<PAGE>
As filed with the Securities and
Exchange Commission on May 13, 1998.
Registration No. 33-38066
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
Post Effective Amendment No. 9
to
FORM S-1
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
SBM CERTIFICATE COMPANY
(Exact name of registrant as specified in charter)
Minnesota
(State or other jurisdiction of incorporation or organization)
6725
(Primary Standard Industrial Classification Code Number)
41-1671595
(I.R.S. Employer Identification No.)
c/o ARM Financial Group, Inc.
515 W. Market Street
Louisville, Kentucky 40202
(502)582-7900
(Address, including zip code, and telephone number, including
area code, of registrant's principal executive office)
CT Corporation System Inc.
405 Second Avenue South
Minneapolis, Minnesota 55401
(612)333-4315
(Name, address, including zip code, and telephone number,
including area code, of agent for service)
Approximate date of commencement of proposed sale to the public: As soon after
the effective date of this Registration Statement as is practicable.
If any of the securities being registered on this Form are to be offered on a
delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933 check the following box. [ ]
If this Form is filed to register additional securities for an offering pursuant
to Rule 462(b) under the Securities Act, please check the following box and list
the Securities Act registration statement number of the earlier effective
registration statement for the same offering. [ ]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [ ]
The registrant has registered an indefinite amount of securities under the
Securities Act of 1933 pursuant to Rule 24f-2 under the Investment Company Act
of 1940. The Rule 24f-2 Notice for the issuer's most recent fiscal year will be
filed in March 1998.
<PAGE>
SBM Certificate Company
Cross Reference Sheet
S-1 Item and Location in Prospectus
Item 1 Prospectus Cover
Item 2 Inside Front Cover
Item 3 Sections entitled The Company, Risk Factors
Item 4 Section entitled Use of Proceeds
Item 5 Not Applicable
Item 6 Not Applicable
Item 7 Not Applicable
Item 8 Sections entitled Underwriting Agreement and Underwriter's
Compensation
Item 9 Section entitled Description of the Certificates
Item 10 Section entitled Experts
Item 11(a) Section entitled About the Company, History and Business
Item 11(b) Section entitled About the Company, Description of Property
Item 11(c) Section entitled About the Company, Legal Proceedings
Item 11(d) Not Applicable
Item 11(e) See Index to Financial Statements
Item 11(f) Section entitled Selected Financial Data
Item 11(g) Not Applicable
Item 11(h) Section entitled Management's Discussion and Analysis of Results
of Operations and Financial Condition
Item 11(i) Not Applicable
Item 11(j) Section entitled Executive Officers and Directors of the Company
Item 11(k) Not Applicable
Item 11(l) Section entitled About the Company
Item 11(m) Section entitled Relationship with ARM and Affiliates
Item 12 Section entitled Executive Officers and Directors of the Company
2
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SBM CERTIFICATE COMPANY
SERIES 503 CERTIFICATES
PROSPECTUS
MAY 1, 1998
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 Compounded
Paid Quarterly Paid Annually Annually
Year 1 x.xx% x.xx% x.xx%
Year 2 x.xx% x.xx% x.xx%
Year 3 x.xx% x.xx% x.xx%
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
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......................................5
Federal Income Tax Treatment................................6
Transfer of Ownership.......................................6
Reserves and Deposits with Custodian........................6
Certain Financial Information...............................6
Use of Proceeds.............................................6
Investment Policies.........................................7
About the Company.......................................................7
Executive Officers and Directors of the Company.........................9
Relationship with ARM and Affiliates...................................11
Experts................................................................11
Selected Financial Data................................................12
Management's Discussion and Analysis of Results of
Operations and Financial Condition.....................................13
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.
In addition, the SEC maintains a web site that contains reports, proxies, and
other information regarding registrants that file electronically, such as SBM
Certificate Company. The address of the SEC web site is http//www.sec.gov.
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 515 W. Market Street, 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. 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.
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 dated June 14, 1995, between the Company
and ARM Securities Corporation ("ARM Securities"), formerly SBM Financial
Services, Inc., (a wholly owned subsidiary of ARM registered as a broker-dealer
under the 1934 Act), ARM Securities has the exclusive right to solicit
applications for and to distribute the Certificates. Pursuant to such agreement,
ARM Securities agrees to continuously solicit such applications, as long as
Certificates are available for sale. The Company reserves the right to reject
any application. ARM Securities 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.
The Company's Board of Directors, including a majority of directors who are not
interested persons of ARM Securities or ARM, approve the Underwriting Agreement
annually. The Underwriting Agreement is terminable by either party with sixty
days' notice.
5
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UNDERWRITER'S COMPENSATION
In accordance with the Underwriting Agreement, the Company pays ARM Securities
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. ARM Securities pays compensation to its representatives and pays other
selling expenses in connection with the sale of Certificates. The Company has
paid ARM Securities $314,805, $263,089, and $443,579 in 1997, 1996, and 1995,
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.
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
6
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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 ARM Securities. Further documentation
may be required from corporations, executors (executrixes), partnerships,
administrators (administratrices), 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%.
Method of Distribution
The Certificates are distributed by registered representatives of ARM Securities
and also by registered representatives of other broker-dealers that have selling
agreements with ARM Securities. Pursuant to the Underwriting Agreement between
the Company and ARM Securities, the Company pays sales compensation to ARM
Securities for distribution of the Certificates. ARM Securities in turn pays
compensation to its representatives and pays other distribution expenses. See
"Underwriting Agreement".
7
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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 ARM
Securities. Further documentation may be required from corporations, executors
(executrixes), partnerships, administrators (administratrices), 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 Trust 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
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, 1997, such composition was:
Cash and cash equivalents 21.9 %
Fixed maturities:
8
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U.S. Treasury securities and
obligations of U.S. government agencies 19.0
Corporate securities 8.6
Asset-backed securities 1.7
Collateralized mortgage obligations 44.1
Other mortgage-backed securities 1.5
Other fixed maturities 1.4
Other investments 1.8
------
Total Cash and Investments 100.0%
======
The Company's fixed maturity portfolio is 99% investment grade as of December
31, 1997. 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 investment adviser (see "About The Company-Business" below). The
Board of Directors of the Company regularly reviews investment decisions. The
Company's investment adviser, in accordance with the investment policies of the
Company, uses its 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.
ABOUT THE COMPANY
History
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.
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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 the Midwest.
The Company's face-amount certificates are distributed exclusively by ARM
Securities, a wholly owned subsidiary of ARM, pursuant to an Underwriting
Agreement. See "Underwriting Agreement". ARM Securities 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. Historically, such services were provided in part through
ARM's wholly owned subsidiary ARM Capital Advisors, Inc. ("ARM Capital
Advisors"). On November 7, 1997, ARM transferred substantially all of the assets
and operations of ARM Capital Advisors to a newly formed subsidiary, ARM Capital
Advisors, LLC ("New ARMCA"), and sold an 80% interest in New ARMCA to ARM
Capital Advisors Holdings, LLC, an entity controlled by Emad A. Zikry, the
President of ARM Capital Advisors prior to the sale. Under the terms of the
sale, New ARMCA will provide ARM's subsidiaries (including the Company) with
investment management services on the same basis as in the past. The terms of
the sale further provide that after December 31, 1997, ARM can continue to
engage New ARMCA as its investment adviser at agreed upon rates, but may also
consider retaining other investment management firms.
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 and other 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 in the issuance of face
amount certificates is IDS Certificate Company.
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 had been pledged
pursuant to a credit agreement among ARM and certain lenders to secure a bank
loan made to ARM. A release and amended agreement dated December 15, 1997 was
made to the credit agreement pursuant to which the pledged shares were released
as collateral.
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 8 of Notes to Financial Statements), and a variety of other
restrictions on the operation
10
<PAGE>
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 515 W. Market Street, 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 31,010 square feet of office
space held pursuant to a lease between ARM and the lessor which expires on
September 1, 2006, and which is subject to two five (5) year renewal options.
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. 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.
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 51 - 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 41 - Director and Chairman of the Board of the Company
since January 1996; President of the Company since June 1995. Mr. McGeeney is
the Executive Vice President--Retail Business Division 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 61 - 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.
Walter L. Sales, age 49 - Director of the Company beginning in 1998. Since 1984
Mr. Sales has been a partner in the Louisville law firm of Ogden, Newell & Welch
where he is chairman of the firm's litigation department and currently serves on
its executive committee. From 1974 to 1984 he was a partner with the law firm of
Segal, Isenberg, Sales & Stewart.
Dennis L. Carr, age 48 - Executive Vice President--Chief Product Development
Officer and Actuary. Mr. Carr is an Executive Vice President and Chief 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 50 - Executive Vice President--Chief Administrative
Officer. Mr. Ferguson is an Executive Vice President and Chief Technology
Officer 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
11
<PAGE>
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 42 - 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.
Patricia L. Winter, age 39 - Executive Vice President--Investment Assurance and
Institutional Products. Ms. Winter was named Executive Vice President -
Investment Assurance and Institutional Products in February 1998. She had served
in other various positions within the Company since April 1992, the last of
which was Senior Vice President - Mergers/Acquisitions and Investment Assurance.
Prior to that time, Ms. Winter had been a Director-Accumulation Product
Development of the ICH Capital Management Group, ICH Corporation from August
1990 to March 1992.
Peter S. Resnik, age 37 - 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.
Barry G. Ward, age 36 - 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 33 - Secretary. Mr. Howard is a Legal Officer and Assistant
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.
Michael A. Cochran, age 38 - Tax Officer. Mr. Cochran is the Tax Officer of ARM
and also holds this office for other ARM subsidiaries. Mr. Cochran has been Tax
Officer of ARM since November 1997. Prior to joining ARM, he was a tax principal
with Ernst & Young LLP from July 1984 to October 1997.
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 New
ARMCA) 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.
12
<PAGE>
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 ARM Securities, 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 ARM Securities a sales
commission not to exceed $30.00 per $1,000 invested per three-year Certificate
maturity period.
For the year ended December 31, 1997, the Company paid ARM $116,544 for
investment management services and $129,924 for administrative services.
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 of the Company included herein at
December 31, 1997 and 1996, and for the years then ended, have been audited by
Ernst & Young LLP as set forth in their reports appearing elsewhere herein and
are included in reliance upon such reports given upon the authority of such firm
as experts in accounting and auditing.
13
<PAGE>
Selected Financial Data
The following table sets forth selected financial data of the Company for the
years ended December 31, 1993 through 1997 that were derived from audited
financial statements of the Company. The report of the Company's independent
auditors, Ernst & Young LLP, with respect to the years ended December 31, 1997,
1996 and 1995 appears elsewhere in this Prospectus. The following financial
information should be read in conjunction with "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and the audited
financial statements and the related notes thereto included elsewhere in this
Prospectus.
