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SBM CERTIFICATE COMPANY
SERIES 503 CERTIFICATES
PROSPECTUS
MAY 1, 1996
The security offered by this Prospectus is a fully paid fixed-rate face-amount
certificate, as defined by the Investment Company Act of 1940 (the "1940 Act"),
designated as an investment certificate Series 503 ("Series 503 Certificate", or
"Certificate"). The issuer of this face-amount certificate is SBM Certificate
Company (the "Company"). A fully paid fixed-rate face-amount certificate is a
security pursuant to which the issuer promises to pay the amount invested
("face-amount"), plus accrued but unpaid interest, on a fixed future date
("maturity date"), in return for the investor making a single lump sum payment
to the issuer.
The Company's Series 503 Certificates initially mature three years from the date
of issue. The Certificates provide for automatic extensions of the maturity date
for ten additional three-year periods unless you notify the Company to the
contrary.
The Company agrees to pay interest until maturity or redemption on the face-
amount invested at a minimum interest rate of 2.50% per annum. Such interest
may be compounded annually on the anniversary date of the Certificate's issuance
(the "Certificate Anniversary Date") and paid at maturity or redemption.
Alternatively, interest may be paid, at your option, yearly on the Certificate
Anniversary Date, or quarterly on a quarterly payment date based upon the date
of the Certificate's issuance (the "Certificate Issuance Date"). The Company may
determine, in advance, to pay interest at a rate in excess of the minimum
interest rate.
As of the date of this Prospectus, the Company has determined to pay interest
for each of the three Certificate years prior to the initial maturity date at
the following combined rates, instead of the lesser rate provided in the
Certificate:
If Interest is If Interest is If interest is
Paid Quarterly Paid Annually Compounded
Annually
Year 1 5.20% 5.25% 5.35%
Year 2 5.45% 5.50% 5.60%
Year 3 5.70% 5.75% 5.85%
These rates are payable for the initial three-year period only. Although the
Company intends to declare in advance additional interest rates which result in
combined interest rates above the 2.50% minimum rate for Certificate years
beyond the initial maturity date, there is no obligation to do so. See
"Description of the Certificates - Additional Interest Rates". Sales
compensation, not to exceed $30.00 per $1,000, per three-year maturity period,
will be paid to the underwriter of the Series 503 Certificates from the general
funds of the Company and will not be deducted from the amount invested.
No interest will be paid on Certificates surrendered for redemption less than
three months after the issue date. In addition, if a Certificate is redeemed
during any three-year maturity term, the interest paid or accrued will be
reduced in accordance with rates declared by the Company. If you have elected
to have interest paid quarterly or annually, the reduced interest rate may cause
the amount paid upon surrender to be less than the amount invested. A
Certificate surrendered during any three-year maturity term will receive
interest for the number of full months the Certificate was in force from the
Certificate Issuance Date (subject to the three-month limitation and interest
rate reduction referred to above) or the latest date at which interest was paid.
See "Description of the Certificates" for a complete description of the terms of
your Certificate.
PROSPECTIVE INVESTORS SHOULD CAREFULLY CONSIDER THE FACTORS SET FORTH UNDER
"RISK FACTORS."
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE COMMISSION OR
ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS
PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
INVESTORS ARE ADVISED TO RETAIN THE PROSPECTUS FOR FUTURE REFERENCE.
THESE SECURITIES ARE NOT SAVINGS ACCOUNTS, DEPOSITS OR OTHER OBLIGATIONS OF, OR
GUARANTEED OR ENDORSED BY, ANY BANK AND ARE NOT INSURED OR GUARANTEED BY THE
U.S. GOVERNMENT, THE FEDERAL DEPOSIT INSURANCE CORPORATION BANK INSURANCE FUND,
THE FEDERAL RESERVE BOARD, OR ANY GOVERNMENTAL AGENCY. AN INVESTMENT IN THESE
SECURITIES INVOLVES INVESTMENT RISK, INCLUDING THE POSSIBLE LOSS OF PRINCIPAL.
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TABLE OF CONTENTS
Page
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Available Information. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
The Company. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Risk Factors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Underwriting Agreement . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Underwriter's Compensation . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Description of the Certificates. . . . . . . . . . . . . . . . . . . . . . . . 4
Investment Amounts. . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Minimum Interest Rate . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Additional Interest Rates . . . . . . . . . . . . . . . . . . . . . . . . 4
Maturity. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Redemption. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Deferred Payment. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Method of Distribution. . . . . . . . . . . . . . . . . . . . . . . . . . 6
Federal Income Tax Treatment. . . . . . . . . . . . . . . . . . . . . . . 6
Transfer of Ownership . . . . . . . . . . . . . . . . . . . . . . . . . . 6
Reserves and Deposits with Custodian. . . . . . . . . . . . . . . . . . . 6
Certain Financial Information . . . . . . . . . . . . . . . . . . . . . . 7
Use of Proceeds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
Investment Policies . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
About the Company. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
Executive Officers and Directors of the Company. . . . . . . . . . . . . . . .10
Relationship with ARM and Affiliates . . . . . . . . . . . . . . . . . . . . .11
Experts. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .12
Selected Financial Data. . . . . . . . . . . . . . . . . . . . . . . . . . . .13
Management's Discussion and Analysis of Results of Operations and
Financial Condition. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .14
Index to Financial Statements. . . . . . . . . . . . . . . . . . . . . . . . .17
AVAILABLE INFORMATION
The Company is subject to certain of the informational requirements of the
Securities Exchange Act of 1934, as amended (the "1934 Act"). Reports and other
information on the Company are required to be filed with the Securities and
Exchange Commission ("SEC") and, when filed, are available for inspection and
copying at the public reference section of the SEC, Room 1024, 450 Fifth Street,
N.W., Washington, D.C. 20549 and also at the public reference facilities at the
SEC's regional offices located at Room 1400, 75 Park Place, New York, New York
10007, and Northwestern Atrium Center, 500 West Madison Street, Suite 1400,
Chicago, Illinois 60661. Copies of such material can be obtained at prescribed
rates by writing to the SEC, Public Reference Section, Washington, D.C. 20549.
This Prospectus does not contain all of the information set forth in the
Registration Statement and exhibits thereto (the "Registration Statement")
covering the securities offered by this Prospectus. The Company has filed such
Registration Statement with the SEC. Certain portions of such Registration
Statement have been omitted pursuant to the rules and regulations of the SEC.
Reference is made to such materials for further information with respect to the
Company and the Certificates offered by this Prospectus.
The Company is not required by applicable laws to furnish you with an annual
report. The Company will furnish an annual report, containing financial
statements that have been audited and reported upon by independent certified
public accountants, if you request a copy.
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THE COMPANY
SBM Certificate Company is a Minnesota corporation and a wholly owned subsidiary
of ARM Financial Group, Inc. ("ARM"), a financial services holding company based
in Louisville, Kentucky providing retail and institutional products and services
to the long-term savings and retirement market. The executive offices of the
Company are located at 239 S. Fifth Street, 12th Floor, Louisville, Kentucky
40202. The telephone number is (502)582-7900.
RISK FACTORS
Prospective purchasers of the Certificates should examine and carefully consider
this entire Prospectus, including the following items, for important information
concerning an investment in the Certificates.
ABSENCE OF A RATING
The Company has not applied for or received a rating for its Series 503
Certificates from any nationally recognized rating organization.
RELATIONSHIP WITH ARM
While the Company is an independent operating entity, it is also a wholly owned
subsidiary of ARM. The Company relies upon ARM and its affiliates with respect
to the provision of services which impact the management, operations,
investments, and capital of the Company. For this reason, factors affecting ARM
also may affect the Company, including ARM's operating results, consolidated
business and capital plans, and its relationship with various regulators. See
"Relationship with ARM and Affiliates".
EFFECTS OF CHANGES IN INTEREST RATES
The market value of the Company's investment portfolio, which consists primarily
of publicly traded, investment grade debt securities, is affected by economic
and market conditions and fluctuations in interest rates. Although the Company
seeks to control this interest rate risk, during periods of sharp changes in
interest rates the Company may experience unrealized losses in the value of
assets held in its investment portfolio. In such an environment, if the Company
were required to sell assets to meet liquidity needs, the Company could
recognize losses on the sale of such assets. Such losses would reduce the
overall capital resources available to the Company to provide a source of funds
for Company operations, including the making of payments on Certificates.
EARLY REDEMPTIONS OF CERTIFICATES
If a Certificate is surrendered for redemption within three months of its issue
date, no interest will be paid. In addition, if a Certificate is redeemed
during any three-year maturity term, interest on the Certificate will be paid at
a reduced rate. If you have elected to have interest paid quarterly or
annually, the reduced interest rate may cause the amount paid upon surrender to
be less than the amount invested.
ADDITIONAL INTEREST RATES
The initial rates are payable for the initial three-year period only. Although
the Company intends to declare in advance additional interest rates which result
in combined interest rates above the 2.50% minimum rate for Certificate years
beyond the initial maturity date, there is no obligation to do so.
UNDERWRITING AGREEMENT
Pursuant to an Underwriting Agreement between the Company and SBM Financial
Services, Inc. ("SBM Financial Services") (a wholly owned subsidiary of ARM
registered as a broker-dealer under the 1934 Act), dated June 14, 1995, SBM
Financial Services has the exclusive right to solicit applications for and to
distribute the Certificates. Pursuant to such agreement, SBM Financial Services
agrees to continuously solicit such applications, as long as Certificates are
available for sale. The Company reserves the right to reject any application.
SBM Financial Services has no obligation to purchase or sell any designated
dollar amount or quantity of Certificates but is only required to use its best
efforts on the Company's behalf.
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The Company's Board of Directors, including a majority of directors who are not
interested persons of SBM Financial Services or ARM, approve the Underwriting
Agreement annually. The Underwriting Agreement is terminable by either party
with sixty days' notice.
UNDERWRITER'S COMPENSATION
In accordance with the Underwriting Agreement, the Company pays SBM Financial
Services compensation which does not exceed $30.00 per $1,000 invested per
three-year maturity period. Such compensation is paid from the general funds
of the Company. SBM Financial Services pays compensation to its representatives
and pays other selling expenses in connection with the sale of Certificates.
The Company has paid SBM Financial Services $443,579, $507,995, and $377,675, in
1995, 1994, and 1993, respectively, as compensation and other issuance,
underwriting, and sales expenses.
DESCRIPTION OF THE CERTIFICATES
INVESTMENT AMOUNTS
The Series 503 Certificate may be purchased by submitting an application and a
single payment of at least (1) $1,000 if you choose to have interest paid or
compounded annually, or (2) $5,000 if you choose to have interest paid
quarterly. The amount of your payment is the face-amount of the Certificate.
MINIMUM INTEREST RATE
The Series 503 Certificate bears a minimum rate of interest of 2.50% per annum.
