<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 8-K
CURRENT REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
October 1, 1997
Date of Report (Date of earliest event reported)
SAFECO CORPORATION
(Exact name of registrant as specified in Charter)
WASHINGTON 1-6563 91-0742146
(State or other (Commission (IRS Employer
jurisdiction of File Number) Identification No.)
incorporation)
SAFECO Plaza, Seattle, Washington 98185
(Address of principal executive offices) (Zip Code)
(206) 545-5000
(Registrant's telephone number, including area code)
-1-
<PAGE>
Item 2. Acquisition or Disposition of Assets
On October 1, 1997, SAFECO Corporation, a Washington corporation
("SAFECO"), announced that it had completed its acquisition of American States
Financial Corporation, an Indiana corporation ("ASFC").
On October 1, 1997, ASFC Acquisition Co., an Indiana corporation and a
wholly owned subsidiary of SAFECO ("Merger Sub"), merged with and into ASFC (the
"Merger"), pursuant to the terms of the Agreement and Plan of Merger (the
"Merger Agreement"), dated as of June 6, 1997 by and among SAFECO, Merger Sub,
and ASFC. As a result of the Merger, ASFC is now a wholly owned subsidiary of
SAFECO.
ASFC is an insurance holding company whose insurance subsidiaries are
primarily involved in property and casualty insurance. Prior to its acquisition
by SAFECO it was a public company traded on the New York Stock Exchange.
SAFECO paid $47 in cash for each outstanding share of ASFC common stock,
for a total cash purchase price of approximately $2.8 billion. In connection
with the Merger Agreement, SAFECO also agreed to pay approximately $100 million
to Lincoln National Corporation ("LNC"), an Indiana corporation and former
holder of approximately 83% of the outstanding shares of ASFC common stock, in
consideration for LNC's agreement to release ASFC from certain debt obligations
and agreed to repay a $200 million term loan from LNC.
SAFECO financed the acquisition of ASFC's common stock and the repayment
of obligations to LNC from various sources, including the proceeds from (i)
the issuance of $200 million aggregate principal amount of 10-year senior
notes, (ii) the issuance of $850 million aggregate liquidation amount ($841.5
million net of underwriting compensation) of 40-year, SAFECO-obligated,
mandatorily redeemable preferred securities that are callable after 10-years
("capital securities") by a subsidiary trust, (iii) the issuance of $1.5
billion of commercial paper, and (iv) a $600 million special dividend from
its property and casualty subsidiaries. SAFECO expects to close the sale of
13,000,000 shares of its Common Stock on October 20, 1997 and intends to
apply the proceeds of $595.5 million (net of underwriting commissions) to
retire a like amount of commercial paper in late October 1997. Pending such
uses, the net proceeds will be invested in short-term, investment-grade,
interest-bearing securities. SAFECO, through a subsidiary trust, may issue an
additional $150 million aggregate liquidation amount of capital securities in
the fourth quarter of 1997 to retire an additional amount of commercial paper.
Item 7. Financial Statements, Pro Forma Financial Information and Exhibits
(a) Financial Statements of Business Acquired
The financial statements of ASFC required to be filed are
incorporated by reference. See exhibits 99.2 and 99.3 below.
(b) Pro Forma Financial Information
The required pro forma financial information is incorporated by
reference. See exhibit 99.4 below.
(c) Exhibits
-2-
<PAGE>
2.1 Agreement and Plan of Merger dated as of June 6, 1997 by and
among ASFC, SAFECO and ASFC Acquisition Co. (filed as Exhibit 2.1
to SAFECO's report on Form 8-K dated June 6, 1997 and
incorporated by reference).
99.1 Press Release issued by SAFECO on October 1, 1997.
99.2 Consolidated Balance Sheets of ASFC and Subsidiaries as of
December 31, 1996 and 1995, and the related Consolidated
Statements of Income, Shareholders' Equity and Cash Flows for
each of the three years in the period ended December 31, 1996,
together with the notes thereto and the related report of
Independent Accountants (incorporated by reference to pages 34
to 57 of the ASFC Annual Report on Form 10-K for the year
ended December 31, 1996 (Commission File Number 001-11733)).
The Consolidated Balance Sheets and Consolidated Statements of
Income, Shareholders' Equity and Cash Flows on pages 34 to 57
of the ASFC Annual Report on Form 10-K are included in this
Form 8-K as Exhibit 99.2.
99.3 Consolidated Balance Sheets of ASFC and Subsidiaries as of
June 30, 1997 and December 31, 1996, and the related
Consolidated Statements of Income, Shareholders' Equity and
Cash Flows for the Six Months Ended June 30, 1997 and 1996
(unaudited), together with the notes thereto (incorporated by
reference to pages 1 to 10 of the ASFC Quarterly Report on
Form 10-Q for the quarter ended June 30, 1997 (Commission File
Number 001-11733)). The Consolidated Balance Sheets and
Consolidated Statements of Income, Shareholders' Equity and
Cash Flows on pages 1 to 10 of the ASFC Quarterly Report on
Form 10-Q are included in this Form 8-K as Exhibit 99.3.
99.4 Unaudited Pro Forma Combined Condensed Financial Statements of
SAFECO reflecting the acquisition of ASFC and certain related
financings, as of June 30, 1997. Includes Unaudited Pro Forma
Combined Condensed Balance Sheet as of June 30,1997 and Unaudited
Pro Forma Combined Condensed Statements of Income for the Six
Months Ended June 30, 1997 and Year Ended December 31, 1996, and
related notes, incorporated by reference to pages 12 to 17 of
SAFECO's prospectus dated September 15, 1997 contained
in the Registration Statement on Form S-3 dated August 19, 1997
(Registration No. 333-33927). The pro forma financial information
on pages 12 to 17 of the prospectus contained in the
Registration Statement are included in this Form 8-K as Exhibit
99.4.
-3-
<PAGE>
SIGNATURE
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 hereunto duly authorized.
SAFECO CORPORATION
Dated: October 15, 1997 By: /s/ H. Paul Lowber
---------------------------
H. Paul Lowber
Vice President, Controller and
Chief Accounting Officer
-4-
<PAGE>
EXHIBIT INDEX
2.1 Agreement and Plan of Merger dated as of June 6, 1997 by and
among ASFC, SAFECO and ASFC Acquisition Co. (filed as Exhibit 2.1
to SAFECO's report on Form 8-K dated June 6, 1997 and
incorporated by reference).
99.1 Press Release issued by SAFECO on October 1, 1997.
99.2 Consolidated Balance Sheets of ASFC and Subsidiaries as of
December 31, 1996 and 1995, and the related Consolidated
Statements of Income, Shareholders' Equity and Cash Flows for
each of the three years in the period ended December 31, 1996,
together with the notes thereto and the related report of
Independent Accountants (incorporated by reference to pages 34
to 57 of the ASFC Annual Report on Form 10-K for the year
ended December 31, 1996 (Commission File Number 001-11733)).
The Consolidated Balance Sheets and Consolidated Statements of
Income, Shareholders' Equity and Cash Flows on pages 34 to 57
of the ASFC Annual Report on Form 10-K are included in this
Form 8-K as Exhibit 99.2.
99.3 Consolidated Balance Sheets of ASFC and Subsidiaries as of
June 30, 1997 and December 31, 1996, and the related
Consolidated Statements of Income, Shareholders' Equity and
Cash Flows for the Six Months Ended June 30, 1997 and 1996
(unaudited), together with the notes thereto (incorporated by
reference to pages 1 to 10 of the ASFC Quarterly Report on
Form 10-Q for the quarter ended June 30, 1997 (Commission File
Number 001-11733)). The Consolidated Balance Sheets and
Consolidated Statements of Income, Shareholders' Equity and
Cash Flows on pages 1 to 10 of the ASFC Quarterly Report on
Form 10-Q are included in this Form 8-K as Exhibit 99.3.
99.4 Unaudited Pro Forma Combined Condensed Financial Statements of
SAFECO reflecting the acquisition of ASFC and certain related
financings, as of June 30, 1997. Includes Unaudited Pro Forma
Combined Condensed Balance Sheet as of June 30,1997 and Unaudited
Pro Forma Combined Condensed Statements of Income for the Six
Months Ended June 30, 1997 and Year Ended December 31, 1996, and
related notes, incorporated by reference to pages 12 to 17 of
SAFECO's prospectus dated September 15, 1997 contained
in the Registration Statement on Form S-3 dated August 19, 1997
(Registration No. 333-33927). The pro forma financial information
on pages 12 to 17 of the prospectus contained in the
Registration Statement are included in this Form 8-K as Exhibit
99.4.
-5-
<PAGE>
SAFECO CORPORATION COMPLETES ACQUISITION OF
AMERICAN STATES FINANCIAL CORPORATION
SEATTLE -- (October 1, 1997) -- SAFECO Corporation (NASDAQ: SAFC) announced
today that it has completed the acquisition of American States Financial
Corporation for $47 per share, or $2.8 billion.
"We are very excited to finalize this acquisition and begin the next
stage of combining the two companies," said Roger Eigsti, chairman and chief
executive officer of SAFECO. "Together, SAFECO and American States can
provide independent agents with a broad and comprehensive package of products
and services that meet our customers' diverse insurance and investment needs."
Founded in 1923 as the General Insurance Company of America, SAFECO
today is one of the largest diversified financial corporations in the country
with more than $27 billion in combined assets as of June 30, 1997, and
combined 1996 revenues of $6 billion. Property and casualty insurance was
SAFECO's original business and remains its largest operation. With the
acquisition of American States, SAFECO ranks as the 15th largest property and
casualty insurer in the country.
In addition, SAFECO engages in life and health insurance and surety, and
conducts commercial credit, asset management, insurance agency and financial
services distribution operations, and real estate investment and management.
SAFECO is headquartered in Seattle, with major operations in Washington,
Indiana, Missouri, Oregon, Texas, California, Colorado, Ohio, Illinois,
Georgia, Kansas, New Mexico, Wisconsin and Connecticut. The corporation
employs more than 11,000 people and is represented by more than 8,000
independent agents nationwide.
<PAGE>
REPORT OF INDEPENDENT AUDITORS
Board of Directors
American States Financial Corporation
We have audited the accompanying consolidated balance sheets of American States
Financial Corporation and subsidiaries as of December 31, 1996 and 1995, and the
related consolidated statements of income, shareholders' equity, and cash flows
for each of the three years in the period ended December 31, 1996. Our audits
also include the financial statement schedules listed in the index at item
14(a)(2). These financial statements and schedules are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
American States Financial Corporation and subsidiaries at December 31, 1996 and
1995, and the consolidated results of its operations and its cash flows for each
of the three years in the period ended December 31, 1996, in conformity with
generally accepted accounting principles. Also, in our opinion, the related
financial statements and schedules, when considered in relation to the basic
consolidated financial statements taken as a whole, present fairly in all
material respects the information set forth therein.
