<PAGE>
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended: December 31, 1995 Commission file number: 811-6268
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SBM CERTIFICATE COMPANY
(Exact name of registrant as specified in its charter)
MINNESOTA 41-1671595
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
C/O ARM FINANCIAL GROUP, INC.
239 S. FIFTH STREET, 12TH FLOOR
LOUISVILLE, KENTUCKY 40202
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (502) 582-7900
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
[X] Yes [_] No
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [_]
As of February 15, 1996, 250,000 shares of the registrant's common stock
were outstanding. The registrant is a wholly-owned subsidiary and its common
stock is not traded on a public market.
DOCUMENTS INCORPORATED BY REFERENCE
None
The registrant meets the conditions set forth in General Instruction
J(1)(a) and (b) of Form 10-K and is therefore filing this Form with the reduced
disclosure format.
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Exhibit Index is on page 36.
Page 1 of 38 pages.
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TABLE OF CONTENTS
<TABLE>
<CAPTION>
Item Page
- ---- ----
<C> <S> <C>
PART I
1. Business............................................................. 3
2. Properties........................................................... 4
3. Legal Proceedings.................................................... 5
4. Submission of Matters to a Vote of Security Holders.................. 5
PART II
5. Market for Registrant's Common Equity
and Related Stockholder Matters.................................... 6
6. Selected Financial Data.............................................. 6
7. Management's Discussion and Analysis of
Results of Operations and Financial Condition...................... 6
8. Financial Statements and Supplementary Data.......................... 11
9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure............................. 31
PART III
10. Directors and Executive Officers of the Registrant................... 32
11. Executive Compensation............................................... 32
12. Security Ownership of Certain Beneficial Owners and Management....... 32
13. Certain Relationships and Related Transactions....................... 32
PART IV
14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K..... 33
</TABLE>
2
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PART I
ITEM 1. BUSINESS
(A) GENERAL DEVELOPMENT OF BUSINESS
SBM Certificate Company (the "Company") was incorporated in Minnesota on
June 18, 1990, to assume 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"). On June 14, 1995, the Company
became a wholly owned subsidiary of ARM Financial Group, Inc. ("ARM")
pursuant to ARM's purchase of substantially all of the assets and business
operations of SBM (the "Acquisition"). ARM is a financial services holding
company based in Louisville, Kentucky, that provides retail and
institutional products and services to the long-term savings and retirement
market. At December 31, 1995, ARM had over $5 billion of customer deposits
and funds under management.
(B) FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS.
The Company has one business segment.
(C) NARRATIVE DESCRIPTION OF BUSINESS
The Company is an issuer of fixed-rate 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 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 to the public one
single-payment investment certificate. 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 by SBM Financial
Services, Inc. ("SBM Financial Services"), a wholly owned subsidiary of ARM,
pursuant to an Underwriting Agreement. SBM Financial Services currently uses
a network of independent agents to sell and service the business. The
Company continues to investigate opportunities to expand upon its
distribution channels. SBM Financial Services is registered with the
Securities and Exchange Commission (the "SEC") as a broker-dealer under the
provisions of the Securities Exchange Act of 1934.
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 from
gross margin. The investment spread is affected by general economic
conditions, government monetary policy, the policies of regulatory
authorities that influence
3
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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.
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 products. Some of
these other products are insured by governmental agencies or funds or
independent third parties. The certificates offered by the Company are not
guaranteed or insured by any governmental agency or fund or independent
third party. The Company's business is highly competitive and the Company
competes with many other companies having greater financial resources,
larger sales forces, and greater access to customers. 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 has no
employees. Pursuant to an Investment Services Agreement and an
Administrative Services Agreement, the Company's operations are managed by
ARM.
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, 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 ("MDC") 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 MDC conducts
examinations of the Company on a periodic basis. The offer and sale of the
Company's face-amount certificates also are subject to federal and state
securities laws.
(D) FINANCIAL INFORMATION ABOUT FOREIGN AND DOMESTIC OPERATIONS AND EXPORT
SALES
The Company has no foreign operations.
ITEM 2. PROPERTIES
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 location of the Company's corporate executive officers
and the primary location for ARM's investment accounting, corporate accounting,
legal and marketing activities and various support personnel.
The Company's administrative offices are located in New Ulm, Minnesota, at
100 North Minnesota Street, in a building 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.
4
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ITEM 3. 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.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
This information is omitted in accordance with Instruction (J)(2)(c) to
Form 10-K.
5
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PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
There is currently no public market or trading in the common stock of the
Company. All of the Company's 250,000 currently outstanding shares of common
stock are held by ARM as of December 31, 1995. The Company has never paid cash
dividends on its common stock.