Interest accrues monthly and compounds annually if not paid. Interest may be
compounded annually on the Certificate Anniversary Date and paid at maturity or
redemption. Alternatively, interest may be paid at your option, annually on the
Certificate Anniversary Date, or quarterly based upon the Certificate
Anniversary Date. The election to have interest accrued or paid may not be
changed after the Certificate has been issued.
ADDITIONAL INTEREST RATES
The Certificate may earn interest at a rate in excess of the minimum rate of
2.50% per annum. From time to time, the Company may declare additional interest
rates. The sum of the additional interest rate and the minimum rate of 2.50%
make up the combined interest rate.
For new purchases of Series 503 Certificates, the Company has declared that
interest shall be payable at the combined rate set forth on the cover page of
this Prospectus (or any applicable supplement thereto) for each of the three
years of the initial term of the Certificate.
Notwithstanding the foregoing, as market conditions warrant, the Company may
from time to time change the additional interest rates to be accrued for the
Series 503 Certificates. The combined interest rates applicable to a particular
Certificate will be the rates in effect on the date the investor's application
is accepted at the Company's administrative office. The combined interest rates
may be greater or lesser than the combined interest rates shown on the cover
page of this Prospectus. However, no such change in rates will affect the
combined interest rates of any Certificate purchased prior to the effective date
of the change.
The combined interest rate in effect at the initial maturity date and each
subsequent maturity date is the basis for the interest paid on a Certificate for
any subsequent renewal periods. There is no obligation on the part of the
Company to declare and pay additional interest in years following the initial
maturity date. Therefore, the combined interest rates on a Certificate for
years beyond the initial three-year term of the Certificate may be greater or
lesser than the rate in effect for that Certificate for the first three years.
It is the Company's current policy to pay interest on renewed Certificates at a
rate based on the combined rate in effect at the initial or any subsequent
maturity date (as applicable) plus .10%. This policy is subject to change at
any time without prior notice with respect to any renewal periods applicable to
any Certificates currently outstanding or to be issued in the future.
The prevailing investment rates available on interest-bearing instruments is a
primary consideration in deciding upon the declaration of additional interest
rates. Nonetheless, irrespective of such rates, the Company has complete
discretion as to what additional interest rates, if any, shall be declared.
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MATURITY
Your Series 503 Certificate matures three years from the Certificate Issuance
Date. At maturity, you will be entitled to receive the original invested amount
if you elected to receive interest payments annually or quarterly. If you
elected to have interest compounded, you will be entitled to receive at maturity
the original invested amount plus accrued interest.
At the end of the original three-year period, the maturity date automatically
extends for an additional three-year period unless you notify the Company to the
contrary. The Company will provide you with written notice not less than
fifteen days prior to the original maturity date, and any additional maturity
date, that the maturity date of the Certificate will be automatically extended
for an additional three-year period unless you elect by written notice to the
Company not to extend such maturity date. The total number of additional three-
year periods for which your Series 503 Certificate may be extended, beyond the
original term, is ten periods, or a total of thirty additional years beyond the
original maturity date. During any such additional maturity period or periods
for which the Certificate has been extended, the Certificate shall continue to
accrue interest, interest shall be paid out or compounded, or the Certificate
may be surrendered for redemption, all in accordance with the terms provided in
the Certificate issued for the initial three-year term of the Certificate.
REDEMPTION
You may surrender your Certificate to the Company, properly endorsed, at any
time prior to maturity and be entitled to receive in cash the face amount of
your Certificate and all interest, if any, then due and unpaid except as set
forth below. You may also withdraw at any time a portion of the original amount
invested (including any accrued but unpaid interest on the withdrawn amount).
The minimum amount you may withdraw is $1,000 and the remaining balance must not
be less than $1,000 if you elected to have interest compounded to maturity or
paid annually, nor less than $5,000 if you elected to have interest paid
quarterly. You may make such a redemption with a written request to the Company
accompanied by the Certificate, properly endorsed. If your Certificate has been
lost, the Company will require you to obtain a Lost Instrument Bond at your
expense. The written redemption request should be signed by you exactly as the
Certificate is registered. For redemptions of $20,000 or more, your signature
or signatures must be guaranteed by a national securities exchange, a member
firm of a principal stock exchange, a registered securities association, a
clearing agency, a bank or trust company, a savings association, a credit union,
a broker or dealer, a municipal securities broker or dealer, a government
securities broker or dealer, or a representative of SBM Financial Services.
Further documentation may be required from corporations, executors
(executrixes), partnerships, administrators (administratrixes), trustees or
custodians. For your protection, Certificates should be sent by registered
mail.
No interest will be paid on Certificates surrendered for redemption less than
three months after the Certificate Issuance Date. In addition, if a Certificate
is redeemed during any three-year maturity term, the interest paid or accrued
will be reduced in accordance with rates declared by the Company. If you have
elected to have interest paid quarterly or annually, the reduced interest rate
may cause the amount paid upon surrender to be less than the amount invested. A
Certificate surrendered during any three-year maturity term will be entitled to
receive interest for the number of full months the Certificate was in force from
the Certificate Issuance Date (subject to the three-month limitation and
interest rate reduction referred to above) or the latest date at which interest
was paid, as applicable.
DEFERRED PAYMENT
The Company reserves the right, prior to maturity, to defer any payment for up
to thirty days. During such period, interest will accrue on the deferred amount
at not less than the minimum interest rate of 2.50%.
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METHOD OF DISTRIBUTION
The Certificates are distributed by registered representatives of SBM Financial
Services and also by registered representatives of other broker-dealers that
have selling agreements with SBM Financial Services. Pursuant to the
Underwriting Agreement between the Company and SBM Financial Services, the
Company pays sales compensation to SBM Financial Services for distribution of
the Certificates. SBM Financial Services in turn pays compensation to its
representatives and pays other distribution expenses. See "Underwriting
Agreement".
FEDERAL INCOME TAX TREATMENT
Under Internal Revenue Service rules and regulations, investors holding Series
503 Certificates realize current income for tax purposes. Under these
guidelines, interest accrued on a face-amount certificate, including additional
interest, must be reported by the Certificate holder as taxable ordinary income
each year on a current basis. These regulations require a Series 503
Certificate holder who has elected to have interest compounded annually to
recognize interest income for income tax purposes in the years in which it is
accrued despite payment of the interest to the Certificate holder in later years
under the terms of the Certificate. The Company will send you annually a report
showing the income to be reported with respect to your Certificate under these
regulations.
Pursuant to federal law, each investor must provide the Company with a correct
taxpayer identification number. Generally, this number is the investor's Social
Security or employer identification number. Failure to provide such number may
make it necessary for the Company to withhold a portion of any accrued interest.
TRANSFER OF OWNERSHIP
There is no public market for resale of the Certificates, nor is it anticipated
that one will develop in the future. Your Certificate may be assigned on the
records of the Company if you send the Certificate to the Company, properly
endorsed, along with proper transfer information concerning the person or entity
to whom the Certificate will be transferred. You should sign the written
transfer request exactly as the Certificate is registered. For transfers of
$20,000 or more, your signature or signatures must be guaranteed by a national
securities exchange, a member firm of a principal stock exchange, a registered
securities association, a clearing agency, a bank or trust company, a savings
association, a credit union, a broker or dealer, a municipal securities broker
or dealer, a government securities broker or dealer, or a representative of SBM
Financial Services. Further documentation may be required from corporations,
executors (executrixes), partnerships, administrators (administratrixes),
trustees or custodians. For your protection, Certificates should be sent by
registered mail.
RESERVES AND DEPOSITS WITH CUSTODIAN
The Company accrues liabilities ("reserves") for its Certificate obligations in
accordance with the 1940 Act. In general, reserves are established monthly in
an amount equal to the face-amount of each Certificate plus the amount of
accrued but unpaid interest on each Certificate as of that date.
The 1940 Act requires the Company to have capital stock in an amount not less
than $250,000 and to keep on deposit, with a qualified custodian, certain kinds
of investments having a value not less than $250,000 plus the amount of its
outstanding certificate reserves. For information on the value of the Company's
investments on deposit and the Company's reserves on all outstanding
certificates, see Notes 1, 3, 4, and 8 of Notes to Financial Statements.
Most of the Company's investments are on deposit pursuant to the terms of a
custody agreement with First Bank National Association, a national banking
association, located in Minneapolis, Minnesota. The Company also maintains
separate deposits as required by certain states. The custody agreement requires
the Company to maintain investments on deposit with a value (calculated in
accordance with the provisions of the 1940 Act) in excess of the Company's
reserves for outstanding certificate obligations. The Company may not withdraw
from the custodian's possession any specific investments unless the Company
deposits in their place investment(s) with an equivalent or higher value, or the
remaining investments on deposit have a value in excess of the Company's
required certificate reserves. If the Company fails to make any payment
required by the terms of any certificate, the custodian is required, upon the
request of a Certificate holder pursuant to custody agreement, to pay such
obligation from the investments the custodian holds.
CERTAIN FINANCIAL INFORMATION
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For information regarding the amounts of revenue, results of operations and
assets attributable to the Company's face-amount certificate business and
significant events relating to the Company's business, see "Selected Financial
Data", and "Management's Discussion and Analysis of Results of Operations and
Financial Condition".
USE OF PROCEEDS
The Certificates are issued and guaranteed by the Company, a wholly owned
subsidiary of ARM. The Company backs the Certificates by investing the money
received and keeping the invested assets on deposit. The Company's investments
are varied and of generally high quality. The composition and quality of the
Company's investments is subject to change from time to time at the Company's
sole discretion. At December 31, 1995, such composition was:
Cash and cash equivalents 6.5%
Fixed maturities:
U.S. Treasury securities and
obligations of U.S. government agencies 10.6
Corporate securities 8.3
Collateralized mortgage obligations 47.6
Other mortgage-backed securities 22.8
Other fixed maturities 1.8
Other investments 2.4
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Total 100.0%
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More than 98% of our fixed maturities portfolio is rated investment grade as of
December 31, 1995. Investment grade securities are those classified as 1 or 2
by the National Association of Insurance Commissioners, or where such
classifications are not available, having a rating on the scale used by Standard
& Poor's Corporation of BBB- or above.
INVESTMENT POLICIES
Investment decisions relating to the Company's investment portfolio are made by
the Company's Chief Investment Officer (the "CIO"). The Board of Directors
regularly reviews the decisions of the CIO. The CIO, in accordance with the
investment policies of the Company, uses his best judgment in deciding the
amount and type of investments to be purchased and sold subject to certain
limitations on investments prescribed by the 1940 Act. Section 28 of the 1940
Act requires the Company to deposit only "qualified investments". Qualified
investments are defined as those investments which life insurance companies are
permitted to invest in or hold under the provisions of the Insurance Code of the
District of Columbia.
