<PAGE> 1
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
------------------
[ ] 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 001-11462
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DELPHI FINANCIAL GROUP, INC.
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(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C> <C>
Delaware (302) 478-5142 13-3427277
- ------------------------------- ------------------------------- -------------------------------
(State or other jurisdiction of (Registrant's telephone number, (I.R.S. Employer Identification
incorporation or organization) including area code) Number)
</TABLE>
<TABLE>
<S> <C>
1105 North Market Street, Suite 1230, P.O. Box 8985, Wilmington, Delaware 19899
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(Address of principal executive offices) (Zip Code)
</TABLE>
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 filing requirements
for the past 90 days:
Yes X No
--- ---
As of November 6, 1998, the Registrant had 14,413,654 shares of Class A Common
Stock and 5,574,844 shares of Class B Common Stock outstanding.
<PAGE> 2
DELPHI FINANCIAL GROUP, INC.
FORM 10-Q
INDEX
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<CAPTION>
Page
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PART I. FINANCIAL INFORMATION
<S> <C>
Consolidated Statements of Income for the Three and Nine
Months Ended September 30, 1998 and 1997....................................... 3
Consolidated Balance Sheets at September 30, 1998 and
December 31, 1997.............................................................. 4
Consolidated Statements of Shareholders' Equity for the
Nine Months Ended September 30, 1998 and 1997.................................. 5
Consolidated Statements of Cash Flows for the
Nine Months Ended September 30, 1998 and 1997.................................. 6
Notes to Consolidated Financial Statements........................................ 7
Management's Discussion and Analysis of Financial
Condition and Results of Operations............................................ 9
PART II. OTHER INFORMATION................................................................. 13
</TABLE>
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<PAGE> 3
PART I. FINANCIAL INFORMATION
DELPHI FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(DOLLARS IN THOUSANDS, 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>
Revenue:
Insurance premiums and fees ............................ $ 101,753 $ 89,848 $ 303,863 $ 267,658
Net investment income .................................. 34,184 40,428 122,407 124,948
Net realized investment (losses) gains ................. (10,044) 5,214 23,255 9,577
--------- --------- --------- ---------
125,893 135,490 449,525 402,183
--------- --------- --------- ---------
Benefits and expenses:
Benefits, claims and interest credited to policyholders 77,060 72,762 240,006 220,231
Commissions ............................................ 8,459 6,932 24,601 19,944
Amortization of cost of business acquired .............. 4,664 7,177 18,081 21,557
Other operating expenses ............................... 15,792 14,045 44,772 41,205
--------- --------- --------- ---------
105,975 100,916 327,460 302,937
--------- --------- --------- ---------
Operating income ................................. 19,918 34,574 122,065 99,246
Interest expense ......................................... 4,232 3,562 12,056 11,399
--------- --------- --------- ---------
Income before income tax expense and
dividends on Capital Securities of Delphi
Funding L.L.C................................. 15,686 31,012 110,009 87,847
Income tax expense ....................................... 3,618 9,660 34,932 28,550
--------- --------- --------- ---------
Income before dividends on Capital Securities
of Delphi Funding L.L.C....................... 12,068 21,352 75,077 59,297
Dividends on Capital Securities of Delphi Funding L.L.C... 1,513 1,513 4,539 3,143
--------- --------- --------- ---------
Net income ....................................... $ 10,555 $ 19,839 $ 70,538 $ 56,154
========= ========= ========= =========
Basic results per share of common stock:
Income excluding realized investment (losses) gains .... $ 0.85 $ 0.86 $ 2.80 $ 2.63
Realized investment (losses) gains, net of taxes ....... (0.32) 0.18 0.76 0.33
--------- --------- --------- ---------
Net income ....................................... $ 0.53 $ 1.04 $ 3.56 $ 2.96
========= ========= ========= =========
Diluted results per share of common stock:
Income excluding realized investment (losses) gains .... $ 0.82 $ 0.82 $ 2.69 $ 2.48
Realized investment (losses) gains, net of taxes ....... (0.31) 0.17 0.74 0.31
--------- --------- --------- ---------
Net income ....................................... $ 0.51 $ 0.99 $ 3.43 $ 2.79
========= ========= ========= =========
</TABLE>
See notes to consolidated financial statements.
