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1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K/A
AMENDMENT NO. 4
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1996
Commission file number 1-11422
PENNCORP FINANCIAL GROUP, INC.
- --------------------------------------------------------------------------------
(Exact name of Registrant as specified in its charter)
Delaware 13-3543540
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(State or other jurisdiction of (I.R.S. employer identification no.)
incorporation or organization)
590 Madison Avenue, NY, NY 10022
- ---------------------------------------- ----------
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: (212) 832-0700
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
------------------- -----------------------------------------
Common Stock, $.01 par value New York Stock Exchange
$3.375 Convertible Preferred New York Stock Exchange
Stock, $.01 par value
Securities registered pursuant to Section 12(g) of the Act:
None
- --------------------------------------------------------------------------------
(Title of Class)
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 in 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. [ ]
The aggregate market value of the voting stock held by non-affiliates of the
registrant as of March 14, 1997: $1,038,930,511.50.
The number of Common Stock shares outstanding as of March 14, 1997 was
28,462,502.
DOCUMENTS INCORPORATED BY REFERENCE
NONE
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2
Explanatory Note
PENNCORP FINANCIAL GROUP, INC.
ANNUAL REPORT ON FORM 10-K/A AMENDMENT NO. 4
FOR THE YEAR ENDED DECEMBER 31, 1996
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PART IV
Item 14. Exhibits Financial Statement Schedules, and Reports on Form 8-K...3
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3
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 10-K/A
AMENDMENT NO. 4
(a) Documents
1. Exhibits
99.1 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, which were filed on Form 8-K on November 14,
1997.
99.2 Consent of KPMG Peat Marwick LLP.
99.3 Consent of KPMG Peat Marwick LLP.
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4
(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.
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5
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
PENNCORP FINANCIAL GROUP, INC.
(The Registrant)
Dated: February 27, 1998 By: /s/ STEVEN W. FICKES
Steven W. Fickes
President and Chief Financial Officer
(Authorized officer and principal
accounting and financial officer of
the registrant)
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6
INDEX TO EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
------- -----------
99.1 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, which were filed on Form 8-K on November 14,
1997.
99.2 Consent of KPMG Peat Marwick LLP.
99.3 Consent of KPMG Peat Marwick LLP.
<PAGE> 1
EXHIBIT 99.1
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, 1996 and 1995, and the
related consolidated statements of income, shareholders' equity and cash flows
for each of the years in the three-year period ended December 31, 1996. In
connection with our audits of the consolidated financial statements, we have
also audited the financial statement schedules as listed in the accompanying
index. These consolidated financial statements and financial statement schedules
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these consolidated financial statements and financial
statement schedules 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 at December 31, 1996 and 1995, and the results of
their operations and their cash flows for each of the years in the three-year
period ended December 31, 1996, in conformity with generally accepted accounting
principles. Also, in our opinion, the related financial statement schedules,
when considered in relation to the basic consolidated financial statements taken
as a whole, present fairly, in all material respects, the information set forth
therein.
/s/KPMG PEAT MARWICK LLP
Raleigh, North Carolina
February 28, 1997
(except as to Note 19 which is as of November 14, 1997)
<PAGE> 2
CONSOLIDATED STATEMENTS OF INCOME
(As restated)
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FOR THE YEARS ENDED DECEMBER 31,
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE INFORMATION) 1996 1995 1994
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REVENUES:
Premiums, principally accident and sickness $ 256,859 $ 239,010 $ 214,674
Interest sensitive policy product charges 91,231 62,879 29,748
Net investment income 210,734 102,291 51,850
Other income 22,666 17,076 1,056
Net gains (losses) from the sale of investments 1,257 3,770 (3,556)
--------- --------- ---------
Total revenues 582,747 425,026 293,772
--------- --------- ---------
BENEFITS AND EXPENSES:
Claims incurred 188,727 141,876 112,650
Change in liability for future policy benefits and other
policy benefits 83,184 20,047 (9,329)
Amortization of present value of insurance in force and
deferred policy acquisition costs 56,470 51,535 28,466
Amortization of costs in excess of net assets acquired 8,648 6,486 5,241
Underwriting and other administrative expenses 116,560 106,105 77,817
Interest and amortization of deferred debt issuance costs 18,579 19,520 18,274
--------- --------- ---------
Total benefits and expenses 472,168 345,569 233,119
--------- --------- ---------
Income before income taxes, undistributed earnings in
unconsolidated affiliates and extraordinary charge 110,579 79,457 60,653
Income taxes 40,957 27,829 22,163
--------- --------- ---------
Net income before undistributed earnings in unconsolidated
affiliates and extraordinary charge 69,622 51,628 38,490
Undistributed earnings in unconsolidated affiliates 21,037 4,718 --
--------- --------- ---------
Net income before extraordinary charge 90,659 56,346 38,490
Extraordinary charge (net of income taxes of $1,277, $- and $-) (2,372) -- --
--------- --------- ---------
Net income 88,287 56,346 38,490
Preferred stock dividend requirements 14,646 6,540 1,151
--------- --------- ---------
Net income applicable to common stock $ 73,641 $ 49,806 $ 37,339
========= ========= =========
PER SHARE INFORMATION:
Primary:
Net income applicable to common stock before extraordinary charge $ 2.67 $ 2.17 $ 1.88
Extraordinary charge, net of income taxes (0.08) -- --
--------- --------- ---------
Net income applicable to common stock $ 2.59 $ 2.17 $ 1.88
========= ========= =========
Common shares used in computing primary earnings per share 28,462 22,985 19,830
========= ========= =========
Fully diluted:
Net income applicable to common stock before extraordinary charge $ 2.49 $ 2.09
Extraordinary charge, net of income taxes (0.07) --
--------- ---------
Net income applicable to common stock $ 2.42 $ 2.09
========= =========
Common shares used in computing fully diluted earnings per share 35,229 25,566
========= =========
</TABLE>
See accompanying Notes to Consolidated Financial Statements
<PAGE> 3
CONSOLIDATED BALANCE SHEETS
(As restated)
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(AMOUNTS IN THOUSANDS, EXCEPT SHARE INFORMATION) AS OF DECEMBER 31,
1996 1995
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ASSETS:
Investments:
Fixed maturity securities:
Held for investment, at amortized cost (fair value $89,759 in 1996 and $51,354 in 1995) $ 87,330 $ 51,366
Available for sale, at fair value (amortized cost $2,941,268 in 1996 and $1,414,187 in 1995) 2,993,925 1,486,985
Equity securities available for sale, at fair value (cost $17,511 in 1996 and $13,707 in 1995) 20,867 15,172
Trading securities, at fair value 31,140 86,104
Mortgage loans on real estate, net of allowance of $4,211 in 1996 and $- in 1995 264,732 36,563
Policy loans 145,976 125,179
Short term investments 63,113 416,953
Other investments 48,062 30,332
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Total investments 3,655,145 2,248,654
Cash 39,464 40,325
Accrued investment income 48,360 30,992
Accounts and notes receivable, net of allowance of $6,528 in 1996 and $8,388 in 1995 47,295 39,445
Investments in unconsolidated affiliates 140,526 121,325
Present value of insurance in force 339,010 283,106
Deferred policy acquisition costs 252,428 185,570
Costs in excess of net assets acquired 148,080 122,398
Other assets 139,015 71,103
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Total assets $ 4,809,323 $ 3,142,918
=========== ===========
LIABILITIES:
Policy liabilities and accruals:
Future policy benefits $ 3,481,148 $ 2,145,721
Policy and contract claims 44,878 36,429
Other policyholder funds 40,429 39,011
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Total policy liabilities and accruals 3,566,455 2,221,161
Income taxes payable, primarily deferred 55,840 23,713
Notes payable 210,325 307,271
Accrued expenses and other liabilities 114,462 101,638
----------- -----------
Total liabilities 3,947,082 2,653,783
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Mandatorily redeemable preferred stock:
Series B, $.01 par value, $100 initial redemption value; authorized, issued and
outstanding 127,500 in 1996 and 1995 14,689 13,307
Series C, $.01 par value, $100 initial redemption value; authorized, issued and
outstanding 178,500 in 1996 and 1995 18,175 16,700
SHAREHOLDERS' EQUITY:
$3.375 Convertible Preferred Stock, $.01 par value, $50 redemption value;
authorized issued and outstanding 2,300,000 in 1996 and 1995 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 1996 139,157 --
Common stock, $.01 par value; authorized 50,000,000; issued and outstanding
28,647,714 in 1996 and 22,879,708 in 1995 286 229
Additional paid-in capital 393,156 220,482
Unrealized foreign currency translation losses (14,961) (15,529)
Unrealized gains on securities available for sale 20,064 30,353
Retained earnings 186,032 117,987
Treasury shares (189,750 in 1996 and 1995) (3,370) (3,370)
Notes receivable secured by common stock (1,500) (1,537)
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Total shareholders' equity 829,377 459,128
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Total liabilities and shareholders' equity $ 4,809,323 $ 3,142,918
=========== ===========
</TABLE>
See accompanying Notes to Consolidated Financial Statements
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CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(As restated)
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(AMOUNTS IN THOUSANDS) FOR THE YEARS ENDED DECEMBER 31,
1996 1995 1994
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CONVERTIBLE PREFERRED STOCK:
Balance at beginning of year $ 110,513 $ -- $ --
Issuance of convertible preferred stock 139,157 110,513 --
--------- --------- ---------
Balance at end of year 249,670 110,513 --
--------- --------- ---------
COMMON STOCK:
Balance at beginning of year 229 191 191
Issuance of common stock 56 38 --
Exercise of stock options 1 -- --
--------- --------- ---------
Balance at end of year 286 229 191
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ADDITIONAL PAID-IN CAPITAL:
Balance at beginning of year 220,482 169,310 169,301
Issuance of common stock 170,393 51,172 --
Exercise of stock options 2,281 -- --
Treasury stock awarded to employees, net of unearned award -- -- 9
--------- --------- ---------
Balance at end of year 393,156 220,482 169,310
--------- --------- ---------
UNREALIZED FOREIGN CURRENCY TRANSLATION LOSSES:
Balance at beginning of year (15,529) (17,875) (13,118)
Change in unrealized foreign currency translation losses during
the year, net of income taxes 568 2,346 (4,757)
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Balance at end of year (14,961) (15,529) (17,875)
--------- --------- ---------
UNREALIZED GAINS (LOSSES) ON SECURITIES AVAILABLE FOR SALE:
Balance at beginning of year 30,353 (24,454) --
Cumulative effect of accounting change, net of income taxes -- -- 9,328