The following policies currently govern the Company's investment decisions, but
may be changed by the Board of Directors without shareholder or Certificate
holder approval. The Company will not purchase any securities on margin or
participate on a joint or joint and several basis in any trading account in
securities. It will not effect the short sale of any security. The Company has
the authority to borrow money and may borrow in the future if management feels
it is necessary or desirable in conducting its business in the most advantageous
manner. It may do this either for temporary or extended purposes and may pledge
some of its assets as security. The Company does not generally deal in real
estate, but reserves freedom of action to do so if such arrangement would
provide a desirable investment or a source of mortgage loans. The Company does
not intend to engage in the purchase and sale of commodities or commodity
contracts. Also, the Company does not at present intend to act as underwriter
of securities issued by other persons. It may make real estate loans of various
types and may make other kinds of loans should such form of investment appear to
be desirable in the future. It is not restricted by its Articles of
Incorporation or By-Laws as to the concentration of its investments in any
particular industry or group of industries. Subject to the basic restriction of
investment in qualified investments, the Company reserves freedom of action with
regard to portfolio turnover.
In past years, the Company made mortgage loans, principally consisting of
commercial real estate mortgage loans. The current policy of the Company is not
to make any new mortgage loans, though the Company may make new loans in
connection with the disposition of its properties and may restructure existing
mortgage loans.
ABOUT THE COMPANY
HISTORY
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The Company was incorporated in Minnesota on June 18, 1990, to assume the face-
amount certificate business of SBM Company ("SBM"). The Company became a wholly
owned subsidiary of ARM pursuant to ARM's purchase of substantially all of the
assets of SBM (the "Acquisition") in June 1995. SBM had issued various series
of face-amount certificates of the fully paid and installment type since 1914.
The Company was registered as an investment company under the 1940 Act and
assumed the obligations of SBM's outstanding face-amount certificates in January
1991. SBM owned the Company directly until December 31, 1993, at which time SBM
transferred all of the shares of the Company to its subsidiary State Bond and
Mortgage Life Insurance Company ("SBM Life"). Following the Acquisition, all of
the shares of the Company were transferred from SBM Life to ARM.
BUSINESS
The Company's sole business is issuing fixed-rate face-amount certificates
registered under the 1940 Act. A face-amount certificate is an obligation of
the Company requiring the Company to pay a certain amount, plus a specified
return, to an investor at a given maturity date, or lesser amounts if the
Certificate is redeemed prior to maturity. The Company is currently offering
one series of single-payment investment certificates. The Company's face-amount
certificate operations include issuance of single-payment certificates and the
servicing of outstanding single-payment and installment certificates, the
investment of related funds, and other related service activities. The
Company's face-amount certificates are sold primarily in Minnesota, Iowa,
California, South Dakota, Wisconsin and Illinois.
The Company's face-amount certificates are distributed exclusively by SBM
Financial Services, a wholly-owned subsidiary of ARM, pursuant to an
Underwriting Agreement. See "Underwriting Agreement". SBM Financial Services
is registered with the SEC as a broker-dealer under the provisions of the 1934
Act. In addition, ARM provides investment management services to the Company
pursuant to an Investment Services Agreement. Such services are provided in
part through ARM's wholly-owned subsidiary ARM Capital Advisors, Inc. ("ARM
Capital Advisors"). See "Relationship with ARM and Affiliates". ARM Capital
Advisors is registered with the SEC as an investment adviser under the
provisions of the Investment Advisers Act of 1940.
The Company's gross margin is derived primarily from the margin between earnings
on investments and amounts paid or credited on its fixed rate Certificate
deposits ("investment spread"). The Company's net income is determined by
deducting investment expenses and federal income taxes. The investment spread
is affected principally by general economic conditions, government monetary
policy, the policies of regulatory authorities that influence market interest
rates, and the Company's ability to respond to changes in such rates. Changes
in market interest rates may have a negative impact on the Company's earnings.
See "Management's Discussion and Analysis of Results of Operations and Financial
Condition" and "Risk Factors".
The Company has no foreign sales.
COMPETITION
The Company's face-amount certificate business competes in general with various
types of individual savings products which offer a fixed rate of return on
investors' money, especially insurance and bank and thrift products. Some of
these other products are insured by governmental agencies or funds or private
third parties (e.g., banks and thrifts typically have federal deposit insurance
covering monies deposited with them). The Certificates offered by this
Prospectus are not guaranteed or insured by any governmental agency or fund or
independent third party. The Company's ability to offer competitive interest
rates, attractive terms, and efficient service are the Company's primary basis
for meeting competition. The Company's main competitor is IDS Certificate
Company.
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EMPLOYEES
The Company currently has no employees. Investment, administrative, and
distribution services are provided pursuant to an Investment Services
Agreement, an Administrative Services Agreement, and an Underwriting Agreement,
all of which are dated as of June 14, 1995. See "Underwriting Agreement" and
"Relationship with ARM and Affiliates".
CAPITAL STRUCTURE
The Company has 1,000,000 shares of authorized common stock, $1.00 par value, of
which 250,000 shares are currently issued and outstanding. ARM owns all of the
Company's issued and outstanding shares. All such shares are currently pledged
pursuant to a credit agreement among ARM and certain lenders to secure a bank
loan made to ARM.
REGULATION
Like many financial service companies which offer investment opportunities to
the public, the Company is subject to regulation and supervision by federal and
state regulators. The 1940 Act and rules issued by the SEC thereunder specify
certain terms for face-amount certificates, the method for calculating reserve
liabilities on outstanding certificates, the minimum amounts and types of
investments to be deposited with a qualified custodian to support such reserve
liabilities (see "Description of the Certificates - Reserves/Deposits with
Custodian" and Note 3 of Notes to Financial Statements), and a variety of other
restrictions on the operation and governance of a face-amount certificate
company. Pursuant to statutory authority, the Minnesota Department of Commerce
and the Illinois Secretary of State exercise supervisory powers over the
Company's face-amount certificate business similar to those under the 1940 Act.
In addition, the Minnesota Department of Commerce conducts examinations of the
Company on a periodic basis. The offer and sale of Series 503 Certificates also
are subject to federal and state securities laws.
The Company is not a bank, broker-dealer or insurance company. THE CERTIFICATES
ARE NOT BANK PRODUCTS, EQUITY INVESTMENTS, ANNUITIES OR LIFE INSURANCE, AND ARE
NOT GUARANTEED OR INSURED BY ANY GOVERNMENTAL AGENCY OR FUND OR PRIVATE THIRD
PARTY.
DESCRIPTION OF PROPERTY
The Company's and ARM's corporate executive offices (the "Corporate Offices")
are located at 239 S. Fifth Street, 12th Floor, Louisville, Kentucky. The main
telephone number for the Corporate Offices is (502) 582-7900. The Corporate
Offices are the primary location for ARM's and the Company's investment
accounting, corporate accounting, legal and marketing activities and various
support personnel. These offices contain approximately 18,900 square feet of
office space held pursuant to a lease between ARM and the lessor that runs
through April 30, 1998, and approximately 7048 square feet of office space
leased on a month to month basis.
The Company's administrative offices are located in New Ulm, Minnesota, at 100
North Minnesota Street. The building is owned by the Company. The building
has a total office space of approximately 49,000 square feet, was built in 1936
and was remodeled extensively in 1972, 1974, and 1986. A significant portion of
the building (approximately 15,000 square feet) is leased exclusively to State
Bank & Trust Company of New Ulm, a former subsidiary of SBM. Parts of the
building are leased to other persons.
LEGAL PROCEEDINGS
The Company is not a party to, nor is any of the Company's property the subject
of, any material pending legal proceedings, other than ordinary litigation
routine to the Company's business.
9
<PAGE>
EXECUTIVE OFFICERS AND DIRECTORS OF THE COMPANY
EXECUTIVE OFFICERS AND DIRECTORS
The Company's directors and executive officers are as follows:
Steven B. Bing, age 49 - Director of the Company since January 1996. Mr Bing is
currently employed by R. Gene Smith, Inc., a private investment and venture
firm. In that capacity he reviews business opportunities and manages certain
operating companies funded by the Smith group. Previously, he served
approximately eight years as an officer (including President) of ICH
Corporation, a public holding company that owned and operated life and health
insurance companies.
John R. McGeeney, age 39 - Director and Chairman of the Board of the Company
since January 1996; President of the Company since June 1995. Mr. McGeeney is
Co-General Counsel of ARM and holds various offices with other subsidiaries of
ARM. Prior to joining ARM in October 1993, from February 1988 to October 1993,
he served successively as Attorney, Counsel and Assistant General Counsel for
the Accumulation and Investment Group of Providian Corporation. From 1986 to
1988, he was an associate with the law firm of Middleton & Reutlinger.
Theodore S. Rosky, age 59 - Director of the Company since January 1996. Mr.
Rosky retired as Executive Vice President & Chief Financial Officer of Providian
Corporation in April 1992, and he has served on several corporate boards of
directors including insurance company and mutual fund boards.
Martin Snyder, age 48 - Director of the Company since January 1996. Mr. Snyder
is currently President of Ohio Valley International, specializing in
international trade and business law. Previously, he served as Chief Executive
Officer of Taustine, Post, Sotsky, Berman, Fineman & Kohn from 1972 to 1993.
Dennis L. Carr, FSA, MAAA, age 46 - Executive Vice President--Chief Product
Development Officer and Actuary. Mr. Carr is an Executive Vice President and
the Actuary of ARM and holds various offices with other subsidiaries of ARM.
Prior to joining ARM, from July 1988 to September 1993, he was Director of
Product Development for the Accumulation and Investment Group of Providian
Corporation. From July 1983 to July 1988, Mr. Carr was a consulting actuary for
Tillinghast, being named a principal of that firm in 1987.
David E. Ferguson, age 48 - Executive Vice President--Chief Administrative
Officer. Mr. Ferguson is an Executive Vice President of ARM and holds various
offices with other subsidiaries of ARM. Mr. Ferguson has been associated with
ARM and its predecessors since March 1992. Prior to joining ARM, from 1990 to
March 1992, he was the President and Chief Executive Officer of the James Graham
Brown Foundation, Inc., a private philanthropy in Louisville, Kentucky. From
1984 to 1990, Mr. Ferguson was a partner at Ernst & Young LLP and National
Director of their Insurance Industry Consulting group.
Edward L. Zeman, age 41 - Executive Vice President--Chief Financial Officer.
Mr. Zeman is an Executive Vice President and the Chief Financial Officer of ARM
and holds various offices with other subsidiaries of ARM. Prior to joining ARM
in September 1995, he was Vice President, Chief Operating Officer, Chief
Financial Officer and Treasurer of SBM. From 1977 through 1990, Mr. Zeman
served as a Senior Manager for Deloitte & Touche LLP. Mr. Zeman currently also
serves on the Board of Directors of Dotronix, Inc.
