- --------------------------------------------------------------------------------
UNITED STATES
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
For the fiscal year ended December 31, 1997
Commission File Number 1-11422
PENNCORP FINANCIAL GROUP, INC.
(Exact name of Registrant as specified in its charter)
Delaware 13-3543540
(State or other jurisdiction
of incorporation or organization) (I.R.S. employer identification no.)
590 Madison Avenue 10022
New York, New York (Zip code)
(Address of principal executive offices)
Registrant's telephone number, including area code: (212) 896-2700
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
Name of Each Exchange
Title of Each Class on Which Registered
- ------------------------------------- ---------------------------------------
Common Stock, $.01 par value New York Stock Exchange
- ------------------------------------- ---------------------------------------
$3.375 Convertible Preferred Stock,
$.01 par value New York Stock Exchange
- ------------------------------------- ---------------------------------------
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. Yes [X] 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 amendments to
this Form 10-K. [X]
The aggregate market value of the voting stock held by non-affiliates of
the registrant as of March 25, 1998: $806,003,479.80.
The number of Common Stock shares outstanding as of March 25, 1998, was
27,853,252.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the Annual Meeting of Shareholders
scheduled for May 21, 1998, is incorporated by reference into Part III hereof.
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1
<PAGE>
ANNUAL REPORT ON FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 1997
TABLE OF CONTENTS
Page
PART I
Item 1. Business 3
Item 2. Properties 22
Item 3. Legal Proceedings 22
Item 4. Submission of Matters to a Vote of Security Holders 24
PART II
Item 5. Market for the Registrant's Common Equity and
Related Shareholder Matters 26
Item 6. Selected Consolidated Financial Data 27
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 28
Item 8. Financial Statements and Supplementary Data 40
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 104
PART III
Item 10. Directors and Executive Officers of the Registrant 104
Item 11. Executive Compensation 104
Item 12. Security Ownership of Certain Beneficial
Owners and Management 104
Item 13. Certain Relationships and Related Transactions 104
PART IV
Item 14. Exhibits, Financial Statement Schedules,
and Reports on Form 8-K 105
2
<PAGE>
PART I
Item 1. Business
GENERAL DESCRIPTION AND HISTORY
PennCorp Financial Group, Inc. ("PennCorp" or the "Company"), incorporated
in Delaware in 1989, is a holding company the principal subsidiaries of which
are insurance companies with operations in Raleigh, North Carolina; Dallas and
Waco, Texas; Baton Rouge, Louisiana; and Toronto, Canada. The Company's
insurance subsidiaries market and underwrite fixed benefit accident and sickness
insurance, life insurance and accumulation products to lower- and middle- income
markets throughout the United States and Canada. The Company's insurance
products are sold through several distribution channels including exclusive
agents, general agents, payroll deduction programs and through financial
institutions. PennCorp's only significant industry segment is insurance.
Information relating to the Company's U.S. and Canadian operations appears in
Note 4 of "Notes to Consolidated Financial Statements" on Page 53 hereof. For
more information regarding the Company's markets, see "Insurance" and Marketing
and Distribution" included herein.
During 1997 the Company restructured its operating units into three primary
business units, Career Sales Division, Payroll Sales Division and Financial
Services Division.
Career Sales Division includes the operations of Penn Life. Penn Life,
collectively, Pennsylvania Life Insurance Company ("PLIC") and Penncorp Life
Insurance Company, markets and underwrites fixed benefit accident and sickness
products and, to a lesser extent, life products through a sales force exclusive
to the Company throughout the United States and Canada. With the January 2, 1998
consummation of the acquisition of Southwestern Financial Corporation and
Subsidiaries ("SW Financial"), the Company has been taking steps to integrate
Union Bankers Insurance Company ("Union Bankers") with the Career Sales
Division.
Payroll Sales Division includes the operations of AA Life, Professional
Insurance Corporation ("Professional") and Occidental Life Insurance Company of
North Carolina ("OLIC"). AA Life, collectively, Pioneer Security Life Insurance
Company ("Pioneer Security") and its subsidiaries, American-Amicable Life
Insurance Company of Texas ("American- Amicable") and Pioneer American Insurance
Company ("Pioneer American"), markets and underwrites customized life insurance
and accumulation products to U.S. military personnel and federal employees
through a general agency force. Professional and OLIC provide individual fixed
benefit and life products utilizing a network of independent agents primarily in
the southeastern United States through employer-sponsored payroll deduction
programs.
Financial Services Division is comprised of Integon Life Insurance
Corporation ("Integon Life") and United Life & Annuity Insurance Company
("United Life"). Integon Life markets life insurance and, to a lesser extent
annuity products through independent general agents who sell directly to
individuals primarily in the southeastern United States. United Life principally
markets fixed and variable annuities through financial institutions and
independent general agents, primarily in the southern and western United States.
Since its acquisition on January 2, 1998, Southwestern Life Insurance Company
("Southwestern Life") has been integrated and managed as part of the Financial
Services Division.
The Company's growth strategy has emphasized the acquisition of
complementary insurance operations and the utilization of the Company's several
distribution channels to further penetrate its target markets. In making
acquisitions, the Company has sought to broaden its distribution channels,
increase its product offerings and expand its geographical presence. The Company
also seeks benefits from expense reduction through the consolidation of
facilities and staff and the creation of common administrative systems. Since
1990, the Company has acquired OLIC, Professional, AA Life, Integon Life, United
Life and SW Financial.
RECENT DEVELOPMENTS
On February 18, 1998, the Company announced that it has engaged investment
banking firms Salomon Smith Barney and Fox-Pitt, Kelton Inc. to review strategic
alternatives for maximizing shareholder value, including the sale of the
Company's Career Sales Division. On February 18, 1998, the Company also
announced that it will incur restructuring and
3
<PAGE>
other charges which, in the aggregate, are not expected to exceed $25.0 million,
a significant portion of which will be recognized in the first quarter. The
restructuring charge recognizes: (a) severance and related benefits incurred due
to staff reductions, (b) estimated holding costs of vacated facilities, (c) the
write-off of certain fixed assets and other impaired assets and (d) estimated
contract termination costs.
THE SW FINANCIAL INVESTMENT
Prior to the Company's acquisition of the controlling interest in SW
Financial on January 2, 1998, the Company held a significant economic interest
in SW Financial. Such economic interest was derived through its direct
investment of $120.0 million in SW Financial. Without giving effect to the
conversion of the SW Financial convertible debentures, the Company beneficially
owned 75.4% of SW Financial's outstanding common stock, including 100.0% of SW
Financial's non-voting common stock and 21.0% of SW Financial's voting common
stock. The Company also owned preferred stock of SW Financial and its
subsidiary. In August 1997, in anticipation of the acquisition of SW Financial,
the Company acquired all of SW Financial's subordinated indebtedness aggregating
$40.0 million.
Through the Company's limited partnership interest in the Knightsbridge
Capital Fund I, L.P. ("Knightsbridge Fund"), the Company indirectly owned an
additional economic interest in SW Financial aggregating 2.6 percent.
THE KNIGHTSBRIDGE RESTRUCTURING PLAN
In February 1996, the Company's Board of Directors began discussions with
Messrs. Stone and Fickes on a means of consolidating their outside business
interests, including the Knightsbridge Fund, under the Company. Subsequently,
Messrs. Stone and Fickes and the members of the Knightsbridge and Compensation
Committees of the Company's Board developed a plan to enable the Company to
manage the Knightsbridge Fund and to provide Messrs. Stone and Fickes with a
compensation program that offers them compensation opportunities with economic
interests aligned with stockholders generally and that provides incentives for
each to make a long-term, full-time commitment to the Company.
The components of the Knightsbridge restructuring plan are as follows:
o The adoption of compensation arrangements pursuant to which Messrs.
Stone and Fickes have entered into five-year employment agreements
with the Company. These compensation arrangements are described in
detail under the captions "Executive Compensation - Employment
Agreements" in Item 11 hereof.
o The acquisition by the Company of the interests of Messrs. Stone and
Fickes in Knightsbridge Management, L.L.C. ("Knightsbridge
Management"), Knightsbridge Capital L.L.C. and Knightsbridge
Consultants L.L.C. (collectively, "The Fickes and Stone Knightsbridge
Interests").
o The acquisition by the Company from the Knightsbridge Fund and Messrs.
Stone and Fickes of their respective holdings of common stock and the
common stock warrants of SW Financial (collectively, "The Southwestern
Financial Controlling Interest") provided that if the Amended Proposed
Settlement (as defined in "Item 3 - Legal Proceedings" below) is
approved by the Delaware Chancery Court after notice to the Company's
stockholders, Messrs. Stone and Fickes will cancel their SW Financial
common stock warrants for no additional consideration). See Item 3 -
Legal Proceedings on page 22 hereof.
The acquisition of The Fickes and Stone Knightsbridge Interests and the
acquisition of the Southwestern Financial Controlling Interest were approved by
a vote of the stockholders of the Company at its Annual Meeting of Stockholders
held on December 31, 1997 and were consummated on January 5, 1998 and January 2,
1998, respectively.
Further information regarding the SW Financial investment appears in Note 6
of "Notes to Consolidated Financial Statements" and SW Financial financial
statements for the years ended December 31, 1997 and 1996 are included on pages
78 to 103 hereof. Information relating to the relationship between the Company
and the Knightsbridge Fund, the acquisition of The Fickes and Stone
Knightsbridge Interests and the Southwestern Financial Controlling Interest
appear in Notes 15, 16 and 19 of "Notes to Consolidated Financial Statements,"
and in Item 13 hereof.
4
<PAGE>
INSURANCE
The Company's insurance subsidiaries underwrite a variety of insurance
products with the primary emphasis on modest premium policies in the
accumulation, life and fixed benefit product sectors. Fixed benefit products
include indemnity insurance policies in which the benefit amounts are fixed at
the time of policy issue. Those products provide supplemental income payments
directly to the insured who is disabled and unable to work due to accident or
sickness. Life products are primarily low face amount traditional whole life or
universal life products which build cash values that are available to the
policyholder. Accumulation products include various forms of annuity products
which are utilized by policyholders primarily as a means of tax deferred
savings. Pro forma 1997 ratios and amounts include the results of SW Financial
as if SW Financial was acquired January 1, 1997. Such pro forma information is
provided for comparative purposes only and does not purport to be indicative of
what would have occurred had the acquisition been made as of January 1, 1997, or
results which may occur in the future.
The following table presents the historical percentages of consolidated
insurance operations revenues derived from these product types:
<TABLE>
<CAPTION>
PERCENTAGE OF CONSOLIDATED
INSURANCE OPERATIONS
REVENUES FOR THE YEARS ENDED
DECEMBER 31,
-----------------------------------------------
Pro forma
INSURANCE PRODUCT TYPE 1995 1996 1997 1997
---------------------- ---- ---- ---- ----
<S> <C> <C> <C> <C>
Fixed benefit.................................... 48.8% 34.1% 29.8% 30.5%
Life............................................. 43.5 46.2 43.1 46.8
Accumulation..................................... 7.7 19.7 27.1 22.7
----- ----- ----- -----
Total.......................................... 100.0% 100.0% 100.0% 100.0%
===== ===== ===== =====
</TABLE>
The amount of annualized premium in force and policy activity by type of
business for the past three years is as follows:
<TABLE>
<CAPTION>
ANNUALIZED PREMIUM IN FORCE
AS OF DECEMBER 31,
($ in thousands)
-----------------------------------------------
Pro forma
INSURANCE PRODUCT TYPE 1995 1996 1997 1997
- ---------------------- ---- ---- ---- ----
<S> <C> <C> <C> <C>
Fixed benefit.............................. $ 189,681 $ 194,475 $ 184,214 $ 256,272
Life(1).................................... 216,263 217,538 219,180 372,409
---------- ---------- ----------- -----------
Total.................................... $ 405,944 $ 412,013 $ 403,394 $ 628,681
========== ========== =========== ===========
- -------------------
(1) Life annualized premium in force includes target premium for interest
sensitive products. Interest sensitive policy revenue may vary from target
premium as policyholders have no obligation to pay target premium.
Additionally, interest sensitive policy revenues are determined based upon
contractual charges assessed against policyholder funds and are not
determined by policy revenues collected.
</TABLE>
5
<PAGE>
<TABLE>
<CAPTION>
1995 1996 1997
------------------------ -------------------------- --------------------------
Fixed Accum- Fixed Accum- Fixed Accum-
Benefit Life ulation Benefit Life ulation Benefit Life ulation
------- ---- ------- ------- ---- ------- ------- ---- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Policies in force - January 1...... 761,082 422,056 6,861 733,893 562,620 34,854 698,072 558,697 90,265
New issues...................... 111,999 60,097 1,691 81,547 54,157 4,834 84,286 62,449 5,012
Business acquired, net.......... 200 170,136 32,069 15,664 67,731 64,210 -- -- --
Policies terminated............. (139,388) (89,669) (5,767) (133,032) (125,811) (13,633) (127,422) (114,233) (25,508)
------- ------- ------ ------- ------- ------ ------- ------- ------
Policies in force - December 31. 733,893 562,620 34,854 698,072 558,697 90,265 654,936 506,913 69,769
======= ======= ====== ======= ======= ====== ======= ======= ======
</TABLE>
As a result of the acquisition of Integon life, the Company acquired a
substantial block of credit insurance policies (550,152 policies at acquisition;
111,579 policies as of December 31, 1997). Integon Life no longer markets such
products and nearly all of Integon Life's credit insurance is subject to a
100.0% coinsurance agreement. Such policies have been excluded from the above
table.
MARKETING AND DISTRIBUTION
The Company's insurance subsidiaries collectively are licensed to market
the Company's insurance products in all states (other than New York) and in the
District of Columbia, all provinces of Canada, Puerto Rico and certain Caribbean
countries. In addition, the Company is authorized to sell its products at U.S.
military installations in foreign countries.
The Company's broadly defined markets are reached through four primary
distribution channels: agents contracted exclusively with the Company,
independent general agents who sell on an individual basis, independent general
agents who sell through payroll deduction programs and arrangements for
distribution through various financial institutions. Those market segments are
further divided as follows:
Major Market Sub-Market
------------ ----------
Individual Low and moderate income households
Non-English speaking households
U.S. military enlistees
Suburban and rural locales
Government Local governments and governmental agencies
U.S. federal government
Self-employed
Each of the Company's market segments may be served by each of the primary
distribution channels. Additionally, though there are certain regions in which
all sales forces are active, the Company's sales forces generally operate in
geographically discrete regions.
The following tables illustrate, by direct cash premium collected and
relative percentages, the principal marketing regions in which the Company
collected in excess of $10.0 million of policy revenues for the year ended
December 31, 1997.
6
<PAGE>
<TABLE>
<CAPTION>
Direct Premium Collected
--------------------------------------------------------
Jurisdiction Amount Percentage
------------ ------ ----------
<S> <C> <C>
Canada..................... $ 56,067 11.3%
North Carolina............. 40,451 8.1
Georgia.................... 35,984 7.2
Louisiana.................. 35,763 7.2
Florida.................... 35,406 7.1
California................. 26,156 5.3
Texas...................... 22,500 4.5
Ohio....................... 20,713 4.2
Missouri................... 18,029 3.6
Illinois................... 15,143 3.0
Indiana.................... 15,099 3.0
South Carolina............. 14,082 2.8
Alabama.................... 13,604 2.7
Virginia................... 12,040 2.4
---------- -----
Subtotal................ 361,037 72.4
All Others................. 137,032 27.6
---------- -----
Total................... $ 498,069 100.0%
========== =====
Pro forma Direct Premium Collected
--------------------------------------------------------
Jurisdiction Amount Percentage
------------ ------ ----------
Texas...................... $ 95,367 12.2%
Canada..................... 56,068 7.2
North Carolina............. 53,256 6.8
Florida.................... 46,589 5.9
Georgia.................... 44,069 5.6
Indiana.................... 42,569 5.4
Louisiana.................. 39,643 5.1
California................. 36,701 4.7
Ohio....................... 34,510 4.4
Missouri................... 31,939 4.1
Pennsylvania............... 24,727 3.2
Wisconsin.................. 23,493 3.0
Virginia................... 21,953 2.8
Illinois................... 21,221 2.7
South Carolina............. 17,815 2.2
Oklahoma................... 17,063 2.2
Alabama.................... 16,005 2.0
Kentucky................... 12,446 1.6
Kansas..................... 12,286 1.6
Tennessee.................. 11,614 1.5
Michigan................... 11,502 1.4
---------- -----
Subtotal................ 670,836 85.6
All Others................. 112,418 14.4
---------- -----
Total................... $ 783,254 100.0%
========== =====
</TABLE>
Career Sales Division
Penn Life's agents constitute substantially all of the Company's career
sales force. On a pro forma basis Union Bankers is considered part of the Career
Sales Division. Penn Life is organized under a regional/branch office structure.
The
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<PAGE>
regional sales managers are responsible for approximately 100 sales locations in
the United States and Canada. Commissions are shared among the regional and
branch office managers and the writing agent. Commissions allocated to the
branch offices are used to pay "overwrite" commissions to agents who train new
agents and to pay the expenses of the branch office. Any commissions allocated
to the branch offices remaining after payment of "overwrite" commissions and
expenses, essentially the branch "profit", are allocated among the senior sales
managers and the Company. The Company retained approximately $3.1 million, $2.8
million and $2.4 million during 1997, 1996 and 1995, respectively, in profit
sharing income, which is recorded as an offset to commissions. During 1997 the
Company worked closely with the U.S. based career sales force to develop and
implement a new compensation structure which resulted in the Company giving up
its rights to a portion of the profit participation associated with the branch
compensation structures. As a result, career sales force agents will receive a
lower base commission structure on new business and will fully absorb all field
office costs. The new compensation structure allows for bonuses to be paid to
agents based upon improving persistency and new sales growth.
Management believes that the expansion of the Penn Life sales force can
best be accomplished by broadening the base of sales offices. Penn Life has
opened the following new offices and continues to evaluate additional geographic
locations which will complement the current office network.
NEW LOCATIONS
-------------
1995 1996 1997
---- ---- ----
Bellaire, TX Salt Lake City, UT Charlotte, NC
Amarillo, TX San Antonio, TX Hughson, CA
Springfield, MO Gainesville, FL Malibu, CA
Gilbert, AZ Portland, OR Hollywood, FL
The Penn Life career sales force is organized into three distinct
divisions: Instant Issue, Special Services and Individual Life. The Instant
Issue and Special Services Divisions sell fixed benefit products and the
Individual Life Division sells life products. All divisions concentrate
primarily on individual sales or sales to self-employed individuals.
Instant Issue. Instant Issue agents make "cold call" door-to-door
presentations and market small denomination policies that provide scheduled
payments in fixed amounts to insureds who, as a result of specified types of
accidents, become unable to work or who become hospitalized. The relatively
modest annual premium required to purchase this policy facilitates the initial
sale. Prior to 1996, the Instant Issue agent typically utilized a special
field-underwritten policy form that required the applicant to answer certain
questions designed to confirm that the applicant is within the Company's basic
underwriting guidelines. During 1996, the Company determined that the use of
field-underwritten policies needed to be curtailed for a significant number of
products typically sold by this sales force. To the extent similar products are
sold, the products are now primarily underwritten in the home office. Such
action was instituted by management to help curb rising loss ratios in Instant
Issue products.
Special Services. Instant Issue policyholders are a significant source of
leads for the Special Services Division. A Special Services agent visits the
policyholder's residence to collect renewal premiums on products purchased for
the Instant Issue Division. The sales agent also delivers a standardized sales
presentation on more comprehensive and higher premium policies. These policies
either provide scheduled payments to insureds who are required to be
hospitalized as the result of accident or sickness or, less frequently scheduled
payments to insureds who are disabled and unable to work as a result of accident
or sickness.
Individual Life. Existing policyholders are the primary source of leads for
the Individual Life Division, which sells life products. The Company has worked
to restructure this division, expand its product portfolio and aggressively
recruit new agents. New product offerings include universal life products and
term life products which have been widely accepted by the Penn Life sales force.
8
<PAGE>
The Penn Life sales force is made up of approximately 1,000 agents who
produce business annually. The following table sets forth information regarding
the Career Sales Division:
<TABLE>
<CAPTION>
1995 1996 1997
---- ---- ----
($ in thousands)
<S> <C> <C> <C>
INSTANT ISSUE
Agents under contract.............................. 643 682 388
Weekly average agents producing new business....... 213 225 183
Submitted annualized new business premiums......... $ 11,685 $ 9,497 $ 7,541
Annualized new business premium per agent.......... $ 54.9 $ 42.2 $ 41.2
SPECIAL SERVICES
Agents under contract.............................. 1,001 962 1,012
Weekly average agents producing new business....... 342 393 398
Submitted annualized new business premiums......... $ 29,122 $ 30,936 $ 33,683
Annualized new business premium per agent.......... $ 85.2 $ 78.7 $ 84.6
INDIVIDUAL LIFE
Agents under contract.............................. 161 197 182
Weekly average agents producing new business....... 75 91 78
Submitted annualized new business premiums......... $ 6,969 $ 8,224 $ 7,006
Annualized new business premium per agent.......... $ 92.9 $ 90.4 $ 89.8
TOTAL ALL CAREER SALES DIVISIONS
Agents under contract.............................. 1,805 1,841 1,582
Weekly average agents producing new business....... 630 709 659
Submitted annualized new business premiums......... $ 47,776 $ 48,657 $ 48,230
Annualized new business premium per agent.......... $ 75.8 $ 68.6 $ 73.2
</TABLE>
Penn Life is continually striving to develop a core group of agents with
proven ability to produce and service new business. The focus on a strong core
group of agents has allowed the Company to increase productivity without a
related incremental increase in agent overhead expenses.
The revenue earned by the career sales distribution system by product type
is shown below:
<TABLE>
<CAPTION>
Pro forma
INSURANCE PRODUCT TYPE 1995 1996 1997 1997
------- -------- --------- ---------
($ in millions)
<S> <C> <C> <C> <C>
Fixed benefit..................... $ 156.0 $ 148.1 $ 142.3 $ 377.2
Life.............................. 34.4 32.8 31.6 81.7
------- -------- --------- ---------
Accumulation...................... 0.5 1.0 1.6 2.7
------- -------- --------- ---------
Total.......................... $ 190.9 $ 181.9 $ 175.5 $ 461.6
======= ======== ========= =========
</TABLE>
9
<PAGE>
The percentage of Career Sales Division revenue to the Company's total
insurance operations revenue by product type is shown below:
<TABLE>
<CAPTION>
Pro forma
INSURANCE PRODUCT TYPE 1995 1996 1997 1997
- ---------------------- ---- ---- ---- ----
<S> <C> <C> <C> <C>
Fixed benefit..................................... 76.7% 76.8% 74.3% 88.5%
Life ............................................ 19.0 12.6 11.5 17.5
Accumulation...................................... 1.4 0.9 0.9 1.3
Total division revenue to the Company's
total insurance operations revenue.......... 45.8 32.2 27.3 41.6
</TABLE>
Payroll Sales Division
The Payroll Sales Division includes marketing units of Professional, AA
Life and OLIC. Each of the marketing units is divided into regions utilizing a
hierarchical approach to managing the sales representative. Additionally, AA
Life and OLIC also utilize field marketing directors and independent marketing
organizations to access potential policyholders. During 1997, the Company formed
Occidental Benefit Services, Inc. ("OBSI"). OBSI maintains relationships with
senior industry producers who have access to a broad array of large payroll
accounts (average employee base in excess of 1,000). OBSI forms joint venture
relationships with the producers or employers in order to access large accounts.
During 1997, OBSI formed its first such relationship resulting in access to an
18,000 person employee group in the southeastern United States.
The Payroll Sales Division markets products solely through the channels of
employer-sponsored payroll deduction or government-sponsored allotment programs.
Under those programs, the agent is permitted by the employer to meet on the
employer's premises with its employees and to make both group and individual
presentations implicitly endorsed by the employer concerning available products.
If an employee elects to purchase a policy, arrangements are made with the
employer to deduct the premiums from the employee's wages. The employer
therefore is able to provide its employees with insurance benefits without
incurring any premium costs. The Company's billing system can be integrated into
the employer's payroll system without additional cost to the employer, a feature
that facilitates the Company's access to employees of businesses that have not
previously participated in payroll deduction programs.
The following tables set forth information regarding the Payroll Sales
Division:
<TABLE>
<CAPTION>
PAYROLL SALES DIVISION 1995 1996 1997
---------------------- ---- ---- ----
($ in thousands)
<S> <C> <C> <C>
Agents under contract.............................. 6,578 7,539 6,784
Number of agents annually producing new business... 2,684 2,750 2,955
Submitted annualized new business premiums......... $ 39,435 $ 39,069 $ 42,527
Annualized new business premium per agent.......... $ 14.7 $ 14.2 $ 14.4
</TABLE>
The revenue earned by the Payroll Sales Division by product type is shown
below:
<TABLE>
<CAPTION>
INSURANCE PRODUCT TYPE 1995 1996 1997
---------------------- ---- ---- ----
($ in millions)
<S> <C> <C> <C>
Fixed benefit........................................ $ 38.0 $ 39.5 $ 48.9
Life................................................. 82.0 84.1 116.4
Accumulation......................................... 5.9 8.0 7.2
--------- --------- ---------
Total.............................................. $ 125.9 $ 131.6 $ 172.5
========= ========= =========
</TABLE>
10
<PAGE>
The percentage of the Payroll Sales Division revenue to the Company's total
insurance operations revenue by insurance product is shown below:
<TABLE>
<CAPTION>
Pro forma
INSURANCE PRODUCT TYPE 1995 1996 1997 1997
---------------------- ---- ---- ---- ----
<S> <C> <C> <C> <C>
Fixed benefit.......................................... 18.7% 20.5% 25.5% 11.5%
Life................................................... 45.2 32.3 42.2 24.9
Accumulation........................................... 18.5 7.2 4.1 3.4
Total division revenue to the Company's
total insurance operations revenue................. 30.2 23.3 26.8 15.6
</TABLE>
Financial Services Division
The Financial Services Division includes marketing units of Integon Life
and United Life and on a pro forma basis, Southwestern Life. The Financial
Services Division markets products to individual customers through leads
developed over time. This division utilizes field marketing directors,
affiliations with independent marketing organizations, financial institutions
and financial planners to reach its customer base.
The sales agents for this division often make sales presentations on a
one-on-one basis with potential prospects. Sales representatives are often faced
with competition from other agents and/or products from other companies.
The following tables set forth information regarding the Financial Services
Division.
<TABLE>
<CAPTION>
Pro forma
FINANCIAL SERVICES DIVISION 1995 1996 1997 1997
--------------------------- ---- ---- ---- ----
($ in thousands)
<S> <C> <C> <C> <C>
Agents under contract.................................. 4,638 9,164 7,730 18,980
Number of agents annually producing new business....... 2,033 2,842 2,206 4,674
Submitted annualized new business premiums............. $ 11,879 $ 118,528 $ 139,483 $ 153,803
Annualized new business premium per agent.............. $ 5.8 $ 41.7 $ 63.2 $ 32.9
</TABLE>
The revenue earned by the Financial Services Division by product type is
shown below:
<TABLE>
<CAPTION>
Pro forma
INSURANCE PRODUCT TYPE 1995 1996 1997 1997
---------------------- ---- ---- ---- ----
($ in millions)
<S> <C> <C> <C> <C>
Fixed benefit..................................... $ 9.4 $ 5.3 $ 0.3 $ 0.3
Life.............................................. 65.0 143.7 127.9 270.0
Accumulation...................................... 25.9 102.2 166.9 203.3
--------- --------- --------- ---------
Total........................................... $ 100.3 $ 251.2 $ 295.1 $ 473.6
========= ========= ========= =========
</TABLE>
11
<PAGE>
The percentage of the Financial Services Division revenue to the Company's
total insurance operations revenue by insurance product is shown below:
<TABLE>
<CAPTION>
Pro forma
INSURANCE PRODUCT TYPE 1995 1996 1997 1997
---------------------- ---- ---- ---- ----
<S> <C> <C> <C> <C>
Fixed benefit.......................................... 4.6% 2.8% 0.2% 0.1%
Life................................................... 35.8 55.1 46.3 57.7
Accumulation........................................... 80.1 91.9 95.0 95.4
Total division revenue to the Company's
total insurance operations revenue................. 24.0 44.5 45.9 42.8
</TABLE>
PRODUCTS
General
The Company's products generally are small premium policies with defined
fixed benefits or low face amount life insurance policies, each of which
demonstrate stable risk characteristics. The Company's more recent acquisitions
of Integon Life and United Life added a portfolio of accumulation products for
which the Company actively manages pricing spreads. The acquisition of SW
Financial substantially expands the Company's fixed benefit and interest
sensitive life product portfolios and, to a lesser extent, accumulation
products.
Product profitability is achieved through a pricing policy that is based
upon conservative actuarial assumptions which take into account the underwriting
risks associated with the product being sold, including lapse rates, mortality,
morbidity and whether the product is underwritten in the field or by the home
office, as well as the administrative expenses associated with the business. The
Company, on an ongoing basis, evaluates new products for use by its sales
forces.
The Company believes that, because of the characteristics of the market it
serves and the nature of its products, the lapse rates for its products,
although stable, tend to be higher than those experienced by other life and
health insurance companies that operate in more affluent markets. The Company
prices its products to reflect these higher lapse rates. To encourage
policyholders to maintain their coverages with the Company, fixed benefit
products generally incorporate a small fixed annual increase in benefits. Early
surrender of accumulation and life products is discouraged by either their low
rate of accumulation of cash values or by high surrender charges.
Fixed Benefit Products
Fixed benefit products are sold in large volume and are characterized by
low average annual premiums. These products provide one or more of three
principal types of benefits: (i) fixed periodic payments to an insured who
becomes disabled and unable to work because of an accident and/or sickness, (ii)
fixed periodic payments to an insured who becomes hospitalized, and (iii) fixed
single payments that vary in amount generally for specified surgical or
diagnostic procedures. Because the benefits are fixed in amount at the time of
policy issuance and are not intended to provide reimbursement for medical and
hospital expenses, payment amounts are not affected by inflation or the rising
cost of health care services. Fixed benefit products, primarily those covering
inability to work due to an accident, provide payments while the insured is
disabled and unable to work, subject to the terms and conditions of the
applicable policy. Fixed benefit products under which payments are made to
insureds who are disabled and unable to work may be purchased with coverage for
either (i) specified types of accidents, (ii) all other types of accidents, or
(iii) a combination of accident and sickness. The Company's practice is to sell
products that together with other similar coverages, do not provide monthly
benefits in excess of $2,000 or 75% of the insured's income, if less.
Certain fixed benefit products, primarily those covering hospitalization
due to sickness, provide payments during the period the insured is hospitalized.
Most of the Company's fixed benefit products also provide additional fixed
periodic payments to an insured who becomes hospitalized. Payments under these
products are not designed to cover the actual costs of the insured's hospital
stay, but merely to provide the insured with a means of paying supplemental
expenses during the
12
<PAGE>
hospitalization period. The Company's practice is to provide hospitalization
benefits of not more than $250 per day ($1,000 if the insured requires intensive
care treatment).
The accident and sickness policies also may be purchased with riders
providing for fixed single payments that vary in amount generally for various
surgical and diagnostic procedures. The Company's practice is to sell riders
that do not provide benefit payments in excess of $5,000. If the covered
procedure is performed on an out-patient basis, the insured receives one-half of
the scheduled payment.
The acquisition of SW Financial expanded the Company's fixed benefits
products to include long term care and medicare supplement policies. Union
Bankers medicare supplement policies provide Medicare enrollees with coverage
for certain medical expenses not paid in full by Medicare. In addition, Union
Bankers historically marketed non-fixed benefit products such as individual
major medical coverage and Preferred Provider Options ("PPO"). Subsequent to
acquisition by the Company, Union Bankers has stopped accepting major medical
and PPO applications, but continues to process renewals.
Life Insurance Products
Of the policy revenues attributable to life products, approximately 51.7%
are related to interest sensitive life insurance policies and the remainder are
related to traditional term and whole life insurance policies.
The Company designs its interest sensitive life insurance policies to avoid
the early accumulation of cash values and to discourage early surrenders or
terminations by imposing relatively high average surrender charges. This is done
to reduce the risk of the Company's insurance subsidiaries having to liquidate
investment assets to meet a liquidity demand resulting from the surrender of
large numbers of life insurance policies. In addition to the basic policies,
policyholders also may purchase accidental death, waiver of premium and annuity
riders. The average face amount of the life insurance policies in force at
December 31, 1997 was $50,100.
Accumulation Products
For policyholders seeking a convenient investment vehicle for their excess
funds, the Company offers single premium deferred annuities, flexible premium
deferred annuities and variable annuity products. Historically, the Company had
not actively marketed accumulation products.
The acquisition of United Life provided the Company with its first platform
to actively market accumulation products. Prior to its acquisition by PennCorp,
Integon Life ceased marketing various annuity products as a result of changes in
its ratings and financial performance.
As of December 31, 1997, the Company maintained annuity reserves
aggregating $1,458.7 million at an average credited rate of interest of 5.4%. Of
the $1,458.7 million of annuity reserves, approximately 48.7% were subject to
surrender charges averaging 5% or more of the contractholder's account balance.
INSURANCE UNDERWRITING
Prior to 1996, most of the products offered by the instant issue sales
forces, primarily accident only products, were field underwritten. Beginning in
1996, for nearly all fixed benefit products, the underwriting practice of the
Company allows the home office underwriting staff to review each applicant's
written application for insurance and, if applicable, an attending physician's
report. In some circumstances, the Company will require a more complete medical
history before issuing a policy, which may be issued with exclusionary riders.
The Company's current practice is not to issue fixed benefit products to
individuals in substandard risk classes to the extent permitted by law.
In general, the Company permits simplified underwriting of life products,
unless the amount of requested coverage is greater than specified levels between
$25,000 and $100,000, depending on the age of the applicant. If full
underwriting is required, the Company reviews the policy application and an
attending physician's report and may require a paramedical
13
<PAGE>
examination or complete physical examination depending on the age of the
applicant and the amount of coverage requested. If the total amount of coverage
applied for plus any coverage in force with the Company exceeds $100,000, a
prospective policyholder must submit a screening for antibodies related to
Acquired Immune Deficiency Syndrome ("AIDS") , to the extent permitted by law.
The life products are specifically designed and priced for the mortality risks
associated with the Company's simplified underwriting procedures.
Although the increasing incidence of AIDS is expected to affect mortality
adversely for the life insurance industry as a whole, the Company believes that
the impact of AIDS on its operations should not be material due to the small
average size of the life insurance policies sold. The Company requires and
considers AIDS information to the fullest extent permitted by law in
underwriting and pricing decisions. During the twelve months ended December 31,
1997, 1996 and 1995, the Company estimated it paid approximately $2.1 million,
$3.2 million and $1.9 million, respectively in death benefits (representing less
than 3.2% of total death benefits paid by the Company during each such period)
under individual life policies due to deaths believed by the Company to be
AIDS-related.
INVESTMENT PORTFOLIO
The Company's investment portfolio is managed with the objectives of
maintaining high credit quality and liquidity, maximizing current income within
acceptable levels of risk, minimizing market and credit risk and matching the
anticipated maturities of investments to the Company's liabilities. To achieve
these objectives, the portfolio consists primarily of United States and Canadian
government and investment-grade fixed maturity securities, which together with
high quality short-term investments accounted for approximately 78.4% and 79.7%
of the Company's total invested assets at December 31, 1997 and 1996,
respectively. The Company believes that the nature of its fixed benefit
products, which have no inflation risk, and its life products, which limit the
early accumulation of cash values, permit it to utilize this conservative
investment strategy.
At December 31, 1997, 54.1% of the Company's fixed maturity bonds were
rated AA or higher by Standard & Poor's and approximately 92.5% were rated BBB
or higher by Standard & Poor's, respectively. All dollar amounts or percentages
set forth in this discussion are based on carrying value unless otherwise
indicated.
Other than issues of the United States and Canadian governments and
government agencies and authorities, no single issuer represented more than 0.1%
of total invested assets at December 31, 1997.
14
<PAGE>
The following table summarizes the Company's investments as of December 31,
1997:
<TABLE>
<CAPTION>
Percent of
Amortized Fair Carrying Carrying
Cost Value(1) Value Value
---- -------- ----- -----
($ in thousands)
<S> <C> <C> <C> <C>
Fixed maturities available for sale:
U.S. Government and agency bonds.............. $ 135,256 $ 142,686 $ 142,686 4.3%
Debt securities issued or guaranteed by
foreign governments(2)...................... 66,635 73,812 73,812 2.2
Municipal bonds............................... 27,043 22,757 22,757 0.7
Corporate bonds............................... 1,146,776 1,192,079 1,192,079 36.0
Mortgage-backed bonds......................... 1,242,805 1,287,648 1,287,648 38.8
----------- ----------- ---------- -----
Total fixed maturity securities
available for sale........................ 2,618,515 2,718,982 2,718,982 82.0
Equity securities available for sale............. 30,084 30,257 30,257 0.9
Commercial mortgages............................. 205,960 215,553 205,960 6.2
Residential mortgages............................ 34,919 32,499 34,919 1.1
Real estate...................................... 17,807 17,807 17,807 0.5
Policy loans..................................... 145,108 145,108 145,108 4.4
Short-term investments........................... 84,141 84,141 84,141 2.5
Other investments................................ 78,068 78,068 78,068 2.4
----------- ----------- ---------- -----
Total invested assets....................... $ 3,214,602 $ 3,322,415 $3,315,242 100.0%
=========== =========== ========== =====
- --------------
(1) Fair values are obtained principally from the Company's investment advisor.
(2) Consists principally of Canadian provincial government bonds and bonds
issued or guaranteed by the Canadian federal government (in U.S. $).
</TABLE>
15
<PAGE>
The following table summarizes the Company's investments, as of December
31, 1997, and includes SW Financial on a pro forma basis:
<TABLE>
<CAPTION>
Percent of
Amortized Fair Carrying Carrying
Cost Value(1) Value Value
---- -------- ----- -----
($ in thousands)
<S> <C> <C> <C> <C>
Fixed maturities available for sale:
U.S. Government and agency bonds.............. $ 162,748 $ 170,257 $ 170,257 3.2%
Debt securities issued or guaranteed by
foreign governments(2)...................... 87,160 95,158 95,158 1.8
Municipal bonds............................... 49,512 45,461 45,461 0.8
Corporate bonds............................... 1,899,222 1,955,772 1,955,772 36.7
Mortgage-backed bonds......................... 2,063,642 2,129,842 2,129,842 39.9
----------- ----------- ---------- -----
Total fixed maturity securities
available for sale........................ 4,262,284 4,396,490 4,396,490 82.4
Equity securities available for sale............. 30,772 31,336 31,336 0.6
Commercial mortgages............................. 254,819 265,158 254,819 4.8
Residential mortgages............................ 37,130 34,710 37,130 0.7
Real estate...................................... 19,700 19,700 19,700 0.4
Policy loans..................................... 268,149 268,149 268,149 5.0
Short-term investments........................... 241,281 241,281 241,281 4.5
Other investments................................ 85,606 86,529 86,529 1.6
----------- ----------- ---------- -----
Total invested assets....................... $ 5,199,741 $ 5,343,353 $5,335,434 100.0%
=========== =========== ========== =====
- --------------
(1) Fair values are obtained principally from the Company's investment advisor.
(2) Consists principally of Canadian provincial government bonds and bonds
issued or guaranteed by the Canadian federal government (in U.S. $).
</TABLE>
The table set forth below indicates the composition of the Company's fixed
maturity portfolio by rating as of December 31, 1997:
<TABLE>
<CAPTION>
Percent of
Total Total
Carrying Carrying
Rating Value Value
- ------ ----- -----
<S> <C> <C>
AAA(1)................................................................ $1,396,576 51.4%
AA.................................................................... 73,570 2.7
A..................................................................... 522,956 19.2
BAA................................................................... 522,187 19.2
---------- -----
Total investment grade.............................................. 2,515,289 92.5
---------- -----
BB.................................................................... 90,233 3.3
B..................................................................... 77,285 2.9
---------- -----
Total below-investment grade........................................ 167,518 6.2
---------- -----
Nonrated.............................................................. 36,175 1.3
---------- -----
Total fixed maturities.............................................. $2,718,982 100.0%
========== =====
- --------------
(1) Includes approximately $142.7 million of United States government and
agency bonds and approximately $73.8 million of Canadian provincial
government bonds and bonds issued or guaranteed by the Canadian federal
government (in U.S. dollars).
</TABLE>
16
<PAGE>
The following table reflects investment results for the Company for each of
the periods indicated.
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
-----------------------------------------------------------
Pro forma
1995 1996 1997 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
End of period total invested assets(1)...... $ 2,286,203 $ 3,673,504 $ 3,339,979 $ 5,510,039
Net investment income(2).................... 102,291 210,734 273,237 393,021
Net realized investment gains(3)............ 3,770 1,257 17,487 19,327
Average annual yield........................ 7.3% 7.5% 7.6% 7.2%
--------------
(1) Consists of total investments plus cash, less amounts due to brokers for
securities committed to be purchased at end of period.
(2) Net investment income is net of investment expenses and excludes capital
gains or losses and provision for income taxes.
(3) Amounts shown above are before income taxes, and include provisions for
impairments in value which are considered to be other than temporary.
</TABLE>
The Company's investments must comply with the insurance laws of the states
in which its insurance subsidiaries are domiciled and in which they are licensed
as well as applicable provisions of the Company's 9 1/4% Senior Subordinated
Notes due 2003. These laws and provisions prescribe the kind, quality and
concentration of investments that may be made by the Company and/or its
insurance subsidiaries.
REINSURANCE
In keeping with industry practice, the Company reinsures portions of its
life insurance exposure with unaffiliated insurance companies under traditional
indemnity reinsurance agreements. New insurance sales are reinsured above
prescribed limits and do not require the reinsurer's prior approval under
contracts that are renewable on an annual basis. Generally, the Company enters
into indemnity reinsurance arrangements to assist in diversifying its risk and
to limit its maximum loss on risks that exceed the Company's policy retention
limits ranging from $25,000 to $500,000 per life, depending on insurer issue
age, the product type and each subsidiary's historical practice. Generally,
accidental death benefits in excess of $50,000 per life are reinsured on a bulk
basis. Indemnity reinsurance does not fully discharge the Company's obligation
to pay policy claims on the reinsured business. The ceding insurer remains
responsible for policy claims to the extent the reinsurer fails to pay such
claims. At no time during the past ten years has any present reinsurer of any
continuing block of business ceded by any of the Company's insurance company
subsidiaries failed to pay any policy claims with respect to such ceded
business. At December 31, 1997 and 1996, of the approximately $24.6 billion and
$31.5 billion of life insurance in force, approximately $4.4 billion and $5.9
billion had been ceded to reinsurers, respectively. As of December 31, 1997 the
Company's principal reinsurers are Transamerica Occidental Life Insurance
Company, Reassurance Company of Hanover, Cologne Life Reinsurance Co., Life
Reassurance Corp. of America, Worldwide Assurance Company, Ltd., Lincoln
National Life Insurance Company, Swiss Re Life & Health Insurance Company,
Allianz Life Insurance Company and Phoenix Home Life Mutual Insurance Company,
which collectively have reinsured approximately 66.8% of the ceded business.
YEAR 2000 ISSUES
Many computer and software programs were designed to accommodate only two
digit fields to represent a given year (e.g. "97" represents 1997). It is highly
likely that such systems will not be able to accurately process data containing
date information for the year 2000 and beyond. The year 2000 issue has the
potential to affect the Company and its subsidiaries through the disruption of
the processing of business both internally and between the Company and other
businesses with which it interacts.
To address the impacts of the year 2000 on its businesses, the Company has
initiated a formal year 2000 assessment and remediation effort to identify and
correct concerns relating to both the Company's own processing and the
processing
17
<PAGE>
activities for which the Company is dependent upon its business partners. The
Company has engaged certain outside vendors and focused certain employees full
time efforts to help in the full array of its year 2000 initiative. This
includes systems assessment and monitoring advice, actual code remediation,
communication and consultation with critical business partners and additional
data center and testing resources. During 1997, the Company incurred
approximately $1.9 million of cost associated with year 2000 compliance work.
Nearly all such costs were associated with outside contractors and advisors.
Over the next two years, the Company expects to incur internal and external
costs associated with such expertise ranging from $9.3 million to $14.9 million,
which are likely to be incurred primarily during 1998 and early 1999, and which
represents approximately 25% of the Company's technology costs. Of the total
range of estimated costs the Company anticipates approximately 42% of the costs
to be internal allocation of resources.
Each of the operating divisions is primarily responsible for its
remediation efforts with corporate oversight provided as necessary. The Company
believes that the Career Sales Division has substantially completed its year
2000 assessment and remediation efforts, which will be subject to ongoing tests
for the remainder of 1998. The Payroll Sales Division has completed the
remediation of its largest administrative platforms, except for AA Life, and
anticipates successful remediation and testing of the remaining sub-system and
system interfaces during 1998. AA Life is in the process of upgrading its policy
administration system to a year 2000 compliant version. AA Life will rely on
contracted vendor resources in working to complete its upgrade process. The
Company's Financial Services Division has only recently begun its year 2000
remediation efforts. Those efforts are dependent on the utilization of outside
resources. The Company believes that the Financial Services Division has
contracted with sufficient resources to be able to remediate its essential
business systems. In addition, Union Bankers has committed to a strategy of
utilizing third party administrative experts, who have indicated year 2000
compliance, to handle the processing of its health insurance business, thus
eliminating the need for the upgrade or modification of certain existing health
administration systems.
Although the Company believes that its operating divisions, outside vendors
and most critical business partners will be sufficiently compliant that the year
2000 issue should not cause a material disruption in the Company's business,
there can be no assurance that there will not be material disruptions to the
Company's business or an increase in the cost of the Company doing business.
Although the Company believes that the year 2000 issues should not cause a
material disruption in the Company's business, the Company is currently
evaluating various contingency plans associated with remediation tasks which the
Company believes are at a higher risk for potential failure.
COMPETITION
The accident and health and life insurance industry is highly competitive.
PennCorp competes with many insurance companies and insurance holding company
systems that have substantially greater capital and surplus, higher A.M. Best
Company ("A.M. Best") ratings, larger and more diversified product portfolios,
and access to larger agency sales forces. In the United States, there are more
than 1,700 life and accident and health insurance companies, most of which
compete in the states in which PennCorp conducts business.