ERNST & YOUNG LLP
Indianapolis, Indiana
January 28, 1997
34
<PAGE>
AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31,
---------------------------
1996 1995
---- ----
(Dollars in Thousands)
<S> <C> <C>
ASSETS
Investments:
Securities available-for-sale at fair value:
Fixed maturity (amortized cost: 1996 - $3,579,807; 1995 - $3,590,601) $3,763,880 $3,860,883
Equity (cost: 1996 - $362,720; 1995 - $374,232) 435,137 437,685
Mortgage loans 32,293 33,319
Short-term investments 73,276 63,170
Other invested assets 37,986 35,178
---------- ----------
Total investments 4,342,572 4,430,235
Cash 13,610 12,708
Premium receivable, less allowance for doubtful accounts (1996 - $3,045;
1995 - $2,860) 413,444 377,802
Deferred policy acquisition costs 202,233 199,192
Properties to be sold, less valuation allowances (1996 - $26,916;
1995 - $28,350) 30,633 41,403
Property and equipment-at cost, less allowances for depreciation (1996 -
$73,789; 1995 - $79,011) 31,143 29,823
Accrued investment income 64,602 66,173
Deferred federal income taxes recoverable 128,742 100,647
Cost in excess of net assets of acquired subsidiaries, less amortization
(1996 - $46,036; 1995 - $42,618) 97,772 101,190
Ceded reinsurance on claims and claims expense reserves 179,445 136,939
Miscellaneous 36,887 43,073
---------- ----------
Total Assets $5,541,083 $5,539,185
---------- ----------
---------- ----------
</TABLE>
(continued on next page)
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
35
<PAGE>
AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (Continued)
<TABLE>
<CAPTION>
December 31,
-------------------------------
1996 1995
---- ----
(Dollars in Thousands)
<S> <C> <C>
LIABILITIES AND SHAREHOLDERS' EQUITY
Policy liabilities and accruals:
Losses, loss adjustment expense and future policy benefits $2,868,348 $2,828,337
Unearned premiums 711,955 718,478
---------- ----------
Total policy liabilities and accruals 3,580,303 3,546,815
Commissions and other expenses 120,872 134,031
Current federal income taxes payable 5,303 7,095
Outstanding checks 69,901 67,308
Short-term debt due LNC 66,667 -
Notes payable 99,511 -
Debt due LNC 133,333 -
Other liabilities 129,154 115,229
---------- ----------
Total liabilities 4,205,044 3,870,478
Shareholders' equity:
Common stock, no par value: 195,000,000 shares authorized,
shares issued and outstanding: 1996 - 60,050,515; 1995 - 50,000,000 304,493 387,547
Net unrealized gain on securities available-for-sale 163,647 211,767
Retained earnings 867,899 1,069,393
---------- ----------
Total shareholders' equity 1,336,039 1,668,707
---------- ----------
Total liabilities and shareholders' equity $5,541,083 $5,539,185
---------- ----------
---------- ----------
</TABLE>
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
36
<PAGE>
AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
Year Ended December 31,
---------------------------------------------------
1996 1995 1994
---- ---- ----
(Dollars in Thousands,
Except Per Share Data)
<S> <C> <C> <C>
Revenue:
Premiums and other revenue $1,674,122 $1,746,386 $1,745,971
Net investment income 274,314 266,569 260,454
Realized gain on investments 35,538 41,044 19,936
Loss on operating properties - (28,350) -
---------- ---------- ----------
Total revenue 1,983,974 2,025,649 2,026,361
Benefits and expenses:
Benefits and settlement expenses 1,248,879 1,242,270 1,271,957
Commissions 282,991 291,551 296,886
Operating and administrative expenses 206,755 236,825 208,123
Taxes, licenses and fees 37,295 45,891 49,003
Interest on debt 12,372 - 125
---------- ---------- ----------
Total benefits and expenses 1,788,292 1,816,537 1,826,094
Income before federal income taxes 195,682 209,112 200,267
Federal income taxes (credit):
Current 28,160 35,298 26,124
Deferred (2,184) (4,450) (l0,4l5)
---------- ---------- ----------
Total federal income taxes 25,976 30,848 15,709
---------- ---------- ----------
Net income $ 169,706 $ 178,264 $ 184,558
---------- ---------- ----------
---------- ---------- ----------
Net income per share $ 3.03 $ 3.57 $ 3.69
---------- ---------- ----------
---------- ---------- ----------
Weighted average shares outstanding 55,975,238 50,000,000 50,000,000
---------- ---------- ----------
---------- ---------- ----------
</TABLE>
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
37
<PAGE>
AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(Dollars in Thousands)
<TABLE>
<CAPTION>
Net Unrealized
Common Stock Gain (Loss) on
----------------------- Securities
Number Available- Retained
of Shares Amount for-Sale Earnings Total
--------- ------ -------- -------- -----
<S> <C> <C> <C> <C> <C>
Balance at January 1, 1994 . . . . . . . . . . 50,000,000 $ 387,547 $ 239,080 $1,085,571 $1,712,198
Change in unrealized gain (loss) on
securities available-for-sale. . . . . . . . - - (248,190) - (248,190)
Cash dividends paid to LNC . . . . . . . . . . - - - (180,000) (180,000)
Net income . . . . . . . . . . . . . . . . . . - - - 184,558 184,558
---------- ---------- ---------- ---------- ----------
Balance at December 31, 1994 . . . . . . . . . 50,000,000 387,547 (9,110) 1,090,129 1,468,566
Change in unrealized gain (loss) on
securities available-for-sale. . . . . . . . - - 220,877 - 220,877
Cash dividends paid to LNC . . . . . . . . . . - - - (199,000) (199,000)
Net income . . . . . . . . . . . . . . . . . . - - - 178,264 178,264
---------- ---------- ---------- ---------- ----------
Balance at December 31, 1995 . . . . . . . . . 50,000,000 387,547 211,767 1,069,393 1,668,707
Public offering of common stock. . . . . . . . 10,000,000 215,182 - - 215,182
Common stock issued for employee benefit
plans. . . . . . . . . . . . . . . . . . . . 50,515 1,162 - - 1,162
Assumption and issuance of debt in
exchange with LNC. . . . . . . . . . . . . . - (299,398) - - (299,398)
Change in unrealized gain (loss) on
securities available-for-sale. . . . . . . . - - (48,120) - (48,120)
Dividends to LNC prior to public offering:
Assets dividended. . . . . . . . . . . . . . - - - (299,866) (299,866)
Cash dividend. . . . . . . . . . . . . . . . - - - (46,134) (46,134)
Cash dividends declared and paid after
public offering ($.42 per share) . . . . . . - - - (25,200) (25,200)
Net income . . . . . . . . . . . . . . . . . . - - - 169,706 169,706
---------- ---------- ---------- ---------- ----------
Balance at December 31, 1996 . . . . . . . . . 60,050,515 $ 304,493 $ 163,647 $ 867,899 $1,336,039
---------- ---------- ---------- ---------- ----------
---------- ---------- ---------- ---------- ----------
</TABLE>
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
38
<PAGE>
AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Year Ended December 31,
---------------------------------------
1996 1995 1994
---- ---- ----
(Dollars in Thousands)
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 169,706 $ 178,264 $ 184,558
Adjustments to reconcile net income to cash provided by
operating activities:
Deferred policy acquisition costs 172 (280) 1,743
Premiums and fees in course of collection (35,642) 6,220 4,558
Accrual of discount on investments (18,656) (17,166) (13,113)
Amortization of premium on investments 4,973 6,782 12,571
Accrued investment income (2,859) 6,253 (622)
Policy liabilities and accruals (290) (95,605) (111,825)
Federal income taxes (3,976) 803 (12,485)
Provision for depreciation 7,549 10,535 10,453
Gain on sale of investments (35,538) (41,044) (19,936)
Loss on operating properties - 28,350 -
Ceded reinsurance on claims and claims expense reserves (42,506) 1,224 12,589
Other 2,419 23,554 5,302
--------- --------- ---------
Net adjustments (124,354) (70,374) (110,765)
--------- --------- ---------
Net cash provided by operating activities 45,352 107,890 73,793
CASH FLOWS FROM INVESTING ACTIVITIES
Securities available-for-sale:
Purchase of investments (1,173,931) (1,002,548) (1,009,660)
Sales of investments 892,669 990,781 983,684
Maturities and redemptions 58,042 68,846 110,236
Purchase of mortgage loans and other investments (10,973) (11,441) (13,441)
Sale or maturity of mortgage loans and other investments 8,515 28,039 11,747
Net (increase) decrease in short-term investments (10,106) 42,275 34,653
Purchase of property and equipment, net 1,900 (4,815) (9,871)
Other 11,807 (12,191) 1,989
--------- --------- ---------
Net cash provided by (used in) investing activities (222,077) 98,946 109,337
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of common stock 215,182 - -
Principal payments on notes payable - - (5,000)
Universal life investment contract deposits 47,240 47,805 47,285
Universal life investment contract withdrawals (13,461) (9,067) (9,330)
Dividends paid (71,334) (244,000) (215,000)
--------- --------- ---------
Net cash provided by (used in) financing activities 177,627 (205,262) (182,045)
--------- --------- ---------
Net increase in cash 902 1,574 1,085
Cash at beginning of period 12,708 11,134 10,049
--------- --------- ---------
Cash at end of period $ 13,610 $ 12,708 $ 11,134
--------- --------- ---------
--------- --------- ---------
</TABLE>
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
39
<PAGE>
AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
1. BASIS OF PRESENTATION
PRINCIPLES OF CONSOLIDATION
On February 5, 1996, American States Financial Corporation (the "Company") was
incorporated in the State of Indiana to serve as a holding company. The
consolidated financial statements include the accounts of American States
Insurance Company ("ASI") and its wholly-owned insurance subsidiaries and have
been presented as if the holding company formation occurred at the earliest date
presented herein. The Company was a wholly owned subsidiary of Lincoln National
Corporation ("LNC") until May 22, 1996, when LNC's ownership was reduced to 83%
as a result of an initial public offering by the Company. ASI has licenses to
write business in all 50 states and the District of Columbia. ASI and its
subsidiaries write standard commercial and personal lines, and life insurance
business throughout the United States with the greatest volume in the Midwest
and Pacific Northwest. All significant intercompany accounts and transactions
are eliminated in consolidation.
During 1994, American Union Reinsurance Company and Amstats Insurance Company
were sold. These transactions had no significant effect on the results of
operation for that year.
HOLDING COMPANY FORMATION AND INITIAL PUBLIC OFFERING
As noted above, the financial statements have been presented as if the Company
had been organized at the earliest date presented herein. The formation of the
Company was done in contemplation of an initial public offering. On April 22,
1996, ASI declared, and on May 15, 1996, it paid to LNC, a dividend of $300,000
consisting primarily of tax-exempt municipal securities ("Dividended Assets").
On May 16, 1996, LNC transferred all of the outstanding shares of ASI to the
Company in exchange for 50,000,000 shares of Common Stock and $300,000 debt of
the Company. The transfer of ASI stock to the Company by LNC in exchange for
Company Common Stock and debt have been accounted for similar to a pooling of
interests, thus the assets, liabilities, shareholders' equity and the results of
operation of the Company and its subsidiaries have been combined at historical
carrying values.
On May 29, 1996, the closing date of the initial public offering, the Company
issued 10,000,000 shares of Common Stock at $23 per share to the public. The
net proceeds, after deduction of underwriting discounts and offering expenses
were $215,182. The Company contributed $140,500 of such net proceeds to ASI
to enable it to invest in taxable securities for its investment portfolio and
the remainder was retained by the Company for general corporate purposes.
The 50,000,000 shares held by LNC are "restricted shares" as defined by Rule
144 of the Securities Act of 1933, as amended (the "Securities Act"). Such
shares may not be resold in the absence of registration under the Securities Act
or exemptions from such registration including, among others, the exemption
provided by Rule 144 of the Securities Act. As an affiliate of the Company, LNC
is subject to certain volume restrictions on the sale of shares of the Company's
Common Stock.
The Company's Common Stock is publicly traded on the New York Stock Exchange
under the symbol "ASX".
40
<PAGE>
AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
2. SIGNIFICANT ACCOUNTING POLICIES
INVESTMENTS
Fixed maturity and equity securities (common and perpetual preferred stocks)
are classified as available-for-sale and accordingly, are carried at fair value.
For the mortgage-backed bond portion of the fixed maturity securities
portfolio, the Company recognizes income using a constant effective yield
based on anticipated prepayments and the estimated economic life of the
securities. When actual prepayments differ significantly from anticipated
prepayments, the effective yield is recalculated to reflect actual payments
to date and anticipated future payments. The net investment in the securities
is adjusted to the amount that would have existed had the new effective yield
been applied since the acquisition of the securities. This adjustment is
reflected in net investment income.
Mortgage loans on real estate are carried at the outstanding principal
balances less unaccrued discounts and allowances for losses. Short-term
investments which are carried at cost, include all highly liquid debt
instruments purchased with a maturity of one year or less, and the carrying
value approximates fair value.
Realized gains and losses on investments are recognized in net income using
the specific identification method. Changes in the fair values of securities
carried at fair value are reflected directly in shareholders' equity after
deductions for related adjustments for deferred policy acquisition costs and
deferred taxes.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost, less allowances for depreciation.
Depreciation is computed generally by the straight-line method at rates
calculated to amortize costs over the estimated useful lives of the assets.
Properties to be sold are carried at the lower of amortized cost or estimated
fair value, less selling costs. The difference between book value and fair value
is recognized by maintaining a valuation allowance.
COST IN EXCESS OF NET ASSETS OF ACQUIRED SUBSIDIARIES
Cost in excess of net assets from the purchase of subsidiaries is being
amortized using the straight-line method up to 40 years. The carrying value of
these assets will be reviewed if the facts and circumstances suggest that it may
be impaired. If the undiscounted cash flows estimated to be generated by these
assets are less than the carrying amounts, an impairment loss would be
recognized.
USE OF ESTIMATES
The nature of the insurance business requires management to make estimates and
assumptions that affect the amounts reported in the financial statements. Actual
results reported in future financial statements could differ from these
estimates. The effects of changes in estimates are included in the operating
results for the period in which such changes occur.
41
<PAGE>
AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
2. SIGNIFICANT ACCOUNTING POLICIES (Continued)
LOSSES, LOSS ADJUSTMENT EXPENSE AND FUTURE POLICY BENEFITS
The liability for losses and loss adjustment expense is determined using case
basis evaluation and statistical analysis and represents estimates of the
ultimate net cost of all reported and unreported losses which are unpaid at year
end. This liability includes estimates of future trends in claim severity and
frequency and other factors which could vary as the losses are ultimately
settled. Although it is not possible to measure the degree of variability
inherent in such estimates, management believes that the liability for losses
and loss adjustment expense is adequate. The estimates are continually reviewed
and as adjustments become necessary to this liability, they are made and
reflected in current operations. The reserve for losses and loss adjustment
expense is stated at an amount after deduction of salvage and subrogation
recoverable. At December 31, 1996, the Company has guaranteed and is
contingently liable in the amount of $43,855 with respect to annuities purchased
to fund structured settlements. In the normal course of settling losses, the
Company has been named in various lawsuits. The ultimate settlement of these
lawsuits is not expected to be material to the Company's operations.
Future policy benefits on traditional life insurance have been computed using
principally a net-level premium method and assumptions for investment yields,
withdrawals and mortality based principally on Company experience projected at
the time of policy issue, with provision for possible adverse deviations.
Interest assumptions for direct individual life reserves range from
approximately 4.5% for 1958 issues to 6.75% for 1996 issues. With respect to
universal life and annuity products, the retrospective deposit accounting method
is used. Policy reserves represent the premiums received plus accumulated
interest, less mortality and administrative charges.
RECOGNITION OF INCOME AND EXPENSES
Premiums include property and casualty insurance premiums and life insurance
premiums and contract charges earned. Direct property and casualty insurance
premiums are earned ratably over the terms of the policies. Assumed reinsurance
premiums are earned ratably over the terms of the original policies issued and
terms of the reinsurance contracts. The reserve for unearned premiums is
computed by the semi-monthly pro rata method. Life insurance premiums on
traditional life business are generally earned when due. Revenues for universal
life and investment products consist of policy charges for the cost of
insurance, policy administration charges, amortization of policy initiation
fees, and surrender charges assessed against policyholder account balances
during the period. Expenses related to these products include interest credited
to policyholder account balances and death benefits incurred in excess of
policyholder account balances. Commissions, premium taxes, and certain other
expenses incurred in the acquisition of business are deferred and amortized as
the related premiums are earned. Acquisition costs that are not recoverable from
future premiums and related investment income are expensed. The amounts of
acquisition costs amortized were $338,012, $359,840 and $359,747 in 1996, 1995
and 1994, respectively.