The Company is subject to two principal restrictions on its ability to pay
dividends in addition to the generally applicable restrictions and requirements
of Minnesota corporate law. First, pursuant to Section 28(b) of the 1940 Act,
the Company is required to establish and maintain qualified assets having a
value not less than the aggregate of certificate reserves plus $250,000. Second,
the MDC has determined that face-amount certificate companies such as the
Company 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. The Company could not pay
dividends if it did not meet both of these two requirements or if payment of a
dividend would cause it not to meet such requirements. As of December 31, 1995,
the Company had qualified assets in excess of certificate reserves plus $250,000
of $6.2 million and assets in excess of the 5% ratio of $1.1 million.
ITEM 6. SELECTED FINANCIAL DATA
This information is omitted in accordance with Instruction (J)(2)(a) to Form
10-K.
ITEM 7. 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
6
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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%, 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.
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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
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$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 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.
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
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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.
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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
<TABLE>
<CAPTION>
INDEX
<S> <C>
FINANCIAL STATEMENTS
Reports of Independent Auditors.......................................................... 12
Balance Sheets as of December 31, 1995 and 1994.......................................... 14
Statements of Income for the Years Ended December 31, 1995, 1994, and 1993............... 16
Statements of Shareholder's Equity for the Years Ended December 31, 1995, 1994 and 1993.. 17
Statements of Cash Flows for the Years Ended December 31, 1995, 1994 and 1993............ 18
Notes to Financial Statements............................................................ 19
SUPPLEMENTARY DATA
None
</TABLE>
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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
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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 and Touche LLP
Minneapolis, Minnesota
March 29, 1995
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<TABLE>
<CAPTION>
SBM Certificate Company
Balance Sheets
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.
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<TABLE>
<CAPTION>
SBM Certificate Company
Balance Sheets (Continued)
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.
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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.
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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.
17
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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.
18
<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
19
<PAGE>
Notes to Financial Statements (continued)
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 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.
20
<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.
21
<PAGE>
Notes to Financial Statements (continued)
<TABLE>
<CAPTION>
Seven Months
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 activities:
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>
22
<PAGE>
Notes to Financial Statements (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>
23
<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.
December 31, 1995
------------------------
Estimated
Fair
Cost Value
- ------------------------------------------------------------------------
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
========================
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.
24
<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.
25
<PAGE>
Notes to Financial Statements (continued)
<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.
26
<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.
27
<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,
28
<PAGE>
Notes to Financial Statements (continued)
they do not necessarily equal the costs which would have been or will be
incurred by the Company on a stand-alone basis.
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
29
<PAGE>
Notes to Financial Statements (continued)
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>
30
<PAGE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
A change in accountants for the year ended December 31, 1995, in
connection with ARM's acquisition of the Company, was previously reported to the
Commission on a Form 8-K filed on February 23, 1996.
There have been no disagreements with accountants on accounting,
auditing, or financial reporting matters.
31
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
This information is omitted in accordance with Instruction (J)(2)(c)
to Form 10-K.
ITEM 11. EXECUTIVE COMPENSATION
This information is omitted in accordance with Instruction
(J)(2)(c) to Form 10-K.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
This information is omitted in accordance with Instruction
(J)(2)(c) to Form 10-K.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
This information is omitted in accordance with Instruction
(J)(2)(c) to Form 10-K.
32
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(A) DOCUMENTS FILED AS PART OF THIS REPORT
1. Financial Statements.
See financial statements index on page 11 of this document for a
listing of financial statements included in this report.
2. Financial Statement Schedules
The following financial statement schedules of the Company and the
related Report of Independent Auditors are incorporated herein by
reference and were previously filed as Part II Item 16(b) to Post
Effective Amendment No. 7 to Registration Statement on Form S-1 of the
Company filed March 5, 1996 (File No. 33-38066):
Report of Independent Auditors
Schedule I Investments in Securities of Unaffiliated
Issuers--December 31, 1995
Schedule III Mortgage Loans on Real Estate and Interest Earned
on Mortgages--Year Ended December 31, 1995
Schedule V Qualified Assets on Deposit--December 31, 1995
Schedule VI Certificate Reserves--Year Ended December 31, 1995
Schedules III, IV, VI, and VII as of or for the year ended December
31, 1994, and related Independent Auditors' Report, included in the
Company's Post Effective Amendment No. 6 to Registrant Statement on
Form S-1 filed March 31, 1995, and Schedule III and IV for the year
ended December 31, 1993, and related Independent Auditors' Report,
included in the Company's Post Effective Amendment No. 5 to
Registration Statement on Form S-1 filed February 25, 1994, (File No.
33-38066), are incorporated herein by reference.
Schedules required by Article 6 of Regulation S-X for face-amount
certificate investment companies other than those listed are omitted
because they are not required, are not applicable, or equivalent
information has been included in the financial statements and notes
thereto, or elsewhere herein.
3. Exhibits
See Exhibit Index on page 36 of this report.