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<PAGE> 4
DELPHI FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
---------- ----------
<S> <C> <C>
Assets:
Investments:
Fixed maturity securities, available for sale ............................. $2,236,796 $2,165,069
Cash and cash equivalents ................................................. 216,956 50,580
Other investments ......................................................... 228,093 264,753
---------- ----------
2,681,845 2,480,402
Cost of business acquired ...................................................... 96,409 92,931
Reinsurance receivables ........................................................ 356,056 234,746
Other assets ................................................................... 262,052 322,985
Assets held in separate account ................................................ 65,571 72,649
---------- ----------
Total assets .............................................................. $3,461,933 $3,203,713
========== ==========
Liabilities and Shareholders' Equity:
Future policy benefits ......................................................... $ 474,559 $ 436,021
Unpaid claims and claim expenses ............................................... 574,976 531,409
Policyholder account balances .................................................. 669,352 689,542
Corporate debt ................................................................. 234,230 178,769
Advances from Federal Home Loan Bank ........................................... 125,681 201,057
Other liabilities and policyholder funds ....................................... 636,575 494,082
Liabilities related to separate account ........................................ 57,184 63,347
---------- ----------
Total liabilities ......................................................... 2,772,557 2,594,227
---------- ----------
Company-obligated mandatorily redeemable Capital Securities of Delphi
Funding L.L.C. holding solely junior subordinated deferrable interest
debentures of the Company ................................................. 100,000 100,000
---------- ----------
Shareholders' equity:
Preferred Stock, $.01 par; 10,000,000 shares authorized ................... - -
Class A Common Stock, $.01 par; 40,000,000 shares authorized;
14,356,438 and 12,884,188 shares issued and outstanding, respectively . 144 129
Class B Common Stock, $.01 par; 20,000,000 shares authorized;
5,574,844 and 6,156,787 shares issued and outstanding, respectively ... 56 62
Additional paid-in capital ................................................ 311,158 262,963
Net unrealized appreciation on investments ................................ 21,631 40,545
Retained earnings ......................................................... 256,387 205,787
---------- ----------
Total shareholders' equity ............................................ 589,376 509,486
---------- ----------
Total liabilities and shareholders' equity ....................... $3,461,933 $3,203,713
========== ==========
</TABLE>
See notes to consolidated financial statements.
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<PAGE> 5
DELPHI FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(DOLLARS IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
Unrealized
Class A Class B Additional (Depreciation)
Common Common Paid-in Appreciation Retained
Stock Stock Capital on Investments Earnings Total
--------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
Balance, January 1, 1997 ......... $ 118 $ 63 $ 240,203 $ (17,949) $ 144,530 $ 366,965
---------
Net income ....................... - - - - 56,154 56,154
Decrease in net unrealized
depreciation on investments ... - - - 23,675 - 23,675
---------
Comprehensive income ............. 79,829
Issuance of stock, exercise of
stock options and conversion
of shares ..................... 6 (2) 3,060 - - 3,064
Stock dividend ................... 2 1 13,720 - (13,726) (3)
--------- --------- --------- --------- --------- ---------
Balance, September 30, 1997 ...... $ 126 $ 62 $ 256,983 $ 5,726 $ 186,958 $ 449,855
========= ========= ========= ========= ========= =========
Balance, January 1, 1998 ......... $ 129 $ 62 $ 262,963 $ 40,545 $ 205,787 $ 509,486
---------
Net income ....................... - - - - 70,538 70,538
Decrease in net unrealized
appreciation on investments ... - - - (18,914) - (18,914)
---------
Comprehensive income ............. 51,624
Issuance of stock, exercise of
stock options and conversion
of shares ..................... 12 (7) 28,265 - - 28,270
Stock dividend ................... 3 1 19,930 - (19,938) (4)
--------- --------- --------- --------- --------- ---------
Balance, September 30, 1998 ...... $ 144 $ 56 $ 311,158 $ 21,631 $ 256,387 $ 589,376
========= ========= ========= ========= ========= =========
</TABLE>
See notes to consolidated financial statements.