Equity in unrealized losses of unconsolidated affiliate (6,045) -- --
Change in unrealized gains (losses) on securities available for
sale during the year, net of income taxes (4,244) 54,807 (33,782)
--------- --------- ---------
Balance at end of year 20,064 30,353 (24,454)
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RETAINED EARNINGS:
Balance at beginning of year 117,987 69,475 33,003
Net income 88,287 56,346 38,490
Dividends on common stock (5,630) (1,327) (765)
Amortization of discount and dividends on preferred stock (14,646) (6,540) (1,151)
Treasury stock awarded to employees, net of unearned award -- -- (102)
Earned portion of treasury stock awarded to employees 34 33 --
--------- --------- ---------
Balance at end of year 186,032 117,987 69,475
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TREASURY SHARES:
Balance at beginning of year (3,370) (386) (280)
Purchases of treasury shares -- (2,984) (232)
Treasury shares awarded to employees, net of unearned award -- -- 126
--------- --------- ---------
Balance at end of year (3,370) (3,370) (386)
--------- --------- ---------
NOTES RECEIVABLE SECURED BY COMMON STOCK: (1,500) (1,537) (115)
--------- --------- ---------
Total shareholders' equity $ 829,377 $ 459,128 $ 196,146
========= ========= =========
</TABLE>
See accompanying Notes to Consolidated Financial Statements
<PAGE> 5
CONSOLIDATED STATEMENTS OF CASH FLOWS
(As restated)
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<CAPTION>
(AMOUNTS IN THOUSANDS) FOR THE YEARS ENDED DECEMBER 31,
1996 1995 1994
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CASH FLOWS FROM OPERATING ACTIVITIES:
Net income before undistributed earnings in unconsolidated affiliates and
extraordinary charge $ 69,622 $ 51,628 $ 38,490
Adjustments to reconcile net income before undistributed earnings in unconsolidated
affiliates and extraordinary charge to net cash provided by operating activities:
Capitalization of deferred policy acquisition costs (98,140) (84,089) (58,509)
Amortization of present value of insurance in force, deferred policy acquisition costs,
intangibles, depreciation and accretion, net 63,588 54,160 36,453
Increase (decrease) in policy liabilities and accruals and other policyholder funds 77,549 4,531 (39,701)
Purchases of trading securities -- (1,031) --
Sales of trading securities 56,004 47,145 --
Other, net (16,476) 12,701 28,835
--------- --------- ---------
Net cash provided by operating activities 152,147 85,045 5,568
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Cash expended in acquisition of businesses, net of cash acquired
of $-, $- and $12,931 (99,596) (18,363) (89,137)
Purchases of fixed maturity securities held for investment (27,000) (15,950) (472)
Purchases of fixed maturity securities available for sale (920,430) (188,388) (174,872)
Purchases of equity securities (8,398) (13,415) (8,294)
Purchase of affiliate -- (107,366) --
Maturities of fixed maturity securities held for investment 42,351 6,214 18,098
Maturities of fixed maturity securities available for sale 81,538 27,198 41,370
Sales of fixed maturity securities held for investment 4,910 -- --
Sales of fixed maturity securities available for sale 368,331 99,804 83,182
Sales of equity securities 5,328 9,993 9,574
Decrease (increase) in short-term investments, net
(including changes in amounts due to broker) 412,687 39,392 (20,269)
Acquisitions and originations of mortgage loans (112,473) -- --
Sales of mortgage loans 151,972 -- --
Principal collected on mortgage loans 21,657 -- --
Other, net 4,521 (3,288) (3,553)
--------- --------- ---------
Net cash used in investing activities (74,602) (164,169) (144,373)
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of notes payable 230,000 130,783 83,500
Issuance of common stock 155,450 51,210 --
Issuance of preferred stock 139,157 110,513 33,034
Purchases of treasury stock -- (2,984) (232)
Reduction of notes payable (330,624) (91,507) (5,271)
Redemption of preferred stock -- (33,415) --
Receipts from interest sensitive products credited to policyholders' account balances 160,403 91,175 47,497
Return of policyholders' account balances on interest sensitive products (365,554) (144,413) (45,426)
Repurchase agreement, net (52,839) -- --
Other, primarily dividends, net (14,399) (4,950) --
--------- --------- ---------
Net cash provided (used) by financing activities (78,406) 106,412 113,102
--------- --------- ---------
Net increase (decrease) in cash (861) 27,288 (25,703)
CASH AT BEGINNING OF YEAR 40,325 13,037 38,740
--------- --------- ---------
CASH AT END OF YEAR $ 39,464 $ 40,325 $ 13,037
========= ========= =========
SUPPLEMENTAL DISCLOSURES:
Income taxes paid (refunded) $ (4,992) $ 787 $ 2,474
Interest paid 18,185 20,001 15,443
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 affiliate -- 11,114 --
</TABLE>
See accompanying Notes to Consolidated Financial Statements
<PAGE> 6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (As restated)
(1) BASIS OF PRESENTATION
PennCorp Financial Group. Inc. (the "Company" or "PennCorp") is an insurance
holding company. The Company commenced operations with the acquisition of
Pennsylvania Life Insurance Company ("PLIC") and Executive Fund Life Insurance
Company (which was merged into PLIC effective July 1, 1996) and Pacific Life
and Accident Insurance Company ("PLAIC") on August 23, 1990. Through its
wholly-owned life insurance subsidiaries, 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"), Salem Life Insurance
Corporation ("Salem Life") and its wholly-owned subsidiaries Integon Life
Insurance Corporation ("ILIC"), Georgia International Life Insurance Company
and Occidental Life Insurance Company of North Carolina ("OLIC") (Salem Life
and its wholly-owned subsidiaries collectively referred to as "Integon Life"),
United Life and Annuity Insurance Company ("United Life"), Marketing One, Inc.
("Marketing One"), a third party marketing organization, and 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 information, are stated in thousands.
The financial statements and certain notes thereto have been restated as
discussed in Note 19.
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 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 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 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
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
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 market.
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.
Effective January 1, 1994, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and
Equity Securities," which was issued by the Financial Accounting Standards Board
("FASB") in May 1993. Since December 1991, the Company has utilized concepts
considered in SFAS No. 115 regarding the classification of investments in debt
securities. The implementation of SFAS No. 115 has resulted in the Company
reflecting certain invested assets at fair value rather than lower of aggregate
cost or market as was the previous accounting practice. As of January 1, 1994
the adoption of SFAS No. 115 resulted in an increase in the value reflected in
the financial statements for the fixed maturity securities available for sale of
approximately $14,351 and an increase in shareholders' equity of $9,328, net of
deferred tax.
<PAGE> 7
Notes to Consolidated Financial Statements, continued
In November 1995, the FASB announced that for the year ended December 31, 1995,
companies that are subject to the reporting requirements of SFAS No. 115 would
have a one-time opportunity to reclassify securities currently classified as
held for investment without the risk of tainting the accounting for investments
on a historical basis. The Company has evaluated the securities contained in
this portfolio and has determined under which conditions it may dispose of such
securities. In light of this review, the Company has reclassified approximately
$61,410 of securities which were previously classified as held for investment to
available for sale. The result of such reclassification was to increase
shareholders' equity by $1,198, net of applicable deferred income taxes.
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.
POLICY LIABILITIES
Liabilities for future policy benefits 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.
ACCOUNTS AND NOTES RECEIVABLE
Accounts and notes receivable consist primarily of agents' balances and premiums
receivable from agents and policyholders in the United States and Canada.
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.
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
on 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.
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 $144,327 and $118,601 as
of December 31, 1996 and 1995, respectively.
<PAGE> 8
Notes to Consolidated Financial Statements, continued
NET INCOME PER COMMON SHARE
Net income per common share is determined after recognition of preferred stock
dividends and accretion of discount on preferred stock and is based on the
weighted average number of common shares outstanding during the year after
giving consideration to the dilutive effect of stock options and stock warrants.
Fully diluted net income per share assumes the conversion of convertible
preferred stock.
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 Accounting Principles Board Opinion ("APB") No. 25, "Accounting for Stock
Issued to Employees", and related Interpretations. Note 12 of the Consolidated
Financial Statements contains a summary of the pro forma effects to reported net
income applicable to common stock and earnings per share for 1996 and 1995, if
the Company had elected to account for employee stock compensation plans
utilizing the fair value methodology prescribed by SFAS No. 123.
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
$35,061 and $26,413 as of December 31, 1996 and 1995, respectively.
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.
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 differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases and 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.
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 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.
RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform to the current year
presentation.
<PAGE> 9
Notes to Consolidated Financial Statements, continued
(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 $81,500 resulting in $28,556 of costs
in excess of net assets acquired.
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 cost basis. The purchase allocation is
preliminary and is expected to be completed by June 30, 1997.
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 $6,378 resulting in
$42,218 of costs in excess of net assets acquired.
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 Holdings
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.
On August 31, 1994, the Company consummated the acquisition of AA Life for a
total cash purchase price of $103,392 including acquisition expenses of $1,865.
The fair value of net assets acquired was $86,880 resulting in $16,512 of costs
in excess of net assets acquired.
The AA 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 cost basis.
The results of operations of the acquired companies are included in the
accompanying financial statements since the respective acquisition dates.
The following unaudited pro forma data represents the Company's consolidated
results of operations as if (i) the Integon Life and AA Life acquisitions
occurred as of January 1, 1994, and (ii) the United Life acquisition occurred as
of January 1, 1995. This unaudited pro forma data has been prepared for
comparative purposes only and does not purport to be indicative of what would
have occurred had the acquisitions been made as of January 1, 1995 and 1994,
respectively, or results which may occur in the future.
