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 MARCH 31, 1996
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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
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RELIASTAR FINANCIAL CORP.
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(Exact name of registrant as specified in its charter)
DELAWARE 41-1620373
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(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 April 30, 1996 was
36,514,624.
<PAGE>
PART I-FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
RELIASTAR FINANCIAL CORP.
Condensed Consolidated Balance Sheets
(in millions)
(unaudited)
<TABLE>
<CAPTION>
MARCH 31, 1996 DECEMBER 31, 1995
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<S> <C> <C>
ASSETS
Fixed Maturity Securities, Available-for-Sale $ 8,909.5 $ 9,053.7
Equity Securities 35.7 35.9
Mortgage Loans on Real Estate 1,967.6 1,948.4
Real Estate and Leases 100.9 97.9
Policy Loans 508.6 499.8
Other Invested Assets 46.1 47.0
Short-Term Investments 217.0 131.5
-------------- ------------
Total Investments 11,785.4 11,814.2
Cash 24.9 48.5
Accounts and Notes Receivable 184.9 165.3
Reinsurance Receivable 163.2 162.9
Deferred Policy Acquisition Costs 925.4 860.7
Present Value of Future Profits 232.6 192.0
Property and Equipment, Net 121.9 123.2
Accrued Investment Income 167.8 164.7
Other Assets 279.0 299.1
Participation Fund Account Assets 319.4 319.6
Assets Held in Separate Accounts 1,567.8 1,369.0
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TOTAL ASSETS $ 15,772.3 $ 15,519.2
============== ============
LIABILITIES
Future Policy and Contract Benefits $ 11,083.9 $ 11,033.2
Pending Policy Claims 260.3 257.7
Other Policyholder Funds 186.5 174.4
Notes and Mortgages Payable 423.3 422.3
Income Taxes 124.4 170.2
Other Liabilities 347.4 358.8
Participation Fund Account Liabilities 319.4 319.6
Liabilities Related to Separate Accounts 1,562.3 1,362.9
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TOTAL LIABILITIES 14,307.5 14,099.1
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Company-Obligated Mandatorily Redeemable Preferred
Securities Issued by a Consolidated Subsidiary 120.8 -
SHAREHOLDERS' EQUITY
10% Senior Cumulative Preferred Stock 63.2 63.2
ESOP Convertible Preferred Stock 28.8 28.9
Note Receivable from ESOP (23.0) (23.4)
Common Stock (Shares Issued: 1996, 39.8; 1995, 39.8) 566.0 566.5
Unamortized Restricted Stock Awards (2.9) (3.0)
Net Unrealized Investment Gains 128.3 246.8
Retained Earnings 683.7 647.2
Less Treasury Common Stock, at Cost (Shares Held: 1996, 3.3;
1995, 3.5) (100.1) (106.1)
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TOTAL SHAREHOLDERS' EQUITY 1,344.0 1,420.1
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TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY $ 15,772.3 $ 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 MARCH 31
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1996 1995
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<S> <C> <C>
REVENUES
Premiums $ 205.0 $ 209.4
Net Investment Income 232.3 214.2
Realized Investment Gains (Losses) 6.2 (3.8)
Policy and Contract Charges 59.8 52.7
Other Income 30.1 32.7
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Total 533.4 505.2
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BENEFITS AND EXPENSES
Benefits to Policyholders 323.8 323.3
Sales and Operating Expenses 100.2 88.9
Amortization of Deferred Policy Acquisition Costs
and Present Value of Future Profits 24.5 23.9
Interest Expense 7.3 5.8
Dividends and Experience Refunds to Policyholders 3.3 4.9
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Total 459.1 446.8
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Income Before Income Taxes and Net Dividends on Preferred
Securities of Subsidiary 74.3 58.4
Income Tax Expense 26.2 20.6
Net Dividends on Preferred Securities of Subsidiary .1 -
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Net Income $ 48.0 $ 37.8
============ =============
NET INCOME PER COMMON SHARE
Primary $ 1.24 $ .98
============ =============
Fully Diluted $ 1.17 $ .93
============ =============
Net Income Available to Common Shareholders $ 45.9 $ 35.7
============ =============