Emad A. Zikry, MA, PhD, age 47 - Executive Vice President--Chief Investment
Officer. Mr. Zikry is an Executive Vice President of ARM and is a Director and
President of ARM Capital Advisors, Inc., a registered investment adviser. Prior
to joining ARM, Mr. Zikry was President and Chief Investment Officer of
Kleinwort Benson Investment Management Americas Inc. From 1987 to 1992, he
served as Managing Director and Head of Fixed Income and Quantitative Services
at Mitchell Hutchins Institutional Investors, Inc. Prior to that time, he was a
director at Bankers Trust New York Corporation.
Peter S. Resnik, CFA, CPA, age 35 - Treasurer. Mr. Resnik is the Treasurer of
ARM and also holds this office for other ARM subsidiaries. Mr. Resnik has been
associated with ARM and its predecessors since July 1992. Prior to joining ARM,
from 1986 through July 1992, he served as Assistant Vice President of
Commonwealth Insurance, a subsidiary of Providian Corporation in various
management positions, the last of which was Director of Planning and Budgets in
the Agency Group Division.
10
<PAGE>
Barry G. Ward, CPA, age 34 - Controller. Mr. Ward is the Controller of ARM and
also holds this office for other ARM subsidiaries. Prior to joining ARM, from
January 1989 to October 1993, he served in various positions within Ernst &
Young LLP's Insurance Industry Accounting and Auditing Practice, the last of
which was Manager.
Kevin L. Howard, age 31 - Secretary. Mr. Howard is Assistant General Counsel of
ARM and holds various offices with other subsidiaries of ARM. Prior to joining
ARM in 1994, from April 1992 to January 1994, he was Assistant General Counsel
for Providian Corporation, practicing primarily in the areas of securities and
real estate law. From 1989 to 1992, he was an associate with the law firm of
Greenebaum Doll & McDonald.
Rose M. Culbertson, CPA, age 40 - Tax Officer. Ms. Culbertson is the Tax
Officer of ARM and also holds this office for other ARM subsidiaries. Prior to
joining ARM in 1994, she was a Tax Manager with Coopers & Lybrand. From mid
1986 to 1990, she served in various positions with Providian Corporation, the
last of which was Manager of Tax Compliance.
LIMITATION OF LIABILITY AND INDEMNIFICATION
Pursuant to the Company's Articles of Incorporation, the liability of the
Company's directors to the Company and its stockholders is eliminated to the
fullest extent permitted by Minnesota law, as it exists or may be amended from
time to time, except as prohibited by the 1940 Act. Under Minnesota law, a
director's personal liability to a corporation or its stockholders for monetary
damages for breach of fiduciary duty as a director may be eliminated if provided
by the Articles of Incorporation, except liability resulting from a breach of
the duty of loyalty to the corporation or its stockholders, liability for an act
or omission not in good faith, involving intentional misconduct or a knowing
violation of law, liability for illegal distributions or liability for any
transaction undertaken for improper personal benefit. The 1940 Act prohibits a
company from indemnifying or by any other means limiting a director's liability
resulting from willful misfeasance, bad faith, gross negligence or reckless
disregard of his or her duties. In accordance with Minnesota law, the By-Laws
of the Company provide, as modified by certain limitations specified by the SEC
under the 1940 Act, for the indemnification of an officer or director of the
Company against judgments, penalties, fines, settlements, and expenses incurred
as a result of being made a party to a proceeding by reason of his or her
official capacity with the Company.
Insofar as indemnification for liabilities arising under the Securities Act of
1933 (the "1933 Act") may be permitted to directors, officers or persons
controlling the Company pursuant to the foregoing provisions, the Company has
been informed that in the opinion of the SEC such indemnification is against
public policy as expressed in the 1933 Act and is therefore unenforceable.
RELATIONSHIP WITH ARM AND AFFILIATES
Pursuant to an Investment Services Agreement and an Administrative Services
Agreement entered into in June 1995 between the Company and ARM, the Company
reimburses ARM for investment management services (provided in part through ARM
Capital Advisors) as well as administrative services. ARM's charges are based
upon .20% of invested assets annually for investment management services and
.25% of total certificate reserves annually for administrative services, but may
be reduced by agreement of the parties.
Prior to the Acquisition, the Company reimbursed the costs incurred by SBM for
management services provided to the Company pursuant to a management agreement
between such parties then in effect by payment of a management fee. Such fee
equaled the costs incurred by SBM in its performance of management services for
the Company in accordance with such management agreement.
Pursuant to a Tax Allocation Agreement for taxable periods beginning January 1,
1995, the Company has agreed to reimburse ARM for any tax benefits arising from
the inclusion of the Company's separate company taxable income in ARM's
consolidated income tax returns (e.g., the potential tax benefit which may arise
if consolidated net operating losses were used to offset a portion of the
Company's income tax liability).
The Underwriting Agreement between the Company and SBM Financial Services, a
wholly owned subsidiary of ARM and a registered broker-dealer, is described
under the section entitled "Underwriting Agreement".
Prior to the Acquisition, in accordance with an underwriting agreement then in
effect between the Company and SBM, the Company paid SBM Financial Services a
sales commission not to exceed $30.00 per $1,000 invested per three-year
Certificate maturity period.
11
<PAGE>
For the period from June 14, 1995, through December 31, 1995, the Company paid
ARM $84,986 for investment management services and $66,993 for administrative
services. During such period, in the ordinary course of business, the Company
sold $4,001,345 of Federal National Mortgage Association ("FNMA") bonds to
Morgan Stanley & Co. Incorporated ("MSCI") in accordance with the Company's
investment objectives. The sales were arms-length transactions made on the open
market at prevailing market prices pursuant to a competitive bidding process and
resulted in a net profit to the Company. MSCI is registered as a broker-dealer
under the 1934 Act and is a subsidiary of Morgan Stanley Group Inc. which holds
a less than 10% beneficial interest in the voting securities of ARM. In
addition, during such period, the Company sold fixed-income instruments held in
its investment portfolio in the amount of $7,337,632 to Integrity Life Insurance
Company ("Integrity"), an ARM subsidiary, at open-market prices, and purchased
fixed-income instruments in the amount of $7,418,338 from Integrity at open-
market prices. The purpose of such purchases and sales was to diversify the
Company's investment portfolio in accordance with its investment policies.
EXPERTS
Ernst & Young LLP is the Company's independent auditors. Ernst & Young LLP, on
an annual basis, will audit certain financial statements prepared by management
and express an opinion on such financial statements based on their audits.
The financial statements and schedules included herein for the year ended
December 31, 1995, have been audited by Ernst & Young LLP as stated in their
reports appearing herein and have been included in reliance upon such reports
given their authority as experts in auditing and accounting.
The financial statements and schedules of the Company for the years ended
December 31, 1994 and 1993, have been audited by Deloitte & Touche LLP,
independent auditors, as stated in their reports included herein or incorporated
by reference in the Company's Registration Statement, and have been so included
or incorporated by reference in reliance upon such reports given their authority
as experts in auditing and accounting.
12
<PAGE>
SELECTED FINANCIAL DATA
The following selected financial data for the years ended December 31, 1995,
1994, 1993, 1992, and 1991 has been derived from the audited financial
statements and should be read in conjunction with those statements and the
related notes to the financial statements. The historical financial statements
of the Company may not necessarily reflect the results of operations or
financial position that would have been obtained had the Company been a
separate, independent company. See Note 1 of Notes to Financial Statements.
Also see "Management's Discussion and Analysis of Results of Operations and
Financial Condition" for additional comments.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
----------------------------------------------------------
(IN THOUSANDS, EXCEPT PER SHARE DATA) 1995* 1994 1993 1992 1991
- -------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA
Total investment income $ 4,889 $ 5,326 $ 5,439 $ 5,492 $ 5,837
Total investment expenses 958 1,225 1,289 1,161 1,215
Provision for certificate reserves 2,929 3,575 4,090 4,532 5,343
Net investment income (loss) 595 363 103 (64) (398)
Net realized investment gains losses 181 20 (2) (21) 340
Net income (loss) 777 383 101 13 (58)
Net earnings (loss) per share ** 3.11 1.53 0.40 0.05 (0.23)
BALANCE SHEET DATA (END OF PERIOD)
Total assets $ 60,580 $ 60,609 $ 71,021 $ 70,400 $ 69,364
Face-amount certificate reserves 52,460 60,355 67,029 66,550 67,159
Shareholder's equity 4,986 187 3,881 3,732 1,840
</TABLE>
* The Company was acquired by ARM effective as of May 31, 1995. The results
of operations for 1995 represent the historical results of the Company for the
period from January 1, 1995 to May 31, 1995 combined with the results of
operations of the Company subsequent to the acquisition from June 1, 1995 to
December 31, 1995. The operating results subsequent to the acquisition include
the effect of new accounting values assigned to invested assets and intangibles
and differences in management and investment advisory fees charged by ARM and
SBM.
** Earnings (loss) per share based on 250,000 shares issued and outstanding
13
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
GENERAL
The Company was acquired by ARM effective May 31, 1995. The results of
operations for 1995 represent the historical results of the Company for the
period from January 1, 1995 to May 31, 1995 combined with the results of
operations of the Company subsequent to the Acquisition from June 1, 1995 to
December 31, 1995. The operating results subsequent to the acquisition include
the effect of new accounting values assigned to invested assets and intangibles
and differences in management and investment advisory fees charged by ARM and
SBM.
RESULTS OF OPERATIONS
The Company's results of operations are derived primarily from the margin
between earnings on investments and amounts paid or credited on its fixed-rate
certificate deposits ("investment spread").
1995 COMPARED WITH 1994
Net investment income for 1995 was $595,354 compared to $363,420 for 1994.
The increase in net investment income is primarily due to a higher investment
spread and lower investment expenses (principally as a result of lower
management fees and lower amortization of deferred charges since the
Acquisition). Investment spread increased to $2.0 million in 1995 from $1.8
million in 1994. These amounts represent the difference between the Company's
investment yield on average cash and investments and average rate credited on
certificate deposits of 2.97% and 2.10% for 1995 and 1994, respectively.
The investment yields on average cash and investments for 1995 and 1994
were 8.21% and 7.63%, respectively. This increase is primarily attributable to
higher yields attained as a result of a restructuring of the investment
portfolio subsequent to the Acquisition, as well as accretion resulting from
purchase accounting adjustments.
The average rates of interest credited on certificate deposits for 1995 and
1994 were 5.24% and 5.53%, respectively. This decrease is a result of new and
renewal certificates issued during 1995 accumulating interest at rates lower
than those credited during 1994. The Company monitors new interest credited
rates against competitive products, mainly bank certificates of deposit.
Interest credited rate adjustments (up or down) on new certificates are made as
the Company deems necessary.
Certificate reserves decreased 13.1% during 1995, as maturities and
surrenders have exceeded sales and renewals. The Company believes a significant
factor leading to the decrease is the certificate of deposit marketplace
currently being very competitive, as many financial institutions are offering
special high rates to induce customers to open new accounts. For certificates
reaching their maturity date during 1995, 72% were renewed.