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE INFORMATION)
<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------
FOR THE YEARS ENDED DECEMBER 31, 1996 1995 1994
-------------------------------------------------------- -------- -------- --------
<S> <C> <C> <C>
Total revenues $652,781 $642,914 $484,181
Income before income taxes, undistributed earnings in
unconsolidated affiliates and extraordinary charge 118,563 107,922 53,851
Net income applicable to common stock 78,752 50,857 31,038
Per share information:
Net income applicable to common stock - primary 2.65 1.73 1.23
Net income applicable to common stock - fully diluted 2.48 1.71
</TABLE>
<PAGE> 10
Notes to Consolidated Financial Statements, continued
(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 for the years ended December 31 were as follows:
<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------
1996 1995 1994
---------- ---------- ----------
<S> <C> <C> <C>
TOTAL REVENUES:
Insurance operations
U.S
Fixed benefit products $ 147,226 $ 162,747 $ 159,644
Life products 252,902 174,934 91,322
Accumulation products 109,374 32,378 --
Canada
Fixed benefit products 45,695 40,596 37,641
Life products 6,690 6,430 5,618
Non-insurance operations, corporate and eliminations 20,860 7,941 (453)
---------- ---------- ----------
$ 582,747 $ 425,026 $ 293,772
========== ========== ==========
INCOME BEFORE INCOME TAXES, UNDISTRIBUTED EARNINGS
IN UNCONSOLIDATED AFFILIATES AND EXTRAORDINARY
CHARGE:
Insurance operations
U.S
Fixed benefit products $ 38,333 $ 48,045 $ 20,410
Life products 47,920 27,202 41,305
Accumulation products 26,893 12,389 --
Canada
Fixed benefit products 15,435 15,568 13,007
Life products 642 2,451 1,391
Non-insurance operations, corporate and eliminations (18,644) (26,198) (15,460)
---------- ---------- ----------
$ 110,579 $ 79,457 $ 60,653
========== ========== ==========
</TABLE>
Total assets as of December 31 were as follows:
<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------------
1996 1995
---------- ----------
<S> <C> <C>
TOTAL ASSETS:
Insurance operations
U.S
Fixed benefit products $ 480,408 $ 441,760
Life products 1,677,150 1,496,110
Accumulation products 2,339,787 940,565
Canada
Fixed benefit products 139,887 120,011
Life products 43,613 39,357
Non-insurance operations, corporate and eliminations 128,478 105,115
---------- ----------
$4,809,323 $3,142,918
========== ==========
</TABLE>
<PAGE> 11
Notes to Consolidated Financial Statements, continued
(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 1995
-----------------------------------------------
AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE
-----------------------------------------------
<S> <C> <C> <C> <C>
Canadian government obligations $80,492 $88,671 $61,245 $66,374
======= ======= ======= =======
</TABLE>
The amortized cost and fair value of investments in fixed maturities held for
investment as of December 31 were as follows:
<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>
<TABLE>
<CAPTION>
1995
--------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Corporate securities $ 51,366 $ -- $ 12 $ 51,354
======== ======== ======== ========
</TABLE>
The amortized cost and fair value of investments in fixed maturities available
for sale as of December 31 were as follows:
<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>
<TABLE>
<CAPTION>
1995
----------------------------------------------------------
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 $ 484,945 $ 23,288 $ 1,880 $ 506,353
U.S. Treasury securities and obligations of
U.S. Government corporations and agencies 363,305 18,207 980 380,532
Debt securities issued by foreign governments 61,245 5,210 81 66,374
Corporate securities 504,692 33,486 4,452 533,726
---------- ---------- ---------- ----------
$1,414,187 $ 80,191 $ 7,393 $1,486,985
========== ========== ========== ==========
</TABLE>
<PAGE> 12
Notes to Consolidated Financial Statements, continued
The amortized cost and fair value of fixed maturities held for investment as of
December 31, 1996, by contractual maturity, are shown below:
<TABLE>
<CAPTION>
AMORTIZED FAIR
COST VALUE
-------- --------
<S> <C> <C>
Due in one year or less $ 5,223 $ 5,223
Due after 1 through 5 years 16,793 16,854
Due after 5 through 10 years 30,768 30,829
Mortgage-backed securities, principally
obligations of U.S. Government agencies 34,546 36,853
-------- --------
$ 87,330 $ 89,759
======== ========
</TABLE>
The amortized cost and fair value of fixed maturities available for sale as of
December 31, 1996, by contractual maturity, are shown below:
<TABLE>
<CAPTION>
--------------------------------------------------------------------------------
AMORTIZED FAIR
COST VALUE
---------- ----------
<S> <C> <C>
Due in one year or less $ 126,527 $ 127,588
Due after 1 through 5 years 340,267 348,026
Due after 5 through 10 years 781,999 798,307
Due after 10 years 284,351 291,680
Mortgage-backed securities, principally
obligations of U.S. Government agencies 1,408,124 1,428,324
---------- ----------
$2,941,268 $2,993,925
========== ==========
</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 and
1995, are below investment-grade securities with an amortized cost, which
approximates fair value, of $34,624 and $39,281, respectively. Included in fixed
maturities held for investment as of December 31, 1996, are unrated securities
with an amortized cost of $46,413 and a fair value of $48,831.
Included in fixed maturities available for sale as of December 31, 1996 and
1995, are below investment-grade securities with an amortized cost of $91,590
and $30,556 and a fair value of $92,494 and $33,541, respectively. Included in
fixed maturities available for sale as of December 31, 1996, are unrated
securities with an amortized cost of $92,315 and a fair value of $92,752.
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. As of December 31, 1995, net unrealized
appreciation in equity securities available for sale of $1,465 consisted of
gross unrealized gains of $2,031, less gross unrealized losses of $566.
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
$264,732 and $36,563, respectively, and, fair values of approximately $269,142
and $37,190, respectively, as of December 31, 1996 and 1995. The fair values for
mortgage loans on real estate are estimated using the quoted market prices for
securities collateralized 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.
<PAGE> 13
Notes to Consolidated Financial Statements, continued
As of December 31, 1996, 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 $43,688 16.5%
Florida 41,448 15.7
Colorado 32,385 12.3
Virginia 18,410 6.9
Tennessee 16,308 6.2
Alabama 15,598 5.9
Louisiana 14,337 5.4
All other 82,558 31.1
-------- -----
$264,732 100.0%
======== =====
</TABLE>
Investments with a carrying value of $62,767 and $49,036 were on deposit with
certain regulatory authorities as of December 31, 1996 and 1995, respectively.
Realized, and changes in unrealized gains and losses, on investments for the
years ended December 31 were as follows:
<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------
1996 1995 1994
--------- --------- ---------
<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 (2,186)
--------- --------- ---------
(133) 1 (2,186)
Securities available for sale:
Gross gains from sales 2,562 6,185 182
Gross losses from sales (1,800) (2,616) (1,572)
Net gains (losses) from redemptions (166) 201 20
--------- --------- ---------
596 3,770 (1,370)
Mortgage loans 794 -- --
--------- --------- ---------
Net realized gains (losses) $ 1,257 $ 3,770 $ (3,556)
========= ========= =========
CHANGES IN UNREALIZED GAINS (LOSSES):
Securities held for investment $ 2,441 $ 3,563 $ (9,639)
Securities available for sale (18,250) 111,732 (51,972)
--------- --------- ---------
Net change in unrealized gains (losses) $ (15,809) $ 115,295 $ (61,611)
========= ========= =========
TRADING PORTFOLIO:
Net gains from sales $ 4,930 $ 1,830
Net change in unrealized gains (losses) (3,626) 3,880
--------- ---------
Total trading gains $ 1,304 $ 5,710
========= =========
</TABLE>
Major categories of net investment income for the years ended December 31,
consisted of the following:
<TABLE>
<CAPTION>
------------------------------------------------------------------------
1996 1995 1994
--------- --------- --------
<S> <C> <C> <C>
Fixed maturity securities $ 169,847 $ 70,715 $ 44,759
Mortgage loans on real estate 11,888 2,783 1,702
Policy loans 8,409 5,240 2,725
Short term investments 12,966 16,891 1,641
Other investments 13,100 10,168 2,291
--------- --------- --------
Gross investment income 216,210 105,797 53,118
Less: investment expenses 5,476 3,506 1,268
--------- --------- --------
Net investment income $ 210,734 $ 102,291 $ 51,850
========= ========= ========
</TABLE>
The Company had non-income producing fixed maturity investments with an
amortized cost of $17,115 and $10,184 as of December 31, 1996 and 1995,
respectively.
<PAGE> 14
Notes to Consolidated Financial Statements, continued
(6) SOUTHWESTERN LIFE INVESTMENT
On December 14, 1995, Southwestern Financial Corporation ("SW Financial"), a
newly organized corporation formed by the Company and Knightsbridge Capital Fund
I, L.P. ("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
preferred stock of SW Financial. 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%
As part of the SW Financial investment, PennCorp, the Knightsbridge Fund and its
affiliates and SW Financial entered into a 10-year stockholders agreement. The
agreement includes customary provisions for corporate governance (including the
right to elect or appoint members of the Board of Directors of SW Financial),
"drag-along" and "tag-along" rights and "demand" and "piggy-back" registration
rights. In addition, each issuance of preferred stock of SW Financial and its
subsidiaries held by PennCorp allows for class voting rights under certain
circumstances.
SW Financial has restated its financial statements for the year ended December
31, 1996. The restatement resulted from SW Financial reconsidering certain
accounting practices.
The significant accounting practices incorporated in the restatement are as
follows:
(i) the recognition of investment income (approximately $182 reduction in net
income for the year ended December 31, 1996); and
(ii) the allocation of purchase consideration (approximately $99 increase in
net income for the year ended December 31, 1996).
The consolidated condensed results of operations and financial position of SW
Financial, accounted for utilizing the equity method, are provided below:
<TABLE>
<CAPTION>
(AS RESTATED)
- -----------------------------------------------------------------------------------------------------------------------------------
FOR THE YEAR ENDED FOR THE PERIOD
DECEMBER 31,1996 DECEMBER 14-31, 1995
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
REVENUES:
Policy revenues $196,912 $ 12,668
Net investment income 128,692 6,015
Other income (including limited partnership distributions of 15,811 in 1996) 27,439 54
Net gains from the sale of investments 516 --
-------- --------
Total revenues 353,559 18,737
BENEFITS AND EXPENSES:
Claims incurred 211,460 15,831
Change in liability for future policy benefits and
other policy benefits (13,616) (2,318)
Insurance and other operating expenses 92,632 2,577
Interest and amortization of deferred debt issuance costs 14,052 664
-------- --------
Total benefits and expenses 304,528 16,754
-------- --------
Income before income taxes 49,031 1,983
Income taxes 18,149 694
-------- --------
Net income 30,882 1,289
Preferred stock dividend requirements 2,754 205
-------- --------
Net income applicable to common stock $ 28,128 $ 1,084
======== ========
</TABLE>
<TABLE>
<CAPTION>
(AS RESTATED)
------------------------------------------------------------------------------
AS OF DECEMBER 31, 1996 1995
----------------------------------------------------- ---------- -----------
<S> <C> <C>
ASSETS:
Invested assets $1,641,348 $ 1,711,174
Insurance assets 107,230 115,831
Other assets 459,324 384,454
---------- -----------
Total assets $2,207,902 $ 2,211,459
========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY:
Insurance liabilities $1,745,160 $ 1,821,292
Long-term debt 159,750 160,000
Other liabilities 127,237 74,826
Redeemable preferred stock 33,879 31,099
Shareholders' equity 141,876 124,242
---------- -----------
Total liabilities and shareholders' equity $2,207,902 $ 2,211,459
========== ===========
</TABLE>
<PAGE> 15
Notes to Consolidated Financial Statements, continued
(7) DEFERRED POLICY ACQUISITION COSTS AND PRESENT VALUE OF INSURANCE IN
FORCE
Deferred policy acquisition costs represent commissions, certain costs of policy
issuance, including underwriting, certain variable agency costs and marketing
costs and other costs directly associated with those functions to the extent
such costs are determined to vary with and are primarily related to the
production of new business.