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<PAGE> 6
DELPHI FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
------------------------------
1998 1997
----------- -----------
<S> <C> <C>
Operating activities:
Net income ......................................................................... $ 70,538 $ 56,154
Adjustments to reconcile net income to net cash (used) provided
by operating activities:
Change in future policy benefits, unpaid claims and claim expenses,
reinsurance receivables and policyholder accounts ........................... 56,435 40,245
Group employee benefit product reserves ceded to Oracle Reinsurance Ltd. ....... (101,500) -
Amortization, principally the cost of business acquired and investments ........ (29,278) 15,166
Deferred costs of business acquired ............................................ (26,311) (24,724)
Net realized gains on investments .............................................. (23,255) (9,577)
Net change in trading account securities ....................................... 24,974 231
Net change in federal income tax liability ..................................... (22,173) 15,177
Other .......................................................................... (44,848) (29,039)
----------- -----------
Net cash (used) provided by operating activities ............................ (95,418) 63,633
----------- -----------
Investing activities:
Securities available for sale:
Purchases of investments and loans made ........................................ (2,452,526) (1,023,969)
Sales of investments and receipts from repayment of loans ...................... 2,617,332 804,911
Maturities of investments ...................................................... 30,243 25,925
Cash portion of the SIG Merger contingent consideration ............................ (6,447) -
Cash acquired in acquisition of Matrix, net of consideration paid .................. (5,356) -
Change in deposit in separate account .............................................. 915 (1,033)
----------- -----------
Net cash provided (used) by investing activities ............................... 184,161 (194,166)
----------- -----------
Financing activities:
Deposits to policyholder accounts .................................................. 36,577 53,114
Withdrawals from policyholder accounts ............................................. (59,995) (50,352)
Proceeds from issuance of common stock and exercise of stock options ............... 1,301 3,061
Borrowings under Credit Agreement .................................................. 77,000 -
Principal payments under Credit Agreement .......................................... (27,000) (52,000)
Repayment of advances from the Federal Home Loan Bank .............................. (75,000) -
Change in liability for securities loaned or sold under agreements to repurchase ... 124,750 45,090
Net proceeds from issuance of Capital Securities of Delphi Funding L.L.C............ - 98,750
----------- -----------
Net cash provided by financing activities ...................................... 77,633 97,663
----------- -----------
Increase (decrease) in cash and cash equivalents ....................................... 166,376 (32,870)
Cash and cash equivalents at beginning of period ....................................... 50,580 89,711
----------- -----------
Cash and cash equivalents at end of period ..................................... $ 216,956 $ 56,841
=========== ===========
</TABLE>
See notes to consolidated financial statements.
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<PAGE> 7
DELPHI FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE A - SIGNIFICANT ACCOUNTING POLICIES
The financial statements included herein were prepared in conformity with
generally accepted accounting principles for interim financial information and
with the instructions to Form 10-Q and Article 10 of Regulation S-X.
Accordingly, they do not include all of the information and footnotes required
by generally accepted accounting principles for complete financial statements.
Such principles were applied on a basis consistent with those reflected in the
Company's report on Form 10-K for the year ended December 31, 1997. The
information furnished includes all adjustments and accruals of a normal
recurring nature which are, in the opinion of management, necessary for a fair
presentation of results for the interim periods. Operating results for the nine
months ended September 30, 1998 are not necessarily indicative of the results
that may be expected for the year ended December 31, 1998. Certain
reclassifications have been made in the 1997 financial statements to conform to
the 1998 presentation. For further information refer to the consolidated
financial statements and footnotes thereto included in the Company's report on
Form 10-K for the year ended December 31, 1997. Capitalized terms used herein
without definition have the meanings ascribed to them in the Company's report on
Form 10-K for the year ended December 31, 1997.
As of January 1, 1998, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 130, "Reporting Comprehensive Income." SFAS No. 130
establishes new rules for the reporting and display of comprehensive income and
its components; however, the adoption of SFAS No. 130 had no impact on the
Company's net income or shareholders' equity. SFAS No. 130 requires unrealized
gains and losses on the Company's available-for-sale securities, which are
reported as a separate component of shareholders' equity, to be included as a
component of comprehensive income. Prior year financial statements have been
reclassified to conform to the requirements of SFAS No. 130.
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities," which is
required to be adopted in fiscal years beginning after June 15, 1999. SFAS No.
133 permits early adoption as of the beginning of any quarter after its
issuance. The Company has not yet determined when it will adopt this standard.
SFAS No. 133 will require all derivatives to be recognized on the balance sheet
at fair value. Derivatives that are not hedges must be adjusted to fair value
through earnings. If the derivatives are a hedge, depending on the nature of the
hedge, changes in fair value of the derivatives will either be offset against
the change in fair value of the hedged items through earnings or recognized in
other comprehensive income until the hedged item is recognized in earnings. The
portion of a derivative's change in fair value not effective as a hedge will be
immediately recognized in earnings. The Company has not yet determined what the
effects of SFAS No. 133 will be on the earnings and financial position of the
Company.
NOTE B - INVESTMENTS
At September 30, 1998, the Company had fixed maturity securities available for
sale with a carrying value and a fair value of $2,236.8 million and an amortized
cost of $2,192.6 million. At December 31, 1997, the Company had fixed maturity
securities available for sale with a carrying value and a fair value of $2,165.1
million and an amortized cost of $2,101.9 million.