FEDERAL INCOME TAXES
A consolidated federal income tax return is filed by LNC and includes the
Company. Pursuant to an agreement with LNC, the Company provides for income
taxes on the basis of a separate return calculation. The taxes computed are
remitted to or collected from LNC.
42
<PAGE>
AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
2. SIGNIFICANT ACCOUNTING POLICIES (Continued)
PENSION PLAN AND OTHER RETIREMENT BENEFITS
A qualified non-contributory defined benefit retirement plan covers
substantially all employees. Benefits are based on total years of service and
the highest 60 months of compensation during the last 10 years of employment.
The plan is funded by contributions to tax-exempt trusts consistent with
requirements of federal law and regulations. Contributions are intended to
provide not only the benefits attributed to service to date, but also those
expected to be earned in the future. Plan assets consist principally of listed
equity securities, corporate obligations, and United States government bonds.
The Company also sponsors an unfunded, nonqualified, supplemental defined
benefit pension plan for certain employees.
Further, the Company sponsors an unfunded defined benefit plan that provides
postretirement medical and life insurance benefits to full-time employees who
have worked 10 years and attained age 55 while in service with the Company. The
plan is contributory, with retiree contributions adjusted annually, and contains
other cost-sharing features such as deductibles and coinsurance.
Eligible employees also participate in a defined contribution plan. The
Company's contribution to the plan is equal to a participant's pre-tax
contribution, not to exceed 6% of base pay, multiplied by a percentage, ranging
from 25% to 150%, which varies according to certain incentive criteria as
determined by the Board of Directors. Expense for this plan amounted to $5,297,
$6,644 and $11,419 in 1996, 1995 and 1994, respectively.
STOCK OPTIONS
The Company utilizes the intrinsic value method of accounting to determine
whether compensation expense should be recognized in conjunction with its
stock option incentive plan. Using the intrinsic value method, compensation
cost is the excess, if any, of the quoted market price of the stock at the
grant date, or other measurement date, over the amount an employee must pay
to acquire the stock. Since all options are granted at market price, the
Company has not recognized compensation expense relating to the stock option
incentive plan.
RECLASSIFICATIONS
Amounts from prior periods have been reclassified to conform to the 1996
presentation. Net income and shareholders' equity have not been affected by
these reclassifications.
43
<PAGE>
AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
3. INVESTMENTS
The cost, unrealized gains and losses and fair value of securities
available-for-sale are as follows:
<TABLE>
<CAPTION>
Securities Available-for-Sale
-----------------------------------------------------
Amortized Unrealized Unrealized
Cost Gains Losses Fair Value
---- ----- ------ ----------
<S> <C> <C> <C> <C>
DECEMBER 31, 1996
United States treasury securities and other United States
government agencies . . . . . . . . . . . . . . . . . . . $ 188,574 $ 7,583 $ 320 $ 195,837
Obligations of states and political subdivisions . . . . . 1,965,798 131,626 1,323 2,096,101
Corporate securities . . . . . . . . . . . . . . . . . . . 1,052,694 49,929 8,721 1,093,902
Mortgage-backed securities . . . . . . . . . . . . . . . . 298,733 4,365 2,282 300,816
Redeemable preferred stocks . . . . . . . . . . . . . . . . 74,008 3,590 374 77,224
----------- ----------- ----------- -----------
Total fixed maturity securities . . . . . . . . . . . . . . 3,579,807 197,093 13,020 3,763,880
Common and perpetual preferred stocks . . . . . . . . . . . 362,720 76,475 4,058 435,137
----------- ----------- ----------- -----------
$ 3,942,527 $ 273,568 $ 17,078 $ 4,199,017
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
DECEMBER 31, 1995
United States treasury securities and other United States
government agencies . . . . . . . . . . . . . . . . . . . $ 301,547 $ 27,097 $ 86 $ 328,558
Obligations of states and political subdivisions . . . . . 2,222,697 153,728 2,211 2,374,214
Corporate securities . . . . . . . . . . . . . . . . . . . 679,983 77,831 692 757,122
Mortgage-backed securities . . . . . . . . . . . . . . . . 312,705 11,326 320 323,711
Redeemable preferred stocks . . . . . . . . . . . . . . . . 73,669 3,985 376 77,278
----------- ----------- ----------- -----------
Total fixed maturity securities . . . . . . . . . . . . . . 3,590,601 273,967 3,685 3,860,883
Common and perpetual preferred stocks . . . . . . . . . . . 374,232 71,306 7,853 437,685
----------- ----------- ----------- -----------
$ 3,964,833 $ 345,273 $ 11,538 $ 4,298,568
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
</TABLE>
Fair values for fixed maturity securities are based on quoted market prices,
where available. For fixed maturity securities not actively traded, fair values
are estimated using values obtained from independent pricing services or, in the
case of private placements, are estimated by discounting expected future cash
flows using a current market rate applicable to the yield, credit quality, and
maturity of the investments. The fair values for equity securities are based on
quoted market prices.
The amortized cost and estimated fair value of fixed maturity securities at
December 31, 1996, by contractual maturity, is shown below. Expected maturities
will differ from contractual maturities because borrowers may have the right to
call or prepay obligations without call or prepayment penalties.
Amortized Fair
Cost Value
---- -----
Available-for-sale:
Due in one year or less . . . . . . . . . . $ 120,401 $ 121,124
Due after one year through five years . . . 728,552 776,878
Due after five years through ten years. . . 1,214,593 1,277,075
Due after ten years . . . . . . . . . . . . 1,217,528 1,287,987
------------ ------------
3,281,074 3,463,064
Mortgage-backed securities . . . . . . . . . . 298,733 300,816
------------ ------------
$ 3,579,807 $ 3,763,880
------------ ------------
------------ ------------
44
<PAGE>
AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
3. INVESTMENTS (Continued)
Major categories of investment income are summarized as follows:
<TABLE>
<CAPTION>
1996 1995 1994
----------- ----------- -----------
<S> <C> <C> <C>
Fixed maturity:
Tax exempt. . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 123,608 $ 134,506 $ 145,940
Taxable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 120,571 100,611 81,000
----------- ----------- -----------
244,179 235,117 226,940
Equity. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21,048 23,328 26,759
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11,348 11,938 11,754
----------- ----------- -----------
276,575 270,383 265,453
Less investment expense. . . . . . . . . . . . . . . . . . . . . . . 2,261 3,814 4,999
----------- ----------- -----------
Net investment income. . . . . . . . . . . . . . . . . . . . . . . . $ 274,314 $ 266,569 $ 260,454
----------- ----------- -----------
----------- ----------- -----------
The change in unrealized gain (loss) on securities available-for-sale is as
follows:
<CAPTION>
1996 1995 1994
----------- ----------- -----------
<S> <C> <C> <C>
Fixed maturity securities available-for-sale . . . . . . . . . . . . . $ (86,209) $ 308,589 $ (346,946)
Equity securities available-for-sale . . . . . . . . . . . . . . . . . 8,964 44,921 (46,001)
----------- ----------- -----------
Net change in unrealized gain (loss) on securities
available-for-sale . . . . . . . . . . . . . . . . . . . . . . . . . (77,245) 353,510 (392,947)
Adjustment for effect on other balance sheet
accounts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,214 (11,877) 11,116
Less deferred income taxes . . . . . . . . . . . . . . . . . . . . . . 25,911 (120,756) 133,641
----------- ----------- -----------
Change in unrealized gain (loss) included in
shareholders' equity . . . . . . . . . . . . . . . . . . . . . . . . $ (48,120) $ 220,877 $ (248,190)
----------- ----------- -----------
----------- ----------- -----------
The realized gain (loss) on investments is summarized as follows:
<CAPTION>
1996 1995 1994
----------- ----------- -----------
<S> <C> <C> <C>
Available-for-sale:
Fixed maturity
Gross gain. . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 9,975 $ 5,816 $ 18,977
Gross loss. . . . . . . . . . . . . . . . . . . . . . . . . . . . (11,505) (5,063) (11,300)
Equity securities
Gross gain. . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 54,169 $ 63,123 $ 36,663
Gross loss. . . . . . . . . . . . . . . . . . . . . . . . . . . . (16,413) (24,264) (29,942)
Other, net of expenses . . . . . . . . . . . . . . . . . . . . . . . (688) 1,432 5,538
----------- ----------- -----------
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 35,538 $ 41,044 $ 19,936
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
The Company has estimated the fair value of its investment in mortgage loans
on real estate to be $33,943 and $35,591 at December 31, 1996 and 1995,
respectively. This estimate was established using a discounted cash flow method
based on rating, maturity and future income when compared to the expected yield
for mortgages having similar characteristics.
45
<PAGE>
AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
3. INVESTMENTS (Continued)
The Company had no impaired loans at the end of December 31, 1996 or 1995. A
reconciliation of the mortgage loan allowance for losses is as follows:
<TABLE>
<CAPTION>
1995 1994
----------- -----------
<S> <C> <C>
Balance at beginning of year . . . . . . . . . . . . . . . . . . . . $ 4,435 $ 5,968
Provisions for losses. . . . . . . . . . . . . . . . . . . . . . . . 155 76
Releases due to recoveries . . . . . . . . . . . . . . . . . . . . . - (1,222)
Releases due to sales. . . . . . . . . . . . . . . . . . . . . . . . (4,330) (387)
Transfers to other invested assets . . . . . . . . . . . . . . . . . (260) -
----------- -----------
Balance at end of year . . . . . . . . . . . . . . . . . . . . . . . $ - $ 4,435
----------- -----------
----------- -----------
</TABLE>
The carrying value of short-term investments and other invested assets
approximate fair value.
4. LIABILITY FOR LOSSES AND LOSS ADJUSTMENT EXPENSES
Activity in the liability for losses and loss adjustment expense for
property and casualty operations is summarized as follows:
<TABLE>
<CAPTION>
1996 1995 1994
----------- ----------- -----------
<S> <C> <C> <C>
Balance as of January 1, net of related reinsurance recoverables . . . . $ 2,294,458 $ 2,377,245 $ 2,458,465
Add:
Provision for losses and loss adjustment expense occurring in the
current year, net of reinsurance . . . . . . . . . . . . . . . . . . 1,245,580 1,233,627 1,318,224
Decrease in estimated losses and loss adjustment expense
occurring in prior years, net of reinsurance . . . . . . . . . . . . (45,705) (39,917) (91,984)
----------- ----------- -----------
Incurred losses and loss adjustment expense during the current
year, net of reinsurance . . . . . . . . . . . . . . . . . . . . . . 1,199,875 1,193,710 1,226,240
Deduct:
Losses and loss adjustment expense payments for losses, net of
reinsurance, occurring during:
Current year. . . . . . . . . . . . . . . . . . . . . . . . . . . 653,977 613,580 617,425
Prior years . . . . . . . . . . . . . . . . . . . . . . . . . . . 578,664 662,917 690,035
----------- ----------- -----------
1,232,641 1,276,497 1,307,460
----------- ----------- -----------
Balance as of December 31, net of related reinsurance recoverables . . . 2,261,692 2,294,458 2,377,245
Reinsurance recoverables on losses and loss adjustment expenses
at end of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . 164,413 120,117 119,458
----------- ----------- -----------
Liability for losses and loss adjustment expense, gross of related
reinsurance recoverables, at end of year . . . . . . . . . . . . . . . $ 2,426,105 $ 2,414,575 $ 2,496,703
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
The reconciliation shows a decrease to the liability for estimated losses and
loss adjustment expense arising in prior years. Such reserve adjustments, which
affected current operations during each of the years, resulted from developed
losses from prior years being different than were anticipated when the liability
for losses and loss expense were originally estimated. Favorable development
trends are partially a result of the change the Company has initiated in its
underwriting and claims adjudication practices. These development trends have
been considered in establishing the current year liabilities.
46
<PAGE>
AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
4. LIABILITY FOR LOSSES AND LOSS ADJUSTMENT EXPENSES (Continued)
Included in the liability for losses and loss adjustment expense, net of
related reinsurance recoverables, is the liability for environmental and
asbestos losses of $250,521 and $241,216 as of December 31, 1996 and 1995,
respectively. In establishing liabilities for losses and loss adjustment
expense related to environmental and asbestos matters, management considers
facts currently known and the current state of the law and coverage
litigation. Liabilities are recognized for known losses, including the cost
of related litigation, when sufficient information has been developed to
indicate the involvement of a specific insurance policy and management can
reasonably estimate its liability. In addition, liabilities have been
established to cover additional exposures on both known and unasserted
losses. Estimates of the liabilities are reviewed and updated continually.
Developed case law and adequate claim history do not exist for a portion of
the Company's environmental and asbestos exposure, especially because
significant uncertainty exists about the outcome of coverage litigation and
whether past loss experience will be representative of future loss
experience. Management believes the estimated liabilities provided for
environmental and asbestos losses at December 31, 1996, are adequate;
however, it is reasonably possible that a change in estimate of the required
liability could occur in the future. It is not possible to provide a
meaningful estimate of a range of possible outcomes at this time.
The Company writes personal and commercial lines of property and casualty
insurance throughout the United States. As a result, the Company is always at
risk that there could be significant losses arising in certain geographic
areas from catastrophes, such as earthquakes and hurricanes. In 1996 the
Company's property catastrophe reinsurance program, its "primary coverage",
provided protection of 93% of $150,000, or approximately $139,500, in excess
of a $30,000 retention per occurrence. In 1997, the Company's primary
coverage will provide protection of 90% of $150,000, or approximately
$135,000, in excess of a $30,000 retention per occurrence. In addition, in
1997 the Company has also purchased an additional coverage layer of 90% of
$100,000, or $90,000, in excess of its primary coverage. This additional 1997
layer provides protection solely for non-California earthquake exposure.