Information relating to these costs for the years ended December 31, is as
follows:
<TABLE>
<CAPTION>
1996 1995 1994
--------- --------- ---------
<S> <C> <C> <C>
Balance as of January 1 $ 185,570 $ 131,006 $ 83,179
Policy acquisition costs deferred:
Commissions 49,775 50,528 32,140
Underwriting and issue costs 48,365 33,561 26,369
--------- --------- ---------
98,140 84,089 58,509
Policy acquisition costs amortized (30,744) (29,007) (9,938)
Unrealized investment loss adjustment (461) (1,007) -
Foreign currency translation adjustment (77) 489 (744)
--------- --------- ---------
Balance as of December 31 $ 252,428 $ 185,570 $ 131,006
========= ========= =========
</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 the 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.
<PAGE> 16
Notes to Consolidated Financial Statements, continued
Information related to the present value of insurance in force is as follows:
<TABLE>
<CAPTION>
1996 1995 1994
--------- --------- ---------
<S> <C> <C> <C>
Balance as of January 1 $ 283,106 $ 199,705 $ 163,080
Addition due to acquisition 69,077 132,949 56,000
Accretion of interest 27,205 22,260 16,044
Amortization (52,931) (44,788) (34,573)
Unrealized investment gain (loss) adjustment 12,582 (27,425) -
Foreign currency translation adjustment (29) 405 (846)
--------- --------- ---------
Balance as of December 31 $ 339,010 $ 283,106 $ 199,705
========= ========= =========
</TABLE>
Expected gross amortization, based upon current assumptions and accretion of
interest at a policy liability or contract rate ranging from 3.5% to 14.5%, 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> <C>
1997 $339,010 $ 61,446 $ 24,420 $ 37,026
1998 301,984 53,591 22,092 31,499
1999 270,485 48,356 19,913 28,443
2000 242,042 43,417 17,936 25,481
2001 216,561 37,724 16,129 21,595
</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 products 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.
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.
The following table presents information on changes in the liability for
accident and sickness claims for the years ended December 31:
<TABLE>
<CAPTION>
1996 1995 1994
--------- --------- ---------
<S> <C> <C> <C>
Claim liability at January 1 $ 127,078 $ 126,920 $ 136,043
Less reinsurance recoverables 1,372 2,050 2,750
--------- --------- ---------
Net balance at January 1 125,706 124,870 133,293
--------- --------- ---------
Addition due to acquisition 1,079 1,095 -
--------- --------- ---------
Add claims incurred during the year related to:
Current year 63,673 62,106 76,686
Prior years (6,816) (2,855) (579)
--------- --------- ---------
Total incurred 56,857 59,251 76,107
--------- --------- ---------
Less claims paid during the year related to:
Current year 19,057 20,346 32,828
Prior years 36,435 39,164 51,702
--------- --------- ---------
Total paid 55,492 59,510 84,530
--------- --------- ---------
Net balance at December 31 128,150 125,706 124,870
Plus reinsurance recoverables 2,242 1,372 2,050
--------- --------- ---------
Claim liability at December 31* $ 130,392 $ 127,078 $ 126,920
========= ========= =========
</TABLE>
* Included in the balance sheet captions "future policy benefits" and "policy
and contract claims".
<PAGE> 17
Notes to Consolidated Financial Statements, continued
(9) NOTES PAYABLE
The outstanding principal amounts of the notes payable consist of the following
as of December 31:
<TABLE>
<CAPTION>
1996 1995
--------- --------
<S> <C> <C>
Unsecured 9 1/4% Senior Subordinated Notes due 2003 (a) $ 114,646 $150,000
Bank Debt due in 1996 (b) - 100,000
Bank Debt with annual principal requirement (c) - 57,000
Revolving bank credit facility (d) 92,000 -
Unsecured 9% Notes payable due December 31, 1996 - 271
Other 3,679 -
--------- --------
$ 210,325 $307,271
========= ========
</TABLE>
(a) Interest costs under the Notes totaled $13,545, $14,463 and $15,206
during 1996, 1995 and 1994, respectively. At December 31, 1996, the
effective rate for the Notes was approximately 9.6 percent.
(b) Interest costs under the $100,000 credit facility totaled $1,701 and
$362 in 1996 and 1995, respectively. The effective rate of interest
charged on amounts outstanding during 1996 was 7.2 percent.
(c) Interest costs under the $57,000 in bank debt totaled $836 and $3,839
in 1996 and 1995, respectively. The effective rate of interest charged
on amounts outstanding during 1996 was 8.1 percent.
(d) Interest costs under the $175,000 revolving credit facility totaled
$1,558 in 1996. The effective rate of interest charged was 6.0% during
1996 on a weighted average outstanding balance of $25,861.
The fair value of amounts outstanding as notes payable for the years ended
December 31, 1996 and 1995, amounted to $215,341 and $311,771, 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, 1996, are as follows: 1997, $570; 1998, $617; 1999, $668; 2000,
$724; 2001, $92,951.
All of the Company's debt obligations contain financial and operating covenants.
The Company and its subsidiaries were in compliance with all applicable
covenants as of December 31, 1996.
The Company realized an after-tax extraordinary charge of $2,372 for the year
ended December 31, 1996. 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 AA Life, PLAIC, and
Salem Life groups each file a consolidated federal life insurance company income
tax return on a calendar year basis with their life insurance subsidiaries.
Total income taxes for the years December 31, 1996, 1995, and 1994 were
allocated as follows:
<TABLE>
<CAPTION>
--------------------------------------------------------
1996 1995 1994
-------- -------- ---------
<S> <C> <C> <C>
Income from operations $ 40,957 $ 27,829 $ 22,163
Extraordinary item (1,277) - -
Shareholders' equity (1,864) 28,493 (13,015)
-------- -------- ---------
$ 37,816 $ 56,322 $ 9,148
======== ======== =========
</TABLE>
<PAGE> 18
Notes to Consolidated Financial Statements, continued
The provisions for income tax expense (benefit) attributable to income before
extraordinary charge for the years ended December 31, 1996, 1995 and 1994, are
as follows:
<TABLE>
<CAPTION>
---------------------------------------------------------
1996 1995 1994
-------- -------- --------
<S> <C> <C> <C>
Current U.S. $ (1,285) $ (1,311) $ 1,174
Current foreign 2,319 4,519 2,210
Deferred U.S. 35,482 22,516 18,036
Deferred foreign 4,441 2,105 661
Charge in lieu of tax - - 82
-------- -------- --------
Income tax expense $ 40,957 $ 27,829 $ 22,163
======== ======== ========
</TABLE>
Taxes computed using the federal statutory rate of 35% in 1996, 1995 and 1994,
are reconciled to the Company's actual income tax expense attributable to income
before extraordinary charge as follows:
<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------
1996 1995 1994
-------- -------- --------
<S> <C> <C> <C>
Tax expense computed at statutory rate $ 38,702 $ 27,810 $ 21,229
Dividends received deduction (977) (85) (8)
Amortization of costs in excess of net assets acquired 3,040 2,275 1,834
Change in valuation allowance (1,265) (5,102) (2,388)
Foreign taxes net of U.S. tax benefit 1,507 2,937 1,437
Other (50) (6) 59
-------- -------- --------
Income tax expense $ 40,957 $ 27,829 $ 22,163
======== ======== ========
</TABLE>
Temporary differences between the financial statement carrying amounts and tax
bases of assets and liabilities that give rise to the deferred tax liabilities
at December 31, 1996 and 1995, relate to the following:
<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------------------------------------
1996 1995
----------------------------------------------------
DEFERRED DEFERRED DEFERRED DEFERRED
TAX TAX TAX TAX
ASSETS LIABILITIES ASSETS LIABILITIES
-------- ----------- -------- -----------
<S> <C> <C> <C> <C>
Deferred policy acquisition costs $ - $ 67,101 $ - $ 44,718
Present value of insurance and force - 91,135 - 97,960
Future policy benefits 67,940 - 82,506 -
Net operating losses 38,557 - 35,524 -
Foreign and alternative minimum tax credits 21,252 - 16,030 -
Unrealized gain on investment securities - 13,650 - 15,478
Other 23,048 17,267 35,545 20,639
-------- --------- -------- ---------
150,797 189,153 169,605 178,795
Valuation allowance (15,892) - (17,157) -
-------- --------- -------- ---------
$134,905 $ 189,153 $152,448 $ 178,795
======== ========= ======== =========
</TABLE>
The valuation allowance for deferred tax assets as of January 1, 1996 and 1995
was $17,157 and $17,261, respectively. The net change in the total valuation
allowance for the years ended December 31, 1996 and 1995, was a decrease of
$1,265 and of $104, respectively. If recognized as a tax benefit, a portion of
the valuation allowance totaling $7,349 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 at December 31, 1996.
At December 31, 1996, the Company has life consolidated net operating loss
carryforwards of approximately $100,009 for tax return purposes. In addition,
OLIC and Peninsular have available, on a separate return basis, acquired net
operating loss carryforwards of approximately $10,153. 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.
<PAGE> 19
Notes to Consolidated Financial Statements, continued
The approximate net operating loss carryforwards for income tax purposes expire
as follows:
<TABLE>
<CAPTION>
LIFE LIFE
CONSOLIDATED SEPARATE
EXPIRATION DATE RETURN RETURN
-------------------------------- ------------------------------- -------------------
<S> <C> <C> <C>
2004 $ - $ 5,072
2005 533 4,981
2006 - -
2007 15,967 -
2008 38,047 100
2009 9,985 -
2010 - -
2011 35,477 -
--------- --------
$ 100,009 $ 10,153
========= ========
</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 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, 1996, were $1,677. As of December 31, 1996, the
estimated fair value of the Series II Convertible Preferred Stock, based upon
market-maker quotes, was $170,703.
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 $1,939 and $557 on the Series B Preferred
Stock and $2,175 and $700 on the Series C Preferred Stock, respectively, as of
December 31, 1996 and 1995.
On March 15, 1997, the Company will redeem all of the previously outstanding
Series B Mandatory redeemable 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,
1996 and 1995 were $1,660. As of December 31, 1996, the estimated fair value of
the Convertible Preferred Stock, based upon active market quotes, was $193,200.
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 and 1994, the Company paid or accrued
dividends on the Series A Preferred Stock amounting to $1,725 and $1,151,
respectively.