NOTE C - MATRIX ACQUISITION
On June 30, 1998, the Company acquired Matrix Absence Management, Inc.
("Matrix"), a provider of integrated disability and absence management services
to the employee benefits market. The purchase price of $33.8 million consisted
of 385,810 shares of the Company's Class A Common Stock, $7.9 million of cash
and $5.7 million of 8% subordinated notes due in 2003 (the "Subordinated
Notes"). Additional consideration of $4.2 million will be payable in cash if
Matrix's earnings meet specified targets over a four year period. The
acquisition was accounted for using the purchase accounting method, and the
results of Matrix will be included in the Company's results from the date of the
acquisition. The acquisition of Matrix is not expected to have a material impact
on Delphi's results before 1999.
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<PAGE> 8
DELPHI FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(UNAUDITED)
NOTE D - REINSURANCE AGREEMENT
In January 1998, an offering was completed whereby shareholders and
optionholders of the Company received, at no cost, rights to purchase shares of
Delphi International, a newly-formed, independent Bermuda insurance holding
company. During 1998, the Company entered into various reinsurance agreements
with Oracle Re, a wholly owned subsidiary of Delphi International. Pursuant to
these agreements, approximately $101.5 million of group employee benefit
reserves ($35.0 million of long-term disability insurance reserves and $66.5
million of excess workers' compensation and casualty insurance reserves) were
ceded to Oracle Re. The Company has received collateral security from Oracle Re
in an amount sufficient to support the ceded reserves. These agreements are not
expected to have a material effect on the Company's financial condition,
liquidity or results of operations.
NOTE E - COMPUTATION OF NET INCOME PER SHARE
The Company's Board of Directors declared a 2% stock dividend on April 1, 1998,
which was distributed to stockholders on May 4, 1998. Results per share and
applicable share amounts have been restated to reflect the stock dividend. Prior
period results per share and applicable share amounts have also been restated to
reflect the adoption of Statement of Financial Accounting Standards No. 128,
"Earnings Per Share." The following table sets forth the numerators and
denominators used to calculate basic and diluted results per share:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------ ----------------------
1998 1997 1998 1997
------------ ------------ ------------ --------
(dollars in thousands, except per share data)
<S> <C> <C> <C> <C>
Numerator:
Income excluding realized investment (losses) gains.. $ 17,084 $ 16,450 $ 55,422 $ 49,929
Realized investment (losses) gains, net of taxes..... (6,529) 3,389 15,116 6,225
------------ ------------ ------------ ------------
Net income....................................... $ 10,555 $ 19,839 $ 70,538 $ 56,154
============ ============ ============ ============
Denominator:
Weighted average common shares outstanding .......... 20,081 19,042 19,791 18,988
Effect of dilutive securities.................... 781 1,056 790 1,111
------------ ------------ ------------ ------------
Weighted average common shares outstanding,
assuming dilution................................ 20,862 20,098 20,581 20,099
============ ============ ============ ============
</TABLE>
NOTE F - SUBSEQUENT EVENT
On November 11, 1998, the Company entered into a definitive agreement to acquire
Unicover Managers, Inc. and certain of its affiliates ("Unicover"). Unicover is
a reinsurance underwriting manager specializing in alternative workers'
compensation coverage and receives fee income from the management of reinsurance
pools and facilities. The purchase price will consist of a $22.0 million initial
cash payment plus contingent consideration to be paid over the next four and a
quarter years based on an average multiple of approximately 1.1 times pre-tax
cash flow. The contingent consideration will consist of approximately 60% cash
and 40% shares of the Company's Class A Common Stock. Unicover's pre-tax cash
flow was approximately $11.0 million for the first nine months of 1998. The
acquisition is expected to close during the fourth quarter of 1998.
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<PAGE> 9
DELPHI FINANCIAL GROUP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
The following is an analysis of the results of operations and financial
condition of Delphi Financial Group, Inc. (the "Company," which term includes
the Company and its consolidated subsidiaries unless the context specifies
otherwise). This analysis should be read in conjunction with the Consolidated
Financial Statements and related notes included in this document, as well as the
Company's report on Form 10-K for the year ended December 31, 1997. Capitalized
terms used herein without definition have the meanings ascribed to them in the
Company's report on Form 10-K for the year ended December 31, 1997.
