<PAGE>
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, 1998
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
-------------------------------------------------- -----
(Address of principal executive offices) (Zip Code)
(612) 372-5432
--------------
(Registrant's telephone number, including area code)
- --------------------------------------------------------------------------------
(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 30, 1998 was
91,142,830.
<PAGE>
PART I-FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
RELIASTAR FINANCIAL CORP.
Condensed Consolidated Balance Sheets
(in millions)
(unaudited)
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
------------- ------------
<S> <C> <C>
ASSETS
Fixed Maturity Securities $11,666.5 $11,146.7
Equity Securities 64.0 27.0
Mortgage Loans on Real Estate 2,107.2 2,270.7
Real Estate and Leases 52.5 74.5
Policy Loans 689.1 663.3
Other Invested Assets 148.8 81.1
Short-Term Investments 155.8 157.2
--------- ---------
Total Investments 14,883.9 14,420.5
Cash 36.5 46.4
Accounts and Notes Receivable 317.8 217.5
Reinsurance Receivable 371.4 324.4
Deferred Policy Acquisition Costs 1,169.8 1,091.9
Present Value of Future Profits 416.0 480.0
Property and Equipment, Net 115.2 112.4
Accrued Investment Income 203.8 200.6
Other Assets 403.0 641.2
Participation Fund Account Assets 314.9 316.6
Assets Held in Separate Accounts 3,512.6 3,149.3
--------- ---------
TOTAL ASSETS $21,744.9 $21,000.8
========= =========
LIABILITIES
Future Policy and Contract Benefits $13,429.5 $13,329.4
Pending Policy Claims 402.3 340.5
Other Policyholder Funds 309.8 286.5
Notes and Mortgages Payable 367.0 593.5
Income Taxes 254.6 192.1
Other Liabilities 615.6 545.5
Participation Fund Account Liabilities 314.9 316.6
Liabilities Related to Separate Accounts 3,507.1 3,143.8
--------- ---------
TOTAL LIABILITIES 19,200.8 18,747.9
--------- ---------
Company-Obligated Mandatorily Redeemable Preferred
Securities Issued by Consolidated Subsidiaries 242.2 241.9
--------- ---------
SHAREHOLDERS' EQUITY
Common Stock (Shares Issued: 1998 and 1997, 98.1) .9 .9
Additional Paid-in Capital 1,006.9 1,019.8
Retained Earnings 1,119.6 964.8
Net Unrealized Investment Gains 337.0 226.2
Note Receivable from ESOP (19.9) (20.8)
Unamortized Restricted Stock Awards (.9) (1.0)
Treasury Common Stock, at Cost
(Shares Held: 1998, 6.6; 1997, 7.7) (141.7) (178.9)
--------- ---------
TOTAL SHAREHOLDERS' EQUITY 2,301.9 2,011.0
--------- ---------
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY $21,744.9 $21,000.8
========= =========
</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 Nine Months Ended
September 30 September 30
---------------- ---------------------
1998 1997 1998 1997
------- ------ -------- --------
<S> <C> <C> <C> <C>
REVENUES
Premiums $248.5 $229.1 $ 740.8 $ 648.9
Net Investment Income 277.3 269.6 826.0 737.0
Realized Investment Gains, Net 1.0 2.7 18.5 5.2
Policy and Contract Charges 95.7 100.7 298.4 230.3
Other Income 86.4 65.4 236.6 175.5
------ ------ -------- --------
Total 708.9 667.5 2,120.3 1,796.9
------ ------ -------- --------
BENEFITS AND EXPENSES
Benefits to Policyholders 373.0 374.2 1,138.3 1,012.6
Sales and Operating Expenses 162.1 140.7 465.2 384.3
Amortization of Deferred Policy Acquisition Costs
and Present Value of Future Profits 47.1 43.7 137.2 103.7
Interest Expense 6.8 6.0 19.7 15.6
Dividends and Experience Refunds to Policyholders 8.0 4.4 24.5 18.9
------ ------ -------- --------
Total 597.0 569.0 1,784.9 1,535.1
------ ------ -------- --------
Income from Continuing Operations Before Income Taxes
and Dividends on Preferred Securities of Subsidiaries 111.9 98.5 335.4 261.8
Income Tax Expense 40.0 34.3 119.5 92.0
Dividends on Preferred Securities of Subsidiaries,
Net of Tax 3.3 3.4 9.9 7.2
------ ------ -------- --------
Income from Continuing Operations 68.6 60.8 206.0 162.6
Income (Loss) from Discontinued Operations, Net of Tax - .7 (3.4) 2.1
------ ------ -------- --------
Net Income $ 68.6 $ 61.5 $ 202.6 $ 164.7
====== ====== ========= ========
PER COMMON SHARE
Basic
Income from Continuing Operations $ .75 $ .66 $ 2.26 $ 1.94
Income (Loss) from Discontinued Operations - .01 (.04) .02
------ ------ -------- --------
Net Income $ .75 $ .67 $ 2.22 $ 1.96
====== ====== ======== ========
Diluted
Income from Continuing Operations $ .74 $ .65 $ 2.22 $ 1.91
Income (Loss) from Discontinued Operations - .01 (.04) .02
------ ------ -------- --------
Net Income $ .74 $ .66 $ 2.18 $ 1.93
====== ====== ======== ========
Weighted Average Common Shares
Basic 91.5 91.3 91.2 84.0
Diluted 93.1 93.0 92.9 85.4
</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
----------------------
1998 1997
-------- --------
<S> <C> <C>
Common Stock
Beginning of Year $ .9 $ .4
Issued for Acquisition - .1
Issued for Common Stock Split - .4
-------- --------
End of Period .9 .9
-------- --------
Additional Paid-in Capital
Beginning of Year 1,019.8 571.9
Issued for Benefit Plans - 11.3
Issued for Acquisition - 428.3
Loss on Treasury Shares Reissued for Benefit Plans (22.5) (5.9)
Loss on Treasury Shares Reissued for Acquisitions (.9) -
Tax Benefit on Stock Options Exercised 10.5 6.1
-------- --------
End of Period 1,006.9 1,011.7
-------- --------
Retained Earnings
Beginning of Year 964.8 794.2
Net Income 202.6 164.7
Common Dividends to Shareholders: (Per Share: 1998,
$.525; 1997, $.45) (47.9) (38.0)
Other, Net .1 .5
-------- --------
End of Period 1,119.6 921.4
-------- --------
Net Unrealized Investment Gains
Beginning of Year 226.2 140.8
Change for the Period 110.8 63.8
-------- --------
End of Period 337.0 204.6
-------- --------
Note Receivable from ESOP
Beginning of Year (20.8) (21.6)
Repayments, Accrued or Paid .9 .8
-------- --------
End of Period (19.9) (20.8)
-------- --------
Unamortized Restricted Stock Awards
Beginning of Year (1.0) (1.8)
Awards, Net - (.2)
Amortization of Restricted Stock Awards .1 .7
-------- --------
End of Period (.9) (1.3)
-------- --------
Treasury Common Stock
Beginning of Year (178.9) (66.2)
Acquired (36.0) (131.6)
Reissued for Acquisitions 21.2 -
Reissued, Other 52.0 12.1
-------- --------
End of Period (141.7) (185.7)