<TABLE>
<CAPTION>
Year Ended December 31
- -----------------------------------------------------------------------------------------
(in thousands, except per share data) 1997 1996 1995* 1994 1993
- ------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Statement of Operations Data
Total investment income $ 3,933 $ 4,290 $ 4,889 $ 5,326 $ 5,439
Interest credited on certificate reserves (2,795) (2,822) (2,929) (3,575) (4,090)
-------------------------------------------------
Net investment spread 1,138 1,468 1,960 1,751 1,349
Total investment and other expenses (755) (815) (958) (1,225) (1,289)
Federal income tax (expense) benefit (124) (238) (406) (163) 43
-------------------------------------------------
Net investment income (loss) 259 415 596 363 103
Net realized investment gains (losses) (164) 317 181 20 (2)
-------------------------------------------------
Net income 95 732 777 383 101
Earnings per share ** 0.38 2.93 3.11 1.53 0.40
Balance Sheet Data (End of Period)
Total assets $ 60,270 $ 55,726 $ 60,580 $ 60,609 $ 71,021
Face-amount certificate reserves 45,127 50,186 52,460 60,355 67,029
Shareholder's equity 4,982 5,064 4,986 187 3,881
</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 per share based on 250,000 shares issued and outstanding.
14
<PAGE>
Management's Discussion and Analysis of Financial Condition and Results of
Operation
General
The Company was acquired by ARM in connection with ARM's acquisition of
substantially all of the assets and business operations of SBM effective May 31,
1995. The results of operations for the year ended December 31, 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. Historical results of
operations are not completely comparable with results of operations subsequent
to the Acquisition primarily due to differing asset/liability management
strategies and expense allocation methodologies of ARM and SBM management.
Therefore, results of operations for 1996 are not completely comparable with
1995.
Results of Operations
1997 Compared with 1996
Net investment income (net income excluding net realized investment gains
and losses) was $258,205 and $414,670 for 1997 and 1996, respectively. The
decrease in net investment income was primarily attributable to a decrease in
net investment spread, partially offset by lower investment and other expenses
and lower federal income tax expense.
Net investment spread, which is the difference between investment income
and interest credited on certificate reserves, decreased to $1.1 million during
1997 from $1.5 million in 1996. These amounts reflect net investment spread of
1.63% and 2.28% during 1997 and 1996, respectively, between the Company's
investment yield on average cash and investments and the average rate credited
on certificate reserves. The Company's investment income decreased to $3.9
million from $4.3 million for 1997 and 1996, respectively. These amounts
represent investment yields of 7.43% and 7.78% on average cash and investments
of $51.3 million and $54.5 million for 1997 and 1996, respectively. This
decrease in investment yield on cash and investments was primarily attributable
to the Company selling its mortgage-backed derivative securities during the
last half of 1997 and reinvesting the proceeds when generally lower reinvestment
rates were available. As a result of this trading activity, above normal
average cash balances were held, further depressing the investment yield.
Interest credited on certificate reserves was $2.8 million for both 1997
and 1996. These amounts represent average rates of interest credited of 5.80%
and 5.50% on average certificate reserves of $46.3 million and $50.4 million for
1997 and 1996, respectively. The majority of the Company's outstanding
face-amount certificates are fixed-rate three year contracts. The Company
monitors credited interest rates for new and renewal issues against competitive
products, mainly bank certificates of deposit. Credited interest rate
adjustments (up or down) on new certificates are made as the Company deems
necessary. New and renewal contracts issued during 1997 have crediting rates
that are generally higher than contracts that matured during 1997, resulting in
the overall increase in the average crediting rate.
Investment and other expenses were $755,256 and $815,094 for 1997 and
1996, respectively. The decrease in investment and other expenses is primarily
attributable to (i) a decrease in goodwill amortization, (ii) a decrease in real
estate expenses at the Company's Minnesota facility and (iii) a decrease in
other expenses which included decreases in annual regulatory examination expense
and filing fees. Such decreases were partially offset by an increase in renewal
commissions.
Realized investment losses were $268,002 for 1997 compared to realized
investment gains of $485,135 for 1996. Such realized investment gains and losses
were interest-rate and credit related and attributable to the asset/liability
management strategies of the Company. Fixed maturities and equity securities
(i.e., non-redeemable preferred stock) classified as available- for-sale are
sold during rising and falling interest rate environments which can result in
period-to-period swings in interest-rate related realized investment gains and
losses.
During 1997, net income was $94,688 compared to $731,981 in 1996. The
decrease was primarily attributable to a decrease in realized investment gains
and net investment income.
Certificate reserves decreased $5.1 million or 10.1% during 1997, as
maturities and surrenders exceeded sales and renewals. The Company believes a
significant factor leading to the decrease is that the certificate of deposit
marketplace is currently very competitive. For certificates reaching their
maturity date during 1997 and 1996, 64% and 73%, respectively, were renewed.
1996 Compared with 1995
15
<PAGE>
During 1996, net income was $731,981 compared to $776,739 in 1995. Net
investment income was $414,670 and $595,354 for 1996 and 1995, respectively. The
decrease in net investment income was primarily attributable to a decrease in
net investment spread, partially offset by lower investment and other expenses
and lower federal income tax expense.
Net investment spread decreased to $1.5 million during 1996 from $2.0
million in 1995. These amounts reflect net investment spread of 2.28% and 3.05%
during 1996 and 1995, respectively, between the Company's investment yield on
average cash and investments and the average rate credited on certificate
reserves. The Company's investment income decreased to $4.3 million from $4.9
million for 1996 and 1995, respectively. These amounts represent investment
yields of 7.78% and 8.29% on average cash and investments of $54.5 million and
$54.8 million for 1996 and 1995, respectively. This decrease in investment yield
on cash and investments was primarily attributable to a reduction in the average
duration of the investment portfolio during 1996 and to the December 1995 sale
of the Company's mortgage loan portfolio. The proceeds from the sale of mortgage
loans were invested in fixed maturities of a generally higher quality, but with
lower yields.
Interest credited on certificate reserves was $2.8 million and $2.9
million for 1996 and 1995, respectively. These amounts represent average rates
of interest credited of 5.50% and 5.24% on average certificate reserves of $50.4
million and $52.9 million for 1996 and 1995, respectively. New and renewal
contracts issued and outstanding during 1996 had crediting rates that were
generally higher than contracts that matured or surrendered during 1996,
resulting in the overall increase in the average crediting rate.
Investment and other expenses were $815,094 and $957,593 for 1996 and
1995, respectively. The decrease in investment and other expenses was primarily
attributable to the decrease in management and investment advisory fees.
Currently, management and investment advisory fees charged by ARM are computed
as a percentage of the Company's average certificate reserves and qualified
assets. Such fees were lower since the June 30, 1995 acquisition of the Company
primarily as a result of ARM's lower marginal operating cost attributable to
greater economies of scale.
Realized investment gains were $485,135 and $283,885 for 1996 and 1995,
respectively. These realized investment gains were interest-rate related and
attributable to the asset/liability management strategies of the Company.
Certificate reserves decreased $2.3 million or 4.3% during 1996, as
maturities and surrenders exceeded sales and renewals. The Company believes a
significant factor leading to the decrease was 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 face-
amount certificates reaching their maturity date during 1996 and 1995, 73% and
72%, respectively, 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. The Company's investments in fixed maturities were 99% and 98% investment
grade for the years ended December 31, 1997 and 1996, 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,
securities are classified by a nationally recognized statistical rating
organization (i.e., Standard & Poor Corporation's rating of BBB- or above).
Additionally, the Company's investment portfolio has minimal exposure to real
estate, mortgage loans and common equity securities, which represented 0.8% and
1.0% of qualified assets at December 31, 1997 and 1996, respectively. As of
December 31, 1997, the Company held no securities which had defaulted on
principal or interest payments.
Fixed maturities include mortgage-backed and asset-backed securities,
corporate securities, U.S. Treasury securities and other government obligations.
Mortgage-backed securities ("MBSs"), which include pass-through securities and
collateralized mortgage obligations ("CMOs"), totaled $27.3 million at December
31, 1997, representing 54.2% of total qualified assets, net of unsettled
securities trades (58.9% at December 31, 1996). The Company's investments in
CMOs represented 52.4% and 52.8% of the Company's qualified assets, net of
unsettled securities trades as of December 31, 1997 and 1996, respectively.
Currently, 76.9% of the CMOs are backed by the U.S. Government or U.S.
Government agencies. MBSs, including CMOs, are subject to risks associated
with prepayments of the underlying mortgage loans. Prepayments cause these
securities to have actual maturities different from those expected at the
time of purchase. The degree to which a security is susceptible to either an
increase or decrease in yield due to prepayment speed adjustments is
influenced by the difference between its amortized cost and par, the relative
sensitivity of the underlying mortgages backing the assets to prepayments in
a changing interest rate environment and the repayment priority of the
securities in the overall securitization structure. Prepayment sensitivity is
evaluated and monitored, giving full consideration to the collateral
characteristics such as weighted average coupon rate, weighted average
maturity and the prepayment history of the specific loan pool. Additionally,
the Company routinely projects three year liability and asset cash flows with
the goal of maintaining an adequate level of liquidity for maturing
face-amount certificates. The Company's asset/liability management strategies
not only allow the Company to monitor its short-term liquidity needs, but
also aim to provide protection to the investment portfolio from adverse
changes in interest rates.
16
<PAGE>
Based on the provisions of Statement of Financial Accounting Standards
("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity
Securities," 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. Fluctuations in interest rates during
1997 resulted in unrealized gains of $54,723 (net of $29,466 in deferred income
taxes) at December 31, 1997 compared to unrealized gains of $231,541 (net of
$124,676 in deferred income taxes) at December 31, 1996. 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 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, 1997, the Company had $14.6 million of qualified assets
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 8.2% at
December 31, 1997.
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, 1997, cash and cash equivalents totaled $13.1 million, an
increase of $9.9 million from December 31, 1996. 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 $4.0 million, $3.6 million and $4.1 million were generated
from operating activities in 1997, 1996 and 1995, 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 $93.1 million, $39.4 million and $51.8
million in cash flows during 1997, 1996 and 1995, respectively, which were
offset by purchases of investments of $79.5 million, $38.5 million and $44.2
million, respectively.
Year 2000
During 1996, ARM completed an evaluation of all computer systems for Year
2000 compliance. Based on that initial review, it was determined that the
administration system which processes face-amount certificate transactions could
not accept Year 2000 data. The administration of face-amount certificates is
expected to be corrected or moved to a compliant system during 1998. This Year
2000 compliance project, as it relates to the Company, is provided for under the
Administrative Services Agreement between ARM and the Company.
17
<PAGE>
SBM Certificate Company
Index to Financial Statements
Report of Independent Auditors.........................................F-2
Balance Sheets as of December 31, 1997 and 1996........................F-3
Statements of Operations for the Years Ended
December 31, 1997, 1996, and 1995.................................... F-5
Statements of Shareholder's Equity for the
Years Ended December 31, 1997, 1996 and 1995...........................F-6
Statements of Cash Flows for the Years Ended
December 31, 1997, 1996 and 1995..................................... F-7
Notes to Financial Statements..........................................F-8
18
<PAGE>
Report of Independent Auditors
Board of Directors
SBM Certificate Company
We have audited the accompanying balance sheets of SBM Certificate Company as of
December 31, 1997 and 1996, and the related statements of income, shareholder's
equity, and cash flows for each of the three years in the period ended December
31, 1997. 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 audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of SBM Certificate Company at
December 31, 1997 and 1996, and the results of its operations and its cash flows
for each of the three years in the period ended December 31, 1997, in conformity
with generally accepted accounting principles.