Weighted Average Shares
Common and Common Equivalent Shares (Primary) 36.9 36.3
Common Shares Assuming Maximum Dilution (Fully Diluted) 39.5 38.9
</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>
THREE MONTHS ENDED MARCH 31
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1996 1995
---- ----
<S> <C> <C>
10% SENIOR CUMULATIVE PREFERRED STOCK
Beginning and End of Period $ 63.2 $ 63.2
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ESOP CONVERTIBLE PREFERRED STOCK
Beginning of Year 28.9 29.3
Redeemed (.1) (.1)
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End of Period 28.8 29.2
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NOTE RECEIVABLE FROM ESOP
Beginning of Year (23.4) (24.6)
Repayments, Accrued or Paid .4 .3
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End of Period (23.0) (24.3)
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COMMON STOCK
Beginning of Year 566.5 293.4
Issued for Acquisition - 265.9
Gain on Treasury Shares Reissued for Acquisition - 10.1
Other, Net (.5) .1
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End of Period 566.0 569.5
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UNAMORTIZED RESTRICTED STOCK AWARDS
Beginning of Year (3.0) (2.1)
Awards, Net (.2) (2.1)
Amortization of Restricted Stock Awards .3 .2
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End of Period (2.9) (4.0)
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NET UNREALIZED INVESTMENT GAINS (LOSSES)
Beginning of Year 246.8 (79.4)
Change for the Period (118.5) 85.5
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End of Period 128.3 6.1
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RETAINED EARNINGS
Beginning of Year 647.2 528.4
Net Income 48.0 37.8
Dividends to Shareholders:
10% Senior Cumulative Preferred Stock ($2.50 Per Share) (1.6) (1.6)
ESOP Convertible Preferred Stock ($.5475 Per Share) (.7) (.7)
Common Stock (Per Share: 1996 $.25; 1995 $.225) (9.1) (8.3)
Tax Benefit on ESOP Convertible Preferred Stock Dividend .2 .2
Redemption of ESOP Convertible Preferred Stock (.3) (.1)
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End of Period 683.7 555.7
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TREASURY COMMON STOCK
Beginning of Year (106.1) (9.7)
Acquired with Acquisition - (72.7)
Reissued for Acquisition - 9.7
Acquired, Other (1.8) (17.9)
Reissued, Other 7.8 6.9
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End of Period (100.1) (83.7)
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TOTAL SHAREHOLDERS' EQUITY $ 1,344.0 $ 1,111.7
============= ============
</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>
THREE MONTHS ENDED MARCH 31
---------------------------
1996 1995
---- ----
<S> <C> <C>
OPERATING ACTIVITIES
Net Income $ 48.0 $ 37.8
Adjustments to Reconcile Net Income to Net Cash Provided by
Operating Activities
Interest Credited to Insurance Contracts 122.3 119.7
Future Policy Benefits (72.1) (16.3)
Capitalization of Deferred Policy Acquisition Costs (44.5) (45.4)
Amortization of Deferred Policy Acquisition Costs 24.5 23.9
Deferred Income Taxes 2.9 3.3
Net Change in Receivables and Payables 3.6 (44.6)
Other Assets 17.0 (2.4)
Realized Investment (Gains) Losses, Net (6.2) 3.8
Other - 1.8
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Net Cash Provided by Operating Activities 95.5 81.6
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INVESTING ACTIVITIES
Proceeds from Sales of Available-for-Sale Fixed Maturity Securities 20.1 17.7
Proceeds from Maturities or Repayment of Fixed Maturity Securities 201.6 187.2
Cost of Fixed Maturity Securities Acquired (348.0) (332.4)
Sales of Equity Securities, Net - 7.7
Proceeds of Mortgage Loans Sold, Matured or Repaid 66.7 54.3
Cost of Mortgage Loans Acquired (89.8) (51.6)
Sales (Purchases) of Real Estate and Leases, Net .2 (.3)
Policy Loans Issued, Net (8.8) (16.9)
Sales of Other Invested Assets, Net 5.0 7.2
Purchases of Short-Term Investments, Net (85.5) (34.6)
Net Cash Acquired with Acquisition of USLICO Corp. - 1.3
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Net Cash Used by Investing Activities (238.5) (160.4)
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FINANCING ACTIVITIES
Deposits to Insurance Contracts 281.4 340.2