RESULTS OF OPERATIONS
Nine Months Ended September 30, 1998 Compared to
Nine Months Ended September 30, 1997
Insurance Premiums and Fees. Insurance premiums and fees for the nine months
ended September 30, 1998 were $303.9 million as compared to $267.7 million for
the nine months ended September 30, 1997, an increase of 13.5%. This increase
was primarily attributable to the Company's group employee benefits product line
and reflects strong production of new business, normal growth in employment and
salary levels for the Company's existing customer base and expansion within the
alternative risk transfer market. Also contributing to the increase was the
inclusion of $2.9 million of fee income from the Company's disability and
absence management business, which was acquired at the end of the second quarter
of 1998. Deposits from the Company's single premium deferred annuity products,
including the Company's market value adjusted annuity product, were $33.2
million for the first nine months of 1998 as compared to $47.7 million for the
same period of 1997. Deposits for these products, which are long-term in nature,
are not recorded as premiums; instead, the deposits are recorded as a liability.
The decrease in deposits was principally attributable to a decline in the demand
for fixed annuity products due to the low interest rate environment.
Net Investment Income. Net investment income for the nine months ended September
30, 1998 was $122.4 million as compared to $124.9 million for the nine months
ended September 30, 1997. A decrease in the weighted average annualized yield on
invested assets due to the third quarter decline in financial markets was
partially offset by an increase in average invested assets. The weighted average
annualized yield on invested assets, excluding realized and unrealized
investment gains and losses, was 7.8% on average invested assets of $2,086.8
million for the first nine months of 1998 and 8.1% on average invested assets of
$2,054.0 million for the comparable period of 1997.
Net Realized Investment Gains. Net realized investment gains were $23.3 million
for the nine months ended September 30, 1998 as compared to $9.6 million for the
nine months ended September 30, 1997. The Company's investment strategy results
in periodic sales of securities and the recognition of realized investment
gains and losses.
Benefits and Expenses. Policyholder benefits and expenses for the nine months
ended September 30, 1998 were $327.5 million as compared to $302.9 million for
the nine months ended September 30, 1997, an increase of 8%. Benefits and
expenses for group employee benefit products for the first nine months of 1998
increased by $30.8 million as compared to the same period of 1997 principally
due to growth in this product line. The combined ratio (loss ratio plus expense
ratio) for group employee benefit products was 95.4% for the nine months ended
September 30, 1998 as compared to 96.6% for the nine months ended September 30,
1997. The decrease was primarily attributable to the low level of expenses
associated with the products being offered in the alternative risk transfer
market. Benefits and interest credited on asset accumulation products decreased
by $3.6 million primarily due to a decrease in average funds under management
from $677.1 million for the first nine months of 1997 to $631.9 million for the
first nine months of 1998. The weighted average annualized crediting rate on
asset accumulation products for the nine months ended September
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<PAGE> 10
30, 1998 and 1997 was 5.3% in both periods. The amortization of cost of business
acquired related to asset accumulation products was decelerated by $2.0 million
during the first nine months of 1998 and accelerated by $1.5 million in the 1997
period. Acceleration and deceleration of the amortization of cost of business
acquired related to asset accumulation products primarily results from
differences between expected and actual investment results.
Operating Income. Operating income before interest and income tax expense and
dividends for the nine months ended September 30, 1998 was $122.1 million as
compared to $99.2 million for the nine months ended September 30, 1997, an
increase of 23%. The increase was primarily due to the increase in net realized
investment gains in the first nine months of 1998 and growth in the Company's
group employee benefits product line.
Interest Expense. Interest expense for the nine months ended September 30, 1998
was $12.1 million as compared to $11.4 million for the nine months ended
September 30, 1997. The increase was primarily due to an increase in the
weighted average borrowings under the Credit Agreement.
Income Tax Expense. Income tax expense for the nine months ended September 30,
1998 was $34.9 million as compared to $28.6 million for the nine months ended
September 30, 1997. The Company's effective tax rate decreased from 32.5% for
the first nine months of 1997 to 31.8% in the 1998 period principally due to
tax-exempt investment income.
Three Months Ended September 30, 1998 Compared to
Three Months Ended September 30, 1997
Insurance Premiums and Fees. Insurance premiums and fees for the three months
ended September 30, 1998 were $101.8 million as compared to $89.8 million for
the three months ended September 30, 1997, an increase of 13%. This increase was
primarily attributable to the Company's group employee benefits product line and
reflects strong production of new business and normal growth in employment and
salary levels for the Company's existing customer base. Also contributing to the
increase was the inclusion of $2.9 million of fee income from the Company's
disability and absence management business, which was acquired at the end of the
second quarter of 1998. These increases were partially offset by a $3.5 million
decrease in excess workers' compensation premiums principally due to state
mandated reductions in workers' compensation premium rates and increased
competition. The Company does not expect this reduction in premiums to have a
material impact on the underwriting results for this product as decreased
benefit levels, also mandated by the states, are expected to offset the decline
in premiums. Deposits from the Company's single premium deferred annuity
products, including the Company's market value adjusted annuity product, were
$11.1 million in the third quarter of 1998 as compared to $11.6 million for the
comparable period of 1997. Deposits for these products, which are long-term in
nature, are not recorded as premiums; instead, the deposits are recorded as a
liability.