The Company's policies providing earthquake, hurricane and related coverage
in the midwest, western and southeastern coastal areas of the United States
could expose the Company to losses exceeding its reinsurance limits. Although
the exposure exists, the Company has not encountered losses in excess of its
reinsurance limits during the past twenty years. It is also possible that
catastrophes could have an adverse effect on the Company's reinsurers. As the
Company is not relieved of its primarv obligation to the policyholder in a
reinsurance transaction, an event or series of events which render
uncollectible any amounts due from its reinsurers could have a material
adverse effect on the Company.
The following is a reconciliation of the activity in the liability for losses
and loss adjustment expense for property and casualty operations to the
consolidated balance sheets and statements of income:
<TABLE>
<CAPTION>
1996 1995 1994
----------- ----------- -----------
<S> <C> <C> <C>
Property and casualty incurred losses and loss adjustment expense
during the current year, net of reinsurance. . . . . . . . . . . . . . $ 1,199,875 $ 1,193,710 $ 1,226,240
Life insurance benefits and settlement expenses,
net of reinsurance . . . . . . . . . . . . . . . . . . . . . . . . . . 49,004 48,560 45,717
----------- ----------- -----------
Benefits and settlement expenses, net of reinsurance . . . . . . . . . . $ 1,248,879 $ 1,242,270 $ 1,271,957
----------- ----------- -----------
----------- ----------- -----------
Liability for property and casualty losses and loss adjustment
expense, at end of year. . . . . . . . . . . . . . . . . . . . . . . . $ 2,426,105 $ 2,414,575 $ 2,496,703
Liability for life future policy benefits, at end of year. . . . . . . . 442,243 413,762 381,532
----------- ----------- -----------
Liability for losses, loss adjustment expense and future policy
benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 2,868,348 $ 2,828,337 $ 2,878,235
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
47
<PAGE>
AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
4. LIABILITY FOR LOSSES AND LOSS ADJUSTMENT EXPENSES (Continued)
<TABLE>
<CAPTION>
1996 1995 1994
----------- ----------- -----------
<S> <C> <C> <C>
Reinsurance recoverables on property and casualty losses and loss
adjustment expenses, at end of year. . . . . . . . . . . . . . . . . . $ 164,413 $ 120,117 $ 119,458
Reinsurance recoverables on life future policy benefits,
at end of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15,032 16,822 18,705
----------- ----------- -----------
Ceded reinsurance on claims and claims expense reserves,
at end of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 179,445 $ 136,939 $ 138,163
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
5. NOTES PAYABLE AND DEBT DUE LNC
In conjunction with the formation of the Company, $100,000 of debt was assumed
from LNC ("Assumed Debt"). The Assumed Debt is governed by an agreement between
the Company and LNC (the "Assumption Agreement") which provides for the payment
by the Company of the currently outstanding 7 1/8% notes due July 15, 1999,
originally issued to the public by LNC on July 15, 1992. LNC continues to be the
primary obligor of this public debt; however, pursuant to the Assumption
Agreement, the Company will make a $100 million principal payment on July 15,
1999 to repay the holders of the public debt. The Assumption Agreement also
provides that interest at 7 1/8% is payable semi-annually by the Company.
Also in conjunction with the formation of the Company, a $200,000 term note
was issued to LNC ("Term Note"). The Term Note will pay interest quarterly at a
rate of 50 basis points over the rate on three year Treasury Notes through
November 14, 1997, 50 basis points over the rate on two year Treasury Notes from
November 15, 1997 through November 14, 1998 and 50 basis points over the rate on
one-year Treasury Bills from November 15, 1998 through the maturity date. The
current rate of interest on the Term Note is 6.7%. The Term Note will be payable
in three equal principal payments due on August 15, 1997, 1998 and 1999.
Pursuant to the provisions on the Term Note, the Company will have the right to
prepay the Term Note at any time. The Term Note also contains covenants that
will, among other things, (i) require the Company to maintain certain levels of
adjusted consolidated net worth (as defined in the Term Note), and (ii) restrict
the ability of the Company to incur indebtedness in excess of 50% of its
adjusted consolidated net worth and to enter into a major corporate transaction
unless the Company is the survivor and would not be in default.
In 1996, the Company incurred and paid interest cost of $12,372 and $7,218,
respectively.
Minimum repayments on the outstanding Assumed Debt and Term Note at
December 31, 1996 are scheduled as follows:
1997 (included in short-term debt due LNC) . . . . . . . . . . . $ 66,667
1998 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66,667
1999 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 166,667
On May 29, 1996, the Company entered into a revolving credit agreement with
third party financial institutions in which the Company may borrow and repay
amounts up to a maximum of $200,000 (the "Line of Credit"). Borrowings using the
Line of Credit will bear interest generally at variable rates tied to LIBOR, an
adjusted certificate of deposit rate or other short-term indices. No debt was
outstanding using the Line of Credit at December 31, 1996.
48
<PAGE>
AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
6. FEDERAL INCOME TAXES
Federal income taxes paid in 1996, 1995 and 1994 were $29,952, $30,045, and
$28,556, respectively.
The effective tax rate on pre-tax income is lower than the prevailing
corporate federal income tax rate. A reconciliation of this difference is as
follows:
<TABLE>
<CAPTION>
1996 1995 1994
----------- ----------- -----------
<S> <C> <C> <C>
Tax on pre-tax income at 35% . . . . . . . . . . . . . . . . . . . . . . $ 68,489 $ 73,189 $ 70,093
Add (deduct) tax effect of:
Tax exempt bond interest . . . . . . . . . . . . . . . . . . . . . . . (42,286) (47,174) (51,333)
Dividends earned . . . . . . . . . . . . . . . . . . . . . . . . . . . (5,482) (5,513) (6,028)
15% of tax exempt interest and dividends received deduction. . . . . . 6,660 7,311 7,828
Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,196 1,196 1,219
Other. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (2,601) 1,839 (6,070)
----------- ----------- -----------
Federal income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . $ 25,976 $ 30,848 $ 15,709
----------- ----------- -----------
----------- ----------- -----------
Significant components of net deferred tax assets and liabilities are as
follows:
<CAPTION>
1996 1995
----------- -----------
<S> <C> <C>
Deferred tax assets:
Unearned premium reserve . . . . . . . . . . . . . . . . . . . . . . . $ 48,286 $ 48,916
Discounting of losses and loss adjustment expense reserve. . . . . . . 162,094 165,991
Other postretirement benefits. . . . . . . . . . . . . . . . . . . . . 25,596 24,926
Sale/leaseback of building . . . . . . . . . . . . . . . . . . . . . . 7,758 8,000
Nondeductible accruals . . . . . . . . . . . . . . . . . . . . . . . . 21,432 22,879
Other. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24,591 29,607
----------- -----------
Total deferred tax assets. . . . . . . . . . . . . . . . . . . . . . . . 289,757 300,319
Deferred tax liabilities:
Deferred acquisition costs . . . . . . . . . . . . . . . . . . . . . . (64,411) (72,496)
Net unrealized gains on securities . . . . . . . . . . . . . . . . . . (88,117) (114,028)
Other. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (8,487) (13,148)
----------- -----------
Total deferred tax liabilities . . . . . . . . . . . . . . . . . . . . . (161,015) (199,672)
----------- -----------
Net deferred tax asset . . . . . . . . . . . . . . . . . . . . . . . . . $ 128,742 $ 100,647
----------- -----------
----------- -----------
</TABLE>
As defined by previous life insurance company tax law, certain amounts were
accumulated tax free in a special memorandum account designated as
"Policyholders' Surplus Account" and generally are not subject to federal income
taxes until distributed to stockholders. The aggregate accumulation in this
account is $17,623 at December 31, 1996. No provision has been made for federal
income taxes on this account since distributions are not presently contemplated.
7. RESTRICTIONS ON SHAREHOLDERS' EQUITY
Generally, the net assets of the Company's insurance subsidiaries available
for transfer to ASFC are limited to the amounts that the insurance
subsidiaries' net assets, as determined in accordance with statutory
accounting practices, exceed minimum statutory capital requirements; however,
payments of such amounts as dividends may be subject to approval by
regulatory authorities. At December 31, 1996, $7,200 of consolidated
shareholders' equity represents net assets of the Company's insurance
subsidiaries that cannot be transferred in the form of dividends, loans or
advances to ASFC.
49
<PAGE>
AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
8. RECONCILIATION WITH STATUTORY ACCOUNTING POLICIES
Net income of ASI and subsidiaries, as determined in accordance with
statutory accounting practices, was $171,822, $197,058 and $177,654, for 1996,
1995 and 1994, respectively. Consolidated statutory shareholder's equity for ASI
was $965,987 and $ 1,010,992 at December 31, 1996 and 1995, respectively.
9. EMPLOYEE BENEFIT PLANS
PENSION PLAN. The funded status of the defined benefit pension plan and the
amount recognized in the balance sheet are as follows:
<TABLE>
<CAPTION>
1996 1995
----------- -----------
<S> <C> <C>
Actuarial present value of benefit obligation:
Vested . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (146,298) $ (134,836)
Non vested . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (5,751) (7,909)
----------- -----------
Accumulated benefit obligation . . . . . . . . . . . . . . . . . . . . . (152,049) (142,745)
Effect of future compensation increases. . . . . . . . . . . . . . . . . (44,999) (48,595)
----------- -----------
Projected benefit obligation . . . . . . . . . . . . . . . . . . . . . . (197,048) (191,340)
Plan assets available for benefits . . . . . . . . . . . . . . . . . . . 187,445 172,913
----------- -----------
Projected benefit obligation in excess of plan assets. . . . . . . . . . (9,603) (18,427)
Unrecognized prior service cost. . . . . . . . . . . . . . . . . . . . . 2,209 2,561
Unrecognized net loss. . . . . . . . . . . . . . . . . . . . . . . . . . 7,342 19,355
----------- -----------
Prepaid (accrued) pension cost included in the balance sheet . . . . . . $ (52) $ 3,489
----------- -----------
----------- -----------
Assumptions used in the foregoing calculations are as follows:
<CAPTION>
1996 1995 1994
----------- ----------- -----------
<S> <C> <C> <C>
Assumed rate on plan assets. . . . . . . . . . . . . . . . . . . . . . . 9.0% 9.0% 9.0%
Weighted average discount rate . . . . . . . . . . . . . . . . . . . . . 7.0 7.0 8.0
Future compensation trends . . . . . . . . . . . . . . . . . . . . . . . 4.5 5.0 5.0
The change in discount rate increased the accumulated benefit obligation by
$17,800 as of December 31, 1995.
Net pension cost for the defined benefit pension plans includes the
following components:
<CAPTION>
1996 1995 1994
----------- ----------- -----------
<S> <C> <C> <C>
Service cost benefits earned . . . . . . . . . . . . . . . . . . . . . . $ 9,418 $ 8,091 $ 8,982
Interest cost on projected benefit obligation. . . . . . . . . . . . . . 12,482 11,322 10,189
Actual return on assets. . . . . . . . . . . . . . . . . . . . . . . . . (17,547) (31,425) 3,338
Net amortization and deferral. . . . . . . . . . . . . . . . . . . . . . 2,850 20,708 (13,779)
Impact of realignment of field operations (see Note 14). . . . . . . . . - 3,029 -
----------- ----------- -----------
Net periodic pension cost. . . . . . . . . . . . . . . . . . . . . . . . $ 7,203 $ 11,725 $ 8,730
----------- ----------- -----------
----------- ----------- -----------
POSTRETIREMENT BENEFIT PLAN. The postretirement defined benefit plan is
unfunded; however, the details of the amount included in other liabilities
are as follows:
<CAPTION>
1996 1995
----------- -----------
<S> <C> <C>
Accumulated postretirement benefit obligation:
Retirees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 28,538 $ 34,715
Fully eligible active plan participants. . . . . . . . . . . . . . . . 11,774 12,746
Other active plan participants . . . . . . . . . . . . . . . . . . . . 16,146 16,384
----------- -----------
56,458 63,845
Unrecognized net gain. . . . . . . . . . . . . . . . . . . . . . . . . . 16,648 7,378
----------- -----------
Accrued postretirement benefit cost. . . . . . . . . . . . . . . . . . . $ 73,106 $ 71,223
----------- -----------
----------- -----------
</TABLE>
50
<PAGE>
AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
9. EMPLOYEE BENEFIT PLANS (Continued)
Assumptions used in the foregoing calculation at December 31 are as follows:
<TABLE>
<CAPTION>
1996 1995 1994
----------- ----------- -----------
<S> <C> <C> <C>
Discount rate. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7.0% 7.0% 8.0%
Rate of compensation increases . . . . . . . . . . . . . . . . . . . . . 4.5 5.0 5.0
Net periodic postretirement benefit cost includes the following components:
<CAPTION>
1996 1995 1994
----------- ----------- -----------
<S> <C> <C> <C>
Service cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,685 $ 1,395 $ 2,033
Interest cost. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,700 4,057 4,373
Net amortization and deferral. . . . . . . . . . . . . . . . . . . . . . (1,104) (1,120) (115)
----------- ----------- -----------
Net periodic benefit cost. . . . . . . . . . . . . . . . . . . . . . . . $ 4,281 $ 4,332 $ 6,291
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
The calculation of the accumulated postretirement benefit obligation assumes
a weighted-average annual assumed rate of increase in the per capita cost of
covered benefits (i.e., health care cost trend rate) of 8.5% for 1997 gradually
decreasing to 5.0% by 2005. The health care cost trend rate assumption has a
significant effect on the amounts reported. For example, increasing the assumed
health care cost trend rates by one percentage point in each year would increase
the accumulated postretirement benefit obligation at December 31, 1996 by
$3,952, and the aggregate of the service and interest cost components of net
periodic postretirement benefit cost for 1996 by $431.