/s/ Ernst & Young LLP
Louisville, Kentucky
February 9, 1998
19
<PAGE>
SBM Certificate Company
Balance Sheets
<TABLE>
<CAPTION>
======================================================================================================
December 31,
1997 1996
- ------------------------------------------------------------------------------------------------------
<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:
1997-$45,602,442; 1996-$49,863,826) $45,614,870 $50,169,361
Equity securities, at fair value (cost: 1997-$340,473; 1996-$493,912) 412,234 544,594
Certificate loans 186,292 273,368
Other invested assets 471,992 523,083
Cash and cash equivalents 13,054,864 3,247,192
------------------------
Total cash and investments 59,740,252 54,757,598
Receivables:
Dividends and interest 328,516 533,958
Receivable for investment securities sold -- 122,570
------------------------
Total receivables 328,516 656,528
------------------------
Total qualified assets 60,068,768 55,414,126
Deferred acquisition cost 157,994 132,163
Goodwill -- 113,095
Other assets 42,948 66,163
------------------------
Total assets $60,269,710 $55,725,547
========================
</TABLE>
20
<PAGE>
SBM Certificate Company
Balance Sheets (Continued)
<TABLE>
<CAPTION>
=====================================================================================
December 31,
1997 1996
- -------------------------------------------------------------------------------------
<S> <C> <C>
Liabilities and shareholder's equity
Liabilities:
Certificate reserves $45,127,084 $50,186,386
Payable for investment securities purchased 9,731,948 --
Deferred federal income taxes 98,320 445,419
Accounts payable and other liabilities 330,686 29,940
------------------------
Total liabilities 55,288,038 50,661,745
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 3,050,000
Net unrealized gains on available-for-sale securities 54,723 231,541
Retained earnings 1,626,949 1,532,261
------------------------
Total shareholder's equity 4,981,672 5,063,802
------------------------
Total liabilities and shareholder's equity $60,269,710 $55,725,547
========================
See accompanying notes
</TABLE>
21
<PAGE>
SBM Certificate Company
Statements of Operations
<TABLE>
<CAPTION>
====================================================================================================
Year Ended December 31,
---------------------------------------
1997 1996 1995
- ----------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Investment income:
Interest income from securities $ 3,729,295 $ 4,089,948 $ 4,276,460
Interest income from mortgage loans -- -- 366,321
Other investment income 203,810 200,127 246,597
---------------------------------------
Total investment income 3,933,105 4,290,075 4,889,378
Investment and other expenses:
Management and investment advisory fees 246,468 246,468 358,486
Deferred acquisition cost amortization and renewal
commissions 288,974 245,126 289,875
Real estate expenses 166,670 205,029 137,777
Amortization of goodwill 23,833 79,824 92,248
Other expenses 29,311 38,647 79,207
---------------------------------------
Total investment and other expenses 755,256 815,094 957,593
Interest credited on certificate reserves 2,795,360 2,821,912 2,929,357
---------------------------------------
Net investment income before federal
income taxes 382,489 653,069 1,002,428
Federal income tax expense (124,284) (238,399) (407,074)
---------------------------------------
Net investment income 258,205 414,670 595,354
Realized investment gains (losses) (268,002) 485,135 283,885
Federal income tax benefit (expense) on realized investment
gains and losses 104,485 (167,824) (102,500)
---------------------------------------
Net realized investment gains (losses) (163,517) 317,311 181,385
---------------------------------------
Net income $ 94,688 $ 731,981 $ 776,739
=======================================
See accompanying notes
</TABLE>
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, 1995 $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 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
Net income 731,981 731,981
Change in net unrealized gains
(losses) on available-for-sale
securities (654,337) (654,337)
-------------------------------------------------------------
Balance, December 31, 1996 250,000 3,050,000 231,541 1,532,261 5,063,802
Net income 94,688 94,688
Change in net unrealized gains on
available-for-sale securities (176,818) (176,818)
-------------------------------------------------------------
Balance, December 31, 1997 $250,000 $ 3,050,000 $ 54,723 $ 1,626,949 $4,981,672
============================================================
</TABLE>
See accompanying notes
23
<PAGE>
SBM Certificate Company
Statements of Cash Flows
<TABLE>
<CAPTION>
================================================================================================================
Year Ended December 31,
-----------------------------------------
1997 1996 1995
- ----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash flows provided by (used in) operating activities:
Net income $ 94,688 $ 731,981 $ 776,739
Adjustments to reconcile net income to cash flows provided
by operating activities:
Provision for certificate reserves 2,795,360 2,821,912 2,929,357
Realized investment (gains) losses 268,002 (485,135) (283,885)
Deferral of acquisition costs (314,805) (263,788) (430,852)
Amortization of deferred acquisition costs and
renewal commissions 288,974 245,126 289,875
Other amortization and depreciation 465,553 530,429 228,861
Deferred tax expense (benefit) (162,627) 178,606 295,464
(Increase) decrease in dividends and interest receivable 205,442 (136,060) 34,571
Changes in other assets and liabilities 323,093 (40,816) 250,559
------------------------------------------
Cash flows provided by operating activities 3,963,680 3,582,255 4,090,689
Cash flows provided by (used in) investing activities:
Fixed maturity investments:
Purchases (79,455,679) (38,523,432) (44,224,876)
Maturities and redemptions 10,812,744 5,642,891 2,678,900
Sales 82,250,553 33,578,496 44,977,473
Sales, maturities and redemptions--mortgage loans 3,091 155,643 4,192,459
Additions to other invested assets -- -- (81,200)
Repayment of certificate loans, net 87,076 6,095 59,416
------------------------------------------
Cash flows provided by investing activities 13,697,785 859,693 7,602,172
Cash flows provided by (used in) financing activities:
Amounts paid to face-amount certificate holders (8,179,248) (6,063,787) (13,322,027)
Amounts received from face-amount certificate holders 325,456 968,537 2,498,761
Capital contribution -- -- 1,500,000
------------------------------------------
Cash flows used in financing activities (7,853,792) (5,095,250) (9,323,266)
------------------------------------------
Net change in cash and cash equivalents 9,807,673 (653,302) 2,369,595
Cash and cash equivalents at beginning of year 3,247,192 3,900,494 1,530,899
------------------------------------------
Cash and cash equivalents at end of year $ 13,054,865 $ 3,247,192 $ 3,900,494
==========================================
</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 (the "Acquisition"). On November 29,
1996, SBM Financial Services, Inc. changed its name to ARM Securities
Corporation ("ARM Securities"). 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 and is 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
certificate holders the original invested amount of the certificate, plus a
three-year fixed-rate return, at a given maturity date. The Company's face-
amount certificates are sold primarily in the Midwest. Face-amount certificates,
which are similar to bank certificates of deposit, generally compete with
various types of individual savings products offered by banks and insurance
companies that provide a fixed rate of return on investors' money.
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).
Investments
Fixed maturities 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 as a separate component
of shareholder's equity in accordance with Statement of Financial Accounting
Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and
Equity Securities." The amortized cost of fixed maturities classified as
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 investment income. 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 from the 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.
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
25
<PAGE>
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. The reserve accumulation rates, cash surrender values, and
certificate reserves, among other matters, are governed by the 1940 Act.
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 based on a proportionate share of
consolidated taxable income. Additionally, 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 was 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 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 operations 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
operations 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 and differing asset/liability
management strategies and expense allocation methodologies of ARM and SBM
management.
26
<PAGE>
<TABLE>
<CAPTION>
Seven
Months
Five Months Ended Year Ended
Ended December 31, December 31,
May 31, 1995 1995 1995
------------------------------------------
<S> <C> <C> <C>
Combined Condensed Statement of Operations:
Total investment income $ 2,013,780 $ 2,875,598 $ 4,889,378
Total investment and other expenses 511,343 446,250 957,593
Interest credited on 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
==========================================
Combined Condensed Statement of Cash Flows:
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:
Amounts paid to face-amount certificate holders (7,066,042) (6,255,985) (13,322,027)
Amounts received from face-amount certificate
holders 1,926,095 572,666 2,498,761
Capital contribution from SBM Life 1,500,000 -- 1,500,000
------------------------------------------
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>
27
<PAGE>
3. Investments
The amortized cost and estimated fair values of available-for-sale
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, 1997:
Fixed maturities:
U.S. Treasury securities and
obligations of U.S. government
agencies $11,343,142 $ 11,763 $ 2,985 $11,351,920
Obligations of state and political
subdivisions 387,196 12,225 -- 399,421
Foreign governments 450,960 -- 49,052 401,908
Corporate securities 5,102,468 40,992 -- 5,143,460
Asset-backed securities 1,033,932 -- 2,372 1,031,560
Mortgage-backed securities 27,284,744 121,331 119,474 27,286,601
--------------------------------------------------
Total fixed maturities 45,602,442 186,311 173,883 45,614,870
Equity securities 340,473 73,277 1,516 412,234
--------------------------------------------------
Total available-for-sale securities $45,942,915 $259,588 $175,399 $46,027,104
==================================================
December 31, 1996:
Fixed maturities:
U.S. Treasury securities and
obligations of U.S. government
agencies $ 3,467,777 $ -- $ 38,359 $ 3,429,418
Obligations of state and political
subdivisions 456,112 3,498 8,838 450,772
Foreign governments 951,123 13,000 5,893 958,230
Corporate securities 7,569,178 63,776 15,206 7,617,748
Asset-backed securities 5,131,230 3,763 35,468 5,099,525
Mortgage-backed securities 32,288,406 498,888 173,626 32,613,668
--------------------------------------------------
Total fixed maturities 49,863,826 582,925 277,390 50,169,361
Equity securities 493,912 53,270 2,588 544,594
--------------------------------------------------
Total available-for-sale securities $50,357,738 $636,195 $279,978 $50,713,955
==================================================
</TABLE>
28
<PAGE>
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 and
asset-backed securities provide for periodic payments throughout their life.
December 31, 1997
------------------------
Estimated
Fair
Cost Value
- ----------------------------------------------------------------------
Available-for-sale:
Due in one year or less $ 2,541,168 $ 2,549,592
Due after one year through five years 14,269,221 14,247,246
Due after five years through ten years 161,745 168,915
Due after ten years 225,450 230,506
Asset-backed securities 1,033,932 1,031,560
Mortgage-backed securities 27,284,744 27,286,601
Redeemable preferred stock 86,182 100,450
------------------------
Total fixed maturities $45,602,442 $45,614,870
========================
Gross gains of $765,664, $642,039, $815,733, and $7,399 and gross losses
of $1,082,809, $175,226, $148,041, and $321,399 were realized on sales of fixed
maturities classified as available-for-sale for the year ended December 31, 1997
and 1996, the seven months ended December 31, 1995 and the five months ended May
31, 1995, respectively.
Gross gains of $49,143, $23,980 and zero were recognized on equity
securities sold during 1997, 1996, and 1995, respectively. Gross losses of zero
for both 1997 and 1996, and $5,075 for 1995 were recognized on equity securities
sold. Gross losses of $64,732 were realized on the sale of substantially all
mortgage loans in December 1995.
