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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
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For the fiscal year ended: December 31, 1998 Commission file number: 811-6268
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SBM CERTIFICATE COMPANY
(Exact name of registrant as specified in its charter)
MINNESOTA 41-1671595
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
C/O ARM FINANCIAL GROUP, INC.
515 WEST MARKET STREET
LOUISVILLE, KENTUCKY 40202
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (502) 582-7900
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
/X/ Yes / / No
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. /X/
As of February 26, 1999, 250,000 shares of the registrant's common stock
were outstanding. The registrant is a wholly owned subsidiary and its common
stock is not traded on a public market.
DOCUMENTS INCORPORATED BY REFERENCE
None
The registrant meets the conditions set forth in General Instruction I (1)
(a) and (b) of Form 10-K and is therefore filing this Form with the reduced
disclosure format.
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TABLE OF CONTENTS
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ITEM PAGE
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PART I
1. Business.............................................................................................3
2. Properties...........................................................................................4
3. Legal Proceedings....................................................................................4
4. Submission of Matters to a Vote of Security Holders..................................................5
PART II
5. Market for Registrant's Common Equity
and Related Stockholder Matters....................................................................6
6. Selected Financial Data..............................................................................6
7. Management's Discussion and Analysis of
Financial Condition and Results of Operations......................................................6
8. Financial Statements and Supplementary Data.........................................................11
9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure............................................................12
PART III
10. Directors and Executive Officers of the Registrant..................................................13
11. Executive Compensation..............................................................................13
12. Security Ownership of Certain Beneficial Owners and Management......................................13
13. Certain Relationships and Related Transactions......................................................13
PART IV
14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K....................................14
Signatures..........................................................................................15
Index to Financial Statements......................................................................F-1
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PART I
ITEM 1. BUSINESS
(a) GENERAL DEVELOPMENT OF BUSINESS
SBM Certificate Company (the "Company") was incorporated in Minnesota
in June of 1990, to assume the face-amount certificate business of SBM
Company ("SBM"). Effective December 31, 1993, SBM transferred all of the
Company's shares of common stock to its wholly owned subsidiary, State Bond
and Mortgage Life Insurance Company ("SBM Life"). On June 14, 1995, the
Company became a wholly owned subsidiary of ARM Financial Group, Inc.
("ARM") pursuant to ARM's purchase of substantially all of the assets and
business operations of SBM (the "Acquisition"). ARM specializes in the
growing asset accumulation business with particular emphasis on retirement
savings and investment products. At December 31, 1998, ARM had $9.9 billion
of assets under management.
(b) FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS.
The Company has one business segment.
(c) NARRATIVE DESCRIPTION OF BUSINESS
The Company is an issuer of fixed-rate face-amount certificates
registered under the Investment Company Act of 1940, as amended (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 selects the interest rate offered on the face-amount
certificates based on the short to intermediate term sections of the yield
curve. 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. The Company's face-amount certificates are
sold primarily in the Midwest.
The Company's face-amount certificates are distributed by ARM
Securities Corporation ("ARM Securities"), a wholly owned subsidiary of
ARM, pursuant to an Underwriting Agreement. Prior to November 29, 1996, ARM
Securities operated under the name SBM Financial Services, Inc. ARM
Securities currently uses a network of independent agents to sell and
service the business. The Company continues to investigate opportunities to
expand upon its distribution channels. ARM Securities is registered with
the Securities and Exchange Commission (the "SEC") as a broker-dealer under
the provisions of the Securities Exchange Act of 1934, as amended.
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 ("net investment spread"). The Company's net income is
determined by deducting investment and other expenses and federal income
taxes from gross margin. The net investment spread is affected 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.
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The Company's face-amount certificate business competes in general with
various types of individual savings products which offer a fixed rate of
return on investors' money, especially insurance and bank products. Some of
these other products are insured by governmental agencies or funds or
independent third parties. The certificates offered by the Company are not
guaranteed or insured by any governmental agency or fund or independent
third party. The Company's business is highly competitive and the Company
competes with many other companies having greater financial resources,
larger sales forces, and greater access to customers. The Company's ability
to offer competitive interest rates, attractive terms, and efficient
service are the Company's primary basis for meeting competition. The
Company has no employees. Pursuant to an Investment Services Agreement and
an Administrative Services Agreement, the Company's operations are
administered and managed by ARM.
Like many financial services companies which offer investment
opportunities to the public, the Company is subject to regulation and
supervision by federal and state regulators. The 1940 Act and rules issued
by the SEC thereunder specify certain terms for face-amount certificates,
the method for calculating reserve liabilities on outstanding certificates,
the minimum amounts and types of investments to be deposited with a
qualified custodian to support such reserve liabilities, and a variety of
other restrictions on the operation and governance of a face-amount
certificate company. Pursuant to statutory authority, the Minnesota
Department of Commerce ("MDC") and the Illinois Secretary of State exercise
supervisory powers over the Company's face-amount certificate business
similar to those under the 1940 Act. In addition, the MDC conducts
examinations of the Company on a periodic basis. The offer and sale of the
Company's face-amount certificates also are subject to federal and state
securities laws.
(d) FINANCIAL INFORMATION ABOUT FOREIGN AND DOMESTIC OPERATIONS AND EXPORT
SALES
The Company has no foreign operations.