Maturities and Withdrawals from Insurance Contracts (277.1) (244.0)
Net Proceeds from Issuance of Preferred Securities 120.8 -
Increase in Notes and Mortgages Payable 17.1 123.0
Repayment of Notes and Mortgages Payable (16.1) (99.4)
Issuance of Common Stock Under Stock Option and Other Plans 5.8 1.8
Dividends on 10% Senior Cumulative Preferred Stock (1.6) (1.6)
Dividends on Common Stock (9.1) (8.3)
Acquisition of Treasury Common Stock (1.8) (17.9)
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Net Cash Provided by Financing Activities 119.4 93.8
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Increase (Decrease) in Cash (23.6) 15.0
Cash at Beginning of Period 48.5 20.3
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Cash at End of Period $ 24.9 $ 35.3
============= ==============
</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 change 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
pro forma effect on net income and earnings per share in its consolidated
financial statements for the year ended 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
6
<PAGE>
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 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. As of March 29, 1996, 5,000,000 shares of Preferred Securities were
outstanding.
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):
Three Months
ENDED MARCH 31
--------------
1996 1995
---- ----
Pretax Income (Loss) Excluding Realized
Investment Gains (Losses):
Individual Insurance $ 50.2 $ 43.2
Employee Benefits 9.8 11.0
Life and Health Reinsurance 11.9 11.1
Pension 4.1 2.3
Corporate and Other (7.9) (5.4)
--------- --------
Pretax Operating Income 68.1 62.2
Net Pretax Realized Investment Gains (Losses) 6.2 (3.8)
--------- --------
Pretax Income Before Net Dividends
on Preferred Securities of Subsidiary 74.3 58.4
Income Tax Expense 26.2 20.6
Net Dividends on Preferred Securities of Subsidiary .1 -
---------- ---------
Net Income $ 48.0 $ 37.8
======= ======
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 Northwestern National Life Insurance Company
(Northwestern), Northern Life Insurance Company (Northern), United Services Life
Insurance Company (USL) and Bankers Security Life Insurance Society (BSL). The
North Atlantic Life Insurance Company of America was merged into BSL on December
28, 1995. These subsidiaries are sometimes collectively referred to as the
Insurers.
Pretax operating income for the first three months of 1996 increased $7.0
million or 16 percent compared with the same period in 1995. The increase in
earnings is primarily due to an increase in interest spreads and a 10 percent
growth in assets under management. The average interest spread of 262 basis
points in the first quarter of 1996, compares to 235 basis points in the first
quarter of 1995. This increase in spreads reflects a 17 basis point reduction in
the average crediting rate and a 10 basis point increase in the portfolio yield.
Management expects interest spreads in the remaining three quarters of 1996 to
decline from the first 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 prepayments, 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
<PAGE>
EMPLOYEE BENEFITS
Pretax operating income for the first three months of 1996 decreased $1.2
million compared with the same period in 1995. The decrease for the first
quarter was primarily due to unfavorable group life mortality. Partially
offsetting the unfavorable mortality experience was higher earnings from the
health lines of business, including improved results in the group long-term
disability line of business resulting from changes in pricing and underwriting.
LIFE AND HEALTH REINSURANCE
Pretax operating income of the Life and Health Reinsurance segment for the three
months ended March 31, 1996 increased $.8 million when compared with the same
period in 1995. Income for the segment was higher than 1995 due primarily to a
four percent increase in earned premiums, lower rate credits and higher net
investment income. These positive earnings variances were partially offset by a
slightly higher 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 three months ended March
31, 1996, increased $1.8 million when compared with the same period in 1995.