INCENTIVE PLANS. Prior to the initial public offering, certain employees of
the Company participated in various incentive plans maintained by LNC. In
conjunction with the initial public offering, the Company established various
incentive plans for eligible employees that provide for the issuance of stock
options, restricted stock, stock appreciation rights, phantom stock or cash.
These plans are comprised primarily of stock option incentive plans. Stock
options are granted at the market price on the date of grant and, subject to
termination of employment, expire 10 years from the date of grant. The
options are exercisable in 25% increments on the option issuance anniversary
in the four years following issuance. The maximum number of shares which can
be granted from the stock option incentive plan is 1,000,000 from the
inception of the plan to the plan expiration date on July 1, 2000. During
1996, options for 199,400 shares were granted with an exercise price of $23
per share. None of these options were exercisable nor were any forfeited
during the year.
In addition, 50,515 restricted shares of the Company's Common Stock were
issued to key personnel. The shares are restricted from sale or trade for
three years after grant except in a situation relating to death or
disability. In addition, at the time restrictions lapse, compensation equal
to the amount of dividends that would have been paid during the period the
shares were restricted is paid to the personnel.
The Company utilizes the intrinsic value method of accounting to determine
whether compensation expense should be recognized in conjunction with its
stock option incentive plan. As the amount the employee must pay to acquire
the stock is equal to the quoted market price of the stock at the grant date,
no compensation expense has been recognized for stock option incentive plans.
Had compensation expense for the Company's stock option incentive plans for
options been determined based on the estimated fair value at the grant date
for awards under those plans, the Company's pro forma net income and earnings
per share for 1996 would have been $168,266 or $3.01 per share, a decrease of
$1,440 or $.02 per share. The effects on 1996 pro forma net income and
earnings per share of expensing the estimated fair value of stock options are
not necessarily representative of the effects on reported net income for
future years due to factors such as the vesting period of the stock options
and the potential for issuance of additional stock options in future years.
51
<PAGE>
AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
9. EMPLOYEE BENEFIT PLANS (Continued)
The fair value of options granted during 1996 were estimated as of the date of
grant using a Black-Scholes option pricing model. The option pricing assumptions
include a dividend yield of 3.7%; an expected volatility of 30%; a risk-free
interest rate of 6.8%; and an expected life of 9 years. The average fair value
per option granted during 1996 was $11.12 based on these assumptions.
10. RENT EXPENSE
The principal leased property is the home office which is leased through a
sale-leaseback agreement. The agreement,which was entered into in 1984, provides
for a 25 year lease period with options to renew for six additional terms of
five years each. The agreement also provides the Company with the right of first
refusal to purchase the property during the term of the lease, including renewal
periods, at a price as defined in the agreements. In addition, the Company has
the option to purchase the leased property at fair market value as defined in
the agreements on the last day of the initial 25 year lease period ending in
2009 or the last day of any of the renewal periods.
Rent expense included in benefits and expenses amounted to approximately
$16,980, $16,123 and $16,898 in 1996, 1995 and 1994, respectively. At
December 31, 1996, future minimum payments, by year and in the aggregate, for
noncancelable operating leases with initial or remaining terms of one year or
more consisted of the following:
1997 . . . . . . . . . . . . . . . $10,052
1998 . . . . . . . . . . . . . . . 8,808
1999 . . . . . . . . . . . . . . . 8,969
2000 . . . . . . . . . . . . . . . 10,279
2001 . . . . . . . . . . . . . . . 9,938
2002 and thereafter. . . . . . . . 77,750
52
<PAGE>
AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
11. REINSURANCE ACTIVITIES
The principal sources of reinsurance assumed are national and state
associations. Reinsurance is ceded to other companies for risks which exceed
retention limits and to provide for catastrophic claims.
The effect of reinsurance on premiums written and earned is as follows:
<TABLE>
<CAPTION>
Earned
Written ------------------------------------
Property- Property-
Casualty Casualty Life Total
-------- -------- ---- -----
<S> <C> <C> <C> <C>
1996
Direct . . . . . . . . . . . . . . $1,642,016 $1,650,216 $58,975 $1,709,191
Assumed . . . . . . . . . . . . . . 8,905 15,622 2,596 18,218
Ceded . . . . . . . . . . . . . . . (50,034) (48,603) (4,684) (53,287)
---------- ---------- ------- ----------
Net . . . . . . . . . . . . . . . $1,600,887 $1,617,235 $56,887 $1,674,122
---------- ---------- ------- ----------
---------- ---------- ------- ----------
1995
Direct . . . . . . . . . . . . . . $1,674,470 $1,689,668 $57,872 $1,747,540
Assumed . . . . . . . . . . . . . . 43,481 46,562 2,870 49,432
Ceded . . . . . . . . . . . . . . . (46,391) (46,635) (3,951) (50,586)
---------- ---------- ------- ----------
Net . . . . . . . . . . . . . . . $1,671,560 $1,689,595 $56,791 $1,746,386
---------- ---------- ------- ----------
---------- ---------- ------- ----------
1994
Direct . . . . . . . . . . . . . . $1,657,930 $1,686,388 $54,469 $1,740,857
Assumed . . . . . . . . . . . . . . 55,557 61,031 2,060 63,091
Ceded . . . . . . . . . . . . . . . (58,028) (53,977) (4,000) (57,977)
---------- ---------- ---------- ----------
Net . . . . . . . . . . . . . . . $1,655,459 $1,693,442 $52,529 $1,745,971
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
</TABLE>
Benefits and settlement expenses were reduced by $33,821, $22,904 and $24,399
in 1996, 1995 and 1994, respectively, as a result of ceded reinsurance
arrangements. The Company remains contingently liable with respect to losses
reinsured in the event any reinsurer is unable to meet obligations assumed.
12. OTHER TRANSACTIONS WITH AFFILIATES
On March 29, 1995, the Company purchased 4,986,507 shares, or 29.22% of
EMPHESYS Financial Group, Inc. from LNC for $193,227. This investment was
accounted for using the equity method and resulted in earnings of $6,449 being
included in net investment income through September 30, 1995. On August 22,
1995, a tender offer was extended by Humana, Inc. and on October 7, 1995, the
Company tendered its investment in EMPHESYS stock resulting in an after-tax loss
of $9,004.
In January of 1996, the Company agreed to assume $63.7 million of
liabilities, primarily loss and loss adjustment expense reserves, from an
affiliate of LNC, on a closed block of specialty lines business. The Company
received $63.7 million in assets, primarily cash, as part of the transaction.
This run-off business covers primarily property, casualty, accident and
health exposures on sports, leisure and entertainment venues.
53
<PAGE>
AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
12. OTHER TRANSACTIONS WITH AFFILIATES (Continued)
In addition to the above, the Company has various other transactions with LNC
and its affiliates in the normal course of operations. These transactions
include systems, strategic planning and management advice, financial services,
investment services, legal services, accounting services, and assistance with
employee benefits, information services, data processing, actuarial, marketing
and human resources. In addition, the Company pays to LNC affiliates investment
advisory fees. In 1996, 1995 and 1994, the Company paid LNC and its affiliates
fees totaling $10,145, $10,454, and $7,614.
At December 31, 1995, the Company had $37,910 invested in LNC's short-term
investment pool. During 1996, the Company established its own short-term
investment pool. In addition, the Company had $31,037 and $40,072, at cost,
invested in mutual funds administered by a subsidiary of LNC with a fair value
of $40,088 and $41,198 at December 31, 1996 and 1995, respectively.
The Company provides supervision and administrative services to wholly-owned
property and casualty insurance subsidiaries of LNC. In 1996, 1995 and 1994, LNC
paid the Company fees totaling $432, $924, and $625, respectively.
LNC paid the Company $7,425, $6,277 and $5,298 during 1996, 1995 and 1994 for
administrative services and insurance coverages provided by the Company to LNC.
The Company paid LNC $2,757, $6,935 and $2,601 during 1996, 1995 and 1994 for
services rendered by LNC to purchase corporate insurance coverages. The
Company's life insurance subsidiary paid LNC $4,267, $3,042 and $3,528 during
1996, 1995 and 1994 for reinsurance coverages.
54
<PAGE>
AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
13. SEGMENT INFORMATION
The Company, operates within the property/casualty and the life insurance
industry through a network of independent agents. The property/casualty
insurance industry is further broken down into commercial, personal and
reinsurance business in runoff. Revenues, pre-tax operation income and
identifiable assets for the property/casualty, life and holding company segments
are as follows:
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Revenue
Property/casualty operations
Net premiums earned and other revenue:
Personal $ 690,799 $ 684,091 $ 684,903
Commercial 925,680 1,005,364 1,003,209
Reinsurance business in runoff 755 140 5,330
Net investment income 238,227 233,759 230,945
Net realized gain on investments 34,370 38,778 19,228
Loss on operating properties - (28,350) -
---------- ---------- ----------
Total property/casualty operations 1,889,831 1,933,782 1,943,615
---------- ---------- ----------
Life operations
Net premiums earned and other revenue $ 56,888 $ 56,791 $ 52,529
Net investment income 33,975 32,810 29,509
Net realized gain on investments 1,161 2,266 708
---------- ---------- ----------
Total life operations 92,024 91,867 82,746
Holding company
Net investment income $ 2,112 $ - $ -
Net realized gain on investments 7 - -
---------- ---------- ----------
Total holding company 2,119 - -
---------- ---------- ----------
Net revenues $1,983,974 $2,025,649 $2.026,361
---------- ---------- ----------
---------- ---------- ----------
Pre-tax income
Property/casualty operations
Underwriting gain (loss):
Personal $ (59,955) $ (32,789) $ (49,800)
Commercial (1,537) 45,762 4,533
Reinsurance business in runoff (26,639) (69,826) (23,777)
Net investment income 238,227 233,759 230,945
Net realized gain on investments 34,211 38,778 19,228
Loss on operating properties - (28,350) -
---------- ---------- ----------
Total property/casualty operations 184,307 187,334 181,129
Total life operations 21,993 21,778 19,138
Holding company (10,618) - -
---------- ---------- ----------
Total pre-tax income $ 195,682 $ 209,112 $ 200,267
---------- ---------- ----------
---------- ---------- ----------
</TABLE>
55
<PAGE>
AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
13. SEGMENT INFORMATION (Continued)
1996 1995
---- ----
Identifiable assets
Property/casualty operations. . . . . . . . . . $4,907,722 $4,981,343
Life operations . . . . . . . . . . . . . . . . 585,726 560,325
Holding company . . . . . . . . . . . . . . . . 1,663,690 1,668,707
Eliminations. . . . . . . . . . . . . . . . . . (1,616,055) (1,671,190)
---------- ----------
Total identifiable assets . . . . . . . . . . $5,541,083 $5,539,185
---------- ----------
---------- ----------
The operating expenses of the Company have all been considered to be allocable
to the segments since the Company's activities were all directly related to
those segments through December 31, 1996. Capital expenditures and depreciation
expense are not material.
14. REALIGNMENT OF FIELD OPERATIONS
In November 1995, the Company approved a realignment plan which included the
consolidation of the field operations from 20 divisional offices into four
regional offices. Certain of the locations will be converted to service offices.
Those operating properties owned by the Company that will not be used as a
regional office will be sold. For each location to be downsized, job
classifications, positions to be eliminated and individuals impacted were
identified and severance benefits were communicated. This process was started in
1995 with the majority of the Realignment occurring in 1996 and the balance to
be completed in 1997. Management estimated that the costs of realignment and
valuation allowance for the sale of the operating properties based on
independent appraisals with net carrying value representing the lower of cost or
market, net of taxes, approximated $13,700 and $18,500, respectively, and was
charged to income in 1995; accordingly, net income decreased $32,200.
During 1996, the Company sold 4 of the divisional offices. At December 31,
1995, the Company had estimated that it would incur approximately $21,000
related to the various costs associated with the realignment plan and had
accrued such costs. Through December 31, 1996, approximately $14,000 of the
accrued costs have been paid. Management believes the balance of $7,000 is
adequate to cover future expected payments.
15. CONTINGENCIES
The Company is routinely involved in pending or threatened legal proceedings.
Those proceedings sometimes involve alleged breaches of contract, torts
(including bad faith and fraud claims) and miscellaneous other causes of action.
Some of the pending litigation includes claims for punitive damages in addition
to compensatory damages and other relief. While the aggregate dollar amounts
involved in these legal proceedings cannot be determined with certainty, the
amounts at issue could have a significant effect on the Company's results of
operations. However, based upon information presently available, and in light of
legal and other defenses available to the Company, management does not believe
that any of these routine proceedings will have a material adverse effect on the
financial results or operations of the Company.
56
<PAGE>
AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
15. CONTINGENCIES (Continued)
On February 14, 1996, three of the Company's property and casualty insurance
subsidiaries were among 23 underwriters of real property insurance named
defendants in a case brought in the United States District Court for the Western
District of Missouri alleging that their underwriting, sales and marketing
practices violated a number of civil rights laws (including, without limitation,
the Fair Housing Act). The plaintiffs seek to represent themselves and a
putative class of similarly situated persons in the State of Missouri. This
action seeks injunction relief, unspecified compensatory damages, punitive
damages and attorneys' fees. In response to motions filed by the defendants, the
court dismissed the conspiracy court by Order dated October 2, 1996 but has
required that the defendants answer the remaining counts and discovery has now
begun. Management believes, based upon current information, that the Company's
underwriting, sales and marketing practices have complied in all material
respects with the applicable requirements of both state and federal law. The
Company intends to vigorously defend this action.