-------- --------
Total Shareholders' Equity $2,301.9 $1,930.8
======== ========
</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
-------------------
1998 1997
--------- --------
<S> <C> <C>
OPERATING ACTIVITIES
Net Income $ 202.6 $ 164.7
Adjustments to Reconcile Net Income to Net Cash Provided by
Operating Activities
Interest Credited to Insurance Contracts 436.7 398.6
Future Policy Benefits (515.1) (238.8)
Capitalization of Policy Acquisition Costs (174.7) (149.8)
Amortization of Deferred Policy Acquisition Costs and Present
Value of Future Profits 137.2 103.7
Deferred Income Taxes 10.5 7.1
Net Change in Receivables and Payables (22.0) (11.8)
Other Assets 304.7 (103.2)
Realized Investment Gains, Net (18.5) (5.2)
Other (18.4) (7.4)
--------- --------
Net Cash Provided by Operating Activities 343.0 157.9
--------- --------
INVESTING ACTIVITIES
Proceeds from Sales of Fixed Maturity Securities 308.3 284.9
Proceeds from Maturities or Repayment of Fixed Maturity Securities 803.3 694.9
Cost of Fixed Maturity Securities Acquired (1,458.6) (957.8)
Sales (Purchases) of Equity Securities, Net (39.1) 13.1
Proceeds of Mortgage Loans Sold, Matured or Repaid 497.2 551.2
Cost of Mortgage Loans Acquired (334.9) (794.6)
Sales of Real Estate and Leases, Net 25.1 12.2
Policy Loans Issued, Net (25.8) (34.6)
Purchases of Other Invested Assets, Net (12.3) (13.7)
Sales (Purchases) of Short-Term Investments, Net 2.1 (42.6)
Cash Acquired with Acquisitions, Net 1.3 18.5
--------- --------
Net Cash Used by Investing Activities (233.4) (268.5)
--------- --------
FINANCING ACTIVITIES
Deposits to Insurance Contracts 1,242.1 1,000.2
Maturities and Withdrawals from Insurance Contracts (1,080.3) (965.1)
Net Proceeds from Issuance of Trust Originated Preferred Securities - 120.8
Increase in Notes and Mortgages Payable 64.0 115.6
Repayment of Notes and Mortgages Payable (290.9) (15.5)
Issuance of Common Stock Under Stock Option and Other Plans 29.5 17.9
Dividends on Common Stock (47.9) (38.0)
Acquisition of Treasury Common Stock (36.0) (131.6)
--------- --------
Net Cash Provided (Used) by Financing Activities (119.5) 104.3
--------- --------
Decrease in Cash (9.9) (6.3)
Cash at Beginning of Period 46.4 32.4
--------- --------
Cash at End of Period $ 36.5 $ 26.1
========= ========
</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 Annual Report on Form 10-K of
ReliaStar Financial Corp. (the Company or ReliaStar) for the year ended December
31, 1997 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,
1997, has been prepared by management without audit by independent certified
public accountants. The condensed consolidated balance sheet as of December 31,
1997 has been derived from, and does not include all of the disclosures
contained in, the audited consolidated financial statements for the year ended
December 31, 1997.
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 Company's 1997 Annual Report on Form 10-K.
Note 2. Accounting Changes
ACCOUNTING FOR TRANSFERS AND SERVICING OF FINANCIAL ASSETS AND EXTINGUISHMENTS
OF LIABILITIES
Effective for transactions occurring on or after January 1, 1998, the Company
adopted those provisions of Statement of Financial Accounting Standards (SFAS)
No. 125, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities," which were deferred by SFAS No. 127, "Deferral
of the Effective Date of Certain Provisions of FASB Statement No. 125." SFAS No.
125 requires a company to recognize the financial and servicing assets it
controls and the liabilities it has incurred and to derecognize financial assets
when control has been surrendered in accordance with the criteria provided in
SFAS No. 125. The adoption of these provisions had no effect on the financial
results of the Company.
REPORTING COMPREHENSIVE INCOME
Effective January 1, 1998, the Company adopted SFAS No. 130, "Reporting
Comprehensive Income." SFAS No. 130 establishes standards for the reporting and
display of comprehensive income and its components in a company's full set of
financial statements. SFAS No. 130 defines comprehensive income as "the change
in equity (net assets) of a business enterprise during a period from
transactions and other events and circumstances from nonowner sources. It
includes all changes in equity during a period except those resulting from
investments by owners and distributions to owners." Comprehensive income for the
three and nine month periods ended September 30, 1998 and 1997, was as follows
(in millions):
Three Months Ended Nine Months Ended
September 30 September 30
------------------ -----------------
1998 1997 1998 1997
---- ---- ---- ----
Net Income $ 68.6 $ 61.5 $202.6 $164.7
Change in Net Unrealized Investment Gains 92.0 73.0 110.8 63.8
------ ------ ------ ------
Comprehensive Income $160.6 $134.5 $313.4 $228.5
====== ====== ====== ======
6
<PAGE>
DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION
Effective January 1, 1998, the Company adopted SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information." SFAS No. 131 establishes
standards for the way that a company reports information about operating
segments in financial statements using a "management approach" to aggregate
operating segments. The Company operates in four reportable segments: Personal
Financial Services, which represents the Company's individual life insurance
products; Worksite Financial Services, which sells group and individual life
insurance products, retirement plans and financial services to employers and
their employees at the worksite; Tax-Sheltered and Fixed Annuities, which sells
403(b) annuities and other retirement products, primarily to the K-12
schoolteacher market; and Reinsurance, which sells group life, health and
special risk reinsurance and specialty insurance products in the United States
and internationally.
ACCOUNTING FOR THE COSTS OF COMPUTER SOFTWARE DEVELOPED OR OBTAINED FOR INTERNAL
USE
During the second quarter of 1998, the Company adopted Statement of Position
(SOP) No. 98-1, "Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use." SOP No. 98-1 provides guidance on accounting for
costs associated with computer software developed or obtained for internal use.