Pretax operating income from the small employer 401(k) line of business
increased $.4 million to $.9 million for the three months ended March 31, 1996.
Income in this line increased primarily due to higher fee revenues attributable
to the growth in the asset base for this line. Pretax operating income in the
participating pension and GIC lines of business increased $1.4 million to $3.2
million for the three months ended March 31, 1996. Income in these lines was
higher primarily due to higher interest margins.
CORPORATE AND OTHER
The pretax operating loss for Corporate and Other for the three months ended
March 31, 1996, increased $2.5 million when compared with the same period in
1995. This unfavorable variance was primarily due to gains from bulk sales of
mortgage servicing rights in the Company's mortgage banking operations, of $4.8
million in the first quarter of 1995. There were no such sales in the first
quarter of 1996. Offsetting the unfavorable variance from the bulk sales of
servicing rights was improved operating results from the mortgage banking
(excluding the gains on bulk sales) and mutual fund operations and lower levels
of unrecovered corporate costs.
REALIZED INVESTMENT GAINS AND LOSSES
The sources of the pretax realized investment gains (losses) were as follows (in
millions):
Three Months
ENDED MARCH 31
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1996 1995
---- ----
Net Gains (Losses) on Sales of Investments
Fixed Maturity Securities $ 3.8 $ (1.2)
Equity Securities - (1.0)
Foreclosed Real Estate (.1) (.1)
Real Estate .7 .5
Other 4.1 (1.5)
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8.5 (3.3)
------ --------
9
<PAGE>
Provision for Losses on Investments
Mortgage Loans (1.1) -
Foreclosed Real Estate (1.2) (.5)
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(2.3) (.5)
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Net Pretax Realized Investment Gains (Losses) $ 6.2 $(3.8)
====== ======
Gross realized gains and gross realized losses from the sale of
available-for-sale fixed maturity securities were as follows (in millions):
Three Months
ENDED MARCH 31
--------------
1996 1995
---- ----
Gross Realized Gains $ 3.9 $ 1.2
Gross Realized Losses $ (.1) $ (2.4)
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.
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 Northwestern to pay dividends to it. Under Minnesota insurance law
regulating the payment of dividends by Northwestern, any such payment must be in
an amount deemed prudent by Northwestern'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
Northwestern. 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, Northwestern 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
Northwestern's statutory surplus at the prior year-end or (ii) 100% of
Northwestern'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 Northwestern 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% Trust-Originated Preferred Securities
(TOPrSsm). The Company will use the proceeds from this offering to redeem its
10% Senior Cumulative Preferred Stock on July 1, 1996, repay short-term bank
debt and general corporate purposes.
10
<PAGE>
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 March 31, 1996, the Insurers' investment portfolio included $6.7
billion (42% of total assets) of short-term investments and investment grade
marketable bonds. The March 31, 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 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.
11
<PAGE>
CONSOLIDATED CASH FLOWS
The Company's cash balance at March 31, 1996 was $24.9 million. During the first
three months of 1996, net cash provided by operating and financing activities
was $95.5 million and $119.4 million, respectively, which was offset by net cash
used by investing activities of $238.5 million.
The $95.5 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 used by investing activities of $238.5 million was affected by the
excess purchases of fixed maturity securities ($348.0 million) compared with the
maturity or sale of invested assets during the period. Net cash provided by
financing activities of $119.4 million was primarily the result of positive cash
flow from insurance contracts and proceeds from the issuance of TOPrSsm
securities.
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 new 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 Northwestern to
facilitate 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.