<PAGE> 20
Notes to Consolidated Financial Statements, continued
(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>
1996 1995 1994
--------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
Number of shares subject to option/warrant:
Outstanding at beginning of year 2,329,754 $10.86 2,261,981 $ 9.61 2,221,034 $ 8.78
Granted 44,000 $31.09 110,000 $17.64 137,000 $15.84
Expired/canceled (59,000) $13.82 (42,227) $13.43 (96,053) $13.24
Exercised (147,867) $ 5.40 -- $ -- -- $ --
--------- ------ --------- ------ --------- ------
Outstanding at end of year 2,166,887 $11.56 2,329,754 $10.86 2,261,981 $ 9.61
========= ====== ========= ====== ========= ======
Exercisable at end of year 2,105,438 $11.00 -- $ -- -- $ --
========= ====== ========= ====== ========= ======
Available for future grant at end of year 2,792,000 144,063 262,024
========= ========= ====== =========
</TABLE>
The following table summarizes information concerning outstanding and
exercisable options and warrants as of December 31, 1996:
<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> <C>
$4.00 - $5.40 893,887 5.8 4.51 893,887 4.51
$14.00 - $19.58 1,229,000 6.2 15.96 1,211,551 15.78
$27.25 - $32.43 44,000 8.4 31.70 --- ---
--------- ---------
2,166,887 2,105,438
========= =========
</TABLE>
In accordance with 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 as a
component on net income. If the Company had elected to recognize compensation
cost based on the fair value of the options and warrants as of the grant date as
prescribed by SFAS No. 123, the reduction in net income applicable to common
stock and earnings per share would have been immaterial.
<PAGE> 21
Notes to Consolidated Financial Statements, continued
(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, Salem Life and Pioneer Security
(collectively, the "Surplus Note Companies"). The amounts outstanding under the
surplus debentures totaled $367.9 million and $315.8 million as of December 31,
1996 and 1995, respectively. 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 Company's cash flow is derived principally from dividends and principal and
interest payments on the surplus debentures issued by the insurance
subsidiaries.
Dividend payments of 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 1997, the insurance
subsidiaries will be able to pay a maximum of $27,165 in dividends to the
Company without prior regulatory approval. In 1997, the insurance subsidiaries,
subject to availability of cash, statutory capital and surplus and regulatory
approval, could pay a maximum of $50,730 of 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, 1996 and 1995, totaled
$264,080 and $151,293, respectively. Shareholders' equity of the Company's life
insurance subsidiaries included in the consolidated balance sheet totaled
$580,334 and $406,374 at December 31, 1996 and 1995, respectively. Statutory net
income (loss) of the Company's life insurance subsidiaries as reported to
regulatory authorities totaled $(28,600), $13,579 and $20,156 for the years
ended December 31, 1996, 1995 and 1994, respectively. Surplus note interest
expense of $51,254, $24,170 and $11,527 for the years ended December 31, 1996,
1995, and 1994, 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
$51,567 and $43,186 as of December 31, 1996 and 1995, respectively.
Remittances to PLIC from the Canadian operations totaled $-, $2,485 and $5,761
for the years ended December 31, 1996, 1995 and 1994, 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
participant's 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, 1996, 1995 and 1994, amounted to $1,520, $1,335 and $1,105, respectively.
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 $1,144, $691
and $180 under this plan during the years ended December 31, 1996, 1995 and
1994, respectively.
<PAGE> 22
Notes to Consolidated Financial Statements, continued
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 fully diluted earnings per share. Bonus awards range from
0% to 200% of a predetermined target annually. During 1996, the Company did not
accrue for such bonuses as the employment arrangements containing the bonus plan
are contingent upon the purchase by the Company of the Fickes and Stone
Knightsbridge Interests (see Notes 15 and 16 below).
Prior to its acquisition by the Company, Integon provided postretirement life
and health benefits for employees who retired at age 55 or later and agents who
retired at age 65 or later with 10 or more years of service. A closed group of
agent retirees under age 65 was also eligible for benefits. Spouses, surviving
spouses and dependent children were eligible for life and health benefits.
Retired employees under age 65 are covered by a health maintenance organization
under which benefits are generally paid at 100% after various copayments.
Retired agents or employees outside the service area are covered by a
self-funded indemnity plan which has a deductible with 20%-30% coinsurance.
Retirees contribute toward their own benefits and contributions are required for
spouses and dependent children. Under the plan, health benefits for retirees are
the same as before retirement, except amounts paid by Medicare are excluded from
consideration. The plan was terminated as of the date of acquisition.
Postretirement benefits are accrued (but not funded) for eligible retirees. The
components of the accumulated postretirement benefit obligation as of December
31 were as follows:
<TABLE>
<CAPTION>
1996 1995
------- -------
<S> <C> <C>
Retirees $ 5,279 $ 5,253
Fully eligible active plan participants - 1,778
Other active plan participants - 658
------- -------
Accrued postretirement benefit obligation $ 5,279 $ 7,689
======= =======
</TABLE>
For the year ended December 31, 1996, the postretirement benefit liability was
calculated assuming an annual trend rate in health care inflation of 8% in 1997
grading down to 5.5% in 2000 and after. If the health care cost trend rate
assumption increased by 1%, the accumulated postretirement benefit obligation as
of December 31, 1996, would increase $198 or 3.8%.
(15) RELATED PARTY TRANSACTIONS
During 1995, two of the Company's officers and directors, Messrs. Stone and
Fickes, formed a fund, Knightsbridge Capital Fund I, L.P., ("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. However, the
agreement provides that if either Mr. Stone or Mr. Fickes, or both, ceases to be
a member of Knightsbridge Capital or otherwise actively involved in the
management and operations of Knightsbridge, Knightsbridge may not subsequently
call additional capital from the limited partners. However, the limited partners
have consented to the Company's proposed acquisition of Messrs. Stone's and
Fickes' interests in Knightsbridge Capital.
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 Knightsbridge Management, L.L.C.
("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.
<PAGE> 23
Notes to Consolidated Financial Statements, continued
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.
In February 1996, the PennCorp Board of Directors (the "PennCorp Board") and the
principals of Knightsbridge began discussions on consolidating Messrs. Stone's
and Fickes' outside interests under PennCorp. Such discussions culminated in a
restructuring of the Knightsbridge relationship including the following
completed and pending transactions (see Note 16) (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 proposed acquisition of the Fickes and Stone
Knightsbridge Interests, (iii) the proposed acquisition of the Fickes and Stone
interests in SW Financial, subject to certain contingencies, and (iv) the
purchase by the Company, from the limited partners of Knightsbridge, the right
to acquire United Life for $7,575.
For the years ended December 31, 1996 and 1995, PennCorp paid or accrued $2,548
and $3,900 in transaction fees to KM related to the United Life and SW
Financial transactions, respectively. During 1996, certain of the Company's
affiliates and subsidiaries paid management fees to KM amounting to $2,190
which have been expensed in the accompanying financial statements pending the
shareholder vote on the acquisition of the Fickes and Stone Knightsbridge
Interests. SW Financial and United Life incurred KM investment advisory fees
totaling $2,426 and $- during 1996 and 1995, respectively. In addition,
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 $895, $738 and $789
during 1996, 1995 and 1994, respectively.
Certain individuals, who are shareholders, directors and officers of PennCorp,
and affiliates of these individuals, provide services to the Company. During
1996 and 1995, payments aggregating $250 and $210, respectively, were made to
these individuals and their affiliates for services provided in connection with
the Company's acquisition activity. During 1994, fees amounting to $813 were
paid in connection with the establishment of PennCorp's Canadian subsidiary, the
acquisition of AA Life, and certain reinsurance transactions.
(16) OTHER COMMITMENTS AND CONTINGENCIES
On January 22, 1997, the Company filed with the Securities and Exchange
Commission ("SEC"), a preliminary PennCorp Financial Group, Inc. and Washington
National Corporation Joint Proxy Statement and Prospectus ("Joint Proxy
Statement") in which the Company, pending final review by the SEC, will be
soliciting shareholder approval for the following transactions: (i) the
Washington National Merger, (ii) the acquisition of the Controlling Interest in
SW Financial, (iii) the acquisition of the Fickes and Stone Knightsbridge
Interests, and (iv) other items.
Under the terms of the amended and restated Washington National Merger
agreement, Washington National shareholders will receive the right to receive
$29.50 per share of consideration in the form of cash, PennCorp Common Stock, or
a combination of cash and PennCorp Common Stock. The aggregate consideration to
be received by the Washington National shareholders will be approximately
$377,000, of which no more than $100,000 will be payable in cash. (See Note 18.)
PennCorp will receive its right to acquire the Controlling Interest in SW
Financial through the assignment by Fickes and 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 $67,500 to $69,600 (not including expenses) depending
upon the outcome of certain contingencies.
<PAGE> 24
Notes to Consolidated Financial Statements, continued
In addition, PennCorp has proposed to acquire 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.
It is anticipated that PennCorp common shareholders will vote on the above
transactions in April 1997, and, subject to shareholder approval, the Company
intends to consummate such transactions as expeditiously as possible (see Note
18).
As part of an amended purchase agreement with the former parent company of
United Life, PennCorp agreed to purchase 483,839 shares of the Company's Common
Stock effective February 12, 1997 for an amount to be determined.
The Company and its subsidiaries are obligated under operating leases, primarily
for office space. Rent expense, net of sublease income, was $8,416, $8,489 and
$7,172 in 1996, 1995 and 1994, respectively.
<TABLE>
<S> <C> <C>
MINIMUM LEASE COMMITMENTS ARE:
1997 $ 8,806
1998 4,269
1999 2,852
2000 1,716
2001 796
2002 and thereafter 177
--------
Total minimum payments required* $ 18,616
========
</TABLE>
* Total minimum lease payments have not been reduced by minimum sublease rentals
of $947 due in the future under non-cancelable subleases.
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.
<PAGE> 25
Notes to Consolidated Financial Statements, continued
The defendants and the plaintiffs' counsel entered into a Stipulation and
Agreement of Compromise and Settlement dated March 28, 1997 (the "Proposed
Settlement") of the shareholder derivative actions. The Proposed Settlement
consists 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 the Company to purchase the SW Financial Controlling
Interest for $67.5 million, reducing the price to be paid by the Company for the
SW Financial Controlling Interest by approximately $2.0 million, (ii) the
Company's Board of Directors 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 Company's Board
of Directors 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 Company's Board of Directors will
submit the purchase of The Fickes and Stone Knightsbridge Interests and the SW
Financial Controlling Interest to a vote of a majority of the Company's
stockholders present at the stockholders 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.
Because the Knightsbridge restructuring will have the effect of eliminating
potential future conflicts of interest between Messrs. Stone and Fickes and
PennCorp, and because the 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
action, the PennCorp Board has determined that the 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 plaintiff's counsel of legal fees and disbursements not to exceed
$530,000 in connection with the lawsuit and the related settlement negotiations,
if the Proposed Settlement is approved by the Delaware Chancery Court after
notice to PennCorp stockholders.