Private insurers and voluntary and cooperative plans, such as Blue Cross
and Blue Shield, provide insurance for meeting hospitalization and medical
expenses. Much of this insurance is sold on a group basis. The federal and state
governments also pay substantial costs of medical treatment through Medicare and
Medicaid programs. Such major medical insurance generally covers a substantial
amount of the medical (but not non-medical) expenses incurred by an insured as a
result of major illnesses. PennCorp's fixed benefit products policies are
designed to provide coverage which is supplemental to that provided by major
medical insurance and may also be used to defray non-medical expenses.
PennCorp's supplemental insurance is not an alternative to major medical
insurance, but is sold to complement major medical insurance by covering the gap
between major medical insurance reimbursements and the total costs of an
individual's health-care expense.
Thus, the Company competes directly with other insurers offering
supplemental health insurance and believes that its current policies and premium
rates are generally competitive with those offered by other companies selling
similar types of insurance. Management believes that the Company's product and
market focuses are not widespread in the insurance industry and that it
generally does not face direct competition from major national insurers,
although the Company
18
<PAGE>
experiences competition from smaller, regional insurance companies. Management
also believes that few major national insurers compete directly in the sale of
fixed benefit products and life products to the primary market sub segments to
which the Company is focused.
The Company's expansion of its product line to include a higher percentage
of life and accumulation product revenue as compared to total revenue has
resulted in a broadening of the markets in which the Company faces competition.
The sale of life insurance products, and to a greater extent, the sale of
accumulation products is very sensitive to an organization's A.M. Best rating,
its size and perceived financial strength and the competitiveness and the
financial performance of the products themselves. Like the market focus of its
fixed benefit products, the Company believes that its target market is not
widely served by many of the large, national insurers, but does face direct
competition from smaller regional and niche-market focused companies.
REGULATORY MATTERS
Life insurance companies are subject to regulation and supervision by the
states in which they transact business. The laws of the various states establish
regulatory agencies with broad administrative and supervisory powers related to,
among other things, granting and revoking licenses to transact business,
regulating trade practices, establishing guaranty associations, licensing
agents, approving policy forms, filing premium rates on certain business,
setting reserve requirements, determining the form and content of required
financial statements, determining the reasonableness and adequacy of capital and
surplus and prescribing the type of permitted investments and the maximum
concentrations of certain classes of investments. The Company's insurance
subsidiaries are subject to periodic examinations by state regulatory
authorities.
During 1997, six of the Company's insurance subsidiaries were subject to
financial triennial examinations. Final examination reports issued by the
Departments of Insurance for North Carolina and Pennsylvania resulted in a
decrease in the statutory capital and surplus of approximately $37.1 million
(after giving effect to certain timing differences) and requests for certain
remedial action plans which the Company has filed with the respective
Departments of Insurance. The most significant adjustments related to: (i) the
disallowance of certain reinsurance credits, (ii) reserve strengthening and
(iii) issues of timing of recognition of certain valuation issues that the
Company's insurance subsidiaries reflected in their 1997 statutory statements
that were deemed by the examination teams to relate to periods prior to 1997.
The Company does not expect such examination reports to have a material impact
on the Company's results of operations. During 1998, the Company expects United
Life, and all of the Company's Texas domiciled insurance subsidiaries to be
subject to examination in the normal course of exam scheduling.
Most states have enacted legislation regulating insurance holding company
systems, including acquisitions of control of insurance companies, dividends,
the terms of surplus debentures, the terms of transactions with affiliates,
investments in subsidiaries and other related matters. Regulatory restrictions
on investments in subsidiaries and affiliates requires the Company to
continually review and occasionally modify or restructure the insurance
subsidiaries within the insurance holding company system. The Company has
ongoing dialogues with the applicable state insurance departments regarding this
issue. The Company is registered as an insurance holding company system in
Louisiana, North Carolina, Pennsylvania and Texas, (the domiciliary states of
its insurance companies), and routinely reports to other jurisdictions in which
its insurance subsidiaries are licensed.
There continues to be substantial scrutiny of the insurance regulatory
framework, and a number of state legislatures have enacted legislative proposals
that alter, and in many cases increase, state authority to regulate insurance
companies and their holding company systems. The National Association of
Insurance Commissioners ("NAIC") and state insurance regulators also have become
involved in a process of re-examining existing laws and regulations and their
application to insurance companies. In particular, this re-examination has
focused on insurance company investment and solvency issues and, in some
instances, has resulted in new interpretations of existing law, the development
of new laws and the implementation of internal guidelines. The NAIC has formed
committees to study and formulate regulatory proposals on such diverse issues as
the use of surplus debentures, accounting for reinsurance transactions,
assumption reinsurance, valuation of securities, the adoption of risk-based
capital rules, the codification of Statutory Accounting Principles, and the
regulation of various products offered by insurance companies.
19
<PAGE>
In connection with its accreditation of states to conduct periodic
insurance company examinations, the NAIC has encouraged states to adopt model
NAIC laws on specific topics, such as holding company regulations and the
definition of extraordinary dividends. Model legislation proposed by the NAIC to
control the amount of dividends that may be paid by insurance companies without
prior regulatory approval has been adopted in most states and is being
considered by the legislatures of the other states. As of the date hereof,
Louisiana (United Life's domiciliary state) has adopted the NAIC's most
restrictive dividend test. Pennsylvania (Penn Life's domiciliary state), Texas
(Pacific Life & Accident Insurance Company's ("PLAIC") AA Life's,
Professional's, Integon Life's, OLIC's, Southwestern Life's and Union Bankers'
domiciliary state), have adopted dividend tests that are substantially similar
to that of the NAIC's model legislation, though less restrictive than that of
Louisiana. Most states only allow dividends to be paid out of unassigned funds.
A dividend may be paid by PLIC if the amount of such dividend together with
all dividends made in the preceding twelve months does not exceed the greater
of: (i) 10% of its statutory surplus as of the end of the prior calendar year or
(ii) its net income for the prior calendar year. Any dividend above the
prescribed amount is an "extraordinary" dividend, and a Pennsylvania insurer may
not pay an "extraordinary" dividend to its stockholders until the earlier of:
(i) 30 days after the Pennsylvania Insurance Commissioner has received written
notice of the declaration thereof and has not within such period disapproved
such payment, or (ii) the receipt of approval from the Pennsylvania Insurance
Commissioner.
Texas law permits PLAIC, AA Life, Professional, Integon Life, OLIC,
Southwestern Life and Union Bankers to pay a dividend without prior consent of
the Texas Insurance Commissioner if the amount paid, together with all other
dividends paid in the preceding 12 months, does not exceed the greater of: (i)
10% of such insurer's surplus as regards to policyholders as of the 31st day of
December next preceding, or (ii) the net gain from operations of such insurer
for the 12 month period ending the 31st day of December next preceding. Any
dividend above this amount would be considered an "extraordinary" dividend and
could not be paid until the earlier of: (i) 30 days after the Texas Insurance
Commissioner has received notice of the declaration thereof and has not within
such period disapproved such payment, or (ii) the Texas Insurance Commissioner
shall have approved such payment within the 30 day period.
Louisiana law permits United Life to pay a dividend without prior consent
of the Louisiana Insurance Commissioner if the amount paid, together with all
other dividends paid in the preceding 12 months, does not exceed the lesser of:
(i) 10% of such insurer's surplus as regards to policyholders as of the 31st day
of December next preceding, or (ii) the insurer's net gain from operations, not
including realized capital gains, for the 12 month period ending the 31st day of
December next preceding. Any dividend above this amount would be considered an
"extraordinary" dividend and could not be paid until the earlier of: (i) 30 days
after the Louisiana Insurance Commissioner has received notice of the
declaration thereof and has not within such period disapproved such payment, or
(ii) the receipt of approval from the Louisiana Insurance Commissioner. As part
of its July 1996 approval of the Company's acquisition of United Life, the
Louisiana Insurance Commissioner approved a dividend plan for United Life
pursuant to which United Life may pay a specified amount of dividends for each
of the five years following the acquisition, beginning in 1997, amounting to the
lesser of the pro forma dividend amounts in such plan or the actual earnings of
United Life, and conditioned on United Life maintaining a risk-based capital of
at least 300% authorized control level.
On the basis of 1997 statutory financial statements filed with the state
insurance regulators, the NAIC calculates twelve financial ratios to assist
state regulators in monitoring the financial condition of insurance companies. A
"usual range" of results for each ratio is used as a benchmark. Departure from
the usual range on four or more of the ratios could lead to inquiries from
individual state insurance departments. PLAIC had three ratios and Pioneer
Security had two ratios outside of the usual range established by the NAIC.
PLAIC and Pioneer Security are primarily holding companies for their principal
assets, being the common stock of certain of the Company's insurance
subsidiaries. Integon Life had none of the twelve ratios outside of the usual
range. PLIC had three of the twelve ratios outside of the usual range, while
OLIC had four and Peninsular had two, Professional had two, American-Amicable
had none, Pioneer American had none and United Life had none of the twelve
ratios outside of the usual ranges. PLIC's variances were caused primarily as a
result of examination adjustments required by the Pennsylvania Department of
Insurance. Remedial action was taken by the Company in 1997 and 1998.
Professional's variances were caused primarily as a result of statutory losses.
OLIC's and Peninsular's variances were caused primarily as a result of increased
reinsurance between these two companies. Southwestern Life had no ratios, Union
Bankers had three ratios, Marquette National had three ratios and Constitution
had three ratios outside the usual ranges.
20
<PAGE>
In the past, variances in the insurance companies' ratios have resulted in
inquiries from insurance departments to which the Company has responded. The
Company may receive inquiries from certain insurance departments concerning its
ratio results for 1997, and there can be no assurance that such insurance
departments will not take action against the insurance companies.
In December 1992, the NAIC adopted the Risk-Based Capital for Life and/or
Health Insurers Model Act (the "Model Act"). The main purpose of the Model Act
is to provide a tool for insurance regulators to evaluate the capital of
insurers with respect to the risks assumed by them and determine whether there
is a need for possible corrective action with respect to them. To date, either
the Model Act or similar legislation or regulation has been adopted in all the
domiciliary states of the Company's insurance subsidiaries.
The Model Act provides for four different levels of regulatory action with
respect to statutory financial statements for the calendar year 1994 and
thereafter, each of which may be triggered if an insurer's Total Adjusted
Capital (as defined in the Model Act) is less than a corresponding "level" of
risk-based capital ("RBC"). The "Company Action Level" is triggered if an
insurer's Total Adjusted Capital is less than 200.0% of its "Authorized Control
Level RBC" (as defined in the Model Act) or less than 250.0% of its Authorized
Control Level RBC and the insurer has a negative trend. At the Company Action
Level, the insurer must submit a comprehensive plan to the regulatory authority
which discusses proposed corrective actions to improve its capital position. The
"Regulatory Action Level" is triggered if an insurer's Total Adjusted Capital is
less than 150.0% of its Authorized Control Level RBC. At the Regulatory Action
Level, the regulatory authority will perform a special examination of the
insurer and issue an order specifying corrective actions that must be followed.
The "Authorized Control Level" is triggered if an insurer's Total Adjusted
Capital is less than 100.0% of its Authorized Control Level RBC, and at that
level the regulatory authority is authorized (although not mandated) to take
regulatory control of the insurer. The "Mandatory Control Level" is triggered if
an insurer's Total Adjusted Capital is less than 70.0% of its Authorized Control
Level RBC, and at that level the regulatory authority must take regulatory
control of the insurer. Regulatory control may lead to rehabilitation or
liquidation of an insurer.
Calculations using the NAIC formula and the life insurance subsidiaries'
statutory financial statements as of December 31, 1997, indicate that each of
the insurance subsidiaries' capital substantially exceeded RBC requirements.
Certain licenses of the Company's insurance company subsidiaries are
subject to limits on the amount of new business that may be written in various
states. Of these license restrictions, most were imposed prior to the
acquisition of the relevant insurance subsidiary by PennCorp, or relate to
events occurring prior to those acquisitions. These license restrictions have
not had a material adverse effect on the Company's results of operations and are
not expected to have a material adverse effect in the future. In some states, a
license restriction, suspension or revocation by another state may result in
reciprocal regulatory action.
The Company may be required, under the solvency or guaranty laws of most
states in which it does business, to pay assessments (up to certain prescribed
limits) to fund policyholder losses or liabilities of insurance companies that
become insolvent. Recent insolvencies of insurance companies increase the
possibility that such assessments may be required. These assessments may be
deferred or forgiven under most guaranty laws if they would threaten an
insurer's financial strength and, in certain instances, may be offset against
future premium taxes. The occurrence and amount of such assessments have
increased in recent years and generally are expected to increase in future
years. The Company paid approximately $2.5 million, $2.6 million and $1.7
million for the years ended December 31, 1997, 1996 and 1995, respectively, as a
result of such assessments. The likelihood and amount of any other future
assessments cannot be estimated and are beyond the control of the Company.
Although the federal government does not directly regulate the business of
insurance, federal legislation and administrative policies in several areas,
including pension regulation, age and sex discrimination, financial services
regulation and federal taxation can significantly affect the insurance business.
In addition, there were proposals under consideration since 1994 at the
federal and state levels regarding reforms to the health care system in the
United States. Although these proposals were not adopted at the federal level,
many states have adopted some form of health care reform since then. These
reforms have focused on the increasing cost of health care
21
<PAGE>
and insurance plans that reimburse insureds or health care providers for medical
and related costs. Because the Company's fixed benefit products provide
supplemental income payments directly to the insured and are not designed to
reimburse health care providers, the Company does not expect such reforms to
have a material adverse effect on its business.
There can be no assurance that existing insurance-related laws and
regulations will not become more restrictive in the future and thereby have a
material adverse effect on the operations of the Company and on the ability of
the insurance companies to pay dividends or on the ability of PLAIC, Pioneer
Security and Constitution Life Insurance Company ("Constitution") to make
payments on their respective surplus debentures. For further information related
to said surplus debentures, see "Management's Discussion and Analysis of Results
of Operations and Financial Condition--Financial Condition, Liquidity and
Capital Resources--Surplus Debentures and Dividend Restrictions" and Note 13 of
"Notes to Consolidated Financial Statements."
RATINGS
A.M. Best assigns fifteen letter ratings to insurance companies, with the
highest being "A++ (Superior)." A.M. Best ratings are based upon factors
relevant to policyholders and are not directed toward the protection of
investors, such as holders of the Common Stock. AA Life and United Life carry an
"A- (Excellent)" rating from A. M. Best. An "A- (Excellent)" rating is the
fourth highest letter rating. Professional, OLIC, Integon Life, Southwestern
Life, Union Bankers, Constitution and PLIC carry a "B++ (Very Good)" rating from
A.M. Best. A "B++ (Very Good)" rating is the fifth highest letter rating. A.M.
Best also has a "Not Assigned" category, which contains nine classifications for
companies not assigned or not eligible for an A.M. Best rating. The A.M. Best
rating for Peninsular is "NA-9," which is a "no rating at the company's
request." This classification was requested by the prior owner of Peninsular.
The Company does not intend to seek a letter rating at this time for Peninsular
from A.M. Best as Peninsular is not currently a direct writer of insurance
products.
Item 2. Properties
FACILITIES
The Company's primary administrative offices are located in Raleigh, North
Carolina and Dallas, Texas. The Company owns and occupies a home office facility
comprising approximately 165,000 rentable square feet, in Raleigh, North
Carolina. The Company subleases a portion of its prior Raleigh home office
facility which has a lease term expiring in 1999 and requires annual lease
payments of approximately $1.1 million.
The Company leases approximately 100 offices throughout its sales
territories and has a separate Canadian business office facility that includes
office and storage space. SFSC leases approximately 125,000 square feet in
Dallas, Texas. American-Amicable owns its home office facility in Waco, Texas
and United Life leases office space in Baton Rouge, Louisiana. In addition, the
Company leases office space for its holding company operations in Bethesda,
Maryland and New York City. The Company believes that the current makeup of its
properties is adequate for its operations and, based on its recent experience,
that it will be able to find suitable replacement properties on acceptable terms
for any properties the Company chooses to replace or for which leases are
terminated or not renewed.
Item 3. Legal Proceedings
In January 1996, stockholder derivative lawsuits styled Tozour Energy
Systems Retirement Plan v. David J. Stone et al. and PennCorp Financial Group,
Inc., C.A. No. 14775 and Lois Miller v. David J. Stone et al. and PennCorp
Financial Group, Inc., C.A. No. 14795 were filed against the Company and each of
its directors, individually, in the Delaware Court of Chancery. The complaint in
the Miller suit has not yet been served on the Company or the other defendants.
Both suits allege that the SW Financial investment involved the usurpation of a
corporate opportunity and a waste of the Company's assets by Messrs. Stone and
Fickes, and that the directors of the Company in approving that transaction,
failed to act in good faith and breached their fiduciary duties, including the
duty of loyalty to the Company and its stockholders, having favored the
interests of Messrs. Stone and Fickes over the Company and its stockholders.
These lawsuits seek judgments against each of the defendants for the amount of
damages sustained or to be sustained by the Company as a result of the breaches
of
22
<PAGE>
fiduciary duty alleged in the complaint, the imposition of a constructive trust
for the benefit of the Company on profits or benefits obtained by any defendant
through the alleged breaches of fiduciary duty, attorney's fees and costs, and
such other relief as the court determines to be just, proper or equitable.
The defendants in the Tozour Case have filed a motion seeking its dismissal
on the ground that the plaintiff failed to comply with the requirements of
Delaware law before instituting a derivative suit and intend to defend the
lawsuit vigorously. Because the Company has not been served with the Miller
complaint, no action has been taken in that case, although the Company would
also defend it vigorously. The defendants believe, however, that it would not be
in the best interests of the Company and its shareholders to expend considerable
management and director time and to incur substantial expenses to litigate the
actions. Consequently, the Company's legal advisors have met or spoken by
telephone with the plaintiff's counsel on several occasions to discuss the terms
of a potential settlement.
The defendants and the plaintiffs' counsel entered into a stipulation of
settlement on March 28, 1997 (the "Original Proposed Settlement"). The Original
Proposed Settlement consisted of the following principal elements: (i) Messrs.
Stone and Fickes will cancel the 335,564 SW Financial common stock warrants they
hold for no consideration enabling PennCorp to purchase the SW Financial
Controlling Interest for $67.5 million, reducing the price to be paid by
PennCorp for the SW Financial Controlling Interest by approximately $2.0
million, (ii) the PennCorp Board will proceed with the purchase of The Fickes
and Stone Knightsbridge Interests, having received a fairness opinion of a
nationally recognized investment banking firm with respect to the price to be
paid for The Fickes and Stone Knightsbridge Interests, (iii) the PennCorp Board
will proceed with the acquisition of the SW Financial Controlling Interest,
having received a fairness opinion of a nationally recognized investment banking
firm with respect to the price to be paid for the SW Financial Controlling
Interest, (iv) the PennCorp Board will submit the purchases of The Fickes and
Stone Knightsbridge Interests and the SW Financial Controlling Interest to a
shareholder vote of a majority of the PennCorp stockholders present at a meeting
and entitled to vote, and stockholders must approve both transactions, (v)
Messrs. Stone and Fickes will abstain from voting on the proposals to approve
the purchase of The Fickes and Stone Knightsbridge Interests and the SW
Financial Controlling Interest, and (vi) the plaintiffs' counsel will be
entitled to conduct confirmatory discovery.
On December 1, 1997, the defendants and the plaintiffs' counsel agreed in
principle to amend the Original Proposed Settlement (as so amended, the "Amended
Proposed Settlement") following the PennCorp Board's conclusion that it would be
appropriate to increase the amount paid to the Knightsbridge Fund for the SW
Financial Controlling Interest to compensate the limited partners for, among
other things, the unexpected and substantial delay in the consummation of the
purchase of the SW Financial Controlling Interest. The terms of the Amended
Proposed Settlement are identical to the terms of the Original Proposed
Settlement, except that the Amended Proposed Settlement provides that the
Company will acquire the SW Financial Controlling Interest for $73.8 million,
and will provide a one-time "price protection" payment associated with a
disposition of the SW Financial Controlling Interest by PennCorp during the
12-month period ending November 25, 1998. The Amended Proposed Settlement also
requires Messrs. Stone and Fickes to grant PennCorp a price protection right in
the event of a sale of their Portsmouth investment.
The Amended Proposed Settlement is subject to approval by the Chancery
Court after notice to PennCorp stockholders. A settlement hearing in the Court
of Chancery is scheduled for May 12, 1998. Messrs. Stone and Fickes have agreed
that, if the Amended Proposed Settlement is approved by the Chancery Court, they
will cancel their SW Financial common stock warrants and they will not
participate in the increased consideration (other than the possible price
protection right) for the SW Financial Controlling Interest to the extent it
relates to their $7.0 million personal investment in SW Financial, which
together will reduce the price to be paid by PennCorp for the SW Financial
Controlling Interest by approximately $3.7 million. Because the Knightsbridge
restructuring will have the effect of substantially eliminating potential future
conflicts of interest between Messrs. Stone and Fickes and PennCorp, and because
the Amended Proposed Settlement will have the effect of reducing the price to be
paid for the SW Financial Controlling Interest and will obviate the need to
expend considerable management and director time to litigate the actions, the
PennCorp Board has determined that the Amended Proposed Settlement is in the
best interests of PennCorp and its shareholders and confers a substantial
economic benefit on PennCorp. Accordingly, the PennCorp Board has authorized the
payment to plaintiffs' counsel of legal fees of $785,000 and documented expenses
not to exceed $50,000 in connection with the lawsuits and the related settlement
23
<PAGE>
negotiations, if the Amended Proposed Settlement is approved by the Delaware
Chancery Court after notice to PennCorp stockholders. The Company has accrued
$835,000 for such costs as of December 31, 1997.
The Company is a party to various pending or threatened legal actions
arising in the ordinary course of business some of which include allegations of
insufficient policy illustrations and agent misrepresentations. Although the
outcome of such actions is not presently determinable, management does not
believe that such matters, individually or in the aggregate, would have a
material adverse effect on the Company's financial position or results of
operations if resolved against the Company.
Item 4. Submission of Matters to a Vote of Security Holders
The Company held its Annual Meeting of Shareholders on December 31, 1997.
1. The election of three Class II Directors, each to hold office for a
three year term expiring at the 2000 annual meeting of shareholders
and/or until such director's successor shall be elected and qualified.
VOTING
- --------------------------------------------------------------------------------
NUMBER OF NUMBER OF
NUMBER OF SHARES BROKER
SHARES FOR WITHHELD NON-VOTES
---------- -------- ---------
Allan D. Greenberg 21,980,530 448,648 0
Kenneth Roman 22,260,060 169,118 0
Maurice W. Slayton 22,260,068 169,110 0
2. The adoption of certain amendments to the Company's 1996 Stock Award
and Stock Option Plan.
VOTING
- --------------------------------------------------------------------------------
NUMBER OF NUMBER OF NUMBER OF
NUMBER OF SHARES SHARES BROKER
SHARES FOR AGAINST ABSTAINED NON-VOTES
---------- ------- --------- ---------
16,980,422 5,409,996 38,760 0
3. The adoption of an amendment to the Company's Second Restated
Certificate of Incorporation increasing the number of its authorized
shares of common stock from 50,000,000 to 100,000,000.
VOTING
- --------------------------------------------------------------------------------
NUMBER OF NUMBER OF NUMBER OF
NUMBER OF SHARES SHARES BROKER
SHARES FOR AGAINST ABSTAINED NON-VOTES
---------- ------- --------- ---------
21,504,840 905,670 18,668 0
24
<PAGE>
4. The adoption of an amendment to the Company's Second Restated
Certificate of Incorporation to reduce the minimum required number of
members constituting the Company's Board of Directors from nine to
seven.
VOTING
- --------------------------------------------------------------------------------
NUMBER OF NUMBER OF NUMBER OF
NUMBER OF SHARES SHARES BROKER
SHARES FOR AGAINST ABSTAINED NON-VOTES
---------- ------- --------- ---------
19,738,244 2,673,644 17,290 0
5. The approval of the purchase by the Company of The Fickes and Stone
Knightsbridge Interests.
VOTING
- --------------------------------------------------------------------------------
NUMBER OF NUMBER OF NUMBER OF
NUMBER OF SHARES SHARES BROKER
SHARES FOR AGAINST ABSTAINED NON-VOTES
---------- ------- --------- ---------
15,042,284 2,069,597 1,106,483 4,210,814
6. The approval of the purchase by the Company of all the outstanding
common stock and common stock warrants of Southwestern Financial
Corporation not already owned by the Company.
VOTING
- --------------------------------------------------------------------------------
NUMBER OF NUMBER OF NUMBER OF
NUMBER OF SHARES SHARES BROKER
SHARES FOR AGAINST ABSTAINED NON-VOTES
---------- ------- --------- ---------
15,043,357 2,069,046 1,105,961 4,210,814
7. The approval of the adjournment of the Annual Meeting in the event
there are not sufficient votes to approve the above proposals at the
time of the Annual Meeting.
VOTING
- --------------------------------------------------------------------------------
NUMBER OF NUMBER OF NUMBER OF
NUMBER OF SHARES SHARES BROKER
SHARES FOR AGAINST ABSTAINED NON-VOTES
---------- ------- --------- ---------
16,774,851 5,540,679 113,648 0
25
<PAGE>
PART II
Item 5. Market for the Registrant's Common Equity and Related Shareholder
Matters
MARKET FOR COMMON STOCK
The shares of PennCorp Financial Group, Inc. are listed on the New York
Stock Exchange ("NYSE") under the ticker symbol "PFG." The following table sets
forth for the calendar periods indicated, the high and low sales price per share
of the Company's Common Stock as reported on the NYSE and the quarterly cash
dividends declared on the Common Stock with respect to each quarter since
January 1, 1996. The prices do not include mark-ups, mark-downs, or commissions.
As of February 27, 1998, there are approximately 179 shareholders of record
throughout the United States and abroad.
The price history as provided by NYSE and dividends for the years ended
December 31, 1997 and 1996, are presented below:
<TABLE>
<CAPTION>
SALES PRICE DIVIDEND
FOR THE YEAR ENDED DECEMBER 31, 1997 HIGH LOW DECLARED
- ------------------------------------ ---- --- --------
<S> <C> <C> <C>
Fourth quarter...................................... $ 35.875 $ 30.188 $ 0.05
Third quarter....................................... 40.375 29.500 0.05
Second quarter...................................... 38.500 30.125 0.05
First quarter....................................... 39.000 32.000 0.05
SALES PRICE DIVIDEND
FOR THE YEAR ENDED DECEMBER 31, 1996 HIGH LOW DECLARED
- ------------------------------------ ---- --- --------
Fourth quarter..................................... $ 36.375 $ 32.000 $ 0.05
Third quarter...................................... 34.125 25.750 0.05
Second quarter..................................... 33.625 26.750 0.05
First quarter...................................... 33.000 26.875 0.05
</TABLE>
(Remainder of Page Intentionally Left Blank)
26
<PAGE>
Item 6. Selected Consolidated Financial Data
(In thousands, except per share amounts)
<TABLE>
<CAPTION>
For the years ended December 31, 1997 1996 1995 1994 1993
- -------------------------------- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Revenues:
Policy revenues.................................... $ 345,566 $ 348,090 $ 301,889 $ 244,422 $ 201,788
Net investment income.............................. 273,237 210,734 102,291 51,850 43,114
Other income(1).................................... 46,476 43,703 21,794 1,056 3,817
Net gains (losses) from the sale of investments.... 17,487 1,257 3,770 (3,556) 1,439
---------- ---------- ---------- ---------- ----------
Total revenues................................. 682,766 603,784 429,744 293,772 250,158
---------- ---------- ---------- ---------- ----------
Benefits and expenses:
Claims incurred.................................... 202,472 188,727 141,876 112,650 95,232
Change in liability for future policy benefits and
other policy benefits............................ 121,817 83,184 20,047 (9,329) (13,857)
Insurance and other operating expenses............. 264,607 181,678 164,126 111,524 113,114
Interest and amortization of deferred
debt issuance costs............................. 23,355 18,579 19,520 18,274 7,461
---------- ---------- ---------- ---------- ----------
Total benefits and expenses.................... 612,251 472,168 345,569 233,119 201,950
---------- ---------- ---------- ---------- ----------
Income before income taxes and extraordinary charge... 70,515 131,616 84,175 60,653 48,208
Income taxes....................................... 20,375 40,957 27,829 22,163 17,336
---------- ---------- ---------- ---------- ----------
Income before extraordinary charge.................... 50,140 90,659 56,346 38,490 30,872
Extraordinary charge, net of income taxes...... -- (2,372) -- -- (3,322)
---------- ---------- ---------- ---------- ----------
Net Income............................................ 50,140 88,287 56,346 38,490 27,550
Preferred stock dividend requirements.......... 19,533 14,646 6,540 1,151 --
---------- ---------- ---------- ---------- ----------
Net income applicable to common stock................. $ 30,607 $ 73,641 $ 49,806 $ 37,339 $ 27,550
========== ========== ========== ========== ==========
(1) Includes $19.0 million, $21.0 million and $4.7 million of equity in
earnings of unconsolidated affiliates for the years ended 1997, 1996 and
1995, respectively.
Per Share Information:
Basic:
Net income applicable to common stock
before extraordinary charge..................... $ 1.09 $ 2.79 $ 2.26 $ 1.95 $ 1.71
Net income applicable to common stock before net gains
(losses) from the sale of investments, restructuring
and transaction costs and extraordinary charge(2) $ 1.58 $ 2.76 $ 2.26 $ 2.07 $ 1.65
Extraordinary charge, net of income taxes......... $ -- $ (0.09) $ -- $ -- $ (0.18)
Common shares used in computing basic earnings
per share....................................... 28,016 27,208 22,048 19,112 18,090
Diluted:
Net income applicable to common stock before
extraordinary charge........................... $ 1.07 $ 2.49 $ 2.12 $ 1.88 $ 1.63
Net income applicable to common stock before net
gains (losses) from the sale of investments,
restructuring and transaction costs and
extraordinary charge(2)........................ $ 1.54 $ 2.47 $ 2.12 $ 2.00 $ 1.58
Extraordinary charge, net of income taxes......... $ -- $ (0.07) $ -- $ -- $ (0.18)
Common shares used in computing diluted
earnings per share.............................. 28,645 35,273 25,216 19,851 18,970
Cash dividends declared.............................. $ 0.20 $ 0.20 $ 0.06 $ 0.04 $ 0.04
As of December 31,
Assets:
Investments and cash................................. $3,340,114 $3,694,609 $2,288,979 $ 822,778 $ 674,552
Insurance assets..................................... 617,318 639,798 499,668 342,547 256,066
Other assets......................................... 766,703 474,916 354,271 144,244 132,767
---------- ---------- ---------- ---------- ----------
Total assets...................................... $4,724,135 $4,809,323 $3,142,918 $1,309,569 $1,063,385
========== ========== ========== ========== ==========
Liabilities and shareholders' equity:
Insurance liabilities................................ $3,289,925 $3,566,455 $2,221,161 $ 788,223 $ 649,899
Long-term debt....................................... 359,755 210,325 307,271 229,041 150,812
Other liabilities.................................... 194,352 170,302 125,351 58,903 73,924
Redeemable preferred stock........................... 19,867 32,864 30,007 37,256 --
Shareholders' equity................................. 860,236 829,377 459,128 196,146 188,750
---------- ---------- ---------- ---------- ----------
Total liabilities and shareholders' equity........ $4,724,135 $4,809,323 $3,142,918 $1,309,569 $1,063,385
========== ========== ========== ========== ==========
(2) Excludes amortization associated with net gains (losses) from the sale of
investments of $9.4 million for the year ended December 31, 1997. In
addition, restructuring accruals and period costs and transaction costs
associated with a terminated merger agreement during 1997 all of which
aggregate $29.0 million have been excluded for purposes of such
calculations. In 1997, common shares used for diluted earnings per share
calculation were 33,733. During 1995, the Company incurred restructuring
charges aggregating $3.9 million.
</TABLE>
27
<PAGE>
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
CAUTIONARY STATEMENT
Cautionary Statement for purposes of the Safe Harbor Provisions of the
Private Securities Litigation Reform Act of 1995. The statements below that
relate to future plans, events or performances are forward-looking statements
that involve a number of risks or uncertainties. Among those items that could
adversely affect the Company's financial condition, results of operations and
cash flows are the following: changes in regulations affecting insurance
companies, interest rates, the federal income tax code (to the extent the
Company's product mix includes tax deferred accumulation products), the ratings
assigned to the Company's insurance subsidiaries by independent rating
organizations such as A.M. Best Company ("A.M. Best") (which the Company
believes are particularly important to the sale of annuity and other
accumulation products) and unanticipated litigation. There can be no assurance
that other factors not currently anticipated by management will not also
materially and adversely affect the Company's results of operations.
GENERAL
The Company, through its operating subsidiaries, is a low cost provider of
accumulation, life, and fixed benefit accident and sickness insurance products
throughout the United States and Canada. The Company's products are sold through
several distribution channels, including exclusive agents, general agents,
financial institutions, and payroll deduction programs, and are targeted
primarily to lower and middle-income individuals in rural and suburban areas.
These products are primarily small premium accident and sickness insurance
policies with defined fixed benefit amounts, traditional whole life and
universal life insurance with low face amounts and accumulation products such as
single premium deferred annuities.
The Company's financial condition and results of operations for the periods
covered by this and future "Management's Discussion and Analysis of Financial
Condition and Results of Operations" are or will be affected by several common
factors, each of which is discussed below.
Strategic Review of Business Units. As a result of the tremendous growth
the Company has experienced, the diversification of the underlying business
units resulting from acquisitions over time, and the need for the Company to be
able to rapidly integrate future acquisitions, the Company began a strategic
business evaluation during the third quarter of 1996. The review resulted in the
Company establishing three primary divisional platforms, Career Sales Division,
Payroll Sales Division and Financial Services Division.
As a result, the Company began to realign its existing operating companies
and incurred restructuring and period costs aggregating $21.4 million for the
year ended December 31, 1997, directly associated with the initial divisional
restructuring which will have no future economic benefit ("restructuring
costs"), including the costs of employee termination benefits and relocation,
early service contract termination, and facility abandonment.
In addition, on August 30, 1997 the merger agreement between Washington
National Corporation ("Washington National") and the Company terminated. The
Company incurred legal, accounting and financial advisory fees associated with
the merger. In addition, the Company had begun to provide certain resources to
Washington National including personnel to perform policy administration and
claims processing function on Washington National's behalf. The aggregate
advisory and administration costs incurred by the Company during 1997 were
approximately $7.6 million.
On January 2, 1998, the Company acquired the Controlling Interest in SW
Financial. As a result of such acquisition, the Company is able to complete its
divisional restructuring which began in 1997. As a result of the Company's plans
to consolidate certain of its operating locations and corporate functions, the
Company expects to incur restructuring and certain other charges during 1998 not
to exceed approximately $25.0 million.
On February 18, 1998, the Company announced that it had engaged investment
banking firms to review strategic alternatives for maximizing shareholder value,
including the sale of the Career Sales Division. The Company anticipates the
disposition of the Career Sales Division within one year. See Note 19 of Notes
to Consolidated Financial Statements.
28
<PAGE>
Acquisitions. The Company's historical growth strategy has emphasized the
acquisition of complementary insurance operations and the utilization of the
Company's several distribution channels to further penetrate its target markets.
In making acquisitions, the Company has sought to broaden its distribution
channels, increase its product offerings and expand its geographic presence. The
Company also seeks benefits from expense reduction through the consolidation of
facilities and staff and the conversion to common administrative systems.
Each of the operating considerations outlined above as well as the cost of
capital to the Company, expected cash flows from the target acquisition and
actuarial factors, such as future premium, mortality, morbidity, surrenders,
operating expenses and yields on assets held to back policy liabilities are
considered and weighted in determining the relative risk of financial rewards
for taking on the acquisition target.
On July 22, 1996, the Company acquired United Life & Annuity Insurance
Company ("United Life") from United Companies Financial Corporation. United Life
markets fixed and variable annuity products through independent agents and
financial institution marketing channels.
On December 14, 1995, Southwestern Financial Corporation ("SW Financial"),
a newly organized corporation formed by the Company and Knightsbridge (see Notes
15 and 16 to Notes to Consolidated Financial Statements), purchased Southwestern
Life Insurance Company, Union Bankers Insurance Company and certain other
related assets from I.C.H. Corporation for $260,000.
Through its initial direct investment of $120,000 in SW Financial (the
"Southwestern Life Investment"), the Company beneficially owns 74.8% of SW
Financial's outstanding common stock, including 100% of SW Financial's
non-voting common stock, 14.3% of SW Financial's voting common stock, and 100%
of SW Financial preferred stock. PennCorp is also a 16.3% limited partner in
Knightsbridge. As a result, the Company has an economic interest in SW Financial
aggregating 78.0 percent (for additional information regarding SW Financial see
Notes 6 and 19 of "Notes to Consolidated Financial Statements").
On July 25, 1995, the Company consummated the acquisition of Integon Life
Insurance Corporation ("Integon Life"). Integon Life's life and annuity products
are marketed through a general agency sales force, primarily in the Southeastern
United States.
The comparability of the Company's financial position, results of
operations and cash flows for each of the periods presented has been affected by
these acquisitions. The pro forma effects of the acquisition of United Life is
described in Note 3 of Notes to Consolidated Financial Statements included
elsewhere herein.
Financing Activities. As a part of each of the Company's acquisitions and
as part of a long-term plan to maintain an appropriate balance in its capital
structure, PennCorp has undertaken various public and private financing
transactions. As a result, the Company's historical financial results reflect
significant variations in financing costs including preferred stock dividends
and extraordinary charges resulting from the early extinguishment of debt.
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
The Company's liquidity requirements are funded primarily by its insurance
subsidiaries. The insurance subsidiaries' principal sources of cash are premiums
and investment income. The insurance subsidiaries' primary uses of cash are
policy claims, commissions, operating expenses, income taxes and payments to the
Company for principal and interest due under surplus debentures, tax sharing
payments and dividends. Both sources and uses of cash are reasonably
predictable.
Financings. In March 1997, the Company entered into a $450.0 million
revolving credit agreement with a syndicate of banks ("the bank credit
agreement") which replaced the Company's previously outstanding $175.0 million
credit agreement which had been entered into in May 1996. Borrowings under the
bank credit agreement during 1997 were used to: (i) retire previously
outstanding bank indebtedness aggregating $92.0 million, (ii) make capital
contributions to its
29
<PAGE>
insurance subsidiaries amounting to $14.9 million, (iii) the acquisition of the
SW Financial subordinated indebtedness and preferred stock of Acordia
aggregating a total of $65.6 million, (iv) repurchase the previously outstanding
Series B Redeemable Preferred Stock in the amount of $14.7 million, (v) fund
restructuring costs incurred by various operating subsidiaries aggregating $14.9
million, and (vi) for other corporate purposes.
During 1997, the Company announced a stock repurchase program in which the
Company was authorized by its Board of Directors to purchase up to 4.5 million
shares of common stock in the open market, through arranged transactions and
otherwise. During 1997, the Company borrowed approximately $28.8 million to
repurchase approximately 819,000 shares.
On August 2, 1996, the Company issued 2,875,000 shares of $3.50 Series II
Convertible Preferred Stock ("Series II Convertible Preferred Stock") for net
proceeds of $139.2 million. The cash raised through this offering, along with
borrowings under the Company's bank credit facility, were utilized: (i) to fund
the cash portion of the purchase price for United Life, aggregating $100.4
million, (ii) to fund a capital contribution of $57.3 million to United Life,
and (iii) to pay related expenses of the acquisition of United Life of $9.7
million. The Company accrued or paid dividends of $10.1 million and $4.0 million
during 1997 and 1996, respectively, related to the Series II Convertible
Preferred Stock.
On February 28, 1996, PennCorp completed the sale of 5,131,300 shares of
Common Stock, netting proceeds of $155.5 million ("February 1996 Common Stock
Offering"). Proceeds from this offering were utilized to repay $80.0 million of
corporate and $57.0 million of subsidiary indebtedness, and to pay $10.0 million
to SW Financial's former owner in lieu of PennCorp's obligation to issue an
equivalent number of shares of Common Stock.
In May 1996, the Company entered into its previously outstanding revolving
credit agreement with a syndicate of banks for up to $175.0 million of funds
available at any one time to replace the $100.0 million bridge facility utilized
by the Company to make the investment in SW Financial, which was repaid out of
the proceeds of the February 1996 Common Stock Offering. During the remainder of
1996, the Company borrowed amounts aggregating $92.0 million for: (i) the
repurchase of $35.4 million in principal amount of the Company's 9 1/4% Senior
Subordinated Debenture due 2003 (the "Notes") for $37.7 million, including
interest and premium on early redemption of $2.3 million, (ii) the refinancing
of $20.0 million of indebtedness under the previously outstanding bridge
facility, (iii) the repayment of $16.5 million of amounts owed certain
subsidiaries, and (iv) $17.8 million for general corporate purposes including
the United Life acquisition, interest payments and common and preferred stock
dividend payments.
On July 14, 1995, PennCorp issued 2,300,000 shares of $3.375 Convertible
Preferred Stock ("Convertible Preferred Stock") for net proceeds of $110.5
million. On March 16, 1995, PennCorp issued 3,750,000 shares of Common Stock,
for net proceeds of approximately $51.2 million. The proceeds from these two
offerings were used to: (i) consummate the acquisition of Integon Life, which
utilized funds totaling $33.4 million (including a capital contribution of $15.0
million), (ii) repay $28.5 million outstanding under, and subsequently cancel, a
revolving credit facility, (iii) repurchase, for $34.6 million, all of the
Company's Series A Preferred Stock, (iv) repay $11.2 million due to Integon
Life's former parent company under a subordinated debenture, (v) pay the $15.4
million cash portion of the purchase price of Occidental Life Insurance Company
of North Carolina ("OLIC") (which PennCorp purchased from Pennsylvania Life
Insurance Company and its wholly-owned subsidiary, Penncorp Life Insurance
Company (collectively referred to herein as "Penn Life") and subsequently
contributed to Integon Life), (vi) prepay $20.0 million principal amount of
subsidiary indebtedness, and (vii) make payments for general corporate purposes,
including interest payments and the cancellation of certain interest rate swap
agreements. The Company paid or accrued dividends on the Convertible Preferred
Stock amounting to $7.8 million, $7.8 million and $3.6 million during 1997, 1996
and 1995, respectively.
As part of the financing for the Integon Life acquisition, PennCorp issued
Series B Preferred Stock with an initial value of $12.8 million, which accretes
at 10.4% per annum until its maturity on June 30, 1997, and Series C Preferred
Stock with an initial value (subject to offset) of $17.9 million, which accretes
at 9.3% per annum until its maturity on June 30, 1998. The Series C Preferred
Stock's estimated initial value for financial statement purposes was
approximately $16.0 million. Preferred stock dividends accreted during 1997,
1996 and 1995, on the Series B and Series C Preferred Stock amounted to $1.7
million, $2.9 million and $1.3 million, respectively. On March 14, 1997, the
Company redeemed all the
30
<PAGE>
outstanding Series B Preferred Stock for $14.7 million, utilizing proceeds
available under the bank credit facility. On March 31, 1998, the Company plans
to redeem the Series C Preferred Stock into shares of the Company's Common Stock
under provision of the Series C Preferred Stock certificate of designation.
The Notes, the bank credit agreement and the Series C Preferred Stock
impose certain covenants on the Company, including covenants restricting the
amount of additional indebtedness the Company may incur, its ability to engage
in future acquisitions and certain other business transactions, and the amount
of dividends the Company may declare and pay, and requires the Company to
maintain specified financial ratios and meet specified financial tests, all of
which may impose limitations on the Company's future liquidity.
Surplus Debentures, Dividend Restrictions and Cash Flows. Cash generated by
the Company's insurance subsidiaries is made available to PennCorp principally
through periodic payments of principal and interest on surplus debentures issued
by Pacific Life and Accident Insurance Company ("PLAIC") and Pioneer Security
Life Insurance Company ("Pioneer Security") (collectively, the "Surplus Note
Companies"). The amounts outstanding under the surplus debentures totaled $358.3
million and $367.9 million as of December 31, 1997 and 1996, respectively. The
surplus debentures generally require (subject to availability of statutory
capital and surplus and in some instances, regulatory approval) principal and
interest payments to be made periodically in amounts sufficient to allow
PennCorp to meet its cash requirements.
The Surplus Note Companies rely upon dividends and tax sharing payments
from their respective insurance subsidiaries. Each of the insurance subsidiaries
is in turn subject to regulatory restrictions with respect to the maximum amount
of dividends that can be paid to the Surplus Note Companies without prior
regulatory approval. Such dividend restrictions are primarily in the form of (i)
the greater of 10% of statutory capital and surplus or statutory earnings, or
(ii) the lesser of 10% of statutory capital and surplus or statutory earnings,
depending upon applicable state laws. The Company believes that such
restrictions will not significantly impact the Company's liquidity for the
foreseeable future.
For the years ended December 31, 1997, 1996 and 1995, the Company received
net payments from the Surplus Note Companies of $44.1 million, $31.9 million and
$19.1 million, respectively. The Surplus Note Companies received $32.1 million,
$25.8 million and $21.6 million in dividends and tax sharing payments from their
respective insurance subsidiaries.
The primary cash requirements of the Company are interest payments,
preferred stock dividends and common stock dividends which aggregated $47.4
million, $33.9 million and $ 24.5 million for the years ended December 31, 1997,
1996 and 1995, respectively. For the years ended December 31, 1997, 1996 and
1995, cash requirements of the Company exceeded cash made available to the
Company through payments under the surplus debentures by $3.3 million, $2.0
million and $ 5.4 million, respectively. During each of these periods, the
Company utilized a balance of dividends and surplus note payments from the
insurance subsidiaries and borrowings under the Company's credit facilities to
fund PennCorp's cash requirements. This balance resulted in what management
believes to be, along with other factors, an appropriate retention of statutory
capital and surplus to improve the insurance subsidiaries' A.M. Best ratings
without placing an undue debt burden upon the Company.