ITEM 2. PROPERTIES
The Company's and ARM's corporate executive offices (the "Corporate
Offices") are located at 515 West Market Street, Louisville, Kentucky. The
Corporate Offices are the location of the Company's executive officers and the
primary location for ARM's accounting, legal and marketing activities and
various other support personnel.
The Company's administrative offices are located in New Ulm, Minnesota, at
100 North Minnesota Street.
ITEM 3. LEGAL PROCEEDINGS
The Company is not a party to, nor is any of the Company's property the
subject of, any material pending legal proceedings, other than ordinary
litigation routine to the Company's business.
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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
This information is omitted in accordance with Instruction (I)(2)(c) to
Form 10-K.
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PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
There is currently no public market or trading in the common stock of the
Company. All of the Company's 250,000 outstanding shares of common stock are
held by ARM as of December 31, 1998. The Company has never paid cash dividends
on its common stock.
The Company is subject to two principal restrictions on its ability to pay
dividends in addition to the generally applicable restrictions and requirements
of Minnesota corporate law. First, pursuant to Section 28(b) of the 1940 Act,
the Company is required to establish and maintain qualified assets having a
value not less than the aggregate of certificate reserves plus $250,000. Second,
the MDC has determined that face-amount certificate companies such as the
Company should maintain a ratio of shareholder's equity to total assets of a
minimum of 5%. For purposes of determining compliance with both requirements,
assets are based upon a valuation of available-for-sale securities reflected at
amortized cost. The Company could not pay dividends if it did not meet both of
these two requirements or if payment of a dividend would cause it not to meet
such requirements. As of December 31, 1998, the Company had qualified assets in
excess of certificate reserves plus $250,000 of $3.9 million and total assets in
excess of the 5% ratio of $3.0 million.
ITEM 6. SELECTED FINANCIAL DATA
This information is omitted in accordance with Instruction (I)(2)(a) to
Form 10-K.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS
1998 COMPARED WITH 1997
Net investment income (net income excluding net realized investment gains
and losses) was $133,733 and $258,205 for 1998 and 1997, 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.
Net investment spread, which is the difference between investment income
and interest credited on certificate reserves, decreased to $0.8 million during
1998 from $1.1 million in 1997. These amounts reflect net investment spread of
1.12% and 1.63% during 1998 and 1997, 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 $2.8
million from $3.9 million for 1998 and 1997, respectively. These amounts
represent investment yields of 6.46% and 7.43% on average cash and investments
of $43.8 million and $52.9 million for 1998 and 1997, respectively. This
decrease in annualized investment yield on cash and investments was primarily
attributable to the Company investing in more corporate and plain vanilla
mortgage-backed securities
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during 1998 compared to 1997. Further depressing the investment yield, above
normal cash balances were held to provide necessary liquidity for maturing
face-amount certificates.
Interest credited on certificate reserves was $2.1 million and $2.8 million
for 1998 and 1997, respectively. These amounts represent average rates of
interest credited of 5.34% and 5.80% on average certificate reserves of $38.7
million and $48.2 million for 1998 and 1997, 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 1998 have
crediting rates that are generally lower than contracts that matured during that
period, resulting in the overall decrease in the average crediting rate.
Investment and other expenses were $575,823 and $755,256 for 1998 and 1997,
respectively. The decrease in investment and other expenses is primarily
attributable to a decrease in management and investment advisory fees and real
estate expenses in 1998 of $39,333 and $76,247, respectively, compared to 1997.
In addition, there was zero goodwill amortization during the year ended December
31, 1998 compared to the $23,833 for the year ended December 31, 1997. The
goodwill asset became fully amortized during the second quarter of 1997.
Realized investment losses were $152,977 and $268,002 for 1998 and 1997,
respectively. Realized investment losses for 1998 include a loss of $178,795
related to the write-down to fair value and subsequent sale of the Company's
real estate investment. Other realized investment gains and losses were
primarily interest-rate 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 1998, net income was $30,643 compared to $94,688 in 1997. The
decrease was primarily attributable to a decrease in net investment income
partially offset by a reduction in net realized investment losses.
Certificate reserves decreased $11.1 million or 24.5% during 1998, 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 1998 and 1997, 61% and 64%, respectively, were renewed.
1997 COMPARED WITH 1996
Net investment income 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 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
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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 $52.9 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 reinvestments 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 $48.2 million and $50.4 million for
1997 and 1996, respectively. New and renewal contracts issued during 1997 had
crediting rates that were 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 was 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 was that the certificate of deposit
marketplace was very competitive, as many financial institutions offered special
high rates to induce customers to open new accounts. For face-amount
certificates reaching their maturity date during 1997 and 1996, 64% and 73%,
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 97% and 99% investment
grade for the years ended December 31, 1998 and 1997, 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 no exposure to real estate,
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mortgage loans and common equity securities. As of December 31, 1998, 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 $18.4 million at December
31, 1998, representing 48.0% of total qualified assets (54.2% at December 31,
1997). The Company's investments in CMOs represented 46.7% and 52.4% of the
Company's qualified assets as of December 31, 1998 and 1997, respectively. 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.