29
<PAGE>
4. Certificate Reserves
Total certificate reserves at December 31 are summarized as follows:
<TABLE>
<CAPTION>
Minimum Additional
1997 1996 Interest Interest
----------------------------------------------------------
<S> <C> <C> <C> <C>
Fully-paid certificates:
Single-payment series 503 $41,533,024 $46,302,625 2.50% 1.85% to 4.60%
Installment 2,220,962 2,270,515 2.50% to 3.50% 1.50% to 2.75%
Optional settlement 521,643 592,513 2.50% to 3.00% 2.00% to 2.75%
Due to unlocated certificate
holders 2,878 2,878 None
-------------------------
44,278,507 49,168,531
Installment certificates:
Reserves to mature, by series:
120, 215, and 220 393,801 424,651 3.25% 1.75% to 2.00%
315 191,975 296,064 3.50% 1.50% to 1.75%
Advance payments 262,801 297,140 * *
-------------------------
848,577 1,017,855
-------------------------
Total certificate reserves $45,127,084 $50,186,386
=========================
</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 5.00% and will continue at that rate
through 1998.
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
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.
30
<PAGE>
<TABLE>
<CAPTION>
December 31, 1997 December 31, 1996
-------------------------------------------------
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 $45,614,870 $45,614,870 $50,169,361 $50,169,361
Equity securities 412,234 412,234 544,594 544,594
Certificate loans 186,292 186,292 273,368 273,368
Other invested assets 471,992 471,992 523,083 523,083
Cash and cash equivalents 13,054,864 13,054,864 3,247,192 3,247,192
Other assets 42,948 42,948 66,163 66,163
Liabilities:
Certificate reserves 45,127,084 45,340,626 50,186,386 50,767,396
Accounts payable and other liabilities 330,686 330,686 29,940 29,940
</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.
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.
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 5.25%
at December 31, 1997 and 1996.
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.
31
<PAGE>
6. Federal Income Taxes
Deferred federal income taxes reflect 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, 1997 and December 31, 1996 were:
<TABLE>
<CAPTION>
December 31,
----------------------
1997 1996
- ------------------------------------------------------------------------ ----------------------
<S> <C> <C>
Deferred tax liabilities:
Real estate limited partnership $ 99,798 $ 178,736
Net unrealized gains on available-for-sale securities 29,466 124,676
Other 2,932 --
-----------------------
Total deferred tax liabilities 132,196 303,412
Deferred tax assets:
Fixed maturities 19,568 45,524
Other investments 93,789 93,789
Fixed assets 38,677 38,149
Capital loss carryover 281,842 363,267
Other -- 31,785
-----------------------
Total deferred tax assets 433,876 572,514
Valuation allowance for deferred tax assets (400,000) (714,521)
-----------------------
Net deferred tax assets 33,876 (142,007)
-----------------------
Deferred tax liabilities shown on the accompanying balance sheets $ 98,320 $ 445,419
=======================
</TABLE>
The components of the provision for federal income tax expense consist of the
following:
Year Ended December 31,
--------------------------------
1997 1996 1995
--------------------------------
Current $ 182,426 $227,617 $214,110
Deferred (162,627) 178,606 295,464
--------------------------------
Total federal income tax expense $ 19,799 $406,223 $509,574
================================
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.
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 are applied to first reduce the balance of goodwill. During
1997 and 1995, goodwill was reduced by $89,262 and $189,251, respectively, as a
result of realizing such benefits. No such benefits were realized in 1996. The
1997 reduction in the valuation allowance of $314,521 reduced the goodwill
balance to zero.
Federal income tax expense differs from that computed by using the federal
income tax rate of 35% as shown below.
32
<PAGE>
<TABLE>
<CAPTION>
Seven Months Five Months
Year Ended December 31, Ended Ended
---------------------------- December 31, May 31,
1997 1996 1995 1995 1995
-------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Income tax expense (benefit) at
statutory rate $ 40,070 $398,371 $450,209 $462,915 $(12,706)
Tax-exempt interest (5,677) (7,283) (7,256) (3,350) (3,906)
Dividend received deduction (12,457) (12,577) (14,379) (8,000) (6,379)
Goodwill amortization 8,342 27,938 32,287 32,287 --
Taxable proceeds from life
insurance -- -- 38,482 38,482 --
Other (10,479) (226) 10,231 -- 10,231
-------------------------------------------------------
Total federal income tax
expense (benefit) $ 19,799 $406,223 $509,574 $522,334 $(12,760)
=======================================================
</TABLE>
The Company files a consolidated federal income tax return with its
non-life insurance affiliates. Pursuant to the tax sharing agreement, the
consolidated income tax liability is allocated among the companies based upon
each members' proportionate share of taxable income with current credit being
given for losses utilized against other members' taxable income. The allocated
tax liabilities are settled timely upon the completion of the annual
consolidated federal return. At December 31, 1997 and 1996, $124,435 and
$213,902 were due to ARM, respectively, related to the tax sharing agreement.
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 its subsidiaries'
business activities. The allocations were $246,468 for both the years ended
December 31, 1997 and 1996, $151,967 and $206,519 for the seven months ended
December 31, 1995 and the five months ended May 31, 1995, respectively.
Management believes that the methods used to allocate such expenses are
reasonable. The Company owns and pays operating expenses for a building used by
SBM (prior to the Acquisition) and its affiliates.
The Company has paid ARM Securities, an affiliate, $314,805, $263,089 and
$443,579 for the years ended 1997, 1996 and 1995, 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 ($45.4 million and $50.4 million at December 31, 1997 and
1996, respectively). The Company had qualified assets of $60.0 million and $55.1
million at those respective dates (which excludes $0.1 million and $0.4 million,
respectively, of unrealized pretax gains 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 District of Columbia Insurance
Laws (the "D.C. Laws") as required by the 1940 Act. Qualified assets for which
no provision for valuation is made in the D.C. Laws are valued in accordance
with rules, regulations, or orders prescribed by the Securities and Exchange
33
<PAGE>
Commission. These values are the same as the financial statement carrying
values, 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 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 at amortized cost for
purposes of this calculation. Under this formula, the Company's capital ratio
was 8.2% and 8.7% at December 31, 1997 and 1996, respectively. 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, 1997 and 1996 as shown in the
following table. Certificate loans, secured by applicable certificate reserves,
are deducted from certificate reserves in computing deposit requirements.
1997 1996
------------------------
Assets on deposit with:
Central depositary $48,664,004 $51,522,592
State governmental authorities 245,772 245,102
------------------------
Total deposits $48,909,776 $51,767,694
========================
Required deposits (certificate reserves less
certificate loans plus $250,000) $45,190,792 $50,163,018
========================
Assets on deposit consisted of the following at December 31:
1997 1996
------------------------
Investment securities, at cost plus accrued interest $48,437,784 $51,244,584
First mortgage loans 960 4,068
Other assets on deposit, at cost 471,032 519,042
------------------------
Total deposits $48,909,776 $51,767,694
========================
34
<PAGE>
Part II
Item 13 Other Expenses of Issuance and Distribution
*Fees and expenses of accountants $12,000
*Costs of Printing $20,000
*Legal Fees $1,000
Registration Fees --
Federal Taxes --
State Taxes and Fees --
Trustee and Transfer Agency Fees --
Premium on Indemnification Policy --
-------
Total $33,000
=======
* Estimated
Item 14 Indemnification of Directors and Officers
Pursuant to the Company's Articles of Incorporation, the liability of the
Company's directors is limited to the fullest extent permitted by applicable
Minnesota law, except as prohibited by the Investment Company Act of 1940.
Minnesota law allows the elimination of a director's personal liability to a
corporation or its shareholders for monetary damages for breach of fiduciary
duty as a director, except liability for a breach of the duty of loyalty, acts
or omissions 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. Under the Investment
Company Act of 1940 directors may not be protected by indemnification or other
means from liability for willful misfeasance, bad faith, gross negligence or
reckless disregard of their duties ("disabling conduct").
The Company's By-Laws provide for indemnification of officers and directors to
the fullest extent permitted by applicable Minnesota law. Minnesota law requires
indemnification as long as the party charged acted in good faith, derived no
improper personal benefit, had no reasonable cause to believe his or her act was
unlawful and believed the act to be in the best interest of the corporation.
However, in accordance with the Company's By-Laws, such indemnification is only
allowed if either a court, a majority of a quorum of non-party, non-interested
directors, or an independent legal counsel affirmatively determines that the
officer, director or adviser involved is not liable for any disabling conduct.
In addition, the Company may not make any advances in payment for expenses
incurred by officers, directors or advisers unless such a party undertakes in
writing to repay any such advance and posts security for such undertaking, or if
the Company's insurance would cover a default on such an undertaking, or if the
majority of a quorum of non-party directors or independent legal counsel
determine such advance is justified due to the officer's, director's or
adviser's likely success on the merits.
Item 15 Not Applicable
Item 16(a) Exhibits
(1) Underwriting Agreement by and between the Company and ARM Securities
Corporation (formerly SBM Financial Services, Inc.) dated June 14, 1995
incorporated by reference to Exhibit 1 to Form S-1 Registration Statement of SBM
Certificate Company (File No. 33-38066) filed on March 5, 1996.
(3)(i) Articles of Incorporation of SBM Certificate Company incorporated by
reference to Exhibit 3(i) to Form S-1 Registration Statement of SBM Certificate
Company (File No. 33-38066) filed on December 4, 1990.
(3)(ii) By-Laws of SBM Certificate Company incorporated by reference to Exhibit
3(ii) to Form S-1 Registration Statement of SBM Certificate Company (File No.
33-38066) filed on December 4, 1990.
35
<PAGE>
(4) Form of Series 503 Certificate incorporated by reference to SBM Certificate
Company Registration Statement of Face- Amount Certificate Company on Form
N-8B-4 (File No. 811-6268) filed on April 1, 1991.
(5) Opinion of John R. McGeeney (filed herewith).
(10) Material contracts
(a) Lease by and between the Company and State Bank & Trust Company of New Ulm
dated August 13, 1992, incorporated by reference to Form 10-K of SBM Company
(File No. 811-407) filed on March 31, 1993.
(b) Underwriting Agreement by and between the Company and ARM Securities
Corporation (formerly SBM Financial Services, Inc.) dated June 14, 1995
incorporated by reference to Exhibit 1 to Form S-1 Registration Statement of SBM
Certificate Company (File No. 33-38066) filed on March 5, 1996.
(c) Administrative Services Agreement by and between the Company and ARM
Financial Group, Inc. dated as of June 14, 1995 incorporated by reference to
Exhibit 1 to Form S-1 Registration Statement of SBM Certificate Company (File
No. 33- 38066) filed on March 5, 1996.
(d) Investment Services Agreement by and between the Company and ARM Financial
Group, Inc. dated June 14, 1995 incorporated by reference to Exhibit 1 to Form
S-1 Registration Statement of SBM Certificate Company (File No. 33- 38066) filed
on March 5, 1996.
(e) Custody Agreement, as amended and supplemented, between the Company and
First Bank National Association dated December 20, 1990, incorporated by
reference to Exhibit 10(b) to Form S-1 Registration Statement of SBM Certificate
Company (File No. 33-38066) filed on January 2, 1991.