Realized investment gains were $283,885 and $29,783 for the years ended
December 31, 1995 and 1994, respectively. These realized investment gains were
interest-rate related and primarily attributable to the on-going management of
the Company's fixed maturity securities classified as available-for-sale which
can result in period-to-period swings in realized investment gains and losses
since securities are sold during rising and falling interest rate environments.
1994 COMPARED WITH 1993
Net investment income for 1994 was $363,420 compared to $103,382 for the
same period in 1993. The increase in net investment income is primarily due to
a higher investment spread and lower investment expenses. Investment spread was
$1.8 million in 1994 compared to $1.3 million in 1993. These amounts represent
the difference between the Company's investment yield on average cash and
investments and average rate credited on certificate deposits of 2.10% and 1.42%
for 1994 and 1993, respectively.
The investment yields on average cash and investments for 1994 and 1993
were 7.63% and 7.52%, respectively. The average rates of interest credited on
certificate deposits for 1994 and 1993 were 5.53% and 6.10%,
14
<PAGE>
respectively. The decrease in credited rates is a result of new and renewal
certificates issued during 1994 accumulating interest at rates lower than those
credited during 1993.
Certificate reserves decreased 10.0% during 1994. The Company believes the
decrease was mainly the result of the certificate of deposit marketplace being
very competitive, as many financial institutions were offering special high
rates to induce customers to open new accounts. For certificates reaching their
maturity date during 1994, 66% were renewed.
ASSET PORTFOLIO REVIEW
The Company primarily invests in securities with fixed maturities with the
objective of providing reasonable returns while limiting liquidity and credit
risks. On an amortized cost basis, the Company's investments in fixed
maturities were 98% and 100% investment grade as of December 31, 1995 and 1994,
respectively. Investment grade securities are those classified as 1 or 2 by the
National Association of Insurance Commissioners, or where such classifications
are not available, having a rating on the scale used by Standard & Poor's
Corporation of BBB- or above. Additionally, the Company's investment portfolio
has minimal exposure to real estate, mortgage loans and common equity
securities, which represent 1.1% of the amortized cost of qualified assets at
December 31, 1995. As of December 31, 1995, the book value of securities in the
Company's investment portfolios which had defaulted on principal or interest
payments was zero. The Company attempts to minimize the risks associated with
the non-investment grade securities in its portfolio by limiting the exposure to
any one issuer and by closely monitoring the creditworthiness of such issuers.
To improve its investment spreads, the Company added U.S. Government agency
collateralized mortgage obligations ("CMOs") to its investment portfolio in 1993
and early 1994. The Company has been able to achieve higher yields with these
securities without assuming additional credit risk as the CMOs are primarily
backed by U.S. Government and U.S. Government agencies. All mortgage-backed
securities (including CMOs) are subject to the risk that a changing interest
rate environment might cause prepayment of the underlying obligations at speeds
slower or faster than anticipated at the time of their purchase; however, the
prepayment risk associated with individual CMO structures may vary
significantly. Since the Acquisition in June 1995, an initial restructuring of
the investment portfolio was performed to better match the duration of the
investment portfolio and related certificate deposits and improve investment
yields. In addition, the Company repositioned its mix of CMO holdings to reduce
positions in more volatile or highly leveraged securities in favor of the more
stable CMO tranches. On an amortized cost basis, CMOs represented 46.6% and
49.7% of the Company's qualified assets as of December 31, 1995 and 1994,
respectively.
In December 1995, the Company sold virtually all of its mortgage loan
portfolio resulting in a loss of approximately $65,000.
Based on the provisions of Statement of Financial Accounting Standards
("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity
Securities," adopted as of January 1, 1994, the Company currently classifies its
fixed maturity and equity securities as "available-for-sale." Such securities
are carried at fair value and changes in fair value, net of related deferred
income taxes, are charged or credited directly to shareholder's equity. The
decrease in interest rates since the Acquisition, at which time the Company's
invested assets were restated to fair value in accordance with purchase
accounting rules, has resulted in unrealized gains of $885,878 (net of $477,011
in deferred income taxes) as of December 31, 1995. Volatility in reported
shareholder's equity occurs as a result of SFAS No. 115 which requires some
assets (including all securities held) to be carried at fair value while other
assets are carried at historical cost and all liabilities are carried at
historical values.
The Company manages assets and liabilities in a closely integrated manner to
minimize the volatility of margins. As a result, adjusting the shareholder's
equity for changes in the fair value of the Company's fixed maturities and
equity securities without reflecting offsetting changes in the value of the
Company's liabilities or other assets creates volatility in reported
shareholder's equity but does not reflect the underlying economics of the
Company's business.
LIQUIDITY AND FINANCIAL RESOURCES
The Company has never paid cash dividends on its common stock in order to
maintain and increase capital resources. The Company will, however, evaluate
this on an ongoing basis.
15
<PAGE>
As of December 31, 1995, the Company had $6.2 million in capital in excess
of the minimum amount required by the 1940 Act and the rules and regulations
promulgated thereunder by the SEC, as computed in accordance with Section 28(b)
of the 1940 Act. In addition, the MDC has certain regulatory authority over the
Company. The MDC has historically recommended to the Company that face-amount
certificate companies should maintain a ratio of shareholder's equity to total
assets of a minimum of 5% based upon a valuation of available-for-sale
securities reflected at amortized cost for purposes of this calculation. Under
this formula, the Company's capital ratio was 6.9% at December 31, 1995. In
November 1994, based on the decline in the value of the Company's investment
portfolio, resulting from increasing interest rates in 1994, and the Company's
decreasing liquidity resulting from reduced principal payments on the Company's
CMO portfolio, the MDC recommended that the Company increase its capital level.
The MDC's concern was influenced by the Company's capital ratio, calculated
including the effects of unrealized investment losses. Therefore, on March 29,
1995, SBM Life, the former parent company of the Company, made a $1.5 million
capital contribution to the Company.
The primary liquidity requirement of the Company relates to its payment of
certificate maturities and surrenders. The principal sources of cash to meet
such liquidity requirements are investment income and proceeds from maturities
and redemptions of investments.
At December 31, 1995, cash and cash equivalents totalled $3.9 million, an
increase of $2.4 million from December 31, 1994. The Company's aim is to manage
its cash and cash equivalents position so as to satisfy short-term liquidity
needs. In connection with this management of cash and cash equivalents, the
Company may invest idle cash in short duration fixed maturities to capture
additional yield when short-term liquidity requirements permit.
Cash flows of $4.1 million, $4.2 million, and $4.3 million were generated
from operating activities in 1995, 1994, and 1993, respectively. These cash
flows resulted principally from investment income, less management and
investment advisory fees and commissions paid. Proceeds from sales, redemptions
and maturities of investments generated $51.8 million, $10.6 million, and $35.1
million in cash flows during 1995, 1994, and 1993, respectively, which were
offset by purchases of investments of $44.2 million, $5.1 million, and $37.4
million, respectively. The higher purchases and sales of investments during
1995 were a result of the initial restructuring of the Company's investment
portfolio following the Acquisition.
16
<PAGE>
INDEX TO FINANCIAL STATEMENTS
Page
----
Reports of Independent Auditors. . . . . . . . . . . . . . . . . . . . . . . .17
Balance Sheets as of December 31, 1995 and 1994. . . . . . . . . . . . . . . .19
Statements of Income for the years ended December 31, 1995, 1994, and 1993 . .21
Statements of Shareholder's Equity for the years ended December 31,
1995, 1994 and 1993. . . . . . . . . . . . . . . . . . . . . . . . . . . . .22
Statements of Cash Flows for the years ended December 31, 1995, 1994,
and 1993 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .23
Notes to Financial Statements. . . . . . . . . . . . . . . . . . . . . . . . .24
17
<PAGE>
REPORT OF INDEPENDENT AUDITORS
Board of Directors
SBM Certificate Company
We have audited the balance sheet of SBM Certificate Company as of December 31,
1995, and the related statements of income, shareholder's equity, and cash flows
for the year then ended. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audit.
We conducted our audit 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 audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of SBM Certificate Company at
December 31, 1995, and the results of its operations and its cash flows for the
year then ended in conformity with generally accepted accounting principles.
/s/ Ernst & Young LLP
Louisville, Kentucky
February 22, 1996
18
<PAGE>
INDEPENDENT AUDITORS' REPORT
Board of Directors
SBM Certificate Company
We have audited the balance sheet of SBM Certificate Company (the "Company") as
of December 31, 1994 and the related statements of income and of cash flows for
each of the two years in the period ended December 31, 1994. These financial
statements 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 duties 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, such financial statements present fairly, in all material
respects, the financial position of SBM Certificate Company as of December 31,
1994 and the results of its operations and its cash flows for each of the two
years in the period ended December 31, 1994 in conformity with generally
accepted accounting principles.
The financial statements have been prepared on a historical basis and do not
include any purchase accounting or other adjustments resulting from the sale of
the Company as discussed in Note 2 to the financial statements.
As discussed in Note 1 to the financial statements, in 1994 the Company adopted
Statement of Financial Accounting Standards No. 115, ACCOUNTING FOR CERTAIN
INVESTMENTS IN DEBT AND EQUITY SECURITIES.
/s/ Deloitte & Touche LLP
Minneapolis, Minnesota
March 29, 1995
19
<PAGE>
SBM CERTIFICATE COMPANY
BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1995 1994
- ----------------------------------------------------------------------------------------------- ---------------
<S> <C> <C>
ASSETS
Qualified assets:
Cash and investments:
Investments in securities of unaffiliated issuers:
Fixed maturities available-for-sale, at fair value (amortized
cost: 1995-$53,166,600; 1994-$42,296,611) $ 54,486,378 $ 37,349,231
Fixed maturities held-to-maturity, at amortized cost (fair
value: 1994-$11,913,328) -- 13,944,234
Equity securities, at fair value (cost: 1995-$479,817;
1994-$803,914) 522,928 475,587
Mortgage loans on real estate 13,391 4,271,255
Certificate loans 279,463 338,879
Other invested assets 618,763 1,110,921
Cash and cash equivalents 3,900,494 1,530,899
-------------- --------------
Total cash and investments 59,821,417 59,021,006
Receivables:
Dividends and interest 397,898 432,469
-------------- --------------
Total qualified assets 60,219,315 59,453,475
Deferred acquisition costs 113,500 309,587
Goodwill 192,919 --
Deferred federal income taxes -- 845,629
Other assets 54,203 239
-------------- --------------
Total assets $ 60,579,937 $ 60,608,930
-------------- --------------
-------------- --------------
</TABLE>
SEE ACCOMPANYING NOTES.