12
<PAGE>
The following table provides information regarding the composition of the
Company's invested assets as of the indicated dates:
<TABLE>
<CAPTION>
MARCH 31, 1996 DECEMBER 31, 1995
---------------------- --------------------
(In Millions) AMOUNT PERCENT AMOUNT PERCENT
- - ------------- ------ ------- ------ -------
<S> <C> <C> <C> <C>
Investment Grade Bonds:
Marketable $ 6,457.0 54.8% $ 6,551.5 55.5%
Private Placements 2,023.6 17.2 2,062.1 17.4
---------- ------ ---------- ------
Subtotal 8,480.6 72.0 8,613.6 72.9
Below Investment Grade Bonds:
Marketable 207.8 1.8 198.8 1.7
Private Placements 219.1 1.8 239.3 2.0
--------- ----- ---------- -------
Subtotal 426.9 3.6 438.1 3.7
Equity Securities 35.7 .3 35.9 .3
Commercial Mortgages 1,477.2 12.5 1,465.0 12.4
Mortgages, Residential and Other 490.4 4.2 483.4 4.1
Real Estate 100.9 .9 97.9 .8
Short-Term Investments 217.0 1.8 131.5 1.1
Other 556.7 4.7 548.8 4.7
--------- ----- --------- -----
Total Invested Assets $11,785.4 100.0% $11,814.2 100.0%
========= ===== ========= =====
</TABLE>
FIXED MATURITY SECURITIES
The amount invested in fixed maturity securities as of March 31, 1996 and
December 31, 1995, was $8.9 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 March 31, 1996 were $9.6 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 March 31, 1996, the weighted average book yields of the Company's
investment grade portfolio and below investment grade portfolio were 7.8% and
9.1%, 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.
Effective December 31, 1995, the Company adopted the implementation guidance
contained in the Financial Accounting Series Special Report, "A Guide to
Implementation of Statement 115 on Accounting for Certain Investments in Debt
and Equity Securities." Concurrent with the adoption of this implementation
guidance, the Company reclassified all of its held-to-maturity securities to
available-for-sale based upon a reassessment of the appropriateness of the
classifications of all securities held at that time.
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>
MARCH 31, 1996
- - ----------------------------------------------------------------------------------------------------------
MARKETABLES PRIVATE PLACEMENTS
----------------------------------------- -------------------------------------------
GROSS UNREALIZED GROSS UNREALIZED
NAIC AMORTIZED ---------------- FAIR AMORTIZED ---------------- FAIR
RATING COST GAINS (LOSSES) VALUE COST GAINS (LOSSES) VALUE
- - ------ ---- ----- -------- ----- ---- ----- -------- -----
<C> <C> <C> <C> <C> <C> <C> <C> <C>
1 $4,615.0 $190.1 $(27.7) $4,777.4 $ 801.4 $31.3 $ (3.9) $ 828.8
2 1,616.4 73.8 (10.6) 1,679.6 1,154.0 46.1 (5.3) 1,194.8
3 188.1 5.2 (3.2) 190.1 122.3 4.2 (2.0) 124.5
4 17.1 .4 (1.8) 15.7 30.6 1.3 - 31.9
5 2.0 .1 (.1) 2.0 66.3 .5 (4.8) 62.0
6 - - - - .7 - - .7
Redeemable
Preferred
Stock .5 - - .5 1.6 - (.1) 1.5
-------- ------ ------ -------- -------- ----- ------ --------
Total $6,439.1 $269.6 $(43.4) $6,665.3 $2,176.9 $83.4 $(16.1) $2,244.2
======== ====== ====== ======== ======== ===== ====== ========
<CAPTION>
DECEMBER 31, 1995
- - ----------------------------------------------------------------------------------------------------------
MARKETABLES PRIVATE PLACEMENTS
----------------------------------------- -------------------------------------------
GROSS UNREALIZED GROSS UNREALIZED
NAIC AMORTIZED ---------------- FAIR AMORTIZED ---------------- FAIR
RATING COST GAINS (LOSSES) VALUE COST GAINS (LOSSES) VALUE
- - ------ ---- ----- -------- ----- ---- ----- -------- -----
<C> <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>
MARCH 31, 1996 DECEMBER 31, 1995
--------------------- -------------------
AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE
---- ----- ---- -----
<S> <C> <C> <C> <C>
Due in One Year or Less $ 132.4 $ 132.1 $ 123.1 $ 122.8