During 1998, the maximum dividends and tax sharing payments and
corresponding surplus debenture payments, without prior regulatory approval, are
anticipated to be approximately $79.0 million and the Company's cash
requirements are anticipated to be approximately $59.0 million. As a result of
the Company's historical policy of retaining capital and surplus at the
insurance subsidiary level, and as a result of the Company's simplification of
its corporate structure, including the statutory merger of a number of insurance
companies, combined with realignment of the insurance subsidiaries into
operating divisions, the Company believes that as of December 31, 1997, its
insurance subsidiaries have excess capital and surplus. The Company's own
established targets for estimated risk-based capital requirements indicate that
the insurance divisions could make available approximately $40.0 million to
PennCorp, subject to applicable regulatory approvals.
Investments. The Company's investment portfolio is managed with the
objectives of maintaining high credit quality and liquidity, maximizing current
income within acceptable levels of risk, minimizing market and credit risk, and
matching the anticipated maturities of investments to the Company's liabilities.
The Company believes that a conservative
31
<PAGE>
investment strategy fits the nature of its insurance products which have little
or no inflation risk and limited build-up of cash accumulation values in earlier
years.
The Company continuously evaluates its investment portfolio and the
conditions under which it might sell securities, including changes in interest
rates, changes in prepayment risk, liquidity needs, asset liability matching,
tax planning strategies and other economic factors. Those securities that the
Company believes would be subject to sale prior to the specified maturity date
are included in "securities available for sale," which amounted to $2,719.0
million and $2,993.9 million at December 31, 1997 and 1996, respectively. Of
those securities available for sale, 92.5% and 92.1% were rated Baa or above by
Moody's Investors Services, Inc. at December 31, 1997 and 1996, respectively.
During the years ended December 31, 1997, 1996 and 1995, the Company sold
$801.1 million, $378.6 million and $109.8 million of fixed maturity and equity
securities, and purchased $1,021.5 million, $955.8 million and $217.8 million of
fixed maturity and equity securities, respectively. Such sales and purchases
were often effected to improve the quality of the investment portfolio or to
avoid prepayment risks. As a result of the Company's decision to exit the
private placement bond sector, the Company transferred all of its remaining
assets in the fixed maturities held for investment portfolio to its fixed
maturities available for sale portfolio as of April 1, 1997. In accordance with
Statement of Financial Accounting Standards ("SFAS") No. 115, the Company marked
all assets subject to the transfer to fair value resulting in an increase in
shareholders' equity, net of applicable income taxes, of approximately $1.8
million. During 1996, the Company sold one security in its held for investment
portfolio aggregating $4.9 million as a result of a dramatic deterioration in
its credit rating.
During 1995, the Company established a portfolio of "trading securities" to
provide the Company with the opportunity to undertake interest rate hedging
strategies, to participate in short-term relative value trades and to invest in
special situations with the goal of generating short-term trading profits. As a
result of trading activities, the Company recognized $1.1 million, $1.3 million
and $5.7 million of profits during 1997, 1996 and 1995, respectively. As of
December 31, 1997, the Company held no investments in its trading portfolio.
The Company held $1,287.6 million and $1,428.3 million of mortgage-backed
bonds which represented 38.8% and 38.9% of total invested assets as of December
31, 1997 and 1996, respectively. The Company invests in mortgage- backed
securities in order to enhance portfolio yields and maintain a reliable cash
flow stream from the invested asset portfolio. The Company maintains
sophisticated models to measure the effective duration and option-adjusted
duration of the consolidated investment portfolio. These models are updated on a
monthly basis and are designed to allow accurate measurement of the convexity
risks inherent in that percentage of the portfolio invested in mortgage-backed
securities and other callable securities. The Company manages the portfolio
convexity risk within the context of the overall asset and liability model and
the quantification of disintermediation risk.
Mortgage loans on real estate amounted to 7.3% and 7.2% of total invested
assets as of December 31, 1997 and 1996, respectively. United Life is the
Company's only subsidiary which actively originates new mortgage loans. United
Life invests in first mortgage loans and provides a mortgage loan warehousing
facility for its former parent as a means of obtaining higher invested asset
yields necessary to support competitively priced annuity products. The Company
has established a reserve for loan loss which aggregated $6.0 million as of
December 31, 1997. As of December 31, 1997 and 1996, the Company had
non-performing loans amounting to $698,000 and $1.4 million, respectively. The
Company is in various stages of foreclosure or sales of such loans. The Company
believes its current loan loss provision is adequate to cover any future losses
related to currently performing and non-performing loans.
Cash and short-term investments totaled $109.0 million and $102.6 million
as of December 31, 1997 and 1996, respectively. At December 31, 1997 and 1996,
respectively, the Company held approximately $135,000 and $12.2 million in
short-term investments needed in the settlement of investment trades early in
the following year.
Final Determination of Pre-Acquisition Contingencies and Purchase Price
Allocation. For each of the periods presented, the Company has made certain
valuation determinations with respect to pre-acquisition contingencies or
allocations. For the year ended December 31, 1997, the Company determined the
following with respect to certain material
32
<PAGE>
acquisition contingencies or allocations: (i) the Company increased deferred tax
assets and reduced associated costs in excess of net assets acquired associated
with the Integon Life acquisition by $19.6 million as a result of the Company
resolving certain acquisition date tax contingencies, (ii) the Company reduced
both deferred tax liabilities and associated costs in excess of net assets
acquired associated with the Marketing One acquisition by $1.1 million as a
result of the Company resolving certain acquisition date tax contingencies, and
(iii) the Company reduced costs in excess of net assets acquired and increased
certain mortgage loan values by $1.1 million, associated with the acquisition of
United Life, as a result of final appraisals becoming available.
For the year ended December 31, 1996, the Company determined the following
with respect to certain material acquisition contingencies or allocations: (i)
the Company incurred additional costs associated with the acquisition of United
Life of $2.5 million, which resulted in a corresponding increase to costs in
excess of net assets acquired, (ii) the Company decreased real estate and
mortgage loan loss valuations of Integon Life by $6.8 million, which resulted in
a decrease in costs in excess of net assets acquired of $4.4 million and
deferred tax assets of $2.4 million, and (iii) the Company increased certain
policy reserves of Integon Life aggregating $10.0 million, which resulted in a
corresponding increase to costs in excess of net assets acquired of $10.0
million.
For the year ended December 31, 1995, the Company determined a reduction in
the valuation of the Series A Preferred Stock issued in conjunction with the AA
Life acquisition of $3.9 million was necessary based upon final settlement,
which resulted in a corresponding reduction in costs in excess of net assets
acquired.
Disintermediation Risk. With the acquisition of United Life and Integon
Life, the Company significantly expanded its interest sensitive portfolio of
products including universal life and accumulation products. The Company
actively manages the difference in interest yields on assets backing interest
sensitive liabilities and amounts credited to policyholder account balances so
as to provide a margin or "spread." For the years ended December 31, 1997 and
1996, the Company had total interest sensitive liabilities aggregating $2,563.9
million and $2,685.7 million and obtained a spread on such liabilities of 2.5%
and 2.1%, respectively. As part of the ongoing management of interest sensitive
business, the Company annually undertakes "cash flow testing" sensitivities in
which Management evaluates a range of interest rate scenarios under which
credited interest rates and asset/liability durational matching may become
mismatched. The Company believes that it has sufficient liquidity to withstand
all reasonable scenarios established by Management.
Cash Flows From Operations. The periods covered by Management's Discussion
and Analysis of Financial Condition and Results of Operations indicate cash
provided by operating activities of $53.3 million, $152.1 million and $85.0
million in 1997, 1996 and 1995, respectively. The positive cash flow from
operating activities is not necessarily indicative of the Company's cash flow as
$275.7 million, $205.2 million and $53.2 million of cash was used to fund cash
flows for interest sensitive life and accumulation products during 1997, 1996
and 1995, respectively, which are classified as financing activities in
accordance with generally accepted accounting principles.
Inflation. The Company sells fixed benefit, life, and accumulation
products. Approximately 48.9% of the Company's total policy revenues for the
year ended December 31, 1997, were derived from fixed benefit products. These
products typically provide a predetermined fixed payment that will be paid under
specified conditions. Fixed benefit products are not designed to provide
reimbursement for medical and related costs incurred as a result of accidents
and sickness. Accordingly, payment amounts are not affected by the insured's
actual cost of health care services. Because of the characteristics of its fixed
benefit products, the Company believes that inflation does not have a material
effect on its operations.
Subsequent Events. On December 31, 1997, at the Company's Annual
Shareholders' Meeting, the shareholders approved the acquisition of the
Controlling Interest in SW Financial and the acquisition of the Stone and Fickes
Knightsbridge Interests. On January 2, 1998 and January 5, 1998 the Company
consummated the acquisitions of the Controlling Interest in SW Financial and the
Stone and Fickes Knightsbridge Interests, respectively. The acquisition of the
Controlling Interest in SW Financial will expand the Company's Financial
Services and Career Sales operations with similar products, distribution
channels and asset mixes (see Notes 15, 16 and 19 of Notes to Consolidated
Financial Statements).
33
<PAGE>
On February 18, 1998, the Company announced that it had engaged investment
banking firms to review strategic alternatives for maximizing shareholder value,
including the sale of the Company's Career Sales Division. As a result, in the
future the Company intends to account for the Career Sales Division as
"businesses held for sale" (see Note 19 of "Notes to Consolidated Financial
Statements").
The following unaudited pro forma selected financial data represents the
Company's consolidated results of operations, as if the acquisition of the
Controlling Interest in SW Financial occurred on January 1, 1997, and the pro
forma consolidated financial position, as if such transaction occurred as of
December 31, 1997. In addition, the following pro forma selected consolidated
financial data presents the Company's consolidated results of operations for the
Company's "retained businesses" (those businesses remaining after giving effect
to the disposition of the Career Sales Division) as if the disposition of the
Career Sales Division and the consummation of the acquisition of the Controlling
Interest in SW Financial occurred January 1, 1997 and the pro forma consolidated
statement of financial position as if the Career Sales Division was held for
sale as of December 31, 1997. The unaudited pro forma selected financial data
has been prepared for comparative purposes only and does not purport to be
indicative of what would have occurred had the transactions been consummated as
of January 1, 1997, or December 31, 1997, respectively, or the results of
operations or financial position which may occur in the future. The retained
business pro forma financial information reflects the historical results of the
retained businesses and does not consider the use of proceeds likely to be
derived from the disposition of the businesses held for sale. The significant
subsidiaries included in businesses held for sale are PLIC and Union Bankers, a
subsidiary of SW Financial.
<TABLE>
<CAPTION>
Retained
SW Financial Businesses
As reported Pro forma Pro forma
For the year ended December 31, 1997 1997 1997
------------------------------- ---------- ---------- ----------
(In millions, except share amounts)
<S> <C> <C> <C>
Total revenues............................................ $ 663.8 $ 950.9 $ 666.6
Income before income taxes, equity in earnings of
unconsolidated affiliates, and extraordinary charge.... 51.5 85.0 76.4
Net income applicable to common stock before
extraordinary charge................................... 30.6 31.8 27.5
Diluted net income applicable to common stock before
extraordinary charge per share......................... 1.07 1.10 *
As of December 31,
------------------
Total assets.............................................. $ 4,724.1 $ 6,966.9 $ 6,966.9
Insurance and other liabilities........................... 3,484.2 5,527.8 5,682.3
Long-term debt............................................ 359.8 550.5 396.0
Mandatory redeemable preferred stock...................... 19.9 19.9 19.9
Total shareholders' equity................................ 860.2 868.7 868.7
* Due to the fact that amounts and use of proceeds information is unavailable
regarding the businesses held for sale, per share information is not
provided.
</TABLE>
New Accounting Pronouncements. In June 1997, the FASB issued SFAS No. 130,
"Reporting Comprehensive Income." SFAS No. 130 is effective for annual and
interim periods beginning after December 15, 1997. This statement establishes
standards for reporting and displaying comprehensive income and its components
and requires all items to be recognized under accounting standards as
comprehensive income be reported in a financial statement that is displayed with
the same prominence as other financial statements. Examples of items to be
included in the Company's presentation of comprehensive income, in addition to
net income applicable to common stock, are unrealized foreign currency
translation gains and losses as well as unrealized gains and losses on
securities available for sale. The Company will adopt the provisions of SFAS No.
130 in 1998.
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information," was also issued in June 1997 by the FASB. This Statement requires
that companies disclose segment data on the basis that is used internally
34
<PAGE>
by management for evaluating segment performance and allocating resources to
segments. This Statement requires that a company report a measure of segment
profit or loss, certain specific revenue and expense items, and segment assets.
It also requires various reconciliations of total segment information to amounts
in the consolidated financial statements. The Company's current definition of
its business segments will not materially change from the current presentation.
SFAS No. 131 is effective for fiscal years beginning after December 15, 1997.
In December 1997, the American Institute of Certified Public Accountants
issued Statement of Position ("SOP") 97-3. SOP 97-3 provides: (1) guidance for
determining when an entity should recognize a liability for guaranty-fund and
other insurance-related assessments, (2) guidance on how to measure the
liability, (3) guidance on when an asset may be recognized for a portion or all
of the assessment liability or paid assessment that can be recovered through
premium tax offsets or policy surcharges, and (4) requirements for disclosure of
certain information. This SOP is effective for financial statements for fiscal
years beginning after December 15, 1998. Early adoption is encouraged.
Previously issued annual financial statements are not restated. The Company will
report the effect of initially adopting this SOP in a manner similar to the
reporting of a cumulative effect of a change in accounting principle. The
Company is currently evaluating the financial impact, which is expected to be
immaterial, as well as the changes to its related disclosures.
In February 1998, the FASB adopted SFAS No. 132 "Employers' Disclosures
about Pensions and Other Postretirement Benefits." SFAS No. 132 is effective for
fiscal years beginning after December 31, 1997. Earlier application is
encouraged. Restatement of disclosures for earlier periods provided for
comparative purposes is required. SFAS No. 132 standardizes employers'
disclosures about pension and other postretirement benefits, requires additional
information on changes in the benefit obligations and fair values of plan assets
to facilitate financial analysis, and eliminates certain irrelevant disclosures.
The Company is currently evaluating the changes to its related disclosures.
RESULTS OF OPERATIONS
The following analysis should be read in conjunction with the historical
financial statements of the Company and related notes thereto contained
elsewhere herein. Significant financial information, percentage changes and
ratios of the Company's insurance operations (excluding realized gains and
losses on sale of investments and equity in earnings of unconsolidated
affiliates) are shown in the following table:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Ratios to revenues
Total policy benefits....................................... 51.7% 48.4% 38.9%
Insurance expenses(1)....................................... 18.8 14.0 20.0
Other operating expenses(2)................................. 13.8 14.8 16.8
Interest and amortization of deferred debt issuance costs... 3.7 3.3 4.7
Pretax operating margin..................................... 12.0 19.5 19.6
- -------------------
(1) Excludes amortization associated with realized gains aggregating $9.4
million in 1997.
(2) For the year ended December 31, 1997, other operating expenses excludes
restructuring and transaction costs aggregating $29.0 million.
</TABLE>
Operating Ratios. Pretax operating margin declined considerably to 12.0% of
revenues during 1997 from 19.5% and 19.6% in 1996 and 1995, respectively. The
significant decline in operating ratios was primarily the result of increases in
benefits and insurance expense ratios. The continual increase in the benefits
ratio was anticipated as a result of the Company's most recent acquisitions
which shifted the product base away from lower benefit fixed benefit products to
life and accumulation products.
The ratio of total policy benefits to revenues increased during 1997 to
51.7% from 48.4% and 38.9% in 1996 and 1995, respectively. The increase in the
ratio of total policy benefits to revenues during 1997 was primarily
attributable to the continued increase in life and accumulation products,
relative to fixed benefit products, since benefits for life insurance products
are typically greater, as a percentage of revenues, than benefits for fixed
benefit products. Additionally,
35
<PAGE>
accumulation products, such as deferred annuities, are priced to allow for the
vast majority of interest earned on assets backing policy reserves to be
credited to the policyholder account balance resulting in a faster growth in
policy benefits than policy benefits for fixed benefit products. During 1997,
Penn Life continued to experience an increase of its benefit ratios, resulting
in an increase in the Company's overall benefits ratio of approximately 1.8
percent. The increase was primarily a result of Penn Life's strengthening of
certain claims reserves and the impact of the 1996 conversion to a new valuation
system (see below). During 1996, the Company also experienced higher than
expected mortality and morbidity costs for Penn Life and OLIC, which
collectively resulted in an approximately 2.0% increase in the claims incurred
ratio for the Company as a whole. During 1996, the Company refined the
calculation of certain policy benefit reserves which collectively aggregated
approximately $443.0 million. Such refinement resulted in an increase in future
policy benefits of approximately $1.3 million for 1996. The refinement will
result in slightly larger increases in the change in future policy benefits in
near- term reporting periods.
The Company's insurance expense ratio increased to 18.8% of revenues from
14.0% during 1996. The increase in the insurance expense ratio was primarily a
result of improved gross profit margins for OLIC and Integon during 1997 as
compared with those of 1996, which resulted in greater amortization of deferred
acquisition costs and present value of insurance in force increasing the
insurance expense ratio by approximately 1.8 percent. Also contributing to
higher insurance expense ratios was amortization associated with deferred
acquisition costs for AA Life which added approximately 0.7% to the insurance
expense ratio. AA Life anticipates increasing levels of amortization associated
with its primary new sales product, the "wealth builder." For the year ended
December 31, 1996, certain interest sensitive blocks of business had
significantly less amortization of deferred policy acquisition costs and present
value of insurance in force, as compared to 1995 due to reduced short-term
profit margins from adverse mortality. The Company believes that profit margins
have stabilized and recent variability will not impact the long-term
profitability of such products. However, if mortality experience would
deteriorate, the ultimate recoverability of deferred policy acquisition costs
and present value of insurance in force could be adversely affected.
Other operating expenses declined as a percentage of revenues to 13.8%
during 1997, from 14.8% and 16.8% during 1996 and 1995, respectively. This
downward trend was due to the acquisitions of United Life and Integon Life,
which are administered by the Company at overhead expense rates less than the
business in force prior to their respective acquisitions. Despite the growing
revenue base, the Company's total underlying expense infrastructure has
increased only moderately. In addition, expense costs have shifted from overhead
and maintenance expenses to those more closely related to the production of new
business.
During 1997, the Company's interest cost ratio increased modestly to 3.7%
from 3.3% during 1996 after a decline from the interest cost ratio of 4.7%
during 1995. The increase during 1997 was primarily a result of increased
borrowings under the Company's revolving credit facility to repurchase common
stock, contribute capital to the Company's insurance subsidiaries, acquire
certain invested assets by non-insurance subsidiaries and fund certain of the
Company's restructuring costs. The Company's overall weighted cost of
indebtedness declined to 8.2% during 1997 from 8.8% during 1996. The reduction
in the weighted average cost of indebtedness was due to general market
conditions as the Company borrowings are primarily floating rate bank debt. The
Company anticipates that the ratio of interest costs to total revenues will
increase during 1998 as a result of the Company's acquisition of the Controlling
Interest in SW Financial on January 2, 1998, on a leveraged basis. During 1996,
the Company's interest cost ratio declined to 3.3% from 4.7% during 1995. The
decline was primarily the result of the Company utilizing common and preferred
stock offerings to finance acquisition activities rather than debt. The weighted
average interest cost for outstanding indebtedness dropped to 8.8% for the year
ended December 31, 1996, from 9.0% for the year ended December 31, 1995. The
reduction in such interest costs was the result of the Company replacing
subsidiary indebtedness with borrowings by the Company which carry substantially
lower interest rates.
Policy Revenues. Policy revenues remained relatively constant during 1997
at $345.6 million compared to $348.1 million during 1996 after increasing from
$301.9 million during 1995. The very modest decline was primarily the result of
a decline in policy charges associated with accumulation products due to
increased surrenders.
Fixed benefit policy revenues decreased by 0.2%, 3.1% and 1.2% to $169.0
million, $169.3 million and $174.7 million during 1997, 1996 and 1995,
respectively. During 1997, 1996 and 1995, the Company's operating focus was
36
<PAGE>
concentrated primarily on increasing life policy revenues to achieve a balance
of life policy revenues with those of fixed benefit products. In addition,
during 1996 the Company effectively ceased marketing its "instant issue" fixed
benefit products and as a result of higher than anticipated loss ratios which
resulted in a decline in fixed benefit policy revenues for 1997 and 1996.
Life policy revenues remained nearly constant at $169.5 million for 1997
after increasing 43.9% and 75.0% to $170.0 million and $118.1 million for the
years ended 1996 and 1995, respectively. The acquisition of United Life in July
1996, and Integon Life in July 1995, added $72.4 million and $22.9 million of
life policy revenues during 1996 and 1995, respectively.
Net Investment Income. The effects of a larger average invested asset base
and improved average portfolio yields to 7.6% in 1997 from 7.5% during 1996 and
7.3% in 1995, resulted in net investment income increasing 29.7%, 106.0% and
97.1% in 1997, 1996 and 1995, to $273.2 million, $210.7 million and $102.3
million, respectively. The acquisitions of United Life, which added invested
assets of $1,492.9 million in July 1996 and Integon Life, which added invested
assets of $1,339.1 million in July 1995, contributed to the increase in
investment income. During 1997 and 1996, United life incrementally added $61.4
and $49.3 million of investment income and Integon Life incrementally added
$57.6 million during 1996 as a result of being included for the entire year.
Other income. For purposes of presentation of the summary of the Selected
Consolidated Financial Data, "other income" includes equity in earnings of
unconsolidated affiliates, income as a result of trading portfolio activity and
the income generated by the third party marketing activities of Marketing One.
During 1997, 1996 and 1995, income from unconsolidated affiliates aggregated
$19.0 million, $21.0 million and $4.7 million, respectively, including $19.0
million, $21.0 million and $910,000 as a result of the Company's economic
interest in SW Financial during 1997, 1996 and 1995, respectively. (For
additional information on the operating results of SW Financial see Note 6 of
Notes to Consolidated Financial Statements). During 1995, the Company included
its portion of the operating results of its 49% interest in the limited
partnership which owned Integon Life aggregating $3.8 million prior to the
Company's consummation of the acquisition of the remaining 51% of Integon Life
in July 1995.
In conjunction with the Company's acquisition and investment activities,
Management is regularly presented with investment opportunities to invest in
substantially undervalued securities in corporations which will likely undertake
some form of restructuring. In 1995, the Company established a trading security
account for such investments. The Company reported trading gains amounting to
$1.1 million, $1.3 million and $5.7 million during 1997, 1996 and 1995,
respectively.
Revenues generated by Marketing One aggregated $17.1 million, $20.0 million
and $7.4 million during 1997, 1996 and 1995, respectively. Marketing One was
acquired by the Company in August 1995.
During 1997, the Company recognized a gain from the disposition of its
Panamanian operation aggregating $4.1 million.
Net Gains/Losses From Sale of Investments. The Company maintains an
investment portfolio that focuses on maximizing investment income, without
exposure to unwarranted interest rate and credit risk. The Company actively
manages asset duration and liquidity risks. As a result of this strategy, the
Company routinely sells positions in securities no longer meeting its criteria.
Sales of securities during 1997, 1996 and 1995, resulted in the Company
realizing gains of $17.5 million, $1.3 million and $3.8 million during 1997,
1996 and 1995, respectively. During 1997, the Company liquidated the vast
majority of its equity holdings and private placement bond holdings. In
addition, the Company liquidated other securities available for sale in order to
meet cash flow demands associated with policyholder surrenders that in the
aggregate exceeded policyholder deposits by $275.7 million. During 1995, the
Company liquidated its holdings in Conning & Co. which resulted in a realized
gain of $3.2 million (see Note 15 of Notes to Consolidated Financial Statements
contained elsewhere herein).
Claims Incurred. Claims incurred increased 7.5%, 33.0% and 25.9% during
1997, 1996 and 1995, to $202.8 million, $188.7 million and $141.9 million,
respectively. The increase in claims during 1997 resulted from strengthening
37
<PAGE>
of certain claims reserves for PennLife of approximately $6.9 million,
additional claims of $4.2 million as the result of the inclusion of the results
of United Life for the entire year and modestly higher claims payments for AA
Life and Professional as a result of growth in the underlying business, which in
the aggregate increased $3.2 million. The increase in claims during 1996 was due
to the addition of United Life, $3.3 million, the inclusion of Integon Life for
the full year, $35.1 million, and adverse mortality experience at OLIC and Penn
Life of $4.2 million and $2.6 million, respectively, when compared to the
previously reported period. The Company is continuing to closely monitor the
claims activity in each insurance subsidiary. During 1995, the increase in
claims incurred attributable to Integon Life and AA Life, was $22.8 million and
$10.3 million, respectively.
Insurance Related Expenses. Insurance related expenses (including
commissions, amortization of deferred policy acquisition costs and amortization
of the present value of insurance in force) increased 39.6%, 8.9% and 41.2% to
$127.0 million, $91.0 million and $83.6 million during 1997, 1996 and 1995,
respectively. The increase in insurance related expenses during 1997 as compared
with 1996 and 1995 was primarily related to the amortization of deferred
acquisition costs and the value of insurance in force as commission expenses
increased slightly to $34.9 million for 1997 from $34.7 million and $31.9
million for the years ended 1996 and 1995, respectively. Of the $35.8 million
increase in amortization during 1997, the inclusion of United Life for the full
year resulted in additional amortization expense of $10.5 million, the
amortization associated with realized gains on the sale of investments increased
$9.4 million, increased gross profit margins and unlocking of lapse assumptions
for increased policy surrenders resulted in additional amortization of
approximately $6.0 million with the remainder of the increase due to additional
amortization associated with deferred acquisition costs, primarily associated
with AA Life's wealth builder products and decreased persistency of PennLife's
in force block of business. The increase in the amortization of deferred
acquisition costs and value of insurance in force during 1996 was primarily the
result of the United Life acquisition. The increase during 1995 was the result
of the Integon Life acquisition and a full year of amortization of value of
business in force associated with the AA Life acquisition.
Other Operating Expenses. Other operating expenses (including general
operating, overhead and policy maintenance expenses) increased during 1997 to
$128.1 million compared to $90.1 million during 1996 and $80.7 million during
1995. During 1997 the $38.0 million increase in operating expenses was due to:
(i) restructuring and period costs associated with the Company's restructuring
aggregating $21.4 million, (ii) transaction costs associated with the terminated
Washington National merger totaling $7.6 million, (iii) additional expenses
aggregating $4.6 million as a result of the inclusion of United Life for the
full year period, (iv) certain other non-recurring operating charges aggregating
$5.1 million and (vi) increased operating expenses primarily associated with
outside contracting costs for the Company's year 2000 compliance initiative
which were approximately $1.9 million. The increase in operating expenses during
1996 was primarily a result of the inclusion of Marketing One for the full year
period ended December 31, 1996 which increased operating expenses by $10.1
million.
Also included in other operating expense is the amortization of costs in
excess of net assets acquired which aggregated $9.5 million, $8.6 million and
$6.5 million for 1997, 1996 and 1995, respectively.
The Company has engaged certain outside vendors and focused certain
employees full time efforts to help in the full array of its year 2000
initiative. This includes systems assessment and monitoring advice, actual code
remediation, communication and consultation with critical business partners and
additional data center and testing resources. The Company expects to incur
internal and external costs associated with such expertise ranging from $9.3
million to $14.9 million, which are likely to be incurred primarily during 1998
and early 1999, and which represent approximately 25% of the Company's
technology costs. Of the range of estimated costs, the Company anticipates
approximately 42% of the costs to be internal allocation of resources.
Each of the operating divisions is primarily responsible for its
remediation efforts with corporate oversight provided as necessary. The Company
believes that the Career Division has substantially completed its year 2000
assessment and remediation efforts, which will be subject to ongoing tests for
the remainder of 1998. The Payroll Division has completed the remediation of its
largest administrative platforms, except for AA Life, and anticipates successful
remediation and testing of the remaining sub-system and system interfaces during
1998. AA Life is in the process of upgrading its policy administration system to
a year 2000 compliant version. AA Life will rely on contracted vendor resources
in working to
38
<PAGE>
complete its upgrade process. The Company's Financial Services Division has only
recently begun its year 2000 remediation efforts. Those efforts are dependent on
the utilization of outside resources. The Company believes that the Financial
Services Division has contracted with sufficient resources to be able to
remediate its essential business systems. In addition, the Financial Services
Division has committed to a strategy of utilizing third party administrative
experts, who have indicated year 2000 compliance, to handle the processing of
its health insurance business, thus eliminating the need for the upgrade or
modification of certain existing health administration systems.
Although the Company believes that its operating divisions, outside vendors
and most critical business partners will be sufficiently compliant that the year
2000 issue should not cause a material disruption in the Company's business,
there can be no assurance that there will not be material disruptions to the
Company's business or an increase in the cost of the Company doing business.
Although the Company believes that the year 2000 issues should not cause a
material disruption in the Company's business, the Company is currently
evaluating various contingency plans associated with remediation tasks which the
Company believes are at a higher risk for potential failure.
Income Taxes. The effective tax rates for the years ended December 31,
1997, 1996 and 1995, were 39.5%, 37.0% and 35.0%, respectively. The 1997 and
1996 effective rates are higher than the statutory rate of 35% primarily due to
non- deductible amortization of costs in excess of net assets acquired and
foreign taxes in excess of foreign tax credits utilized. The lower effective tax
rate for 1995 as compared to 1997 and 1996 is due to previously non-deductible
operating losses becoming available to reduce tax on operating earnings.
(Remainder of Page Intentionally Left Blank)
39
<PAGE>
Item 8. Financial Statements and Supplementary Data
Page
Management's Responsibility for Financial Statements...................... 41
PennCorp Financial Group, Inc. and Subsidiaries........................... 42
Southwestern Financial Corporation and Subsidiaries....................... 78
40
<PAGE>
MANAGEMENT'S RESPONSIBILITY FOR FINANCIAL STATEMENTS
The management of the Company is responsible for the preparation and fair
presentation of the consolidated financial statements, financial data and other
information in this annual report. They have been prepared in conformity with
generally accepted accounting principles appropriate in the circumstances and
include amounts based on the best estimates and judgment of management. The
Company's management is also responsible for the accuracy and consistency of
other financial information included in this annual report.
In recognition of its responsibility for the integrity and objectivity of
data in the financial statements, the Company maintains a system of internal
control over financial reporting which is designed to provide reasonable, but
not absolute, assurance with respect to the reliability of the Company's
financial statements. The concept of reasonable assurance is based on the notion
that the cost of the internal control system should not exceed the benefits
derived.
Internal auditors monitor and assess the effectiveness of the internal
control system and report their findings to management and the Board of
Directors throughout the year. The Company's independent auditors are engaged to
express an opinion on the financial statements and with the coordinated support
of the internal auditors, review the financial records and related data and test
the internal control system over financial reporting.
The Audit Committee of the Board of Directors, which is composed of outside
directors, serves in an oversight role to assure the integrity and objectivity
of the Company's financial reporting process. The committee meets periodically
with representatives of management, as well as the independent and internal
auditors, to review matters of a material nature related to financial reporting
and the planning, results and recommendations of audits. The independent and
internal auditors have free access to the Audit Committee, without management
present, to discuss any matter they believe should be brought to the attention
of the committee. The committee is also responsible for making recommendations
to the board of directors concerning the selection of the independent auditors.
(Remainder of Page Intentionally Left Blank)
41
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Shareholders and Board of Directors of PennCorp Financial Group, Inc.
We have audited the accompanying consolidated balance sheets of PennCorp
Financial Group, Inc. and subsidiaries as of December 31, 1997 and 1996, and the
related consolidated statements of income, changes in shareholders' equity and
cash flows for each of the years in the three-year period ended December 31,
1997. These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of PennCorp
Financial Group, Inc. and subsidiaries as of December 31, 1997 and 1996, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 1997, in conformity with generally accepted
accounting principles.
KPMG PEAT MARWICK LLP
Raleigh, North Carolina
March 19, 1998
42
<PAGE>
PENNCORP FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
For the years ended December 31,
(In thousands, except per share amounts) 1997 1996 1995
----------- ----------- -----------
<S> <C> <C> <C>
Revenues:
Premiums, principally accident and sickness........................ $ 254,020 $ 256,859 $ 239,010
Interest sensitive policy product charges.......................... 91,546 91,231 62,879
Net investment income.............................................. 273,237 210,734 102,291
Other income....................................................... 27,504 22,666 17,076
Net gains from the sale of investments............................. 17,487 1,257 3,770
----------- ----------- -----------
Total revenues................................................... 663,794 582,747 425,026
----------- ----------- -----------
Benefits and expenses:
Claims incurred.................................................... 202,472 188,727 141,876
Change in liability for future policy benefits and other
policy benefits.................................................. 121,817 83,184 20,047
Amortization of present value of insurance in force and
deferred policy acquisition costs................................ 92,046 56,470 51,535
Amortization of costs in excess of net assets acquired............. 9,545 8,648 6,486
Underwriting and other administrative expenses..................... 146,245 116,560 102,162
Interest and amortization of deferred debt issuance costs.......... 23,355 18,579 19,520
Restructuring charge............................................... 16,771 -- 3,943
----------- ----------- -----------
Total benefits and expenses...................................... 612,251 472,168 345,569
----------- ----------- -----------
Income before income taxes, equity in earnings of unconsolidated
affiliates and extraordinary charge................................ 51,543 110,579 79,457
Income taxes..................................................... 20,375 40,957 27,829
----------- ----------- -----------
Income before equity in earnings of unconsolidated affiliates and
extraordinary charge............................................... 31,168 69,622 51,628
Equity in earnings of unconsolidated affiliates.................. 18,972 21,037 4,718
----------- ----------- -----------
Income before extraordinary charge.................................... 50,140 90,659 56,346
Extraordinary charge (net of income taxes of $--, $1,277 and $--) -- (2,372) --
----------- ----------- -----------
Net income............................................................ 50,140 88,287 56,346
Preferred stock dividend requirements............................ 19,533 14,646 6,540
----------- ----------- -----------
Net income applicable to common stock................................. $ 30,607 $ 73,641 $ 49,806
=========== =========== ===========
Per Share Information:
Basic:
Net income applicable to common stock before extraordinary charge.. $ 1.09 $ 2.79 $ 2.26
Extraordinary charge, net of income taxes........................ -- (0.09) --
----------- ----------- -----------
Net income applicable to common stock.............................. $ 1.09 $ 2.70 $ 2.26
=========== =========== ===========
Common shares used in computing basic earnings per share.............. 28,016 27,208 22,048
=========== =========== ===========
Diluted:
Net income applicable to common stock before extraordinary charge.. $ 1.07 $ 2.49 $ 2.12
Extraordinary charge, net of income taxes........................ -- (0.07) --
----------- ----------- -----------
Net income applicable to common stock.............................. $ 1.07 $ 2.42 $ 2.12
=========== =========== ===========
Common shares used in computing diluted earnings per share............ 28,645 35,273 25,216
=========== =========== ===========
</TABLE>
See accompanying Notes to Consolidated Financial Statements
43
<PAGE>
PENNCORP FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
As of December 31,
(In thousands, except share amounts) 1997 1996
----------- -----------
Assets:
Investments:
<S> <C> <C>
Fixed maturity securities:
Held for investment, at amortized cost (fair value $89,759 in 1996)............ $ -- $ 87,330
Available for sale, at fair value (amortized cost $2,618,515 in 1997 and
$2,941,268 in 1996).......................................................... 2,718,982 2,993,925
Equity securities available for sale, at fair value (cost $30,084 in 1997 and
$17,511 in 1996)............................................................. 30,257 20,867
Trading securities, at fair value................................................ -- 31,140
Mortgage loans on real estate, net of allowance of $6,041 in 1997 and
$4,211 in 1996.................................................................. 240,879 264,732
Policy loans..................................................................... 145,108 145,976
Short-term investments........................................................... 84,141 63,113
Other investments................................................................ 95,875 48,062
----------- -----------
Total investments ............................................................. 3,315,242 3,655,145
Cash................................................................................ 24,872 39,464
Accrued investment income........................................................... 43,312 48,360
Accounts and notes receivable, net of allowance of $9,025 in 1997 and $6,528 in 1996 46,655 47,295
Investment in unconsolidated affiliate.............................................. 183,158 140,526
Present value of insurance in force................................................. 263,889 339,010
Deferred policy acquisition costs................................................... 310,117 252,428
Costs in excess of net assets acquired.............................................. 116,544 148,080
Other assets........................................................................ 420,346 139,015
----------- -----------
Total assets .................................................................. $ 4,724,135 $ 4,809,323
=========== ===========
Liabilities:
Policy liabilities and accruals..................................................... $ 3,289,925 $ 3,566,455
Income taxes, primarily deferred.................................................... 59,125 55,840
Notes payable....................................................................... 359,755 210,325
Accrued expenses and other liabilities.............................................. 135,227 114,462
----------- -----------
Total liabilities.............................................................. 3,844,032 3,947,082
----------- -----------
Mandatory redeemable preferred stock:
Series B, $.01 par value, $100 initial redemption value; authorized, issued and
outstanding 127,500 in 1996.................................................... -- 14,689
Series C, $.01 par value, $100 initial redemption value; authorized, issued and
outstanding 178,500 in 1997 and 1996........................................... 19,867 18,175
Shareholders' equity:
$3.375 Convertible Preferred Stock, $.01 par value, $50 redemption value; authorized
issued and outstanding 2,300,000 in 1997 and 1996................................ 110,513 110,513
$3.50 Series II Convertible Preferred Stock, $.01 par value, $50 redemption value;
authorized issued and outstanding 2,875,000 in 1997 and 1996..................... 139,157 139,157
Common stock, $.01 par value; authorized 100,000,000 in 1997 and 50,000,000 in 1996;
issued and outstanding 28,860,206 in 1997 and 28,647,714 in 1996................ 289 286
Additional paid-in capital.......................................................... 397,590 393,156
Retained earnings................................................................... 211,055 186,032
Unrealized foreign currency translation losses...................................... (20,602) (14,961)
Unrealized gains on securities available for sale................................... 55,636 20,064
Treasury shares (1,009,589 in 1997 and 189,750 in 1996)............................. (32,130) (3,370)
Notes receivable secured by common stock............................................ (1,272) (1,500)
----------- -----------
Total shareholders' equity..................................................... 860,236 829,377
----------- -----------
Total liabilities and shareholders' equity .................................... $ 4,724,135 $ 4,809,323
=========== ===========
</TABLE>
See accompanying Notes to Consolidated Financial Statements
44
<PAGE>
PENNCORP FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
For the years ended December 31,
(In thousands) 1997 1996 1995
----------- ----------- -----------
<S> <C> <C> <C>
Convertible preferred stock:
Balance at beginning of year....................................... $ 249,670 $ 110,513 $ --
Issuance of convertible preferred stock............................ -- 139,157 110,513
----------- ----------- -----------
Balance at end of year........................................... 249,670 249,670 110,513
----------- ----------- -----------
Common stock:
Balance at beginning of year....................................... 286 229 191
Issuance of common stock........................................... 1 56 38
Exercise of stock options.......................................... 2 1 --
----------- ----------- -----------
Balance at end of year........................................... 289 286 229
----------- ----------- -----------
Additional paid-in capital:
Balance at beginning of year....................................... 393,156 220,482 169,310
Issuance of common stock........................................... 1,697 170,393 51,172
Exercise of stock options.......................................... 2,737 2,281 --
----------- ----------- -----------
Balance at end of year......................................... 397,590 393,156 220,482
----------- ----------- -----------
Retained earnings:
Balance at beginning of year....................................... 186,032 117,987 69,475
Net income......................................................... 50,140 88,287 56,346
Dividends on common stock.......................................... (5,618) (5,630) (1,327)
Accretion of dividends on preferred stock.......................... (19,533) (14,646) (6,540)
Earned portion of treasury stock awarded to employees.............. 34 34 33
----------- ----------- -----------
Balance at end of year......................................... 211,055 186,032 117,987
----------- ----------- -----------
Unrealized foreign currency translation losses:
Balance at beginning of year....................................... (14,961) (15,529) (17,875)
Change in unrealized foreign currency translation losses during
the year, net of income taxes.................................... (5,641) 568 2,346
----------- ----------- -----------
Balance at end of year......................................... (20,602) (14,961) (15,529)
----------- ----------- -----------
Unrealized gains on securities available for sale:
Balance at beginning of year....................................... 20,064 30,353 (24,454)
Change in equity in unrealized gains (losses) on securities
available for sale of unconsolidated affiliate during the year... 24,277 (6,045) --
Change in unrealized gains on securities available for sale during
the year, net of income taxes.................................... 11,295 (4,244) 54,807
----------- ----------- -----------
Balance at end of year......................................... 55,636 20,064 30,353
----------- ----------- -----------
Treasury stock:
Balance at beginning of year....................................... (3,370) (3,370) (386)
Purchases of treasury stock........................................ (28,760) -- (2,984)
----------- ----------- -----------
Balance at end of year......................................... (32,130) (3,370) (3,370)
----------- ----------- -----------
Notes receivable secured by common stock:............................. (1,272) (1,500) (1,537)
----------- ----------- -----------
Total shareholders' equity..................................... $ 860,236 $ 829,377 $ 459,128
=========== =========== ===========
</TABLE>
See accompanying Notes to Consolidated Financial Statements
45
<PAGE>
PENNCORP FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
For the years ended December 31,
(In thousands) 1997 1996 1995
---------- ----------- -----------
<S> <C> <C> <C>
Cash flows from operating activities:
Income before equity in earnings of unconsolidated affiliates and
extraordinary charge.......................................... $ 31,168 $ 69,622 $ 51,628
Adjustments to reconcile income before equity in earnings of
unconsolidated affiliates and extraordinary charge to net cash
provided by operating activities:
Capitalization of deferred policy acquisition costs......... (109 ,482) (98,140) (84,089)
Amortization of present value of insurance in force, deferred
policy acquisition costs, intangibles, depreciation
and accretion, net........................................ 91,902 63,588 54,160
Increase (decrease) in policy liabilities and accruals and
other policyholder funds.................................. (1,644) 77,549 4,531
Purchases of trading securities............................. -- -- (1,031)
Sales of trading securities................................. 29,914 56,004 47,145
Other, net.................................................. 11,425 (16,476) 12,701
---------- ----------- -----------
Net cash provided by operating activities................. 53,283 152,147 85,045
---------- ----------- -----------
Cash flows from investing activities:
Cash expended in acquisition of businesses, net of cash acquired
of $-0-, $-0- and $-0-....................................... -- (99,596) (18,363)
Purchases of fixed maturity securities held for investment...... -- (27,000) (15,950)
Purchases of fixed maturity securities available for sale....... (993,768) (920,430) (188,388)
Purchases of equity securities.................................. (27,776) (8,398) (13,415)
Purchase of interest in affiliate............................... -- -- (107,366)
Maturities of fixed maturity securities held for investment..... -- 42,351 6,214
Maturities of fixed maturity securities available for sale...... 439,938 81,538 27,198
Sales of fixed maturity securities held for investment.......... -- 4,910 --
Sales of fixed maturity securities available for sale........... 777,960 368,331 99,804
Sales of equity securities...................................... 23,121 5,328 9,993
Decrease (increase) in short-term investments, net (including
changes in amounts due to broker)............................ (21,069) 412,687 39,392
Acquisitions and originations of mortgage loans................. (44,375) (112,473) --
Sales of mortgage loans......................................... 13,643 151,972 --
Principal collected on mortgage loans........................... 54,145 21,657 --
Other, net...................................................... (49,671) 4,521 (3,288)
---------- ----------- -----------
Net cash provided (used) by investing activities.......... 172,148 (74,602) (164,169)
---------- ----------- -----------
Cash flows from financing activities:
Issuance of notes payable....................................... 250,000 230,000 130,783
Issuance of common stock........................................ -- 155,450 51,210
Issuance of preferred stock..................................... -- 139,157 110,513
Purchases of treasury stock..................................... (28,760) -- (2,984)
Reduction of notes payable...................................... (100,570) (330,624) (91,507)
Redemption of preferred stock................................... (14,705) -- (33,415)
Receipts from interest sensitive products credited to
policyholders' account balances............................... 186,166 160,403 91,175
Return of policyholders' account balances on interest
sensitive products............................................ (461,888) (365,554) (144,413)
Repurchase agreement, net....................................... -- (52,839) --
Cash transferred on reinsurance ceded to an affiliate........... (50,000) -- --
Other, primarily dividends, net................................. (20,266) (14,399) (4,950)
---------- ----------- -----------
Net cash provided (used) by financing activities.......... (240,023) (78,406) 106,412
---------- ----------- -----------
Net increase (decrease) in cash........................... (14,592) (861) 27,288
Cash at beginning of year.......................................... 39,464 40,325 13,037
---------- ----------- -----------
Cash at end of year................................................ $ 24,872 $ 39,464 $ 40,325
========== =========== ===========
Supplemental disclosures:
Income taxes paid (refunded).................................... $ (1,554) $ (4,992) $ 787
Interest paid................................................... 20,946 18,185 20,001
Non-cash financing activities:
Debt assumed with acquisition................................... $ -- $ -- $ 38,214
Securities issued in conjunction with acquisition............... -- 14,999 28,750
Amounts due on acquisition of interest in affiliate............. -- -- 11,114
Other .......................................................... 1,281 948 --
</TABLE>
See accompanying Notes to Consolidated Financial Statements
46
<PAGE>
PENNCORP FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) BASIS OF PRESENTATION
PennCorp Financial Group, Inc. ("PennCorp", or the "Company") is an
insurance holding company. Through its wholly-owned life insurance subsidiaries,
Pennsylvania Life Insurance Company ("PLIC") and its wholly-owned subsidiary,
Penncorp Life Insurance Company (collectively referred to as "Penn Life"),
Peninsular Life Insurance Company ("Peninsular"), Professional Insurance
Corporation ("Professional"), Pioneer Security Life Insurance Company ("Pioneer
Security") and its wholly-owned subsidiaries American-Amicable Life Insurance
Company of Texas and Pioneer American Insurance Company (Pioneer Security and
its subsidiaries collectively referred to as "AA Life"), Integon Life Insurance
Corporation ("Integon Life"), Occidental Life Insurance Company of North
Carolina ("OLIC"), United Life & Annuity Insurance Company ("United Life"),
Marketing One, Inc. ("Marketing One"), a third party marketing organization, and
Pacific Life and Accident Insurance Company ("PLAIC"), the Company offers a
broad range of accident and sickness, life, and accumulation insurance products
to individuals through a sales force that is contractually exclusive to certain
of the Company's subsidiaries and through general agents.