The Company adopted this pronouncement during the second quarter of 1998,
retroactive to the beginning of the year. Adoption of SOP No. 98-1 did not have
a material effect on the financial results of the Company.
Note 3. Acquisitions
In January 1998, the Company completed the acquisitions of ReliaStar Bancshares,
Inc., formerly known as Citizens Community Bancshares Co., and ReliaStar
Managing Underwriters, Inc., formerly known as LaMar & Phillips, Inc.
ReliaStar Bancshares, Inc. is a thrift holding company whose subsidiary,
ReliaStar Bank, is based in St. Cloud, Minnesota. ReliaStar Bank is a federally
chartered savings bank that provides consumer banking products. This acquisition
was accounted for using the purchase method of accounting and was effected
through a stock-for-stock exchange whereby the Company issued approximately
228,000 shares of ReliaStar common stock from treasury. Goodwill recorded as a
result of this transaction was approximately $3 million.
ReliaStar Managing Underwriters, Inc. is a managing general underwriter, located
in Brentwood, Tennessee, specializing in the HMO reinsurance and provider excess
business. This acquisition was accounted for using the purchase method of
accounting and was effected through a stock-for-stock exchange whereby the
Company issued approximately 330,000 shares of ReliaStar common stock from
treasury. Goodwill recorded as a result of this transaction was approximately
$14 million.
The pro forma effect of these transactions on prior period consolidated results
is not material.
During the first quarter of 1998, the Company repurchased 560,000 of its common
shares in a common stock buyback program completed in conjunction with these
acquisitions.
Note 4. Discontinued Operations
On July 31, 1998, the Company completed the sale of its mortgage banking
subsidiary, ReliaStar Mortgage Corporation (RMC). The results of RMC are
presented as discontinued operations on the Condensed Consolidated Statements of
Income; prior periods have been restated to reflect this presentation.
Revenues of RMC for the three month periods ended September 30, 1998 and 1997,
were $3.5 million and $8.9 million, respectively. Revenues of RMC for the nine
month periods ended September 30, 1998 and 1997, were $18.9 million and $23.5
million, respectively. A $6.3 million pretax loss ($3.5 million after-tax) was
recorded in the second quarter of 1998 on the disposal of RMC and included a
loss from operations totaling $2.8 million pretax ($1.8 million after-tax).
7
<PAGE>
Item 2.
RELIASTAR FINANCIAL CORP.
Management's Discussion and Analysis
of Financial Condition and Results of Operations
RESULTS OF OPERATIONS
Results of operations by operating segment are summarized below (in millions):
<TABLE>
<CAPTION>
Three Months Nine Months
Ended September 30 Ended September 30
------------------ ------------------
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Operating Income (Loss) (1)
Personal Financial Services Segment $24.4 $19.8 $ 69.6 $ 45.5
Worksite Financial Services Segment 15.4 13.3 43.2 37.3
Tax-Sheltered and Fixed Annuities Segment 18.8 17.2 56.1 55.0
Reinsurance Segment 10.4 8.4 31.4 25.4
Other Business Units 3.4 2.0 9.3 3.7
Corporate (4.8) (1.3) (13.4) (6.7)
----- ----- ------ ------
Operating Income 67.6 59.4 196.2 160.2
Net Realized Investment Gains, Net of Tax 1.0 1.4 9.8 2.4
----- ----- ------ ------
Income From Continuing Operations 68.6 60.8 206.0 162.6
Income (Loss) From Discontinued Operations, Net of Tax - .7 (3.4) 2.1
----- ----- ------ ------
Net Income $68.6 $61.5 $202.6 $164.7
===== ===== ====== ======
</TABLE>
- ----------
(1) Operating income is after-tax and excludes realized investment gains and
losses and their impact on the amortization of deferred policy acquisition
costs (DAC) and present value of future profits (PVFP).
Effective January 1, 1998, the Company adopted SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information." As a result, the Company now
reports its segment results consistent with the way it manages its businesses.
The Company has four reportable operating segments: Personal Financial Services,
Worksite Financial Services, Tax-Sheltered and Fixed Annuities, and Reinsurance
(see Note 2 of Notes to Condensed Consolidated Financial Statements). Prior
period segment information has been restated to conform to the current
presentation.
The Company conducts its operations primarily through its life insurance
subsidiaries: ReliaStar Life Insurance Company (ReliaStar Life), Northern Life
Insurance Company (Northern), ReliaStar United Services Life Insurance Company
(United Services), Security-Connecticut Life Insurance Company
(Security-Connecticut), and ReliaStar Life Insurance Company of New York (RLNY).
These subsidiaries are sometimes collectively referred to as the Insurers.
On July 1, 1997, ReliaStar completed the acquisition of Security-Connecticut
Corporation (SCC). The acquisition was accounted for using the purchase method
of accounting and, accordingly, the results of operations prior to July 1, 1997
do not include the results of SCC or its former subsidiaries.
The discussion of segment operating results that follows refers to the above
after-tax segment results and, in each instance, amounts are after-tax unless
otherwise indicated.
Personal Financial Services
- ---------------------------
Operating income of the Personal Financial Services segment for the third
quarter of 1998 increased $4.6 million, or 23%, compared with the same period in
1997. The increase is primarily due to increased interest spreads and lower
expenses. Year-to-date operating income increased 53% over the comparable period
in 1997 primarily due to the additional earnings in the first six months of 1998
from the SCC life insurance subsidiaries which totaled $16.3 million. The
remaining
8
<PAGE>
increase in year-to-date operating income was primarily due to an increase in
interest spreads, growth in assets under management and lower expenses,
partially offset by less favorable mortality experience.
The interest spread for the Personal Financial Services segment of 235 basis
points in the third quarter of 1998 compares to 217 basis points in the third
quarter of 1997. This increase in spreads reflects a 6 basis point increase in
the portfolio yield and a 12 basis point reduction in the average crediting
rate. We expect that the average interest spread for the remainder of 1998 will
be lower than the rate experienced thus far in 1998, primarily as a result of
declining investment portfolio yields. It should be noted that the interest
spread calculation is an annualized measure and can be overly influenced in a
particular period by the level of prepayments, recoveries on problem investments
and other variances in the level of net investment income. For some of the
business included in the Personal Financial Services segment, crediting rates on
in force business are reset annually at the beginning of the calendar year and
are guaranteed for one year. The balance of the business has crediting rates
that can be changed on the policy anniversary or some other date. 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.
Total assets under management increased to $6.7 billion as of September 30, 1998
from $6.6 billion as of September 30, 1997. Separate account assets under
management increased to $1.8 billion as of September 30, 1998 from $1.5 billion
as of September 30, 1997.