(f) Form of Tax Allocation Agreement which will be entered into by and among the
Company, ARM, and certain ARM subsidiaries for taxable periods beginning January
1, 1995 incorporated by reference to Exhibit 1 to Form S-1 Registration
Statement of SBM Certificate Company (File No. 33-38066) filed on March 5, 1996.
(g) Policies on Asset/Liability Risk Management and Investment Management,
adopted as of March 19, 1997 incorporated by reference herein to Exhibit 10(g)
to Form S-1 Registration Statement of SBM Certificate Company (File No.
33-38066) filed herewith.
(h) Indemnification Agreement by and between ARM Financial Group, Inc. dated
June 26, 1997 incorporated by reference herein to Exhibit 10(h) to Form S-1
Registration Statement of SBM Certificate Company (File No. 33-38066) filed
herewith.
(23) Consent of Ernst & Young LLP dated February 23, 1998 (filed herewith).
(27) Financial Data Schedule - Not Applicable
Item 16(b) Financial Statement Schedules
Report of Independent Auditors
Schedule I Investments in Securities of Unaffiliated Issuers - December
31, 1997
Schedule V Qualified Assets on Deposit- December 31, 1997
Schedule VI Certificate Reserves - Year Ended December 31, 1997
Schedule XII Valuation and Qualifying Accounts - December 31, 1997
Schedules I, V, and VI as of or for the year ended December 31, 1996 in the
Company's Post Effective Amendment No. 8 to Registration Statement on Form S-1
filed February 28, 1997 (File No. 33-38066) are incorporated by reference
herein.
36
<PAGE>
Schedules I, III, V, and VI for the year ended December 31, 1995 in the
Company's Post Effective Amendment No. 7 to Registration Statement on Form S-1
filed March 5, 1996 (File No. 33-38066) are incorporated by reference herein.
Schedules required by Article 6 of Regulation S-X for face-amount certificate
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.
Item 17 Undertakings
Insofar as indemnification for liabilities arising under the Securities Act of
1933 (the "1933 Act") may be permitted to directors, officers and controlling
persons of the Company pursuant to the foregoing provisions, or otherwise, the
Company has been advised that in the opinion of the Securities and Exchange
Commission such indemnification is against public policy as expressed in the
1933 Act and is, therefore, unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment by the Company
of expenses incurred or paid by a director, officer or controlling person of the
Company in the successful defense of any action, suit or proceeding) is asserted
by such director, officer or controlling person in connection with the
securities being registered, the Company will, unless in the opinion of its
counsel the matter has been settled by controlling precedent, submit to a court
of appropriate jurisdiction the question whether such indemnification by it is
against public policy as expressed in the 1933 Act and will be governed by the
final adjudication of such issue.
37
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the Company has duly
caused this registration statement to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of Louisville, Commonwealth
of Kentucky, on February 26, 1998.
SBM Certificate Company
By:/s/John R. McGeeney
- ----------------------------------
John R. McGeeney, President
Pursuant to the requirements of the Securities Act of 1933, this registration
statement has been signed by the following persons in the capacities and on the
dates indicated.
Principal Executive Officer:
/s/John R. McGeeney 02/26/98
- ------------------------- --------
John R. McGeeney Date
Chairman of the Board and President
Principal Financial Officer:
/s/Edward L. Zeman 02/26/98
- ------------------------- --------
Edward L. Zeman Date
Executive Vice President--Chief
Financial Officer
Principal Accounting Officer:
/s/Barry G. Ward 02/26/98
- ------------------------- --------
Barry G. Ward Date
Directors:
/s/Steven B. Bing 02/26/98
- ------------------------- --------
Steven B. Bing Date
/s/John R. McGeeney 02/26/98
- ------------------------- --------
John R. McGeeney Date
/s/Theodore S. Rosky 02/26/98
- ------------------------- --------
Theodore S. Rosky Date
/s/Walter L. Sales 02/26/98
- ------------------------- --------
Walter L. Sales Date
38
<PAGE>
SBM Certificate Company
Index to Financial Statement Schedules
December 31, 1997
Page
----
Report of Independent Auditors on Financial Statement Schedules..............S-2
Schedule I Investments in Securities of Unaffiliated Issuers.............S-3
Schedule V Qualified Assets on Deposit.................................. S-7
Schedule VI Certificate Reserves......................................... S-8
Schedule XII Valuation and Qualifying Accounts............................S-14
Schedules required by Article 6 of Regulation S-X 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.
39
<PAGE>
Report of Independent Auditors
Board of Directors
SBM Certificate Company
We have audited the financial statements of SBM Certificate Company as of
December 31, 1997 and 1996, and for each of the three years in the period ended
December 31, 1997, and have issued our report thereon dated February 9, 1998
(included elsewhere in this Registration Statement). Our audit also included the
financial statement schedules listed in Item 16(b) of this Registration
Statement. These schedules are the responsibility of the Company's management.
Our responsibility is to express an opinion based on our audits.
In our opinion, the financial statement schedules referred to above, when
considered in relation to the basic financial statements taken as a whole,
present fairly in all material respects the information set forth herein.
/s/ Ernst & Young LLP
Louisville, Kentucky
February 9, 1998
40
<PAGE>
Schedule I - Investments in Securities of Unaffiliated Issuers
December 31, 1997
<TABLE>
<CAPTION>
Principal
Name of Issuer and Title of Issue Amount Cost (a)(b) Value (a)
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
FIXED MATURITIES AVAILABLE-FOR-SALE:
U.S. Treasury Securities:
U.S. Treasury Note, 5.5%, due 11/15/1998 $ 530,000 $ 531,173 $ 529,422
U.S. Treasury Note, 5.625%, due 10/31/1999 650,000 650,495 649,389
U.S. Treasury Note, 5.625%, due 12/31/1999 5,000,000 4,994,141 4,997,650
U.S. Treasury Note, 5.5%, due 4/15/2000 195,000 193,006 194,208
U.S. Treasury Note, 5.625%, due 12/31/2002 5,000,000 4,974,327 4,981,251
------------------------
11,343,142 11,351,920
Obligations of State and Political Subdivisions:
Belmont County, Ohio, Sanitary Sewer District #3 Waterworks
Revenue Bonds, 4.25%, due 4/01/2004 30,000 28,130 29,625
Chelan County, Washington, Public Utility District #1, Rocky Reach
Hydroelectric Revenue Bonds, 5%, due 7/01/2013 111,000 110,998 111,032
Columbia, Washington, Storage Power Exchange, 3.875%, due
4/01/2003 105,000 105,000 109,305
Douglas County, Washington, Public Utilities District #1, Wells
Hydroelectric Revenue Bonds, 4%, due 9/01/2018 55,000 46,144 50,399
North Marshall, Kentucky, Water District, 5%, due 5/01/2006 30,000 28,615 29,985
Yuba County, California, Water Agency Bonds, 4%, due 3/01/2016 75,000 68,309 69,075
------------------------
387,196 399,421
Foreign Government:
Korea Development Bank, 6.5%, due 11/15/2002 450,000 450,960 401,908
Corporate Securities:
Financial Institutions:
Chrysler Financial Corp., 7.85%, due 10/13/1998 1,000,000 1,011,047 1,013,920
Ford Motor Credit Corp., 5.625%, due 1/15/1999 1,000,000 992,085 995,220
Goldman Sachs Group, 144A, 6.875%, due 9/15/1999 1,000,000 1,004,680 1,015,110
Lehman Brothers Holding, 5.75%, due 2/15/1998 1,000,000 998,947 1,006,250
------------------------
4,006,759 4,030,500
</TABLE>
42
<PAGE>
Schedule I - Investments in Securities of Unaffiliated Issuers (continued)
<TABLE>
<CAPTION>
December 31, 1997
Principal
Amount or
Number of
Name of Issuer and Title of Issue Shares Cost (a)(b) Value (a)
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
FIXED MATURITIES AVAILABLE-FOR-SALE (continued):
Corporate Securities (continued):
Public Utilities (c):
Laclede Gas Co., Series B, 5%, due 3/31/2011 3,000 $ 54,531 $ 66,750
Nicor Inc, 5%, due 5/01/2009 800 31,651 33,700
----------------------
86,182 100,450
Tobacco Products:
Philip Morris, 7.375%, due 2/15/1999 $1,000,000 1,009,527 1,012,510
----------------------
TOTAL CORPORATE SECURITIES 5,102,468 5,143,460
Asset-Backed Securities:
Auto Receivable 96-C A, 7.3%, due 5/10/2002 651,845 650,958 648,586
FASCO Auto Trust 96-AA, 9.504%, due 9/10/2001 503,913 382,974 382,974
----------------------
1,033,932 1,031,560
Mortgage-Backed Securities:
Blackrock Capital Finance BCF 97-R1 WAC, 6.243476%, due
3/25/2027 963,873 955,088 963,877
Capstead Securities Corporation IV 1992-4 I, 5.957%, due 3/25/2022 3,000,000 2,940,468 2,950,290
Countrywide Mortgage-Backed 94-14 A1, 8.22854%, due 7/25/2024 356,172 363,821 357,063
Federal Home Loan Mortgage Corporation:
6.7626%, due 9/15/2027 5,730,000 5,759,338 5,792,629
7%, due 5/15/2024 1,248,402 1,241,743 1,246,841
7.25%, due 3/15/2022 179,398 179,799 181,640
Federal National Mortgage Association:
5.957%, due 2/25/2023 1,849,014 1,801,886 1,821,278
6.6875%, due 2/18/2027 3,300,000 3,308,245 3,304,125
7.5%, due 9/18/2022 7,177,124 7,220,428 7,112,601
8%, due 1/18/2027 775,000 777,252 812,781
9%, due 4/01/2021 43,105 45,004 46,488
Government National Mortgage Association:
6.5%, due 1/20/2026 859,028 874,295 880,237
11.5%, due 4/15/2013 1,443 1,603 1,660
11.5%, due 8/15/2013 937 1,041 1,077
</TABLE>
43
<PAGE>
Schedule I - Investments in Securities of Unaffiliated Issuers (continued)
<TABLE>
<CAPTION>
December 31, 1997
Principal
Amount or
Number of
Name of Issuer and Title of Issue Shares Cost (a)(b) Value (a)
- ------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
FIXED MATURITIES AVAILABLE-FOR-SALE (continued)
Mortgage-Backed Securities (continued):
Government National Mortgage Association (continued):
11.5%, due 3/15/2015 $ 526 $ 585 $ 608
11.5%, due 5/15/2015 644 716 746
Headlands Mortgage Securities, Inc. 1997-5 AI7,
7.25%, due 11/25/2027 1,800,000 1,813,432 1,812,660
------------------------
27,284,744 27,286,601
------------------------
TOTAL FIXED MATURITIES AVAILABLE-FOR-SALE 45,602,442 45,614,870
EQUITY SECURITIES:
Industrial:
Aluminum Co of America (d) 200 11,200 14,313
LTV Corporation (e) 180 2,520 1,777
------------------------
13,720 16,090
Public Utilities:
Carolina Power & Light 500 31,782 38,750
Connecticut Light and Power Co. 400 10,050 9,276
Duquesne Light Co. 400 10,800 14,200
Entergy Louisiana, Inc. 500 31,852 35,900
Entergy New Orleans, Inc. 600 31,902 35,982
GTE Fla Inc. 1,500 25,875 33,188
Illinois Power Co. 600 16,050 22,575
Kansas City Power and Light Co. 200 11,586 11,638
Midamerican Energy Co. 600 34,200 42,300
Pacificorp 500 30,604 34,995
Pennsylvania Power Co. 200 8,838 12,026
Public Service Company of Colorado 600 37,214 43,314
San Diego Gas & Electric Co, 4.40% 4,000 46,000 62,000
------------------------
326,753 396,144
------------------------
TOTAL EQUITY SECURITIES 340,473 412,234
------------------------
TOTAL INVESTMENTS IN SECURITIES OF UNAFFILIATED ISSUERS $45,942,915 $46,027,104
========================
</TABLE>
Schedule I - Investments in Securities of Unaffiliated Issuers (continued)
44
<PAGE>
December 31, 1997
(a) See Note 1 to the financial statements regarding the determination of cost
and fair value.