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. As part
of the outsourcing agreement, the Company has agreed to provide a line of credit
which may be drawn upon during the first two years, with repayment in nearly
equal monthly installments over the remainder of the contract.
The Company has agreed to provide guarantees of indebtedness of certain officers
and directors up to a maximum of $10,000.
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 guaranteed approximately $12,800 in mortgage loans sold to third
parties.
<PAGE> 26
Notes to Consolidated Financial Statements, continued
(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
$300 on any life. Amounts not retained are ceded to other insurance enterprises
or reinsurers on an automatic or facultative basis.
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>
1996 1995 1994
--------- --------- ---------
<S> <C> <C> <C>
Direct policy revenues and amounts
assessed against policyholders $ 358,825 $ 310,693 $ 250,167
Reinsurance assumed 1,320 2,307 765
Reinsurance ceded 12,055 11,111 6,510
--------- --------- ---------
Net premiums and amounts earned $ 348,090 $ 301,889 $ 244,422
========= ========= =========
</TABLE>
Fees incurred for financial reinsurance were approximately, $265 in 1996, $339
in 1995, and $515 in 1994.
18. SUBSEQUENT EVENTS (UNAUDITED)
The Company completed its purchase from ULFC, the former parent of United Life,
483,839 shares of the Company's Common Stock for an aggregate purchase price of
$17,902 plus accrued interest through the closing date, June 9, 1997,
of $295. The value of treasury shares held increased $17,902 as a result of this
transaction.
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 in anticipation of the acquisition of the Controlling Interest in SW
Financial. Interest due under the SW Financial Notes is currently set at 7.0%,
per annum.
On August 30, 1997, the Washington National Merger agreement terminated.
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. PennCorp received fees
aggregating $1,100 from Acordia for its underwriting and participation in the
subordinated notes and preferred stock. KM received sponsor fees and other fees
aggregating $1,714 from Acordia for its role in consummating the Acordia
acquisition.
On November 14, 1997, the Company filed, on Form 8-K, restated financial
statements for the years ended December 31, 1994, 1995 and 1996 and the three
month period ended March 31, 1997 and the three month and six month periods
ended June 30, 1997. For additional information see Note 19.
<PAGE> 27
19. RESTATEMENT OF CONSOLIDATED FINANCIAL STATEMENTS
In August 1997, PennCorp announced that it would likely be restating its
financial statements for each of the years in the three year period ended
December 31, 1996.
The Company has restated its consolidated financial statements for each of the
years in the three-year period ended December 31, 1996. The restatement resulted
from the Company reconsidering certain accounting practices after discussions
with the Securities and Exchange Commission's Division of Corporation Finance.
The significant changes in accounting practices incorporated in the restatement
are as follows:
(i) the methodology for determining deferrable acquisition costs;
(ii) the amortization methodology of deferred acquisition costs;
(iii) the recognition of reserve adjustments for interest sensitive
products;
(iv) the allocation of purchase consideration associated with certain
acquisitions; and
(v) the consolidation of a majority-owned subsidiary.
In addition, the Company corrected immaterial errors identified in previously
issued financial statements.
The following page presents the effects of the restatement.
<PAGE> 28
CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEAR ENDED DECEMBER 31,
<TABLE>
<CAPTION>
1996 1995
(As reported) (Restatement) (As reported) (Restatement)
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
REVENUES:
Premiums, principally accident and sickness $ 256,859 $ 256,859 $ 239,010 $ 239,010
Interest sensitive policy product charges 91,231 91,231 62,879 62,879
Net investment income 213,563 210,734 102,291 102,291
Other income 6,132 22,666 12,845 17,076
Net gains/losses from sale of investments 1,257 1,257 595 3,770
---------- ---------- ---------- ----------
Total revenues 569,042 582,747 417,620 425,026
---------- ---------- ---------- ----------
BENEFITS AND EXPENSES:
Claims incurred 188,727 188,727 141,876 141,876
Change in liability for future policy benefits and other
policy benefits 79,085 83,184 18,126 20,047
Amortization of present value of insurance in force and
deferred policy acquisition costs 52,877 56,470 47,732 51,535
Amortization of costs in excess of net assets acquired 7,990 8,648 6,557 6,486
Underwriting and other administrative expenses 97,685 116,560 93,272 106,105
Interest and amortization of deferred debt issuance costs 18,979 18,579 19,780 19,520
Restructuring charge -- -- -- --
---------- ---------- ---------- ----------
Total benefits and expenses 445,343 472,168 327,343 345,569
---------- ---------- ---------- ----------
Income before income taxes, undistributed earnings of unconsolidated
affiliates and extraordinary charge 123,699 110,579 90,277 79,457
Income taxes 45,418 40,957 31,642 27,829
---------- ---------- ---------- ----------
Net income before undistributed earnings in unconsolidated affiliates
and extraordinary charge 78,281 69,622 58,635 51,628
Undistributed earnings in unconsolidated affiliates 21,102 21,037 4,718 4,718
---------- ---------- ---------- ----------
Net income before extraordinary charge 99,383 90,659 63,353 56,346
Extraordinary charge (2,372) (2,372) -- --
---------- ---------- ---------- ----------
Net income 97,011 88,287 63,353 56,346
Preferred stock dividend requirements 14,646 14,646 6,540 6,540
---------- ---------- ---------- ----------
Net income applicable to common stock $ 82,365 $ 73,641 $ 56,813 $ 49,806
========== ========== ========== ==========
Primary:
Net income applicable to common stock before extraordinary
charge $ 2.98 $ 2.67 $ 2.47 $ 2.17
Extraordinary charge (0.08) (0.08) -- --
---------- ---------- ---------- ----------
Net income applicable to common stock $ 2.90 $ 2.59 $ 2.47 $ 2.17
========== ========== ========== ==========
Common shares used in computing primary earnings per share 28,462 28,462 22,985 22,985
========== ========== ========== ==========
Fully diluted:
Net income applicable to common stock before extraordinary
charge $ 2.74 $ 2.49 $ 2.36 $ 2.09
Extraordinary charge (0.07) (0.07) -- --
---------- ---------- ---------- ----------
Net income applicable to common stock $ 2.67 $ 2.42 $ 2.36 $ 2.09
========== ========== ========== ==========
Common shares used in computing fully diluted earnings per share 35,229 35,229 25,566 25,566
========== ========== ========== ==========
<CAPTION>
1994
(As reported) (Restatement)
---------- ----------
<S> <C> <C>
REVENUES:
Premiums, principally accident and sickness $ 214,674 $ 214,674
Interest sensitive policy product charges 29,748 29,748
Net investment income 51,850 51,850
Other income 1,056 1,056
Net gains/losses from sale of investments (3,556) (3,556)
---------- ----------
Total revenues 293,772 293,772
---------- ----------
BENEFITS AND EXPENSES:
Claims incurred 112,650 112,650
Change in liability for future policy benefits and other
policy benefits (9,329) (9,329)
Amortization of present value of insurance in force and
deferred policy acquisition costs 30,948 28,466
Amortization of costs in excess of net assets acquired 5,241 5,241
Underwriting and other administrative expenses 77,407 77,817
Interest and amortization of deferred debt issuance costs 18,274 18,274
Restructuring charge -- --
---------- ----------
Total benefits and expenses 235,191 233,119
---------- ----------
Income before income taxes, undistributed earnings of unconsolidated
affiliates and extraordinary charge 58,581 60,653
Income taxes 21,437 22,163
---------- ----------
Net income before undistributed earnings in unconsolidated affiliates
and extraordinary charge 37,144 38,490
Undistributed earnings in unconsolidated affiliates -- --
---------- ----------
Net income before extraordinary charge 37,144 38,490
Extraordinary charge -- --
---------- ----------
Net income 37,144 38,490
Preferred stock dividend requirements 1,151 1,151
---------- ----------
Net income applicable to common stock $ 35,993 $ 37,339
========== ==========
Primary:
Net income applicable to common stock before extraordinary
charge $ 1.82 $ 1.88
Extraordinary charge -- --
---------- ----------
Net income applicable to common stock $ 1.82 $ 1.88
========== ==========
Common shares used in computing primary earnings per share 19,830 19,830
========== ==========
Fully diluted:
Net income applicable to common stock before extraordinary
charge
Extraordinary charge
Net income applicable to common stock
Common shares used in computing fully diluted earnings per share
</TABLE>
CONSOLIDATED CONDENSED BALANCE SHEETS
AS OF DECEMBER 31,
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------
1996 1995
-------------------------- --------------------------
(As reported) (Restatement) (As reported) (Restatement)
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
ASSETS:
Investments and cash $3,830,313 $3,835,135 $2,409,427 $2,410,304
Insurance assets 668,972 639,798 513,559 499,668
Other assets 334,448 334,390 227,020 232,946
---------- ---------- ---------- ----------
Total assets $4,833,733 $4,809,323 $3,150,006 $3,142,918
========== ========== ========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY:
Insurance liabilities $3,562,108 $3,566,455 $2,229,047 $2,221,161
Long-term debt 210,325 210,325 307,271 307,271
Other liabilities 183,437 170,302 117,175 125,351
Redeemable preferred stock 32,864 32,864 30,007 30,007
Shareholders' equity 844,999 829,377 466,506 459,128
---------- ---------- ---------- ----------
Total liabilities and shareholders' equity $4,833,733 $4,809,323 $3,150,006 $3,142,918
========== ========== ========== ==========
</TABLE>
<PAGE> 29
SELECTED CONSOLIDATED FINANCIAL DATA
In August 1997, PennCorp Financial Group, Inc. ("PennCorp", the "Company")
announced that it would likely be restating its financial statements. The
discussion below reflects the restated amounts for the periods presented.
The following tables set forth selected consolidated financial information of
PennCorp for each of years in the five-year period ended December 31, 1996. The
selected consolidated financial information of PennCorp for each of years in
the three year period ended December 31, 1996, has been derived from the
audited consolidated financial statements of PennCorp (as restated) included
elsewhere in this Form 8-K. The selected consolidated financial information of
PennCorp for each of years in the two year period ended December 31, 1993, has
been derived from the consolidated financial statements of PennCorp (as
restated).
The Company has restated its selected consolidated financial information for
each of years in the five-year period ended December 31, 1996. The restatement
resulted from the Company reconsidering certain accounting practices after
discussions with the Securities and Exchange Commission's Division of
Corporation Finance.
The significant accounting practices incorporated in the restatement are as
follows:
(i) the methodology for determining deferrable acquisition costs;
(ii) the amortization methodology of deferred acquisition costs;
(iii) the recognition of reserve adjustments for interest sensitive products;
(iv) the allocation of purchase consideration associated with certain
acquisitions; and
(v) the consolidation of a majority-owned subsidiary.
In addition, the Company corrected immaterial errors identified in previously
issued financial statements.