20
<PAGE>
SBM CERTIFICATE COMPANY
BALANCE SHEETS (CONTINUED)
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1995 1994
- ------------------------------------------------------------------------------------------------------
<S> <C> <C>
LIABILITIES AND SHAREHOLDER'S EQUITY
Liabilities:
Certificate reserves:
Fully-paid certificates $ 51,329,262 $ 58,990,855
Installment certificates 1,130,462 1,364,160
---------------- -----------------
Total certificate reserves 52,459,724 60,355,015
Payable for investment securities purchased 2,454,325 --
Deferred federal income taxes 619,148 --
Accounts payable and other liabilities 60,582 66,992
---------------- -----------------
Total liabilities 55,593,779 60,422,007
Shareholder's equity:
Common stock, $1 par value; 1,000,000 shares authorized;
250,000 shares issued and outstanding 250,000 250,000
Additional paid-in capital 3,050,000 3,740,006
Net unrealized gains (losses) on available-for-sale securities 885,878 (4,242,659)
Retained earnings 800,280 439,576
---------------- -----------------
Total shareholder's equity 4,986,158 186,923
---------------- -----------------
Total liabilities and shareholder's equity $ 60,579,937 $ 60,608,930
---------------- -----------------
---------------- -----------------
</TABLE>
SEE ACCOMPANYING NOTES.
21
<PAGE>
SBM CERTIFICATE COMPANY
STATEMENTS OF INCOME
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
---------------------------------------------------
1995 1994 1993
- -------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Investment income:
Interest income from securities $ 4,276,460 $ 4,590,206 $ 4,303,521
Interest income from mortgage loans 366,321 439,709 726,717
Other investment income 246,597 296,010 408,262
---------------------------------------------------
Total investment income 4,889,378 5,325,925 5,438,500
Investment and other expenses:
Management and investment advisory fees 358,486 516,000 490,800
Deferred acquisition cost amortization and
renewal commissions 289,875 518,782 501,377
Real estate expenses 137,777 112,772 152,070
Amortization of goodwill 92,248 -- --
Loan and real estate loss provision -- -- 55,000
Other expenses 79,207 77,876 89,966
---------------------------------------------------
Total investment and other expenses 957,593 1,225,430 1,289,213
Provision for certificate reserves 2,929,357 3,575,075 4,089,905
---------------------------------------------------
Net investment income before federal
income taxes 1,002,428 525,420 59,382
Federal income tax benefit (expense) (407,074) (162,000) 44,000
---------------------------------------------------
Net investment income 595,354 363,420 103,382
Realized investment gains (losses) 283,885 29,783 (3,173)
Federal income tax benefit (expense) on
realized investment gains and losses (102,500) (10,000) 1,000
---------------------------------------------------
Net realized investment gains (losses) 181,385 19,783 (2,173)
---------------------------------------------------
Net income $ 776,739 $ 383,203 $ 101,209
---------------------------------------------------
---------------------------------------------------
</TABLE>
SEE ACCOMPANYING NOTES.
22
<PAGE>
SBM CERTIFICATE COMPANY
STATEMENTS OF SHAREHOLDER'S EQUITY
<TABLE>
<CAPTION>
NET
UNREALIZED
GAINS (LOSSES)
ADDITIONAL ON AVAILABLE- TOTAL
COMMON PAID-IN FOR-SALE RETAINED SHAREHOLDER'S
STOCK CAPITAL SECURITIES EARNINGS EQUITY
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balance, January 1, 1993 $ 250,000 $ 3,740,006 $ (213,024) $ (44,836) $ 3,732,146
Net income 101,209 101,209
Change in net unrealized investment
losses 47,282 47,282
-------------------------------------------------------------------------------------------
Balance, December 31, 1993 250,000 3,740,006 (165,742) 56,373 3,880,637
Adjustment to beginning balance for
change in accounting method, net
of income taxes of $403,000 782,000 782,000
Net income 383,203 383,203
Change in net unrealized losses on
available-for-sale securities (4,858,917) (4,858,917)
-------------------------------------------------------------------------------------------
Balance, December 31, 1994 250,000 3,740,006 (4,242,659) 439,576 186,923
Net income 776,739 776,739
Capital contribution from SBM Life 1,500,000 1,500,000
Purchase accounting adjustment
(NOTE 2) (2,190,006) 1,066,442 (416,035) (1,539,599)
Change in net unrealized gains
(losses) on available-for-sale
securities 4,062,095 4,062,095
-------------------------------------------------------------------------------------------
Balance, December 31, 1995 $ 250,000 $ 3,050,000 $ 885,878 $ 800,280 $ 4,986,158
-------------------------------------------------------------------------------------------
-------------------------------------------------------------------------------------------
</TABLE>
SEE ACCOMPANYING NOTES.
23
<PAGE>
SBM CERTIFICATE COMPANY
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31
---------------------------------------------
1995 1994 1993
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
CASH FLOWS PROVIDED BY (USED IN) OPERATING ACTIVITIES:
Net income $ 776,739 $ 383,203 $ 101,209
Adjustments to reconcile net income to cash flows provided
by operating activities:
Provision for certificate reserves 2,929,357 3,575,075 4,089,905
Realized investment (gains) losses (283,885) (29,783) 3,173
Deferral of acquisition costs (430,852) (507,996) (377,466)
Amortization of deferred acquisition costs and
renewal commissions 289,875 518,782 501,377
Other amortization and depreciation 228,861 (75,111) 13,085
Deferred tax expense (benefit) 295,464 20,000 (35,000)
Provision for loan and real estate losses -- -- 55,000
(Increase) decrease in accrued investment income 34,571 30,851 (12,545)
Changes in other assets and liabilities 250,559 236,812 7,905
---------------------------------------------
Cash flows provided by operating activities 4,090,689 4,151,833 4,346,643
CASH FLOWS PROVIDED BY (USED IN) INVESTING ACTIVITIES:
Fixed maturity investments available-for-sale:
Purchases (44,224,876) (3,922,397) --
Maturities and redemptions 2,627,400 7,563,300 --
Sales 44,977,473 -- --
Fixed maturity investments held-to-maturity:
Purchases -- (1,180,893) (37,373,431)
Maturities and redemptions 51,500 2,761,816 22,962,748
Sales -- -- 6,893,629
Sales, maturities and redemptions--mortgage loans 4,192,459 144,109 5,253,906
Additions to other invested assets (81,200) -- --
Proceeds from sale of other invested assets -- 156,453 22,968
Repayment of certificate loans, net 59,416 11,494 281
---------------------------------------------
Cash flows provided by (used in) investing activities 7,602,172 5,533,882 (2,239,899)
CASH FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITIES:
Capital contribution 1,500,000 -- --
Amounts received from face-amount certificate holders 2,498,761 3,689,960 5,984,921
Amounts paid to face-amount certificate holders (13,322,027) (13,973,106) (9,596,304)
---------------------------------------------
Cash flows used in financing activities (9,323,266) (10,283,146) (3,611,383)
---------------------------------------------
Net change in cash and cash equivalents 2,369,595 (597,431) (1,504,639)
Cash and cash equivalents at beginning of year 1,530,899 2,128,330 3,632,969
---------------------------------------------
Cash and cash equivalents at end of year $ 3,900,494 $ 1,530,899 $ 2,128,330
---------------------------------------------
---------------------------------------------
</TABLE>
SEE ACCOMPANYING NOTES.
24
<PAGE>
SBM CERTIFICATE COMPANY
NOTES TO FINANCIAL STATEMENTS
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION
SBM Certificate Company (the "Company") was incorporated in 1990 for the
purpose of acquiring the face-amount certificate business of SBM Company
("SBM"). Effective December 31, 1993, SBM transferred all of the Company's
shares of common stock to its wholly owned subsidiary, State Bond and Mortgage
Life Insurance Company ("SBM Life"), and the Company became a wholly owned
subsidiary of SBM Life.
On June 14, 1995, ARM Financial Group, Inc. ("ARM"), completed the
acquisition of substantially all of the assets and business operations of SBM,
including all of the issued and outstanding common stock of SBM's subsidiaries,
SBM Life and SBM Financial Services, Inc. ("SBM Financial Services"), and SBM's
management contracts with the State Bond Group of mutual funds (the
"Acquisition"). By virtue of the Acquisition, ARM acquired control of the
Company, a wholly owned subsidiary of SBM Life. Concurrent with the
Acquisition, ARM acquired all outstanding shares of the authorized common stock
of the Company from SBM Life for a purchase price of $3.3 million.
NATURE OF OPERATIONS
The Company is an issuer of face-amount certificates registered under the
Investment Company Act of 1940 (the "1940 Act"). A face-amount certificate is
an obligation of the Company requiring the Company to pay the holder the
original invested amount, plus a specified return, at a given maturity date.
The Company's face-amount certificates are sold primarily in Minnesota, Iowa,
California, South Dakota, Wisconsin, and Illinois. Face-amount certificates
generally compete with various types of individual savings products which offer
a fixed rate of return on investors' money, especially bank and insurance
products.
BASIS OF PRESENTATION
The financial statements are prepared in accordance with generally accepted
accounting principles. The 1995 financial statements reflect purchase
accounting adjustments related to the Acquisition (see Note 2). For periods
prior to the Acquisition, the financial statements reflect the historical basis
of accounting. Certain amounts from prior years have been reclassified to
conform to the current year's presentation. These reclassifications had no
effect on previously reported net income or shareholder's equity.
INVESTMENTS
Fixed maturities are classified as held-to-maturity when the Company has
the positive intent and ability to hold the securities to maturity. Held-to-
maturity securities are stated at amortized cost. Fixed maturities not
classified as held-to-maturity and equity securities are classified as
available-for-sale. Available-for-sale securities are stated at fair value, with
the unrealized gains and losses, net of taxes, reported in a separate component
of shareholder's equity. The amortized cost of fixed maturities classified as
held-to-maturity or available-for-sale is adjusted for amortization of premiums
and accretion of discounts to maturity, or in the case of mortgage-backed
securities, over
25
<PAGE>
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
the estimated life of the security. Such amortization or accretion is computed
using the interest method and is included in investment income. Anticipated
prepayments on mortgage-backed securities are considered in determining the
effective yield on such securities. If a difference arises between anticipated
and actual prepayments, the carrying value of the investment is adjusted with a
corresponding charge or credit to investment income. Interest and dividends are
included in net investment income. Mortgage loans on real estate and certificate
loans are carried at their unpaid principal balances. Cash and cash equivalents
consist of highly liquid investments with maturities of three months or less at
their time of purchase. Security transactions are accounted for on the date the
order to buy or sell is executed. Realized gains and losses on the sale of
investments are determined based upon the specific identification method.
Other invested assets includes real estate, which is recorded at cost, less
accumulated depreciation since the Acquisition.
The Company adopted the provisions of Statement of Financial Accounting
Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and
Equity Securities" for investments held as of or acquired after January 1, 1994.
In accordance with SFAS No. 115, prior period financial statements have not been
restated to reflect the change in accounting principle. The January 1, 1994
opening balance of shareholder's equity was increased by $782,000 (net of
$403,000 in deferred income taxes) to reflect the net unrealized holding gains
on securities classified as available-for-sale previously carried at amortized
cost. The adoption of SFAS No. 115 had no effect on net income. Upon the date
of the Acquisition, the Company classified all fixed maturities classified as
held-to-maturity to the available-for-sale category.