Net Investment Income. Net investment income for the three months ended
September 30, 1998 was $34.2 million as compared to $40.4 million for the three
months ended September 30, 1997. The decrease in investment income was primarily
attributable to a decrease in the weighted average annualized yield on invested
assets due to the decline in financial markets during the third quarter of 1998.
The weighted average annualized yield on invested assets, excluding realized and
unrealized investment gains and losses, was 6.5% on average invested assets of
$2,116.6 million in the third quarter of 1998 and 7.6% on average invested
assets of $2,132.1 million in the comparable period of 1997.
Net Realized Investment (Losses) Gains. Net realized investment losses were
$10.0 million for the three months ended September 30, 1998 as compared to net
realized investment gains of $5.2 million for the three months ended September
30, 1997. The Company's investment strategy results in periodic sales of
securities and the recognition of realized investment gains and losses.
Benefits and Expenses. Policyholder benefits and expenses for the three months
ended September 30, 1998 were $106.0 million as compared to $100.9 million for
the three months ended September 30, 1997, an increase of 5%. Benefits and
expenses for group employee benefit products for the third quarter of 1998
increased by $9.1 million as compared to the same period of 1997 principally due
to growth in this product line. The combined ratio (loss ratio plus expense
ratio) for group employee benefit products decreased from 96.4% for the three
months ended September 30, 1997 to 94.3%
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<PAGE> 11
in the 1998 period. This decrease was primarily the result of premium income
increasing at a greater rate than the corresponding level of administrative
expenses. The amortization of cost of business acquired related to asset
accumulation products was decelerated by $2.0 million during the third quarter
of 1998 as a result of differences between expected and actual investment
results. There was no acceleration or deceleration of cost of business acquired
in the third quarter of 1997. Benefits and interest credited on asset
accumulation products decreased by $1.9 million primarily due to a decrease in
average funds under management from $675.2 million in the third quarter of 1997
to $624.1 million in the third quarter of 1998. Also contributing to the
decrease was a decline in the weighted average annualized crediting rate on
asset accumulation products from 5.4% in the 1997 period to 5.3% in the 1998
period.
Operating Income. Operating income before interest and income tax expense and
dividends for the three months ended September 30, 1998 was $19.9 million as
compared to $34.6 million for the three months ended September 30, 1997. The
decrease was primarily due to net realized investment losses in the 1998 period
as compared to net realized investment gains in the 1997 period.
Interest Expense. Interest expense for the three months ended September 30, 1998
was $4.2 million as compared to $3.6 million for the three months ended
September 30, 1997. This increase was primarily due to an increase in the
weighted average borrowings under the Credit Agreement.
Income Tax Expense. Income tax expense for the three months ended September 30,
1998 was $3.6 million as compared to $9.7 million for the three months ended
September 30, 1997. The Company's effective tax rate decreased from 31.1% in the
third quarter of 1997 to 23.1% in the third quarter of 1998 principally due to
tax-exempt investment income.
LIQUIDITY AND CAPITAL RESOURCES
The Company had approximately $239.5 million of financial resources available at
the holding company level at September 30, 1998, which was primarily comprised
of investments in the common stock of its non-insurance subsidiaries and fixed
maturity securities. The assets of the non-insurance subsidiaries are primarily
invested in fixed maturity securities, balances with independent investment
managers and marketable securities. Substantially all of the amounts invested
with independent investment managers are withdrawable at least annually, subject
to applicable notice requirements. A shelf registration is also in effect under
which up to $49.2 million in securities may be issued by the Company.
Other sources of liquidity at the holding company level include interest and
principal payments made on the Surplus Debenture issued by RSLIC-Texas to the
Company, dividends paid from insurance subsidiaries, primarily generated from
operating cash flows and investments, and borrowings available under the Credit
Agreement. The Company's insurance subsidiaries are permitted, without prior
regulatory or other approval, to make dividend payments of $47.0 million during
1998, of which $25.5 million has been paid during the first nine months of 1998.