The information should be read in conjunction with: (i) the historical
consolidated financial statements of PennCorp and the notes thereto which are
included herein, and (ii) Management's Discussion and Analysis of Financial
Condition and Results of Operations, which is included herein.
<PAGE> 30
(Amounts in thousands, except per share information)
(As restated)
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31, 1996 1995 1994 1993 1992
- --------------------------------------------------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
REVENUES:
Policy revenues $ 348,090 $ 301,889 $ 244,422 $ 201,788 $ 184,690
Net investment income 210,734 102,291 51,850 43,114 41,302
Other income(1) 43,703 21,794 1,056 3,817 632
Net gains (losses) from the sale of investments 1,257 3,770 (3,556) 1,439 5,560
---------- ---------- ---------- ---------- ----------
Total revenues 603,784 429,744 293,772 250,158 232,184
---------- ---------- ---------- ---------- ----------
BENEFITS AND EXPENSES:
Claims incurred 188,727 141,876 112,650 95,232 91,904
Change in liability for future policy benefits
and other policy benefits 83,184 20,047 (9,329) (13,857) (14,971)
Insurance and other operating expenses 181,678 164,126 111,424 113,114 108,974
Interest and amortization of deferred debt 18,579 19,520 18,274 7,461 17,621
issuance costs ---------- ---------- ---------- ---------- ----------
Total benefits and expenses 472,168 345,569 233,119 201,950 203,528
---------- ---------- ---------- ---------- ----------
Income before income taxes and extraordinary
charge 131,616 84,175 60,653 48,208 28,656
Income taxes 40,957 27,829 22,163 17,336 10,695
---------- ---------- ---------- ---------- ----------
Net income before extraordinary charge 90,659 56,346 38,490 30,872 17,961
Extraordinary charge, net of income taxes (2,372) -- -- (3,322) (17,655)
---------- ---------- ---------- ---------- ----------
Net income 88,287 56,346 38,490 27,550 306
Preferred stock dividend requirements 14,646 6,540 1,151 -- 2,903
---------- ---------- ---------- ---------- ----------
Net income (loss) applicable to common stock $ 73,641 $ 49,806 $ 37,339 $ 27,550 $ (2,597)
========== ========== ========== ========== ==========
</TABLE>
(1) Includes $21.0 million and $4.7 million of undistributed earnings in
unconsolidated affiliates for the years ended 1996 and 1995, respectively.
<TABLE>
<CAPTION>
PER SHARE INFORMATION:
-------------------------------------------------
<S> <C> <C> <C> <C> <C>
Primary:
Net income before extraordinary charge $ 2.67 $ 2.17 $ 1.88 $ 1.63 $ 1.34
Net income before net gains (losses) from the
sale of investments and extraordinary $ 2.64 $ 2.06 $ 2.00 $ 1.58 $ 1.02
charge
Extraordinary charge, net of income taxes $ (0.08) $ -- $ -- $ (0.18) $ (1.58)
Common shares used in computing primary
earnings per share 28,462 22,985 19,830 18,957 11,196
Fully diluted:
Net income before extraordinary charge $ 2.49 $ 2.09
Net income before net gains from the sale
of investments and extraordinary charge $ 2.47 1.99
Extraordinary charge, net of income taxes $ (0.07) $ --
Common shares used in computing fully diluted
earnings per share 35,229 25,566
</TABLE>
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
-------------------------------------------------
ASSETS:
<S> <C> <C> <C> <C> <C>
Investments and cash $3,835,135 $2,410,304 $ 822,778 $ 674,552 $ 556,960
Insurance assets 639,798 499,668 342,547 256,066 230,359
Other assets 334,390 232,946 144,244 132,767 117,103
---------- ---------- ---------- ---------- ----------
Total assets $4,809,323 $3,142,918 $1,309,569 $1,063,385 $ 904,422
========== ========== ========== ========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY:
Insurance liabilities $3,566,455 $2,221,161 $ 788,223 $ 649,899 $ 611,342
Long-term debt 210,325 307,271 229,041 150,812 111,082
Other liabilities 170,302 125,351 58,903 73,924 41,519
Redeemable preferred stock 32,864 30,007 37,256 -- --
Shareholders' equity 829,377 459,128 196,146 188,750 140,479
---------- ---------- ---------- ---------- ----------
Total liabilities and shareholders' equity $4,809,323 $3,142,918 $1,309,569 $1,063,385 $ 904,422
========== ========== ========== ========== ==========
</TABLE>
The following pages present the effects of the restatement.
<PAGE> 31
CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEAR ENDED DECEMBER 31,
<TABLE>
<CAPTION>
1996 1995
------------------------- ------------------------
(As reported) (Restatement)(As reported)(Restatement)
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
REVENUES:
Premiums, principally accident and sickness $ 256,859 $ 256,859 $ 239,010 $ 239,010
Interest sensitive policy product charges 91,231 91,231 62,879 62,879
Net investment income 213,563 210,734 102,291 102,291
Other income 27,234 43,703 17,563 21,794
Net gains/losses from sale of investments 1,257 1,257 595 3,770
----------- ----------- ----------- -----------
Total revenues 590,144 603,784 422,338 429,744
----------- ----------- ----------- -----------
BENEFITS AND EXPENSES:
Claims incurred 188,727 188,727 141,876 141,876
Change in liability for future policy benefits and other
policy benefits 79,085 83,184 18,126 20,047
Amortization of present value of insurance in force and
deferred policy acquisition costs 52,877 56,470 47,732 51,535
Amortization of costs in excess of net assets acquired 7,990 8,648 6,557 6,486
Underwriting and other administrative expenses 97,685 116,560 93,272 106,105
Interest and amortization of deferred debt issuance costs 18,979 18,579 19,780 19,520
Restructuring charge -- -- -- --
----------- ----------- ----------- -----------
Total benefits and expenses 445,343 472,168 327,343 345,569
----------- ----------- ----------- -----------
Income before income taxes and extraordinary charge 144,801 131,616 94,995 84,175
Income taxes 45,418 40,957 31,642 27,829
----------- ----------- ----------- -----------
Net income before extraordinary charge 99,383 90,659 63,353 56,346
Extraordinary charge (2,372) (2,372) -- --
----------- ----------- ----------- -----------
Net income 97,011 88,287 63,353 56,346
Preferred stock dividend requirements 14,646 14,646 6,540 6,540
----------- ----------- ----------- -----------
Net income applicable to common stock $ 82,365 $ 73,641 $ 56,813 $ 49,806
=========== =========== =========== ===========
PER SHARE INFORMATION:
Primary:
Net income applicable to common stock before extraordinary
charge $ 2.98 $ 2.67 $ 2.47 $ 2.17
Extraordinary charge (0.08) (0.08) -- --
----------- ----------- ----------- -----------
Net income applicable to common stock $ 2.90 $ 2.59 $ 2.47 $ 2.17
=========== =========== =========== ===========
Common shares used in computing primary earnings per share 28,462 28,462 22,985 22,985
=========== =========== =========== ===========
Fully diluted:
Net income applicable to common stock before extraordinary
charge $ 2.74 $ 2.49 $ 2.36 $ 2.09
Extraordinary charge (0.07) (0.07) -- --
----------- ----------- ----------- -----------
Net income applicable to common stock $ 2.67 $ 2.42 $ 2.36 $ 2.09
=========== =========== =========== ===========
Common shares used in computing fully diluted
earnings per share 35,229 35,229 25,566 25,566
=========== =========== =========== ===========
<CAPTION>
1994
-------------------------
(As reported) (Restatement
----------- -----------
<S> <C> <C>
REVENUES:
Premiums, principally accident and sickness $ 214,674 $ 214,674
Interest sensitive policy product charges 29,748 29,748
Net investment income 51,850 51,850
Other income 1,056 1,056
Net gains/losses from sale of investments (3,556) (3,556)
----------- -----------
Total revenues 293,772 293,772
----------- -----------
BENEFITS AND EXPENSES:
Claims incurred 112,650 112,650
Change in liability for future policy benefits and other
policy benefits (9,329) (9,329
Amortization of present value of insurance in force and
deferred policy acquisition costs 30,948 28,466
Amortization of costs in excess of net assets acquired 5,241 5,241
Underwriting and other administrative expenses 77,407 77,817
Interest and amortization of deferred debt issuance costs 18,274 18,274
Restructuring charge -- --
----------- -----------
Total benefits and expenses 235,191 233,119
----------- -----------
Income before income taxes and extraordinary charge 58,581 60,653
Income taxes 21,437 22,163
----------- -----------
Net income before extraordinary charge 37,144 38,490
Extraordinary charge -- --
----------- -----------
Net income 37,144 38,490
Preferred stock dividend requirements 1,151 1,151
----------- -----------
Net income applicable to common stock $ 35,993 $ 37,339
=========== ===========
PER SHARE INFORMATION:
Primary:
Net income applicable to common stock before extraordinary
charge $ 1.82 $ 1.88
Extraordinary charge -- --
----------- -----------
Net income applicable to common stock $ 1.82 $ 1.88
=========== ===========
Common shares used in computing primary earnings per share
19,830 19,830
=========== ===========
Fully diluted:
Net income applicable to common stock before extraordinary
charge
Extraordinary charge
Net income applicable to common stock
Common shares used in computing fully diluted
earnings per share
</TABLE>
CONSOLIDATED CONDENSED BALANCE SHEETS
AS OF DECEMBER 31,
<TABLE>
<CAPTION>
1996 1995 1994
---------------------------- ------------------------------ ----------------------------
(As reported) (Restatement) (As reported) (Restatement) (As reported) (Restatement)
------------ -------------- -------------- -------------- -------------- ------------
<S> <C> <C> <C> <C> <C> <C>
ASSETS:
Investments and cash $ 3,830,313 $ 3,835,135 $ 2,409,427 $ 2,410,304 $ 822,778 $ 822,778
Insurance assets 668,972 639,798 513,559 499,668 352,932 342,547
Other assets 334,448 334,390 227,020 232,946 144,244 144,244
------------ -------------- -------------- -------------- -------------- ------------
Total assets $ 4,833,733 $ 4,809,323 $ 3,150,006 $ 3,142,918 $ 1,319,954 $ 1,309,569
============ ============== ============== ============== ============== ============
LIABILITIES AND SHAREHOLDERS' EQUITY:
Insurance liabilities $ 3,562,108 $ 3,566,455 $ 2,229,047 $ 2,221,161 $ 798,030 $ 788,223
Long-term debt 210,325 210,325 307,271 307,271 229,041 229,041
Other liabilities 183,437 170,302 117,175 125,351 59,107 58,903
Redeemable preferred stock 32,864 32,864 30,007 30,007 37,256 37,256
Shareholders' equity 844,999 829,377 466,506 459,128 196,520 196,146
------------ -------------- -------------- -------------- -------------- ------------
Total liabilities and
shareholders' equity $ 4,833,733 $ 4,809,323 $ 3,150,006 $ 3,142,918 $ 1,319,954 $ 1,309,569
============ ============== ============== ============== ============== ============
</TABLE>
<PAGE> 32
CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEAR ENDED DECEMBER 31,
<TABLE>
<CAPTION>
1993 1992
--------------------------- ----------------------------
(As reported) (Restatement) (As reported) (Restatement)
------------ ------------ ------------ -------------
<S> <C> <C> <C> <C>
REVENUES:
Policy revenues $ 201,788 $ 201,788 $ 184,690 $ 184,690
Net investment income 43,114 43,114 41,302 41,302
Other income 3,817 3,817 632 632
Net gains/losses from sale of investments 1,439 1,439 5,560 5,560
------------ ------------ ------------ ------------
Total revenues 250,158 250,158 232,184 232,184
------------ ------------ ------------ ------------
BENEFITS AND EXPENSES:
Claims incurred 95,232 95,232 91,904 91,904
Change in liability for future policy benefits and other
policy benefits (13,857) (13,857) (14,971) (14,971)
Insurance and other operating expenses 110,598 113,114 108,833 108,974
Interest and amortization of deferred debt issuance costs 7,461 7,461 17,621 17,621
------------ ------------ ------------ ------------