Total sales (annualized new premiums and deposits) for the third quarter of 1998
were $116.8 million compared to $97.2 million in the same period of 1997. The
increase in sales reflects a 40% increase in individual life insurance sales and
a 50% increase in fixed annuity sales. Variable annuity sales were unchanged in
the third quarter of 1998 compared to the third quarter of 1997. Total sales for
the first nine months of 1998 were $347.4 million compared to $260.8 million in
the same period of 1997. The increase in sales reflects a 50% increase in
individual life insurance sales, a 54% increase in fixed annuity sales and a 20%
increase in variable annuity sales. Included in the sales results are $34.1
million of sales from the SCC life insurance subsidiaries in the first six
months of 1998 for which there are no comparable sales in 1997, as SCC was
acquired on July 1, 1997.
Worksite Financial Services
- ---------------------------
Operating income of the Worksite Financial Services segment for the third
quarter of 1998 increased $2.1 million, or 16%, compared with the same period in
1997. The increase in operating income is primarily due to increased investment
income and lower expenses in the employee benefits unit; higher fee income,
reflecting growth in assets under management, in the retirement plans unit; and
higher investment income in the pension lines of business, partially offset by
increased start-up costs in the Worksite Advisory Services unit. Year-to-date
operating income increased 16%, compared with the same period in 1997. The
increase in year-to-date operating income is primarily due to favorable claims
experience, higher investment income and lower expenses in the employee benefits
unit and higher assets under management in the retirement plans unit. This
increase in year-to-date operating income was partially offset by increased
start-up costs in the Worksite Advisory Services unit. Total sales for the third
quarter of 1998 were $117.4 million compared with $149.6 million in the same
period of 1997. Total sales for the first nine months of 1998 were $375.1
million compared to $404.7 million in the same period of 1997. The decrease in
sales is due primarily to lower retirement plan sales.
During September 1998, the Company entered into a strategic alliance with
Trustmark Insurance Co. (Trustmark) related to its insured group medical and
Administrative Services Only (ASO) product lines. Under the alliance, ReliaStar
transferred to Trustmark the claims processing and administration for its
insured group medical, ASO and split risk product lines. The group medical
contracts will continue to be underwritten by ReliaStar until their renewal
date, at which time Trustmark will directly provide products and services to
these customers, in addition to handling claims processing and administration.
Operating income of the product lines affected by the alliance were not material
in the past.
Tax-Sheltered and Fixed Annuities
- ---------------------------------
Operating income of the Tax-Sheltered and Fixed Annuities segment for the third
quarter of 1998 increased $1.6 million, or 9%, compared with the same period in
1997. The increase in operating income is primarily due to growth in assets
9
<PAGE>
under management and lower expenses, offset by lower interest spreads.
Year-to-date operating income increased 2% compared with the same period in 1997
and is primarily due to growth in assets under management.
The interest spread of 248 basis points in the third quarter of 1998 compares to
255 basis points in the third quarter of 1997. This decrease in spreads reflects
a 17 basis point decrease in the portfolio yield and a 10 basis point reduction
in the average crediting rate. We expect that the average interest spread for
the remainder of 1998 will be lower than the rate experienced thus far in 1998,
primarily as a result of declining investment portfolio yields. It should be
noted that the interest spread calculation is an annualized measure and can be
overly influenced in a particular period by the level of prepayments, recoveries
on problem investments and other variances in the level of net investment
income. For most of the business included in the Tax-Sheltered and Fixed
Annuities segment, crediting rates on in force business are reset annually at
the beginning of the calendar year and are guaranteed for one year. The balance
of the business has crediting rates that can be changed on the policy
anniversary or some other date. 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.
Total assets under management increased 9% to $7.2 billion as of September 30,
1998 from $6.6 billion as of September 30, 1997. Separate account assets under
management increased 139% to $263 million at September 30, 1998 from $110
million at September 30, 1997.
Total sales for the third quarter of 1998 were $157.3 million compared with
$136.5 million in the same period of 1997. The increase in sales reflects a 113%
increase in sales of variable annuities and an 8% decrease in fixed annuity
sales. Total sales for the first nine months of 1998 were $429.3 million
compared with $387.1 million in the same period of 1997. The increase in sales
reflects a 104% increase in sales of variable annuities and a 10% decrease in
fixed annuity sales.
Reinsurance
- -----------
Operating income of the Reinsurance segment for the third quarter of 1998
increased $2.0 million, or 24%, compared with the same period in 1997. The
increase in operating income is primarily due to a 58% increase in net earned
premiums, partially offset by higher commission expenses and a less favorable
overall loss ratio. Year-to-date operating income also increased 24% compared
with the same period in 1997. The increase in year-to-date operating income is
primarily due to an increase in net earned premiums, partially offset by higher
commission expenses and a less favorable overall loss ratio. 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 included
in this segment.
Total sales for the third quarter of 1998 were $48.6 million compared with $29.8
million in the same period of 1997, an increase of 63%, primarily due to strong
sales of group life and managed care reinsurance. Total sales for the first nine
months of 1998 were $149.3 million compared to the $82.2 million in the same
period of 1997.
Other Business Units
- --------------------
Other Business Units include the Company's mutual fund operation, broker/dealer
operations, banking operation and personal finance education company. Operating
income of the Other Business Units for the third quarter of 1998 increased $1.4
million compared with the same period in 1997. Year-to-date operating income of
the Other Business Units for the first nine months of 1998 increased $5.6
million compared with the same period in 1997. The increase in third quarter and
year-to-date operating earnings is primarily due to higher revenues on increased
broker/dealer volume and higher assets under management at the mutual fund
operation. In addition, the year-to-date comparisons were impacted by a $2.7
million pretax gain in the first quarter of 1998 from the sale of 12b-1 fees
attributable to a portion of the mutual fund operation's Class B shares.
Corporate
- ---------
Corporate includes financing costs, goodwill amortization and other unallocated
costs. Operating losses of Corporate
10
<PAGE>
for the third quarter of 1998 increased $3.5 million compared with the same
period in 1997. The operating losses of Corporate for the first nine months of
1998 increased $6.7 million compared with the same period in 1997. The increase
in year-to-date operating losses is primarily due to increased financing costs
and goodwill amortization related to purchase acquisitions. The increase in
third quarter operating losses is primarily due to a $2.3 million gain
recognized in 1997 related to the sale of certain assets of the Company's third
party investment manager and increased goodwill amortization related to purchase
acquisitions.