33
<PAGE>
(B) REPORTS ON FORM 8-K
On February 23 , 1996, the Company filed a current report on Form 8-K to
report under Item 4 the change in the Company's certifying accountant from
Deloitte & Touche LLP to Ernst & Young LLP.
34
<PAGE>
SIGNATURES
Pursuant to the requirements of the Section 13 or 15(d) of the Securities
and Exchange Act of 1934, the Registrant has duly caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized, on
February 26, 1996.
SBM Certificate Company
By: /s/ JOHN R. McGEENEY
------------------------------------------------
John R. McGeeney
Chairman of the Board of Directors and President
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant in the capacities indicated on the 26th day of February 1996.
Name Title
---- -----
/s/ JOHN R. MCGEENEY Chairman of the Board of Directors
- ---------------------- and President (Principal Executive Officer)
John R. McGeeney
/s/ EDWARD L. ZEMAN Executive Vice President--Chief Financial
- ---------------------- Officer (Principal Financial Officer)
Edward L. Zeman
/s/ DON W. CUMMINGS Controller (Principal Accounting Officer)
- ----------------------
Don W. Cummings
/s/ STEPHEN B. BING Director
- ----------------------
Stephen B. Bing
/s/ THEODORE S. ROSKY Director
- ----------------------
Theodore S. Rosky
Director
- ----------------------
Martin R. Snyder
35
<PAGE>
<TABLE>
<CAPTION>
SBM CERTIFICATE COMPANY
EXHIBIT INDEX
===================================================================================================================================
Exhibit
Number Description
- -----------------------------------------------------------------------------------------------------------------------------------
<C> <S>
3.1 Articles of Incorporation-filed as Exhibit 3(a) to Registration Statement No. 33-38066 dated December 4, 1990.*
3.2 By-laws-filed as Exhibit 3(b) to Registration Statement No. 33-38066 dated December 4, 1990.*
4 Instruments defining the rights of security holders-Form of Series 503 Certificate filed as Exhibit 4 to
Registration Statement on Form N-8B-4, File No. 811-6268, filed April 1, 1991.*
10.1 Underwriting Agreement by and between the Company and SBM Financial Services, Inc. dated June 14, 1995, filed as
Exhibit 10(b) to Amendment No. 7 to Registration Statement No. 33-38066 of the Company dated March 5, 1996.*
10.2 Administrative Services Agreement by and between the Company and ARM Financial Group, Inc. dated as of June 14,
1995, filed as Exhibit 10(c) to Amendment No. 7 to Registration Statement No. 33-38066 of the Company dated
March 5, 1996.*
10.3 Investment Services Agreement by and between the Company and ARM Financial Group, Inc. dated as of June 14, 1995,
filed as Exhibit 10(d) to Amendment No. 7 to Registration Statement No. 33-38066 of the Company dated March 5,
1996.*
10.4 Custody Agreement, as amended and supplemented, between the Company and First Bank National Association dated
December 20, 1990, filed as Exhibit 10(b) to Amendment No. 1 to Registration Statement No. 33-38066 of the
Company dated January 2, 1991.*
10.5 Lease between the Company and State Bank & Trust Company of New Ulm dated August 13, 1992, filed as Exhibit 10A
to Form 10-K of SBM Company filed March 31, 1993 (File No. 811-407).*
10.6 Form of Tax Allocation Agreement by and among the Company, ARM and certain ARM subsidiaries, filed as Exhibit
10(f) to Amendment No. 7 to Registration Statement No. 33-38066 of the Company dated March 5, 1996.*
23.1 Consent of Ernst & Young LLP, filed herewith.
23.2 Consent of Deloitte & Touche LLP, filed herewith.
27 Not applicable.
* Previously filed as indicated and incorporated herein by reference.
</TABLE>
36
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in this Annual Report (Form 10-K)
of SBM Certificate Company for the year ended December 31, 1995, of our reports
dated February 22, 1996, with respect to the financial statements and schedules
of SBM Certificate Company included in Amendment No. 7 to the Registration
Statement (Form S-1 No. 33-38066) and related Prospectus of SBM Certificate
Company.
/s/ Ernst & Young LLP
Louisville, Kentucky
February 26, 1996
37
<PAGE>
EXHIBIT 23.2
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in this Annual Report on Form 10-K
under the Securities Exchange Act of 1934 of SBM Certificate Company for the
year ended December 31, 1995 of our reports dated March 29, 1995 and February
18, 1994 and contained in Registration Statement No. 33-38066 of SBM Certificate
Company on Form S-1 under the Securities Act of 1933 insofar as such reports
relate to the financial statement schedules of SBM Certificate Company for the
two years ended December 31, 1994.
/s/ Deloitte & Touche, LLP
Minneapolis, Minnesota
February 26, 1996
38