DEFERRED ACQUISITION COSTS
Costs of issuing new face-amount certificates (principally commissions)
have been deferred. These costs are amortized on a straight-line basis over the
initial maturity period of the certificates which is three years.
FACE-AMOUNT CERTIFICATE RESERVES
Face-amount certificates issued by the Company entitle certificate holders,
who have made either single or installment payments, to receive a definite sum
of money at maturity. Certificate reserves accrue interest, and cash surrender
values are less than accumulated certificate reserves prior to maturity dates.
Certificate reserves are maintained for advance payments by certificate holders
and accrued interest thereon and for interest earned and accrued due to
additional interest rates declared. The reserve accumulation rates, cash
surrender values, and certificate reserves, among other matters, are governed by
the 1940 Act.
26
<PAGE>
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
INCOME TAXES
In accordance with SFAS No. 109, "Accounting for Income Taxes", the Company
uses the liability method of accounting for income taxes. The Company's taxable
income or loss is included in the consolidated federal income tax return of ARM.
The Company provides for income taxes on a separate return basis, except that
tax benefits are recognized for losses to the extent they can be used in the
consolidated return. It is the Company's and ARM's policy that any tax benefit
recorded by one entity will be reimbursed by the benefitted entity.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management of the Company to make
estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates.
2. ACQUISITION OF THE COMPANY
The Acquisition has been accounted for using the purchase method of
accounting. Under purchase accounting, assets and liabilities are adjusted to
their estimated fair value and reflect an allocation of the Company's portion of
the cost of the Acquisition, commonly referred to as "push-down accounting."
The purchase accounting adjustment reflected in the accompanying statement
of shareholder's equity for the year ended December 31, 1995 was recorded on May
31, 1995, the effective date of the Acquisition. The adjustment restated
shareholder's equity on that date to $3.3 million, the purchase price allocated
to the Company by ARM. The December 31, 1995, balances for "retained earnings"
and "net unrealized gains (losses) on available-for-sale securities" reflect
net income and the change in the fair value of fixed maturities and equity
securities subsequent to the Acquisition.
The following combined condensed statements of income and cash flows
present results for the five months ended May 31, 1995, prior to the
Acquisition, and the seven months ended December 31, 1995, following the
Acquisition. The combined amounts agree to the accompanying statements of
income and cash flows for the year ended December 31, 1995. The operating
results subsequent to the Acquisition include the effect of new accounting
values assigned to invested assets and intangibles.
27
<PAGE>
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
<TABLE>
<CAPTION>
SEVEN MONTHS ENDED
FIVE MONTHS ENDED YEAR ENDED
ENDED MAY 31, DECEMBER 31, DECEMBER 31,
1995 1995 1995
-----------------------------------------------------------
<S> <C> <C> <C>
Total investment income $ 2,013,780 $ 2,875,598 $ 4,889,378
Total investment expenses 511,343 446,250 957,593
Provision for certificate reserves 1,224,738 1,704,619 2,929,357
-----------------------------------------------------------
Net investment income before federal income taxes 277,699 724,729 1,002,428
Federal income tax expense (94,000) (313,074) (407,074)
-----------------------------------------------------------
Net investment income 183,699 411,655 595,354
Realized investment gains (losses) (314,000) 597,885 283,885
Federal income tax benefit (expense) on realized
investment gains and losses 106,760 (209,260) (102,500)
-----------------------------------------------------------
Net income (loss) $ (23,541) $ 800,280 $ 776,739
----------------------------------------------------------
-----------------------------------------------------------
CASH FLOWS PROVIDED BY OPERATING ACTIVITIES $ 1,462,487 $ 2,628,202 $ 4,090,689
CASH FLOWS PROVIDED BY (USED IN) INVESTING ACTIVITIES:
Fixed maturity investments:
Purchases (21,615) (44,203,261) (44,224,876)
Maturities and redemptions 903,084 1,775,816 2,678,900
Sales 5,090,653 39,886,820 44,977,473
Sales, maturities and redemptions -- mortgage loans 392,947 3,799,512 4,192,459
Additions to other invested assets, net (81,200) -- (81,200)
Repayments of certificate loans, net 66,731 (7,315) 59,416
-----------------------------------------------------------
Cash flows provided by investing activities 6,350,600 1,251,572 7,602,172
CASH FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITES:
Capital contribution from SBM Life 1,500,000 -- 1,500,000
Amounts received from face-amount certificate
holders 1,926,095 572,666 2,498,761
Amounts paid to face-amount certificate holders (7,066,042) (6,255,985) (13,322,027)
-----------------------------------------------------------
Cash flows used in financing activities (3,639,947) (5,683,319) (9,323,266)
-----------------------------------------------------------
Net change in cash and cash equivalents 4,173,140 (1,803,545) 2,369,595
Cash and cash equivalents at beginning of period 1,530,899 5,704,039 1,530,899
----------------------------------------------------------
Cash and cash equivalents at end of period $ 5,704,039 $ 3,900,494 $ 3,900,494
-----------------------------------------------------------
-----------------------------------------------------------
</TABLE>
28
<PAGE>
NOTES TO FINANCIAL STATMENTS (CONTINUED)
3. INVESTMENTS
The amortized cost and estimated fair values of available-for-sale
securities and held-to-maturity securities were as follows:
<TABLE>
<CAPTION>
AVAILABLE-FOR-SALE SECURITIES
----------------------------------------------------------------------------
GROSS GROSS
UNREALIZED UNREALIZED ESTIMATED
COST GAINS LOSSES FAIR VALUE
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
DECEMBER 31, 1995:
Fixed maturities:
U.S. treasury securities and obligations
of U.S. government agencies $ 6,319,243 $ 25,950 $ -- $ 6,345,193
Obligations of state and political
subdivisions 560,292 4,243 6,927 557,608
Foreign governments 500,000 8,125 -- 508,125
Corporate securities 4,868,279 96,683 173 4,964,789
Mortgage-backed securities 40,918,786 1,202,966 11,089 42,110,663
----------------------------------------------------------------------------
Total fixed maturities 53,166,600 1,337,967 18,189 54,486,378
Equity securities 479,817 43,156 45 522,928
----------------------------------------------------------------------------
Total available-for-sale securities $ 53,646,417 $ 1,381,123 $ 18,234 $ 55,009,306
----------------------------------------------------------------------------
----------------------------------------------------------------------------
DECEMBER 31, 1994:
Fixed maturities:
Mortgage-backed securities $ 42,031,999 $ 43,073 $ 4,933,343 $ 37,141,729
Corporate securities 264,612 4,500 61,610 207,502
----------------------------------------------------------------------------
Total fixed maturities 42,296,611 47,573 4,994,953 37,349,231
Equity securities 803,914 -- 328,327 475,587
----------------------------------------------------------------------------
Total available-for-sale securities $ 43,100,525 $ 47,573 $ 5,323,280 $ 37,824,818
----------------------------------------------------------------------------
----------------------------------------------------------------------------
<CAPTION>
HELD-TO-MATURITY SECURITIES
----------------------------------------------------------------------------
GROSS GROSS
UNREALIZED UNREALIZED ESTIMATED
COST GAINS LOSSES FAIR VALUE
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
DECEMBER 31, 1994:
Fixed maturities:
U.S. treasury securities and obligations
of U.S. government agencies $ 168,461 $ -- $ 15,248 $ 153,213
Obligations of state and political
subdivisions 667,053 5,601 34,254 638,400
Mortgage-backed securities 13,108,720 -- 1,987,005 11,121,715
----------------------------------------------------------------------------
Total fixed maturities held-to-maturity $13,944,234 $5,601 $2,036,507 $11,913,328
----------------------------------------------------------------------------
----------------------------------------------------------------------------
</TABLE>
29
<PAGE>
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
The amortized cost and estimated fair value of securities by contractual
maturity are shown below. Expected maturities will differ from contractual
maturities because borrowers may have the right to call or repay obligations
with or without call or prepayment penalties and because mortgage-backed
securities provide for periodic payments throughout their life.
<TABLE>
<CAPTION>
DECEMBER 31, 1995
-------------------------------
ESTIMATED
FAIR
COST VALUE
- --------------------------------------------------------------------------
<S> <C> <C>
AVAILABLE-FOR-SALE:
Due in one year or less $ 49,991 $ 49,960
Due after one year through five years 7,288,590 7,323,115
Due after five years through ten years 4,111,734 4,181,225
Due after ten years 797,499 821,415
Mortgage-backed securities 40,918,786 42,110,663
Equity securities 479,817 522,928
-------------------------------
Total available-for-sale securities $ 53,646,417 $ 55,009,306
-------------------------------
-------------------------------
</TABLE>
Gross gains of $815,733 and $7,399 and gross losses of $148,041 and
$321,399 were realized on sales of fixed maturities classified as available-for-
sale for the seven months ended December 31, 1995 and the five months ended May
31, 1995, respectively. There were no sales of fixed maturities available-for-
sale in 1994. Gross gains of $1,864 and $201,597 and gross losses of zero and
$238 were realized on sales of fixed maturities classified as held-to-maturity
during the years ended December 31, 1994, and 1993, respectively.
Gross gains of zero and $2,159 and gross losses of $5,075 and $255 were
recognized on equity securities sold during 1995 and 1994, respectively. Gross
losses of $64,732 were realized on the sale of substantially all mortgage loans
in December 1995.
30
<PAGE>
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
4. CERTIFICATE RESERVES
Total certificate reserves at December 31 are summarized as follows:
<TABLE>
<CAPTION>
MINIMUM ADDITIONAL
1995 1994 INTEREST INTEREST
-----------------------------------------------------------------
<S> <C> <C> <C> <C>
Fully-paid certificates:
Single-payment series 503 $ 48,440,527 $ 56,056,890 2.50% 1.85% to 4.50%
Installment 2,267,503 2,311,547 2.50% to 3.50% 2.00% to 2.50%
Optional settlement 618,419 615,811 2.50% to 3.00% 2.00% to 2.50%
Due to unlocated certificate
holders 2,813 6,607 None
----------------------------
51,329,262 58,990,855
Installment certificates:
Reserves to mature, by series:
120, 215, and 220 447,033 554,466 3.25% 2.25%
315 364,368 425,412 3.50% 1.75%
Advance payments 319,061 384,282 * *
----------------------------
1,130,462 1,364,160
----------------------------
Total certificate reserves $ 52,459,724 $ 60,355,015
----------------------------
----------------------------
</TABLE>
* Minimum interest rates on advance payments are generally the
same as the rates on scheduled installment payments.
Interest credited on advance payments, however, is accruing
at 5.25% and will continue at that rate through 1996.