REALIZED INVESTMENT GAINS AND LOSSES
The sources of net realized investment gains (losses) were as follows (in
millions):
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30 September 30
--------------- -----------------
1998 1997 1998 1997
----- ---- ----- -----
<S> <C> <C> <C> <C>
Net Gains (Losses) on Sales of Investments
Fixed Maturity Securities
Gross Gains $ 5.7 $2.0 $14.9 $ 4.6
Gross Losses (1.5) (.4) (3.2) (4.6)
Equity Securities .1 1.5 1.0 3.9
Mortgage Loans .2 - (.1) .1
Foreclosed Real Estate (1.2) - 1.8 .1
Real Estate .4 .2 .7 .3
Other .7 1.1 14.6 6.7
Provision for Losses on Investments
Fixed Maturity Securities (1.2) - (7.5) (1.7)
Mortgage Loans - (.5) - (1.9)
Foreclosed Real Estate 2.3 (.5) .8 (1.6)
Real Estate (.2) (.7) (.2) (.7)
Other (4.3) - (4.3) -
----- ---- ----- -----
Pretax Realized Investment Gains 1.0 2.7 18.5 5.2
DAC/PVFP Amortization (1) .6 (.5) (3.2) (1.5)
Income Taxes (.6) (.8) (5.5) (1.3)
----- ---- ----- -----
Net Realized Investment Gains, Net of Tax $ 1.0 $1.4 $ 9.8 $ 2.4
===== ==== ===== =====
</TABLE>
(1) Due to pretax realized investment gains and losses.
The Company establishes allowances and writes down the value of specific assets
based upon its continuing review of individual problem investments. The
Company's recording of allowances and write-downs based upon a review of
individual problem investments 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.
11
<PAGE>
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 is subject to restrictions imposed by applicable laws and
regulations.
The payment of future dividends by ReliaStar will be largely dependent upon the
ability of ReliaStar Life to pay dividends to the Company. 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 1998, the amount of dividends which can be paid by ReliaStar Life without
Commissioner approval is $186.4 million.
The Company maintains a $125.0 million unsecured revolving credit facility with
a group of banks. As of September 30, 1998, $70.0 million remained available for
borrowing under this facility.
During the first quarter of 1998, the Company repurchased 560,000 of its common
shares at an average price of $46.58 per share in a common stock buyback program
completed in conjunction with the acquisition of ReliaStar Managing
Underwriters, Inc. and ReliaStar Bancshares, Inc.
On October 6, 1998, the Company announced plans to repurchase up to $125 million
of the Company's common stock. The Company expects to complete the buyback
program by the end of 1998. Through November 6, 1998, 482,700 shares had been
repurchased. Initially, the program is being financed using bank debt, but
permanent financing is expected to be in place by the end of the year.
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, 1998, the Insurers' investment portfolios included
$8.1 billion (37% of consolidated assets) of short-term investments and
investment grade marketable bonds. The September 30, 1998 investment portfolio
also included $2.8 billion of investment grade privately placed bonds which,
while not publicly traded, are a source of liquidity.
Some of the policies and annuities issued by the Insurers 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 such withdrawals or surrenders. The Insurers 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.
While the Insurers have experienced an increase in withdrawal and
12
<PAGE>
surrender activity attributable to their individual fixed annuity products, the
surrender activity is well below a level 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 seeks assets which have
duration characteristics similar to the liabilities which they support. The
Company also uses derivative instruments, such as interest rate swaps, to adjust
the duration of the asset and liability portfolios (see Investments-Derivative
Financial Instruments).
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 generally
accepted accounting principles (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 or
equity infusions by the Company with funds generated through debt or equity
offerings.
The state of domicile of each of the Insurers imposes NAIC developed 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 and various levels of activity, based
upon the nature and perceived degree of risk associated with such balances and
levels of activity. Regulatory compliance is measured by a company's risk-based
capital ratio, which is calculated as a company's regulatory total adjusted
capital, as defined, divided by its authorized control level risk-based capital,
as defined. Companies with ratios below specific trigger points are classified
within certain regulatory action levels, each of which requires specified
corrective action. The risk-based capital ratio of each of the Insurers
significantly exceeds the ratio at which regulatory corrective action would be
required.
CONSOLIDATED CASH FLOWS
The company's cash balance at September 30, 1998 was $36.5 million. During the
nine months ended September 30, 1998, net cash provided by operating activities
was $343.0 million, and cash used by investing and financing activities was
$233.4 million and $119.5 million, respectively.
The $343.0 million of net cash provided by operating activities was primarily
the result of positive cash flow from premiums and investment income in excess
of cash outflows for insurance benefits and sales and operating expenses and the
effects of the sale of our mortgage banking subsidiary. Net cash used by
financing activities of $119.5 million was primarily the result of the repayment
of commercial paper previously issued by our mortgage banking subsidiary which
was sold. Other uses of cash for financing activities included the payment of
dividends on common stock, offset by short term borrowings and net deposits to
insurance contracts.
INVESTMENTS
The current 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 for the
remainder of 1998 to the acquisition of investment grade marketable and
privately placed bonds and commercial mortgages. 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 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
13
<PAGE>
Company internally allocates assets within the Insurers 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 within each
Insurer. Assets within these portfolios are selected to provide duration, cash
flow and return characteristics which are compatible with the liabilities they
support. 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 (in millions):
September 30, December 31,
1998 1997
------------------ ------------------
Amount Percent Amount Percent
--------- ------- --------- -------
Investment Grade Bonds:
Marketables $ 7,973.9 53.6% $ 7,824.4 54.2%
Private Placements 2,821.0 19.0 2,619.4 18.2
--------- ----- -------- -----
Subtotal 10,794.9 72.6 10,443.8 72.4
Below Investment Grade Bonds:
Marketables 367.7 2.5 296.7 2.0
Private Placements 488.6 3.3 400.6 2.8
--------- ----- -------- -----
Subtotal 856.3 5.8 697.3 4.8
Equity Securities 64.0 .4 27.0 .2
Commercial Mortgages 1,612.5 10.8 1,594.9 11.1
Mortgages, Residential and Other 494.7 3.3 675.8 4.7
Real Estate 52.5 .4 74.5 .5
Short-Term Investments 155.8 1.0 157.2 1.1
Other 853.2 5.7 750.0 5.2
--------- ----- -------- -----
Total Invested Assets $14,883.9 100.0% $14,420.5 100.0%
========= ===== ========= =====
FIXED MATURITY SECURITIES
The amounts invested in fixed maturity securities as of September 30, 1998 and
December 31, 1997 were $11.7 billion and $11.1 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, 1998 were $9.5
million and $7.2 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' categories 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, 1998, the weighted average book yields of the Company's
investment grade portfolio and below investment grade portfolio were 7.5% and
8.4%, 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.