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
1998 resulted in unrealized gains of $70,448 (net of $37,936 in deferred income
taxes) at December 31, 1998 compared to unrealized gains of $54,723 (net of
$29,466 in deferred income taxes) at December 31, 1997. 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.
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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, 1998, the Company had $3.9 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 12.6% at
December 31, 1998.
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, 1998, cash and cash equivalents totaled $3.3 million, a
decrease of $9.8 million from December 31, 1997. The December 31, 1997 cash and
cash equivalent balance included $9.7 million of cash needed to settle a payable
during January 1998 for investment securities purchased in December 1997. 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 $2.2 million, $4.0 million and $3.6 million were generated
from operating activities in 1998, 1997 and 1996, 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 $50.1 million, $93.1 million and $39.4
million in cash flows during 1998, 1997 and 1996, respectively, which were
offset by purchases of investments of $49.3 million, $79.5 million and $38.5
million, respectively.
YEAR 2000
ARM has undertaken a Year 2000 project that includes all of its
subsidiaries, including the Company. ARM's Year 2000 compliance project, as it
relates to the Company, is provided for under the Investment Services Agreement
and Administrative Services Agreement between ARM and the Company. Pursuant to
the agreements, the Company's operations are administered and managed by ARM.
The cost of ARM's Year 2000 initiatives is not expected to be material to ARM's
results of operations or financial condition. Likewise, any cost to the Company
related to Year 2000 compliance is not expected to be material to the Company's
results of operations or financial condition.
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ARM has completed the assessment phase of the project for all production
applications, hardware (personal computers and servers), system software,
vendors, and business partners. Although ARM is still receiving information from
a few vendors and business partners and assessing various logistic concerns with
its facilities, ARM's major production systems are substantially Year 2000
compliant. However, it was determined that the administrative system which
processes face-amount certificate transactions can not correctly process Year
2000 data because it uses a two digit year field. Where Year 2000 problems were
found, as in the case of the Company, the necessary upgrades and repairs have
begun and are scheduled for completion no later than May 31, 1999. Specifically,
in regards to the Company, management plans to replace the face-amount
certificate administrative system with an application that is Year 2000
compliant and then covert the business to that application.
As well as assessing its facilities, ARM is also currently in the repair
and certification testing phase of its project. The testing phase will serve to
verify the results of repairs and assessments. Steps needed to correct any
problems uncovered during testing will begin immediately at that time. ARM's
Year 2000 project is well underway and because management believes that it will
be completely Year 2000 compliant by May 31, 1999, it currently has no
contingency plans for system issues in place beyond its normal disaster recovery
procedures. As a precaution, ARM is developing a contingency and business
resumption plan to address various logistic concerns with its facilities. The
contingency and business resumption plan is scheduled for completion no later
than September 30, 1999.
Although ARM anticipates no major interruption of business activities, that
will be dependent, in part, upon the activity of third parties. Even though ARM
has assessed and continues to assess third party issues, it has no direct
ability to influence the compliance actions of such parties. Accordingly, while
ARM believes its actions in this regard should have the effect of reducing Year
2000 risks, it is unable to eliminate them or to estimate the ultimate effect
Year 2000 risks will have on ARM's operations.
The estimated completion date on which ARM believes it will complete its
Year 2000 compliance efforts, and the expenses related to ARM's Year 2000
compliance efforts are based upon management's best estimates, which were based
on assumptions of future events, including the availability of certain
resources, third party modification plans and other factors. There can be no
assurances that these results and estimates will be achieved, and the actual
results could materially differ from those anticipated.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Company's financial statements begin on page F-3. Reference is made to
the Index to Financial Statements on page F-1 herein. There is no additional
supplementary data filed herein.
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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
There have been no changes in or disagreements with independent accountants
on accounting, auditing, or financial reporting matters.
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PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
This information is omitted in accordance with Instruction (I)(2)(c) to
Form 10-K.
ITEM 11. EXECUTIVE COMPENSATION
This information is omitted in accordance with Instruction (I)(2)(c) to
Form 10-K.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
This information is omitted in accordance with Instruction (I)(2)(c) to
Form 10-K.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
This information is omitted in accordance with Instruction (I)(2)(c) to
Form 10-K.
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PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) DOCUMENTS FILED AS PART OF THIS REPORT
1. FINANCIAL STATEMENTS.
See financial statements index on page F-1 of this document for a
listing of financial statements and related report of independent
auditors included in this report.
2. FINANCIAL STATEMENT SCHEDULES
The following financial statement schedules of the Company and the
related Report of Independent Auditors are incorporated herein by
reference and were previously filed as Part II Item 16(b) to Post
Effective Amendment No. 10 to Registration Statement on Form S-1 of the
Company filed on February 26, 1999 (File No. 33-38066):
Report of Independent Auditors
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Schedule I Investments in Securities of Unaffiliated Issuers-December 31, 1998
Schedule V Qualified Assets on Deposit-December 31, 1998
Schedule VI Certificate Reserves-Year Ended December 31, 1998
Schedule XII Valuation and Qualifying Accounts-December 31, 1998
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Schedules I and VI as of or for the year ended December 31, 1997
included in the Company's Post Effective Amendment No. 9 to
Registration Statement on Form S-1 filed March 2, 1998, are
incorporated herein by reference.