5. FAIR VALUES OF FINANCIAL INSTRUMENTS
The following disclosure of the estimated fair values of financial
instruments is made in accordance with the requirements of SFAS No. 107,
"Disclosures about Fair Value of Financial Instruments." The estimated fair
value amounts have been determined using available market information and
appropriate valuation methodologies. However, considerable judgement was
necessarily required to develop these estimates. Accordingly, the estimates are
not necessarily indicative of the amounts which could be realized in a current
market exchange. The use of different market assumptions or estimation
methodologies may have a material effect on the estimated fair value amounts.
31
<PAGE>
NOTES TO FINANCIAL STATEMENTS (CONTINEUD)
<TABLE>
<CAPTION>
DECEMBER 31, 1995 DECEMBER 31, 1994
----------------------------------------------------------------------
CARRYING ESTIMATED CARRYING ESTIMATED
VALUE FAIR VALUE VALUE FAIR VALUE
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Assets:
Investments in securities of unaffiliated
issuers:
Fixed maturities available-for-sale $ 54,486,378 $ 54,486,378 $ 37,349,231 $ 37,349,231
Fixed maturities held-to-maturity -- -- 13,944,234 11,913,328
Equity securities 522,928 522,928 475,587 475,587
Mortgage loans on real estate 13,391 13,391 4,271,255 4,304,269
Certificate loans 279,463 279,463 338,879 338,879
Other invested assets 618,763 618,763 1,110,921 1,110,921
Cash and cash equivalents 3,900,494 3,900,494 1,530,899 1,530,899
Other assets 54,203 54,203 239 239
Liabilities:
Certificate reserves 52,459,724 52,758,441 60,355,015 60,050,268
Accounts payable and other liabilities 60,582 60,582 66,992 66,992
</TABLE>
The following methods and assumptions were used in estimating fair values:
INVESTMENTS IN SECURITIES OF UNAFFILIATED ISSUERS
Fair values for investments in securities of unaffiliated issuers are based
on quoted market prices, where available. For investments in securities of
unaffiliated issuers for which a quoted market price is not available, fair
values are estimated using internally calculated estimates or quoted market
prices of comparable instruments.
MORTGAGE LOANS ON REAL ESTATE
At December 31, 1995, book value is deemed to be fair value. At December
31, 1994, the estimated fair value is based upon discounted cashflow analyses of
the loans in the portfolio.
CERTIFICATE LOANS
The carrying value of certificate loans approximates their fair value.
CASH AND CASH EQUIVALENTS
The carrying amounts of cash and cash equivalents approximate their fair
value given the short-term nature of these assets.
32
<PAGE>
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
CERTIFICATE RESERVES
The fair value of certificate reserves is based on a discounted cashflow
analysis, using the current interest rate offered on new certificates of 5.60%
and 6.00% at December 31, 1995 and 1994, respectively.
OTHER INVESTED ASSETS, OTHER ASSETS, ACCOUNTS PAYABLE AND OTHER LIABILITIES
The financial statement carrying amounts of other invested assets, other
assets, accounts payable and other liabilities are deemed to be a reasonable
approximation of their fair value.
6. FEDERAL INCOME TAXES
Deferred income tax reflects the net tax effects of (i) temporary
differences between the carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes, and (ii)
operating and capital losses. Significant components of the deferred tax
liabilities and assets as of December 31, 1995 and December 31, 1994 were:
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1995 1994
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Deferred tax liabilities:
Real estate limited partnership $ 172,851 $ 189,000
Net unrealized gains on available-for-sale securities 477,011 --
Other 39,725 33,000
----------------------------------
Total deferred tax liabilities 689,587 222,000
Deferred tax assets:
Fixed maturities 196,991 --
Net unrealized losses on available-for-sale securities -- 1,794,000
Other investments 108,143 --
Fixed assets 39,030 --
Capital loss carryover 420,357 --
Other 20,439 34,629
----------------------------------
Total deferred tax assets 784,960 1,828,629
Valuation allowance for deferred tax assets (714,521) (761,000)
----------------------------------
Net deferred tax assets 70,439 1,067,629
----------------------------------
Deferred tax assets (liabilities) shown on the accompanying balance sheets $ (619,148) $ 845,629
----------------------------------
----------------------------------
</TABLE>
Current and deferred federal income tax expenses for the seven months ended
December 31, 1995 were $233,870 and $288,464, respectively. For the five months
ended May 31, 1995 the current tax benefit was $19,760 and the deferred tax
expense was $7,000. For the year ended December 31, 1994, the current and
deferred expense components were $152,000 and $20,000, respectively. For the
year ended December 31, 1993, the current expense and deferred benefit
components were $4,000 and $49,000, respectively.
33
<PAGE>
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
In the event that future tax assets are recognized on deductible temporary
differences for which a valuation allowance was provided at the Acquisition
date, such benefits will be applied to first reduce the balance of goodwill.
During 1995, goodwill was reduced by $189,251 as a result of realizing such
benefits. The balance of goodwill at December 31, 1995 was $192,919 and is being
amortized straight-line over the three year period subsequent to the
Acquisition.
Federal income taxes differ from that computed by using the expected
federal income tax rate of 35% for 1995 and 1994, and 34% for 1993. The sources
of the differences were:
<TABLE>
<CAPTION>
SEVEN MONTHS FIVE MONTHS
YEAR ENDED ENDED ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, MAY 31, DECEMBER 31, DECEMBER 31,
1995 1995 1995 1994 1993
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Income tax benefit (expense)
at statutory rate $ (450,209) $ (462,915) $ 12,706 $ (194,321) $ (19,111)
Tax-exempt interest 7,256 3,350 3,906 10,000 47,000
Dividend received deduction 14,379 8,000 6,379 15,000 15,000
Goodwill amortization (32,287) (32,287) -- -- --
Taxable proceeds from life
insurance (38,482) (38,482) -- -- --
Other (10,231) -- (10,231) (2,679) 2,111
-----------------------------------------------------------------------------------
Total federal income tax
benefit (expense) $ (509,574) $ (522,334) $ 12,760 $ (172,000) $ 45,000
-----------------------------------------------------------------------------------
-----------------------------------------------------------------------------------
</TABLE>
7. RELATED PARTY TRANSACTIONS
For the periods presented, management and investment advisory fee expenses
reflected in the accompanying financial statements represent allocations of
expenses from SBM and ARM for the respective periods prior and subsequent to the
Acquisition. These allocations include amounts for administrative and
investment services, including use of property, equipment and facilities. The
allocations are currently based on the proportion which such business and assets
managed represents of all of ARM's and its subsidiaries business activities.
Prior to the Acquisition, the allocations were primarily based on the amount of
time spent by SBM employees on the face-amount certificate business and on the
proportion which such business represents of all of SBM's and subsidiaries'
business activities. The allocations were $151,967, $206,519, $516,000, and
$490,800, for the seven months ended December 31, 1995, the five months ended
May 31, 1995 and for the years ended December 31, 1994, and 1993, respectively.
The Company owns and pays operating expenses for a building used by SBM (prior
to the Acquisition) and its affiliates. The total rent and utilities
reimbursement paid to the Company in 1994 and 1993 by SBM and affiliates was
$146,554 and $236,162, respectively. At December 31, 1994, the Company owed SBM
$46,000 related to the above. Management believes the foregoing allocations
were made on a reasonable basis; however,
34
<PAGE>
they do not necessarily equal the costs which would have been or will be
incurred by the Company on a stand-alone basis.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
The Company has paid SBM Financial Services, an affiliate, $443,579,
$507,995, and $377,675 for the years ended 1995, 1994, and 1993, respectively,
for sales commissions and other issuance, underwriting, and sales expenses.
8. SHAREHOLDER'S EQUITY AND REGULATORY MATTERS
The Company is subject to two principal restrictions relating to its
regulatory capital requirements. First, under the 1940 Act, the Company is
required to establish and maintain qualified assets (as defined in Section 28(b)
of the 1940 Act) having a value not less than the aggregate of certificate
reserves plus $250,000 ($52.7 million and $60.6 million at December 31, 1995 and
1994, respectively). The Company had qualified assets of $58.9 million and
$64.7 million at those respective dates (before addition of $1.4 million and
reduction of $5.3 million, respectively, for net unrealized pretax gains and
losses on fixed maturities and equity securities classified as available-for-
sale).
For purposes of determining compliance with the foregoing provisions,
qualified assets are valued in accordance with such provisions of the Code of
the District of Columbia as are applicable to life insurance companies as
required by the 1940 Act. Qualified assets for which no provision for valuation
is made in such Code are valued in accordance with rules, regulations, or orders
prescribed by the Securities and Exchange Commission. These values are the same
as the financial statement carrying value, except that for financial statement
purposes, fixed maturities and equity securities classified as available-for-
sale are carried at fair value. For qualified asset purposes, fixed maturities
securities classified as available-for-sale are valued at amortized cost and
equity securities are valued at cost.
Second, the Minnesota Department of Commerce ("MDC") has historically
recommended to the Company that face-amount certificate companies should
maintain a ratio of shareholder's equity to total assets of a minimum of 5%
based upon a valuation of available-for-sale securities reflected at amortized
cost for purposes of this calculation. Under this formula, the Company's
capital ratio was 6.9% at December 31, 1995. In November 1994, based on the
decline in the value of the Company's investment portfolio, resulting from
increasing interest rates in 1994 and the Company's decreasing liquidity
resulting from reduced principal payments on the Company's collateralized
mortgage obligations portfolio, the MDC recommended that the Company increase
its capital level. The MDC's concern was influenced by the Company's capital
ratio, calculated including the effects of unrealized investment losses.
Therefore, on March 29, 1995, SBM Life, the former parent company of the
Company, made a $1.5 million capital contribution to the Company.
Pursuant to the required calculations of various states, the provisions of
the certificates, depository agreements, and the 1940 Act, qualified assets of
the Company were deposited with independent custodians to meet certificate
liability requirements as of December 31, 1995 and 1994
35
<PAGE>
as shown in the following table. Certificate loans, secured by applicable
certificate reserves, are deducted from certificate reserves in computing
deposit requirements.
<TABLE>
<CAPTION>
1995 1994
---------------------------------
<S> <C> <C>
Assets on deposit with:
Central depositary $ 57,278,134 $ 64,092,848
State governmental authorities 193,756 170,435
---------------------------------
Total deposits $ 57,471,890 $ 64,263,283
---------------------------------
---------------------------------
Required deposits $ 52,430,261 $ 60,266,136
---------------------------------
---------------------------------
</TABLE>
Assets on deposit consisted of the following at December 31:
<TABLE>
<CAPTION>
1995 1994
----------------------------------
<S> <C> <C>
Investment securities, at cost plus accrued interest $ 56,839,655 $ 58,871,273
First mortgage loans, at cost less allowance for loan losses 13,472 4,281,089
Other assets on deposit, at cost 618,763 1,110,921
----------------------------------
$ 57,471,890 $ 64,263,283
----------------------------------
----------------------------------
</TABLE>
36
<PAGE>
239 South Fifth Street
12th Floor
Louisville, KY 40202