The accompanying consolidated financial statements include the accounts of
the Company and its subsidiaries. All significant intercompany accounts and
transactions have been eliminated. All dollar amounts presented hereafter,
except share amounts, are stated in thousands.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities as well
as revenues and expenses. Accounts that the Company deems to be acutely
sensitive to changes in estimates include deferred policy acquisition costs,
policy liabilities and accruals, present value of insurance in force and
deferred taxes. In addition, the Company must determine the requirements for
disclosure of contingent assets and liabilities as of the date of the financial
statements based upon estimates. As additional information becomes available, or
actual amounts are determinable, the recorded estimates may be revised and
reflected in operating results. Although some variability is inherent in these
estimates, management believes the amounts provided are adequate. In all
instances, actual results could differ from estimates.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Investments
Fixed maturities classified as held for investment are recorded at cost,
adjusted for amortization of premium or discount, as the Company has the intent
and ability to hold them to maturity. Fixed maturities and equity securities
classified as available for sale are recorded at fair value, as they may be sold
in response to changes in interest rates, prepayment risk, liquidity needs, the
need or desire to increase income, capital or other economic factors. Changes in
unrealized gains and losses related to securities available for sale are
recorded as a separate component of shareholders' equity, net of income taxes.
Securities classified as trading securities are reported at fair value with
realized gains and losses and changes in unrealized gains and losses included in
the determination of net income as a component of other income. The
classification of securities as held for investment, available for sale or
trading is generally determined at the date of purchase. The Company carries a
certain equity investment in an affiliate on the equity basis of accounting as a
result of its percentage ownership and lack of voting control. Mortgage-backed
fixed maturity securities held for investment or available for sale are
amortized using the interest method including anticipated prepayments at the
date of purchase. Significant changes in estimated cash flows from original
assumptions are reflected in the period of such change. Mortgage loans on real
estate are recorded at cost, adjusted for amortization of premium or discount
and provision for loan loss, if necessary. Policy loans, short-term investments,
and other investments are recorded at cost, which approximates fair value.
As a result of the Company's decision to exit the private placement bond
sector, the Company transferred all of its remaining assets in the fixed
maturities held for investment portfolio aggregating $49,384 to its fixed
maturities available for sale portfolio as of April 1, 1997. In accordance with
Statement of Financial Accounting Standards No. 115, the
47
<PAGE>
Company marked all assets subject to the transfer to fair value resulting in a
net increase in shareholders' equity, net of applicable income taxes, of $1,800.
Realized investment gains and losses and declines in value which are other
than temporary, determined on the basis of specific identification, are included
in net income.
Accounts and Notes Receivable
Accounts and notes receivable consist primarily of agents' balances and
premiums receivable from agents and policyholders. Agents' balances are
partially secured by commissions due to agents in the future and premiums
receivable are secured by policy liabilities. An allowance for doubtful accounts
is established, based upon specific identification and general provision, for
amounts which the Company estimates will not ultimately be collected.
Present Value of Insurance In Force
The present value of insurance in force represents the anticipated gross
profits to be realized from future revenues on insurance in force at the date
such insurance was purchased, discounted to provide an appropriate rate of
return and amortized, with interest based upon the policy liability or contract
rate, over the years that such profits are anticipated to be received in
proportion to the estimated gross profits. Accumulated amortization was $192,049
and $144,327 as of December 31, 1997 and 1996, respectively.
Deferred Policy Acquisition Costs
Estimated costs of acquiring new business which vary with, and are
primarily related to, the production of new business, have been deferred to the
extent that such costs are deemed recoverable from future revenues. Such
estimated costs include commissions, certain costs of policy issuance,
underwriting, certain variable agency and marketing expenses and other costs
directly associated with these functions to the extent such costs are determined
to vary with and are primarily related to the production of new business. Costs
deferred associated with accident and sickness and traditional life policies are
amortized, with interest, over the anticipated premium-paying period of the
related policies in proportion to the ratio of annual premium revenue to
expected total premium revenue to be received over the life of the policies.
Expected premium revenue is estimated by using the same mortality, morbidity and
withdrawal assumptions used in computing liabilities for future policy benefits.
For interest sensitive products and limited pay life products, policy
acquisition costs are amortized in relation to the emergence of anticipated
gross profits over the life of the policies.
Costs in Excess of Net Assets Acquired
Costs in excess of the fair value of net assets acquired are amortized on a
straight-line basis primarily over 20 years. Accumulated amortization was
$44,606 and $35,061 as of December 31, 1997 and 1996, respectively.
For each of the periods presented, the Company has made certain valuation
determinations with respect to pre- acquisition contingencies or allocations.
For the year ended December 31, 1997, the Company determined the following with
respect to certain material acquisition contingencies or allocations: (i) the
Company increased deferred tax assets and reduced associated costs in excess of
net assets acquired associated with the Integon Life acquisition by $19.6
million as a result of the Company resolving certain acquisition date tax
contingencies, (ii) the Company reduced both deferred tax liabilities and
associated costs in excess of net assets acquired associated with the Marketing
One acquisition by $1.1 million as a result of the Company resolving certain
acquisition date tax contingencies, and (iii) the Company reduced costs in
excess of net assets acquired and increased certain mortgage loan values by $1.1
million, associated with the acquisition of United Life, as a result of final
appraisals becoming available.
For the year ended December 31, 1996, the Company determined the following
with respect to certain material acquisition contingencies or allocations: (i)
the Company incurred additional costs associated with the acquisition of United
Life of $2.5 million, which resulted in a corresponding increase to costs in
excess of net assets acquired, (ii) the Company
48
<PAGE>
decreased real estate and mortgage loan loss valuations of Integon Life by $6.8
million, which resulted in a decrease in costs in excess of net assets acquired
of $4.4 million and deferred tax assets of $2.4 million, and (iii) the Company
increased certain policy reserves of Integon Life aggregating $10.0 million,
which resulted in a corresponding increase to costs in excess of net assets
acquired of $10.0 million.
The Company continually monitors the value of costs in excess of net assets
acquired based upon estimates of future earnings. Any amounts deemed to be
impaired are charged, in the period in which such impairment was determined, as
an expense against earnings. For the periods presented there was no charge to
earnings for the impairment of costs in excess of net assets acquired.
Policy Liabilities
Future policy benefits for traditional life insurance products generally
have been computed on the net level premium method, based on estimated future
investment yield, mortality, morbidity and withdrawals. Estimates used are based
on experience adjusted to provide for possible adverse deviation. These
estimates are periodically reviewed and compared with actual experience. Future
policy benefits for interest sensitive products include the balance that accrues
to the benefit of the policyholders and amounts that have been assessed to
compensate the life insurance subsidiaries for services to be provided in the
future.
Policy and contract claims represent estimates of both reported claims and
claims incurred but not reported based on experience.
Income Taxes
Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to temporary differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases as well as operating loss and tax credit carryforwards.
Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in income in the
period that includes the enactment date.
Treasury Shares
Shares purchased are recorded at cost as a reduction of shareholders'
equity.
Insurance Revenue Recognition
Accident and sickness insurance premiums are recognized as revenue ratably
over the time period to which premiums relate. Revenues from traditional life
insurance policies represent premiums which are recognized as earned when due.
Benefits and expenses are associated with earned premiums so as to result in
recognition of profits over the lives of the policies. This association is
accomplished by means of the provision for liabilities for future policy
benefits and the deferral and amortization of policy acquisition costs.
Revenues for interest sensitive products such as universal life and annuity
contracts represent charges assessed against the policyholders' account balance
for the cost of insurance, surrenders and policy administration. Benefits
charged to expenses include benefit claims incurred during the period in excess
of policy account balances and interest credited to policy account balances.
Net Income per Common Share
In February 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard ("SFAS") No. 128, "Earnings Per
Share." SFAS No. 128 supersedes and simplifies the former computation,
49
<PAGE>
presentation and disclosure requirements for earnings per share outlined under
Accounting Principles Board Opinion ("APB") No. 15, "Earnings Per Share." SFAS
No. 128 is effective for both interim and annual financial statements issued
after December 15, 1997. The Company adopted SFAS No. 128 to compute earnings
per share for all periods presented.
The following is a reconciliation of net income applicable to common stock
as well as common stock used to compute basic and diluted earnings per share for
the years ended December 31:
<TABLE>
<CAPTION>
1997 1996 1995
-------- --------- ---------
<S> <C> <C> <C>
Reconciliation of net income applicable to common stock:
Basic net income applicable to common stock:
Net income applicable to common stock before
extraordinary charge...................................... $ 30,607 $ 76,013 $ 49,806
Extraordinary charge......................................... -- (2,372) --
-------- --------- ---------
$ 30,607 $ 73,641 $ 49,806
======== ========= =========
Diluted net income applicable to common stock:
Net income applicable to common stock before
extraordinary charge...................................... $ 30,607 $ 76,013 $ 49,806
Common stock equivalents:
Convertible preferred stock dividend requirements.......... -- 11,788 3,558
-------- --------- ---------
53,364
Extraordinary charge......................................... -- (2,372) --
-------- --------- ---------
$ 30,607 $ 85,429 $ 53,364
======== ========= =========
Common stock used to compute basic and diluted earnings per share:
Basic:
Shares outstanding beginning of period......................... 28,648 22,880 19,130
Common stock issuance:
Issuance of 3,750 common shares on March 14, 1995............ -- -- 3,010
Issuance of 5,131 common shares on March 5, 1996............. -- 4,232 --
Acquisition of United Life (483,839 common shares)........... -- 212 --
Incremental shares applicable to Stock Warrants/Stock Options.. 143 74 --
Treasury shares................................................ (775) (190) (92)
-------- --------- ---------
28,016 27,208 22,048
======== ========= =========
Diluted:
Shares outstanding beginning of period......................... 28,648 22,880 19,130
Common stock issuance:
Issuance of 3,750 common shares on March 14, 1995............ -- -- 3,010
Issuance of 5,131 common shares on March 5, 1996............. -- 4,232 --
Acquisition of United Life (483,839 common shares)........... -- 212 --
Incremental shares applicable to Stock Warrants/Stock Options.. 772 1,347 938
Treasury shares................................................ (775) (190) (92)
Conversion of $3.375 Convertible Preferred Stock at a rate
of 2.2123 common shares to 1 preferred share................. -- 5,088 2,230
Conversion of $3.50 Series II Convertible Preferred Stock at
a rate of 1.4327 common shares to 1 preferred share.......... -- 1,704 --
-------- --------- ---------
28,645 35,273 25,216
======== ========= =========
</TABLE>
The Company adopted the disclosure requirements of SFAS No. 123,
"Accounting for Stock-Based Compensation," in 1996. This statement provides a
choice for the accounting of employee stock compensation plans. A company may
elect to use a new fair-value methodology, under which compensation cost is
measured and recognized in results of operations, or continue to account for
these plans under APB No. 25, "Accounting for Stock Issued to Employees", and
related Interpretations. Note 12 of the Notes to Consolidated Financial
Statements contains a summary of the pro forma effects to reported net income
applicable to common stock and earnings per share for 1997 and 1996, as if the
Company had elected to account for employee stock compensation plans utilizing
the fair value methodology prescribed by SFAS No. 123.
50
<PAGE>
Business Combinations
Business combinations accounted for as a purchase result in the allocation
of the purchase consideration to the fair values of the assets and liabilities
acquired establishing such fair values as the new accounting bases. Purchase
consideration in excess of the fair value of net assets acquired is allocated to
"costs in excess of net assets acquired." Should the fair value of the net
assets acquired exceed the purchase consideration, such excess is utilized to
reduce certain intangible assets, primarily "present value of insurance in
force." Allocation of purchase price is performed in the period in which the
purchase is consummated and may be preliminary. Adjustments resulting from
completion of the purchase allocation process affect the value of the assets and
liabilities acquired.
Foreign Currency Translation
The financial statement accounts of the Company's Canadian operations,
which are denominated in Canadian dollars, are translated into U.S. dollars as
follows: (i) Canadian currency assets and liabilities are translated at the
rates of exchange as of the balance sheet dates and the related unrealized
translation adjustments are included as a separate component of shareholders'
equity, and (ii) revenues, expenses and cash flows, expressed in Canadian
dollars, are translated using a weighted average of exchange rates for each of
the periods presented.
Reinsurance
Financial reinsurance that does not transfer significant insurance risk is
accounted for as deposits. The cost of reinsurance related to long-duration
contracts is accounted for over the life of the underlying reinsured policies.
Balances due to, or from, reinsurers have been reflected as assets and
liabilities rather than being netted against the related account balances.
Realized gains on retroactive reinsurance arrangements are deferred and
amortized into net income over the estimated duration of the reinsured business.
Accounting Pronouncements Not Yet Adopted
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income." SFAS No. 130 is effective for annual and interim periods beginning
after December 15, 1997. This statement establishes standards for reporting and
displaying comprehensive income and its components and requires all items to be
recognized under accounting standards as comprehensive income be reported in a
financial statement that is displayed with the same prominence as other
financial statements. Examples of items to be included in the Company's
presentation of comprehensive income, in addition to net income applicable to
common stock, are unrealized foreign currency translation gains and losses as
well as unrealized gains and losses on securities available for sale. The
Company will adopt the provisions of SFAS No. 130 in 1998.
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information," was also issued in June 1997 by the FASB. This Statement requires
that companies disclose segment data on the basis that is used internally by
management for evaluating segment performance and allocating resources to
segments. This Statement requires that a company report a measure of segment
profit or loss, certain specific revenue and expense items, and segment assets.
It also requires various reconciliations of total segment information to amounts
in the consolidated financial statements. The Company's current definition of
its business segments will not materially change from the current presentation.
SFAS No. 131 is effective for fiscal years beginning after December 15, 1997.
In December 1997, the American Institute of Certified Public Accountants
issued Statement of Position ("SOP") 97-3. SOP 97-3 provides: (1) guidance for
determining when an entity should recognize a liability for guaranty-fund and
other insurance-related assessments, (2) guidance on how to measure the
liability, (3) guidance on when an asset may be recognized for a portion or all
of the assessment liability or paid assessment that can be recovered through
premium tax offsets or policy surcharges, and (4) requirements for disclosure of
certain information. This SOP is effective for financial statements for fiscal
years beginning after December 15, 1998. Early adoption is encouraged.
Previously issued annual financial statements are not restated. The Company will
report the effect of initially adopting this SOP in a manner similar
51
<PAGE>
to the reporting of a cumulative effect of a change in accounting principle. The
Company is currently evaluating the financial impact, which is expected to be
immaterial, as well as the changes to its related disclosures.
In February 1998, the FASB adopted SFAS No. 132 "Employers' Disclosures
about Pensions and Other Postretirement Benefits." SFAS No. 132 is effective for
fiscal years beginning after December 31, 1997. Earlier application is
encouraged. Restatement of disclosures for earlier periods provided for
comparative purposes is required. SFAS No. 132 standardizes employers'
disclosures about pension and other postretirement benefits, requires additional
information on changes in the benefit obligations and fair values of plan assets
to facilitate financial analysis, and eliminates certain irrelevant disclosures.
The Company is currently evaluating the necessary changes to its related
disclosures.
Reclassifications
Certain prior year amounts have been reclassified to conform to the current
year presentation.
(3) ACQUISITIONS
On July 22, 1996, the Company consummated the acquisition of United Life
for a total purchase price of $110,056 including expenses incurred of $9,706 and
earnings through the date of consummation of the acquisition of $3,608. The fair
value of net assets acquired amounted to $82,580 (as adjusted) resulting in
$27,476 (as adjusted) of costs in excess of net assets acquired which will be
amortized over 20 years.
The United Life acquisition has been accounted for as a purchase
transaction in accordance with generally accepted accounting principles, and
accordingly, all assets and liabilities acquired were recorded at fair value as
of the acquisition date which became the new accounting basis.
On July 25, 1995, the Company consummated the acquisition of Integon Life
for a total purchase price of $48,596 including acquisition expenses of
approximately $3,200. The fair value of net assets acquired amounted to $28,575
(as adjusted) resulting in $20,021 (as adjusted) of costs in excess of net
assets acquired which will be amortized over 20 years.
The acquisition of Integon Life was initiated on January 20, 1995, when the
Company and its subsidiaries entered into a series of related agreements to
acquire all of the issued and outstanding capital stock of Salem Holding
Corporation (formerly Integon Life Corporation), including the purchase for
$15,000 in cash, of a 49% limited partnership interest in the ultimate limited
partner that controlled Integon Life. Prior to the consummation of the
acquisition, the Company's 49% equity interest in the net income of Integon
Life, which aggregated $3,808, was reported on the equity method of accounting
as undistributed earnings in unconsolidated affiliates for the period from
January 20, 1995 to July 25, 1995.
The Integon Life acquisition has been accounted for as a purchase
transaction in accordance with generally accepted accounting principles, and
accordingly, assets and liabilities acquired have been recorded as a step
purchase with fair values determined as of January 20, 1995 and July 25, 1995,
which became the new cost basis.
52
<PAGE>
The following unaudited pro forma financial information represents the
Company's consolidated results of operations as if the United Life acquisition
occurred as of January 1, 1996. This unaudited pro forma financial information
has been prepared for comparative purposes only and does not purport to be
indicative of what would have occurred had the acquisition been made as of
January 1, 1996, or results which may occur in the future.
<TABLE>
<CAPTION>
(In thousands, except per share amounts)
For the years ended December 31, 1996
- -------------------------------- ----
<S> <C>
Total revenues...................................................................... $ 652,781
Income before income taxes, equity in earnings of unconsolidated
affiliate and extraordinary charge............................................... 117,654
Net income applicable to common stock............................................... 74,894
Per share information:
Net income applicable to common stock - basic..................................... 2.63
Net income applicable to common stock - diluted................................... 2.38
</TABLE>
(4) FOREIGN INFORMATION AND BUSINESS SEGMENT INFORMATION
The Company's only reportable industry segment is life insurance, and its
only significant foreign operations are conducted in Canada. Within the life
insurance segment the Company's significant lines of business include fixed
benefit, life and accumulation products. Assets and related investment income
are allocated based upon related insurance liabilities which are backed by such
assets. Other operating expenses are allocated in relation to the mix of related
revenues.
The components of operations were as follows for the years ended December
31:
<TABLE>
<CAPTION>
1997 1996 1995
----------- ---------- ----------
<S> <C> <C> <C>
Total revenues:
Insurance operations
U.S.
Fixed benefit products ........................... $ 145,883 $ 147,226 $ 162,747
Life products .................................... 269,209 252,902 174,934
Accumulation products ............................ 174,391 109,374 32,378
Canada
Fixed benefit products ........................... 45,686 45,695 40,596
Life products .................................... 7,968 6,690 6,430
Non-insurance operations, corporate and eliminations... 20,657 20,860 7,941
----------- ---------- ----------
$ 663,794 $ 582,747 $ 425,026
=========== ========== ==========
Income before income taxes, equity in earnings of unconsolidated
affiliates and extraordinary charge:
Insurance operations
U.S.
Fixed benefit products ........................... $ 42,700 $ 38,333 $ 48,045
Life products .................................... 33,881 47,920 27,202
Accumulation products ............................ 24,810 26,893 12,389
Canada
Fixed benefit products ........................... 8,636 15,435 15,568
Life products .................................... 1,506 642 2,451
Non-insurance operations, corporate and eliminations... (59,990) (18,644) (26,198)
----------- ---------- ----------
$ 51,543 $ 110,579 $ 79,457
=========== ========== ==========
</TABLE>
53
<PAGE>
Total assets were as follows as of December 31:
<TABLE>
<CAPTION>
1997 1996
------------ ------------
<S> <C> <C>
Total assets:
Insurance operations
U.S.
Fixed benefit products............................ $ 381,253 $ 480,408
Life products..................................... 1,909,985 1,677,150
Accumulation products............................. 2,114,204 2,339,787
Canada
Fixed benefit products ........................... 112,319 139,887
Life products..................................... 69,449 43,613
Non-insurance operations, corporate and eliminations .. 136,925 128,478
------------ ------------
$ 4,724,135 $ 4,809,323
============ ============
</TABLE>
(5) INVESTMENTS
The following investments, other than obligations of the U.S. Government or
agencies thereof, individually exceeded 10% of total shareholders' equity as of
December 31:
<TABLE>
<CAPTION>
1996
--------------------------
Amortized Fair
Cost Value
----------- -----------
<S> <C> <C>
Canadian government obligations................... $ 80,492 $ 88,671
=========== ===========
</TABLE>
The amortized cost and fair value of investments in fixed maturities held
for investment were as follows as of December 31:
<TABLE>
<CAPTION>
1996
---------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
----------- ----------- ----------- ------------
<S> <C> <C> <C> <C>
Mortgage-backed securities, principally
obligations of U.S. Government agencies....... $ 34,546 $ 2,307 $ -- $ 36,853
Corporate securities............................ 52,784 124 2 52,906
----------- ----------- ----------- ------------
$ 87,330 $ 2,431 $ 2 $ 89,759
=========== =========== =========== ============
</TABLE>
The amortized cost and fair value of investments in fixed maturities
available for sale were as follows as of December 31:
<TABLE>
<CAPTION>
1997
---------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
----------- ----------- ----------- ------------
<S> <C> <C> <C> <C>
Mortgage-backed securities, principally
obligations of U.S. Government agencies....... $ 1,242,805 $ 46,157 $ 1,313 $ 1,287,649
U.S. Treasury securities and obligations of
U.S. Government corporations and agencies..... 135,255 7,551 120 142,686
Debt securities issued by foreign governments... 66,635 7,188 12 73,811
Corporate securities............................ 1,173,820 49,164 8,148 1,214,836
------------ ----------- ----------- ------------
$ 2,618,515 $ 110,060 $ 9,593 $ 2,718,982
============ =========== =========== ============
</TABLE>
54
<PAGE>
<TABLE>
<CAPTION>
1996
---------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
----------- ----------- ----------- ------------
<S> <C> <C> <C> <C>
Mortgage-backed securities, principally
obligations of U.S. Government agencies....... $ 1,408,124 $ 25,710 $ 5,510 $ 1,428,324
U.S. Treasury securities and obligations of
U.S. Government corporations and agencies..... 326,484 5,783 2,760 329,507
Debt securities issued by foreign governments... 80,492 8,179 -- 88,671
Corporate securities............................ 1,126,168 30,422 9,167 1,147,423
------------ ----------- ------------ ------------
$ 2,941,268 $ 70,094 $ 17,437 $ 2,993,925
============ =========== ============ ============
</TABLE>
The amortized cost and fair value of fixed maturities available for sale as
of December 31, 1997, by contractual maturity, are shown below:
<TABLE>
<CAPTION>
Amortized Fair
Cost Value
------------- -------------
<S> <C> <C>
Due in one year or less ............................... $ 33,709 $ 33,964
Due after 1 through 5 years ........................... 419,383 433,117
Due after 5 through 10 years .......................... 649,210 676,765
Due after 10 years .................................... 273,408 287,487
Mortgage-backed securities, principally
obligations of U.S. Government agencies............. 1,242,805 1,287,649
------------- -------------
$ 2,618,515 $ 2,718,982
============= =============
</TABLE>
Expected maturities will differ from contractual maturities because
borrowers may have the right to call or prepay obligations with or without
prepayment penalties.
Included in fixed maturities held for investment as of December 31, 1996,
are below investment-grade securities with an amortized cost, which approximates
fair value, of $34,624.
Included in fixed maturities available for sale as of December 31, 1997 and
1996, are below investment-grade securities with an amortized cost of $165,511
and $91,590 and a fair value of $167,518 and $92,494, respectively. Included in
fixed maturities available for sale as of December 31, 1997, are unrated
securities with an amortized cost of $26,563 and a fair value of $36,175.
As of December 31, 1997, net unrealized appreciation in equity securities
available for sale of $173 consisted of gross unrealized gains of $242, less
gross unrealized losses of $69. As of December 31, 1996, net unrealized
appreciation in equity securities available for sale of $3,356 consisted of
gross unrealized gains of $4,047, less gross unrealized losses of $691.
Fair values for fixed maturity securities were provided by independent
pricing services using market quotations, prices provided by market makers, or
estimates of fair values obtained from yield data relating to investment
securities with similar characteristics. The fair values for equity securities
were determined using market quotations from principal public exchange markets.
The Company's commercial and residential mortgage portfolios had carrying
values $240,879 and $264,732, respectively, and, fair values of approximately
$248,052 and $269,142, respectively, as of December 31, 1997 and 1996. The fair
values for mortgage loans on real estate are estimated using the quoted market
prices for securities collateralized
55
<PAGE>
by similar mortgage loans, adjusted for the differences in loan characteristics.
For mortgage loans on real estate where quoted market prices are not available,
the fair values are estimated using discounted cash flow analysis and interest
rates for loans with similar credit ratings.
As of December 31, 1997, commercial and residential mortgage loan
investments were concentrated in the following states:
<TABLE>
<CAPTION>
Percent of Total
Carrying Value Carrying Value
-------------- --------------
<S> <C> <C>
Georgia..................................... $ 47,834 19.9%
Florida..................................... 37,312 15.5
Colorado.................................... 32,796 13.6
Virginia.................................... 19,484 8.1
Tennessee................................... 13,540 5.6
Alabama..................................... 12,410 5.2
Arizona..................................... 11,837 4.9
Texas....................................... 11,640 4.8
Louisiana................................... 9,970 4.1
All other (less than 4% individually)....... 44,056 18.3
---------- -----
$ 240,879 100.0%
========== =====
</TABLE>
Investments with a carrying value of $68,219 and $62,767 were on deposit
with certain regulatory authorities as of December 31, 1997 and 1996,
respectively.
56
<PAGE>
Realized, and changes in unrealized gains and losses, on investments were
as follows for the years ended December 31:
<TABLE>
<CAPTION>
1997 1996 1995
----------- ---------- ----------
<S> <C> <C> <C>
Realized gains (losses) on dispositions of investments:
Securities held for investment:
Gross gains from sales................................ $ -- $ -- $ --
Gross losses from sales............................... -- (28) --
Net gains (losses) from redemptions................... -- (105) 1
----------- ---------- ----------
-- (133) 1
----------- ---------- ----------
Securities available for sale:
Gross gains from sales................................ 22,076 2,562 6,185
Gross losses from sales............................... (6,186) (1,800) (2,616)
Net gains (losses) from redemptions................... -- (166) 200
----------- ---------- ----------
15,890 596 3,769
----------- ---------- ----------
Mortgage loans.......................................... (284) 794 --
Other investments....................................... 1,881 -- --
----------- ---------- ----------
Net realized gains................................. $ 17,487 $ 1,257 $ 3,770
=========== ========== ==========
Changes in unrealized gains:
Securities held for investment.......................... $ (2,429) $ 2,441 $ 3,563
Securities available for sale........................... 44,627 (18,250) 111,732
----------- ---------- ----------
Net change in unrealized gains..................... $ 42,198 $ (15,809) $ 115,295
=========== ========== ==========
Trading portfolio:
Net gains (losses) from sales........................... $ (142) $ 4,930 $ 1,830
Net change in unrealized gains (losses)................. 1,258 (3,626) 3,880
----------- ---------- ----------
Total net trading gains ........................... $ 1,116 $ 1,304 $ 5,710
=========== ========== ==========
Major categories of net investment income consisted of the following
for the years ended December 31:
1997 1996 1995
Fixed maturity securities................................. $ 231,867 $ 169,847 $ 70,715
Mortgage loans on real estate ............................ 26,498 11,888 2,783
Policy loans ............................................. 9,037 8,409 5,240
Short-term investments ................................... 6,366 12,966 16,891
Other investments......................................... 9,177 13,100 10,168
----------- ---------- ----------
Gross investment income ................................ 282,945 216,210 105,797
Less: investment expenses................................. 9,708 5,476 3,506
----------- ---------- ----------
Net investment income .................................. $ 273,237 $ 210,734 $ 102,291
=========== ========== ==========
</TABLE>
The Company had non-income producing fixed maturity investments with an
amortized cost of $ -- and $17,115 as of December 31, 1997 and 1996,
respectively.
On September 1, 1997, the Company purchased $25,000 of ACO Acquisition
Corp. (subsequently re-named Acordia, Inc. ("Acordia") subordinated indebtedness
and $20,000 of ACO Brokerage Holdings Corporation ("ACO"), an affiliate of
Acordia, preferred stock. The Acordia subordinated notes pay interest on a
current basis at 12.5%, per annum, payable in semi-annual installments. The ACO
preferred stock dividends are payable in cash (subject to certain restrictions),
or in-kind at the option of ACO, at a rate of 17 percent. Acordia is an
insurance broker specializing in the marketing of commercial property and
casualty programs. Acordia is 28.6% owned by Knightsbridge Capital Fund I, L.P.
57
<PAGE>
("Knightsbridge"). PennCorp received fees aggregating $1,100 from Acordia for
its underwriting and participation in the subordinated notes and preferred stock
offering. Knightsbridge Management, L.L.C. ("KM") received sponsor fees and
other fees aggregating $1,714 from Acordia for its role in consummating the
Acordia acquisition.
(6) SOUTHWESTERN LIFE INVESTMENT
On December 14, 1995, Southwestern Financial Corporation ("SW Financial"),
a newly organized corporation formed by the Company and Knightsbridge (see Notes
15 and 16) purchased Southwestern Life Insurance Company, Union Bankers
Insurance Company and certain other related assets from I.C.H. Corporation for
$260,000.
Through its initial direct investment of $120,000 in SW Financial (the
"Southwestern Life Investment"), the Company beneficially owns 74.8% of SW
Financial's outstanding common stock, including 100% of SW Financial's
non-voting common stock, 14.3% of SW Financial's voting common stock, and 100%
of SW Financial preferred stock. PennCorp is also a 16.3% limited partner in
Knightsbridge. As a result, the Company has an economic interest in SW Financial
aggregating 78.0 percent. Retained earnings of the Company include undistributed
earnings of SW Financial aggregating $40,919, $21,947 and $910 as of December
31, 1997, 1996 and 1995, respectively.
On August 5, 1997, the Company purchased $40,000 of SW Financial
Subordinated Notes (the "SW Financial Notes") from the liquidating trust for the
creditors of ICH Corporation, SW Financial's former parent. SW Financial had
issued the SW Financial Notes as part of the acquisition consideration paid to
the liquidating trust. The SW Financial Notes were purchased by the Company at
par and are included in other investments. Interest due under the SW Financial
Notes is currently set at 7.0%, per annum.
On January 2, 1998, the Company acquired the SW Financial Controlling
Interest (see Note 19).
58
<PAGE>
The Company accounts for its investment in SW Financial utilizing the
equity method. The consolidated condensed results of operations and financial
position of SW Financial, are provided below:
<TABLE>
<CAPTION>
For the years ended December 31, For the period
1997 1996 December 14-31, 1995
---- ---- --------------------
<S> <C> <C> <C>
Revenues:
Policy revenues........................................ $ 145,818 $ 196,912 $ 12,668
Net investment income.................................. 126,427 128,692 6,015
Other income (including limited partnership
distributions of $15,811 in 1996).................... 16,039 27,439 54
Net gains from the sale of investments................. 1,841 516 --
------------ ------------ ----------
Total revenues.................................. 290,125 353,559 18,737
------------ ------------ ----------
Benefits and expenses:
Claims incurred........................................ 201,385 211,460 15,831
Change in liability for future policy benefits and
other policy benefits................................ (35,103) (13,616) (2,318)
Insurance and other operating expenses................. 66,319 92,632 2,577
Interest and amortization of deferred debt issuance costs 13,773 14,052 664
------------ ------------ ----------
Total benefits and expenses........................ 246,374 304,528 16,754
------------ ------------ ----------
Income before income taxes............................. 43,751 49,031 1,983
Income taxes......................................... 16,416 18,149 694
------------ ------------ ----------
Net income ............................................ 27,335 30,882 1,289
Preferred stock dividend requirements................ 3,012 2,754 205
------------ ------------ ----------
Net income applicable to common stock.................. $ 24,323 $ 28,128 $ 1,084
============ ============ ==========
As of December 31, 1997 1996
------------------ ------------ ------------
Assets:
Invested assets....................................... $ 2,026,768 $ 1,641,348
Insurance assets...................................... 114,395 107,230
Other assets.......................................... 283,717 459,324
------------ ------------
Total assets.......................................... $ 2,424,880 $ 2,207,902
============ ============
Liabilities and Shareholders' Equity:
Insurance liabilities................................. $ 1,942,214 $ 1,745,160
Long-term debt........................................ 154,750 159,750
Other liabilities..................................... 98,509 127,237
Redeemable preferred stock............................ 36,891 33,879
Shareholders' equity.................................. 192,516 141,876
------------ ------------
Total liabilities and shareholders' equity ......... $ 2,424,880 $ 2,207,902
============ ============
</TABLE>
59
<PAGE>
(7) DEFERRED POLICY ACQUISITION COSTS AND PRESENT VALUE OF INSURANCE IN FORCE
Information relating to deferred policy acquisition costs is as follows for
the years ended December 31:
<TABLE>
<CAPTION>
1997 1996 1995
----------- ---------- ----------
<S> <C> <C> <C>
Balance as of January 1................................. $ 252,428 $ 185,570 $ 131,006
Policy acquisition costs deferred:
Commissions........................................... 59,238 49,775 50,528
Underwriting and issue costs ......................... 50,244 48,365 33,561
----------- ---------- ----------
109,482 98,140 84,089
Policy acquisition costs amortized ..................... (44,323) (30,744) (29,007)
Unrealized investment loss adjustment .................. (2,344) (461) (1,007)
Foreign currency translation adjustment ................ (1,482) (77) 489
Impact of sale of certain foreign operations............ (3,644) -- --
----------- ---------- ----------
Balance as of December 31............................. $ 310,117 $ 252,428 $ 185,570
=========== ========== ==========
</TABLE>
As a part of the purchase accounting for the Company's acquisitions, a
present value of insurance in force asset is established which represents the
value of the right to receive future cash flows from insurance contracts
existing at the date of acquisition. Such value is the actuarially determined
present value of the projected cash flows from the acquired policies, discounted
at an appropriate risk rate of return.
The methods used by the Company to value the fixed benefit, life, and
accumulation products purchased are consistent with the valuation methods used
most commonly to value blocks of insurance business. It is also consistent with
the basic methodology generally used to value insurance assets. The method used
by the Company includes identifying the future cash flows from the acquired
business, the risks inherent in realizing those cash flows and the rate of
return the Company believes it must earn in order to accept the risks inherent
in realizing the cash flows, and determining the value of the insurance asset by
discounting the expected future cash flows by the discount rate the Company
requires.
The discount rate used to determine such values is the rate of return
required in order to invest in the business being acquired. In selecting the
rate of return, the Company considered the magnitude of the risks associated
with the type of business acquired and actuarial factors described in the
following paragraph, cost of capital available to the Company to fund the
acquisition, compatibility with other Company activities that may favorably
affect future profits, and the complexity of the acquired company.
Expected future cash flows used in determining such values are based on
actuarial determinations of future premium collection, mortality, morbidity,
surrenders, operating expenses and yields on assets held to back policy
liabilities as well as other factors. Variances from original projections,
whether positive or negative, are included in income as they occur and will
affect the present value of insurance in force amortization rates for insurance
products accounted for under SFAS No. 97. To the extent that these variances
indicate that future cash flows will differ from those included in the original
scheduled amortization of the present value of insurance in force, future
amortization may be adjusted. Recoverability of the present value of insurance
in force is evaluated annually and appropriate adjustments are then determined
and reflected in the financial statements for the applicable period.
60
<PAGE>
Information related to the present value of insurance in force is as
follows:
<TABLE>
<CAPTION>
1997 1996 1995
----------- ---------- ----------
<S> <C> <C> <C>
Balance as of January 1 .................................. $ 339,010 $ 283,106 $ 199,705
Addition due to acquisition .............................. -- 69,077 132,949
Accretion of interest .................................... 20,371 27,205 22,260
Amortization ............................................. (68,094) (52,931) (44,788)
Transfer to Southwestern Life Insurance Company
pursuant to reinsurance transaction..................... (2,291) -- --
Unrealized investment gain (loss) adjustment ............. (24,444) 12,582 (27,425)
Foreign currency translation adjustment .................. (663) (29) 405
----------- ---------- ----------
Balance as of December 31 .............................. $ 263,889 $ 339,010 $ 283,106
=========== ========== ==========
</TABLE>
Expected gross amortization of the present value of insurance in force,
based upon current assumptions and accretion of interest at a policy liability
or contract rate ranging from 3.5 to 14.5 percent, for the next five years is as
follows:
<TABLE>
<CAPTION>
Beginning Gross Accretion Net
Balance Amortization of Interest Amortization
------- ------------ ----------- ------------
<S> <C> <C> <C> <C>
1998.......................................... $ 263,889 $ 48,217 $ 19,817 $ 28,400
1999.......................................... 235,489 44,438 17,804 26,634
2000.......................................... 208,855 39,980 16,010 23,970
2001.......................................... 184,885 36,190 14,366 21,824
2002.......................................... 163,061 32,652 12,917 19,735
</TABLE>
(8) FUTURE POLICY BENEFITS
The liability for future policy benefits consists of reserves for fixed
benefit, life and accumulation products. For interest sensitive life and annuity
products, the liability for future policy benefits is equal to the accumulated
fund value. Fund values are equal to the premium received and interest credited
to the fund value less deductions for mortality costs and expense charges.
Current declared interest rates credited range from 4.0 to 6.75 percent.
Mortality costs and expense charges are established by the Company based upon
its experience and cost structure and in accordance with policy terms.
For traditional life products, the liability for future policy benefits is
based primarily upon Commissioners' Standard Ordinary Tables with interest rates
ranging from 2.5 to 6.0 percent. Fixed benefit products establish a liability
for future policy benefits equal to the excess of the present value of future
benefits to or on behalf of the policyholder over the future net premium
discounted at interest rates ranging primarily from 4.5 to 8.0 percent.
Traditional life products and fixed benefit products future policy benefits may
also be determined using Company experience as to mortality, morbidity and
lapses with a provision for adverse deviation. The Company may vary assumptions
by year of policy issue.
61
<PAGE>
The following table presents information on changes in the liability for
accident and sickness claims for the years ended December 31:
<TABLE>
<CAPTION>
1997 1996 1995
---------- ---------- ----------
<S> <C> <C> <C>
Claim liability as of January 1................................... $ 130,392 $ 127,078 $ 126,920
Less reinsurance recoverables................................... 2,242 1,372 2,050
---------- ---------- ----------
Net balance as of January 1................................... 128,150 125,706 124,870
---------- ---------- ----------
Addition due to acquisition....................................... -- 1,079 1,095
---------- ---------- ----------
Add claims incurred during the year related to:
Current year.................................................... 60,727 63,673 62,106
Prior years..................................................... 6,344 (6,816) (2,855)
---------- ---------- ----------
Total claims incurred......................................... 67,071 56,857 59,251
---------- ---------- ----------
Less claims paid during the year related to:
Current year.................................................... 28,268 19,057 20,346
Prior years..................................................... 47,796 36,435 39,164
---------- ---------- ----------
Total claims paid............................................. 76,064 55,492 59,510
---------- ---------- ----------
Net balance as of December 31..................................... 119,157 128,150 125,706
Plus reinsurance recoverables................................... 5,848 2,242 1,372
---------- ---------- ----------
Claim liability as of December 31............................. $ 125,005 $ 130,392 $ 127,078
========== ========== ==========
</TABLE>
(9) NOTES PAYABLE
The outstanding principal amounts of the notes payable consist of the
following as of December 31:
<TABLE>
<CAPTION>
1997 1996
---------- -----------
<S> <C> <C>
Unsecured 9 1/4% Senior Subordinated Notes due 2003(a).............. $ 114,646 $ 114,646
Revolving bank credit facility maturing 2002(b)..................... 242,000 92,000
Other............................................................... 3,109 3,679
---------- -----------
$ 359,755 $ 210,325
========== ===========
- -------------------
(a) Interest costs under the Notes totaled $11,461, $13,545 and $14,463 during
1997, 1996 and 1995, respectively. As of December 31, 1997, the effective
rate for the Notes was approximately 9.6 percent.
(b) Interest costs under the $450,000 revolving credit facility totaled $9,188
during 1997. The effective rate of interest was approximately 6.4%,
including annual commitment fee of 0.25%, as of December 31, 1997. During
1997 and 1996, the Company had a $175,000 revolving credit facility for
which it incurred interest costs of $1,855 and $1,558, respectively.
</TABLE>
The fair value of amounts outstanding as notes payable for the years ended
December 31, 1997 and 1996, amounted to $364,914 and $215,341, respectively. All
recorded amounts other than the Senior Subordinated Notes approximate market as
they carry variable rates of interest which adjust at least every 90 days. The
fair value of the Senior Subordinated Notes is determined based upon quotes from
market makers.
The aggregate maturities of notes payable during each of the five years
after December 31, 1997, are as follows: 1998, $617; 1999, $668; 2000, $724;
2001, $951; 2002, $242,149.
62
<PAGE>
All of the Company's debt obligations contain financial and operating
covenants. The Company and its subsidiaries were in compliance with or had
received waivers from all applicable covenants as of December 31, 1997.
For the year ended December 31, 1996, the Company realized an after-tax
extraordinary charge of $2,372. The charge represents (i) the write-off of $816
of deferred financing costs related to the retirement of certain indebtedness of
the Company and its subsidiaries, and (ii) the write-off of $1,556 of deferred
financing, swap cancellation and other costs related to the repurchase of
approximately $35,354 in principal amount of the Senior Subordinated Notes.
(10) INCOME TAXES
The Company and a number of its non-insurance subsidiaries file a
consolidated federal income tax return with a July 31 year end, which differs
from its financial year end. Marketing One and its subsidiaries file a
consolidated federal income tax return with a December 31 year end. The life
insurance subsidiaries file federal income tax returns on a calendar year basis
with either PLAIC or Pioneer Security as the parent of the particular
consolidated life insurance company tax group.
Total income taxes were allocated as follows for the years ended December
31:
<TABLE>
<CAPTION>
1997 1996 1995
----------- ----------- -----------
<S> <C> <C> <C>
Income from operations.................................. $ 20,375 $ 40,957 $ 27,829
Extraordinary item...................................... -- (1,277) --
Shareholders' equity.................................... 5,412 (1,864) 28,493
----------- ----------- -----------
$ 25,787 $ 37,816 $ 56,322
=========== =========== ===========
</TABLE>
The provisions for income tax expense (benefit) attributable to income
before income taxes, equity in earnings of unconsolidated affiliates and
extraordinary charge are as follows for the years ended December 31:
<TABLE>
<CAPTION>
1997 1996 1995
----------- ----------- -----------
<S> <C> <C> <C>
Current U.S............................................... $ 3,775 $ (1,285) $ (1,311)
Current foreign........................................... 3,598 2,319 4,519
Deferred U.S.............................................. 10,984 35,482 22,516
Deferred foreign.......................................... 2,018 4,441 2,105
----------- ----------- -----------
Income tax expense...................................... $ 20,375 $ 40,957 $ 27,829
=========== =========== ===========
</TABLE>
Taxes computed using the federal statutory rate of 35% are reconciled to
the Company's actual income tax expense attributable to income before
extraordinary charge as follows for the years ended December 31:
<TABLE>
<CAPTION>
1997 1996 1995
----------- ----------- -----------
<S> <C> <C> <C>
Tax expense computed at statutory rate.................... $ 18,040 $ 38,702 $ 27,810
Dividends received deduction.............................. (1,450) (977) (85)
Amortization of costs in excess of net assets acquired.... 3,341 3,040 2,275
Change in valuation allowance............................. (525) (1,265) (5,102)
Foreign taxes net of U.S. tax benefit..................... 263 1,507 2,937
Other..................................................... 706 (50) (6)
----------- ----------- -----------
Income tax expense...................................... $ 20,375 $ 40,957 $ 27,829
=========== =========== ===========
</TABLE>
63
<PAGE>
Temporary differences between the financial statement carrying amounts and
tax bases of assets and liabilities that give rise to the deferred tax assets
and liabilities relate to the following as of December 31:
<TABLE>
<CAPTION>
1997 1996
------------------------- ------------------------
Deferred Deferred Deferred Deferred
Tax Tax Tax Tax
Assets Liabilities Assets Liabilities
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Deferred policy acquisition costs............. $ -- $ 90,151 $ -- $ 67,101
Present value of insurance in force........... -- 74,192 -- 91,135
Future policy benefits........................ 62,131 -- 67,940 --
Net operating losses.......................... 38,584 -- 38,557 --
Foreign and alternative minimum tax credits... 22,851 -- 21,252 --
Unrealized gain on investment securities...... -- 20,140 -- 13,650
Other......................................... 19,133 1,593 23,048 17,267
---------- ---------- ---------- ----------
142,699 186,076 150,797 189,153
Valuation allowance........................... (10,367) -- (15,892) --
---------- ---------- ---------- ----------
$ 132,332 $ 186,076 $ 134,905 $ 189,153
========== ========== ========== ==========
</TABLE>
The valuation allowance for deferred tax assets as of January 1, 1997 and
1996, was $15,892 and $17,157, respectively. The net change in the total
valuation allowance for the years ended December 31, 1997 and 1996, was a
decrease of $5,525 (including $5,000 that was used to reduce costs in excess of
net assets acquired) and $1,265, respectively. During 1997, an additional
$14,635 increase to the deferred tax asset was used to reduce costs in excess of
net assets acquired related to the Integon Life acquisition as acquisition date
tax contingencies were resolved. If recognized as a tax benefit, a portion of
the December 31, 1997, valuation allowance totaling $2,349 would be allocated to
reduce costs in excess of net assets acquired.
In assessing the realization of deferred taxes, management considers
whether it is more likely than not that some portion or all of the deferred tax
assets will be realized. The ultimate realization of deferred tax assets is
dependent on the generation of future taxable income during the periods in which
those temporary differences become deductible. Management considers the
scheduled reversal of deferred tax liabilities, projected future taxable income
and tax planning strategies in making this assessment. Based upon those
considerations, management believes it is more likely than not that the Company
will realize the benefits of these deductible differences, net of the existing
valuation allowance as of December 31, 1997.