The Company's current liquidity needs, in addition to funding operating
expenses, include distributions on the Capital Securities and principal and
interest payments on outstanding borrowings under the Credit Agreement, the
Senior Notes, the SIG Senior Notes and the Subordinated Notes. The Junior
Debentures underlying the Capital Securities are not redeemable prior to March
25, 2007, and, at the Company's current level of borrowings, no principal
repayments would be required under the Credit Agreement until October 1, 2002.
The Senior Notes mature in their entirety on October 1, 2003 and are not subject
to any sinking fund requirements nor are they redeemable prior to maturity. The
SIG Senior Notes amortize in $9.0 million annual installments beginning in May
1999, and the Subordinated Notes mature in their entirety on June 30, 2003. In
October 1998, $50.0 million of advances from the FHLB matured and was repaid.
The remaining outstanding advances from the FHLB do not begin to mature until
2003. In addition, the Company utilizes reverse repurchase agreements and
futures and option contracts in connection with its investment strategy. These
transactions require the Company to maintain securities or cash on deposit with
the applicable counterparty as collateral. As the market value of the collateral
or futures and options contracts changes, the Company may be required to deposit
additional collateral or be entitled to have a portion of the collateral
returned to it.
Operating activities increased cash and cash equivalents by $6.1 million,
excluding the one-time effect of the cession of $101.5 million of group employee
benefit product reserves to Oracle Re (see Note D to the Consolidated Financial
Statements), for the nine months ended September 30, 1998. In addition to the
Oracle Re transaction, operating cash flows decreased as compared to the first
nine months of 1997 primarily due to an increase in federal income taxes paid.
This increase was principally due to the increase in realized investment gains
in 1998, which are included in cash flows
-11-
<PAGE> 12
from investing activities, and timing differences in recognizing income from
investing activities. Cash flows from purchases and sales of investments in 1998
reflect the repositioning of a portion of the Company's portfolio into selected
categories of fixed maturity securities to take advantage of opportunities in
the marketplace to enhance investment returns while maintaining the Company's
investment objectives of safety and liquidity. There were no significant changes
in the credit quality of the Company's investment portfolio as a result of this
investment activity. Cash provided by financing activities was primarily used to
fund investment related activities during the 1998 period. Sources of liquidity
available to the Company and its subsidiaries are expected to exceed their cash
requirements on both a short-term and long-term basis.
A significant aspect of the Company's continued profitability is its ability to
manage risks associated with interest-sensitive assets and liabilities. The
Company prices its annuity products based on assumptions concerning prevailing
and expected interest rates and other factors to achieve a positive difference,
or spread, between its expected return on investments and the crediting rate.
The Company achieves this spread by active portfolio management focusing on
matching the durations of invested assets and related liabilities to minimize
the exposure to fluctuations in interest rates and by the adjustment of the
crediting rate on annuity products. The results of this asset/liability matching
are analyzed periodically through cash flow analysis under multiple interest
rate scenarios. The Company believes that it will continue to achieve a positive
spread and that the amount of lapses and surrender rates will remain consistent
with those assumed in the pricing of the products.
IMPACT OF YEAR 2000
The year 2000 issue relates to whether computer systems will properly
recognize date-sensitive information when the year changes to 2000. This
inability to recognize the year 2000 may cause systems to process critical
financial and operational information incorrectly. This, in turn, could cause
disruptions of normal business operations, including the inability to process
claims, bill and collect premium, perform policy administration and manage
investment activities. The Company has a corporate-wide program underway to
address the year 2000 issue, as it relates to its own computer systems, as well
as to instances in which computer systems of third parties may have a
significant impact on the Company's operations, such as those of suppliers,
business partners, customers, facilities and telecommunications.
The Company has completed an assessment of its critical computer
related systems and is in the process of making the necessary modifications or
replacements so that its computer systems will function properly with respect
to dates in the year 2000 and thereafter. Approximately 77% of the Company's
critical internal computer systems are currently year 2000 compliant, and the
necessary modifications to the remaining 23% are expected to be completed and
tested by the second quarter of 1999. The Company is primarily utilizing
external resources to remediate and test its software for year 2000 compliance.
The Company estimates that total internal (opportunity costs) and
external (out-of-pocket) costs for addressing the year 2000 issue will be
approximately $7.0 million (pre-tax), of which $4.6 million is expensed as
incurred and $2.4 million is capitalized and amortized over the life of the
replacement computer systems. During 1997 and the first nine months of 1998,
the Company incurred $4.3 million (pre-tax) of costs for addressing the year
2000 issue of which $3.1 million was expensed and $1.2 million was capitalized.
