1.10 $ 3.74 $ 3.23
=========== ========== =========== ============
Fully Diluted $ 1.19 $ 1.03 $ 3.53 $ 3.04
=========== ========== =========== ============
</TABLE>
24
<TABLE> <S> <C>
<ARTICLE> 7
<LEGEND>
This schedule contains summary financial information extracted from the
condensed consolidated balance sheet and statement of income and is qualified in
its entirety by reference to such financial statements
</LEGEND>
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-END> SEP-30-1996
<DEBT-HELD-FOR-SALE> 9,002,700,000
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 41,000,000
<MORTGAGE> 1,913,100,000
<REAL-ESTATE> 88,800,000
<TOTAL-INVEST> 11,764,800,000
<CASH> 34,000,000
<RECOVER-REINSURE> 179,800,000
<DEFERRED-ACQUISITION> 998,600,000
<TOTAL-ASSETS> 16,219,900,000
<POLICY-LOSSES> 11,207,700,000
<UNEARNED-PREMIUMS> 0
<POLICY-OTHER> 284,600,000
<POLICY-HOLDER-FUNDS> 193,400,000
<NOTES-PAYABLE> 407,400,000
120,900,000
6,400,000
<COMMON> 541,500,000
<OTHER-SE> 774,600,000
<TOTAL-LIABILITY-AND-EQUITY> 16,219,900,000
619,200,000
<INVESTMENT-INCOME> 703,200,000
<INVESTMENT-GAINS> 8,700,000
<OTHER-INCOME> 293,600,000
<BENEFITS> 966,900,000
<UNDERWRITING-AMORTIZATION> 60,000,000
<UNDERWRITING-OTHER> 312,000,000
<INCOME-PRETAX> 226,200,000
<INCOME-TAX> 79,200,000
<INCOME-CONTINUING> 143,700,000
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 147,700,000
<EPS-PRIMARY> 3.74
<EPS-DILUTED> 3.53
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 0
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