As of December 31, 1997, the Company has life consolidated net operating
loss carryforwards of approximately $99,823 for tax return purposes. In
addition, OLIC and Peninsular have available, on a separate return basis,
acquired net operating loss carryforwards of approximately $10,417. The
utilization of acquired net operating loss carryforwards is limited in any one
year to the lesser of (i) the life insurance group's consolidated taxable income
or (ii) the subsidiary's taxable income computed on a separate return basis.
64
<PAGE>
The approximate net operating loss carryforwards for income tax purposes
expire as follows:
<TABLE>
<CAPTION>
Life Life
Consolidated Separate
Return Return
---------- ----------
<S> <C> <C>
2004....................................................... $ -- $ 5,335
2005....................................................... 560 4,982
2006....................................................... -- --
2007....................................................... 15,967 --
2008....................................................... 37,609 100
2009....................................................... 6,311 --
2010....................................................... -- --
2011....................................................... 26,812 --
2012....................................................... 12,564 --
---------- ----------
$ 99,823 $ 10,417
========== ==========
</TABLE>
Under provisions of the Life Insurance Company Tax Act of 1959, certain
special deductions were allowed to life insurance companies for federal income
tax purposes. These special deductions were repealed by the Tax Reform Act of
1984, and the untaxed balances were frozen at their December 31, 1983 levels.
These balances aggregate approximately $42,301 for the Company's life insurance
subsidiaries and are subject to taxation if certain levels of premium income or
life insurance reserves are not maintained, or if the life insurance companies
make excess distributions to shareholders. It is not expected that a tax would
become due on any such balance and no deferred income taxes have been provided.
However, if such tax were to become payable, it would amount to approximately
$14,805.
(11) PREFERRED AND COMMON STOCK
The Company issued 2,875,000 shares of $50 redemption value $3.50 Series II
Convertible Preferred Stock (the "Series II Convertible Preferred Stock") on
August 2, 1996. The Series II Convertible Preferred Stock is convertible at the
option of the holder, unless previously redeemed, into 1.4327 shares of common
stock for each share, subject to adjustment in certain events. Dividends accrued
and unpaid as of December 31, 1997 and 1996, were $1,677. As of December 31,
1997, the estimated fair value of the Series II Convertible Preferred Stock,
based upon market-maker quotes, was $166,750.
On July 25, 1995, the Company issued 127,500 shares of 10% Series B
Preferred Stock and 178,500 shares of 9% Series C Preferred Stock to fund a
portion of the Integon Life purchase price. The Series B Preferred Stock and the
Series C Preferred Stock are mandatorily redeemable on or before June 30, 1997
and June 30, 1998, respectively. The redemption price of the Series C Preferred
Stock is subject to certain offsets related to the Integon Life stock purchase
agreement. Dividends accrued and unpaid were $ -- , and $1,939 on the Series B
Preferred Stock and $3,867 and $2,175 on the Series C Preferred Stock,
respectively, as of December 31, 1997 and 1996. On March 15, 1997, the Company
redeemed all of the previously outstanding Series B preferred stock at its
stated redemption value of $14,705.
The Company issued 2,300,000 shares of $50 redemption value $3.375
Convertible Preferred Stock (the "Convertible Preferred Stock") on July 14,
1995. The Convertible Preferred Stock is convertible at the option of the
holder, unless previously redeemed, into 2.2124 shares of common stock for each
share, subject to adjustment in certain events. Dividends accrued and unpaid as
of December 31, 1997 and 1996 were $1,617. As of December 31, 1997, the
estimated fair value of the Convertible Preferred Stock, based upon active
market quotes, was $186,599.
In conjunction with the acquisition of AA Life in August 1994, the Company
issued 450,000 shares of nonvoting Series A Preferred Stock, $0.01 per share par
value and $100 per share redemption value. The Series A Preferred Stock was
redeemed on August 25, 1995, from the proceeds received from the issuance of the
Convertible Preferred Stock. During 1995, the Company paid or accrued dividends
on the Series A Preferred Stock amounting to $1,725.
65
<PAGE>
(12) STOCK OPTIONS AND WARRANTS
The Company has established two management stock option plans, the 1992
Stock Option Plan which set aside up to 475,635 shares for grant and the 1996
Stock Option Plan which set aside up to 2,800,000 shares for grant. Options
granted under the 1992 Stock Option Plan are deemed to be in four equal units
which are earned over four years from the date of grant and are exercisable
during a one-year period immediately following the fourth anniversary of the
date of grant. The 1996 Stock Option Plan allows for awards of stock or options
subject to such terms, conditions, and restrictions, and/or limitations, if any,
as the Stock Option Committee of the Board of Directors deems appropriate.
The Company has also established a senior management stock award plan
("Warrant Plan"). The Warrant Plan allows for grants to senior executive
officers of PennCorp and Directors of PennCorp who are not executive officers of
the Company. Grant prices are determined based on the average price of the
shares traded on the date of grant. Warrants granted under the Warrant Plan are
determined by the Compensation Committee and are exercisable at such times and
in such amounts as the Compensation Committee shall determine, but no warrant
granted under the Warrant Plan will be exercisable more than ten years after the
date of grant. Upon change of control (as defined) of PennCorp, all outstanding
warrants become immediately vested and exercisable, and any warrants that remain
unexercised shall be canceled and replacement warrants shall be issued by the
surviving entity.
As part of an employment agreement effective August 1990, the Company
issued to a former officer of the Company, warrants to purchase up to 570,760
shares of the common stock of the Company at any time up to 10 years from the
date of the agreement. The warrants are exercisable at a price of $4.00 per
share which was fair value on the date of grant.
The Company has established a U.S. Sales Manager incentive stock option
plan in which the senior sales manager of one of the Company's insurance
subsidiaries may earn stock options in the amount of 275,000 shares over a
five-year period, subject to achieving certain performance goals, in addition to
an initial grant of 100,000 options. Such options are vested immediately as
earned, except for the initial 100,000 which vest in September 1999, and option
prices range from $15 per share, for the initial 100,000 options, to the fair
value of the common stock of the Company on the date of grant for those shares
subject to performance goals.
The following table summarizes data relating to stock options and warrants
activity and associated weighted average option exercise price information for
the years ended December 31:
<TABLE>
<CAPTION>
1997 1996 1995
--------- -------- --------- --------- --------- -------
<S> <C> <C> <C> <C> <C> <C>
Number of shares subject to option/warrant:
Outstanding at beginning of year..... 1,984,049 $ 11.56 2,148,599 $ 10.86 2,057,724 $ 9.61
Granted.............................. 1,565,500 $ 32.34 44,000 $ 31.09 110,000 $ 17.64
Expired/cancelled.................... (46,303) $ 11.41 (59,000) $ 13.82 (19,125) $ 13.43
Exercised............................ (158,769) $ 7.97 (149,550) $ 5.40 -- $ --
--------- --------- ---------
Outstanding at end of year ........ 3,344,477 $ 21.73 1,984,049 $ 11.56 2,148,599 $ 10.86
========= ========= =========
Exercisable at end of year.............. 2,036,442 $ 15.38 1,808,207 $ 11.40 -- $ --
========= ========= =========
Available for future grant at end of year 1,488,460 2,792,000 144,063
========= ========= =========
</TABLE>
66
<PAGE>
The following table summarizes information concerning outstanding and
exercisable options and warrants as of December 31, 1997:
<TABLE>
<CAPTION>
Options/Warrants Outstanding Options/Warrants Exercisable
------------------------------------------------------- ------------------------------
Weighted Weighted Weighted
Range of Number Average Remaining Average Number Average
Exercise Prices Outstanding Contractual Life Exercise Price Exercisable Exercise Price
--------------- ----------- ---------------- -------------- ----------- --------------
<S> <C> <C> <C> <C> <C> <C>
$ 4.00- $ 4.00 570,760 2.64 $ 4.00 570,760 $ 4.00
$ 5.40- $19.58 1,173,317 4.89 $ 15.91 1,115,567 $ 15.89
$27.25- $38.40 1,600,400 3.15 $ 32.32 350,115 $ 32.32
--------- ---------
3,344,477 2,036,442
========= =========
</TABLE>
(Remainder of Page Intentionally Left Blank)
67
<PAGE>
As allowed under the provisions of SFAS No. 123, the Company applies APB
Opinion 25 and related Interpretations in accounting for its stock option and
warrant plans and, accordingly, does not recognize compensation cost based on
fair value as a component of net income applicable to common stock. If the
Company had elected to recognize compensation cost based on the fair value of
the options and warrants as of the grant date, estimated utilizing the Black-
Scholes multiple options approach prescribed by SFAS No. 123, the Company's net
income applicable to common stock as well as earnings per share would have been
reduced by the pro forma amounts indicated in the following table:
<TABLE>
<CAPTION>
1997 1996 1995
----------- ----------- -----------
<S> <C> <C> <C>
Reconciliation of net income applicable to common stock:
Basic net income applicable to common stock:
Net income applicable to common stock before
extraordinary charge (As reported).......................... $ 30,607 $ 76,013 $ 49,806
Extraordinary charge...................................... -- (2,372) --
----------- ----------- -----------
Net income applicable to common stock (As reported).... 30,607 73,641 49,806
Pro forma compensation expense............................ (10,229) (287) (719)
----------- ----------- -----------
Net income applicable to common stock (Pro forma)...... 20,378 $ 73,354 $ 49,087
=========== =========== ===========
Diluted net income applicable to common stock:
Net income applicable to common stock before
extraordinary charge (As reported)......................... $ 30,607 $ 76,013 $ 49,806
Common stock equivalents:
Convertible preferred stock dividend requirements...... -- 11,788 3,558
Extraordinary charge...................................... -- (2,372) --
----------- ----------- -----------
Net income applicable to common stock (As reported).... 30,607 85,429 53,364
Pro forma compensation expense............................ (10,229) (287) (719)
----------- ----------- -----------
Net income applicable to common stock (Pro forma)...... $ 20,378 $ 85,143 $ 52,645
=========== =========== ===========
Per share information:
Basic net income applicable to common stock:
Net income applicable to common stock before extraordinary
charge (As reported)........................................ $ 1.09 $ 2.79 $ 2.26
Extraordinary charge...................................... -- (0.09) --
----------- ----------- -----------
Net income applicable to common stock (As reported).... 1.09 2.70 2.26
Pro forma compensation expense............................ (0.37) (0.01) (0.03)
----------- ----------- -----------
Net income applicable to common stock (Pro forma)...... $ 0.72 $ 2.69 $ 2.23
=========== =========== ===========
Common shares used in computing basic earnings per share........ 28,016 27,208 22,048
=========== =========== ===========
Diluted net income applicable to common stock:
Net income applicable to common stock before extraordinary
charge (As reported)........................................ $ 1.07 $ 2.16 $ 1.98
Common stock equivalents:
Convertible preferred stock dividend requirements...... -- 0.33 0.14
Extraordinary charge...................................... -- (0.07) --
----------- ----------- -----------
Net income applicable to common stock (As reported).... 1.07 2.42 2.12
Pro forma compensation expense............................ (0.36) (0.01) (0.03)
----------- ----------- -----------
Net income applicable to common stock (Pro forma)...... $ 0.71 $ 2.41 $ 2.09
=========== =========== ===========
Common shares used in computing diluted earnings per share...... 28,645 35,273 25,216
=========== =========== ===========
</TABLE>
68
<PAGE>
(13) STATUTORY ACCOUNTING AND DIVIDEND RESTRICTIONS
Cash generated by the Company's insurance subsidiaries is made available to
PennCorp principally through periodic payments of principal and interest on
surplus debentures issued by PLAIC and Pioneer Security (collectively, the
"Surplus Note Companies"). The amounts outstanding under the surplus debentures
totaled $358,346 and $367,900 as of December 31, 1997 and 1996, respectively.
These surplus debentures generally require (subject to availability of statutory
capital and surplus and in some instances, regulatory approval) principal and
interest payments to be made periodically in amounts sufficient to allow
PennCorp to meet its cash requirements.
Dividend payments by the Company's insurance subsidiaries are limited by,
or subject to the approval of the insurance regulatory authority of each
subsidiary's state of domicile. Such dividend requirements and approval
processes vary significantly from state to state. In 1998, the insurance
subsidiaries (including SW Financial), subject to availability of cash,
statutory capital and surplus and regulatory approval, will be able to pay a
maximum of $56,749 in dividends to the Surplus Note Companies (including SW
Financial). In 1998, the Surplus Note Companies, subject to availability of cash
and the dividend capacity of the insurance subsidiaries, could pay a maximum of
$76,408 on surplus note payments to the Company.
Statutory capital and surplus of the Company's life insurance subsidiaries
as reported to regulatory authorities at December 31, 1997 and 1996, totaled
$299,062 and $264,080, respectively. Shareholders' equity of the Company's life
insurance subsidiaries included in the consolidated balance sheet totaled
$755,365 and $580,334 at December 31, 1997 and 1996, respectively. Statutory net
income (loss) of the Company's life insurance subsidiaries as reported to
regulatory authorities totaled $18,776, ($28,600) and $13,579 for the years
ended December 31, 1997, 1996, and 1995, respectively. Surplus note interest
expense of $34,758, $51,254 and $24,170 for the years ended December 31, 1997,
1996, and 1995, respectively, is included in statutory net income (loss).
The Company's Canadian branch and Canadian subsidiary report to Canadian
regulatory authorities based upon Canadian statutory accounting principles that
vary in some respects from U.S. statutory accounting principles. Consolidated
Canadian net assets based upon Canadian statutory accounting principles were
$51,428 and $51,567 as of December 31, 1997 and 1996, respectively.
Remittances to PLIC from the Canadian operations totaled $ --, $ -- and
$2,485 for the years ended December 31, 1997, 1996 and 1995, respectively.
(14) RETIREMENT AND PROFIT SHARING PLANS
On October 1, 1990, the Company established a defined contribution
retirement plan (the "Defined Contribution Plan") for all employees of the
Company who have attained age 21, and for certain agents whose commission
earnings represent more than 50% of their income from the Company. Contributions
to the Defined Contribution Plan are made pursuant to salary deferral elections
by participants in an amount equal to 1% to 15% of their annual compensation. In
addition, the Company makes matching contributions in an amount equal to 50% of
each participant's salary deferral to a maximum of 3% of annual compensation.
The Defined Contribution Plan also provides for a discretionary employer profit
sharing contribution, which is determined annually by the Board of Directors for
the succeeding plan year. Profit sharing contributions are credited to
participants' accounts on the basis of their respective compensation in
accordance with a formula that provides a higher percentage contribution for
compensation in excess of the federal Social Security wage base. Salary deferral
contribution accounts are at all times fully vested, while matching contribution
accounts vest ratably from one to two years of service, and profit sharing
contribution accounts vest ratably from one to five years of service. All
participant accounts are fully vested at death, disability or attainment of age
65. Payment of vested benefits under the Defined Contribution Plan may be
elected by a participant in a variety of forms of payment. The Company's funding
policy is to contribute annually an amount that can be deducted for federal
income tax purposes. Expenses related to this plan for the years ended December
31, 1997, 1996 and 1995, amounted to $1,483, $1,520 and $1,335, respectively.
69
<PAGE>
The Company has an established bonus plan for insurance subsidiary
officers. The amount available to pay awards for any year is determined by a
committee of senior executives of the Company and is subject to the review and
recommendation of the Compensation Committee and approval of the Board of
Directors of the Company. Awards are based primarily on the income growth of the
Company and the performance of eligible participants. The Company accrued or
paid $1,417, $1,144 and $691 under this plan during the years ended December 31,
1997, 1996 and 1995, respectively.
If the Company meets established performance goals, the Company's two most
senior officers are eligible to receive annual cash bonuses based primarily on
annual growth rates in diluted earnings per share. Bonus awards range from 0% to
200% of a predetermined target annually. During 1997 and 1996, the Company did
not accrue for such bonuses as the employment arrangements containing the bonus
plan were contingent upon the purchase by the Company of The Fickes and Stone
Knightsbridge Interests (see Notes 15 and 16 below).
Postretirement benefits are accrued (but not funded) for eligible retirees
only as all plans are closed to future retirees. The plans principally cover
certain costs associated with medical insurance coverage.
<TABLE>
<CAPTION>
1997 1996
---------- -----------
<S> <C> <C>
Accumulated postretirement benefit obligation....................... $ 14,322 $ 16,089
Unrecognized transition obligation.................................. (4,202) (5,187)
Unrecognized losses................................................. (224) (366)
---------- -----------
Accrued postretirement benefit.................................... $ 9,896 $ 10,536
========== ===========
</TABLE>
For the year ended December 31, 1997, the postretirement benefit liability
was calculated assuming an annual trend rate in health care inflation ranging
from 7% to 8% in 1998 grading down to 5% in 2004 and after. If the health care
cost trend rate assumption increased by 1%, the accumulated postretirement
benefit obligation as of December 31, 1997, would increase $419 or 3 percent.
(15) RELATED PARTY TRANSACTIONS
Related party transactions described herein include those transactions not
included elsewhere in the Notes to Consolidated Financial Statements.
During 1995, two of the Company's officers and directors, Messrs. Stone and
Fickes, formed a fund, Knightsbridge, for the purpose of making equity and
equity linked investments in companies engaged primarily in the life insurance
industry. Knightsbridge has received subscriptions for approximately $92,000 in
limited partnership interests, including a $15,000 subscription from the
Company. The general partner of Knightsbridge is Knightsbridge Capital L.L.C.
("Knightsbridge Capital"), the members of which are David J. Stone and Steven W.
Fickes. Allan D. Greenberg, a member of the Company's Board of Directors,
formerly owned a 5% interest in Knightsbridge Capital which was purchased by
Messrs. Stone and Fickes. The general partner of Knightsbridge cannot be removed
by the limited partners, unless a court has finally determined that the general
partner has committed a willful and material breach of the limited partnership
agreement.
In the second half of 1995, the Company and Knightsbridge determined that a
joint venture strategy was in the best interest of both parties. As part of that
joint venture, Knightsbridge provides PennCorp with a right of first refusal
with respect to all insurance transactions considered by Knightsbridge. The
joint venture entity formed for this purpose is KM. PennCorp participates in 45%
of the net distributable income of KM.
The Company has established an independent committee of the Board of
Directors to oversee the relationship between PennCorp and Knightsbridge. KM has
the primary responsibility for negotiating the terms of, and arranging the
financing for PennCorp or PennCorp/Knightsbridge shared transactions. Certain of
those individuals involved in the daily operations of KM are also officers of
the Company.
70
<PAGE>
KM receives management fees from all of its limited partners, including the
Company, for the management of Knightsbridge. KM also receives payment in kind
consideration in lieu of additional management fees from PennCorp for providing
corporate and financial management services to the Company. Fees received by KM
from the Knightsbridge limited partners including PennCorp, as well as the
management fees paid in kind by the Company are subject to offset in future
periods based upon a portion of transaction fees generated by KM.
On December 31, 1997, at the Company's annual shareholders meeting,
shareholders approved a restructuring of the Knightsbridge relationship which
included the following transactions (see Notes 16 and 19); (i) Messrs. Stone and
Fickes entered into five-year employment agreements which include the contingent
issuance of options to purchase 559,000 shares of Common Stock to both Messrs.
Stone and Fickes, (ii) the acquisition of The Fickes and Stone Knightsbridge
Interests, and (iii) the acquisition of The Fickes and Stone Interests in SW
Financial, subject to certain contingencies.
For the years ended December 31, 1997, 1996 and 1995, PennCorp paid or
accrued $2,385, $2,548 and $3,900 in transaction fees and expenses to KM related
to the Washington National, United Life and SW Financial transactions,
respectively. During 1997 and 1996, certain of the Company's affiliates and
subsidiaries paid management fees to KM amounting to $5,325 and $3,333,
respectively. SW Financial and United Life incurred KM investment advisory fees
totaling $4,358, $2,426 and $ -- during 1997, 1996 and 1995, respectively. In
addition during 1996, PennCorp received a $1,000 stand-by commitment fee from SW
Financial for contingent financing on a real estate transaction. SW Financial
did not draw upon the commitment which has expired.
As required by the joint venture agreement, all bonuses paid to officers of
KM who are also officers of PennCorp must be approved by the Compensation
Committee of the Board of Directors of PennCorp. During 1995, the Company paid
or accrued for KM incentive bonuses to certain individuals who are officers of
PennCorp and KM totaling $2,565. Such bonuses were expensed in the accompanying
financial statements.
In August 1995, the Company sold its preferred and common stock position in
a company which has historically provided investment management services to the
PennCorp insurance subsidiaries and for which a senior executive officer of the
investment management firm is a member of the PennCorp Board of Directors. Fees
paid for such investment management services amounted to $1,083, $895 and $738
during 1997, 1996 and 1995, respectively.
During 1997, the Company's insurance subsidiaries paid management and
commitment fees aggregating $444 to investment funds managed by a member of the
Board of Directors.
Certain individuals, who are shareholders and directors of PennCorp, and
affiliates of these individuals, provide services to the Company. During 1997,
1996 and 1995, payments aggregating $250, $250 and $210, respectively, were made
to these individuals and their affiliates for services provided in connection
with the Company's acquisition activity.
At December 31, 1997, an insurance subsidiary entered into a reinsurance
agreement with Southwestern Life to coinsure certain annuities which had GAAP
policy liabilities of $256,673. Cash of $50,000 and securities were transferred
which had fair values equal to statutory policy liabilities of $255,195. No gain
or loss was recognized on the transaction.
(16) OTHER COMMITMENTS AND CONTINGENCIES
On December 31, 1997, PennCorp shareholders approved the acquisition of the
Controlling Interest in SW Financial through the assignment by Fickes, Stone and
Knightsbridge ("the Controlling Parties") of certain rights, including common
stock and common stock equivalents of SW Financial. The controlling Parties will
receive aggregate cash consideration ranging from $73,777 to $77,444 (not
including expenses) depending upon the outcome of certain contingencies.
In addition, PennCorp shareholders approved the acquisition of the
interests of Messrs. Stone and Fickes in Knightsbridge Management, L.L.C.
("Knightsbridge Management"), Knightsbridge Capital L.L.C. and Knightsbridge
Consultants L.L.C. (collectively, "The Fickes and Stone Knightsbridge
Interests") for total consideration estimated to be $10,000. Fickes and Stone
will each receive consideration in the form of estimated annual payments of $330
due April 15, 1997, each year through 2001 and issuance by PennCorp of 173,160
shares of PennCorp Common Stock to each of Fickes and Stone on April 15, 2001.
71
<PAGE>
As part of the Knightsbridge restructuring plan as approved, PennCorp must
acquire Fickes and Stone's co- investment in Acordia for $5,200, which amount
represents Fickes' and Stone's actual cost.
The Company and its subsidiaries are obligated under operating leases,
primarily for office space. Rent expense, net of sublease income, was $5,178,
$8,416 and $8,489 in 1997, 1996 and 1995, respectively.
<TABLE>
<CAPTION>
Minimum lease commitments are:
<S> <C>
1998.................................................... $ 5,305
1999.................................................... 3,895
2000.................................................... 2,606
2001.................................................... 1,583
2002 and thereafter..................................... 358
------------
Total minimum payments required...................... $ 13,747
============
</TABLE>
In January 1996, stockholder derivative lawsuits styled Tozour Energy
Systems Retirement Plan v. David J. Stone et al and the PennCorp Financial
Group, Inc., C.A. No. 14775 (the "Tozour Case") and Lois Miller v. David J.
Stone et al, and the PennCorp Financial Group, Inc., C. A. No. 14795 (the
"Miller Complaint") were filed against the Company and each of its directors,
individually, in the Delaware Court of Chancery. The complaint in the Miller
suit has not yet been served on the Company or the other defendants. Both suits
allege that the SW Financial Investment involved the usurpation of a corporate
opportunity and a waste of the Company's assets by Messrs. Stone and Fickes, and
that the directors of the Company in approving that transaction, failed to act
in good faith and breached their fiduciary duties, including the duty of loyalty
to the Company and its stockholders, having favored the interests of Messrs.
Stone and Fickes over the Company and its stockholders. These lawsuits seek
judgments against each of the defendants for the amount of damages sustained, or
to be sustained, by the Company as a result of the breaches of fiduciary duty
alleged in the complaint, the imposition of a constructive trust for the benefit
of the Company on profits or benefits obtained by any defendant through the
alleged breaches of fiduciary duty, attorney's fees and costs, and such other
relief as the court determines to be just, proper or equitable.
The defendants in the Tozour Case have filed a motion seeking its dismissal
on the ground that the plaintiff failed to comply with the requirements of
Delaware law before instituting a derivative suit and intend to defend the
lawsuit vigorously. Because the Company has not been served with the Miller
Complaint, no action has been taken in that case, although the Company would
also defend it vigorously. The defendants believe, however, that it would not be
in the best interests of the Company and its shareholders to expend considerable
management and director time and to incur substantial expenses to litigate the
actions. Consequently, the Company's legal advisors have met or spoken by
telephone with the plaintiffs' counsel on several occasions to discuss the terms
of a potential settlement.
The defendants and the plaintiffs' counsel entered into a stipulation of
settlement on March 28, 1997 (the "Original Proposed Settlement"). The Original
Proposed Settlement consisted of the following principal elements: (i) Messrs.
Stone and Fickes will cancel the 335,564 SW Financial common stock warrants they
hold for no consideration enabling PennCorp to purchase the SW Financial
Controlling Interest for $67.5 million, reducing the price to be paid by
PennCorp for the SW Financial Controlling Interest by approximately $2.0
million, (ii) the PennCorp Board will proceed with the purchase of The Fickes
and Stone Knightsbridge Interests, having received a fairness opinion of a
nationally recognized investment banking firm with respect to the price to be
paid for The Fickes and Stone Knightsbridge Interests, (iii) the PennCorp Board
will proceed with the acquisition of the SW Financial Controlling Interest,
having received a fairness opinion of a nationally recognized investment banking
firm with respect to the price to be paid for the SW Financial Controlling
Interest, (iv) the PennCorp Board will submit the purchases of The Fickes and
Stone Knightsbridge Interests and the SW Financial Controlling Interest to a
shareholder vote of a majority of the PennCorp stockholders present at a meeting
and entitled to vote, and stockholders must approve both transactions, (v)
Messrs. Stone and Fickes will abstain from voting on the proposals to approve
the purchase of The Fickes and Stone Knightsbridge Interests and the SW
Financial Controlling Interest, and (vi) the plaintiffs' counsel will be
entitled to conduct confirmatory discovery.
72
<PAGE>
On December 1, 1997, the defendants and the plaintiffs' counsel agreed in
principle to amend the Original Proposed Settlement (as so amended, the "Amended
Proposed Settlement") following the PennCorp Board's conclusion that it would be
appropriate to increase the amount paid to the Knightsbridge Fund for the SW
Financial Controlling Interest to compensate the limited partners for, among
other things, the unexpected and substantial delay in the consummation of the
purchase of the SW Financial Controlling Interest. The terms of the Amended
Proposed Settlement are identical to the terms of the Original Proposed
Settlement, except that the Amended Proposed Settlement provides that the
Company will acquire the SW Financial Controlling Interest for $73.8 million,
and will provide a one-time "price protection" payment associated with a
disposition of the SW Financial Controlling Interest by PennCorp during the
12-month period ending November 25, 1998. The Amended Proposed Settlement also
requires Messrs. Stone and Fickes to grant PennCorp a price protection right in
the event of a sale of their Portsmouth investment.
The Amended Proposed Settlement is subject to approval by the Chancery
Court after notice to PennCorp stockholders. A settlement hearing is scheduled
for May 12, 1998 in the Chancery Court. As discussed above, Messrs. Stone and
Fickes have agreed that, if the Amended Proposed Settlement is approved by the
Chancery Court, they will cancel their SW Financial common stock warrants and
they will not participate in the increased consideration (other than the
possible price protection right) for the SW Financial Controlling Interest to
the extent it relates to their $7,000 personal investment in SW Financial, which
together will reduce the price to be paid by PennCorp for the SW Financial
Controlling Interest by approximately $3,667. Because the Knightsbridge
restructuring will have the effect of substantially eliminating potential future
conflicts of interest between Messrs. Stone and Fickes and PennCorp, and because
the Amended Proposed Settlement will have the effect of reducing the price to be
paid for the SW Financial Controlling Interest and will obviate the need to
expend considerable management and director time to litigate the actions, the
PennCorp Board has determined that the Amended Proposed Settlement is in the
best interests of PennCorp and its shareholders and confers a substantial
economic benefit on PennCorp. Accordingly, the PennCorp Board has authorized the
payment to plaintiffs' counsel of legal fees of $785 and documented expenses not
to exceed $50 in connection with the lawsuits and the related settlement
negotiations, if the Amended Proposed Settlement is approved by the Delaware
Chancery Court after notice to PennCorp stockholders. Such amounts were expensed
in the accompanying financial statements.
The Company is a party to various pending or threatened legal actions
arising in the ordinary course of business some of which include allegations of
insufficient policy illustrations and agent misrepresentations. Although the
outcome of such actions is not presently determinable, management does not
believe that such matters, individually or in the aggregate, would have a
material adverse effect on the Company's financial position or results of
operations if resolved against the Company.
Effective January 1, 1996, the Company outsourced the vast majority of its
data center operations and administrative systems programming to a third party
vendor. The processing agreement extends through December 2002 and requires the
Company or its insurance subsidiaries to make payments ranging from
approximately $8,399 to $9,248 during each of the contract years. The contract
has standard provisions for early cancellation, including breakage fees.
The life insurance companies are required to be members of various state
insurance guaranty associations in order to conduct business in those states.
These associations have the authority to assess member companies in the event
that an insurance company conducting business in that state is unable to meet
its policyholder obligations. Assessments from guaranty associations, which have
not been material, are recorded as assessments when received.
The Company has a contingent obligation for mortgage loans previously sold
aggregating $10,719 as a result of the Company acting as a servicing conduit.
(17) REINSURANCE
In the normal course of business, the Company reinsures portions of certain
policies that it underwrites to limit disproportionate risks. The Company
retains varying amounts of individual insurance up to a maximum retention of
$500 on any life. Amounts not retained are ceded to other insurance enterprises
or reinsurers on an automatic or facultative basis.
73
<PAGE>
The Company cedes varying amounts of certain accident and sickness policies up
to a maximum cession of $800, as well as varying portions of certain disability
income policies on a facultative basis.
Reinsurance contracts do not relieve the Company from its obligations to
policyholders. Therefore, the Company is contingently liable for recoverable
unpaid claims and policyholder liabilities ceded to reinsurers in the unlikely
event that assuming reinsurers are unable to meet their obligations. The Company
evaluates the financial condition of its reinsurers to minimize its exposure to
significant losses from reinsurer insolvencies. The effect of reinsurance on
policy revenues earned is as follows:
<TABLE>
<CAPTION>
1997 1996 1995
----------- ----------- -----------
<S> <C> <C> <C>
Direct policy revenues and amounts assessed
against policyholders.................................. $ 375,538 $ 358,825 $ 310,693
Reinsurance assumed......................................... 2,527 1,320 2,307
Reinsurance ceded........................................... 32,499 12,055 11,111
----------- ----------- -----------
Net premiums and amounts earned........................ $ 345,566 $ 348,090 $ 301,889
=========== =========== ===========
</TABLE>
Fees incurred for financial reinsurance were approximately, $145 in 1997,
$265 in 1996, and $339 in 1995.
(18) RESTRUCTURING AND OTHER CHARGES
As a result of the Company's initiative to implement an operating division
structure, the Company recorded a cumulative pre-tax restructuring charge of
$19,071 during the three month period ended March 31, 1997. The restructuring
charge recognizes: (a) severance and related benefits incurred due to staff
reductions ($5,355), (b) estimated holding costs of vacated facilities ($6,166),
(c) the write-off of certain fixed assets and other impaired assets ($1,526),
(d) estimated contract termination costs ($24), and (e) the write-off of the
Company's investment in certain foreign operations which will be closed
($6,000). As of December 31, 1997 the Company had charged against the accrual
$2,411 of severance and related benefits, $1,916 of vacated facilities costs,
$332 of fixed asset write-offs and $5,551 associated with the exit of the
Company from certain foreign operations. During the three month period ended
December 31, 1997, the Company re-evaluated such charge and reduced remaining
accruals by $2,300 as a result of final determination of certain obligations.
The Company incurred $4,652 of pre-tax incremental costs associated with
the restructuring during 1997. Such costs are included in the Company results of
operations as underwriting and other general and administrative costs.
In addition during the year ended December 31, 1997, the Company incurred
$7,646 of pre-tax transaction costs associated with the terminated Washington
National merger agreement. Such costs are included in the Company results of
operations.
During 1995, the Company had a restructuring charge of $3,943.
(19) SUBSEQUENT EVENTS
The Company initiated a redemption, effective March 31, 1998, of the Series
C Preferred Stock into shares of the Company's Common Stock under provision of
the Series C Preferred Stock certificate of designation.
On January 2, 1998, the Company acquired the Controlling Interest in SW
Financial for aggregate cash consideration ranging from $73,777 to $77,444
(excluding anticipated acquisition expenses) depending upon the outcome of
certain contingencies (see Note 16). As a result of the Company's plans to
consolidate certain of its operating locations and corporate functions, the
Company expects to incur restructuring and certain other charges during 1998 not
to exceed approximately $25.0 million.
On January 5, 1998, the Company acquired the Fickes and Stone Knightsbridge
interests (see Note 16).
74
<PAGE>
On February 18, 1998, the Company announced that it had engaged investment
banking firms to review strategic alternatives for maximizing shareholder value,
including the sale of the Company's Career Sales Division.
The following unaudited selected pro forma financial information has been
prepared to illustrate the pro forma effects of (i) the acquisition of the
controlling interest of SW Financial including the financing thereof, (ii) the
acquisition of the Fickes and Stone Knightsbridge Interests, including the
financing thereof ((i) and (ii) collectively the SW Financial pro forma) and
(iii) the impact of the Company's decision to dispose of the Career Sales
Division ((i), (ii) and (iii) collectively the Retained Businesses pro forma).
The pro forma statement of operations for the year ended December 31, 1997 gives
effect to the foregoing as though each had occurred on January 1, 1997. The
selected pro forma balance sheet information as of December 31, 1997, gives
effect to the foregoing as through each had occurred on December 31, 1997. The
selected pro forma financial information is not necessarily indicative of either
future results or the results that might have occurred had the transactions
occurred on January 1, 1997 or December 31, 1997 as the case might be.
The acquisitions of the SW Financial Controlling Interest and the Fickes
and Stone Knightsbridge Interests will be accounted for using the purchase
method of accounting. The total purchase price of the acquisitions will be
allocated to the tangible and intangible assets and liabilities acquired based
upon their respective values as of the respective consummation dates. The
allocation of the aggregate purchase price reflected in the selected pro forma
financial information is preliminary. The final allocation of the purchase price
is upon determination of the fair values of the acquired assets and liabilities;
however, that allocation is not expected to differ materially from the
preliminary allocation. The Company's decision to dispose of the Career Sales
Division in a period of time not likely to exceed one year will result in the
assets and liabilities of the Career Sales Division to be considered "assets and
liabilities held for sale," and as such will be segregated from those of the
retained businesses for purposes of presentation of the Company's financial
position. In addition, the Company will be required to provide certain
information regarding the impact of the Career Sales Division on the Company's
consolidated results. The following unaudited selected pro forma financial
information is intended to summarize such transactions. The retained businesses
pro forma information reflects the historical results of the retained businesses
and does not consider the use of proceeds likely to be derived from the
disposition of the businesses held for sale. The significant subsidiaries
included in businesses held for sale are PLIC and Union Bankers, a subsidiary of
SW Financial.
75
<PAGE>
<TABLE>
<CAPTION>
(Unaudited)
---------------------------------
Retained
SW Financial Businesses
As Reported Pro forma Proforma
For the year ended December 31, 1997 1997 1997
------------------------------- ------------ ------------ -------------
<S> <C> <C> <C>
Total revenues.................................... $ 663,794 $ 950,939 $ 666,625
Net income........................................ 50,140 51,357 46,991
Net income applicable to common stock............. 30,607 31,824 27,458
Per share information:
Net income applicable to common stock-basic... 1.09 1.12 *
Net income applicable to common stock-diluted. 1.07 1.10 *
As of December 31,
------------------
Investments and cash.............................. $ 3,340,114 $ 5,326,882 $ 4,655,522
Insurance assets.................................. 617,318 840,764 470,050
Other assets...................................... 766,703 799,242 623,300
Assets of businesses held for sale................ -- -- 1,218,016
------------ ------------ -------------
Total assets.................................... $ 4,724,135 $ 6,966,888 $ 6,966,888
============ ============ =============
Insurance liabilities............................. $ 3,289,925 $ 5,232,139 $ 4,638,392
Long-term debt.................................... 359,755 550,505 395,955
Other liabilities................................. 194,352 295,641 178,520
Liabilities of businesses held for sale........... -- -- 865,418
Redeemable preferred stock........................ 19,867 19,867 19,867
Shareholders' equity.............................. 860,236 868,736 868,736
------------ ------------ -------------
Total liabilities and shareholders' equity...... $ 4,724,135 $ 6,966,888 $ 6,966,888
============ ============ =============
* Due to the fact that amounts and use of proceeds information is unavailable
regarding the businesses held for sale, per share information is not
provided.
</TABLE>
(Remainder of Page Intentionally Left Blank)
76
<PAGE>
(20) UNAUDITED QUARTERLY FINANCIAL DATA
The following is a summary of the quarterly results of operations for the
years ended December 31, 1997 and 1996:
<TABLE>
<CAPTION>
(In thousands, except per share amounts)
1997 Quarter-ended March 31 June 30 September 30 December 31
- ------------------ -------- ------- ------------ -----------
<S> <C> <C> <C> <C>
Total revenues........................................ $ 168,116 $ 163,608 $ 172,968 $ 159,102
Net income (loss) applicable to common stock.......... $ 7,436 $ 13,209 $ 26,070 $ (16,108)
Net income (loss) per share of common stock - basic... $ 0.26 $ 0.47 $ 0.93 $ (0.58)
Net income (loss) per share of common stock - diluted $ 0.25 $ 0.45 $ 0.80 $ (0.58)
1996 Quarter-ended March 31 June 30 September 30 December 31
- ------------------ -------- ------- ------------ -----------
Total revenues........................................ $ 131,358 $ 130,599 $ 153,496 $ 167,294
Net income applicable to common stock................. $ 15,157 $ 18,754 $ 18,701 $ 21,029
Net income per share of common stock - basic.......... $ 0.63 $ 0.67 $ 0.66 $ 0.74
Net income per share of common stock - diluted........ $ 0.56 $ 0.60 $ 0.60 $ 0.66
</TABLE>
The Company's fourth quarter 1997 reported loss was primarily a result of
reserve strengthening aggregating $12,373 associated with the businesses held
for sale and certain non-recurring charges including transaction costs, period
restructuring costs and other costs aggregating $5,222, associated with the
retained businesses. In addition, the Company unlocked certain actuarial
assumptions on interest sensitive blocks of business resulting in additional
amortization of deferred policy acquisition costs and present value of insurance
in force amounting to $6,944.
77
<PAGE>
INDEPENDENT AUDITORS' REPORT
Board of Directors
Southwestern Financial Corporation:
We have audited the accompanying consolidated balance sheets of
Southwestern Financial Corporation and subsidiaries as of December 31, 1997 and
1996 and the related consolidated statements of income, shareholders' equity,
and cash flows for the years then ended. These consolidated financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these consolidated financial statements based on our
audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Southwestern
Financial Corporation and subsidiaries as of December 31, 1997 and 1996 and the
results of their operations and their cash flows for the years then ended in
conformity with generally accepted accounting principles.
KPMG Peat Marwick LLP
Dallas, Texas
March 19, 1998
78
<PAGE>
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
as of December 31,1997 and 1996
(In thousands, except share information)
<TABLE>
<CAPTION>
1997 1996
------------ -------------
<S> <C> <C>
ASSETS
Investments:
Fixed maturities available for sale at fair value (cost $1,643,769
and $1,270,507)............................................................. $ 1,677,508 $ 1,255,270
Equity securities available for sale at fair value (cost $688 and $959)........ 1,079 1,129
Mortgage loans on real estate, net of allowance of $680 in 1997 and
$1,000 in 1996.............................................................. 51,070 59,993
Policy loans................................................................... 123,041 128,551
Short-term investments......................................................... 157,140 135,203
Collateral loans............................................................... -- 21,308
Real estate.................................................................... 1,893 7,649
Other investments.............................................................. 8,461 5,553
------------ -------------
Total investments............................................................ 2,020,192 1,614,656
Cash.............................................................................. 6,576 26,692
Due from reinsurers............................................................... 109,051 259,288
Accrued investment income......................................................... 25,224 20,802
Accounts and notes receivable, net of allowance of $181 and $561.................. 5,507 13,773
Present value of insurance in force............................................... 58,565 71,333
Deferred policy acquisition costs................................................. 30,606 15,095
Deferred income taxes, net........................................................ 34,746 47,954
Other assets...................................................................... 19,025 18,549
Costs in excess of net assets acquired............................................ 115,388 119,760
------------ -------------
Total assets................................................................. $ 2,424,880 $ 2,207,902
============ =============
LIABILITIES
Policy liabilities and accruals:
Future policy benefits on traditional products................................. $ 554,998 $ 584,179
Universal life and investment contract liabilities............................. 1,315,496 1,088,335
Policy and contract claims .................................................... 57,517 55,011
Other policyholder funds....................................................... 14,203 17,635
------------ -------------
Total policy liabilities and accruals........................................ 1,942,214 1,745,160
Federal income taxes payable...................................................... 1,298 9,118
Notes payable..................................................................... 154,750 159,750
Accrued expenses and other liabilities............................................ 97,211 118,119
------------ -------------
Total liabilities............................................................ 2,195,473 2,032,147
------------ -------------
Mandatorily redeemable preferred stock:
Series A 10%, $.01 par value, $100 redemption value; 500,000 shares
authorized, 257,070 and 232,890 issued and outstanding at
December 31, 1997 and 1996, respectively.................................... 25,707 23,289
5.5% preferred stock $.01 par value, $10,000 redemption value; 2,000 shares
authorized, 1,118 and 1,059 shares issued and outstanding at
December 31, 1997 and 1996, respectively..................................... 11,184 10,590
SHAREHOLDERS' EQUITY
Common Stock, Class A, $.01 par value; 18,000,000 shares authorized;
3,500,000 shares issued and outstanding........................................ 35 35
Common Stock, Class B, non-voting $.01 par value; 10,000,000 shares authorized;
8,400,000 shares issued and outstanding........................................ 84 84
Additional paid in capital........................................................ 116,992 120,626
Unrealized gains (losses) on securities available for sale,
net of tax (benefit) of $11,776 and ($4,224)................................... 21,870 (8,081)
Retained earnings................................................................. 53,535 29,212
------------ -------------
Total shareholders' equity................................................... 192,516 141,876
------------ -------------
Total liabilities and shareholders' equity................................... $ 2,424,880 $ 2,207,902
============ =============
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
79
<PAGE>
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
for the Years Ended December 31, 1997 and 1996
(In thousands)
<TABLE>
<CAPTION>
1997 1996
------------ -------------
<S> <C> <C>
Revenues:
Premiums....................................................................... $ 103,138 $ 152,803
Interest sensitive policy product charges...................................... 42,680 44,109
Net investment income.......................................................... 126,427 128,692
Net gains from sale of investments............................................. 1,841 516
Other income, including $15,811 in earnings of limited partnership in 1996..... 16,039 27,439
------------ -------------
Total revenues............................................................... 290,125 353,559
------------ -------------
Benefits and expenses:
Policyholder benefits incurred................................................. 201,385 234,773
Change in liability for future policy benefits and other policy benefits....... (35,103) (36,929)
Amortization of present value of insurance
in force and deferred policy acquisition costs............................... 21,589 23,392
Amortization of costs in excess of net assets acquired......................... 4,130 4,130
Underwriting and other administrative expenses................................. 40,600 65,110
Interest and amortization of deferred debt issuance costs...................... 13,773 14,052
------------ -------------
Total benefits and expenses.................................................. 246,374 304,528
------------ -------------
Income before income taxes........................................................ 43,751 49,031
Income taxes................................................................. 16,416 18,149
------------ -------------
Net income........................................................................ 27,335 30,882
Preferred stock dividend requirements........................................ 3,012 2,754
------------ -------------
Net income available to common shareholders....................................... $ 24,323 $ 28,128
============ =============
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
80
<PAGE>
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
for the Years Ended December 31, 1997 and 1996
(In thousands)
<TABLE>
<CAPTION>
Unrealized
Gain (Loss)
Common Common Additional on Securities
Stock Stock Paid in Available Retained
Class A Class B Capital for Sale, Net Earnings Total
----------- ----------- ----------- ----------- ----------- ----------
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1995..... $ 35 $ 84 $ 120,626 $ 2,413 $ 1,084 $ 124,242
Net income....................... -- -- -- -- 30,882 30,882
Preferred dividends.............. -- -- -- -- (2,754) (2,754)
Unrealized loss on securities
available for sale, net....... -- -- -- (10,494) -- (10,494)
----------- ----------- ----------- ----------- ----------- ----------
Balance at December 31, 1996..... 35 84 120,626 (8,081) 29,212 141,876
Net income....................... -- -- -- 27,335 27,335
Preferred dividends.............. -- -- -- (3,012) (3,012)
Deemed dividend to eliminate
effects of reinsurance contract
with affiliate................ -- -- (3,634) 4,161 -- 527
Unrealized gain on securities
available for sale, net....... -- -- -- 25,790 -- 25,790
----------- ----------- ----------- ----------- ----------- ----------
Balance at December 31, 1997..... $ 35 $ 84 $ 116,992 $ 21,870 $ 53,535 $ 192,516
=========== =========== =========== =========== =========== ==========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
81
<PAGE>
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
for the Years Ended December 31, 1997 and 1996
(In thousands)
<TABLE>
<CAPTION>
1997 1996
---------- ----------
<S> <C> <C>
Cash flows from operating activities:
Net income..................................................................... $ 27,335 $ 30,882
Adjustments to reconcile net income to net cash used by operating activities:
Adjustments relating to universal life and investment products:
Interest credited to account balances...................................... 55,135 56,203
Charges for mortality and administration................................... (50,687) (50,689)
Capitalization of deferred policy acquisition costs.......................... (24,808) (16,806)
Amortization of intangibles, depreciation and accretion, net................. 26,545 29,427
Decrease in policy liabilities, accruals and other policyholder funds........ (24,319) (54,427)
Decrease in accrued expenses and other liabilities........................... (19,673) (7,477)
Decrease (increase) in notes and accounts receivable and
accrued investment income.................................................. 3,844 (3,000)
(Decrease) increase in taxes payable......................................... (7,820) 5,218
Deferred income taxes........................................................ (836) 12,847
Equity in undistributed earnings of limited partnership...................... -- (15,811)
Net gains from sales of investments.......................................... (1,841) (516)
Other, net................................................................... 5,330 7,916
---------- ----------
Net cash used by operating activities...................................... (11,795) (6,233)
---------- ----------
Cash flows from investing activities:
Sales of fixed maturities available for sale................................... 201,402 52,085
Maturities and other redemptions of fixed maturities available for sale........ 129,600 147,114
Sales of mortgages, real estate and other investments.......................... 7,512 57,278
Principal collected on mortgage loans and collateral loans..................... 28,030 4,687
Change in short-term investments, net.......................................... (21,929) 19,369
Distributions from limited partnership......................................... -- 53,520
Purchases of fixed maturities available for sale............................... (419,525) (323,585)
Purchases of other investments................................................. (764) (694)
---------- ----------
Net cash (used) provided by investing activities........................... (75,674) 9,774
---------- ----------
Cash flows from financing activities:
Receipts from interest sensitive products credited to
policyholders' account balances.............................................. 103,243 99,409
Return of policyholders' account balances on interest sensitive products....... (102,112) (117,806)
Cash provided by reinsurance recapture......................................... 21,222 --
Cash provided by assumed reinsurance with affiliate............................ 50,000 --
Reduction of notes payable..................................................... (5,000) (250)
---------- ----------
Net cash provided (used) by financing activities........................... 67,353 (18,647)
---------- ----------
Decrease in cash.................................................................. (20,116) (15,106)
Cash at beginning of year......................................................... 26,692 41,798
---------- ----------
Cash at end of year............................................................... $ 6,576 $ 26,692
========== ==========
Supplemental disclosures:
Income taxes paid.............................................................. $ 25,072 $ 84
Interest paid.................................................................. 12,305 12,714
Non-cash financing activities:
Preferred stock issued as dividends............................................ 3,012 2,754
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
82
<PAGE>
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997 and 1996
(In thousands)
1. Basis of Presentation
On December 14, 1995 (the acquisition date), Southwestern Financial
Corporation (SWF or the Company), a newly organized corporation, was formed by
PennCorp Financial Group, Inc. (PennCorp) and Knightsbridge Capital Fund I, L.P.