The Company has also requested assurances of year 2000 compliance from third
parties, the failure of whose computer systems to be year 2000 compliant may
have a significant impact on the Company's operations, in an effort to identify
and address potential problems arising from such non-compliance. There can be
no assurance, however, that the Company's operations will not be adversely
impacted by such non-compliance on the part of one or more such third parties.
Failure by the Company or significant third parties to successfully
address year 2000 issues could have a material adverse impact on the operations
and financial condition of the Company. During 1999, the Company expects to
finalize and have ready for implementation appropriate contingency plans in the
event any of the computer systems of the Company or significant third parties
are not year 2000 compliant. If the Company's internal computer systems
failed due to the year 2000 issue, the Company would be forced to return to a
paper-based system on an interim basis until the problem could be resolved. With
regard to third parties, the Company would attempt to implement alternative
arrangements where possible if year 2000 problems are encountered as to these
parties. The Company does not believe that these scenarios are reasonably likely
due to planned testing and problem resolution of all mission critical systems
prior to any anticipated material impact of the year 2000 issue; however, no
assurance can be given in this regard.
-12-
<PAGE> 13
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
In connection with, and because it desires to take advantage of, the
"safe harbor" provisions of the Private Securities Litigation Reform Act of
1995, the Company cautions readers regarding certain forward-looking statements
in the above Management's Discussion and Analysis and elsewhere in this Form
10-Q and in any other statement made by, or on behalf of, the Company, whether
or not in future filings with the Securities and Exchange Commission.
Forward-looking statements are statements not based on historical information
and which relate to future operations, strategies, financial results or other
developments. Some forward-looking statements may be identified by the use of
terms such as "expects," "believes," "anticipates," "intends" or "judgment."
Forward-looking statements are necessarily based upon estimates and assumptions
that are inherently subject to significant business, economic and competitive
uncertainties and contingencies, many of which are beyond the Company's control
and many of which, with respect to future business decisions, are subject to
change. Examples of such uncertainties and contingencies include, among other
important factors, those affecting the insurance industry generally, such as
legislative and regulatory developments and market pricing and competitive
trends, and those relating specifically to the Company's business, such as the
level of its insurance premiums, the claims experience of its insurance
products, the performance of its investment portfolio, the successful
completion by the Company of its year 2000 compliance program and acquisitions
of companies or blocks of business. These uncertainties and contingencies can
affect actual results and could cause actual results to differ materially from
those expressed in any forward-looking statements made by, or on behalf of, the
Company. The Company disclaims any obligation to update forward-looking
information.
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
11 - Computation of Earnings Per Share of Common Stock
(incorporated herein by reference to Note E to the
Consolidated Financial Statements included elsewhere
herein)
27 - Financial Data Schedule
(b) Reports on Form 8-K
None
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.
DELPHI FINANCIAL GROUP, INC. (Registrant)
/s/ ROBERT ROSENKRANZ
-------------------------------------------------
Robert Rosenkranz
Chairman of the Board, President and Chief
Executive Officer
(Principal Executive Officer)
/s/ LAWRENCE E. DAURELLE
-------------------------------------------------
Lawrence E. Daurelle
Vice President and Treasurer
(Principal Accounting and Financial Officer)
Date: November 16, 1998
-13-
<TABLE> <S> <C>
<ARTICLE> 7
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEET AS OF SEPTEMBER 30, 1998 (UNAUDITED) AND THE
CONSOLIDATED STATEMENT OF INCOME FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998
(UNAUDITED) 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> 2,236,796
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
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<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 2,464,889
<CASH> 216,956
<RECOVER-REINSURE> 356,056
<DEFERRED-ACQUISITION> 96,409
<TOTAL-ASSETS> 3,461,933
<POLICY-LOSSES> 1,049,535
<UNEARNED-PREMIUMS> 0
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 669,352
<NOTES-PAYABLE> 234,230
100,000<F1>
0
<COMMON> 200
<OTHER-SE> 589,176
<TOTAL-LIABILITY-AND-EQUITY> 3,461,933
303,863
<INVESTMENT-INCOME> 122,407
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<UNDERWRITING-AMORTIZATION> 18,081
<UNDERWRITING-OTHER> 81,429
<INCOME-PRETAX> 110,009
<INCOME-TAX> 34,932
<INCOME-CONTINUING> 75,077
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<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 70,538
<EPS-PRIMARY> 3.56
<EPS-DILUTED> 3.43
<RESERVE-OPEN> 0
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<FN>
<F1>Represents Company-obligated mandatorily redeemable Capital Securities of
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</FN>
</TABLE>