(b) The aggregate cost of investments in securities of unaffiliated issuers
for federal income tax purposes was $46,273,807 at December 31, 1997.
(c) These securities are redeemable preferred stocks.
(d) This security is a non-redeemable preferred stock.
(e) This security is a common stock and is non-income producing.
45
<PAGE>
Schedule V -- Qualified Assets on Deposit
December 31, 1997
<TABLE>
<CAPTION>
First
Mortgages
and Other
First Liens
Investments on
Name of Depositary Cash in Securities Real Estate Other Total
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
State governmental authorities:
Securities Department
of Illinois $ -- $ 245,772 $ -- $ -- $ 245,772
Central depositary:
First Trust, National Association -- 48,192,012 960 471,032 48,664,004
-----------------------------------------------------------------
Total qualified assets on deposit $ -- $48,437,784 $ 960 $ 471,032 $48,909,776
=================================================================
</TABLE>
46
<PAGE>
Schedule VI -- Certificate Reserves
Part I-Summary of Changes
Year Ended December 31, 1997
<TABLE>
<CAPTION>
Balance at Beginning of Year Additions
------------------------------------- ------------------------------------------
Reserves
Number of (including Reserve
Accounts advance Payments Charged
with Amount of payments) by to Other
Yield Security Maturity with Accrued Charged Certificate Accounts
Description Percent Holders Value Interest to Income Holders (a)
- -------------------------------------------------------------------------------------- ------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Reserves to mature,
installment certificates:
Series 120 2.75 25 $ 129,000 $ 479,673 $ 16,886 $ 4,327 $ --
Series 215 2.41 2 4,800 1,330 (26) -- --
Series 220 2.75 18 91,000 190,785 8,896 3,322 --
Series 315 2.66 80 278,300 346,067 12,891 10,810 --
Single payment
certificates:
Series 503 2.50 4,195 45,751,722 46,302,625 2,651,611 306,998 --
Fully paid installment
certificates 2.50 505 2,537,681 2,270,515 109,014 172,252
Optional settlement
certificates:
Paid-Up certificates 2.50 19 9,678 9,149 250 -- --
Annuities 3.00 52 567,197 583,364 24,737 -- 83,739
Due to unlocated
certificate holders None 24 2,878 2,878 -- -- --
-------------------------------------- ------------------------------------------
Total 4,920 $49,372,256 $50,186,386 $ 2,824,259 $ 325,457 $ 255,991
====================================== ==========================================
Total charged to income, per above $ 2,824,259
Less reserve recoveries from
terminations prior to maturity (28,899)
-----------
Interest credited on certificate reserves,
per statement of operations $ 2,795,360
===========
</TABLE>
Notes to Part I
(a) Transfer to/from other certificate reserves upon conversion.
(b) Direct interest payment to certificate holders.
47
<PAGE>
Schedule VI -- Certificate Reserves (continued)
Part I - Summary of Changes (continued)
Year Ended December 31, 1997
<TABLE>
<CAPTION>
Deductions Balance at End of Year
------------------------------------------ ---------------------------------------
Reserves
Number of (including
Cash Accounts advance
Surrenders with Amount of payments)
Prior to Security Maturity with Accrued
Description Maturities Maturity Other (a)(b) Holders Value Interest
- ----------------------------------------------------------------------------------- ---------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Reserves to mature, installment
certificates:
Series 120 $ -- $ 21,994 $ 40,831 22 $ 115,000 $ 438,061
Series 215 -- 1,304 -- -- -- --
Series 220 -- 11,754 1,622 16 83,000 189,627
Series 315 64,272 32,329 52,278 52 180,400 220,889
Single payment certificates:
Series 503 5,014,960 2,431,675 281,575 3,655 40,229,971 41,533,024
Fully paid installment certificates 9,026 161,993 159,800 490 2,514,514 2,220,962
Optional settlement certificates:
Paid-up certificates -- -- 2,305 18 7,374 7,094
Annuities 171,151 6,140 -- 51 501,684 514,549
Due to unlocated certificate holders -- -- -- 24 2,878 2,878
------------------------------------------ ---------------------------------------
Total $ 5,259,409 $ 2,667,189 $ 538,411 4,328 $43,634,821 $45,127,084
========================================== =======================================
</TABLE>
48
<PAGE>
Schedule VI -- Certificate Reserves (continued)
Part II - Information Regarding Installment Certificates
Classified by Age Groupings
Year Ended December 31, 1997
<TABLE>
<CAPTION>
Balance at Beginning of Year
---------------------------------------------------------------
Number of
Age Grouping In Accounts with Amount of Amount of
Years Security Holders Maturity Value Reserves
---------------------------------------------------------------
<S> <C> <C> <C> <C>
Series:
120 21 1 $ 8,000 $ 8,185
22 1 3,000 3,682
23 1 6,000 12,307
30 1 5,000 12,060
31 1 6,000 14,572
32 1 6,000 15,714
33 1 3,000 8,527
34 1 6,000 18,762
35 -- -- --
36 1 5,000 19,288
37 3 26,000 106,880
38 4 17,000 72,665
39 7 30,000 136,479
40 2 8,000 39,002
Interest reserve 303
Accrued interest payable 11,247
---------------------------------------------
Total 25 $ 129,000 $ 479,673
=============================================
Series:
215 6 2 $ 4,800 $ 1,271
Interest reserve 33
Accrued interest payable 26
---------------------------------------------
Total 2 $ 4,800 $ 1,330
=============================================
</TABLE>
49
<PAGE>
Schedule VI -- Certificate Reserves (continued)
Part II - Information Regarding Installment Certificates
Classified by Age Groupings (continued)
Year Ended December 31, 1997
<TABLE>
<CAPTION>
Deductions Balance at end of year
--------------------- -----------------------------------------------
Number of
Cash Accounts
Surrenders Age with Amount of
Prior to Grouping Security Maturity Amount of
Maturity Other In Years Holders Value Reserves
----------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Series:
120 $ -- $ -- 21 $ -- $ -- $ --
-- -- 22 1 8,000 8,710
-- -- 23 2 9,000 16,494
-- -- 30 1 5,000 12,159
-- -- 31 -- -- --
-- -- 32 1 6,000 15,569
-- -- 33 1 6,000 16,727
-- -- 34 1 3,000 9,079
-- -- 35 1 6,000 19,954
-- -- 36 -- -- --
-- -- 37 2 15,000 62,183
21,994 -- 38 1 10,000 43,551
-- -- 39 3 12,000 54,458
-- -- 40 8 35,000 169,126
Interest reserve 303
Accrued interest payable 9,748
-------------------- --------------------------------
Total $ 21,994 $ -- 22 $115,000 $438,061
==================== ================================
Series:
215 $ 1,304 -- 6 $ -- $ -- $ --
Interest reserve --
Accrued interest payable --
-------------------- --------------------------------
Total $ 1,304 $ -- $ -- $ --
==================== ================================
</TABLE>
50
<PAGE>
Schedule VI -- Certificate Reserves (continued)
Part II - Information Regarding Installment Certificates
Classified by Age Groupings (continued)
Year Ended December 31, 1997
<TABLE>
<CAPTION>
Balance at Beginning of Year
-------------------------------------------------------
Number of
Accounts with
Age Grouping Security Amount of Amount of
In Years Holders Maturity Value Reserves
--------------------------------------------- ---------
<S> <C> <C> <C> <C>
Series:
220 10 1 $ 4,000 $ 1,552
20 1 12,000 11,301
21 -- -- --
26 1 4,000 6,827
28 1 6,000 12,036
29 7 35,000 76,544
30 3 12,000 29,332
31 4 18,000 47,302
32 -- -- --
Interest reserve 1,385
Accrued interest payable 4,506
--------------------------------------------
Total 18 $ 91,000 $190,785
============================================
Series:
315 5 1 $ 2,200 $ 503
7 1 2,200 711
9 4 14,300 8,155
10 2 12,100 6,457
11 4 22,000 13,829
12 4 14,300 10,193
13 5 13,200 10,315
14 14 45,100 38,582
15 14 39,600 37,975
16 3 13,200 16,651
17 6 19,800 27,621
18 2 13,200 25,551
19 7 23,100 38,619
20 13 44,000 81,409
Interest reserve 21,319
Accrued interest payable 8,177
--------------------------------------------
Total 80 $278,300 $346,067
============================================
</TABLE>
51
<PAGE>
Schedule VI -- Certificate Reserves (continued)
Part II - Information Regarding Installment Certificates
Classified by Age Groupings (continued)
Year Ended December 31, 1997
<TABLE>
<CAPTION>
Deductions Balance at end of year
-------------------- ---------------------------------------------
Cash Number of
Surrenders Age Accounts Amount of
Prior to Grouping with Maturity Amount of
Maturity Other in Years Security Value Reserves
Holders
-------------------- ---------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Series:
220 $ -- $ -- 10 -- $ -- $ --
-- -- 20 -- -- --
-- -- 21 1 12,000 13,638
-- -- 26 1 4,000 7,079
-- -- 28 -- -- --
-- -- 29 1 6,000 12,869
-- -- 30 8 38,000 88,898
11,754 -- 31 1 5,000 12,539
-- -- 32 4 18,000 50,280
Interest reserve --
Accrued interest payable 4,324
-------------------- --------------------------------
Total $ 11,754 $ -- 16 $ 83,000 $189,627
==================== ================================
Series: $ -- $ -- 5 1 $ 2,200 $ 523
315 -- -- 7 1 2,200 741
2,436 -- 9 -- -- --
-- -- 10 3 9,900 6,842
-- -- 11 1 6,600 4,033
1,791 -- 12 4 22,000 15,499
-- -- 13 3 12,100 9,438
-- -- 14 6 15,400 13,334
2,512 -- 15 14 45,100 42,440
-- -- 16 3 6,600 7,154
13,006 -- 17 3 13,200 18,178
-- -- 18 5 22,000 39,140
8,211 -- 19 1 2,200 3,586
4,373 -- 20 7 20,900 38,258
Interest reserve 16,565
Accrued interest payable 5,158
-------------------- --------------------------------
Total $ 32,329 $ 0 52 $180,400 $220,889
==================== ================================
</TABLE>
52
<PAGE>
SBM Certificate Company
Schedule XII--Valuation and Qualifying Accounts
<TABLE>
<CAPTION>
Additions
-----------------------
Charged to
Beginning Charged to Other End of
Description of Year Expense Accounts Deductions Year
- ----------------------------------------------------------------------------------------------------------------------
(In thousands)
<S> <C> <C> <C> <C> <C>
Valuation allowance on deferred tax assets:
Year ended December 31:
1997 $ 714,521 -- -- $(314,521)(2) $ 400,000
1996 $ 714,521 -- -- -- $ 714,521
1995(3) $ 903,772(1) $(189,251)(2) $ 714,521
</TABLE>
(1) A valuation allowance for deferred tax assets on acquired capital losses
was established in connection with ARM's acquisition of the Company.