14
<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, 1998
-------------------------------------------------------------------------------------
Marketables Private Placements
---------------------------------------- ----------------------------------------
Gross Unrealized Gross Unrealized
NAIC Amortized ----------------- Fair Amortized ---------------- Fair
Rating Cost Gains (Losses) Value Cost Gains (Losses) Value
- ------ -------- ------- -------- -------- -------- ------- ------ --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
1 $5,338.3 $ 367.3 $ (14.6) $5,691.0 $ 884.1 $ 66.6 $ (.4) $ 950.3
2 2,158.3 138.8 (14.2) 2,282.9 1,771.2 103.4 (3.9) 1,870.7
3 287.4 9.6 (4.1) 292.9 340.8 8.6 (1.5) 347.9
4 80.6 .5 (6.7) 74.4 121.9 1.5 (.8) 122.6
5 .2 - (.2) - 13.3 .3 (.2) 13.4
6 .4 - - .4 4.7 - - 4.7
Redeemable
Preferred
Stock 14.5 .5 (1.2) 13.8 1.5 - - 1.5
-------- ------- ------- -------- -------- ------- ------ --------
Total $7,879.7 $ 516.7 $ (41.0) $8,355.4 $3,137.5 $ 180.4 $ (6.8) $3,311.1
======== ======= ======= ======== ======== ====== ====== ========
</TABLE>
<TABLE>
<CAPTION>
December 31, 1997
-------------------------------------------------------------------------------------
Marketables Private Placements
---------------------------------------- ----------------------------------------
Gross Unrealized Gross Unrealized
NAIC Amortized ----------------- Fair Amortized ---------------- Fair
Rating Cost Gains (Losses) Value Cost Gains (Losses) Value
- ------ -------- ------- -------- -------- -------- ------- ------ --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
1 $5,306.0 $ 260.8 $ (6.6) $5,560.2 $ 877.0 $ 41.6 $ (2.0) $ 916.6
2 2,154.5 114.1 (4.4) 2,264.2 1,634.2 71.7 (3.1) 1,702.8
3 264.2 11.5 (0.8) 274.9 244.7 5.2 (0.6) 249.3
4 19.0 0.5 (0.2) 19.3 137.5 3.9 (1.2) 140.2
5 1.6 0.1 (0.1) 1.6 10.2 0.1 (0.1) 10.2
6 0.9 - - 0.9 0.9 - - 0.9
Redeemable
Preferred
Stock 3.7 0.4 - 4.1 1.5 - - 1.5
-------- ------- ------- -------- -------- ------- ------ --------
Total $7,749.9 $ 387.4 $(12.1) $8,125.2 $2,906.0 $ 122.5 $ (7.0) $3,021.5
======== ========= ====== ======== ======== ======= ====== ========
</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).
September 30, 1998 December 31, 1997
--------------------- ---------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
--------- --------- --------- ---------
Maturing in:
One Year or Less $ 369.0 $ 372.6 $ 199.9 $ 200.9
One to Five Years 3,578.9 3,770.2 3,651.3 3,789.2
Five to Ten Years 3,104.2 3,329.2 3,006.4 3,180.7
Ten Years or Later 1,188.1 1,272.7 1,244.0 1,324.4
Mortgage-Backed/Structured
Finance 2,777.0 2,921.8 2,554.3 2,651.5
--------- --------- --------- ---------
Total $11,017.2 $11,666.5 $10,655.9 $11,146.7
========= ========= ========= =========
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 matrix-based
pricing model. The model considers the current level of risk-free interest
rates, current
15
<PAGE>
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 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 their 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>
Marketables Private Placements
--------------------------- ----------------------------
September 30, December 31, September 30, December 31,
1998 1997 1998 1997
------------- ------------ ------------- ------------
<S> <C> <C> <C> <C>
Basic Materials 6.2% 6.7% 7.5% 8.9%
Consumer Non-Cyclical 5.9 5.7 15.4 18.0
Consumer Products/Services 7.7 7.5 18.7 16.8
Energy 6.0 5.7 7.1 6.6
Financial Services 21.3 20.8 16.9 20.5
Government 2.9 3.2 .2 0.6
Industrial 4.1 3.9 10.4 9.3
Mortgage-Backed/Structured
Finance 31.0 31.4 10.7 4.3
Real Estate 1.1 0.7 1.6 1.5
Retailing 1.9 2.1 5.0 5.6
Technology 1.9 1.8 2.1 2.5
Utilities 10.0 10.5 4.4 5.4
----- ----- ----- -----
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,
1998. The largest investment in below investment grade bonds of any one industry
grouping was approximately 1.8% of invested assets at September 30, 1998. The
portfolio of below investment grade bonds is regularly analyzed and managed in
an effort to avoid concentration risks.
16
<PAGE>
MORTGAGE-BACKED/STRUCTURED FINANCE 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, 1998
-------------------------
Amortized
Cost Fair Value
--------- ----------
Adjustable Rate Pass Through:
Below 6% $ 5.4 $ 5.4
6% - 7% 67.9 67.9
7% - 8% 169.5 168.4
Above 8% 5.9 6.0
Fixed Rate Pass Through:
Below 9% 91.6 97.0
Above 9% 8.2 8.6
Planned Amortization Class:
Below 7% 294.7 322.3
7% - 8% 361.6 388.6
8% - 9% 83.7 88.9
Above 9% 2.3 2.5
Other:
Below 7% 257.3 278.7
7% - 8% 88.3 97.8
8% - 9% 20.4 21.9
Above 9% 9.3 9.6
-------- --------
Total $1,466.1 $1,563.6
======== ========
The Company invests in public and private asset-backed securities in addition to
the MBS securities described above. As of September 30, 1998, the Insurers held
asset-backed securities with an amortized cost of $1,310.9 million and a fair
value of $1,358.2 million. These securities are collateralized by diversified
pools of manufactured housing loans, credit card receivables, automobile loans,
home equity loans, commercial mortgage loans, and high yield bank loans and
corporate bonds. The investment strategy has been to purchase primarily senior
structures and tranches that minimize prepayment and default risk. Approximately
33% of these securities are collateralized by manufactured housing loans, 21% by
commercial mortgage loans, and 20% by high yield bank loans and corporate bonds.
None of the remaining collateral types exceed, on an individual basis, 10% of
total asset-backed securities.
17
<PAGE>
MORTGAGE LOANS
The Company's commercial mortgage loans generally range in size from $4 million
to $7 million, with the average commercial mortgage loan investment as of
September 30, 1998 being approximately $2.7 million.