Schedules required by Article 6 of Regulation S-X for face-amount
certificate investment companies other than those listed are omitted
because they are not required, are not applicable, or equivalent
information has been included in the financial statements and notes
thereto, or elsewhere herein.
3. EXHIBITS
See Exhibit Index on page 15 of this report.
(b) REPORTS ON FORM 8-K
No reports on Form 8-K were filed by the Company during the fourth
quarter of 1998.
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SBM CERTIFICATE COMPANY
EXHIBIT INDEX
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EXHIBIT
NUMBER DESCRIPTION
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3.1 Articles of Incorporation-filed as Exhibit 3(a) to Registration Statement No. 33-38066 dated
December 4, 1990.*
3.2 By-laws-filed as Exhibit 3(b) to Registration Statement No. 33-38066 dated December 4, 1990.*
4 Instruments defining the rights of security holders-Form of Series 503 Certificate filed as Exhibit 4
to Registration Statement on Form N-8B-4, File No. 811-6268, filed April 1, 1991.*
10.1 Underwriting Agreement by and between the Company and SBM Financial Services, Inc. dated June 14, 1995,
filed as Exhibit 10(b) to Amendment No. 7 to Registration Statement No. 33-38066 of the Company dated
March 5, 1996.*
10.2 Administrative Services Agreement by and between the Company and ARM Financial Group, Inc. dated as of
June 14, 1995, filed as Exhibit 10(c) to Amendment No. 7 to Registration Statement No. 33-38066 of the
Company dated March 5, 1996.*
10.3 Investment Services Agreement by and between the Company and ARM Financial Group, Inc. dated as of
June 14, 1995, filed as Exhibit 10(d) to Amendment No. 7 to Registration Statement No. 33-38066 of the
Company dated March 5, 1996.*
10.4 Custody Agreement, as amended and supplemented, between the Company and First Trust National
Association dated December 20, 1990, filed as Exhibit 10(b) to Amendment No. 1 to Registration
Statement No. 33-38066 of the Company dated January 2, 1991.*
10.5 Form of Tax Allocation Agreement by and among the Company, ARM Financial Group, Inc. and certain ARM
subsidiaries dated March 21, 1996, filed as Exhibit 10.1 to Form 10-Q of the Company, File No. 811-6268,
filed May 14, 1996.*
10.6 Policies on Asset/Liability Risk Management and Investment Management of the Company, adopted as of
March 19, 1997, filed as Exhibit 10(g) to Form S-1 Registration Statement of the Company File No.
33-38066, filed March 2, 1998.*
10.7 Indemnification Agreement by and between the Company and ARM Financial Group, Inc. dated June 26, 1997,
filed as Exhibit 10(h) to Form S-1 Registration Statement of the Company File No. 33-38066, filed
March 2, 1998.*
23.1 Consent of Ernst & Young LLP, filed herewith.
27 Not applicable.
* Previously filed as indicated and incorporated herein by reference.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, on March 1, 1999.
SBM Certificate Company
By: /s/ JOHN R. MCGEENEY
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John R. McGeeney
Chairman of the Board of Directors and President
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant in the capacities indicated on the 1st day of March 1999.
<TABLE>
<CAPTION>
Name Title
---- -----
<S> <C>
/s/ JOHN R. McGEENEY Chairman of the Board of Directors
- ------------------------------------------------------
John R. McGeeney and President (Principal Executive Officer)
/s/ EDWARD L. ZEMAN Executive Vice President-Chief Financial
- ------------------------------------------------------
Edward L. Zeman Officer (Principal Financial Officer)
/s/ BARRY G. WARD Controller (Principal Accounting Officer)
- ------------------------------------------------------
Barry G. Ward
/s/ PAUL J. HOUK Director
- ------------------------------------------------------
Paul J. Houk
/s/ ROBERT J. MARSHALL, JR. Director
- ------------------------------------------------------
Robert J. Marshall, Jr.
/s/ WALTER L. SALES Director
- ------------------------------------------------------
Walter L. Sales
</TABLE>
16
<PAGE>
SBM CERTIFICATE COMPANY
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Report of Independent Auditors..................................................................................F-2
Balance Sheets as of December 31, 1998 and 1997.................................................................F-3
Statements of Operations for the Years Ended December 31, 1998, 1997, and 1996..................................F-5
Statements of Shareholder's Equity for the Years Ended December 31, 1998, 1997 and 1996.........................F-6
Statements of Cash Flows for the Years Ended December 31, 1998, 1997 and 1996...................................F-7
Notes to Financial Statements...................................................................................F-8
</TABLE>
F-1
<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, 1998 and 1997, and the related statements of operations,
shareholder's equity, and cash flows for each of the three years in the period
ended December 31, 1998. 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, 1998 and 1997, and the results of its operations and its cash flows
for each of the three years in the period ended December 31, 1998, in conformity
with generally accepted accounting principles.