Due After One Year Through Five Years 2,740.4 2,824.2 2,497.4 2,634.3
Due After Five Years Through Ten Years 2,595.9 2,699.2 2,750.4 2,965.4
Due After Ten Years 1,011.9 1,066.1 1,056.5 1,172.9
Mortgage-Backed/Structured Finance
Securities 2,135.4 2,187.9 2,058.0 2,158.3
--------- --------- ------- ---------
Total $8,616.0 $8,909.5 $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
14
<PAGE>
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 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
---------------------------- -----------------------------
MARCH 31 DECEMBER 31 MARCH 31 DECEMBER 31
1996 1995 1996 1995
---- ---- ---- ----
<S> <C> <C> <C> <C>
Basic Material 6.8% 4.2% 9.1% 7.1%
Consumer Non-Cyclical 6.0 5.8 19.3 18.4
Consumer Products/Services 6.7 6.9 18.6 18.9
Energy 6.2 6.4 7.4 7.1
Financial Services 18.2 17.9 16.6 16.3
Government 4.2 4.4 .9 1.0
Industrial 3.6 6.3 8.8 11.4
Mortgage Backed/Structured
Finance Securities 32.4 31.9 1.4 1.4
Real Estate .1 .1 1.5 1.6
Retailing 2.5 2.6 6.1 6.4
Technology 2.5 2.4 4.6 4.6
Utilities 10.8 11.1 5.7 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 March 31, 1996.
The largest investment in below investment grade bonds of any one industry
grouping was approximately 1.5% of invested assets at March 31, 1996.
Concentrations of the portfolio in below investment grade bonds are regularly
analyzed and adjusted as appropriate.
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
15
<PAGE>
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):
MARCH 31, 1996
---------------------------
AMORTIZED
COST FAIR VALUE
---- ----------
Adjustable Rate Pass Through MBS Securities:
Below 5% $ 65.0 $ 65.1
5% - 6% 87.9 88.9
6% - 7% 403.6 403.5
Above 7% 54.4 54.5
Fixed Rate Pass Through MBS Securities:
Below 8% 7.6 8.0
8% - 9% 10.7 11.5
Above 9% 317.2 325.8
Planned Amortization Class MBS Securities:
Below 7% 348.9 364.2
7% - 8% 131.0 136.7
8% - 9% 31.2 31.9
Above 9% 160.6 164.4
Other MBS Securities:
Below 7% 78.6 84.5
7% - 8% 21.9 23.4
8% - 9% 14.8 15.2
-------- --------
Total MBS Securities $1,733.4 $1,777.6
======== ========
The Company invests in asset-backed securities in addition to the MBS securities
described above. As of March 31, 1996, the Insurers held asset-backed securities
with an amortized cost of $402.0 million and a fair value of $410.3 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
March 31, 1996 being approximately $2.0 million.
The commercial mortgage loan portfolio diversification by property type and
geographic region of the country was as follows:
PROPERTY TYPE
-----------------------------
MARCH 31 DECEMBER 31
1996 1995
---- ----
Apartment 10.4% 9.4%
Retail 14.1 12.8
Office 28.5 30.0
Industrial 25.4 26.2
Hotel/Motel 4.3 4.5
Special Purpose 17.3 17.1
------ ------
Total 100.0% 100.0%
===== =====
16
<PAGE>
GEOGRAPHIC REGION
-----------------------------
March 31 December 31
1996 1995
---- ----
Northeast 6.1% 5.9%
Midwest 33.1 32.5
Southeast 19.5 18.9
Southwest 4.8 4.9
Mountain 6.9 7.1
Pacific 29.6 30.7
------ ------
Total 100.0% 100.0%
===== =====
The weighted average yield of the commercial mortgage loan portfolio as of March
31, 1996 was 9.0%. The weighted average maturity of these loans was 5.6 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 $233.5
million and $174.9 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 March 31, 1996 and December 31,
1995, the Insurers held $487.9 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 March 31, 1996 balance of shareholders' equity was increased by $128.3
million (comprised of net unrealized appreciation in the carrying value of the
securities of $295.0 million, reduced by $97.6 million of related adjustments to
deferred policy acquisition costs and present value of future profits and $69.1
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
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.