On August 29, 1996, the first of two actions were brought in Missouri state
courts alleging that underinsured motorist insurance coverage sold in that state
by three of the Company's property and casualty insurance subsidiaries
constitutes "phantom coverage" when sold at limits equal to the State's
financial responsibility requirements. In both actions, the plaintiffs seek to
represent themselves and a putative class of similarly situated persons in the
State of Missouri. The actions seek both compensatory and punitive damages based
upon a number of legal theories, including, without limitation, breach of
fiduciary duty, negligence, breach of contract, unjust enrichment and
misrepresentation. While it is too early to fully evaluate the plaintiffs'
allegations, the potential defenses available or the size of the putative class
of plaintiffs, management does not believe, based upon current information, that
the allegations have merit and it therefore intends to defend these actions
vigorously.
57
<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1997
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 1-11733
AMERICAN STATES FINANCIAL CORPORATION
INDIANA NO. 35-1976549
State of Incorporation I.R.S. Employer Identification No.
500 NORTH MERIDIAN STREET
INDIANAPOLIS, INDIANA 46204-1275 (317) 262-6262
Address of principal executive offices Telephone Number
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 [ ]
Shares of common stock outstanding as of July 1, 1997: 60,050,515
DOCUMENTS INCORPORATED BY REFERENCE: Certain portions of the Registrant's
Form 8-K, dated June 6, 1997 are incorporated by reference in Part II of this
Form 10-Q.
The exhibit index to this report is located on page 23.
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
June 30, December, 31
1997 1996
---------- ------------
(Dollars in Thousands)
<S> <C> <C>
ASSETS
Investments:
Securities available-for-sale at fair value:
Fixed maturity (amortized cost: 1997 - $3,618,363;
1996 - $3,579,807) $3,787,582 $3,763,880
Equity (cost: 1997 - $362,082; $1996 - $362,720) 460,560 435,137
Mortgage loans 21,871 32,293
Short-term investments 74,194 73,276
Other invested assets 39,450 37,986
---------- ----------
Total investments 4,383,657 4,342,572
Cash 19,338 13,610
Premium receivable 482,774 413,444
Deferred policy acquisition costs 212,250 202,233
Properties to be sold 23,218 30,633
Property and equipment 31,800 31,143
Accrued investment income 64,932 64,602
Current federal income taxes recoverable 4,968 ---
Deferred federal income taxes recoverable 121,066 128,742
Cost in excess of net assets of acquired subsidiaries 96,063 97,772
Ceded reinsurance on claims and claims expense reserves 175,149 179,445
Miscellaneous 36,658 36,887
---------- ----------
Total assets $5,651,873 $5,541,083
---------- ----------
---------- ----------
</TABLE>
(continued on next page)
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
2
<PAGE>
AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (CONTINUED)
<TABLE>
<CAPTION>
June 30, December, 31
1997 1996
---------- ------------
(Dollars in Thousands)
<S> <C> <C>
LIABILITIES AND SHAREHOLDERS' EQUITY
Policy liabilities and accruals:
Losses, loss adjustment expense and future policy benefits $2,854,688 $2,868,348
Unearned premiums 746,058 711,955
---------- ----------
Total policy liabilities and accruals 3,600,746 3,580,303
Commissions and other expenses 103,702 120,872
Current federal income taxes payable --- 5,303
Outstanding checks 64,128 69,901
Short-term debt due LNC 66,667 66,667
Notes payable 99,607 99,511
Debt due LNC 133,333 133,333
Other liabilities 166,731 129,154
---------- ----------
Total liabilities 4,234,914 4,205,044
Shareholders' equity:
Common stock, no par value: 195,000,000 shares authorized,
shares issued and outstanding: 1997 and 1996 - 60,050,515 304,500 304,493
Net unrealized gain on securities available-for-sale 171,494 163,647
Retained earnings 940,965 867,899
---------- ----------
Total shareholders' equity 1,416,959 1,336,039
---------- ----------
Total liabilities and shareholders' equity $5,651,873 $5,541,083
---------- ----------
---------- ----------
</TABLE>
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
3
<PAGE>
AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
1997 1996 1997 1996
---------- ------------ ---------- -----------
(Dollars in Thousands, Except Per Share Data)
<S> <C> <C> <C> <C>
Revenue:
Premiums and other revenue $ 429,821 $ 424,483 $ 853,097 $ 848,477
Net investment income 66,525 66,156 133,003 134,489
Realized gain on investments 9,756 7,374 19,443 28,470
Gain on operating properties 4,208 --- 6,671 ---
---------- ----------- ---------- -----------
Total revenue 510,310 498,013 1,012,214 1,011,436
Benefits and expenses:
Benefits and settlement expenses 323,369 332,342 620,910 655,905
Commissions 71,657 72,510 140,762 144,382
Operating and administrative expenses 46,949 51,051 98,960 102,224
Taxes, licenses and fees 11,120 8,322 21,857 20,240
Interest on debt 5,227 1,835 10,392 1,835
---------- ----------- ---------- -----------
Total benefits and expenses 458,322 466,060 892,881 924,586
Income before federal income taxes 51,988 31,953 119,333 86,850
Federal income taxes (credit):
Current 4,842 (1,530) 17,617 14,401
Deferred 2,907 3,724 3,450 (4,223)
---------- ----------- ---------- -----------
Total federal income taxes 7,749 2,194 21,067 10,178
---------- ----------- ---------- -----------
Net income $ 44,239 $ 29,759 $ 98,266 $ 76,672
---------- ----------- ---------- -----------
---------- ----------- ---------- -----------
Net income per share $ .74 $ .55 $ 1.64 $ 1.48
---------- ----------- ---------- -----------
---------- ----------- ---------- -----------
Weighted average shares outstanding 60,050,515 53,644,692 60,050,515 51,832,414
---------- ----------- ---------- -----------
---------- ----------- ---------- -----------
</TABLE>
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
4
<PAGE>
AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
Six Months Ended
June 30,
1997 1996
---------- -----------
(Dollars in Thousands)
<S> <C> <C>
Common stock:
Balance at beginning of period $ 304,493 $ 387,547
Public offering of common stock --- 215,482
Common stock issued for employee benefit plans 7 1,161
Assumption and issuance of debt in exchange with LNC --- (299,398)
---------- -----------
Balance at end of period 304,500 304,792
Net unrealized gain (loss) on securities available-for-sale:
Balance at beginning of period 163,647 211,767
Change during the period 7,847 (97,793)
---------- -----------
Balance at end of period 171,494 113,974
Retained earnings:
Balance at beginning of period 867,899 1,069,393
Dividend of assets to LNC prior to public offering --- (299,866)
Dividends declared and paid on Common Stock ($.42 per share) (25,200) (46,134)
Net income 98,266 76,672
---------- -----------
Balance at end of period 940,965 800,065
---------- -----------
Total shareholders' equity $1,416,959 $ 1,218,831
---------- -----------
---------- -----------
</TABLE>
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
5
<PAGE>
AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Six Months Ended
June 30,
1997 1996
--------- ---------
(Dollars in Thousands)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 98,266 $ 76,672
Adjustments to reconcile net income to cash provided by
(used in) operating activities:
Deferred policy acquisition costs (9,149) (4,270)
Premiums and fees in course of collection (69,330) (37,052)
Accrual of discount on investments (9,445) (9,617)
Amortization of premium on investments 2,034 2,767
Accrued investment income (331) (1,800)
Policy liabilities and accruals 4,183 76,793
Federal income taxes (6,821) (25,110)
Provisions for depreciation 3,761 3,850
Gain on sale of investments (19,443) (28,470)
Gain on operating properties (6,671) ---
Ceded reinsurance on claims and claims expense reserves 4,296 (36,914)
Other (11,359) (21,514)
--------- ---------
Net adjustments (118,275) (81,337)
--------- ---------
Net cash used in operating activities (20,009) (4,665)
CASH FLOWS FROM INVESTING ACTIVITIES
Securities available-for-sale:
Purchase of investments (335,737) (753,087)
Sales of investments 280,360 583,064
Maturities and redemptions 45,070 38,401
Purchase of mortgage loans and other investments (3,836) (7,011)
Sale or maturity of mortgage loans and other investments 11,684 3,945
Net increase in short-term investments (918) (59,495)
Net sale (purchase) of property and equipment 9,669 (4,472)
Other 28,379 16,518
--------- ---------
Net cash provided by (used in) investing activities 34,671 (182,137)
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of common stock 7 215,482
Universal life investment contract deposits 25,334 24,837
Universal life investment contract withdrawals (9,075) (6,605)
Dividends paid (25,200) (46,134)
--------- ---------
Net cash provided by (used in) financing activities (8,934) 187,580
Net increase (decrease) in cash 5,728 778
Cash at beginning of period 13,610 12,708
--------- ---------
Cash at end of period $ 19,338 $ 13,486
--------- ---------
--------- ---------
</TABLE>
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
6
<PAGE>
AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following notes should be read in conjunction with the notes to
consolidated financial statements included in the American States Financial
Corporation Form 10-K dated February 26, 1997. Unless the context otherwise
indicates; (1) the "Company" refers to American States Financial
Corporation and its wholly-owned, consolidated subsidiaries; (ii) "ASI"
refers to American States Insurance Company, the Company's sole direct
wholly-owned subsidiary, and its consolidated subsidiaries; and (iii) the
"Subsidiaries" refer to the direct and indirect subsidiaries of the Company,
which include ASI and its subsidiaries. Operating results for the six months
ended June 30, 1997 are not necessarily indicative of the results that may be
expected for the full year ending December 31, 1997.
1. ORGANIZATION AND BASIS OF PRESENTATION
On February 5, 1996, the Company was incorporated in the State of
Indiana to serve as the holding company for ASI. The formation of the Company
was done in contemplation of an initial public offering. On April 22, 1996,
ASI declared, and on May 15, 1996, it distributed to its parent, Lincoln
National Corporation ("LNC"), a dividend of $300 million, consisting
primarily of tax-exempt securities ("Dividended Assets"). On May 16, 1996, LNC
transferred all of the outstanding shares of ASI to the Company in exchange
for 50,000,000 shares of the Company's common stock. Concurrently with the
transfer of the ASI stock, the Company assumed $100 million of LNC debt
("Assumed Debt") and issued a $200 million note to LNC (the "Term Note").
On May 29, 1996, the Company issued 10,000,000 shares of common stock at
$23 per share to the public (the "Offering"). The net proceeds from the
Offering (after deduction of underwriting discounts and offering expenses)
were $215.2 million. The Company contributed $140.5 million of such net
proceeds to ASI to enable it to invest in taxable securities for its
investment portfolio to partially replace the Dividended Assets. The
remainder of the net proceeds were retained by the Company for general
corporate purposes. As a result of the Offering, LNC's ownership was reduced
to approximately 83%.
The 50,000,000 shares held by LNC are "restricted shares" as defined by
Rule 144 of the Securities Act of 1993, as amended (the "Securities Act").
Such shares may not be resold in the absence of registration under the
Securities Act or exemptions from such registration, including, among others,
the exemption provided by Rule 144 under the Securities Act. As an affiliate
of the Company, LNC is subject to certain volume restrictions on the sale of
shares of the Company's common stock.
The Company's common stock is publicly traded on the New York Stock
Exchange under the symbol "ASX".
The transfer of ASI stock to the Company by LNC in exchange for Company
common stock and the Assumed Debt and Term Note have been accounted for
similar to a pooling of interests in the consolidated financial statements of
the Company, in that the assets, liabilities, shareholders' equity and the
results of operation of the Company and its subsidiaries have been combined
at historical carrying values.
The consolidated financial statements as of and for the six months ended
June 30, 1997 and 1996, are unaudited. In the opinion of management, these
financial statements include all adjustments, consisting only of normal
recurring items, which are necessary to present fairly the Company's
financial position and results of operations on a basis consistent with that
of prior audited consolidated financial statements. The balance sheet at
December 31, 1996, has been derived from the audited financial statements at
that date but does not include all of the information and footnotes required
by generally accepted accounting principles for complete financial
statements. Significant intercompany balances and transactions have been
eliminated. Certain amounts from prior periods were reclassified to conform to
the 1997 presentation. Net income and shareholders' equity have not been
affected by these reclassifications.
7
<PAGE>
AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
1. ORGANIZATION AND BASIS OF PRESENTATION (Continued)
The Company underwrites property and casualty insurance, concentrating
on providing commercial insurance to small to medium-sized businesses and
preferred personal lines coverages to individuals. As a complement to its
property and casualty operations, the Company also markets life insurance.
The Company writes business throughout the United States with the greatest
volume in the Midwest and Pacific Northwest.
2. CHANGE IN ACCOUNTING PRINCIPLE
In February 1997, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards No. 128 ("FAS 128"),
EARNINGS PER SHARE which the Company will adopt in the fourth quarter of
1997. Earlier adoption is not permitted. In accordance with FAS 128, the
Company will present "basic" and "diluted" earnings per share on the face of
the income statement regardless of the difference between the two
calculations. When calculating the diluted earnings per share, the treasury
stock method will be applied using the average market price for the period
rather than the higher of the average market price or the ending market
price. Using the terms of FAS 128, the basic and diluted earnings per share
for the first six months of 1997 would be $1.64. The basic and diluted
earnings per share for the first six months of 1996 would be $1.48.
In June of 1997, the FASB issued Statement 130, "Reporting Comprehensive
Income". Statement 130 is effective for fiscal years beginning after December
15, 1997 and ASFC will adopt it in the first quarter of 1998. Adoption will
have no effect on net income but will require the reporting of "comprehensive
income," which will include net income and certain items currently reported
in stockholders' equity.