The commercial mortgage loan portfolio diversification by property type and
geographic region of the United States was as follows:
September 30, December 31,
1998 1997
------------- ------------
Property Type
Apartment 23.5% 20.9%
Industrial 21.1 20.8
Office 16.7 20.4
Retail 19.4 18.4
Special Purpose 18.2 18.2
Hotel/Motel 1.1 1.3
----- -----
Total 100.0% 100.0%
===== =====
September 30, December 31,
1998 1997
------------- ------------
Geographic Region
Midwest 33.8% 32.7%
Pacific 25.2 25.3
Southeast 17.6 18.5
Northeast 9.6 9.9
Mountain 8.1 7.5
Southwest 5.7 6.1
----- -----
Total 100.0% 100.0%
===== =====
The weighted average yield of the commercial mortgage loan portfolio as of
September 30, 1998 was 8.2%. The weighted average maturity of these loans was
8.0 years.
The Company invests in individual and pools of individual residential mortgage
loans in addition to the structured finance securities backed by residential
mortgages. As of September 30, 1998 and December 31, 1997, the Insurers held
$493.8 million and $674.6 million, respectively, of non-securitized residential
mortgage loans.
UNREALIZED INVESTMENT GAINS AND LOSSES
The Company's debt and equity securities classified as available-for-sale are
carried at fair value on the Condensed Consolidated Balance Sheets with
unrealized investment gains and losses excluded from income and reported as a
separate component of shareholders' equity.
The components of net unrealized investment gains reported in shareholders'
equity are shown below (in millions):
September 30, December 31,
1998 1997
------------- ------------
Unrealized Investment Gains $ 682.3 $ 489.1
DAC/PVFP Adjustment (164.4) (138.8)
Deferred Income Taxes (180.9) (124.1)
------- -------
Net Unrealized Investment Gains $ 337.0 $ 226.2
======= =======
18
<PAGE>
Changes in unrealized investment gains or losses are primarily the result 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: (i) the Company has the present intent and
practice to hold most of its available-for-sale fixed maturity securities to
maturity and (ii) 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 attempts to structure investment asset portfolios with
compatible characteristics. Investment assets are selected in an effort to
provide yield, cash flow and interest rate sensitivities appropriate to support
the insurance products.
The Company manages its interest rate risk by managing its assets within target
duration ranges, based on the Company's liability profile. The Company uses
duration analysis to estimate the amount of sensitivity to market interest rate
changes. The 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 portfolio
duration includes the duration impact added by interest rate swaps and caps. The
target duration ranges 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. A goal of this
risk control process is to optimize portfolio performance relative to the
product liability requirements.
The following table sets forth the asset duration, portfolio duration and target
duration for the investment portfolio of each operating segment (in years):
September 30, 1998
------------------------------------------
Asset Portfolio Target
Duration Duration Duration
-------- --------- --------
Personal Financial Services 3.9 3.9 3.5-5.0
Worksite Financial Services 3.0 3.3 3.0-6.0
Tax-Sheltered and Fixed Annuities 3.8 4.0 3.5-5.0
Reinsurance 4.4 4.5 3.5-8.0
The Company uses interest rate swaps 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.
At September 30, 1998, the Company had 61 interest rate swap contracts in effect
with a notional amount of $908 million. At December 31, 1997, the Company had 71
interest rate swap contracts in effect with a notional amount of $1.16 billion.
During the nine months ended September 30, 1998, 2 interest rate swap contracts
were entered into with a notional amount of $50.0 million and 12 interest rate
swap contracts matured with a notional amount of $305.0 million. There were no
terminations of interest rate swap contracts prior to maturity during the first
nine months of 1998. The Company had no deferred gains or losses at September
30, 1998 related to interest rate swap contracts terminated early. The estimated
fair value of the interest rate swap contracts in effect at September 30, 1998
was an unrealized gain of $33.9 million which is reported with other invested
assets on the condensed consolidated balance sheet.
All of the interest rate swap contracts 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
19
<PAGE>
contract rate). The following table details the characteristics of the Company's
interest rate swap contracts at September 30, 1998 (dollars in millions).
Notional Range of Fixed
Amount Rates Received
-------- --------------
Maturing in:
One Year or Less $ 55.0 5.2 - 6.4%
One to Three Years 552.5 5.3 - 7.6%
Three to Five Years 160.0 6.3 - 8.2%
Five to Seven Years 140.0 6.0 - 6.8%
------
Total $907.5
======
The Company 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 loss) 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, 1998, the Company held $1.2 billion of
adjustable rate invested assets, short-term investments and cash.
The Company also uses interest rate caps as part of its overall interest rate
risk management strategy for certain annuity products primarily to hedge the
risk of investment losses due to product surrenders in an increasing interest
rate environment. The Company held eight interest rate caps with a notional
amount of $510.0 million and a fair value of approximately $6,100.
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 60 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) principal face amount or timing of
principal repayments on a contingent or absolute basis; or (iv) amount or timing
of payment of accrued interest.
The amortized cost of Problem Investments, net of related write-offs and
allowances and non-recourse debt, was as follows (in millions):
September 30, December 31,
1998 1997
------------- ------------
Private Placement Bonds $10.0 $ 6.2
Marketable Bonds 2.1 2.7
Commercial Mortgage Loans 16.0 12.5
Residential and Other Mortgage Loans 5.3 7.3
Investment Real Estate1 8.4 8.4
Foreclosed Real Estate 27.8 42.3
Other .4 -
----- -----
Total $70.0 $79.4
===== =====
1 The amounts shown represent real estate acquired as an investment which the
Company has determined to be Problem Investments.
20
<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 were as follows (in
millions):
September 30, December 31,
1998 1997
------------- ------------
Private Placement Bonds $ 13.2 $ 6.0
Marketable Bonds 1.2 .8
Commercial Mortgage Loans 9.0 9.0
Residential and Other Mortgage Loans 1.1 1.1
Foreclosed Real Estate 21.1 23.6
Other 4.3 -
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 their
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 investment 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 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 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, marketable bonds, and mortgage loan Potential
Problem Investments were $27.9 million, $12.4 million and $1.3 million,
respectively, at September 30, 1998.
KNOWN TRENDS AND UNCERTAINTIES WHICH MAY AFFECT FUTURE REPORTED RESULTS
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 its businesses, including several class action suits which seek both
compensatory and punitive damages. The Company believes the results of
litigation will not have a material adverse effect on the financial position of
the Company. Some financial services companies have recently been subjected to
significant awards in connection with class actions and/or suits seeking
punitive damages. While the Company is not aware of any actions or allegations
which should reasonably give rise to any material adverse effect, it is possible
that the Company could be subjected to such a claim in an amount which could be
material.