17
<PAGE>
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.
MARCH 31, 1996
------------------------------------
ASSET PORTFOLIO TARGET
DURATION DURATION DURATION
-------- -------- --------
Individual Insurance 3.82 4.07 3.5-5.0
Employee Benefits 3.32 3.78 3.5-8.0
Life and Health Reinsurance 4.33 4.49 3.5-8.0
Pension 2.61 3.30 3.0-4.0
At March 31, 1996 and December 31, 1995, the Company had 73 interest rate swap
contracts in effect with an aggregate notional amount of $1.22 billion. During
the three months ended March 31, 1996, one new interest rate swap contract was
entered into with a notional amount of $20.0 million and one interest rate swap
contract matured with a notional amount of $25.0 million. There were no
terminations of interest rate swaps prior to maturity during the three months
ended March 31, 1996. The Company has no deferred gains or losses at March 31,
1996 related to swap contracts terminated early. The estimated fair value of the
interest rate swap contracts in effect at March 31, 1996 was an unrealized gain
of $17.0 million.
The following table details the characteristics of the Company's interest rate
swap portfolio at March 31, 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).
NOTIONAL RANGE OF FIXED
(In Millions) AMOUNT RATES RECEIVED
- - ------------- ------ --------------
Maturing in One Year or Less $ 245.0 6.7 - 9.8%
Maturing After One Year Through Three Years 320.0 5.2 - 8.7
Maturing After Three Years Through Five Years 472.5 5.3 - 6.9
Maturing After Five Years Through Seven Years 180.0 6.7 - 8.2
--------
Total Notional Amount $1,217.5
========
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
18
<PAGE>
income of the Company's floating or adjustable rate investments in a changing
rate environment. At March 31, 1996 the Company held $1.46 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 March 31, 1996 was $76.5 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 three months ended March 31, 1996, the
gross interest income that would have been recorded had such loans been current
in accordance with their original terms was $.8 million compared with actual
interest recorded of $.7 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):
MARCH 31 DECEMBER 31
1996 1995
--------- -----------
Fixed Maturity Securities 1 $ 23.7 $ 23.9
Commercial Mortgage Loans 27.3 21.9
Residential and Other Mortgage Loans 8.5 8.1
Investment Real Estate 2 12.7 14.9
Foreclosed Real Estate 50.4 50.2
------- -------
Total $122.6 $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
<PAGE>
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):
MARCH 31 DECEMBER 31
1996 1995
--------- -----------
Fixed Maturity Securities $ 8.0 $ 8.0
Commercial Mortgage Loans 11.6 10.9
Residential and Other Mortgage Loans .4 .4
Investment Real Estate 1.0 1.0
Foreclosed Real Estate 30.4 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.
20
<PAGE>
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
-----------------------------
MARCH 31 DECEMBER 31
1996 1995
---- ----
Retail 10.7% 6.1%
Office 68.6 72.8
Industrial 17.9 18.1
Hotel/Motel 2.8 3.0
----- -----
Total 100.0% 100.0%
===== =====
GEOGRAPHIC REGION
-----------------------------
MARCH 31 DECEMBER 31
1996 1995
---- ----
Midwest 40.1% 39.2%
Southeast 26.6 28.4
Southwest 5.2 3.4
Mountain 1.0 1.0
Pacific 27.1 28.0
------ ------
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 $16.5 million and $55.1 million, respectively at March 31, 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 operations acquired from USLICO, 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.
21
<PAGE>
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.
22
<PAGE>
RELIASTAR FINANCIAL CORP.