The FASB issued Statement 131, "Disclosures about Segments of an
Enterprise and Related Information" in June of 1997. FAS 131 changes the way
companies report information about business segments in annual financial
statements and requires the reporting of selected segment information in
their interim reports. FAS 131 is effective for financial statements for
periods beginning after December 15, 1997 except that providing interim
information in the initial year (1998) may be deferred until 1999. ASFC plans
on providing the required segment information in its 1998 annual report and
in its interim reports beginning in 1999. FAS 131 has no effect on net income.
3. FEDERAL INCOME TAXES
A consolidated federal income tax return is filed by LNC and includes
the Company. Pursuant to an agreement with LNC, the Company provides for
income taxes on the basis of a separate return calculation. The taxes
computed are remitted to or collected from LNC.
The effective tax rate on pre-tax income is lower than the prevailing
corporate federal income tax rate primarily due to tax-exempt interest on
municipal securities.
8
<PAGE>
AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
4. NOTES PAYABLE AND DEBT DUE LNC
The Assumed Debt is governed by an agreement between the Company and LNC
(the "Assumption Agreement") which provides for the payment by the Company of
the currently outstanding 7 1/8% notes due July 15, 1999, originally issued
to the public by LNC on July 15, 1992. LNC will continue to be the primary
obligor of this public debt; however, pursuant to the Assumption Agreement,
the Company is obligated to make a $100 million principal payment on July 15,
1999 to repay the holders of the public debt. The Assumption Agreement also
provides that interest at 7 1/8% is payable semi-annually by the Company.
The Term Note will pay interest quarterly at a rate of 50 basis points
over the rate on three year Treasury Notes through and including November 14,
1997, 50 basis points over the rate on two year Treasury Notes from November
15, 1997 through and including November 14, 1998 and 50 basis points over the
rate on one-year Treasury Bills from November 15, 1998 through the maturity
date. The current rate on the Term Note is 6.7%. The Term Note is payable in
three equal principal payments due on August 15, 1997, 1998 and 1999.
Pursuant to the provisions on the Term Note, the Company will have the right
to prepay the Term Note at any time. The Term Note also contains covenants
that will, among other things, (i) require the Company to maintain certain
levels of adjusted consolidated net worth (as defined in the Term Note), and
(ii) restrict the ability of the Company to incur indebtedness in excess of
50% of its adjusted consolidated net worth and to enter into a major
corporate transaction unless the Company is the survivor and would not be in
default.
However, as disclosed in Note 6 to the Notes to Consolidated Financial
Statements, LNC will be paid the outstanding balance and accrued but unpaid
interest thereon of the Assumed Debt and Term Note pursuant to terms of the
pending Agreement and Plan of Merger by and among ASFC, SAFECO Corporation
and ASFC Acquisition Co. if and when the sale is consummated.
On May 29, 1996, the Company entered into a revolving credit agreement
in which the Company may borrow and repay amounts up to a maximum of $200
million (the "Line of Credit"). Borrowings using the Line of Credit will bear
interest generally at variable rates tied to LIBOR, an adjusted certificate
of deposit rate or other short-term indices. No debt was outstanding using
the Line of Credit at June 30, 1997.
5. CONTINGENCIES
On February 14, 1996, three of the Company's property and casualty
insurance subsidiaries were among 23 underwriters of real property insurance
named defendants in a case alleging that their underwriting, sales and
marketing practices violated a number of civil rights laws (including,
without limitation, the Fair Housing Act). It was also alleged that the
defendants' actions constituted a civil conspiracy. Brought in the United
States District Court for the Western District of Missouri, the plaintiffs
sought to represent themselves and a putative class of similarly situated
persons in the State of Missouri. This action sought injunctive relief,
unspecified compensatory damages, punitive damages and attorney's fees. In
response to motions filed by the defendants, the court dismissed the
conspiracy count by Order dated October 2, 1996 but required that the
defendants answer the remaining counts. On June 19, 1997 the court denied
class certification and dismissed the case for lack of standing. On July 17,
1997 the same plaintiffs filed a separate action against the same three
property and casualty subsidiaries of the Company.
9
<PAGE>
AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
5. CONTINGENCIES (Continued)
The plaintiffs in this new case have asked that it be certified as a
class action and make substantially the same allegations and seek
substantially the same remedies as were sought in the original case. In
addition, the plaintiffs filed a notice of appeal in the original case on
July 18, 1997. Management believes, based upon current information, that the
Company's underwriting, sales and marketing practices have complied in all
material respects with the applicable requirements of both state and federal
law. The Company intends to defend these actions vigorously.
On August 29, 1996, the first of two actions were brought in Missouri
state courts alleging that underinsured motorist insurance coverage sold in
that state by three of the Company's property and casualty insurance
subsidiaries constitutes "phantom coverage" when sold at limits equal to the
State's financial responsibility requirements. In both actions, the
plaintiffs sought to represent themselves and a putative class of similarly
situated persons in the State of Missouri. Both actions sought compensatory
and punitive damages based upon a number of legal theories, including,
without limitation, breach of fiduciary duty, negligence, breach of contract,
unjust enrichment and misrepresentation. A motion to consolidate the two
cases has been entered. Discovery has begun. Management does not believe,
based upon current information, that the allegations have merit and it
therefore intends to defend the consolidated action vigorously.
6. RECENT DEVELOPMENTS
On June 6, 1997, ASFC entered into an Agreement and Plan of Merger dated
as of the same date (the "Merger Agreement"), by and among ASFC, SAFECO
Corporation ("Buyer") and ASFC Acquisition Co., a wholly owned subsidiary of
Buyer ("Buyer Sub"). The Merger Agreement provides for, among other things,
the merger of Buyer Sub with and into ASFC (the "Merger"), with ASFC
surviving the Merger as a wholly owned subsidiary of Buyer. Pursuant to the
Merger Agreement and upon consummation of the Merger each outstanding share
of Common Stock of ASFC ("ASFC Common Stock") will be converted into the
right to receive $47 in cash without interest thereon. Consummation of the
Merger is subject to certain conditions, including, among others, (a) the
approval by certain state insurance regulators of the Merger and (b)
compliance with applicable provisions of the Hart-Scott-Rodino Antitrust
Improvements Act of 1976, as amended (the "HSR Act"). Early termination of
the HSR Act waiting period was received on July 15, 1997.
In connection with the Merger Agreement, LNC and Buyer entered into a
Voting, Support and Indemnification Agreement dated June 6, 1997 (the "Voting
Agreement"), certain sections of which were agreed to and acknowledged by
ASFC. Pursuant to the Voting Agreement, LNC agreed, among other things, (a)
to vote all ASFC Common Stock held by it or any of its subsidiaries in favor
of the Merger, the Merger Agreement and the transactions contemplated
thereby, (b) to grant Buyer an irrevocable proxy in all ASFC Common Stock
held by it or any of its subsidiaries for purposes of a vote at a meeting of
the holders of ASFC Common Stock held to consider the Merger and (c) to
allocate between LNC and Buyer certain tax and employee benefits liabilities;
and Buyer agreed, among other things, to pay to LNC (a) $100 million plus an
amount equal to the accrued but unpaid interest on the outstanding 7 1/8%
notes due July 15, 1999, originally issued to the public by LNC on July 15,
1992, in consideration of the termination of the agreement relating to the
Assumed Debt, and (b) the outstanding principle balance of, plus accrued but
unpaid interest on, the Term Note, in consideration of the surrender of the
Term Note by LNC to ASFC for cancellation.
10
<PAGE>
UNAUDITED PRO FORMA COMBINED CONDENSED FINANCIAL STATEMENTS
The following unaudited pro forma combined condensed statements of income
of the Company for the six months ended June 30, 1997 and for the year ended
December 31, 1996 present results for the Company as if the Acquisition, the
Offerings and the other financings consummated by the Company in connection
with the Acquisition (including the Related Financings, as hereinafter
defined) had occurred at January 1, 1996. See "Capitalization." The
accompanying unaudited pro forma combined condensed balance sheet as of June
30, 1997 gives effect to the Acquisition, the Offerings and the other
financings consummated by the Company in connection with the Acquisition
(including the Related Financings) as if they had occurred as of June 30,
1997. The unaudited pro forma combined condensed financial statements do not
purport to represent the Company's financial position or the operating
results that would have been achieved had the Acquisition been consummated as
of the dates indicated and should not be construed as projecting the
Company's future financial position or operating results. The unaudited pro
forma combined condensed financial statements do not reflect any projected
revenue increases or cost savings. The pro forma adjustments are based on
available information and certain assumptions that the Company currently
believes are reasonable under the circumstances.
The unaudited pro forma combined condensed financial statements should be
read in conjunction with the accompanying notes thereto, the historical
consolidated financial statements of SAFECO as of and for the year ended
December 31, 1996 and the six months ended June 30, 1997 and the historical
consolidated financial statements of ASFC as of and for the year ended
December 31, 1996 and the six months ended June 30, 1997, in each case
incorporated by reference in this Prospectus.
The pro forma adjustments are applied to the historical financial
statements to account for, among other things, the Acquisition using the
purchase method of accounting. Under purchase accounting, the total purchase
cost for the Acquisition has been allocated to the assets and liabilities of
ASFC based on their fair values. Allocations are subject to valuations as of
the date of the Acquisition based on appraisals and other studies which are
not yet completed. Accordingly, the final allocations will be different from
the amounts reflected herein. Although the final allocations will differ, the
unaudited pro forma combined condensed financial statements reflect
management's best estimates based on currently available information as of
the date of this Prospectus.
As part of the Acquisition, SAFECO and Lincoln National Corporation
("Lincoln National"), as the majority shareholder of ASFC, jointly elected to
treat the purchase of ASFC by SAFECO as an asset acquisition for federal
income tax purposes pursuant to Section 338(h)(10) of the Internal Revenue
Code of 1986, as amended. This election allows the Company to deduct the
amortization of goodwill recorded in the Acquisition, thereby significantly
improving the Company's future cash flows.