(Knightsbridge). A wholly-owned subsidiary of SWF acquired from I.C.H.
Corporation (ICH), Southwestern Life Insurance Company (Southwestern Life) and
its wholly-owned subsidiary, Constitution Life Insurance Company (Constitution)
and its 83% owned subsidiary, ICH Funding Corp. (ICH Funding), and Union Bankers
Insurance Company (Union Bankers) and its wholly-owned subsidiary, Marquette
National Life Insurance Company (Marquette). In addition, a wholly-owned
subsidiary of SWF acquired from ICH substantially all of the assets and
liabilities of Facilities Management Installation, Inc. (FMI), which had
provided management services to ICH's insurance companies. The acquisition was
accounted for as a purchase in accordance with generally accepted accounting
principles (GAAP) and, accordingly, the purchase price was allocated to assets
and liabilities acquired based on estimates of their fair value as of the
acquisition date, which became the new cost basis. Subsequently, the insurance
companies were reorganized such that Constitution became the parent of
Southwestern Life and Union Bankers. Effective January 2, 1998, PennCorp
acquired Knightsbridge's interest in SWF and SWF became a wholly-owned
subsidiary of PennCorp. (See Note 16).
In August 1997, the Company acquired from ICH the remaining 17% interest in
ICH Funding and certain other assets and released ICH from indemnification
obligations relative to certain tax, litigation and other matters. Minority
interest in ICH Funding, totaling $1,486 at December 31, 1996 is included in
accrued expenses and other liabilities as of December 31, 1996.
SWF and its subsidiaries market and underwrite a broad range of life
insurance, annuities and accident and health products to individuals through a
sales force of independent agents. The insurance subsidiaries are licensed to
write business in 48 states, the District of Columbia and Guam. Approximately
27.4% of the total direct premium of the Company's insurance subsidiaries was
generated from business written in Texas. No other states accounted for more
than 10% of the direct premium of the Company in 1997.
The accompanying consolidated financial statements include the accounts of
the Company and its wholly-owned subsidiaries. All significant intercompany
accounts and transactions have been eliminated.
The preparation of financial statements in conformity with GAAP requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and the reported amounts of revenues and expenses during
the reporting period. Accounts that the Company deems to be acutely sensitive to
changes in estimates include deferred policy acquisition costs, future policy
benefits, policy and contract claims and present value of insurance in force. In
addition, the Company must determine requirements for disclosure of contingent
assets and liabilities as of the date of the financial statements based upon
estimates. In all instances, actual results could differ from estimates.
2. Summary of Significant Accounting Policies
(a) Investments
Fixed maturity and equity securities classified as available for sale are
recorded at fair value, as they may be sold in response to changes in
interest rates, prepayment risk, liquidity needs, the need or desire to
increase income or capital and other economic factors. Changes in
unrealized gains and losses related to securities available for sale are
recorded as a separate component of shareholders' equity, net of applicable
taxes and amount attributable to deferred policy acquisition costs and
present value of insurance in force related to universal life and
investment-type products. Mortgage-backed securities are amortized using
the interest method including
83
<PAGE>
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. Summary of Significant Accounting Policies (Continued)
anticipated prepayments at the date of purchase. Significant changes in
estimated cash flows from original assumptions are reflected in the period
of such change. Mortgage loans on real estate are recorded at cost,
adjusted for the provision for loan losses, if necessary. Policy loans are
recorded at cost. Short-term investments purchased with maturities
generally less than three months are recorded at cost, which approximates
market. All short-term investments are considered to be cash equivalents.
Real estate, substantially all of which was acquired through foreclosure,
is recorded at the lower of fair value, minus estimated costs to sell, or
cost. If the fair value of the foreclosed real estate minus estimated costs
to sell is less than cost, a valuation allowance is provided for the
deficiency. Increases in the valuation allowance are charged to income.
Collateral loans are carried at their aggregate unpaid principal balances.
The Company regularly evaluates the carrying value of their investments
based on current economic conditions, past credit loss experience and other
circumstances. A decline in net realizable value that is other than
temporary is recognized as a realized investment loss and a reduction in
the cost basis of the investment. The Company discounts expected cash flows
in the computation of net realizable value of its investments, other than
certain mortgage-backed securities. In those circumstances where the
expected cash flows of residual interest and interest-only mortgage-backed
securities, discounted at a risk-free rate of return, result in an amount
less than the carrying value, a realized loss is reflected in an amount
sufficient to adjust the carrying value of a given security to its fair
value.
Realized investment gains and losses and declines in value which are other
than temporary, determined on the basis of specific identification, are
included in the determination of net income.
(b) Insurance Revenue Recognition
Accident and health insurance premiums are recognized as revenue ratably
over the time period to which premiums relate. Revenues from traditional
life insurance policies represent premiums which are recognized as earned
when due. Benefits and expenses are associated with earned premiums so as
to result in recognition of profits over the lives of the policies. This
association is accomplished by means of the provision for liabilities for
future policy benefits and the deferral and amortization of policy
acquisition costs.
Revenues for interest sensitive products such as universal life and annuity
contracts represent charges assessed against the policyholders' account
balance for the cost of insurance, surrenders and policy administration.
Benefits charged to expenses include benefit claims incurred during the
period in excess of policy account balances and interest credited to policy
account balances.
(c) Policy Liabilities and Accruals
Liabilities for future policy benefits for traditional life products
generally have been computed on the net level premium method, based on
estimated future investment yield, mortality, and withdrawals. For accident
and health products, liabilities for future policy benefits are established
equal to the excess of the present value of future benefits to or on behalf
of policyholders over discounted net future premiums. Estimates used are
based on the Company's experience adjusted to provide for possible adverse
deviation. These estimates are periodically
84
<PAGE>
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. Summary of Significant Accounting Policies (Continued)
reviewed and compared with actual experience. Liabilities for future policy
benefits for interest sensitive products include the balance that accrues
to the benefit of the policyholders and amounts that have been assessed to
compensate the life insurance subsidiaries for services to be provided in
the future.
Policy and contract claims represent estimates of reported claims and
claims incurred but not reported based on experience.
(d) Accounts and Notes Receivable
Accounts and notes receivable consist primarily of agents' balances and
premium receivable from agents and policyholders. Agents' balances are
partially secured by commissions due to agents in the future and premiums
receivable are secured by policy liabilities. An allowance for doubtful
accounts is established, based upon specific identification and general
provision, for amounts which the Company estimates will not ultimately be
collected.
(e) Deferred Policy Acquisition Costs
Estimated costs of acquiring new business which vary with, and are
primarily related to, the production of new business, have been deferred to
the extent that such costs are deemed recoverable from future revenues.
Such estimated costs include commissions and certain costs of policy
issuance and underwriting. Costs deferred on accident and health and
traditional life policies are amortized, with interest, over the
anticipated premium-paying period of the related policies in proportion to
the ratio of annual premium revenue to expected total premium revenue to be
received over the life of the policies. Expected premium revenue is
estimated by using the same mortality, morbidity and withdrawal assumptions
used in computing liabilities for future policy benefits. For interest
sensitive products and limited pay life products, policy acquisition costs
are amortized in relation to the emergence of anticipated gross profits
over the life of the policies.
(f) Present Value of Insurance In Force
The present value of insurance in force represents the anticipated gross
profits to be realized from future revenues on insurance in force at the
date such insurance was purchased, discounted to provide an appropriate
rate of return and amortized, with interest, based on credited rate, over
the years that such profits are anticipated to be received in proportion to
the estimated gross profits. Accumulated amortization was $35,386 and
$22,889 as of December 31, 1997 and 1996, respectively.
(g) Deferred Debt Issuance Costs
Deferred debt issuance costs, which are included in other assets, represent
costs incurred in connection with obtaining long-term debt financing which
have been capitalized and are being amortized on an interest yield method
over the terms of the respective debt. Deferred costs totaled $2,530 and
$3,309 which are net of accumulated amortization of $1,580 and $801 at
December 31, 1997 and 1996, respectively.
(h) Costs in Excess of Net Assets Acquired
Costs in excess of the fair value of net assets acquired are amortized on a
straight-line basis over 30 years. Accumulated amortization totaled $8,260
and $4,130 at December 31, 1997 and 1996, respectively.
85
<PAGE>
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. Summary of Significant Accounting Policies (Continued)
(i) Recoverability of Long-lived Assets
The Company continually monitors long-lived assets and certain intangible
assets, such as costs in excess of net assets acquired and present value of
insurance in force, for impairment. An impairment loss is recorded in the
period in which the carrying value of the assets exceeds the fair value or
expected future cash flows. Any amounts deemed to be impaired are charged,
in the period in which such impairment was determined, as an expense
against earnings. For the period presented there was no charge to earnings
for the impairment of long-lived assets.
(j) Income Taxes
Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to (i) temporary differences between the
financial statement carrying amounts of existing assets and liabilities and
their respective tax bases, and (ii) operating losses and tax credit
carryforwards. Deferred tax assets and liabilities are measured using
enacted tax rates expected to apply to taxable income in the years in which
the temporary differences are expected to be recovered or settled. The
effect on deferred tax assets and liabilities of a change in tax rates is
recognized in income in the period that includes the enactment date.
(k) Reinsurance
Financial reinsurance that does not transfer significant insurance risk is
accounted for as a deposit and is reflected as a component of due from
reinsurers. The cost of reinsurance related to long-duration contracts is
accounted for over the life of the underlying reinsurance policies.
Balances due to, or from, reinsurers have been reflected as assets and
liabilities rather than reducing the related account balances.
3. Investments
Investments in a single entity, other than obligations of the U.S.
Government or agencies thereof, totaling in excess of 10% of total shareholders
equity at December 31, 1997 and 1996 are listed below:
<TABLE>
<CAPTION>
1997 1996
-------------------------- --------------------------
Percent of Percent of
Carrying Shareholders' Carrying Shareholders'
Value Equity Value Equity
----- ------ ----- ------
<S> <C> <C> <C> <C>
Fund America Investors Corp., Ser. 93-C,
Class B Certificates................................ $ 19,271 10.0% $ 16,250 11.2%
James M. Fail and Stone Capital, Inc.
Collateral loans.................................... -- -- 21,308 14.7
</TABLE>
86
<PAGE>
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. Investments (Continued)
The amortized cost and fair value of investments in fixed maturities
available for sale at December 31, 1997 and 1996 by categories of securities are
as follows:
<TABLE>
<CAPTION>
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
------------ ------------ ------------ -------------
<S> <C> <C> <C> <C>
December 31, 1997:
Mortgage-backed securities........................ $ 820,837 $ 22,791 $ (1,434) $ 842,194
U.S. Treasury securities and obligations of
U.S. Government corporations and agencies....... 27,492 91 (12) 27,571
Debt securities issued by states of the United States
and political subdivisions of the states....... 22,469 365 (130) 22,704
Debt securities issued by foreign governments..... 20,525 821 -- 21,346
Corporate debt securities......................... 752,446 14,664 (3,417) 763,693
------------ ------------ ------------ -------------
Total fixed maturities available for sale....... $ 1,643,769 $ 38,732 $ (4,993) $ 1,677,508
============ ============ ============ =============
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
------------ ------------ ------------ -------------
December 31, 1996:
Mortgage-backed securities........................ $ 609,593 $ 8,153 $ (7,304) $ 610,442
U.S. Treasury securities and obligations of
U.S. Government corporations and agencies....... 49,598 224 (343) 49,479
Debt securities issued by states of the United States
and political subdivisions of the states....... 15,226 -- (388) 14,838
Debt securities issued by foreign governments..... 22,698 176 (870) 22,004
Corporate debt securities......................... 573,392 1,429 (16,314) 558,507
------------ ------------ ------------ -------------
Total fixed maturities available for sale....... $ 1,270,507 $ 9,982 $ (25,219) $ 1,255,270
============ ============ ============ =============
</TABLE>
The amortized cost and fair value of fixed maturities at December 31, 1997,
by contractual maturity, are shown below:
<TABLE>
<CAPTION>
Amortized Fair
Cost Value
------------ ------------
<S> <C> <C>
Available for sale:
Due in one year or less................................................ $ 28,929 $ 28,921
Due after one year through five years.................................. 234,776 236,677
Due after five years through ten years................................. 272,127 275,248
Due after ten years.................................................... 287,100 294,468
------------ ------------
822,932 835,314
Mortgage-backed securities............................................. 820,837 842,194
------------ ------------
$ 1,643,769 $ 1,677,508
============ ============
</TABLE>
Expected maturities will differ from contractual maturities because
borrowers may have the right to call or prepay obligations with or without
prepayment penalties.
87
<PAGE>
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. Investments (Continued)
Investments with a fair value of $119,695 and $121,617 were on deposit with
certain regulatory authorities at December 31, 1997 and 1996, respectively.
Included in fixed maturities available for sale at December 31, 1997 and
1996, are below investment-grade securities with amortized costs of $71,467 and
$40,177, respectively, and fair values of $74,227 and $39,955, respectively.
Included in fixed maturities available for sale as of December 31, 1997, are
unrated securities with an amortized cost and fair value of $11,811.
During 1997, the Company purchased $7,650 of subordinated indebtedness of
ACO Acquisition Corp., which was subsequently re-named Acordia, Inc. (Acordia).
The Acordia subordinated notes pay interest on a current basis at 12.5% per
annum, payable in semi-annual installment. Acordia is an insurance broker
specializing in the marketing of commercial property and casualty programs.
Acordia is 28.6% owned by Knightsbridge.
In addition, during 1997, the Company acquired 41,605 shares of redeemable
preferred stock of Portsmouth Financial Group, Inc. (Portsmouth) for $4,161. The
preferred stock pays dividends of 18.0% of which 12.5% is in cash with the
remainder in the form of additional preferred stock. The shares are mandatorily
redeemable on June 30, 2002. Portsmouth underwrites, acquires, and holds to
receipt of benefits, life insurance contracts covering individuals facing
terminal illnesses. Portsmouth is owned by Knightsbridge and its affiliates. The
Company has agreed, subject to required regulatory approvals to make up to a
$10,000 preferred equity investment in Portsmouth.
The Company had non-income producing investments at December 31, 1997 with
an amortized cost and fair value as follows:
<TABLE>
<CAPTION>
Amortized
Cost Fair Value
------------- -------------
<S> <C> <C>
Fixed maturities................................ $ 487 $ 66
Equity securities............................... 688 1,079
Other investments............................... 5,778 5,791
------------- -------------
$ 6,953 $ 6,936
============= =============
</TABLE>
At December 31, 1997 net unrealized appreciation of equity securities of
$391 consisted of gross unrealized gains of $415, less unrealized losses of $24.
At December 31, 1996 net unrealized appreciation of $170 consisted of gross
unrealized gains of $207, less unrealized losses of $37.
88
<PAGE>
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. Investments (Continued)
Following is an analysis of net gains (losses) from sale of investments for
the years ended December 31, 1997 and 1996:
<TABLE>
<CAPTION>
1997 1996
------------- -------------
<S> <C> <C>
Fixed maturities................................ $ 553 $ 1,385
Equity securities............................... -- (43)
Other investments............................... 1,146 1,736
Real estate..................................... 134 (125)
Mortgage loans.................................. -- (2,437)
Short-term investments.......................... 8 --
------------- -------------
$ 1,841 $ 516
============= =============
</TABLE>
For the year ended December 31, 1997, net realized gains on sale of fixed
maturities consisted of gross gains of $2,779 and gross losses of $2,226. For
the year ended December 31, 1996, net realized gains on sale of fixed maturities
consisted of gross gains of $2,923 and gross losses of $1,538.
Following are changes in unrealized appreciation (depreciation) on
investments for the years ended December 31, 1997 and 1996:
<TABLE>
<CAPTION>
1997 1996
------------ -------------
<S> <C> <C>
Investments carried at fair value:
Fixed maturities.................................................. $ 48,976 $ (18,991)
Equity securities................................................. 221 194
Other investments................................................. (713) 1,652
------------ -------------
48,484 (17,145)
Eliminate effects from reinsurance contract with affiliate........... (4,161) --
Less effect on other balance sheet accounts:
Value of business acquired and deferred acquisition costs......... (2,768) 1,362
Deferred income taxes............................................. (16,000) 5,524
Minority interest in unrealized losses............................ 235 (235)
------------ -------------
Change in unrealized investment gains and losses..................... $ 25,790 $ (10,494)
============ =============
</TABLE>
89
<PAGE>
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. Investments (Continued)
Major categories of net investment income for the years ended December 31,
1997 and 1996 consist of the following:
<TABLE>
<CAPTION>
1997 1996
------------ -------------
<S> <C> <C>
Fixed maturities........................................ $ 98,906 $ 87,348
Equity securities....................................... -- 58
Mortgage loans.......................................... 5,490 11,156
Policy loans............................................ 7,621 8,011
Short-term investments.................................. 4,442 7,738
Collateral loans........................................ 2,218 2,947
Real estate............................................. 441 3,956
Investments held in trust under reinsurance treaty(a)... 9,617 12,130
Other investments....................................... 1,250 1,503
Investment expenses..................................... (3,558) (6,155)
------------ -------------
$ 126,427 $ 128,692
============ =============
- -------------------
(a) Investments held in trust by a reinsurer with carrying values of $121,016
as of December 31, 1996, are included in amounts due from reinsurers. This
contract was recaptured during 1997 (see Note 10).
</TABLE>
At December 31, 1997 and 1996 the Company held mortgage loans principally
involving commercial real estate with carrying values of $51,070 and $59,993,
respectively, net of an allowance for losses of $680 and $1,000 at December 31,
1997 and 1996, respectively. Estimated fair values of mortgage loans totaled
$51,816 and $59,993 at December 31, 1997 and 1996, respectively. The average
outstanding loan balances were approximately $1,027 and $955 at December 31,
1997 and 1996, respectively. At December 31, 1997 mortgage loan investments were
concentrated in the following states:
<TABLE>
<CAPTION>
Percent of Total
Carrying Value Carrying Total
-------------- --------------
<S> <C> <C>
Texas........................................................... $ 23,832 46.7%
Illinois........................................................ 7,029 13.7
Oklahoma........................................................ 4,915 9.6
Florida......................................................... 3,180 6.3
Kansas.......................................................... 2,527 4.9
All other....................................................... 9,587 18.8
---------- -----
Balance, end of period.......................................... $ 51,070 100.0%
========== =====
</TABLE>
During 1996, the Company had a limited partnership investment representing
a 50% interest in a partnership, GSSW, L.P. (GSSW) formed to acquire through
auction certain mortgage loans and real estate formerly held by failed savings
and loan associations. Effective December 31, 1996, GSSW liquidated the general
partner interests through distribution of certain assets at fair value, sold
substantially all remaining investments and utilized the proceeds to buy the
limited partnership interest not owned by the Company. As a result of these
transactions, the Company became the parent of GSSW, realized earnings on GSSW
of $13,171, received net cash distributions of $47,520 and paid PennCorp, a
shareholder, a fee of $1,000 as guarantor in GSSW's sale of assets.
90
<PAGE>
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. Investments (Continued)
Following is an analysis of the investment in the GSSW limited partnership
for the year ended December 31, 1996:
<TABLE>
<S> <C>
Balance, beginning of period.................................. $ 39,600
Equity in operating earnings during year...................... 3,640
Equity in earnings on transactions at December 31, 1996....... 13,171
Distributions during year..................................... (6,000)
Net distributions at December 31, 1996........................ (47,520)
-----------
Balance, December 31, 1996.................................... $ 2,891
===========
</TABLE>
At December 31, 1997 and 1996, the accounts of GSSW are consolidated into
the accompanying consolidated balance sheet.
4. Policy Liabilities and Accruals
For interest sensitive life products and annuity products, the liability
for future policy benefits is equal to the accumulated fund value. Fund values
are equal to the excess premium received and interest credited to the fund value
less deductions for mortality costs and expense charges. Current interest rates
credited range from 4% to 8%. Mortality costs and expense charges are
established by the Company based upon its experience and cost structure.
For traditional life products, the liability for future policy benefits has
been computed by the net level premium method based on estimated future
investment yield, mortality, and withdrawal experience. Reserve interest
assumptions are graded and range from 6.25% to 7.375%. For accident and health
products, liabilities for future policy benefits are established equal to the
excess of the present value of future benefits to or on behalf of policyholders
over future net premiums discounted at interest rates ranging primarily from
6.5% to 8.0%. The future policy benefits of traditional life products and
accident and health products are determined using mortality, morbidity and
withdrawal assumptions that reflect the experience of the Company modified as
necessary to reflect anticipated trends and to include provisions for possible
unfavorable deviations. The assumptions vary by plan, year of issue and
duration.
The Company has carefully monitored a block of interest sensitive life
policies where overall financial performance was not satisfactory. During the
third quarter of 1997, management implemented certain corrective actions. These
actions included reduction in credited interest rates, increased monthly expense
charges and cost of insurance increases on selected policy forms. As a result,
reserves on this block were reduced approximately $17,000.
Policy and contract claims include provisions for reported claims in
process of settlement, valued in accordance with the terms of the related
policies and contracts, as well as provisions for claims incurred and unreported
based on the Company's prior experience.
While management believes the estimated amounts included in financial
statements for policy liabilities and accruals are adequate, such estimates may
be more or less than the amounts ultimately paid when the claims are settled. In
addition, the Company is involved in certain litigation regarding policyholder
benefits. The Company intends to vigorously defend its position relative to
these claims; however, if unsuccessful, the level of reserves currently provided
could be adversely effected.
91
<PAGE>
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. Policy Liabilities and Accruals (Continued)
Total policy liabilities and accruals consist of the following as of
December 31, 1997 and 1996:
<TABLE>
<CAPTION>
1997 1996
------------- -------------
<S> <C> <C>
Future policy benefits on traditional products:
Traditional life insurance contracts.......................... $ 335,283 $ 344,520
Traditional annuity products.................................. 105,663 105,246
Individual accident and health................................ 87,152 104,071
Unearned premiums............................................. 26,900 30,342
------------- -------------
Total future policy benefits 554,998 584,179
------------- -------------
Universal life and investment contract liabilities:
Universal life and annuities.................................. 1,315,333 1,086,632
Guaranteed investment contracts............................... 163 1,703
------------- -------------
Total universal and investment contract liabilities........ 1,315,496 1,088,335
------------- -------------
Policy and contract claims...................................... 57,517 55,011
Other policyholder funds........................................ 14,203 17,635
------------- -------------
Total policy liabilities and accruals...................... $ 1,942,214 $ 1,745,160
============= =============
</TABLE>
The following table presents information on changes in the liability for
policy and contract claims for the years ended December 31, 1997 and 1996:
<TABLE>
<CAPTION>
1997 1996
------------- -------------
<S> <C> <C>
Policy and contract claims at January 1......................... $ 55,011 $ 62,140
Less reinsurance recoverables................................... 153 118
------------- -------------
Net balance at January 1...................................... 54,858 62,022
------------- -------------
Add claims incurred, net of reinsurance related to:
Current year.................................................. 81,168 91,496
Prior years................................................... (6,012) (2,646)
------------- -------------
75,156 88,850
------------- -------------
Deduct claims paid, net of reinsurance related to:
Current year.................................................. 58,658 52,240
Prior years................................................... 13,839 43,774
------------- -------------
72,497 96,014
------------- -------------
Policy and contract claims, net of related reinsurance
recoverables at December 31.................................. 57,517 54,858
Plus reinsurance recoverables................................... -- 153
------------- -------------
Policy and contract claims at December 31....................... $ 57,517 $ 55,011
============= =============
</TABLE>
As a result of changes in estimates of insured events in prior years, the
liability for policy and contract claims decreased, net of reinsurance, by
$6,012 in 1997 and $2,646 in 1996.
92
<PAGE>
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. Notes Payable
The outstanding principal amounts of notes payable at December 31, 1997 and
1996 consist of the following:
<TABLE>
<CAPTION>
1997 1996
------------- -------------
<S> <C> <C>
Revolving bank debt............................................. $ 90,250 $ 95,000
Bank debt with quarterly principal requirements................. 24,500 24,750
7.0% convertible subordinated note.............................. 40,000 40,000
------------- -------------
$ 154,750 $ 159,750
============= =============
</TABLE>
Interest costs under the revolving bank debt totaled $7,860 and $8,128 for
the years ended December 31, 1997 and 1996, respectively. The interest rate of
the debt is based on, at the Company's option, either a floating rate (based on
the base rate of the First National Bank of Chicago) plus a margin of 1.75% or a
Eurodollar rate (based on the London Interbank Offered Rate or LIBOR) plus a
margin of 2.75%. At December 31, 1997, the effective rate of the revolving loan
was approximately 9.13%. The revolving bank debt was repaid on January 2, 1998.
Interest costs under the bank term debt totaled $2,229 and $2,250 for the
years ended December 31, 1997 and 1996, respectively. The interest rate of the
term debt is based on, at the Company's option, either a floating rate (based on
the base rate of the First National Bank of Chicago) plus a margin of 2.25% or a
Eurodollar rate (based on LIBOR) plus a margin of 3.25%. At December 31, 1997,
the effective rate of the term loans was approximately 9.63%. The bank term debt
was repaid on January 2, 1998.
As part of the consideration for the acquisition of Southwestern Life,
Union Bankers, Constitution and Marquette from ICH, the Company issued to ICH a
$40,000 aggregate principal amount of SWF's 7.0% Convertible Subordinated Notes
due 2005. The notes are convertible into an aggregate 3,200,000 shares of common
stock of SWF, of which 800,000 will be Class B non-voting common stock. In the
aggregate the shares upon conversion represent approximately 21.2% of SWF's
fully diluted shares at closing before giving effect to certain warrants
outstanding. During 1997, PennCorp acquired the notes from the liquidating trust
for the creditors of ICH for $40,000 plus accrued interest. The Convertible
Notes are unsecured obligations and are subordinate in right of payment to SWF's
bank debt and all of the indebtedness of SWF. Interest costs under the
Convertible Notes totaled $2,800 for the years ended December 31, 1997 and 1996.
The Company agreed to maintain sufficient cash and cash equivalents to fund the
interest payments on the Convertible Notes for the first three years. At
December 31, 1997 and December 31, 1996, restricted cash and short-term
investments totaled $3,339 and $5,959, respectively.
In conjunction with the bank debt, the Company entered into interest rate
protection agreements in the form of a series of interest rate caps in the
notional amount of $62,500 which expire May 1998. These entitle the Company to
revenue should three-month LIBOR exceed the cap rate of 7.5%. At December 31,
1997, three-month LIBOR was 5.81%.
6. Preferred and Common Stock
On December 14, 1995, the Company issued 210,000 shares of Series A
preferred stock with a liquidation value of $21,000 to PennCorp and one of its
subsidiaries. The Series A preferred stock accrues dividends at a rate of 10.0%
per annum, compounded quarterly and is mandatorily redeemable at December 31,
2005. Dividends on the Series A preferred stock are payable in cash, or at SWF's
option, are payable in kind. The Series A preferred stock is not redeemable at
the option of the Company but at maturity will be required to be redeemed for
approximately $56 million in cash assuming no cash dividend distributions. If
the Company fails to satisfy its mandatory redemption obligation, the holders of
the Series A preferred stock
93
<PAGE>
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. Preferred and Common Stock (Continued)
will be entitled to elect 49.0% of the members of the Board of SWF and, upon
receipt of regulatory approval, a majority of the directors of SWF. The Series A
preferred stock is senior preferred stock. The holders of the Series A preferred
stock are entitled to class voting rights under certain circumstances, including
in connection with a merger of SWF or a sale of all or substantially all its
assets or the authorization or issuance of senior or pari passu preferred stock,
and as otherwise provided by law. For the years ended December 31, 1997 and
1996, 24,180 and 21,900 additional shares were issued with a redemption value of
$2,418 and $2,190, respectively in lieu of cash to satisfy dividend
requirements.
In addition, certain of PennCorp's insurance subsidiaries purchased $10,000
liquidation value of 5.5% Mandatorily Redeemable Preferred Stock, par value
$0.01 per share (the 5.5% Preferred Stock) of Southwestern Life Acquisition
Corporation, a wholly-owned subsidiary of SWF. During 1996 SLAC was dissolved
and the 5.5% Preferred Stock was exchanged for 5.5% Preferred Stock of
Southwestern Life Companies, Inc. (SLC), also a wholly-owned subsidiary of SWF.
The 5.5% Preferred Stock accrues dividends payable in cash or, subject to
certain conditions, through the issuance of additional shares of 5.5% Preferred
Stock. The 5.5% Preferred Stock is not subject to optional redemption and
matures on December 31, 2005. If SLC fails to satisfy its mandatory redemption
obligation or if dividends payable on the 5.5% Preferred Stock are in arrears
for four or more quarterly dividend periods, the holders of the 5.5% Preferred
Stock will be entitled to elect 49.0% of the members of the Board of Directors
of SLC and, upon receipt of regulatory approval, a majority of the Board of
Directors of SLC. The 5.5% Preferred Stock is the only preferred stock of SLC
authorized for issuance. The holders of the 5.5% Preferred Stock are entitled to
class voting rights under certain circumstances, including in connection with a
merger of SLC or a sale of all or substantially all its assets or the
authorization or issuance of senior pari passu preferred stock, and as otherwise
provided by law. For the years ended December 31, 1997 and 1996, 59 and 59
additional shares were issued with a redemption value of $594 and $590,
respectively in lieu of cash to satisfy dividend requirements.
7. Income Taxes
The Company and its non-insurance subsidiaries file a consolidated federal
income tax return. The Company's life insurance subsidiaries also file a
consolidated federal income tax return.
Total income taxes for the years ended December 31, 1997 and 1996 are as
follows:
<TABLE>
<CAPTION>
1997 1996
------------- -------------
<S> <C> <C>
Current........................................................ $ 17,252 $ 5,302
Deferred....................................................... (836) 12,847
------------- -------------
$ 16,416 $ 18,149
============= =============
</TABLE>
Income taxes computed using the prevailing corporate tax rate of 35% are
reconciled to the Company's actual income tax expense attributable to income for
the years ended December 31, 1997 and 1996, as follows:
<TABLE>
<CAPTION>
1997 1996
------------- -------------
<S> <C> <C>
Tax expense computed at statutory rate.......................... $ 15,313 $ 17,161
Amortization of costs in excess of net assets acquired.......... 1,445 1,445
Change in deferred tax asset valuation allowance................ 364 (183)
Other........................................................... (706) (274)
------------- -------------
$ 16,416 $ 18,149
============= =============
</TABLE>
94
<PAGE>
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. Income Taxes (Continued)
Temporary differences, including $1,956 in 1997 of deferred tax assets
transferred in association with a reinsurance contract with an affiliate,
between the financial statement carrying amounts and tax bases of assets and
liabilities that give rise to the deferred tax assets (liabilities) at December
31, 1997 and 1996 relate to the following:
<TABLE>
<CAPTION>
1997 1996
------------- -------------
<S> <C> <C>
Deferred tax assets:
Deferred policy acquisition costs............................. $ 9,548 $ 10,407
Future policy benefits........................................ 73,660 112,408
Invested assets, subject to capital gains treatment........... 24,907 16,770
Net unrealized loss........................................... -- 4,224
------------- -------------
108,115 143,809
------------- -------------
Deferred tax liabilities:
Present value of insurance in force........................... (20,498) (24,967)
Other assets and liabilities.................................. (20,123) (50,280)
Net unrealized gain........................................... (11,776) --
------------- -------------
(52,397) (75,247)
------------- -------------
Net deferred tax asset........................................ 55,718 68,562
Valuation allowance........................................... (20,972) (20,608)
------------- -------------
$ 34,746 $ 47,954
============= =============
</TABLE>
The valuation allowances at December 31, 1997 and 1996, are attributable to
deferred tax assets principally arising from differences in the book and tax
bases of invested assets subject to capital gains treatment that existed as of
the date of acquisition of the company's insurance subsidiaries. To the extent
that income tax benefits relative to such tax assets are ultimately realized,
the reduction in the related valuation allowance would be allocated to reduce
costs in excess of net assets acquired.
In assessing the realizability of deferred tax assets, management considers
whether it is more likely than not that some portion or all of the deferred tax
assets will be realized. The ultimate realization of deferred tax assets is
dependent on the generation of future taxable income during the periods in which
those temporary differences become deductible. Management considers the
scheduled reversal of deferred tax liabilities, projected future taxable income
and tax planning strategies in making this assessment. Based upon those
considerations, management believes it is more likely than not that the Company
will realize the benefits of these deductible differences, net of the existing
valuation allowance at December 31, 1997.
95
<PAGE>
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. Deferred Policy Acquisition Costs and Present Value of Insurance in Force
Deferred policy acquisition costs represent commissions and certain costs
of policy issuance and underwriting. Information relating to these costs for the
years ended December 31, 1997 and 1996, is as follows:
<TABLE>
<CAPTION>
1997 1996
------------- -------------
<S> <C> <C>
Balance at beginning of period.................................. $ 15,095 $ --
Policy acquisition costs deferred:
Commissions................................................... 17,443 11,810
Underwriting and issue costs.................................. 7,366 4,996
Released by 80% coinsurance of Medicare business (see Note 10) -- (1,243)
Policy acquisition costs amortized.............................. (9,092) (503)
Unrealized investment (gain) loss adjustment.................... (206) 35
------------- -------------
Unamortized deferred policy acquisition costs at period end..... $ 30,606 $ 15,095
============= =============
</TABLE>
As part of the purchase accounting for the Company's acquisitions, a
present value of insurance in force asset is established which represents the
value of the right to receive future cash flows from insurance contracts
existing at the date of acquisition. Such value is the actuarially determined
present value of the projected cash flows from the acquired policies, discounted
at an appropriate risk rate of return.
The methods used by the Company to value the health, life and annuity
products purchased are consistent with the valuation methods used most commonly
to value blocks of insurance business. It is also consistent with the basic
methodology generally used to value insurance assets. The method used by the
Company includes identifying the future cash flows from the acquired business,
the risks inherent in realizing those cash flows, the rate of return the Company
believes it must earn in order to accept the risks inherent in realizing the
cash flows, and determining the value of the insurance asset by discounting the
expected future cash flows by the discount rate the Company requires.
The discount rate used to determine such values is the rate of return
required in order to invest in the business being acquired. In selecting the
rate of return, the Company considered the magnitude of the risks associated
with actuarial factors described in the following paragraph, cost of capital
available to the Company to fund the acquisition, compatibility with other
Company activities that may favorably affect future profits, and the complexity
of the acquired company.
Expected future cash flows used in determining such values are based on
actuarial determinations of future premium collection, mortality, morbidity,
surrenders, operating expenses and yields on assets held to back policy
liabilities as well as other factors. Variances from original projections,
whether positive or negative, are included in income as they occur. To the
extent that these variances indicate that future cash flows will differ from
those included in the original scheduled amortization of the value of the
insurance in force, current and future amortization may be adjusted.
Recoverability of the value of insurance in force is evaluated annually and
appropriate adjustments are then determined and reflected in the financial
statements for the applicable period.
96
<PAGE>
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. Deferred Policy Acquisition Costs and Present Value of Insurance in Force
(Continued)
Information related to the present value of insurance in force for the
years ended December 31, 1997 and 1996 is as follows:
<TABLE>
<CAPTION>
1997 1996
------------- -------------
<S> <C> <C>
Balance at beginning of year.................................... $ 71,333 $ 115,831
Released by 80% coinsurance of Medicare business (see Note 10) -- (22,936)
Accretion of interest........................................... 3,806 4,415
Amortization.................................................... (16,303) (27,304)
Transferred on assumed reinsurance contract with affiliate...... 2,291 --
Unrealized investment (gain) loss adjustment.................... (2,562) 1,327
------------- -------------
Balance at end of year........................................ $ 58,565 $ 71,333
============= =============
</TABLE>
Expected amortization, based upon current assumptions and accretion of
interest at a policy liability or contract rate ranging from 5.5% to 6.6% for
the next five years of the present value of insurance in force is as follows:
<TABLE>
<CAPTION>
Beginning Gross Accretion Net
Balance Amortization of Interest Amortization
------- ------------ ----------- ------------
<S> <C> <C> <C> <C>
1998................................... $ 58,565 $ 12,805 $ 3,226 $ 9,579
1999................................... 48,986 7,806 2,719 5,087
2000................................... 43,899 8,374 2,315 6,059
2001................................... 37,840 6,957 1,989 4,968
2002................................... 32,872 5,673 1,724 3,949
</TABLE>
9. Statutory Accounting and Dividend Restrictions
Pursuant to the terms of the surplus debenture issued by Constitution to
the benefit of SLC, a non-insurance subsidiary of SWF, Constitution may make
principal and interest payments to the extent that Constitution's surplus,
excluding the statutory carrying value of Southwestern Life and Union Bankers,
exceeds $1,200. Constitution's surplus at December 31, 1997 was $174,715, of
which $161,098 was attributable to its ownership of Southwestern Life and Union
Bankers.
The Company's cash flow is derived principally from dividends and principal
and interest payments owed on the surplus debenture by Constitution. The
principal source of repayment of the surplus debenture is dividends from
Constitution's subsidiaries, Southwestern Life and Union Bankers. Generally, the
net assets of the insurance subsidiaries available for transfer to the Company
are limited to the greater of the subsidiary net gain from operations during the
preceding year or 10% of the subsidiary net statutory surplus as of the end of
the preceding year as determined in accordance with accounting practices
prescribed or permitted by insurance regulatory authorities. Payment of
dividends in excess of such amounts would generally require approval by the
regulatory authorities. Based upon Constitution's earned surplus at December 31,
1997, no dividends can be paid to its parent without prior regulatory approval.
The insurance subsidiaries prepare their statutory financial statements in
accordance with accounting practices prescribed or permitted by their respective
state insurance departments. Prescribed statutory accounting practices include
state laws, regulations, and general administrative rules, as well as a variety
of publications of the National Association of Insurance Commissioners (NAIC).
Permitted statutory accounting practices encompass all accounting practices that
are approved by insurance regulatory authorities; such practices differ from
state to state, and may differ from company to company within
97
<PAGE>
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. Statutory Accounting and Dividend Restrictions (Continued)
a state, and may change in the future. Furthermore, the NAIC has a project to
codify statutory accounting practices, the result of which is expected to
constitute the only source of "prescribed" statutory accounting practices.
Accordingly, that project, will likely change to some extent prescribed
statutory accounting practices, and may result in changes to the accounting
practices that insurance enterprises use to prepare their statutory financial
statements.
Statutory capital and surplus of the Company's life insurance subsidiaries
as reported to regulatory authorities at December 31, 1997 and 1996 totaled
approximately $174,715 and $177,510, respectively. Statutory net income (loss)
of the Company's life insurance subsidiaries as reported to regulatory
authorities totaled ($2,521) and $24,919 for the years ended December 31, 1997
and 1996.
10. Reinsurance
In the normal course of business, the Company reinsures portions of certain
policies that it underwrites to limit disproportionate risks. The Company
retains varying amounts of individual insurance up to a maximum retention of
$500 on any life. Amounts not retained are ceded to other insurance enterprises
or reinsurers on an automatic or facultative basis.
Reinsurance contracts do not relieve the Company from its obligations to
policyholders. Therefore, the Company is contingently liable for recoverable
unpaid claims and policyholder liabilities ceded to reinsurers in the unlikely
event that assuming reinsurers are unable to meet their obligations. The Company
evaluates the financial condition of its reinsurers to minimize its exposure to
significant losses from reinsurer insolvencies. The effect of reinsurance on
policy revenues earned and the related benefits incurred by such reinsurers for
the years ended December 31, 1997 and 1996 is as follows:
<TABLE>
<CAPTION>
1997 1996
------------- -------------
<S> <C> <C>
Direct policy revenues and amounts assessed against policyholders... $ 252,656 $ 255,352
Reinsurance assumed................................................. 1,182 3,483
Reinsurance ceded................................................... (108,020) (61,923)
------------- -------------
Net premiums and amounts earned..................................... $ 145,818 $ 196,912
============= =============
Policyholder benefits ceded......................................... $ 78,767 $ 25,513
============= =============
</TABLE>
Effective July 1, 1996, Union Bankers entered into reinsurance agreements
with Cologne Life Reinsurance Company ("Cologne") to coinsure 80% of its
Medicare supplement business in force on July 1, 1996 and to coinsure 80% of its
Medicare policies issued on or after July 1, 1996. The Company recorded a
deferred gain on the transaction of $53,893 as of July 1, 1996, which is being
amortized into income over the life of the business. For the year ended December
31, 1997 and for the period from July 1, 1996 to December 31, 1996 $14,222 and
$6,445, respectively of the deferred gain has been recognized and is included in
other income. The Company is not subject to any negative experience adjustments
if the ceded business is unprofitable; however, the Company may participate in a
portion of future earnings from the ceded business after Cologne recovers its
initial ceding commission plus interest at a specified rate. Union Bankers
retained administration for the ceded block of business and is reimbursed by
Cologne for administrative costs at the rate of 8.5% of ceded renewal premiums
and 11.5% of ceded first year premiums.
Southwestern Life previously ceded a block of annuities under a reinsurance
agreement with Employees Reassurance Corporation (ERC). Such reinsurance,
accounted for as a financing arrangement, is not reflected in the accompanying
financial statements except for the risk fees paid to ERC. The reinsurance
agreement was terminated as of November 30,
98
<PAGE>
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. Reinsurance (Continued)
1997.Statutory surplus provided by this treaty totaled $8,714 at December 31,
1996. Risk fees paid to the reinsurer were 2% of the net amount of surplus
provided, but not less than a minimum fee of $40 per quarter, and totaled $110
and $222 for the years ended December 31, 1997 and 1996, respectively. Amounts
due from reinsurers included amounts due from ERC of $121,016 at December 31,
1996. The underlying assets held by ERC had carrying values of $121,016 and fair
values of $122,639 at December 31, 1996.
At December 31, 1997, Southwestern Life entered into a reinsurance
agreement with Integon Life Insurance Corporation (Integon), an indirect
wholly-owned subsidiary of PennCorp, to coinsure certain annuities which had
GAAP policy liabilities of $256,673. Cash of $50,000 and securities were
transferred at a cost basis of $198,793 which had fair values equal to statutory
policy liabilities of $255,195. The present value of insurance in force which
Integon had recorded on these policies was estimated to be $2,291. Because
Southwestern Life and Integon are affiliates, the historical GAAP book value of
the securities and the present value of insurance in force at Integon was
retained by Southwestern Life. Rather than record a loss of $3,634, which is net
of taxes of $1,956, on a GAAP basis, Southwestern Life recorded a "deemed
dividend" of this amount as a direct charge to its paid in capital. In addition,
the change in unrealized investment gain (loss) associated with the transferred
securities is recorded as an adjustment to prior unrealized gains.
11. Retirement and Profit Sharing Plans
The Company has a defined contribution retirement plan (Defined
Contribution Plan) for all employees who have attained age 21 and completed a
year of service. Contributions to the Plan are made pursuant to salary deferral
elections by participants in an amount equal to 1% to 15% of their annual
compensation. In addition, the Company makes matching contributions in an amount
equal to 50% of each participant's salary deferral to a maximum of 3% of annual
compensation. The Defined Contribution Plan also provides for a discretionary
employer profit sharing contribution, which is determined annually by the Board
of Directors for the succeeding plan year. Profit sharing contributions are
credited to participant's accounts on the basis of their respective
compensation. Salary deferral contribution accounts are at all times fully
vested, while matching contribution and profit sharing contribution accounts
vest ratably from one to five years of service. All participant accounts are
fully vested at death, disability or attainment of age 65. Payment of vested
benefits under the Defined Contribution Plan may be elected by a participant in
a variety of forms of payment. Expenses related to this plan for the years ended
December 31, 1997 and 1996 amounted to $936 and $696, respectively.