FINANCIAL SERVICES DEREGULATION
The United States Congress is currently considering a number of legislative
proposals intended to reduce or eliminate restrictions on affiliations among
financial services organizations. Proposals are extant which would allow banks
to own or affiliate with insurers and securities firms. An increased presence of
banks in the life insurance and annuity businesses may increase competition in
these markets. The Company cannot predict the impact of these proposals on the
earnings of the Company.
YEAR 2000 SYSTEMS MODIFICATIONS
The Company's business units utilize data processing systems in the
administration of the insurance and financial services products which they
market. Most of the Company's data processing systems have required
modifications to enable them to process dates including the year 2000 and
beyond.
In 1995, the Company initiated an enterprise wide program of identifying and
modifying systems affected by the year 2000. The Company developed a plan
whereby all systems will be identified, modified and tested for year 2000
compliance by the end of 1998. The Company initiated a structured review and
reporting system whereby senior management is regularly advised of the status of
the project. The Company expects that virtually all systems will have completed
testing and be deemed compliant by the end of 1998, with the remaining systems
testwork expected to be completed by the end of the first quarter of 1999.
The Company does business with a multitude of business entities whose ability to
comply with year 2000 systems issues may affect the business operations of the
Company. The Company has made an attempt to determine whether such entities have
adequate plans for year 2000 compliance, and the Company is not aware of any
instances where a key supplier or vendor will not be compliant. The Company does
not have the ability to assure with any certainty the compliance capacity of
third parties.
Since the inception of the year 2000 program and for the remainder of the
program, the Company has and expects to continue to redirect certain internal
and external data processing resources to its year 2000 efforts. Certain
technology initiatives have been deferred to meet the year 2000 objectives. The
Company believes that the net effect of these efforts will not materially impact
the Company's business plans or its 1998 consolidated financial statements,
however, some additional expenditures for external resources have been incurred.
The Company's business would be adversely affected if it does not meet its goals
relative to year 2000 preparedness, and the Company's plans reflect the
importance of this project. Due to the Company's dependence on data processing
for the operation of its business, the Company cannot reasonably develop a
contingency plan which would comprehensively address widespread systems
failures.
IMPACT OF ACCOUNTING PRONOUNCEMENTS TO BE ADOPTED IN THE FUTURE
In September 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 133 provides a comprehensive and
consistent standard for the recognition and measurement of derivatives and
hedging activities. This pronouncement is effective for fiscal years beginning
after September 15, 1999. The Company has not completed its analysis of the
impact on future financial results of applying this pronouncement.
22
<PAGE>
CERTAIN FORWARD-LOOKING INFORMATION
All statements contained in this Form 10-Q, press releases and other public
disclosures relative to markets for the Company's products and trends in the
Company's operations or financial results, as well as other statements including
words such as "anticipate," "believe," "expect," and other similar expressions,
constitute forward-looking statements under the Private Securities Litigation
Reform Act of 1995. These forward-looking statements are subject to known and
unknown risks, uncertainties and other factors that may cause actual results to
be materially different from those contemplated by the forward-looking
statements. Such factors include, among other things: general economic
conditions and other factors, including prevailing interest rate levels and
stock market performance, which may affect the Company's ability to sell its
products, the market value of the Company's investments and the lapse rate and
profitability of the Company's policies; the Company's ability to achieve
anticipated levels of operating efficiencies; mortality and morbidity; changes
in federal income tax laws that may affect the relative tax advantages of some
of the Company's products; and regulatory changes or actions, including those
relating to regulation of financial services affecting bank sales and
underwriting of insurance products and regulation of the sale, underwriting and
pricing of insurance products.
23
<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.
24
<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 11, 1998
--------------------------------
RELIASTAR FINANCIAL CORP.
/s/ James R. Miller
--------------------------------------
by James R. Miller
Senior Vice President, Chief Financial
Officer and Treasurer
25
<PAGE>
EXHIBIT 11
ReliaStar Financial Corp.
Computation of Per Share Earnings
(in millions, except per share amounts)
Three Months Nine Months
Ended September 30 Ended September 30
------------------ ------------------
1998 1997 1998 1997
----- ----- ------ ------
NUMERATOR - BASIC AND DILUTED
Income from Continuing Operations $68.6 $60.8 $206.0 $162.6
Income (Loss) from Discontinued Operations - .7 (3.4) 2.1
----- ----- ------ ------
Net Income $68.6 $61.5 $202.6 $164.7
===== ===== ====== ======
DENOMINATOR
Weighted Average Common Shares Outstanding
During the Period (Basic) 91.5 91.3 91.2 84.0
Dilutive Effect of Stock Options 1.5 1.6 1.6 1.3
Other .1 .1 .1 .1
----- ----- ------ ------
Weighted Average Common Shares
During the Period (Diluted) 93.1 93.0 92.9 85.4
===== ===== ====== ======
PER COMMON SHARE
Basic
Income from Continuing Operations $ .75 $ .66 $ 2.26 $ 1.94
Income (Loss) from Discontinued Operations - .01 (.04) .02
----- ----- ------ ------
Net Income $ .75 $ .67 $ 2.22 $ 1.96
===== ===== ====== ======
Diluted
Income from Continuing Operations $ .74 $ .65 $ 2.22 $ 1.91
Income (Loss) from Discontinued Operations - .01 (.04) .02
----- ----- ------ ------
Net Income $ .74 $ .66 $ 2.18 $ 1.93
===== ===== ====== ======
<TABLE> <S> <C>
<PAGE>
<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>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<DEBT-HELD-FOR-SALE> 11,666,500
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 64,000
<MORTGAGE> 2,107,200
<REAL-ESTATE> 52,500
<TOTAL-INVEST> 14,883,900
<CASH> 36,500
<RECOVER-REINSURE> 371,400
<DEFERRED-ACQUISITION> 1,169,800
<TOTAL-ASSETS> 21,744,900
<POLICY-LOSSES> 13,429,500
<UNEARNED-PREMIUMS> 0
<POLICY-OTHER> 402,300
<POLICY-HOLDER-FUNDS> 309,800
<NOTES-PAYABLE> 367,000
242,200
0
<COMMON> 900
<OTHER-SE> 2,301,000
<TOTAL-LIABILITY-AND-EQUITY> 21,744,900
740,800
<INVESTMENT-INCOME> 826,000
<INVESTMENT-GAINS> 18,500
<OTHER-INCOME> 535,000
<BENEFITS> 1,138,300
<UNDERWRITING-AMORTIZATION> 80,200
<UNDERWRITING-OTHER> 465,200
<INCOME-PRETAX> 335,400
<INCOME-TAX> 119,500
<INCOME-CONTINUING> 206,000
<DISCONTINUED> (3,400)
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 202,600
<EPS-PRIMARY> 2.22
<EPS-DILUTED> 2.18
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 0
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