1
<PAGE>
PRO FORMA COMBINED CONDENSED BALANCE SHEET
AS OF JUNE 30, 1997 (UNAUDITED)
<TABLE>
<CAPTION>
HISTORICAL
------------------------- PRO FORMA
ADJUSTMENTS PRO
AMERICAN INCREASE NOTE FORMA
SAFECO STATES (DECREASE) REFERENCE COMBINED
----------- ------------ --------------- --------- ----------
(IN MILLIONS)
<S> <C> <C> <C> <C> <C>
ASSETS:
Investments:
Fixed maturities available-for-sale, at market value. . . $12,238.2 $3,787.6 $(600.0) (a) $15,425.8
Fixed maturities held-to-maturity, at amortized cost. . . 2,698.1 - 2,698.1
Marketable equity securities, at market value . . . . . . 1,501.1 460.6 1,961.7
Mortgage loans. . . . . . . . . . . . . . . . . . . . . . 460.3 21.9 482.2
Real estate . . . . . . . . . . . . . . . . . . . . . . . 614.6 - 614.6
Short-term investments. . . . . . . . . . . . . . . . . . 110.1 74.2 184.3
Other invested assets . . . . . . . . . . . . . . . . . . 59.4 39.4 98.8
---------- -------- ------- --- ---------
Total investments . . . . . . . . . . . . . . . . . . . 17,681.8 4,383.7 (600.0) 21,465.5
Cash. . . . . . . . . . . . . . . . . . . . . . . . . . . . 80.5 19.3 (42.0) (b) 57.8
Accrued investment income . . . . . . . . . . . . . . . . . 247.6 64.9 312.5
Finance receivables . . . . . . . . . . . . . . . . . . . . 913.8 - 913.8
Premiums and other service fees receivable. . . . . . . . . 486.9 482.8 969.7
Reinsurance recoverables. . . . . . . . . . . . . . . . . . 129.9 175.1 305.0
Deferred policy acquisition costs . . . . . . . . . . . . . 411.6 212.3 623.9
Deferred federal income taxes recoverable . . . . . . . . . - 121.1 102.5 (b) 0.0
(223.6) (b)
Land, buildings and equipment for company use . . . . . . . 171.7 31.8 203.5
Cost in excess of net assets of acquired subsidiaries . . . 41.1 96.1 (96.1) (b) 1,525.1
1,484.0 (b)
Other assets. . . . . . . . . . . . . . . . . . . . . . . . 223.9 64.8 288.7
Separate account assets . . . . . . . . . . . . . . . . . . 662.2 - 662.2
---------- -------- ------- ---------
Total assets. . . . . . . . . . . . . . . . . . . . . . . $21,051.0 $5,651.9 $ 624.8 $27,327.7
---------- -------- ------- ---------
---------- -------- ------- ---------
LIABILITIES AND STOCKHOLDERS' EQUITY:
Losses, adjustment expense and future policy benefits . . . $2,128.8 $2,854.7 (c) $4,983.5
Unearned premiums . . . . . . . . . . . . . . . . . . . . . 981.7 746.1 1,727.8
Funds held under deposit contracts. . . . . . . . . . . . . 10,402.8 - 10,402.8
Short-term debt . . . . . . . . . . . . . . . . . . . . . . 906.3 66.7 $ (66.7) (a) 1,644.8
738.5 (a)
Long-term debt. . . . . . . . . . . . . . . . . . . . . . . 434.9 232.9 (232.9) (a) 634.9
200.0 (a)
Other liabilities . . . . . . . . . . . . . . . . . . . . . 669.3 334.5 41.0 (b) 1,044.8
(d)
Current federal income taxes payable. . . . . . . . . . . . 12.3 - 12.3
Deferred federal income taxes payable . . . . . . . . . . . 482.1 - (223.6) (b) 258.5
Separate account liabilities. . . . . . . . . . . . . . . . 662.2 - 662.2
---------- -------- ------- ---------
Total liabilities . . . . . . . . . . . . . . . . . . . . 16,680.4 4,234.9 456.3 21,371.6
Company-obligated, mandatorily redeemable capital
securities of subsidiary trusts holding solely junior
subordinated debentures of the Company. . . . . . . . . . 990.0 (a) 990.0
---------- -------- ------- ---------
Common stock. . . . . . . . . . . . . . . . . . . . . . . . 227.9 304.5 (304.5) (e) 823.4
595.5 (a)
Retained earnings . . . . . . . . . . . . . . . . . . . . . 3,190.4 941.0 (941.0) (e) 3,190.4
Unrealized appreciation of investment securities, net of tax 956.6 171.5 (171.5) (e) 956.6
Unrealized loss from foreign currency translation,
net of tax. . . . . . . . . . . . . . . . . . . . . . . . (4.3) - (4.3)
---------- -------- ------- ---------
Total stockholders' equity. . . . . . . . . . . . . . . . 4,370.6 1,417.0 (821.5) 4,966.1
---------- -------- ------- ---------
Total liabilities and stockholders' equity. . . . . . . . $21,051.0 $5,651.9 $ 624.8 $27,327.7
---------- -------- ------- ---------
---------- -------- ------- ---------
</TABLE>
2
<PAGE>
PRO FORMA COMBINED CONDENSED STATEMENT OF INCOME
FOR THE SIX MONTHS ENDED JUNE 30, 1997 (UNAUDITED)
<TABLE>
<CAPTION>
HISTORICAL
------------------------- PRO FORMA
ADJUSTMENTS PRO
AMERICAN INCREASE NOTE FORMA
SAFECO STATES (DECREASE) REFERENCE COMBINED
---------- ------------ --------------- --------- ----------
(IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C>
REVENUES:
Insurance:
Property and casualty earned premiums . . . . . . . . . . $1,176.4 $ 824.1 $2,000.5
Life and health premiums and other revenues . . . . . . . 134.9 29.0 163.9
--------- -------- ---------
Total . . . . . . . . . . . . . . . . . . . . . . . . . 1,311.3 853.1 2,164.4
Real estate . . . . . . . . . . . . . . . . . . . . . . . . 32.7 - 32.7
Finance . . . . . . . . . . . . . . . . . . . . . . . . . . 41.0 - 41.0
Asset management. . . . . . . . . . . . . . . . . . . . . . 11.7 - 11.7
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . 25.1 6.7 31.8
Net investment income . . . . . . . . . . . . . . . . . . . 583.7 133.0 $(16.2) (f) 700.5
Realized investment gain. . . . . . . . . . . . . . . . . . 40.8 19.4 60.2
--------- -------- ------- ---------
Total revenues. . . . . . . . . . . . . . . . . . . . . . 2,046.3 1,012.2 (16.2) 3,042.3
--------- -------- ------- ---------
EXPENSES:
Losses, adjustment expense and policy benefits. . . . . . . 1,210.3 620.9 1,831.2
Commissions . . . . . . . . . . . . . . . . . . . . . . . . 226.6 148.3 374.9
Interest. . . . . . . . . . . . . . . . . . . . . . . . . . 37.4 10.4 17.9 (f) 65.7
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . 284.9 122.4 24.8 (f) 431.3
(0.8) (f)
Amortization of deferred policy acquisition costs . . . . . 223.1 169.0 392.1
Deferral of policy acquisition costs. . . . . . . . . . . . (236.1) (178.1) (414.2)
--------- -------- ------- ---------
Total expenses. . . . . . . . . . . . . . . . . . . . . . 1,746.2 892.9 41.9 2,681.0
--------- -------- ------- ---------
Income before income taxes . . . . . . . . . . . . . . . . . 300.1 119.3 (58.1) 361.3
Provision (benefit) for federal income taxes . . . . . . . . 71.4 21.0 (13.1) (g) 79.3
--------- -------- ------- ---------
Income before distributions on capital securities. . . . . . 228.7 98.3 (45.0) 282.0
Distributions on capital securities, net of tax. . . . . . . - - 26.8 (h) 26.8
--------- -------- ------- ---------
Net income available to common stockholders. . . . . . . . . $228.7 $98.3 $(71.8) $ 255.2
--------- -------- ------- ---------
--------- -------- ------- ---------
Net income per share of common stock:
Income before realized gain . . . . . . . . . . . . . . . . $ 1.60 $ 1.56
Realized gain . . . . . . . . . . . . . . . . . . . . . . . .21 .27
--------- ---------
Net income per share . . . . . . . . . . . . . . . . . . . . $ 1.81 $ 1.83
--------- ---------
--------- ---------
Weighted average shares outstanding. . . . . . . . . . . . . 126.3 (i) 139.3
</TABLE>
3
<PAGE>
PRO FORMA COMBINED CONDENSED STATEMENT OF INCOME
FOR THE YEAR ENDED DECEMBER 31, 1996 (UNAUDITED)
<TABLE>
<CAPTION>
HISTORICAL
------------------------ PRO FORMA
ADJUSTMENTS PRO
AMERICAN INCREASE NOTE FORMA
SAFECO STATES (DECREASE) REFERENCE COMBINED
---------- ------------ --------------- --------- ----------
(IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C>
REVENUES:
Insurance:
Property and casualty earned premiums . . . . . . . . . . $2,275.4 $1,617.2 $3,892.6
Life and health premiums and other revenues . . . . . . . 265.9 56.9 322.8
--------- -------- ---------
Total . . . . . . . . . . . . . . . . . . . . . . . . . 2,541.3 1,674.1 4,215.4
Real estate . . . . . . . . . . . . . . . . . . . . . . . . 79.9 - 79.9
Finance . . . . . . . . . . . . . . . . . . . . . . . . . . 75.7 - 75.7
Asset management. . . . . . . . . . . . . . . . . . . . . . 23.2 - 23.2
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . 38.5 - 38.5
Net investment income . . . . . . . . . . . . . . . . . . . 1,116.7 274.3 $ (32.4) (f) 1,358.6
Realized investment gain. . . . . . . . . . . . . . . . . . 90.1 35.6 125.7
--------- -------- ------- ---------
Total revenues. . . . . . . . . . . . . . . . . . . . . 3,965.4 1,984.0 (32.4) 5,917.0
--------- -------- ------- ---------
EXPENSES:
Losses, adjustment expense and policy benefits. . . . . . . 2,362.7 1,248.9 3,611.6
Commissions . . . . . . . . . . . . . . . . . . . . . . . . 415.7 283.0 698.7
Interest. . . . . . . . . . . . . . . . . . . . . . . . . . 72.4 12.4 35.8 (f) 120.6
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . 552.6 243.8 49.5 (f) 844.4
(1.5) (f)
Amortization of deferred policy acquisition costs . . . . . 426.9 338.0 764.9
Deferral of policy acquisition costs. . . . . . . . . . . . (443.4) (337.8) (781.2)
--------- -------- ------- ---------
Total expenses. . . . . . . . . . . . . . . . . . . . . 3,386.9 1,788.3 83.8 5,259.0
--------- -------- ------- ---------
Income before income taxes . . . . . . . . . . . . . . . . . 578.5 195.7 (116.2) 658.0
Provision (benefit) for federal income taxes . . . . . . . . 139.5 26.0 (26.2) (g) 139.3
--------- -------- ------- ---------
Income before distributions on capital securities. . . . . . 439.0 169.7 (90.0) 518.7
Distributions on capital securities, net of tax. . . . . . . - - 53.6 (h) 53.6
--------- -------- ------- ---------
Net income available to common stockholders. . . . . . . . . $ 439.0 $ 169.7 $ (143.6) $ 465.1
--------- -------- ------- ---------
--------- -------- ------- ---------
Net income per share of common stock:
Income before realized gain . . . . . . . . . . . . . . . . $ 3.02 $ 2.75
Realized gain . . . . . . . . . . . . . . . . . . . . . . . .46 .59
--------- ---------
Net income per share . . . . . . . . . . . . . . . . . . . . $ 3.48 $ 3.34
--------- ---------
--------- ---------
Weighted average shares outstanding. . . . . . . . . . . . . 126.1 (i) 139.1
</TABLE>
4
<PAGE>
NOTES TO UNAUDITED PRO FORMA COMBINED CONDENSED FINANCIAL STATEMENTS
(IN MILLIONS, EXCEPT SHARE AMOUNTS)
(a) The following adjustments reflect the funding of the Acquisition:
SOURCES:
Proceeds from issuance of commercial paper (after
application of the net proceeds of the Offerings
and the issuance of an additional $150 aggregate
liquidation amount of capital securities). . . . . . . . $ 738.5
Proceeds from issuance of 6 7/8% Notes due 2007
(the "Senior Notes"). . . . . . . . . . . . . . . . . . . 200.0
Net proceeds from issuance of capital securities. . . . . . 990.0
Net proceeds from issuance of common stock. . . . . . . . . 595.5
Dividend from SAFECO's property and casualty
subsidiaries. . . . . . . . . . . . . . . . . . . . . . . 600.0
--------
Total. . . . . . . . . . . . . . . . . . . . . . . . . $3,124.0
--------
--------
USES:
Purchase price of outstanding shares of common stock of
American States (60,093,615 shares x $47) . . . . . . . . $2,824.4
Retirement of American States debt. . . . . . . . . . . . . 299.6
--------
Total. . . . . . . . . . . . . . . . . . . . . . . . . $3,124.0
--------
--------
(b) The following adjustments result from the allocation of the purchase
price for the Acquisition based on the fair value of the net assets acquired:
DEBIT
(CREDIT)
--------
ASSETS:
Record the direct out-of-pocket costs of the Acquisition. . $ (42.0)
Adjustment to reflect the deferred tax benefit of purchase
accounting adjustments. . . . . . . . . . . . . . . . . . 102.5
Net American States' deferred tax asset against SAFECO's
deferred tax liability. . . . . . . . . . . . . . . . . . (223.6)
Eliminate American States' goodwill . . . . . . . . . . . . (96.1)
Record the excess of the cost to acquire American States
over the fair value of net assets acquired (goodwill) . . 1,484.0
LIABILITIES:
Adjustments to other liabilities:
Record lease-related fair value adjustments . . . . . . . $ (18.0)
Record the estimated liability for change of control and
other costs for certain executive officers and
employees of American States. . . . . . . . . . . . . . (30.0)
Increase liability for pension obligations. . . . . . . . (9.6)
Reduce liability for postretirement obligations . . . . . 16.6
--------
Total adjustments to other liabilities. . . . . . . . . $ (41.0)
--------
--------
(c) Adjustments of unpaid loss and loss adjustment expense resulting from
the Company's evaluation of American States' reserves will be recorded in
operations in the period determined. The Company expects to record $40.0 of
additional reserves in the fourth quarter of 1997, which will result in an
after-tax charge of $26.0 for such quarter.
(d) The Company expects to accrue in the fourth quarter of 1997 an
estimated liability of $23.0 ($15.0 after-tax) for first-year incentive
commissions on certain American States' personal lines business.
(CONTINUED ON NEXT PAGE)
5
<PAGE>
(CONTINUED FROM PREVIOUS PAGE)
(e) Adjustment to eliminate American States' equity:
Common stock. . . . . . . . . . . . . . . . . . . . . . . . $ (304.5)
Retained earnings . . . . . . . . . . . . . . . . . . . . . (941.0)
Unrealized gain . . . . . . . . . . . . . . . . . . . . . . (171.5)
(f) The following adjustments reflect the annual income statement effect
of the pro forma adjustments. The income statement adjustments for the six-month
period ended June 30, 1997 are equal to one-half of the annual amounts
presented:
ANNUAL INCREASE
(DECREASE) IN
PRETAX INCOME
---------------
Investment income:
Loss of investment income due to dividend from
SAFECO's property and casualty subsidiaries
($600.0 x 5.4%, rate based on market yields for
tax-exempt securities at September 5, 1997) . . . . $ (32.4)
Interest expense:
Retire existing American States debt ($100.0 x 7 1/8%,
$200.0 x 6.7%). . . . . . . . . . . . . . . . . . . $ 20.5
Commercial paper interest expense ($738.5 x 5.7%) . . (42.1)
Senior Notes interest expense ($200.0 x 7.1%) . . . . (14.2)
-------
Total interest expense effect . . . . . . . . . . (35.8)
-------
Record the amortization of goodwill over 30 years. . . . . (49.5)
Record amortization of unfavorable lease obligation. . . . 1.5
-------
Total pretax income effect. . . . . . . . . . . . $(116.2)
-------
-------
(g) Record income tax expense (benefit) of the pro forma
adjustments . . . . . . . . . . . . . . . . . . . . $ (26.2)
(h) Distributions on capital securities, net of tax
($1,000 x 8.25% = 82.5) x (100% - 35%). . . . . . . $ 53.6
The interest rate on the Senior Notes and the distribution rate on the
capital securities are based on effective cost, including the cost of an
interest rate lock, of the Senior Notes and $850 aggregate liquidation value of
8.072% capital securities (the "8.072% Capital Securities") issued on July 15,
1997. The Company issued $1,500 of commercial paper in late September 1997
($750 on September 26, 1997 and $750 on September 29, 1997) at interest rates
ranging from 5.65% to 5.70% and maturities ranging from October 20, 1997 to
January 29, 1998 and used all but $16 to finance the Acquisition. The
Company, through a subsidiary trust, may issue an additional $150 aggregate
liquidation amount of capital securities in 1997 to retire a like amount of
commercial paper.
(i) Reflects the issuance of shares of Common Stock at a public offering
price of $47.50 per share and gross proceeds of $617.5.
6