In addition, the Company has a bonus plan for certain key officers. The
amount available to pay awards for any year is determined by a committee of
senior executives of the Company and is subject to approval of the Board of
Directors of the Company. Awards are based on the performance of the Company and
the performance of eligible participants. The Company accrued or paid $1,350 and
$1,700 under this plan during the years ended December 31, 1997 and 1996,
respectively.
The Company provides certain health care and life insurance benefits for
retired employees. Employees meeting certain age and length of service
requirements become eligible for these benefits. The Company's obligation for
accrued postretirement
99
<PAGE>
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. Retirement and Profit Sharing Plans (Continued)
health and welfare benefits is unfunded. Following is an analysis of the change
in the liability for accrued postretirement benefits for the years ended
December 31, 1997 and 1996:
<TABLE>
<CAPTION>
1997 1996
------------- -------------
<S> <C> <C>
Accrued postretirement benefits, beginning of year ................. $ 12,686 $ 12,821
------------- -------------
Recognition of components of net periodic postretirement benefit cost:
Service cost ..................................................... 269 244
Interest cost..................................................... 930 834
------------- -------------
Net periodic postretirement benefit cost.......................... 1,199 1,078
Benefit payments.................................................... (1,290) (1,213)
------------- -------------
Net change.......................................................... (91) (135)
------------- -------------
Accrued postretirement benefits, end of year........................ $ 12,595 $ 12,686
============= =============
The liability for accrued postretirement benefits includes the following at
December 31, 1997 and 1996:
Accumulated postretirement benefit obligation:
Retirees.......................................................... $ 11,167 $ 10,884
Active eligible................................................... 1,076 1,194
Active ineligible................................................. 944 831
------------- -------------
13,187 12,909
Unrecognized actuarial loss......................................... (592) (223)
------------- -------------
Accrued postretirement benefits..................................... $ 12,595 $ 12,686
============= =============
</TABLE>
For measurement purposes, an 5.5% annual rate increase in the health care
cost trend rate was assumed for 1998; the rate was assumed to decrease gradually
to 4.0% by the year 2015 and remain at that level thereafter. The health care
cost trend rate assumption has a significant effect on the amounts reported. To
illustrate, increasing the assumed health care cost trend rates by one
percentage point in each year would increase the accumulated postretirement
health care benefit obligation as of December 31, 1997 by $767 and the aggregate
of the service and interest components of net periodic postretirement health
care benefit cost for 1997 by $127. The weighted average discount rate used in
determining the accumulated postretirement benefit obligation was 7.0%.
12. Related Party Transactions
Related party transactions described herein include those transactions not
included elsewhere in the Notes to Consolidated Financial Statements.
The Company and its subsidiaries have management and services agreements
with entities affiliated with Knightsbridge, a shareholder. In connection with
an Advisory and Management Services Agreement with Knightsbridge Management,
L.L.C., the Company pays an annual fee of $1,500 plus expenses. Each insurance
subsidiary has an Investment Management Agreement with Knightsbridge
Consultants, L.L.C. For the years ended December 31, 1997 and 1996, fees
incurred totaled $1,871 and $1,658, respectively.
100
<PAGE>
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
12. Related Party Transactions (Continued)
The Company agreed to pay PennCorp, a shareholder, $1,000 in conjunction
with the GSSW transaction in 1996 (see Note 3). The Company paid interest of
$1,400 in 1997 in conjunction with PennCorp's acquisition of the Company's 7.0%
convertible subordinated note.
The Company provides services for a wholly-owned subsidiary of PennCorp.
The Company charges the subsidiary for its direct costs and a share of overhead
costs based upon time and utilization studies. These costs totaled approximately
$5,178 during 1997.
13. Other Commitments and Contingencies
The Company and its subsidiaries are obligated under operating leases,
primarily for office space. Rent expense was $2,169 in 1997 and $2,058 in 1996.
There was no significant sublease income in 1997 or 1996.
<TABLE>
<CAPTION>
Minimum lease commitments are:
<S> <C>
1998.......................................................... $ 2,381
1999.......................................................... 2,685
2000.......................................................... 2,666
2001.......................................................... 2,652
2002.......................................................... 2,497
2003 and thereafter........................................... 10,704
-----------
Total minimum payments required............................. $ 23,585
===========
</TABLE>
Certain lawsuits have been brought against the Company's life insurance
subsidiaries in the normal course of the insurance business involving the
settlement of various matters and seeking compensatory and in some cases
punitive damages. Management believes that the ultimate settlement of all such
litigation will not have a materially adverse effect on the Company's
consolidated financial position or results of operation.
The life insurance companies are required to be members of various state
insurance guaranty associations in order to conduct business in those states.
These associations have the authority to assess member companies in the event
that an insurance company conducting business in that state is unable to meet
its policyholder obligations. In some states, these assessments can be partially
recovered through a reduction in future premium taxes. The insurance
subsidiaries paid assessments of $980 in 1997 and $1,357 in 1996. Based on
information currently available, the insurance subsidiaries have accrued $3,194
at December 31, 1997 for future assessments, net of future premium tax
reductions.
101
<PAGE>
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
14. Other Operating Information
Underwriting and other administrative expenses for the years ended December
31, 1997 and 1996 are as follows:
<TABLE>
<CAPTION>
1997 1996
------------- -------------
<S> <C> <C>
Non-deferrable commission expense........................... $ 19,746 $ 30,768
Commission allowances on reinsurance ceded.................. (12,696) (8,331)
Taxes, licenses and fees.................................... 7,492 9,214
General and administrative expenses......................... 34,467 39,241
Expense allowance on reinsurance ceded...................... (8,409) (5,782)
------------- -------------
Underwriting and other administrative expenses............ $ 40,600 $ 65,110
============= =============
</TABLE>
15. Financial Instruments
The following is a summary of the carrying value and fair value of the
Company's financial instruments at December 31, 1997 and 1996:
<TABLE>
<CAPTION>
1997 1996
------------------------ ------------------------
Carrying Fair Carrying Fair
Value Value Value Value
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Assets:
Cash and short-term investments.......................... $ 163,716 $ 163,716 $ 161,895 $ 161,895
Fixed maturities......................................... 1,677,508 1,677,508 1,255,270 1,255,270
Equity securities........................................ 1,079 1,079 1,129 1,129
Mortgage loans........................................... 51,070 51,816 59,993 59,993
Policy loans............................................. 123,041 123,041 128,551 128,551
Collateral loans......................................... -- -- 21,308 21,308
Other investments........................................ 8,461 8,461 5,553 5,553
Interest rate cap........................................ 41 -- 145 --
Agent and premium receivables............................ 5,508 5,508 13,773 13,773
Liabilities:
Notes payable............................................ 154,750 154,750 159,750 159,750
Universal life and investment contract liabilities....... 1,315,496 1,315,496 1,088,335 1,088,335
</TABLE>
The following methods and assumptions were used by the Company in
estimating its fair value disclosures for financial instruments:
Cash and Short-term Investments, Agent and Premium Receivables: The
carrying value of short-term investments and amounts receivable approximate
their fair value due to the short-term maturity of these instruments.
Fixed Maturities and Equities Available for Sale: Fair values for fixed
maturities available for sale are based on quoted market prices, where
available. For fixed maturities not actively traded, fair values are
estimated using values obtained from independent pricing services or are
estimated based on expected future cash flows using a current market rate
applicable to the yield, credit quality, and maturity of the investments.
The fair values for equity securities are based on quoted market prices.
102
<PAGE>
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
15. Financial Instruments (Continued)
Mortgage and Collateral Loans: The fair values for mortgage and collateral
loans are estimated using discounted cash flow analyses, based on interest
rates currently being offered for similar loans to borrowers with similar
credit ratings. Loans with similar characteristics are aggregated for
purposes of the calculations.
Other Investments: The fair value of Company's investment in residual
interests in mortgage-backed securities was obtained from an independent
broker-dealer. The fair values of other miscellaneous invested assets have
not been estimated due to their relative immateriality.
Interest rate cap: The fair value of the interest rate cap is $0 as the
current interest rate is below the cap rate.
Policy Loans: Policy loans are an integral part of life insurance policies
which the Company has in force and, in the Company's opinion, cannot be
valued separately. These loans typically carry an interest rate that is
tied to the crediting rate applied to the related policy and contract
reserves.
Notes Payable: Fair values of the Company's bank obligations approximate
carrying values due to the variable interest structure. The fair value of
the Company's convertible note payable is not valued at December 31, 1997
as it was owned by PennCorp and canceled in February 1998.
Universal Life and Investment Contract Liabilities: The carrying value and
fair values for the Company's liabilities under universal life and
investment-type insurance contracts are the same as the interest rates
credited to these products are periodically adjusted by the Company to
reflect market conditions. The fair values of liabilities under all
insurance contracts are taken into consideration in the overall management
of interest rate risk, which minimizes exposure to changing interest rates
through the matching of investment maturities with amounts due under
insurance contracts.
16. Subsequent Event
On January 2, 1998, PennCorp acquired all of the outstanding common stock
held by Knightsbridge and certain other parties for aggregate cash consideration
ranging from $73,777 to $77,444 (excluding anticipated acquisition expenses)
depending upon the outcome of certain contingencies. As a result, SWF became a
wholly-owned subsidiary of PennCorp. After the acquisition of the common stock,
PennCorp repaid SWF's bank revolving debt in the amount of $90,250 and its bank
term debt in the amount of $24,500. Consequently, the Company will realize an
extraordinary charge in 1998 for the writeoff of deferred costs of $2,571
associated with these loans. In addition, PennCorp canceled the $40,000 SWF note
it acquired from ICH.
On February 18, 1998, PennCorp announced that it had engaged investment
banking firms to review strategic alternatives for maximizing shareholder value,
including the sale of certain divisions, which include Union Bankers,
Constitution, Marquette and affiliated service providing companies ("SW
Financial businesses held for sale"). As of and for the year ended December 31,
1997, the total assets, excess of liabilities over assets, total revenues and
net loss of the SW Financial businesses held for sale aggregated $530,866,
$49,697, $109,387 and $5,201, respectively.
103
<PAGE>
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
PART III
Item 10. Directors and Executive Officers of the Registrant
Information required by this Item is incorporated by reference to "Election
of Directors" and "Executive Officers" in the Company's Proxy Statement for its
1998 Annual Meeting of the Shareholders.
Item 11. Executive Compensation
Information required by this Item is incorporated by reference to
"Director-Fees", "Executive Compensation and Other Information" and
"Compensation Committee Interlocks and Insider Participation" in the Company's
Proxy Statement for its 1998 Annual Meeting of Shareholder, except that the
information required by paragraphs (k) and (l) of Item 402 of Regulation S-K and
set forth in such Proxy Statement is specifically not incorporated by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management
Information required by this Item is incorporated by reference to "Security
Ownership of Certain Beneficial Owners and Management" in the Company's Proxy
Statement for its 1998 Annual Meeting of Shareholders.
Item 13. Certain Relationships and Related Transactions
Information required by this Item is incorporated by reference to
"Compensation Committee Interlocks and Insider Participation" and "Certain
Transactions" in the Company's Proxy Statement for its 1998 Annual Meeting of
Shareholders.
(Remainder of Page Intentionally Left Blank)
104
<PAGE>
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) Documents
1. The financial statements of PennCorp Financial Group, Inc. and
Subsidiaries set forth on pages 43 through 77, and the Independent Auditors'
Report set forth on page 42 hereof are in response to the information required
by this Item.
2. An index to the financial statement schedules required to be filed by
Item 8 of this Report on Form 10-K is set forth immediately before the attached
financial statement schedules on page 111 of this filing.
3. Exhibits
2.1 Purchase Agreement among I.C.H. Corporation, SWL Holding
Corporation, Care Financial Corporation, Facilities Management
Installation, Inc. and Southwestern Financial Corporation,
Southwestern Financial Services Corporation and PennCorp
Financial Group, Inc., dated as of December 1, 1995 and Addendum
to Purchase Agreement dated as of December 14, 1995. (6)
2.2 Amended and Restated Stock Purchase Agreement between United
Companies Financial Corporation and Pacific Life and Accident
Insurance Company dated as of July 24, 1996. (4)
3.1 Restated By-Laws of PennCorp Financial Group, Inc. (12)
3.2 Third Restated Certificate of Incorporation of PennCorp Financial
Group, Inc. (20)
4.1 Certificate of Elimination for Series A Cumulative Preferred
Stock. (5)
4.2 Certificate of Designation of Series B Preferred Stock. (5)
4.3 Certificate of Designation of Series C Preferred Stock. (5)
4.4 Corrected Certificate of Designation of $3.375 Convertible
Preferred Stock. (5)
4.5 Certificate of Designation of $3.50 Series II Convertible
Preferred Stock (3)
4.6 Indenture between PennCorp Financial Group, Inc. and The Bank of
New York, as trustee, with respect to 9 1/4% Senior Subordinate
Notes due 2003. (11)
10.1 Surplus Debenture Number Four in the original principal amount of
$162,539,890, issued by Pacific Life and Accident Insurance
Company to PennCorp Financial Group, Inc., dated January 1, 1994.
(10)
10.2 Surplus Debenture Number Five in the original principal amount of
$17,606,203, issued by Pacific Life and Accident Insurance
Company to PennCorp Financial Group, Inc., dated September 29,
1994. (9)
10.3 Surplus Debenture Number Six in the original principal amount of
$55,000,000, issued by Pacific Life and Accident Insurance
Company to PennCorp Financial Group, Inc., dated July 24, 1996.
(14)
10.4 10% Promissory Note in the original principal amount of
$30,661,996, issued by American-Holdings Corporation to
Pennsylvania Life Insurance Company, dated July 1, 1996. (14)
105
<PAGE>
10.5 Certificate of Contribution in the original principal amount of
$54,332,790 issued by Integon Financial Life Insurance
Corporation to Integon Life Corporation, dated July 25, 1995. (5)
MANAGEMENT COMPENSATION
RELATED AGREEMENTS
10.6 Intentionally omitted.
10.7 PennCorp Financial, Inc. Retirement and Savings Plan. (13)
10.8 PennCorp Financial, Inc. Executive Officer Incentive Plan.
(13)
10.9 PennCorp Financial Group, Inc. 1992 Stock Option Plan. (13)
10.10 PennCorp Financial Group, Inc. Senior Management Warrant
Award Program. (13)
10.11 Form of Restricted Stock Agreement by and between PennCorp
Financial Group, Inc. and certain participants, effective as
of April 1, 1994. (9)
10.12 Employment Agreement between PennCorp Financial Group, Inc.
and David J. Stone entered into June 7, 1996. (14)
10.13 Employment Agreement between PennCorp Financial Group, Inc.
and Steven W. Fickes entered into June 7, 1996. (14)
10.14 Amendment Number One to Employment Agreement between
PennCorp Financial Group, Inc. and David J. Stone dated
April 28, 1997. (15)
10.15 Amendment Number One to Employment Agreement between
PennCorp Financial Group, Inc. and Steven W. Fickes dated
April 28, 1997. (15)
10.16 Amendment No. 2 to Employment Agreement between PennCorp
Financial Group, Inc. and David J. Stone entered into
January 5, 1998. (1)
10.17 Amendment No. 2 to Employment Agreement between PennCorp
Financial Group, Inc. and Steven W. Fickes entered into
January 5, 1998. (1)
10.18 Executive Retention Agreement between Charles Lubochinski
and PennCorp Financial Group, Inc. (1)
10.19 Schedule of similar Executive Retention Agreements. (1)
10.20 PennCorp Financial Group, Inc. 1996 Stock Award and Stock
Option Plan. (14)
10.21 Amendment Number One to PennCorp Financial Group, Inc. 1996
Stock Award and Stock Option Plan. (20)
10.22 PennCorp Financial Group, Inc. 1996 Senior Executive Annual
Incentive Award Plan. (14)
10.23 Real Estate Purchase and Sale Agreement between Peoples Security
Life Insurance Company and PennCorp Financial Group, Inc., dated
March 24, 1995. (8)
106
<PAGE>
10.24 Registration Rights Agreement dated as of December 14, 1995,
between PennCorp Financial Group, Inc., I.C.H. Corporation, SWL
Holding Corporation and Care Financial Corporation. (6)
10.25 Conversion, Standstill and Registration Rights Agreement between
United Companies Financial Corporation and PennCorp Financial
Group, Inc. dated as of July 24, 1996. (14)
10.26 Registration Rights Agreement dated as of August 2, 1996, by and
among PennCorp Financial Group, Inc., Smith Barney Inc.,
Donaldson, Lufkin & Jenrette Securities Corporation and Merrill
Lynch, Pierce, Fenner & Smith Incorporated. (14)
10.27 Stockholders Agreement dated December 14, 1995 between
Southwestern Financial Corporation and the Security holders
listed on the signature pages thereof. (6)
10.28 Credit Agreement dated March 12, 1997 by and among PennCorp
Financial Group, Inc. and The Chase Manhattan Bank, The First
National Bank of Chicago, and NationsBank, NA., as Managing
Agents, Fleet National Bank, Mellon Bank, N.A., Bank of Montreal,
CIBC Inc., and Dresdner Bank AG, New York Branch and Grand Cayman
Branch as Co-Agents and The Bank of New York, as Administrative
Agent. (16)
10.29 Revision Agreement, dated as of May 30, 1997, by and among United
Companies Financial Corporation, PennCorp Financial Group, Inc.,
Pacific Life and Accident Insurance Company and each additional
party set forth on the signature pages thereto. (17)
10.30 Amendment to Surplus Debenture in the original principal amount
of $73,000,000 issued by Pioneer Security Life Insurance Company
to American-Amicable Holdings Corporation, dated May 17, 1996.
(17)
10.31 Second Amendment to Surplus Debenture in the original principal
amount of $73,000,000 issued by Pioneer Security Life Insurance
Company to American-Amicable Holdings Corporation, effective
January 1, 1997. (17)
10.32 Third Amendment to Surplus Debenture in the original principal
amount of $73,000,000 issued by Pioneer Security Life Insurance
Company to American-Amicable Holdings Corporation, effective May
14, 1997. (17)
10.33 Amendment to Surplus Debenture Number Four in the original
principal amount of $162,539,890, issued by Pacific Life and
Accident Insurance Company to PennCorp Financial Group, Inc.,
effective January 1, 1997. (17)
10.34 Second Amendment to Surplus Debenture Number Four in the original
principal amount of $162,539,890, issued by Pacific Life and
Accident Insurance Company to PennCorp Financial Group, Inc.,
effective May 14, 1997. (17)
10.35 Amendment to Surplus Debenture Number Five in the original
principal amount of $17,606,203, issued by Pacific Life and
Accident Insurance Company to PennCorp Financial Group, Inc.,
effective January 1, 1997. (17)
10.36 Second Amendment to Surplus Debenture Number Five in the original
principal amount of $17,606,203, issued by Pacific Life and
Accident Insurance Company to PennCorp Financial Group, Inc.,
effective May 14, 1997. (17)
107
<PAGE>
10.37 Amendment to Surplus Debenture Number Six in the original
principal amount of $55,000,000, issued by Pacific Life and
Accident Insurance Company to PennCorp Financial Group, Inc.,
effective January 1, 1997. (17)
10.38 Second Amendment to Surplus Debenture Number Six in the original
principal amount of $55,000,000, issued by Pacific Life and
Accident Insurance Company to PennCorp Financial Group, Inc.,
effective May 14, 1997. (17)
10.39 Note Purchase, Release and Settlement Agreement, dated July 13,
1997, executed by Lone Star Liquidating Trust, PennCorp Financial
Group, Inc. and Southwestern Financial Corporation . (18)
10.40 Amended and Restated Assignment Agreement dated as of January 2,
1998 by and between PennCorp Financial Group, Inc. and
Knightsbridge Capital Fund I, L.P. (19)
10.41 Amended and Restated Assignment Agreement dated as of January 2,
1998 by and between PennCorp Financial Group, Inc., David J.
Stone, Steven W. Fickes, the Steven Wayne Fickes, Jr. Trust dated
December 21, 1995 and the Kathryn Elizabeth Fickes Trust dated
December 21, 1995. (19)
12 Computation of ratio of earnings to fixed charges. (1)
21 List of subsidiaries of the Registrant. (1)
22.1 Auditors consent. (1)
22.2 Auditors consent. (1)
27 Financial Data Schedule. (1)
(1) Filed herewith.
(2) Such exhibit is incorporated by reference to the Form 8-K dated November
25, 1996, which was filed with the Securities and Exchange Commission by
PennCorp Financial Group, Inc. on December 4, 1996, providing a copy of the
Amended and Restated Agreement and Plan of Merger with Washington National
Corporation.
(3) Such exhibit is incorporated by reference to the Registration Statement on
Form S-3 (Registration No. 333- 13285) of PennCorp Financial Group, Inc.
filed with the Securities and Exchange Commission on October 10, 1996.
(4) Such exhibit is incorporated by reference to the Form 8-K dated July 24,
1996 which was filed with the Securities and Exchange Commission by
PennCorp Financial Group, Inc. on August 8, 1996 relating to the financial
statements and pro forma financial information of United Companies Life
Insurance Company.
(5) Such exhibit is incorporated by reference to the Annual Report on Form 10-K
for the fiscal year ended December 31, 1995 of PennCorp Financial Group,
Inc.
(6) Such exhibit is incorporated by reference to the Form 8-K dated December
14, 1995 which was filed by PennCorp Financial Group, Inc. with the
Securities and Exchange Commission on December 28, 1995 related to its
investment in Southwestern Financial Corporation.
(7) Such exhibit is incorporated by reference to the Form 8-A dated July 11,
1995 which was filed by PennCorp Financial Group, Inc. with the Securities
and Exchange Commission on July 12, 1995.
108
<PAGE>
(8) Such exhibit is incorporated by reference to the Quarterly Report on Form
10-Q for the three months ended June 30, 1995 of PennCorp Financial Group,
Inc.
(9) Such exhibit is incorporated by reference to the Quarterly Report on Form
10-Q for the three months ended September 30, 1994 of PennCorp Financial
Group, Inc.
(10) Such exhibit is incorporated by reference to the Quarterly Report on Form
10-Q for the three months ended June 30, 1994 of PennCorp Financial Group,
Inc.
(11) Such exhibit is incorporated by reference to the Annual Report on Form 10-K
for the fiscal year ended December 31, 1993 of PennCorp Financial Group,
Inc.
(12) Such exhibit is incorporated by reference to the Annual Report on Form 10-K
for the fiscal year ended December 31, 1992 of PennCorp Financial Group,
Inc.
(13) Such exhibit is incorporated by reference to the Registration Statement on
Form S-1 (Registration No. 33-50530) of PennCorp Financial Group, Inc.
filed on August 6, 1992.
(14) Such exhibit is incorporated by reference to the Annual Report on Form 10-K
for the fiscal year ended December 31, 1996 of PennCorp Financial Group,
Inc.
(15) Such exhibit is incorporated by reference to Amendment Number 2 to the
Annual Report on Form 10-K for fiscal year ended December 31, 1996 of
PennCorp Financial Group, Inc.
(16) Such exhibit is incorporated by reference to the Amendment Number 1 to
Annual Report on Form 10-K for the fiscal year ended December 31, 1996 of
PennCorp Financial Group, Inc.
(17) Such exhibit is incorporated by reference to the Quarterly Report on Form
10-Q for the three months ended June 30, 1997 of PennCorp Financial Group,
Inc.
(18) Such exhibit is incorporated by reference to the Quarterly Report on Form
10-Q for the three months ended September 30, 1997 of PennCorp Financial
Group, Inc.
(19) Such exhibit is incorporated by reference to the Form 8-K dated January 13,
1998 which was filed with the Securities and Exchange Commission by
PennCorp Financial Group, Inc. on January 13, 1998 relating to the
acquisition of common stock and common stock warrants of Southwestern
Financial Corporation not previously owned by PennCorp Financial Group,
Inc.
(20) Such exhibit is incorporated by reference to the Registration Statement on
Form S-8 (Registration No. 333-48629) of PennCorp Financial Group, Inc.
filed on March 24, 1998.
(b) Reports on Form 8-K.
A report on Form 8-K, dated November 14, 1997, was filed with the
Securities and Exchange Commission by PennCorp Financial Group, Inc.
on November 14, 1997, providing restated financial statements of
PennCorp Financial Group, Inc. for each of the years in the three year
period ended December 31, 1996 as well as the three month periods
ended March 31, 1997 and 1996 and the three and six month periods
ended June 30, 1997 and 1996.
109
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or Section 15(d) of the
Securities Exchange Act of 1934, PennCorp Financial Group, Inc. has duly caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
PENNCORP FINANCIAL GROUP, INC.
(Registrant)
By: /s/ David J. Stone
------------------------
David J. Stone
Chairman of the Board, Chief Executive Officer and
Director (Principal Executive Officer)
Date: March 30, 1998
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 and in the capacities and on the dates indicated.
/s/ Steven W. Fickes
- ----------------------------------
Steven W. Fickes
President, Chief Financial Officer
and Director(Principal Financial
and Accounting Officer)
Date: March 30, 1998
/s/ Kenneth Roman
- ----------------------------------
Kenneth Roman
Director
Date: March 30, 1998
/s/ Maurice W. Slayton
- ----------------------------------
Maurice W. Slayton
Director
Date: March 30, 1998
/s/ Allan D. Greenberg
- ----------------------------------
Allan D. Greenberg
Director
Date: March 30, 1998
/s/ Thomas A. Player
- ----------------------------------
Thomas A. Player
Director
Date: March 30, 1998
/s/ Bruce W. Schnitzer
- ----------------------------------
Bruce W. Schnitzer
Director
Date: March 30, 1998
/s/ David C. Smith
- ----------------------------------
David C. Smith
Director
Date: March 30, 1998
/s/ David J. Stone
- ----------------------------------
David J. Stone
Chairman of the Board, Chief Executive
Officer and Director (Principal
Executive Officer)
Date: March 30, 1998
110
<PAGE>
PENNCORP FINANCIAL GROUP, INC. AND SUBSIDIARIES
INDEX TO FINANCIAL STATEMENTS AND SCHEDULES
Financial Statements:
Reference is made to data appearing on pages 43 through 77, and to the
Independent Auditors' Report appearing on page 42 hereof.
Schedules:* Page
Independent Auditors' Report - Financial Statement Schedules.... Ex. 22
Schedule II Condensed Financial Information of Registrant. 112
Schedule III Supplementary Insurance Information........... 115
Schedule IV Reinsurance................................... 116
Schedule V Valuation and Qualifying Accounts............. 117
* All other schedules have been omitted as they are not applicable or not
required, or the information is given in the financial statements, notes
hereto or in other schedules.
111
<PAGE>
SCHEDULE II
PENNCORP FINANCIAL GROUP, INC.
(PARENT COMPANY ONLY)
CONDENSED STATEMENTS OF INCOME For the years ended
December 31, 1997, 1996 and 1995
($ in thousands)
<TABLE>
<CAPTION>
1997 1996 1995
----------- ----------- -----------
<S> <C> <C> <C>
Revenue:
Interest income from subsidiaries................................. $ 21,173 $ 35,525 $ 27,680
Other interest income............................................. 3,547 2,428 638
Other income...................................................... 249 423 3,985
----------- ----------- -----------
Total revenue................................................... 24,969 38,376 32,303
----------- ----------- -----------
Operating expenses:
General and administrative expenses............................... 36,939 2,493 2,257
Interest and amortization of deferred debt issuance costs......... 23,103 17,920 15,938
----------- ----------- -----------
Total operating expenses........................................ 60,042 20,413 18,195
----------- ----------- -----------
Income (loss) before income taxes, equity in earnings of
subsidiaries and extraordinary charge............................. (35,073) 17,963 14,108
Income tax expense (benefit).................................... (8,689) 251 4,139
----------- ----------- -----------
Income (loss) before equity in earnings of subsidiaries
and extraordinary charge.......................................... (26,384) 17,712 9,969
Equity in earnings of subsidiaries.............................. 76,524 72,305 46,377
----------- ----------- -----------
Income before extraordinary charge................................... 50,140 90,017 56,346
Extraordinary charge, net of tax benefits of $--, $932 and $--.... -- (1,730) --
----------- ----------- -----------
Net income........................................................... $ 50,140 $ 88,287 $ 56,346
=========== =========== ===========
</TABLE>
See accompanying independent auditors' report.
112
<PAGE>
SCHEDULE II
PENNCORP FINANCIAL GROUP, INC.
(PARENT COMPANY ONLY)
CONDENSED BALANCE SHEETS
As of December 31, 1997 and 1996
($ in thousands)
<TABLE>
<CAPTION>
1997 1996
----------- -----------
<S> <C> <C>
ASSETS
Investments:
Investment in subsidiaries......................................... $ 932,931 $ 830,946
Notes receivable from subsidiaries................................. 235,146 235,146
Equity securities available for sale............................... 22,948 --
Other.............................................................. 4,075 --
----------- -----------
Total investments................................................ 1,232,100 1,066,092
Cash and short term investments...................................... 4,464 2,099
Accrued investment income due from subsidiaries...................... 8,697 3,918
Deferred debt issuance costs......................................... -- 2,482
Furniture and fixtures............................................... -- 463
Other assets......................................................... 9,068 10,728
----------- -----------
$ 1,254,329 $ 1,085,782
=========== ===========
LIABILITIES
Notes payable........................................................ 356,646 206,646
Due to subsidiaries.................................................. 8,404 12,778
Accrued expenses and other liabilities............................... 9,176 4,117
----------- -----------
Total liabilities................................................ 374,226 223,541
----------- -----------
Mandatory redeemable preferred stock, Series B....................... -- 14,689
Mandatory redeemable preferred stock, Series C....................... 19,867 18,175
SHAREHOLDERS' EQUITY
$3.375 Convertible preferred stock................................... 110,513 110,513
$3.50 Series II convertible preferred stock.......................... 139,157 139,157
Common stock......................................................... 289 286
Additional paid in capital........................................... 397,590 393,156
Retained earnings.................................................... 211,055 186,032
Unrealized foreign currency translation adjustment................... (20,602) (14,961)
Unrealized gains on securities available for sale.................... 55,636 20,064
Treasury stock....................................................... (32,130) (3,370)
Notes receivable from officers and employees for stock purchases..... (1,272) (1,500)
----------- -----------
Total shareholders' equity....................................... 860,236 829,377
----------- -----------
Total liabilities and shareholders' equity....................... $ 1,254,329 $ 1,085,782
=========== ===========
</TABLE>
See accompanying independent auditors' report.
113
<PAGE>
SCHEDULE II
PENNCORP FINANCIAL GROUP, INC.
(PARENT COMPANY ONLY)
CONDENSED STATEMENTS OF CASH FLOWS For the years ended
December 31, 1997, 1996 and 1995
($ in thousands)
<TABLE>
<CAPTION>
1997 1996 1995
----------- ----------- -----------
<S> <C> <C> <C>
Cash flows from operating activities:
Net earnings...................................................... $ 50,140 $ 88,287 $ 56,346
Adjustments to reconcile net earnings to net cash
provided (used) in operating activities:
Amortization of intangibles and depreciation.................. 1,389 1,238 1,121
Equity in earnings of subsidiaries............................ (76,524) (72,305) (46,377)
Increase (decrease) in liabilities and due to subs............ 12,870 (544) 7,898
Other, net.................................................... (9,227) 79 (23,754)
----------- ----------- -----------
Net cash provided (used) by operations...................... (21,352) 16,755 (4,766)
----------- ----------- -----------
Cash flows from investing activities:
Cash expended in acquisition of business.......................... -- -- (18,363)
Purchase of affiliate............................................. -- -- (115,454)
Purchase of equity security....................................... (20,000) -- --
Issuance of surplus note to subsidiary............................ -- (155,000) --
Principal payment on surplus note................................. -- 100,000 --
Dividend received from subsidiary................................. 14,677 11,283 1,603
Capital contribution to subsidiary................................ (14,889) (208,708) (54,399)
Other, net........................................................ (42,142) -- --
----------- ----------- -----------
Net cash used by investing activities......................... (62,354) (252,425) (186,613)
----------- ----------- -----------
Cash flows from financing activities:
Issuance of notes payable......................................... 250,000 230,000 101,500
Issuance of common stock.......................................... -- 155,450 51,210
Issuance of preferred stock....................................... -- 139,157 110,513
Purchase of treasury stock........................................ (28,760) -- (2,984)
Reduction of notes payable........................................ (100,000) (273,353) (30,000)
Redemption of preferred stock..................................... (14,705) -- (33,415)
Other, primarily dividends, net................................... (20,464) (15,198) (4,950)
----------- ----------- -----------
Net cash provided by financing activities..................... 86,071 236,056 191,874
----------- ----------- -----------
Increase in cash..................................................... 2,365 386 495
Cash at beginning of year............................................ 2,099 1,713 1,218
----------- ----------- -----------
Cash at end of year.................................................. $ 4,464 $ 2,099 $ 1,713
=========== =========== ===========
Supplemental Disclosure:
Interest paid..................................................... $ 20,946 $ 16,921 $ 15,308
Taxes paid........................................................ -- 200 --
Non-cash financing activities:
Securities issued in conjunction with acquisition................. $ -- $ 14,999 $ 28,750
Note transferred in purchase of affiliate......................... -- -- 28,538
Other ............................................................ 1,281 948 --
</TABLE>
See accompanying independent auditors' report.
114
<PAGE>
SCHEDULE III
PENNCORP FINANCIAL GROUP, INC.
SUPPLEMENTARY INSURANCE INFORMATION
For the years ended December 31, 1997, 1996 and 1995
($ in thousands)
<TABLE>
<CAPTION>
Future
Policy Amorti-
Benefits Benefits, zation of
Deferred Losses, Claims, Deferred
Policy Claims Net Losses & Policy Other
Acquisition & Loss Premium Investment Settlement Acquisition Operating
Costs Expenses Revenue Income Expenses Costs Expenses
----------- ----------- ----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
1997
- ----
Fixed benefit....... $ 160,974 $ 175,524 $ 168,974 $ 19,206 $ 54,630 $ 19,386 $ 73,488
Life................ 122,376 1,342,563 169,518 94,442 164,878 24,154 59,879
Accumulation........ 26,767 1,771,838 7,074 159,589 104,781 783 12,878
----------- ----------- ----------- ----------- ----------- ----------- -----------
Total............ $ 310,117 $ 3,289,925 $ 345,566 $ 273,237 $ 324,289 $ 44,323 $ 146,245
=========== =========== =========== =========== =========== =========== ===========
1996
- ----
Fixed benefit....... $ 127,091 $ 294,068 $ 169,311 $ 22,730 $ 63,663 $ 16,446 $ 55,161
Life................ 105,063 1,212,374 169,974 88,220 137,867 12,010 48,706
Accumulation........ 20,274 2,060,013 8,805 99,784 70,381 2,288 12,693
----------- ----------- ----------- ----------- ----------- ----------- -----------
Total............ $ 252,428 $ 3,566,455 $ 348,090 $ 210,734 $ 271,911 $ 30,744 $ 116,560
=========== =========== =========== =========== =========== =========== ===========
1995
- ----
Fixed benefit....... $ 93,735 $ 290,156 $ 174,708 $ 22,946 $ 64,465 $ 15,580 $ 48,373
Life................ 80,243 1,098,375 119,062 55,457 77,468 9,741 45,324
Accumulation........ 11,592 832,630 8,119 23,888 19,990 3,686 8,465
----------- ----------- ----------- ----------- ----------- ----------- -----------
Total............ $ 185,570 $ 2,221,161 $ 301,889 $ 102,291 $ 161,923 $ 29,007 $ 102,162
=========== =========== =========== =========== =========== =========== ===========
</TABLE>
See accompanying independent auditors' report
115
<PAGE>
SCHEDULE IV
PENNCORP FINANCIAL GROUP, INC.
REINSURANCE
For the years ended December 31, 1997, 1996, and 1994
($ in thousands)
<TABLE>
<CAPTION>
Percentage
Ceded to Assumed Of Amount
Gross Other from Other Net Assumed
Amount Companies Companies Amount to Net
------------- ------------ ------------ ------------- -----------
<S> <C> <C> <C> <C> <C>
Year ended December 31, 1997:
Life insurance in force......... $ 24,618,960 $ 4,366,266 $ 1,251,538 $ 21,504,232
============= ============ ============ =============
Premiums:
Accident and health insurance... $ 172,511 $ 2,537 $ -- $ 169,974 -- %
Life insurance/accumulation..... 204,027 29,962 2,527 176,592 1.4%
------------- ------------ ------------ -------------
$ 375,538 $ 32,499 $ 2,527 $ 345,566
============= ============ ============ =============
Year ended December 31, 1996:
Life insurance in force......... $ 31,498,035 $ 5,884,609 $ 1,779,439 $ 27,392,865
============= ============ ============ =============
Premiums:
Accident and health insurance... $ 169,727 $ 416 $ -- $ 169,311 -- %
Life insurance/accumulation..... 189,098 11,639 1,320 178,779 0.7%
------------- ------------ ------------ -------------
$ 358,825 $ 12,055 $ 1,320 $ 348,090
============= ============ ============ =============
Year ended December 31, 1995:
Life insurance in force......... $ 25,913,359 $ 3,621,309 $ 404,852 $ 22,696,902
============= ============ ============ =============
Premiums:
Accident and health insurance... $ 175,517 $ 1,036 $ 227 $ 174,708 0.1%
Life insurance/accumulation..... 135,176 10,075 2,080 127,181 1.6%
------------- ------------ ------------ -------------
$ 310,693 $ 11,111 $ 2,307 $ 301,889
============= ============ ============ =============
</TABLE>
See accompanying independent auditors' report.
116
<PAGE>
SCHEDULE V
PENNCORP FINANCIAL GROUP, INC.
VALUATION AND QUALIFYING ACCOUNTS For
the years ended December 31, 1997, 1996 and 1995
(In thousands)
<TABLE>
<CAPTION>
Balance at Charge to Charge to Balance at
Beginning Cost and to Other End of
Of Period Expenses Accounts Deductions Period
--------- -------- -------- ---------- ------
<S> <C> <C> <C> <C> <C>
1997:
Mortgage loans on real estate......... $ 4,211 $ 2,106 $ -- $ 276 $ 6,041
Allowance for bond losses............. 189 -- -- 189 --
Unearned loan charges................. 266 1,806 -- 503 1,569
Accounts and notes receivable......... 6,528 9,102 -- 6,605 9,025
1996:
Mortgage loans on real estate......... 4,211(a) -- -- -- 4,211
Allowance for bond losses............. 189(a) -- -- -- 189
Unearned loan charges................. 266(a) -- -- -- 266
Accounts and notes receivable......... 8,388 4,082 -- 5,942 6,528
1995:
Mortgage loans on real estate......... 2,314(b) -- -- 2,314 --
Accounts and notes receivable......... 8,392 615 -- 619 8,388
- -------------------
(a) Amount recorded as a purchase GAAP adjustment in conjunction with the
acquisition of United Life.
(b) Amount recorded as a purchase GAAP adjustment in conjunction with the
acquisition of Integon Life.
</TABLE>
See accompanying independent auditors' report.
117
<PAGE>
INDEX TO EXHIBITS
2.1 Purchase Agreement among I.C.H. Corporation, SWL Holding
Corporation, Care Financial Corporation, Facilities Management
Installation, Inc. and Southwestern Financial Corporation,
Southwestern Financial Services Corporation and PennCorp
Financial Group, Inc., dated as of December 1, 1995 and Addendum
to Purchase Agreement dated as of December 14, 1995. (6)
2.2 Amended and Restated Stock Purchase Agreement between United
Companies Financial Corporation and Pacific Life and Accident
Insurance Company dated as of July 24, 1996. (4)
3.1 Restated By-Laws of PennCorp Financial Group, Inc. (12)
3.2 Third Restated Certificate of Incorporation of PennCorp Financial
Group, Inc. (20)
4.1 Certificate of Elimination for Series A Cumulative Preferred
Stock. (5)
4.2 Certificate of Designation of Series B Preferred Stock. (5)
4.3 Certificate of Designation of Series C Preferred Stock. (5)
4.4 Corrected Certificate of Designation of $3.375 Convertible
Preferred Stock. (5)
4.5 Certificate of Designation of $3.50 Series II Convertible
Preferred Stock (3)
4.6 Indenture between PennCorp Financial Group, Inc. and The Bank of
New York, as trustee, with respect to 9 1/4% Senior Subordinate
Notes due 2003. (11)
10.1 Surplus Debenture Number Four in the original principal amount of
$162,539,890, issued by Pacific Life and Accident Insurance
Company to PennCorp Financial Group, Inc., dated January 1, 1994.
(10)
10.2 Surplus Debenture Number Five in the original principal amount of
$17,606,203, issued by Pacific Life and Accident Insurance
Company to PennCorp Financial Group, Inc., dated September 29,
1994. (9)
10.3 Surplus Debenture Number Six in the original principal amount of
$55,000,000, issued by Pacific Life and Accident Insurance
Company to PennCorp Financial Group, Inc., dated July 24, 1996.
(14)
10.4 10% Promissory Note in the original principal amount of
$30,661,996, issued by American-Holdings Corporation to
Pennsylvania Life Insurance Company, dated July 1, 1996. (14)
10.5 Certificate of Contribution in the original principal amount of
$54,332,790 issued by Integon Financial Life Insurance
Corporation to Integon Life Corporation, dated July 25, 1995. (5)
MANAGEMENT COMPENSATION
RELATED AGREEMENTS
10.6 Intentionally omitted.
10.7 PennCorp Financial, Inc. Retirement and Savings Plan. (13)
118
<PAGE>
10.8 PennCorp Financial, Inc. Executive Officer Incentive Plan.
(13)
10.9 PennCorp Financial Group, Inc. 1992 Stock Option Plan. (13)
10.10 PennCorp Financial Group, Inc. Senior Management Warrant
Award Program. (13)
10.11 Form of Restricted Stock Agreement by and between PennCorp
Financial Group, Inc. and certain participants, effective as
of April 1, 1994. (9)
10.12 Employment Agreement between PennCorp Financial Group, Inc.
and David J. Stone entered into June 7, 1996. (14)
10.13 Employment Agreement between PennCorp Financial Group, Inc.
and Steven W. Fickes entered into June 7, 1996. (14)
10.14 Amendment Number One to Employment Agreement between
PennCorp Financial Group, Inc. and David J. Stone dated
April 28, 1997. (15)
10.15 Amendment Number One to Employment Agreement between
PennCorp Financial Group, Inc. and Steven W. Fickes dated
April 28, 1997. (15)
10.16 Amendment No. 2 to Employment Agreement between PennCorp
Financial Group, Inc. and David J. Stone entered into
January 5, 1998. (1)
10.17 Amendment No. 2 to Employment Agreement between PennCorp
Financial Group, Inc. and Steven W. Fickes entered into
January 5, 1998. (1)
10.18 Executive Retention Agreement between Charles Lubochinski
and PennCorp Financial Group, Inc. (1)
10.19 Schedule of similar Executive Retention Agreements. (1)
10.20 PennCorp Financial Group, Inc. 1996 Stock Award and Stock
Option Plan. (14)
10.21 Amendment Number One to PennCorp Financial Group, Inc. 1996
Stock Award and Stock Option Plan. (20)
10.22 PennCorp Financial Group, Inc. 1996 Senior Executive Annual
Incentive Award Plan. (14)
10.23 Real Estate Purchase and Sale Agreement between Peoples Security
Life Insurance Company and PennCorp Financial Group, Inc., dated
March 24, 1995. (8)
10.24 Registration Rights Agreement dated as of December 14, 1995,
between PennCorp Financial Group, Inc., I.C.H. Corporation, SWL
Holding Corporation and Care Financial Corporation. (6)
10.25 Conversion, Standstill and Registration Rights Agreement between
United Companies Financial Corporation and PennCorp Financial
Group, Inc. dated as of July 24, 1996. (14)
119
<PAGE>
10.26 Registration Rights Agreement dated as of August 2, 1996, by and
among PennCorp Financial Group, Inc., Smith Barney Inc.,
Donaldson, Lufkin & Jenrette Securities Corporation and Merrill
Lynch, Pierce, Fenner & Smith Incorporated. (14)
10.27 Stockholders Agreement dated December 14, 1995 between
Southwestern Financial Corporation and the Security holders
listed on the signature pages thereof. (6)
10.28 Credit Agreement dated March 12, 1997 by and among PennCorp
Financial Group, Inc. and The Chase Manhattan Bank, The First
National Bank of Chicago, and NationsBank, NA., as Managing
Agents, Fleet National Bank, Mellon Bank, N.A., Bank of Montreal,
CIBC Inc., and Dresdner Bank AG, New York Branch and Grand Cayman
Branch as Co-Agents and The Bank of New York, as Administrative
Agent. (16)
10.29 Revision Agreement, dated as of May 30, 1997, by and among United
Companies Financial Corporation, PennCorp Financial Group, Inc.,
Pacific Life and Accident Insurance Company and each additional
party set forth on the signature pages thereto. (17)
10.30 Amendment to Surplus Debenture in the original principal amount
of $73,000,000 issued by Pioneer Security Life Insurance Company
to American-Amicable Holdings Corporation, dated May 17, 1996.
(17)
10.31 Second Amendment to Surplus Debenture in the original principal
amount of $73,000,000 issued by Pioneer Security Life Insurance
Company to American-Amicable Holdings Corporation, effective
January 1, 1997. (17)
10.32 Third Amendment to Surplus Debenture in the original principal
amount of $73,000,000 issued by Pioneer Security Life Insurance
Company to American-Amicable Holdings Corporation, effective May
14, 1997. (17)
10.33 Amendment to Surplus Debenture Number Four in the original
principal amount of $162,539,890, issued by Pacific Life and
Accident Insurance Company to PennCorp Financial Group, Inc.,
effective January 1, 1997. (17)
10.34 Second Amendment to Surplus Debenture Number Four in the original
principal amount of $162,539,890, issued by Pacific Life and
Accident Insurance Company to PennCorp Financial Group, Inc.,
effective May 14, 1997. (17)
10.35 Amendment to Surplus Debenture Number Five in the original
principal amount of $17,606,203, issued by Pacific Life and
Accident Insurance Company to PennCorp Financial Group, Inc.,
effective January 1, 1997. (17)
10.36 Second Amendment to Surplus Debenture Number Five in the original
principal amount of $17,606,203, issued by Pacific Life and
Accident Insurance Company to PennCorp Financial Group, Inc.,
effective May 14, 1997. (17)
10.37 Amendment to Surplus Debenture Number Six in the original
principal amount of $55,000,000, issued by Pacific Life and
Accident Insurance Company to PennCorp Financial Group, Inc.,
effective January 1, 1997. (17)
10.38 Second Amendment to Surplus Debenture Number Six in the original
principal amount of $55,000,000, issued by Pacific Life and
Accident Insurance Company to PennCorp Financial Group, Inc.,
effective May 14, 1997. (17)
120
<PAGE>
10.39 Note Purchase, Release and Settlement Agreement, dated July 13,
1997, executed by Lone Star Liquidating Trust, PennCorp Financial
Group, Inc. and Southwestern Financial Corporation . (18)
10.40 Amended and Restated Assignment Agreement dated as of January 2,
1998 by and between PennCorp Financial Group, Inc. and
Knightsbridge Capital Fund I, L.P. (19)
10.41 Amended and Restated Assignment Agreement dated as of January 2,
1998 by and between PennCorp Financial Group, Inc., David J.