/s/ Ernst & Young LLP
Louisville, Kentucky
February 9, 1999
F-2
<PAGE>
SBM CERTIFICATE COMPANY
BALANCE SHEETS
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------
DECEMBER 31,
1998 1997
-------------------------------------
<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:
1998-$34,136,751; 1997-$45,602,442) $ 34,149,196 $ 45,614,870
Equity securities, at fair value (cost: 1998-$290,688; 1997-$340,473) 390,776 412,234
Certificate loans 164,209 186,292
Other invested assets -- 471,992
Cash and cash equivalents 3,279,970 13,054,864
------------------- -----------------
Cash and investments 37,984,151 59,740,252
Receivables:
Dividends and interest 296,013 328,516
Receivable for investment securities sold 22,249 --
------------------- -----------------
Total receivables 318,262 328,516
------------------- -----------------
Total qualified assets 38,302,413 60,068,768
Other fixed maturities, available-for-sale, at fair value (amortized
cost: 1998-$851,978) (unaffiliated issuer) 847,835 --
Deferred acquisition costs 204,228 157,994
Other assets -- 42,948
------------------- -----------------
Total assets $ 39,354,476 $ 60,269,710
------------------- -----------------
------------------- -----------------
F-3
<PAGE>
SBM CERTIFICATE COMPANY
BALANCE SHEETS (CONTINUED)
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------
DECEMBER 31,
1998 1997
------------------------------------
<S> <C> <C>
LIABILITIES AND SHAREHOLDER'S EQUITY
Liabilities:
Certificate reserves $ 34,067,826 $ 45,127,084
Payable for investment securities purchased -- 9,731,948
Deferred federal income taxes 27,265 98,320
Accounts payable and other liabilities 231,345 330,686
------------------ -----------------
Total liabilities 34,326,436 55,288,038
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
Accumulated other comprehensive income from net unrealized gains
on available-for-sale securities 70,448 54,723
Retained earnings 1,657,592 1,626,949
------------------ -----------------
Total shareholder's equity 5,028,040 4,981,672
------------------ -----------------
Total liabilities and shareholder's equity $ 39,354,476 $ 60,269,710
------------------ -----------------
------------------ -----------------
</TABLE>
SEE ACCOMPANYING NOTES.
F-4
<PAGE>
SBM CERTIFICATE COMPANY
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31,
----------------------------------------------------
1998 1997 1996
----------------------------------------------------
<S> <C> <C> <C>
Investment income:
Interest income from securities $ 2,699,491 $ 3,729,295 $ 4,089,948
Other investment income 127,006 203,810 200,127
----------------- ---------------- -----------------
Total investment income 2,826,497 3,933,105 4,290,075
Investment and other expenses:
Management and investment advisory fees 207,135 246,468 246,468
Deferred acquisition cost amortization and renewal
commissions 279,289 288,974 245,126
Real estate expenses 90,423 166,670 205,029
Amortization of goodwill -- 23,833 79,824
Other expenses (income) (1,024) 29,311 38,647
----------------- ---------------- -----------------
Total investment and other expenses 575,823 755,256 815,094
Interest credited on certificate reserves 2,063,311 2,795,360 2,821,912
----------------- ---------------- -----------------
Net investment income before
income taxes 187,363 382,489 653,069
Income tax expense (53,630) (124,284) (238,399)
----------------- ---------------- -----------------
Net investment income 133,733 258,205 414,670
Realized investment gains (losses) (152,977) (268,002) 485,135
Income tax benefit (expense) on realized
investment gains and losses 49,887 104,485 (167,824)
----------------- ---------------- -----------------
Net realized investment gains (losses) (103,090) (163,517) 317,311
----------------- ---------------- -----------------
Net income $ 30,643 $ 94,688 $ 731,981
----------------- ---------------- -----------------
----------------- ---------------- -----------------
</TABLE>
SEE ACCOMPANYING NOTES.
F-5
<PAGE>
SBM CERTIFICATE COMPANY
STATEMENTS OF SHAREHOLDER'S EQUITY
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------------
ACCUMULATED
ADDITIONAL OTHER TOTAL
COMMON PAID-IN COMPREHENSIVE RETAINED SHAREHOLDER'S
STOCK CAPITAL INCOME EARNINGS EQUITY
----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balance, January 1, 1996 $ 250,000 $ 3,050,000 $ 885,878 $ 800,280 $ 4,986,158
Comprehensive income:
Net income 731,981 731,981
Change in net unrealized
gains on available-for-sale
securities, net of tax (654,337) (654,337)
-------------------
Comprehensive income 77,644
----------------------------------------------------------------------------------------
Balance, December 31, 1996 250,000 3,050,000 231,541 1,532,261 5,063,802
Comprehensive income:
Net income 94,688 94,688
Change in net unrealized
gains on available-for-sale
securities, net of tax (176,818) (176,818)
-------------------
Comprehensive income (82,130)
----------------------------------------------------------------------------------------
Balance, December 31, 1997 250,000 3,050,000 54,723 1,626,949 4,981,672
Comprehensive income:
Net income 30,643 30,643
Change in net unrealized
gains on available-for-sale
securities, net of tax 15,725 15,725
------------------
Comprehensive income 46,368
--------------- ----------------- ---------------- ----------------- ------------------
Balance, December 31, 1998 $ 250,000 $3,050,000 $ 70,448 $ 1,657,592 $5,028,040
--------------- ----------------- ---------------- ----------------- ------------------
--------------- ----------------- ---------------- ----------------- ------------------
</TABLE>
SEE ACCOMPANYING NOTES.