(2) In the event that deferred tax assets are recognized on deductible
temporary differences for which a valuation allowance was provided at the
date of an acquisition, such benefits are applied to first reduce the
balance of intangible assets related to the acquisition, and then income
tax expense. As such, the Company reduced its valuation allowance with an
offsetting reduction to goodwill. After goodwill was reduced to zero
during 1997, the reduction in valuation allowance resulted in a reduction
of income taxes.
(3) For the five months ended May 31, 1995, the valuation allowance on
deferred tax assets was zero.
53
<PAGE>
[SBM Certificate Company letterhead] EXHIBIT 5
March 2, 1998
SBM Certificate Company
515 W. Market Street
Louisville, KY 40202
Re: SBM Certificate Company - Series 503 Certificates
Dear Sirs:
This opinion is furnished in connection with the Registration Statement on Form
S-1 for SBM Certificate Company filed with the Securities and Exchange
Commission (the "SEC") under the Securities Act of 1933.
I have examined all such corporate records of SBM Certificate Company, the form
of the Series 503 Certificates issued (the "Certificates"), the prospectus
proposed to be issued by SBM Certificate Company in connection the sale of the
Certificates, and such other documents and such laws as I consider appropriate
as a basis for the opinion hereinafter expressed. On the basis of such
examination, it is my opinion that:
1. SBM Certificate Company is a corporation duly organized and validly
existing under the laws of the State of Minnesota.
2. SBM Certificate Company has corporate power and authority to issue and
sell face amount certificates on the forms examined by me.
3. The Board of Directors of SBM Certificate Company has, by resolution duly
adopted by it, approved the form of certificate, and the issuance and
sales thereof by ARM Securities Corporation when duly registered and
otherwise qualified for sale.
4. When the Certificates have been duly registered with the SEC under the
Securities Act of 1933, and the Certificates have been duly registered
under applicable state law, and the Certificates are sold pursuant to the
Underwriting Agreement between SBM Certificate Company and ARM Securities
Corporation, the Certificates will be legally issued and binding
obligations of SBM Certificate Company in accordance with their terms.
I hereby consent to the use of this opinion as an exhibit to the Registration
Statement on Form S-1.
Sincerely,
/s/ John R. McGeeney
<PAGE>
EXHIBIT 10 (g)
SBM CERTIFICATE COMPANY
Policies on Asset/Liability Risk Management and Investment Management
(ADOPTED AS OF MARCH 19, 1997)
Pursuant to this document, the Board of Directors of SBM Certificate Company
(the "Company") is endorsing and adopting the following Policies on
Asset/Liability Risk Management and Investment Management.
These policies are intended to facilitate the management of the investments of
the Company and are designed to provide the discretion and flexibility needed
to enable the Company to meet its investment objectives within the applicable
legal requirements. Every effort will be made to attain the investment
objectives contained in these policies within the applicable legal requirements.
I. POLICY ON ASSET/LIABILITY RISK MANAGEMENT
The Company follows a "minimized cost/optimized risk" strategy for
asset/liability risk management. In particular, that strategy is based on the
following principles:
1. NICHE MARKETING AND SERVICE ORIENTATION. The Company should focus
primarily on those market segments where it can have (or can develop) unique
competitive advantages. Advantages come when it consistently differentiates
itself with a highly-distinctive package of (i) products designed more closely
to each customer's needs than those of competitors and (ii) close, attentive,
timely and accurate ongoing service geared to the particular needs of each
customer. By avoiding "one-size-fits-all" or "me-too" approaches, the Company
can bring added value to its customers. Such approach generally builds brand
loyalty, enhances persistency, minimizes anti-selection and lessens the role of
price in the competitive equation.
2. COMPETITIVELY-ADVANTAGED COST STRUCTURE. The Company can minimize unit
operating costs by being easy for customers to deal with (rapid, accurate, as
close to each customer as that customer wants, and attentive to each customer's
particular needs). By engineering service processes, organizational structure
and culture to drive up customer value, both business persistency and market
pricing position can be enhanced.
3. INTEGRATED ASSET/LIABILITY RISK MANAGEMENT. Advantageous pricing, low
acquisition costs and low unit operating costs serve to bring in liabilities on
favorable terms. But to produce strong and predictable spreads between asset
and liability cash flows, more needs to be done. In particular, the Company
needs to:
(i) bring in only the "right" kinds of liabilities (properly and
consistently structured around low-risk asset strategies) from the "right"
kinds of customers (consistently underwritten for persistency);
<PAGE>
(ii) assume asset and liability risks that are principally
"analytical" (that is, quantifiable, hedgable or tradable), rather than
"event-related" (e.g., tied to credit quality); and
(iii) manage the asset/liability elements of the business as an
integrated whole in order to reduce risk for any given level of spreads
(e.g., the design and ongoing management of a product, its related
investment strategies and service supports will not be sequential processes
performed by distinct functional areas; rather, they will be a single
process performed by a cross-functional team).
By lowering the risks in products, the risk of losing money is substantially
reduced. That reduces the amount of capital needed to stand behind customer
obligations, which increases return on equity for any given level of
profitability.
II. APPROACHES TO ASSET/LIABILITY RISK MANAGEMENT
In accordance with the above three principles, the Board of Directors of
the Company endorses the following approaches to asset/liability risk
management:
1. ASSET/LIABILITY RISK MANAGEMENT. As to asset/liability risk management,
the Company shall (i) use price and cost advantages to minimize the need to
take cash flow mismatch and non-analytical investment risks, (ii) use iterative
modeling processes to evaluate and optimize risk/reward trade-offs, and
(iii) design individual products to be surplus-efficient.
2. LIABILITY MANAGEMENT. As to liability management, the Company shall
(i) incorporate non-price features in products that customers value and will pay
for, (ii) employ active management practices as to credited interest rates and
current customer marketing, (iii) use product balancing to dampen overall
portfolio spread volatility (e.g., assemble a mix of products with fixed and
floating credited interest rates tied to as many different points on the yield
curve as is possible), (iv) be a consistent marketer whether interest rates are
"too high" or "too low" (i.e., dampen cost of funds volatility through dollar
averaging of sales), and (v) diversify products, distribution channels and
customers (so no single event or person can materially alter sales or
persistency patterns).
3. ASSET MANAGEMENT. As to asset management, the Company shall (i)
diversify sectors, issuers and cash flow risk profiles, (ii) rotate sectors as
relative values change, (iii) alter credit quality (within tight tolerances) as
relative values change, (iv) alter duration and convexity (within tight
tolerances) as relative values change, and (v) use synthetics and derivatives
in order to (a) custom-design desired interest rate protections and cash flow
patterns to better match liabilities, (b) re-engineer to achieve desired asset
profiles at more favorable prices, and (c) maintain sufficient liquidity.
Management will notify the Board with respect to any changes in tolerances
established with respect to liquidity, credit quality, duration and convexity.
III. POLICY ON INVESTMENT MANAGEMENT
<PAGE>
1. AUTHORITIES. The Company is authorized to buy, sell, exchange, manage
and administer investments in bonds, notes, debentures, stocks, mortgages,
real estate, joint venture or partnership interests, options, warrants, futures
contracts, interest rate and currency swaps, or any other financial instrument
of similar investment nature howsoever characterized, whether public issues or
private placements, direct or indirect (i.e., guaranteed, lease, "take or pay"
contract, mortgage-backed pass-through or production payment), straight or
convertible, senior or subordinated, each such investment as specifically
authorized by the District of Columbia Insurance Statutes (the "D.C. Investment
Laws") and Section 28(b) of the Investment Company Act of 1940, as amended (the
"1940 Act"), or any successor thereto.
2. ACTIONS. All investments may be purchased and/or sold at the
discretion of the Company in accordance with the policies stated herein.
3. LIMITATIONS. The authorities provided herein are subject to the
investment limitations set forth on Exhibit A which in each case shall be at
least as restrictive as the applicable statutory or regulatory standard.
4. BOARD REVIEW. At least quarterly, written reports shall be presented
to the Company's Board of Directors describing all transactions and commitments
made on the Company's behalf during the quarter just past, as well as the
current financial position of the investments portfolio. A report shall be
presented to the Board at least quarterly confirming the Company's compliance
with these policies, including the applicable regulatory standards.
5. COMPLIANCE WITH APPLICABLE LAW. These investment policies will be
subject to all applicable laws and regulations, including those established
under the 1940 Act and the D.C. Investment Laws. In the event of any
discrepancy or any change in any statutory or regulatory standards or
interpretations, the policies set forth herein shall be automatically modified
to comply with such standards or interpretations. In the event of any conflict
between the Company's policies and any statutory or regulatory requirements of
applicable laws, such requirements shall take precedent over such policies and
shall be fully complied with. If the Company fails to comply with any
statutory, regulatory or policy standard, such failure shall be cured at the
earliest opportunity consistent with prudent business practice.
IV. OTHER INVESTMENT POLICIES
1. LIQUIDITY. The need to provide liquidity reserves in the form of
maturing liquid and short-term securities in the Company's portfolio is hereby
acknowledged. The size and character of these reserves will be set and
determined by the Company on an ongoing basis.
<PAGE>
2. DERIVATIVES ACTIVITIES. Subject to supervisory management by the
Company's Board and the Co-Chief Executive Officers of ARM Financial Group,
Inc. ("ARM"), and only to the extent permitted by the 1940 Act and the D.C.
Investment Laws, the Company may use derivative instruments (derivative
instruments can involve a material risk of loss of either interest or principal
(unrelated to credit risks) and can include, but are not limited to, IOs, POs,
residuals, inverse floaters, caps, floors, put and call options, swaps, interest
rate and currency futures, forwards, and swaptions) in order to:
(i) custom design desired interest rate protections and cash flow
patterns to better match liabilities and to adapt to changing market conditions
("hedging"); or
(ii) create desired asset or liability profiles at more favorable
prices than available in the cash market ("synthesizing").
All derivatives programs undertaken must be documented and specifically
authorized by the Co-Chief Executive Officers of ARM.
3. INTEREST RATE RISK. The Company shall engage in asset/liability risk
management practices designed to minimize the risk related to fluctuations in
asset values attributable to changes in market interest rates. The duration of
outstanding certificates shall be estimated by the Company and the assets of the
supporting portfolio shall be selected in a manner which reasonably approximates
the average duration for the liabilities. The asset portfolio shall reflect the
ability of the Company to change interest rates and to collect interest rate
cut-backs on certificates.