Part II. Other Information
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
Exhibits:
(11) Statement re Computation of Per Share Earnings
(27) Financial Data Schedule
Reports on Form 8-K:
A separate Form 8-K dated March 29, 1996 was filed in relation to the issuance
of $125.0 million of Trust-Originated Preferred Securities.
23
<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 MAY 14, 1996
---------------------
RELIASTAR FINANCIAL CORP.
/S/ WAYNE R. HUNEKE
--------------------------
by Wayne R. Huneke
Senior Vice President, Chief Financial Officer and
Treasurer
24
<PAGE>
ReliaStar Financial Corp.
Exhibit Index
DESCRIPTION
- - -----------
(11) Statement re Computation of Per Share Earnings 26
(27) Financial Data Schedule
25
<PAGE>
ReliaStar Financial Corp. EXHIBIT 11
Computation of Earnings Per Share
(in millions, except per share amounts)
<TABLE>
<CAPTION>
THREE MONTHS
ENDED MARCH 31
---------------------------
EARNINGS: 1996 1995
----------- ------------
<S> <C> <C>
Primary:
Net Income, as Reported $ 48.0 $ 37.8
Dividends on ESOP Convertible Preferred Stock (.7) (.7)
Tax Benefit on Unallocated ESOP Dividends .2 .2
Dividends on 10% Senior Cumulative Preferred Stock (1.6) (1.6)
----------- -----------
Net Income, As Adjusted $ 45.9 $ 35.7
=========== ===========
Fully Diluted:
Net Income, as Reported $ 48.0 $ 37.8
Additional Compensation Expense due to Assumed
Conversion of ESOP Convertible Preferred Stock - (.1)
Dividends on 10% Senior Cumulative Preferred Stock (1.6) (1.6)
----------- -----------
Net Income, as Adjusted $ 46.4 $ 36.1
=========== ===========
SHARES:
Primary:
Weighted Average Common Shares Outstanding, Unadjusted 36.4 35.8
Dilutive Effect of Outstanding Stock Options .5 .5
----------- -----------
Weighted Average Common Shares, as Adjusted 36.9 36.3
=========== ===========
Fully Diluted:
Weighted Average Common Shares Outstanding, Unadjusted 36.4 35.8
Dilutive Effect of:
ESOP Convertible Preferred Stock 2.6 2.6
Outstanding Stock Options .5 .5
----------- -----------
Weighted Average Common Shares, as Adjusted 39.5 38.9
=========== ===========
NET INCOME PER COMMON SHARE:
Primary $ 1.24 $ .98
========== ===========
Fully Diluted $ 1.17 $ .93
========== ===========
26
</TABLE>
<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> MAR-31-1996
<DEBT-HELD-FOR-SALE> 8,909,500,000
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 35,700,000
<MORTGAGE> 1,967,600,000
<REAL-ESTATE> 100,900,000
<TOTAL-INVEST> 11,785,400,000
<CASH> 24,900,000
<RECOVER-REINSURE> 163,200,000
<DEFERRED-ACQUISITION> 925,400,000
<TOTAL-ASSETS> 15,772,300,000
<POLICY-LOSSES> 11,083,900,000
<UNEARNED-PREMIUMS> 0
<POLICY-OTHER> 260,300,000
<POLICY-HOLDER-FUNDS> 186,500,000
<NOTES-PAYABLE> 423,300,000
120,800,000
69,000,000
<COMMON> 566,000,000
<OTHER-SE> 709,000,000
<TOTAL-LIABILITY-AND-EQUITY> 15,772,300,000
205,000,000
<INVESTMENT-INCOME> 232,300,000
<INVESTMENT-GAINS> 6,200,000
<OTHER-INCOME> 89,900,000
<BENEFITS> 323,800,000
<UNDERWRITING-AMORTIZATION> 21,000,000
<UNDERWRITING-OTHER> 100,200,000
<INCOME-PRETAX> 74,300,000
<INCOME-TAX> 26,200,000
<INCOME-CONTINUING> 48,000,000
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 48,000,000
<EPS-PRIMARY> 1.24
<EPS-DILUTED> 1.17
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 0
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