F-6
<PAGE>
SBM CERTIFICATE COMPANY
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
- --------------------------------------------------------------- ----------------------------------------------------------
YEAR ENDED DECEMBER 31,
------------------- ------------------ -------------------
1998 1997 1996
------------------- ------------------ -------------------
<S> <C> <C> <C>
CASH FLOWS PROVIDED BY (USED IN) OPERATING ACTIVITIES:
Net income $ 30,643 $ 94,688 $ 731,981
Adjustments to reconcile net income to cash flows
provided by operating activities:
Provision for certificate reserves 2,063,311 2,795,360 2,821,912
Realized investment (gains) losses 152,977 268,002 (485,135)
Deferral of acquisition costs (325,523) (314,805) (263,788)
Amortization of deferred acquisition costs and
renewal commissions 279,289 288,974 245,126
Other amortization and depreciation 110,043 465,553 530,429
Deferred tax expense (benefit) (79,525) (162,627) 178,606
(Increase) decrease in dividends and interest receivable 32,503 205,442 (136,060)
Changes in other assets and liabilities (57,214) 323,092 (40,816)
------------------- ------------------ -------------------
Cash flows provided by operating activities 2,206,504 3,963,679 3,582,255
CASH FLOWS PROVIDED BY (USED IN) INVESTING ACTIVITIES:
Fixed maturity investments:
Purchases (49,260,045) (79,455,679) (38,523,432)
Maturities and redemptions 24,117,893 10,812,744 5,642,891
Sales 26,000,513 82,250,553 33,578,496
Sales, maturities and redemptions-mortgage loans and real
estate 260,296 3,091 155,643
Repayment of certificate loans, net 22,083 87,076 6,095
------------------- ------------------ -------------------
Cash flows provided by investing activities 1,140,740 13,697,785 859,693
CASH FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITIES:
Amounts paid to face-amount certificate holders (13,423,346) (8,179,248) (6,063,787)
Amounts received from face-amount certificate holders 301,208 325,456 968,537
------------------- ------------------ -------------------
Cash flows used in financing activities (13,122,138) (7,853,792) (5,095,250)
------------------- ------------------ -------------------
Net change in cash and cash equivalents (9,774,894) 9,807,672 (653,302)
Cash and cash equivalents at beginning of year 13,054,864 3,247,192 3,900,494
------------------- ------------------ -------------------
Cash and cash equivalents at end of year $ 3,279,970 $13,054,864 $ 3,247,192
------------------- ------------------ -------------------
------------------- ------------------ -------------------
</TABLE>
SEE ACCOMPANYING NOTES.
F-7
<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.
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
F-8
<PAGE>
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
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 files a
consolidated federal income tax return with ARM and ARM's other non-life
insurance subsidiaries. Pursuant to a tax sharing agreement, the consolidated
income tax due is allocated among the companies based on each company's
proportionate share of taxable income. When tax benefits are recognized for
losses, (capital and operating) to the extent they can be used in the
consolidated return, the company that originally generated the loss is
reimbursed by the benefited company. However, in the event that no consolidated
tax is owed, the tax sharing agreement does not require ARM to reimburse its
subsidiaries for the use of a subsidiary's losses to offset ARM income.
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.
F-9
<PAGE>
2. 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, 1998:
Fixed maturities:
Mortgage-backed securities $ 18,342,358 $ 74,953 $ 45,435 $ 18,371,876
Corporate securities 9,637,558 75,980 115,474 9,598,064
U.S. Treasury securities and
obligations of U.S. government
agencies 6,062,081 58,793 7,162 6,113,712
Foreign governments 450,787 -- 42,056 408,731
Asset-backed securities 334,340 -- 2,643 331,697
Obligations of state and political
subdivisions 161,605 11,346 -- 172,951
------------------ ----------------- ---------------- ------------------
Total fixed maturities 34,988,729 221,072 212,770 34,997,031
Equity securities 290,688 100,088 -- 390,776
------------------ ----------------- ---------------- ------------------
Total available-for-sale securities $ 35,279,417 $ 321,160 $ 212,770 $ 35,387,807
------------------ ----------------- ---------------- ------------------
------------------ ----------------- ---------------- ------------------
DECEMBER 31, 1997:
Fixed maturities:
Mortgage-backed securities $ 27,284,744 $ 121,331 $ 119,474 $ 27,286,601
Corporate securities 5,102,468 40,992 -- 5,143,460
U.S. Treasury securities and
obligations of U.S. government
agencies 11,343,142 11,763 2,985 11,351,920
Foreign governments 450,960 -- 49,052 401,908
Asset-backed securities 1,033,932 -- 2,372 1,031,560
Obligations of state and political
subdivisions 387,196 12,225 -- 399,421
------------------ ----------------- ---------------- ------------------
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
------------------ ----------------- ---------------- ------------------
------------------ ----------------- ---------------- ------------------
</TABLE>
F-10
<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.