4. COUNTER-PARTY RISK. For this purpose, counter-party exposure is
determined at any point in time as the number of dollars that would be
potentially at risk, based on certain pre-determined economic scenarios
appropriate to the particular instrument involved. For any counter-party, other
than an exchange (which is judged to have no credit risk), the total dollar
exposure to any given counter-party shall not be in excess of 2% of the
Company's admitted assets. The minimum acceptable credit rating is NAIC 1 or
credit enhanced to be the equivalent of NAIC 1.
<PAGE>
EXHIBIT A 3/19/97
<TABLE>
<CAPTION>
AGGREGATE PER ISSUER PER COUNTRY
SBM CERTIFICATE COMPANY COMMENTS LIMIT LIMIT LIMIT
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Cash Equivalents CDs, BAs, or other bills of exchange None None
of the kind and maturities made
eligible by law for purchase in the
open market by Fed. Res. banks.(D.C.
Code Section 35-634(a)(8))
US Government Treasury Notes/Bonds Must be issued, or guaranteed or None None
insured as to principal and interest,
by the U.S. Treasury. (D.C. Code Secs.
35-634(a)(1)(A) and 35-634(a)(2))
US Government Agency Notes/Bonds: Must be issued, or guaranteed or None None
FHLB insured as to principal and interest,
FHLMC by the U.S. Government Agency. (D.C.
FNMA Code Secs. 35-634(a)(1)(A) and 35-
Private Export Funds 634(a)(2))
TVA
Exempt Obligations
Corporate Bonds - Domestic Issuer must be solvent and
NAIC 1 -- In compliance with Earnings None Not more
NAIC 2 Test set forth Footnote #1 than 2% of
NAIC 3 -- Have no defaults in interest admitted
NAIC 4 for 5 years on securities of assets in any
NAIC 5 equal or higher priority 1 issue of
NAIC 6 with those purchased. any 1 issuer
(D.C. Code Sec. 35-634(a)(7)(A))
Corporate Bonds - Foreign A foreign investment means non-U.S. or See See
NAIC 1 Canada. A company doing business in a Footnote #2 Footnote #2
NAIC 2 foreign country may invest the funds
NAIC 3 required to meet its obligations in
NAIC 4 such country in foreign bonds (subject
NAIC 5 to the parameters set forth in
NAIC 6 Footnote #2). (D.C. Code Sec. 35-
634(c))
Mortgage Loans Must be secured by a 1st lien and have None None
Residential at most a 75% Loan to Value Ratio.
Commercial (D.C. Code Sec. 35-634(a)(5)(A))
Mortgage Backed Securities - U.S. (D.C. Code Secs. 35-634(a)(1)(A) and None None
Government Agency Issuer 35-634(a)(2))
(FNMA, FHLMC, GNMA, RTC, FHA)
NAIC 1
- -----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
AGGREGATE PER ISSUER PER COUNTRY
SBM CERTIFICATE COMPANY COMMENTS LIMIT LIMIT LIMIT
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Mortgage Backed Securities - Non-Agency Treated as a basket investment unless None if None if
Issuer/Residential and Commercial Mortgages qualifying under Secondary Mortgage qualifying qualifying
NAIC 1 Market Enforcement Act of 1984 under SMMEA, under SMMEA,
NAIC 2 ("SMMEA") (see Footnote #3 for SMMEA otherwise otherwise
NAIC 3 eligibility). Basket* Basket*
NAIC 4
NAIC 5
NAIC 6
Asset Backed Securities (NAIC 1 - NAIC 6) Basket* Basket*
Automobile Loans
Credit Cards
Home Equity Loans
Leases
Manufactured Homes
Other
Preferred Stock - Domestic Subject to Earnings and Eligibility None Not more than
Test set forth in Footnote #4. (D.C. 1% of
Code Sec. 35-634(a)(9)(A)) admitted
assets in any
1 issue of
any 1 issuer
Municipals/Tax Exempt Bonds/Notes Must be (1) direct and general None None
obligations; or (2) payable out of
designated revenues pledged to the
payment of principal and interest
thereof. (D.C. Code Sec. 35-
634(a)(3))
Equities Five (5) year dividend history None Not more than
required. 1% of
Also, any preferred stock or bonds or admitted
other obligations of the issuer must assets in the
be eligible for investment in their common stock
own right under the above provisions. of any 1
(D.C. Code Sec. 35-634(a)(10)(A)) corporation
Derivative Instruments Basket* Basket*
I0s, Residuals, Inverse Floaters
Futures, Forwards, Swaps
Options, Caps, Floors
Investments in Mutual Funds Basket* Basket*
Foreign Currency Exposure Basket* Basket*
Real Estate No more than 2% of admitted assets per 5% for income
any 12 month period (subject to producing
certain additional restrictions set property,
forth in Footnote #5). (D.C. Code 10% overall
Sec. 35-634(d))
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
AGGREGATE PER ISSUER PER COUNTRY
SBM CERTIFICATE COMPANY COMMENTS LIMIT LIMIT LIMIT
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
*Basket Capacity (D.C. Code Sec. 35-634(e)) LESSER OF (in Not more than
aggregate): 1% of
(a) 5% of admitted
admitted assets in any
assets or 1 loan or
(b) capital, investment
surplus
and
contingency
reserves
in excess
of $1.5
million
</TABLE>
<PAGE>
FOOTNOTES
(1) An issuing corporation's net average yearly earnings available for its
fixed charges for the five (5) fiscal years next preceding acquisition of
such bonds and during the last year of such five (5) year period shall be
not less than one and one-half times its annual fixed charges at the time
of the investment. In the case of a new issue, the insurer must base this
determination on the corporation's pro forma statement. (See D.C. Code
Sec. 35-634(a)(7)(A)).
"Net earnings available for fixed charges" is the net income after
deducting all operating and maintenance expenses, depreciation and
depletion, and taxes other than federal, state, and District of Columbia
income taxes, but non-recurring items of income and expenses may be
eliminated. "Fixed charges" include interest on all of the fixed interest
bearing debt of the corporation outstanding and maturing in more than 1
year, as of the date of acquisition, and in case of investment in
contingent interest obligations, such term also includes maximum annual
contingent interest as of such date.
The earnings of all predecessor, merged, consolidated, or purchased
companies may be included through the use of pro forma or consolidated
statements provided the fixed charges of the included companies must also
be incorporated into the statements.
(2) A company doing business in a foreign country may invest the funds
required to meet its obligations in such country and in conformity to the
laws thereof in the same kind of securities in such foreign country that
such company is allowed by law to invest in the United States. (See D.C.
Code Sec. 35-634(c)). Assuming SBM Certificate Company does not do business
in any foreign countries, this section acts effectively as a complete
prohibition on the purchase of foreign bonds by SBM Certificate Company.
(3) Mortgage backed securities are eligible for SMMEA if they are (a)
secured by first mortgages on residential real estate, (b) originated by a
savings and loan, a savings bank, a commercial bank, a credit union, an
insurance company or a similar institution supervised by a federal or state
authority, and (c) rated in one of the two highest categories by at least
one nationally recognized statistical rating organization.
(4) A company may invest only in preferred stock of any solvent domestic
corporation (other than its own) that did not fail in any 1 of the 3
fiscal years next preceding the investment to have earned a sum applicable
to dividends on such preferred stock equal at least to 3 times the amount
of dividends due in that year. For a new issue of preferred stock, the
earnings applicable to dividends must be equal to at least 3 times the
amount of pro forma annual dividend requirements after giving effect to the
such new financing. In addition, a corporation's bonds and any other
evidences of indebtedness must also be eligible as investments under the
above provisions governing corporate domestic bonds and obligations. (See
D.C. Code Sec. 35-634(a)(9)(A)).
(5) Real estate may be acquired, held, and conveyed by the Company for
the following purposes and in the following manner: (A) the building in
which the Company has its principal office and the land on which it stands;
(B) such as shall be requisite for its convenient accommodation in the
transaction of its business; (C) such as shall have been acquired for
the accommodation of its business; (D) such as shall have been conveyed
to it in satisfaction of debts, previously contracted, in the course of its
dealings; (E) such as it shall have purchased at trustee sale or sales on
judgments, decrees, or mortgages obtained or made for such debts; and
(F) such as it may purchase or hold for the production of income. The total
value of real estate and improvements thereon acquired or held by a company
for the production of income under the provisions of this subparagraph at
any time must not exceed 5% of such company's admitted assets. Subject to
certain calculation adjustments, no real estate investments shall be made
by any company if such company then owns real estate having a total value
in excess of 10% of its admitted assets or if such investment will cause
such company's aggregate investments in real estate owned by it to exceed
10% its admitted assets. (For certain rules on maximum holding periods
and other limitations regarding real estate, please see D.C. Code
Sec. 35-634(d)).
<PAGE>
EXHIBIT 10 (h)
INDEMNIFICATION AGREEMENT
This Indemnification Agreement (this "Agreement") is made on this 26TH day
of JUNE, 1997 by and between ARM Financial Group, Inc. ("ARM"), a Delaware
corporation, and SBM Certificate Company (the "Company"), a Minnesota
corporation that is registered as a face amount certificate company under the
Investment Company of 1940.
It is understood and agreed between the parties that the Company has
acquired a directors and officers errors and omissions liability policy (the
"Policy") covering the directors and officers of the Company, and of ARM and
certain of its subsidiaries with respect to their activities on behalf of the
Company. The Policy, to be issued by National Union Fire Insurance Company, is
to have a limit of $10,000,000.00 per claim and in the aggregate, a premium of
$160,000.00, a deductible of $1,000,000.00 corporate coverage, and a term of one
year from the date the application for the Policy was submitted to the Company.
In consideration of the Company promising to keep the Policy in full force and
in effect, to provide notice to ARM in the event that the terms of the Policy
change in any way, and other good and valuable consideration, ARM hereby agrees
to indemnify and hold harmless the Company to the extent that the Company fails
to pay or is unable to pay the $1,000,000.00 corporate coverage deductible.
Nothing in this Agreement shall be deemed to create any rights in any
person or entity that is not a party to this Agreement. This Agreement
constitutes the entire understanding and agreement between the parties,
supersedes any and all prior understandings and agreements pertaining to the
subject of this Agreement, and may not be amended, modified or supplemented in
any way except by subsequent written agreement signed by both parties.
<PAGE>
IN WITNESS WHEREOF, the parties hereto have executed this agreement on and
as of the day and year first above written.
ARM FINANCIAL GROUP, INC.
/s/ John Franco
-----------------------------------
John Franco
Co-Chief Executive Officer
/s/ Martin H. Ruby
-----------------------------------
Martin H. Ruby
Co-Chief Executive Officer
SBM CERTIFICATE COMPANY
/s/ John R. McGeeney
-----------------------------------
John R. McGeeney
Chairman of the Board and President
<PAGE>
Exhibit 23
CONSENT OF INDEPENDENT AUDITORS
We consent to the reference to our firm under the captions "Experts" and
"Selected Financial Data" and to the use of our reports dated
February 9, 1998, in Post-Effective Amendment No. 9 to the Registration
Statement (Form S-1 No. 33-38066) and related Prospectus of SBM Certificate
Company.
/s/ Ernst & Young LLP
Louisville, Kentucky
February 23, 1998