Stone, Steven W. Fickes, the Steven Wayne Fickes, Jr. Trust dated
December 21, 1995 and the Kathryn Elizabeth Fickes Trust dated
December 21, 1995. (19)
12 Computation of ratio of earnings to fixed charges. (1)
21 List of subsidiaries of the Registrant. (1)
22.1 Auditors consent. (1)
22.2 Auditors consent. (1)
27 Financial Data Schedule. (1)
(1) Filed herewith.
(2) Such exhibit is incorporated by reference to the Form 8-K dated November
25, 1996, which was filed with the Securities and Exchange Commission by
PennCorp Financial Group, Inc. on December 4, 1996, providing a copy of the
Amended and Restated Agreement and Plan of Merger with Washington National
Corporation.
(3) Such exhibit is incorporated by reference to the Registration Statement on
Form S-3 (Registration No. 333- 13285) of PennCorp Financial Group, Inc.
filed with the Securities and Exchange Commission on October 10, 1996.
(4) Such exhibit is incorporated by reference to the Form 8-K dated July 24,
1996 which was filed with the Securities and Exchange Commission by
PennCorp Financial Group, Inc. on August 8, 1996 relating to the financial
statements and pro forma financial information of United Companies Life
Insurance Company.
(5) Such exhibit is incorporated by reference to the Annual Report on Form 10-K
for the fiscal year ended December 31, 1995 of PennCorp Financial Group,
Inc.
(6) Such exhibit is incorporated by reference to the Form 8-K dated December
14, 1995 which was filed by PennCorp Financial Group, Inc. with the
Securities and Exchange Commission on December 28, 1995 related to its
investment in Southwestern Financial Corporation.
(7) Such exhibit is incorporated by reference to the Form 8-A dated July 11,
1995 which was filed by PennCorp Financial Group, Inc. with the Securities
and Exchange Commission on July 12, 1995.
(8) Such exhibit is incorporated by reference to the Quarterly Report on Form
10-Q for the three months ended June 30, 1995 of PennCorp Financial Group,
Inc.
(9) Such exhibit is incorporated by reference to the Quarterly Report on Form
10-Q for the three months ended September 30, 1994 of PennCorp Financial
Group, Inc.
121
<PAGE>
(10) Such exhibit is incorporated by reference to the Quarterly Report on Form
10-Q for the three months ended June 30, 1994 of PennCorp Financial Group,
Inc.
(11) Such exhibit is incorporated by reference to the Annual Report on Form 10-K
for the fiscal year ended December 31, 1993 of PennCorp Financial Group,
Inc.
(12) Such exhibit is incorporated by reference to the Annual Report on Form 10-K
for the fiscal year ended December 31, 1992 of PennCorp Financial Group,
Inc.
(13) Such exhibit is incorporated by reference to the Registration Statement on
Form S-1 (Registration No. 33-50530) of PennCorp Financial Group, Inc.
filed on August 6, 1992.
(14) Such exhibit is incorporated by reference to the Annual Report on Form 10-K
for the fiscal year ended December 31, 1996 of PennCorp Financial Group,
Inc.
(15) Such exhibit is incorporated by reference to Amendment Number 2 to the
Annual Report on Form 10-K for fiscal year ended December 31, 1996 of
PennCorp Financial Group, Inc.
(16) Such exhibit is incorporated by reference to the Amendment Number 1 to
Annual Report on Form 10-K for the fiscal year ended December 31, 1996 of
PennCorp Financial Group, Inc.
(17) Such exhibit is incorporated by reference to the Quarterly Report on Form
10-Q for the three months ended June 30, 1997 of PennCorp Financial Group,
Inc.
(18) Such exhibit is incorporated by reference to the Quarterly Report on Form
10-Q for the three months ended September 30, 1997 of PennCorp Financial
Group, Inc.
(19) Such exhibit is incorporated by reference to the Form 8-K dated January 13,
1998 which was filed with the Securities and Exchange Commission by
PennCorp Financial Group, Inc. on January 13, 1998 relating to the
acquisition of common stock and common stock warrants of Southwestern
Financial Corporation not previously owned by PennCorp Financial Group,
Inc.
(20) Such exhibit is incorporated by reference to the Registration Statement on
Form S-8 (Registration No. 333-48629) of PennCorp Financial Group, Inc.
filed on March 24, 1998.
122
EXHIBIT 10.16
AMENDMENT NO. 2 TO EMPLOYMENT AGREEMENT
This Amendment No. 2 to Employment Agreement ("Amendment No. 2") is entered
into as the 5th day of January, 1998, between PennCorp Financial Group, Inc., a
Delaware corporation (together with its successors and permitted assigns under
the Employment Agreement, as defined herein, the "Company"), and David J. Stone
(the "Executive").
WITNESSETH
WHEREAS, the Executive and the Company are parties to an Employment
Agreement (herein so called), dated as of June 7, 1996; and
WHEREAS, the Company desires to amend, and the Executive is willing to
amend, the provisions of the Employment Agreement relating to the Executive's
covenant not to compete with the Company under certain circumstances to more
fully set forth the understanding and agreement of the parties with respect to
such covenant;
NOW, THEREFORE, in consideration of the premises and mutual covenants
contained herein and for other good and valuable consideration, the receipt of
which is mutually acknowledged, the Company and the Executive agree as follows:
1. Definitions. Capitalized terms used herein that are not otherwise
defined herein shall have the meaning given such terms in the Employment
Agreement.
2. Amendment to Definitions. There shall be added to Section 1 of the
Employment Agreement new clauses (t), (u) and (v) which shall read in their
entirety as follows:
"(t) 'Knightsbridge Fund' means Knightsbridge Capital Fund I, L.P., a
Delaware limited partnership."
"(u) 'Knightsbridge Fund Partnership Agreement' means the Amended and
Restated Agreement of Limited Partnership of the Knightsbridge
Fund, as amended from time to time."
"(u) Fund Competitive Activity' shall mean any activity engaged in by
the Executive, whether as an employee, consultant, principal,
agent, officer, director, partner or shareholder involving the
establishing or operation of an investment fund (regardless of
the form of entity used for that purpose) the purpose of which is
to identify, acquire equity or equity-linked interests in and/or
manage a portfolio of companies engaged primarily in providing
life and/or accident and health insurance and related services."
3. Amendment to Section 13 of the Employment Agreement. Section 13 of
the Employment Agreement shall be amended by adding new paragraph b.
thereto and renumbering
1
<PAGE>
EXHIBIT 10.16
existing paragraphs b. and c. thereof as new paragraphs "c." and "d."
thereto. New paragraph b. thereto shall read as follows:
"b. The Executive covenants and agrees that he shall not directly or
indirectly engage in any Fund Competitive Activity during (i) the Term
of Employment, or (ii) in the event of a voluntary termination of
employment pursuant to Section 11(g) above prior to the date on which
the aggregate Investments (as defined in the Knightsbridge Fund
Partnership Agreement) made by the Knightsbridge Fund in Portfolio
Companies (as defined in the Knightsbridge Fund Partnership Agreement)
equals or exceeds $92 million, the one year period following the date
of the Executive's termination of employment, or (iii) in the event of
a voluntary termination of employment pursuant to Section 11(g) on or
after the date on which the aggregate Investments (as defined in the
Knightsbridge Fund Partnership Agreement) made by the Knightsbridge
Fund in Portfolio Companies (as defined in the Knightsbridge Fund
Partnership Agreement) equals or exceeds $92 million (the "Fully
Invested Date"), the nine-month period following the Fully Invested
Date or the six- month period following the date of the Executive's
termination of employment, whichever is longer."
4. No Further Modifications. Except as expressly amended by this
Amendment No. 2, the Employment Agreement shall continue in full force and
effect in accordance with its terms.
5. Governing Law. This Amendment No. 2 shall be governed by and
construed and interpreted in accordance with the laws of New York without
reference to principles of conflict of laws.
6. Headings. The headings of the sections contained in this Amendment
No. 2 are for convenience only and shall not be deemed to control or affect
the meaning or construction of any provision of this Agreement.
7. Counterparts. This Agreement may be executed in two or more
counterparts.
[Remainder of Page Left Blank Intentionally]
2
<PAGE>
EXHIBIT 10.16
IN WITNESS WHEREOF, the undersigned have executed this Amendment No. 2 as
of the date first above written.
PFNNCORP FINANCIAL GROUP, INC.
By:/s/ Scott D. Silverman
----------------------
Scott D. Silverman,
Senior Vice President and
General Counsel
By:/s/ Kenneth Roman
-----------------
Kenneth Roman, Chairman
Compensation Committee
/s/ David J. Stone
------------------
David J. Stone
3
EXHIBIT 10.17
AMENDMENT NO. 2 TO EMPLOYMENT AGREEMENT
This Amendment No. 2 to Employment Agreement ("Amendment No. 2") is entered
into as the 5th day of January, 1998, between PennCorp Financial Group, Inc., a
Delaware corporation (together with its successors and permitted assigns under
the Employment Agreement, as defined herein, the "Company"), and Steven W.
Fickes (the "Executive").
WITNESSETH
WHEREAS, the Executive and the Company are parties to an Employment
Agreement (herein so called), dated as of June 7, 1996; and
WHEREAS, the Company desires to amend, and the Executive is willing to
amend, the provisions of the Employment Agreement relating to the Executive's
covenant not to compete with the Company under certain circumstances to more
fully set forth the understanding and agreement of the parties with respect to
such covenant;
NOW, THEREFORE, in consideration of the premises and mutual covenants
contained herein and for other good and valuable consideration, the receipt of
which is mutually acknowledged, the Company and the Executive agree as follows:
1. Definitions. Capitalized terms used herein that are not otherwise
defined herein shall have the meaning given such terms in the Employment
Agreement.
2. Amendment to Definitions. There shall be added to Section 1 of the
Employment Agreement new clauses (t), (u) and (v) which shall read in their
entirety as follows:
"(t) 'Knightsbridge Fund' means Knightsbridge Capital Fund I,
L.P., a Delaware limited partnership."
"(u) 'Knightsbridge Fund Partnership Agreement' means the Amended
and Restated Agreement of Limited Partnership of the Knightsbridge
Fund, as amended from time to time."
"(u) Fund Competitive Activity' shall mean any activity engaged
in by the Executive, whether as an employee, consultant, principal,
agent, officer, director, partner or shareholder involving the
establishing or operation of an investment fund (regardless of the
form of entity used for that purpose) the purpose of which is to
identify, acquire equity or equity-linked interests in and/or manage a
portfolio of companies engaged primarily in providing life and/or
accident and health insurance and related services."
3. Amendment to Section 13 of the Employment Agreement. Section 13 of
the Employment Agreement shall be amended by adding new paragraph b.
thereto and renumbering
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EXHIBIT 10.17
existing paragraphs b. and c. thereof as new paragraphs "c." and "d."
thereto. New paragraph b. thereto shall read as follows:
"b. The Executive covenants and agrees that he shall not directly or
indirectly engage in any Fund Competitive Activity during (i) the Term
of Employment, or (ii) in the event of a voluntary termination of
employment pursuant to Section 11(g) above prior to the date on which
the aggregate Investments (as defined in the Knightsbridge Fund
Partnership Agreement) made by the Knightsbridge Fund in Portfolio
Companies (as defined in the Knightsbridge Fund Partnership Agreement)
equals or exceeds $92 million, the one year period following the date
of the Executive's termination of employment, or (iii) in the event of
a voluntary termination of employment pursuant to Section 11(g) on or
after the date on which the aggregate Investments (as defined in the
Knightsbridge Fund Partnership Agreement) made by the Knightsbridge
Fund in Portfolio Companies (as defined in the Knightsbridge Fund
Partnership Agreement) equals or exceeds $92 million (the "Fully
Invested Date"), the nine-month period following the Fully Invested
Date or the six- month period following the date of the Executive's
termination of employment, whichever is longer."
4. No Further Modifications. Except as expressly amended by this
Amendment No. 2, the Employment Agreement shall continue in full force and
effect in accordance with its terms.
5. Governing Law. This Amendment No. 2 shall be governed by and
construed and interpreted in accordance with the laws of New York without
reference to principles of conflict of laws.
6. Headings. The headings of the sections contained in this Amendment
No. 2 are for convenience only and shall not be deemed to control or affect
the meaning or construction of any provision of this Agreement.
7. Counterparts. This Agreement may be executed in two or more
counterparts.
[Remainder of Page Left Blank Intentionally]
2
<PAGE>
EXHIBIT 10.17
IN WITNESS WHEREOF, the undersigned have executed this Amendment No. 2 as
of the date first above written.
PENNCORP FINANCIAL GROUP, INC.
By:/s/ Scott D. Silverman
-------------------------
Scott D. Silverman,
Senior Vice President and
General Counsel
By:/s/ Kenneth Roman
-------------------------
Kenneth Roman, Chairman
Compensation Committee
/s/ Steven W. Fickes
-------------------------
Steven W. Fickes
3
EXHIBIT 10.18
Executive Retention Agreement
THIS AGREEMENT is entered into this 24th day of November, 1997 ("Effective
Date"), by and between PENNCORP FINANCIAL GROUP, INC., a Delaware corporation
("Company") and Charles Lubochinski ("Executive").
A. The Board of Directors of the Company desires to assure that key
executives will devote their undivided time and attention to the Company
without regard to concerns about an involuntary loss of employment without
cause, and to assure the continuity and cooperation of management in the
event of a change in ownership and the continued attention of Executive to
his duties without any distraction arising out of the circumstances
surrounding a change or potential change in ownership.
B. The Company and Executive desire to enter into an executive
retention arrangement to protect Executive against an involuntary
termination of employment without cause, to recognize the additional
efforts of Executive that may be necessary to assist in and prepare for any
potential change in ownership, and to encourage Executive to diligently
perform his duties and responsibilities to ensure a smooth transition for
any such change in ownership.
For good and valuable consideration, including the mutual covenants herein,
the parties hereto agree as follows:
1. Definitions. The following terms shall have the following meanings for
purposes of this Agreement.
"Annual Pay" means the sum of:
(i) an amount equal to the highest annual base salary rate
payable to the Executive by the Company at any time before or after a
Change in Control, plus
(ii) an amount equal to the product of (x) the average percentage
of base salary paid to the Executive as annual incentive bonuses for
the two immediately preceding calendar years, multiplied by (y) the
highest annual base salary rate payable to the Executive by the
Company at any time before or after a Change in Control.
The highest annual base salary rate payable to the Executive within the
last two years was $225,000.
"Cause" means:
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<PAGE>
EXHIBIT 10.18
(1) for any termination prior to the earlier of a Change in
Control or a Potential Change in Control, (i) a material and
demonstrable adverse change after the Effective Date in the
Executive's performance of his duties and responsibilities in effect
as of the Effective Date, other than any changes in performance by
reason of sickness or disability of the Executive and any changes in
Executive's duties and responsibilities made after the Effective Date,
(ii) willful misconduct or gross negligence in the performance of, or
willful neglect of, the Executive's duties, which has caused
demonstrable and serious injury (monetary or otherwise) to the
Company, (iii) conviction of the Executive of a criminal violation
involving fraud, embezzlement or theft in connection with his duties
or in the course of his employment with the Company, (iv) conviction
of, or plea of nolo contendere to, a felony by the Executive, or (v)
willful and wrongful damage by Executive to property of the Company or
any of its affiliates; and
(2) for any termination on or after a Change in Control or
Potential Change in Control, the Executive's (i) conviction of a
criminal violation involving fraud, embezzlement or theft in
connection with his duties or in the course of his employment with the
Company, (ii) conviction of, or plea of nolo contendere to, a felony,
or (iii) willful and wrongful damage to property of the Company or any
of its affiliates.
No act or omission shall be considered "willful" if the Executive
reasonably believed such acts or omissions were in the best interests of the
Company.
No act or omission shall constitute Cause unless the Board of Directors of
the Company provides to the Executive (a) written notice clearly and fully
describing the particular acts or omissions which the Board reasonably believes
in good faith constitutes Cause and (b) an opportunity, within 30 days following
his receipt of such notice, to meet in person with the Board of Directors to
explain or defend the alleged acts or omissions relied upon by the Board and, to
the extent practicable, to cure such acts or omissions. Executive shall further
have the right to contest a determination of Cause by the Company by requesting
arbitration on an expedited basis in accordance with the terms of Section 5.1
hereof.
"Change in Control" means (1) any "person" (as such term is used in Section
13(d) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"))
becomes the "beneficial owner" (as determined pursuant to Rule 13d-3 under the
Exchange Act), directly or indirectly, of securities of the Company representing
twenty-five percent (25%) or more of the combined voting power of the Company's
then outstanding securities; or (2) during any period of two (2) consecutive
years (not including any period prior to the execution of this Agreement),
individuals who at the beginning of such period constitute the members of the
Company's Board of Directors (the "Board") and any new director, whose election
to the Board or nomination for election to the Board by the Company's
stockholders was approved by a vote of at least two-thirds (2/3) of the
directors then still in office who either were directors at the beginning of the
period or whose election or nomination for election was previously so approved,
cease for any reason to constitute a majority of the Board; or
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<PAGE>
EXHIBIT 10.18
(3) the Company shall merge with or consolidate into any other corporation,
other than a merger or consolidation which would result in the holders of the
voting securities of the Company outstanding immediately prior thereto holding
immediately thereafter securities representing more than sixty percent (60%) of
the combined voting power of the voting securities of the Company or such
surviving entity outstanding immediately after such merger or consolidation; or
(4) the stockholders of the Company approve a plan of complete liquidation of
the Company or an agreement for the sale or disposition by the Company of all or
substantially all of the Company's assets or such a plan is commenced.
"Code" means the Internal Revenue Code of 1986, as amended.
"Good Reason" means any of the following events occurring, without
Executive's prior written consent specifically referring to this Agreement,
within three (3) years following a Change in Control or Potential Change in
Control:
(1) (A) any reduction in the amount of Executive's annual salary or
aggregate incentive compensation opportunities (which reduction may
also occur pursuant to any assignment of performance goals and
corresponding awards which are inconsistent with prior performance
goals and awards), (B) any significant reduction in the aggregate
value of Executive's benefits as such benefits may be increased from
time to time (unless such reduction is pursuant to a general change in
benefits applicable to all similarly situated employees of the Company
and its affiliates) or (C) any material and willful breach by the
Company of any provision of this agreement or any written employment
agreement with Executive;
(2) (A) assignment to Executive of any duties inconsistent with his
status as Senior Vice President-Tax of the Company, (B) the removal of
Executive from his position as Senior Vice President-Tax of the
Company, (C) the failure to retain Executive as the Senior Vice
President-Tax of any successor to the Company (whether by merger,
consolidation or sale or disposition of all or substantially all of
the assets of the Company) or any entity which directly or indirectly
owns twenty five percent (25%) or more of any class of securities of
the Company or any successor to the Company (whether by merger,
consolidation or sale or disposition of all or substantially all of
the assets of the Company) or (D) any significant change in the nature
or status of Executive's duties or responsibilities;
(3) a significant adverse change in the nature or scope of the
authorities, powers, functions, responsibilities or duties attached to
the position with the Company which Executive held immediately prior
to the Change in Control;
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<PAGE>
EXHIBIT 10.18
(4) (A) transfer of Executive's principal place of employment to a
location more than 20 miles from Executive's place of employment
immediately prior to the Change in Control, provided that the distance
between the new principal place of employment and Executive's primary
residence is greater than 10 miles from the distance between the
principal place of employment prior to such transfer and Executive's
primary residence immediately prior to the Change in Control, (B)
Executive is required to travel outside of the continental United
States more than four times during any calendar year or for more than
10 days in the aggregate in any calendar year or (C) the Executive is
required to travel outside the state of the Executive's principal
place of employment immediately prior to the Change in Control for
more than 60 days in any calendar year;
(5) failure by the Company to obtain the assumption agreement referred
to in Section 8 of this Agreement prior to the effectiveness of any
succession referred to therein, unless the purchaser, successor or
assignee referred to therein is bound to perform this Agreement by
operation of law; or
(6) the Executive receives notice from any party to an agreement which
contemplates a Change in Control that, on or after such Change in
Control, an event will occur that will constitute Good Reason as
described in (1) through (5) above.
Notwithstanding the above, (i) the occurrence of any of the events
described in (1) through (5) above will not constitute Good Reason unless the
Executive gives the Company written notice, within 90 calendar days after the
Executive knew or should have known of the occurrence of any of the events
described in (1) through (5) above, that such event constitutes Good Reason, and
the Company thereafter fails to cure the event within the earlier of (x) the
closing for a Change in Control or (y) thirty (30) days after receipt of such
notice, and (ii) the receipt of notice described in (6) above will not
constitute Good Reason until the closing for a Change in Control and will
otherwise not constitute Good Reason if the Executive is provided reasonable
assurances by the Company prior to such closing that an event described in (1)
through (5) above is not contemplated on or after a Change in Control.
"Potential Change in Control" means the occurrence of active discussions
between the Company and a potential purchaser of the Company that contemplates a
transaction which would result in a Change in Control, but only if a Change in
Control results within twelve months following such occurrence.
2. Term. The term of this agreement commences on the Effective Date and
expires upon the earliest to occur of the following:
(a) the Executive's attainment of age 65,
4
<PAGE>
EXHIBIT 10.18
(b) the Executive's death, or
(c) the Executive's disability (within the meaning of the long-term
disability plan in effect for and applicable to the Executive).
3. Involuntary Termination Payment and Benefits
3.1 Involuntary Termination. Subject to Section 3.3 below, in the event
either (i) Executive's employment with the Company or its successor is
terminated by Executive for Good Reason within three years following a Change in
Control or Potential Change in Control, or (ii) the Executive's employment with
the Company or its successor is terminated by the Company without Cause,
Executive shall be entitled to the following payments and other benefits:
a. An amount equal to the sum of (i) Executive's accrued and unpaid
salary, vacation and personal days as of his date of termination of
employment, plus (ii) his accrued and unpaid bonus, if any, for the
Company's prior fiscal year, plus (iii) a pro- rated annual bonus for
the fiscal year of the Executive's termination, which shall be equal
to the Executive's bonus under the Company's annual bonus plan for the
preceding fiscal year, and multiplied by a fraction, the numerator of
which is the number of days elapsed in such fiscal year to the day his
employment terminated, and the denominator of which is 365. The amount
described in (i) above shall be paid on the date of the Executive's
termination of employment, and the amount or amounts described in (ii)
and (iii) above shall be paid on the earlier of the date of the
Executive's termination of employment or the respective date that
bonuses are otherwise paid under the Company's annual bonus plan.
b. Subject to Section 3.2 below, an amount equal to two times
Executive's Annual Pay ("Termination Pay"). Termination Pay shall be
paid on the earlier of (i) within ten (10) days after the Company's
delivery of written notice to the Executive of his termination of
employment without Cause, (ii) within thirty (30) days after the
Executive's delivery of written notice to the Company of his
resignation for Good Reason (unless cured), or (iii) at the closing
for a Change in Control (the "Payment Date").
c. All unexercisable options to purchase shares of stock of the
Company that are held by the Executive shall immediately become
exercisable.
d. All restricted stock of the Company and any other equity-based
rights held by the Executive shall become fully vested and all
restrictions thereon shall lapse.
5
<PAGE>
EXHIBIT 10.18
e. A lump sum payment on the Payment Date equal to the Executive's
unvested accrued benefit under any tax-qualified retirement plan
sponsored by the Company.
f. Executive and his eligible dependents shall be entitled for a
period of three (3) years following his date of termination of
employment to continued coverage, at the cost of the Company, under
the Company's group health, dental and life insurance plans as in
effect from time to time (but not any other welfare benefit plans or
any retirement plans); provided that coverage under any particular
benefit plan shall expire with respect to the period after Executive
becomes covered under another employer's plan providing for a similar
type of benefit. In the event the Company is unable to provide such
coverage on account of any limitations under the terms of any
applicable contract with an insurance carrier or third party
administrator, the Company shall pay Executive an amount equal to the
cost of such coverage.
Except as provided in Section 3.2 below, the foregoing payments and
benefits shall be in addition to and not in lieu of any payments or benefits to
which Executive and his dependents may otherwise be entitled to under the
Company's compensation and employee benefit plans, policies or practices.
Nothing herein shall be deemed to restrict the right of the Company from
amending or terminating any such plan in a manner generally applicable to
similarly situated active employees of the Company and its affiliates, in which
event Executive shall be entitled to participate on the same basis (but at the
cost of the Company) as similarly situated active executives of the Company and
its affiliates.
3.2 Offset for Other Severance Pay. There shall be no duplication of
severance pay in any manner. In this regard, Executive shall not be entitled to
Termination Pay hereunder for more than one position with the Company. Further,
Termination Pay shall be in lieu of any other payments in the nature of
severance pay to which Executive has received or will receive from the Company.
Any other arrangement providing severance payments shall be deemed to be amended
to eliminate any obligation for such payments to be provided thereunder to
Executive. If Executive is entitled to any payment in lieu of notice of
termination of employment under Federal, state or local law, including but not
limited to the Worker Adjustment and Retraining Notification Act, the
Termination Pay to which the Executive would otherwise be entitled under this
Agreement shall be reduced by the amount of any such payment in lieu of notice.
3.3 Consulting Services. Notwithstanding Section 3.1 hereof, if the Company
delivers to Executive notice of his termination of employment without Cause or
Executive delivers to the Company notice of his resignation for Good Reason,
Executive shall continue (i) at the Company's election, in its sole discretion,
as a full-time employee of the Company for a period up to six months following
the date of such notice ("Transition Period") and (ii) as a part-time, casual
employee of the Company for a period of one year following the later of the date
of such notice or the last day of the Transition Period ("Consulting Period").
During the Transition Period, Executive
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<PAGE>
EXHIBIT 10.18
shall be assigned such duties and responsibilities, not inconsistent with his
position, duties and responsibilities as a senior executive officer of the
Company, as the Chief Executive Officer or Board of Directors of the Company may
reasonably and in good faith request, including, but not limited to, ensuring an
orderly transfer of his duties and responsibilities to his successor. During the
Consulting Period, Executive shall be reasonably available for consultation by
the Chief Executive Officer and/or the Board of Directors of the Company;
provided, however, that Executive may render such consulting services at times
and in a manner reasonably convenient to him and his then current employer, if
any (including, but not limited to, by telephone) and shall not be required to
maintain office hours or engage in any business travel. The Company acknowledges
and agrees that Executive shall have the right to obtain new employment during
the Consulting Period, Executive's consulting services hereunder shall be
secondary to any new employment and Executive shall not be obligated in any way
to disclose any propriety or non-public information regarding his current
employer. Executive shall be entitled for his services during the Transition
Period to the same compensation and benefits to which he was entitled from the
Company prior to such period. Executive shall be paid for his services during
the Consulting Period a lump sum in an amount equal to his Annual Pay, payable
on the Payment Date. Executive shall be promptly reimbursed for all
out-of-pocket business expenses incurred by the Executive in connection with his
services to the Company during a Transition Period and the Consulting Period,
subject to documentation in accordance with generally applicable policies of the
Company. To the extent permitted by applicable law, Executive shall not be
liable to the Company for any damages arising from any act or omission of
Executive during a Transition Period and the Consulting Period.
3.4. No Mitigation. The Executive shall not be obligated to secure new
employment, but shall be obligated to report promptly to the Company any actual
employment obtained during the period for which employee benefits continue
pursuant to Section 3.1.
4. Excise Taxes.
a. Anything in this Agreement to the contrary notwithstanding and except as
set forth below, if it is determined that any payment or distribution by the
Company to or for the benefit of Executive (whether paid or payable or
distributed or distributable pursuant to the terms of this Agreement or
otherwise, but determined without regard to any additional payments required
under this Section 4) (a "Payment") would be subject to the excise tax imposed
by Section 4999 of the Code, or any interest or penalties are incurred by
Executive with respect to such excise tax (such excise tax, together with any
such interest and penalties, are hereinafter collectively referred to as the
"Excise Tax"), then Executive shall be entitled to receive an additional payment
("Gross-Up Payment") in an amount such that after payment by Executive of all
taxes (including any interest or penalties imposed with respect to such taxes),
including, without limitation, any income taxes (and any interest and penalties
imposed with respect thereto) and Excise Tax imposed upon the Gross-Up Payment,
Executive retains an amount of the Gross-up Payment equal to the Excise Tax
imposed upon the Payments. Notwithstanding the foregoing provisions of this
paragraph "a", if it is
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EXHIBIT 10.18
determined that Executive is entitled to a Gross-Up Payment, but that Executive,
after taking into account the Payments and Gross-Up Payment, would not receive a
net after-tax benefit of at least $25,000 (taking into account both income taxes
and any Excise Tax) as compared to the net after-tax proceeds to Executive
resulting from an elimination of the Gross-Up Payment and a reduction of the
payments, in the aggregate, to an amount (the "Reduced Amount") such that the
receipt of Payments would not give rise to any Excise Tax, then no Gross-Up
Payment shall be made to Executive and the Payments, in the aggregate, shall be
reduced to the Reduced Amount.
b. Subject to the provisions of paragraph "c" of this Section 4, all
determinations required to be made under this Section 4, including whether and
when a Gross-Up Payment is required and the amount of such Gross-Up Payment and
the assumptions to be used in arriving at such determination, shall be made by a
certified public accounting firm selected by the Company and reasonably
acceptable to Executive (the "Accounting Firm"), which shall be retained to
provide detailed supporting calculations both to the Company and Executive
within 15 business days of the receipt of notice from Executive that there has
been a Payment, or such earlier time as is requested by the Company. All fees
and expenses of the Accounting Firm shall be paid solely by the Company. Any
Gross-Up Payment, as determined pursuant to this Section 4, shall be paid by the
Company to Executive within five (5) days of the receipt of the Accounting
Firm's determination. Any determination by the Accounting Firm shall be binding
upon the Company and Executive. As a result of the uncertainty in the
application of Section 4999 of the Code at the time of the initial determination
by the Accounting Firm hereunder, it is possible that Gross-Up Payments which
will not have been made by the Company should have been made ("Underpayment"),
consistent with the calculations required to be made hereunder. If the Company
exhausts its remedies pursuant to paragraph "c" of this Section 4 and Executive
thereafter is required to make a payment of any Excise Tax, the Accounting Firm
shall determine the amount of the Underpayment that has occurred and any such
Underpayment shall be promptly paid by the Company to or for the benefit of
Executive.
c. Executive shall notify the Company in writing of any claim by the
Internal Revenue Service that, if successful, would require the payment by the
Company of the Gross-Up Payment. Such notification shall be given as soon as
practicable but no later than ten (10) business days after Executive is informed
in writing of such claim and shall apprise the Company of the nature of such
claim and the date on which such claim is requested to be paid or appealed.
Executive shall not pay such claim prior to the expiration of the 30-day period
following the date on which it gives such notice to the Company (or such shorter
period ending on the date that any payment of taxes with respect to such claim
is due). If the Company notifies Executive in writing prior to the expiration of
such period that it desires to contest such claim, Executive shall:
(a) give the Company any information reasonably requested by the
Company relating to such claim,
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EXHIBIT 10.18
(b) take such action in connection with contesting such claims as the
Company shall reasonably request in writing from time to time, including,
without limitation, accepting legal representation with respect to such
claim by an attorney reasonably selected by the Company,
(c) cooperate with the Company in good faith in order to effectively
contest such claim, and
(d) permit the Company to participate in any proceedings relating to
such claim;
provided, however, that the Company shall bear and pay directly all costs and
expenses (including additional interest and penalties) incurred in connection
with such contest and shall indemnify and hold Executive harmless, on an
after-tax basis, for any Excise Tax or income tax (including interest and
penalties with respect thereto) imposed as a result of such representation and
payment of costs and expenses. Without limitation on the foregoing provisions of
this paragraph "c", the Company shall control all proceedings taken in
connection with such contest and, at its sole option, may pursue or forgo any
and all administrative appeals, proceedings, hearings and conferences with the
taxing authority in respect of such claim and may, at its sole option, either
direct Executive to pay the tax claimed and sue for a refund or to contest the
claim in any permissible manner, and Executive agrees to prosecute such contest
to a determination before any administrative tribunal, in a court of initial
jurisdiction and in one or more appellate courts, as the Company shall
determine; provided, however, that if the Company directs Executive to pay such
claim and sue for a refund, the Company shall advance the amount of such payment
to Executive, on an interest-free basis, and shall indemnify and hold Executive
harmless, on an after-tax basis, from any Excise Tax or income tax (including
interest or penalties with respect thereto) imposed with respect to such advance
or with respect to any imputed income with respect to such advance; and further
provided that any extension of the statute of limitations relating to payment of
taxes for the taxable year of Executive with respect to which such contested
amount is claimed to be due is limited solely to such contested amount.
Furthermore, the Company's control of the contest shall be limited to issues
with respect to which a Gross-Up Payment would be payable hereunder, and
Executive shall be entitled to settle or contest, as the case may be, any other
issue raised by the Internal Revenue Service or any other taxing authority.
d. If, after the receipt by Executive of an amount advanced by the Company
pursuant to paragraph "c" of this Section 4, Executive becomes entitled to
receive any refund with respect to such claim, Executive shall (subject to the
Company's complying with the requirements of paragraph "c" of this Section 4)
promptly pay to the Company the amount of such refund (together with any
interest paid or credited thereon after taxes applicable thereto). If after the
receipt by Executive of an amount advanced by the Company pursuant to paragraph
"c" of this Section 4, a determination is made that Executive shall not be
entitled to any refund with respect to such claim and the Company does not
notify Executive in writing of its intent to contest such denial of refund prior
to the expiration of 30 days after such determination, then such advance shall
be forgiven and
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EXHIBIT 10.18
shall not be required to be repaid and the amount of such advance shall offset,
to the extent thereof, the amount of Gross-Up Payment required to be paid.
5. Claims.
5.1 Arbitration of Claims. Company and Executive agree to settle by
arbitration any dispute or controversy arising in connection with this
Agreement, whether or not such dispute involves a plan subject to the Employee
Retirement Income Security of 1974, as amended ("ERISA"). Such arbitration shall
be conducted on an expedited basis in accordance with the rules of the American
Arbitration Association before a panel of three arbitrators sitting in Bethesda,
Maryland. The award of the arbitrators shall be final and nonappealable, and
judgment may be entered on the award of the arbitrators in any court having
proper jurisdiction. All expenses of such arbitration shall be borne by the
Company in accordance with Section 5.2 hereof.
5.2 Payment of Legal Fees and Costs. The Company agrees to pay as incurred,
to the full extent permitted by law, all legal fees and expenses which Executive
may reasonably incur as a result of any contest (regardless of the outcome
thereof) by the Company, Executive or others of any action taken pursuant to the
terms of this Agreement, or of the validity or enforceability of, or liability
under, any provision of this Agreement, or any guarantee of performance thereof
(including as a result of any contest by Executive about the amount of payment
pursuant to this Agreement), plus in each case interest on any delayed payment
at the applicable federal rate provided for in Section 7872(f)(2)(A) of the
Code.
5.3 Agent for Service of Legal Process. Service of legal process with
respect to a claim under this Agreement shall be made upon the General Counsel
of the Company.
6. Tax Withholding. All payments to the Executive under this Agreement will
be subject to the withholding of all applicable employment and income taxes.
7. Severability. In the event that any provision or portion of this
Agreement shall be determined to be invalid or unenforceable for any reason, the
remaining provisions of this Agreement shall be unaffected thereby and shall
remain in full force and effect.
8. Successors. This Agreement shall be binding upon and incur to the
benefit of the Company and any successor of the Company. The Company will
require any successor to all or substantially all of the business and/or assets
of the Company to expressly assume and agree to perform this Agreement in the
same manner and to the same extent that the Company would be required to perform
if no succession had taken place.
9. Entire Agreement. Except for compensation and employee benefit plans or
programs maintained by the Company from time to time, this Agreement constitutes
the entire
10
<PAGE>
EXHIBIT 10.18
agreement between the parties hereto with respect to the subject matter hereof.
This Agreement may not be modified in any manner except by a written instrument
signed by both the Company and the Executive.
10. Notices. Any notice required under this Agreement shall be in writing
and shall be delivered by certified mail return receipt requested to each of the
parties as follows:
To the Executive:
Charles Lubochinski
3 Bethesda Metro Center
Bethesda, MD 20814
To the Company:
PennCorp Financial Group, Inc.
745 Fifth Avenue
New York, New York 10151
Attn: Chief Executive Officer
11. Governing Law. The provisions of this Agreement shall be construed in
accordance of the laws of the state of Delaware, except to the extent preempted
by ERISA.
IN WITNESS WHEREOF, the Executive and the Company have executed this
Agreement as of the date and year first above written.
PENNCORP FINANCIAL GROUP, INC.
/s/ Steven W. Fickes
--------------------
Name: Steven W. Fickes
Title: President and Chief Financial Officer
/s/ Charles Lubochinski
--------------------
Charles Lubochinski
11
EXHIBIT 10.19
James P. McDermott, Michael J. Prager and Scott D. Silverman are parties to
an Executive Retention Agreement on substantially similar terms as Exhibit
10.18.
EXHIBIT 12
PENNCORP FINANCIAL GROUP, INC.
STATEMENT RE RATIO OF EARNINGS TO FIXED CHARGES AND
PREFERRED STOCK DIVIDEND REQUIREMENTS
For the Years Ended December 31, 1997, 1996, 1995,
1994 and 1993 ($ in thousands)
<TABLE>
<CAPTION>
1997 1996 1995 1994 1993
---------- ---------- ---------- ---------- ---------
<S> <C> <C> <C> <C> <C>
Income before income taxes,
equity in earnings of unconsolidated
affiliates and extraordinary charge......... $ 51,543 $ 110,579 $ 79,457 $ 60,653 $ 48,208
Adjustments to earnings:
Fixed charges................................ 25,081 21,756 22,581 20,641 9,811
Interest capitalized......................... -- (400) (260) -- --
Preferred stock dividend requirements........ -- -- -- -- --
---------- ---------- ---------- ---------- ---------
Total earnings and fixed charges................ $ 76,624 $ 131,935 $ 101,778 $ 81,294 $ 58,019
========== ========== ========== ========== =========
Fixed charges:
Interest expense............................. $ 22,497 $ 17,741 $ 18,729 $ 17,404 $ 7,461
Amortization of deferred debt issuance costs. 858 1,238 1,051 870 --
Rental expense............................... 1,726 2,777 2,801 2,367 2,350
---------- ---------- ---------- ---------- ---------
Total fixed charges............................. $ 25,081 $ 21,756 $ 22,581 $ 20,641 $ 9,811
========== ========== ========== ========== =========
Preferred stock dividend requirements:
Preferred stock dividends.................... $ 19,533 $ 14,646 $ 6,540 $ 1,151 $ --
Gross-up for taxes........................... 12,769 8,616 3,525 663 --
---------- ---------- ---------- ---------- ---------
Total preferred stock dividend requirements..... $ 32,302 $ 23,262 $ 10,065 $ 1,814 $ --
========== ========== ========== ========== =========
Ratio of earnings to fixed charges.............. 3.27 6.06 4.51 3.94 5.91
========== ========== ========== ========== =========
Combined ratio of earnings to fixed charges and
preferred stock dividend requirements........ 1.34 2.93 3.12 3.62 5.91
========== ========== ========== ========== =========
</TABLE>
EXHIBIT 21
PENNCORP FINANCIAL GROUP, INC.
As of December 31, 1997
PENNCORP FINANCIAL GROUP, INC. (Delaware)
PennCorp Southwest, Inc. (Delaware)
Southwestern Financial Corporation (Delaware)
Southwestern Financial Services Corporation (Delaware)
Southwestern Life Companies, Inc. (Delaware)
Constitution Life Insurance Company (Texas)
Southwestern Life Insurance Company (Texas)
I.C.H. Funding Corp. (Delaware)
Quail Creek Recreation, Inc. (Arizona)
BGFRTS L.C. (Texas)
GSSW Limited Partnership (Delaware)
GSSW-REO Ownership Corporation (Texas)
Saddlecreek Enterprise, L.L.C. (Texas)
Quail Creek Water Company, Inc. (Arizona)
Union Bankers Insurance Company (Texas)
Marquette National Life Insurance Company (Texas)
American-Amicable Holdings Corporation (Delaware)
Pioneer Security Life Insurance Company (Texas)
Integon Life Insurance Corporation (Texas)
Group Consultants, Inc. (Georgia)
The Network Agency, Inc. (Ohio)
Integon Life Network Corporation (North Carolina)
Occidental Life Insurance Company of North Carolina (Texas)
American-Amicable Life Insurance Company of Texas (Texas)
Pioneer American Insurance Company (Texas)
ALICO Management Company (Texas)
Pacific Life and Accident Insurance Company (Texas)
Professional Insurance Corporation (Texas)
Pennsylvania Life Insurance Company (Pennsylvania)
Peninsular Life Insurance Company (North Carolina)
Penncorp Life Insurance Company (Canada)
Penncorp Canada Marketing, Inc. (Canada)
Marketing One Financial Corporation (Delaware)
Marketing One, Inc. (Nevada)
Marketing One Investment Services Corporation (Texas)
Marketing One of Puerto Rico, Inc. (Puerto Rico)
Finesse Investments, Inc. (Hawaii)
Marketing One of Alabama, Inc. (Alabama)
Marketing One Securities, Inc. (California)
Tax Savers Agency, Inc. (Ohio)
Premier One, Inc. (North Carolina)
United Life & Annuity Insurance Company (Louisiana)
United Variable Services, Inc. (Louisiana)
UC Mortgage Corp. (Delaware)
PennCorp Financial, Inc. (Delaware)
California Sales Agency, Inc. ( California)
Midwest Region, Inc. (Iowa)
Midwest Region Inc. of Colorado (Colorado)
Mississippi Region Associates, Inc. (Alabama)
Safe Drivers Agency Limited (United Kingdom)
Southeastern Region Associates, Inc. (Alabama)
United Silver Spring Associates, Inc. (Delaware)
Occidental Benefits Services, Inc. (Delaware)
Occidental Benefits Services of Alabama, Inc.
PennCorp Financial Services, Inc. (Delaware)
Kivex, Inc. (Delaware)
PennCorp Occidental Corp. (Delaware)
Penn La Franco Corporation (British Virgin Islands)
Exhibit 22.1
CONSENT OF INDEPENDENT AUDITORS
The Board of Directors
PennCorp Financial Group, Inc.:
The audits referred to in our report dated March 19, 1998 included the
related financial statement schedules as of December 31, 1997, and for each of
the years in the three-year period ended December 31, 1997, included herein.
These financial statement schedules are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statement schedules based on our audits. In our opinion, such financial
statements taken as a whole, present fairly in all material respects the
information set forth therein.
We consent to the incorporation by reference in the registration statements
(No. 333-13285) on Form S-3 and (Nos. 333-48629, 333-48631 and 333-48637) on
Form S-8 of PennCorp Financial Group, Inc. of our reports included herein
relating to the consolidated balance sheets of PennCorp Financial Group, Inc.
and subsidiaries as of December 31, 1997 and 1996, and the related consolidated
statements of income, changes in shareholders' equity, and cash flows for each
of the years in the three-year period ended December 31, 1997, and all related
schedules, and to the reference to our firm under the heading "Experts" in the
prospectus related to the Form S-3 registration statement.
KPMG PEAT MARWICK LLP
Raleigh, North Carolina
March 27, 1998
Exhibit 22.2
CONSENT OF INDEPENDENT AUDITORS
The Board of Directors
PennCorp Financial Group, Inc.:
We consent to the incorporation by reference in the registration statements
(No. 333-13285) on Form S-3 and (Nos. 333-48629, 333-48631 and 333-48637) on
Form S-8 of PennCorp Financial Group, Inc. of our report dated March 19, 1998,
relating to the consolidated balance sheets of Southwestern Financial
Corporation and subsidiaries as of December 31, 1997 and 1996, and the related
consolidated statements of income, shareholders' equity, and cash flows for the
years then ended, which report appears in the December 31, 1997 annual report on
Form 10-K of PennCorp Financial Group, Inc.
KPMG PEAT MARWICK LLP
Dallas, Texas
March 27, 1998
<TABLE> <S> <C>
<ARTICLE> 7
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> DEC-31-1997
<DEBT-HELD-FOR-SALE> 2,718,982
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 30,257
<MORTGAGE> 240,879
<REAL-ESTATE> 17,807
<TOTAL-INVEST> 3,315,242
<CASH> 24,872
<RECOVER-REINSURE> 0
<DEFERRED-ACQUISITION> 310,117
<TOTAL-ASSETS> 4,724,135
<POLICY-LOSSES> 3,166,277
<UNEARNED-PREMIUMS> 12,976
<POLICY-OTHER> 41,370
<POLICY-HOLDER-FUNDS> 69,302
<NOTES-PAYABLE> 359,755
19,867
249,670
<COMMON> 289
<OTHER-SE> 610,277
<TOTAL-LIABILITY-AND-EQUITY> 4,724,135
345,566
<INVESTMENT-INCOME> 273,237
<INVESTMENT-GAINS> 17,487
<OTHER-INCOME> 27,504
<BENEFITS> 324,289
<UNDERWRITING-AMORTIZATION> 44,323
<UNDERWRITING-OTHER> 220,284
<INCOME-PRETAX> 51,543
<INCOME-TAX> 20,375
<INCOME-CONTINUING> 50,140
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 30,607
<EPS-PRIMARY> 1.09
<EPS-DILUTED> 1.07
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 0
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