<TABLE>
<CAPTION>
DECEMBER 31, 1998
----------------------------------
ESTIMATED
FAIR
COST VALUE
---------------- -----------------
<S> <C> <C>
FIXED MATURITIES:
Due in one year or less $ 8,650,422 $ 8,715,545
Due after one year through five years 644,631 605,712
Due after five years through ten years 1,243,281 1,271,211
Due after ten years 5,773,697 5,700,990
Asset-backed securities 334,340 331,697
Mortgage-backed securities 18,342,358 18,371,876
---------------- -----------------
Total fixed maturities $ 34,988,729 $ 34,997,031
---------------- -----------------
---------------- -----------------
</TABLE>
Gross gains of $123,867, $765,664, and $642,039 and gross losses of
$95,449, $1,082,809, and $175,226 were realized on sales of fixed maturities
classified as available-for-sale for the year ended December 31, 1998, 1997, and
1996 respectively.
Gross gains of $23,459, $49,143, and $23,980 were recognized on equity
securities sold during 1998, 1997, and 1996, respectively. Gross losses of
$1,062 for 1998 and zero for both 1997 and 1996 were recognized on equity
securities sold.
During 1998, the Company sold its sole investment in real estate and
realized a loss of $178,795 associated with the transaction.
3. COMPREHENSIVE INCOME
As of January 1, 1998, the Company adopted Statement of Financial
Accounting Standards ("SFAS") No. 130, "Reporting Comprehensive Income." SFAS
No. 130 establishes new rules for the reporting and display of comprehensive
income and its components; however, the adoption of this Statement had no impact
on the Company's net income or total shareholders' equity. SFAS No. 130 requires
unrealized gains or losses on the Company's available-for-sale securities to be
included in other comprehensive income. Prior year financial statements have
been reclassified to conform to the requirements of SFAS No. 130.
F-11
<PAGE>
The following table shows, for available-for-sale securities, a
reconciliation of the net unrealized gain (loss) arising during the period and
the change in net unrealized gains (losses) as reported on the accompany
statements of shareholder's equity. Amounts are reported net of related tax at
the 35% statutory rate.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------------------------------
1998 1997 1996
------------------------------------------------------- ------------------- ------------------- -----------------
<S> <C> <C> <C>
Net unrealized gain (loss) arising
during period on available-for-sale securities $ 99,925 $ (235,975) $ (367,123)
Reclassification adjustment for net realized
(gains) losses included in net income (84,200) 59,157 (287,214)
------------------- ------------------- -----------------
Change in net unrealized gains (losses) on
available-for-sale securities $ 15,725 $ (176,818) $ (654,337)
------------------- ------------------- -----------------
------------------- ------------------- -----------------
</TABLE>
4. CERTIFICATE RESERVES
Total certificate reserves at December 31 are summarized as follows:
<TABLE>
<CAPTION>
MINIMUM ADDITIONAL
1998 1997 INTEREST INTEREST
---------------- --------------- ------------------ ---------------------
<S> <C> <C> <C> <C>
Fully-paid certificates:
Single-payment series 503 $ 30,754,255 $ 41,533,024 2.50% 2.25% to 4.60%
Installment 2,084,595 2,220,962 2.50% to 3.50% 1.50% to 2.75%
Optional settlement 594,300 521,643 2.50% to 3.00% 2.00% to 2.75%
Due to unlocated certificate holders 3,126 2,878 None
---------------- ---------------
33,436,276 44,278,507
Installment certificates:
Reserves to mature, by series:
120, 215, and 220 302,400 393,801 3.25% 1.75% to 2.00%
315 135,104 191,975 3.50% 1.50% to 1.75%
Advance payments 194,046 262,801 * *
---------------- ---------------
631,550 848,577
---------------- ---------------
Total certificate reserves $ 34,067,826 $ 45,127,084
---------------- ---------------
---------------- ---------------
</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 1999.
F-12
<PAGE>
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.
<TABLE>
<CAPTION>
DECEMBER 31, 1998 DECEMBER 31, 1997
---------------- ----------------- ---------------- -----------------
CARRYING VALUE ESTIMATED FAIR CARRYING VALUE ESTIMATED FAIR
VALUE VALUE
- -------------------------------------------------- ---------------- ----------------- ---------------- -----------------
<S> <C> <C> <C> <C>
Assets:
Fixed maturities $ 34,997,031 $ 34,997,031 $ 45,614,870 $ 45,614,870
Equity securities 390,776 390,776 412,234 412,234
Certificate loans 164,209 164,209 186,292 186,292
Other invested assets -- -- 471,992 471,992
Cash and cash equivalents 3,279,970 3,279,970 13,054,864 13,054,864
Other assets -- -- 42,948 42,948
Liabilities:
Certificate reserves 34,067,826 34,251,701 45,127,084 45,340,626
Accounts payable and other liabilities 231,345 231,345 330,686 330,686
</TABLE>
The following methods and assumptions were used in estimating fair values:
FIXED MATURITIES AND EQUITY SECURITIES
Fair values for investments in securities are based on quoted market
prices, where available. For fixed maturities and equity securities 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.
F-13
<PAGE>
CERTIFICATE RESERVES
The fair value of certificate reserves is based on a discounted cash flow
analysis, using the current interest rate offered on new certificates of 5.00%
and 5.25% at December 31, 1998 and 1997, respectively.
OTHER INVESTED ASSETS, OTHER ASSETS, ACCOUNTS PAYABLE AND OTHER LIABILITIES
The financial statement carrying amounts of other invested assets, other
assets, accounts payable and other liabilities are deemed to be a reasonable
approximation of their fair value.
6. FEDERAL INCOME TAXES
Deferred 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, 1998 and December 31, 1997 were:
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------------
1998 1997
---------------- -----------------
<S> <C> <C>
Deferred tax liabilities:
Real estate limited partnership $ - $ 99,798
Net unrealized gains on available-for-sale securities 37,936 29,466
Other 1,616 2,932
---------------- -----------------
Total deferred tax liabilities 39,552 132,196
Deferred tax assets:
Investments 73,867 113,357
Net operating loss carryforward 58,420 -
Fixed assets - 38,677
Capital loss carryover - 281,842
---------------- -----------------
Total deferred tax assets 132,287 433,876
Valuation allowance for deferred tax assets (120,000) (400,000)
---------------- -----------------
Net deferred tax assets 12,287 33,876
---------------- -----------------
Deferred tax liabilities shown on the accompanying balance sheets $ 27,265 $ 98,320
---------------- -----------------
---------------- -----------------
</TABLE>
F-14
<PAGE>
The Company's net operating loss carryforward of $166,915 at
December 31, 1998, expires in the year 2018.
The components of the provision for federal income tax expense consist of the
following:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------- --------------- ----------------
1998 1997 1996
---------------- --------------- ----------------
<S> <C> <C> <C>
Current $83,268 $ 182,426 $ 227,617
Deferred (79,525) (162,627) 178,606
---------------- --------------- ----------------
Total federal income tax expense $ 3,743 $ 19,799 $ 406,223
---------------- --------------- ----------------
---------------- --------------- ----------------
</TABLE>
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, goodwill was reduced by $89,262 as a result of realizing such benefits. No
such benefits were realized in 1998 and 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.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------------------
1998 1997 1996
----------------- ------------------ -----------------
<S> <C> <C> <C>
Income tax expense at statutory rate $ 12,035 $ 40,070 $ 398,371
Unreimbursed capital loss carryover used by ARM 281,842 -- --
Decrease in valuation allowance related to capital
loss carryover (280,000) -- --
Dividend received deduction (7,749) (12,457) (12,577)
Tax-exempt interest (4,194) (5,677) (7,283)
Goodwill amortization -- 8,342 27,938
Other 1,809 (10,479) (226)
----------------- ------------------ -----------------
Total federal income tax expense $ 3,743 $ 19,799 $ 406,223
----------------- ------------------ -----------------
----------------- ------------------ -----------------
</TABLE>
The Company files a consolidated federal income tax return with ARM and
ARM's other non-life insurance subsidiaries. At December 31, 1998 and 1997,
$103,373 and $124,435 were due to ARM, respectively, pursuant to the tax sharing
agreement, related to ordinary losses.
F-15
<PAGE>
7. RELATED PARTY TRANSACTIONS
Management and investment advisory fee expenses reflected in the
accompanying financial statements represent allocations of expenses from ARM.
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. The
allocations were $207,135 for the year ended December 31, 1998 and $246,468 for
both the years ended December 31, 1997 and 1996. Management believes that the
methods used to allocate such expenses are reasonable.
The Company has paid ARM Securities, an affiliate, $325,523, $314,805 and
$263,089 for the years ended 1998, 1997 and 1996, 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 ($34.3 million and $45.4 million at December 31, 1998 and
1997, respectively). The Company had qualified assets (at amortized cost) of
$38.3 million and $60.1 million at those respective dates.
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 SEC. 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 12.6% and 8.2% at December 31, 1998 and 1997, respectively.
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, 1998 and 1997, as shown in the
following table. Certificate loans, secured by applicable certificate reserves,
are deducted from certificate reserves in computing deposit requirements.
F-16
<PAGE>
<TABLE>
<CAPTION>
1998 1997
------------------- -----------------
<S> <C> <C>
Qualified assets on deposit with:
Central depositary $37,534,866 $48,664,004
State governmental authorities 196,143 245,772
------------------- -----------------
Total qualified assets on deposit $37,731,009 $48,909,776
------------------- -----------------
------------------- -----------------
Required deposits (certificate reserves less certificate loans
plus $250,000) $34,153,617 $45,190,792
------------------- -----------------
------------------- -----------------
</TABLE>
<TABLE>
<CAPTION>
Qualified assets on deposit consisted of the following at December 31:
1998 1997
------------------- -----------------
<S> <C> <C>
Investment securities, at cost plus accrued interest $37,731,009 $48,437,784
First mortgage loans -- 960
Other assets on deposit, at cost -- 471,032
------------------- -----------------
Total qualified assets on deposit $37,731,009 $48,909,776
------------------- -----------------
------------------- -----------------
</TABLE>
F-17
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in this Annual Report (Form 10-K)
of SBM Certificate Company for the year ended December 31, 1998, of our report
dated February 9, 1999, included in Post Effective Amendment No. 10 to the
Registration Statement (Form S-1 No. 33-38066) and related Prospectus
("Registration Statement"), with respect to the financial statement schedules of
SBM Certificate Company listed in Item 16(b) of the Registration Statement.
/s/ Ernst & Young LLP
Louisville, Kentucky
February 23, 1999