Total benefits and expenses 199,434 201,950 203,387 203,528
------------ ------------ ------------ ------------
Income before income taxes and extraordinary charge 50,724 48,208 28,797 28,656
Income taxes 18,217 17,336 10,744 10,695
------------ ------------ ------------ ------------
Net income before extraordinary charge 32,507 30,872 18,053 17,961
Extraordinary charge (3,322) (3,322) (17,655) (17,655)
------------ ------------ ------------ ------------
Net income 29,185 27,550 398 306
Preferred stock dividend requirements -- -- 2,903 2,903
------------ ------------ ------------ ------------
Net income applicable to common stock $ 29,185 $ 27,550 $ (2,505) $ (2,597)
============ ============ ============ ============
Primary:
Net income applicable to common stock before extraordinary charge $ 1.71 $ 1.63 $ 1.35 $ 1.34
Extraordinary charge (0.18) (0.18) (1.58) (1.58)
------------ ------------ ------------ ------------
Net income applicable to common stock $ 1.53 $ 1.45 $ (0.23) $ (0.24)
============ ============ ============ ============
Common shares used in computing primary earnings per share 18,957 18,957 11,196 11,196
============ ============ ============ ============
</TABLE>
CONSOLIDATED CONDENSED BALANCE SHEETS
AS OF DECEMBER 31,
<TABLE>
<CAPTION>
1993 1992
------------------------------ ------------------------------
(As reported) (Restatement) (As reported) (Restatement)
-------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
Assets:
Investments and cash $ 674,552 $ 674,552 $ 556,960 $ 556,960
Insurance assets 258,723 256,066 230,500 230,359
Other assets 132,767 132,767 117,103 117,103
-------------- -------------- -------------- --------------
Total assets $ 1,066,042 $ 1,063,385 $ 904,563 $ 904,422
============== ============== ============== ==============
Liabilities and shareholders' equity
Insurance liabilities $ 649,899 $ 649,899 $ 611,342 $ 611,342
Long-term debt 150,812 150,812 111,082 111,082
Other liabilities 74,854 73,924 41,568 41,519
Redeemable preferred stock -- -- -- --
Shareholders' equity 190,477 188,750 140,571 140,479
-------------- -------------- -------------- --------------
Total liabilities and shareholders' equity $ 1,066,042 $ 1,063,385 $ 904,563 $ 904,422
============== ============== ============== ==============
</TABLE>
<PAGE> 33
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
(As restated)
INTRODUCTION
In August 1997, PennCorp Financial Group, Inc. ("PennCorp", the "Company")
announced that it would likely be restating its financial statements for each of
the years in the three year period ended December 31, 1996. The discussion below
reflects the restated amounts for each of the years in the three year period
ended December 31, 1996. Further information regarding the restatement is
provided in Note 19 of the Notes to Consolidated Financial Statements contained
elsewhere herein.
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 and 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 which is now nearly complete.
The evaluation considered each of the current operating companies and, in
anticipation of the consummation of the purchase of the Controlling Interest of
Southwestern Financial Corporation ("SW Financial"), the impact of SW Financial
on the Company's current and long-term profitability potential, the ability of
the operating companies to absorb operations related to future acquisitions and
the market focus of the operating companies.
The Company has begun to realign its existing operating companies in light of
the strategic review and anticipates a charge related to costs 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. A charge for the restructuring costs will be included in
the Company's results of operations during 1997. In addition, the Company may
incur additional restructuring costs when integration plans are implemented for
the SW Financial transaction.
Acquisitions. The Company's growth strategy emphasizes 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 seeks 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.
<PAGE> 34
M D & A continued
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 Companies Life 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 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.
On August 31, 1994, the Company acquired American-Amicable Life Insurance
Company of Texas ("AA Life") through American-Amicable Holding Corporation
("AAHC"). AA Life markets life insurance products to military and civilian
employees at U.S. military installations throughout the world.
The comparability of the Company's financial position, results of operations and
cash flows for each of the periods presented have been affected by these
acquisitions. The pro forma effects of the acquisitions of United Life, Integon
Life, and AA Life are described in Note 3 to the Company's 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. 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 $4.0 million during 1996
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 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 a revolving credit agreement with a
syndicate of banks (the "bank credit agreement") 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 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. Total interest and related costs incurred under the bank
credit facility were $1.6 million during 1996.
<PAGE> 35
M D & A continued
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
indebtedness under the AAHC credit facility, 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 and $3.6 million during
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 1996 and
1995, on the Series B and Series C Preferred Stock amounted to $2.9 million and
$1.3 million, respectively. On March 14, 1997, the Company redeemed all the
outstanding Series B Preferred Stock for $14.7 million, utilizing proceeds
available under the bank credit facility.
In addition to the Series B and Series C Preferred Stock, the Company utilized
$30.0 million in borrowings by Salem Holdings Corporation ("SHC"), the parent of
Integon Life, from a syndicate of banks in order to fund a portion of the
Integon Life acquisition. In March 1996, the Company utilized proceeds from the
February Common Stock Offering to repay $30.0 million of indebtedness
outstanding and cancel the SHC bank facility. For the years ended, December 31,
1996 and 1995, the Company incurred interest costs related to borrowings by SHC
of $451,000 and $513,000, respectively.
In order to fund the AA Life acquisition, AAHC borrowed $55.0 million under the
AAHC credit facility. The AAHC credit facility was repaid and cancelled in March
1996. During 1996, 1995 and 1994, AAHC made principal payments of $27.0 million,
$23.0 million and $5.0 million, and had accumulated interest costs of $385,000,
$3.3 million and $1.3 million under this facility, respectively.
As part of the financing of the AA Life acquisition, PennCorp issued 450,000
shares of Series A Preferred Stock with a stated dividend rate of approximately
6.0% for the first five years and approximately 8.0% thereafter, until
redemption in 2009. During 1994, and prior to its full repurchase on August 25,
1995, PennCorp incurred dividends of $1.2 million and $1.7 million,
respectively, related to the Series A Preferred Stock.
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"), Salem Life Insurance
Company ("Salem Life") and Pioneer Security Life Insurance Company ("Pioneer
Security") (collectively, the "Surplus Note Companies"). The amounts outstanding
under the surplus debentures totaled $367.9 million and $315.8 million as of
December 31, 1996 and 1995, 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.
<PAGE> 36
M D & A continued
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, 1996, 1995 and 1994, the Company received net
payments from the Surplus Note Companies of $31.9 million, $19.1 million and
$11.5 million, respectively. The Surplus Note Companies received $25.8 million,
$21.6 million and $900,000 in dividends and tax sharing payments from their
respective insurance subsidiaries. During 1995, and 1994, the Company's
downstream holding companies, SHC and AAHC, each had direct bank indebtedness
outstanding which restricted the amount of payments which could be made by Salem
Life and Pioneer Security for the benefit of the Company. As a result of the
repayment of such indebtedness from proceeds of the Company's February Common
Stock Offering, Salem Life and Pioneer Security may now make payments under
their respective surplus debentures for the benefit of PennCorp.
The primary cash requirements of the Company are interest payments, preferred
stock dividends and common stock dividends which aggregated $33.9 million, $24.5
million and $16.5 million for the years ended December 31, 1996, 1995 and 1994,
respectively. For the years ended December 31, 1996, 1995 and 1994, cash
requirements of the Company exceeded cash made available to the Company through
payments under the surplus debentures by $2.0 million, $5.4 million and $5.0
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 1997, the maximum dividends and corresponding surplus debenture payments,
without prior regulatory approval, are anticipated to be approximately $27.2
million and the Company's cash requirements are anticipated to be approximately
$35.3 million. The Company intends to utilize funds available under its
revolving credit facility to fund the shortfall. For periods beginning in 1998,
under current statutory limitations, the Company believes that it will receive
sufficient cash flow from the Surplus Note Companies and their respective
subsidiaries to satisfy its cash requirements. As a result of the Company's
decision to retain capital and surplus at the insurance subsidiary level, and
with the contemplated realignment of the insurance subsidiaries into operating
divisions, the Company believes that as of December 31, 1996, 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 $50.0 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 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 $2,993.9
million and $1,487.0 million at December 31, 1996 and 1995, respectively. Of
those securities available for sale, 92.1% and 92.7% were rated Baa or above by
Moody's Investors Services, Inc. at December 31, 1996 and 1995, respectively.
During the years ended December 31, 1996, 1995 and 1994, the Company sold
$378.6 million, $109.8 million and $92.8 million of fixed maturity and equity
securities, and purchased $955.8 million, $217.8 million and $183.6 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. 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.
<PAGE> 37
M D & A continued
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 $1.3 million and $5.7
million of profits during 1996 and 1995, respectively.
The Company held $1,428.3 million and $503.7 million of mortgage-backed bonds
which represented 38.9% and 22.0% of total invested assets as of December 31,
1996 and 1995, respectively. The significant increase in mortgage-backed
securities for the year ended December 31, 1996, was the result of the United
Life acquisition. 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 7.2% and 1.6% of total invested assets
as of December 31, 1996 and 1995, respectively. The substantial increase in
mortgage loans was the result of the United Life acquisition. 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 $4.2 million as of
December 31, 1996. As of December 31, 1996 and 1995, the Company had
non-performing loans amounting to $1.4 million and $3.5 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 $102.6 million and $457.3 million as of
December 31, 1996 and 1995, respectively. At December 31, 1996 and 1995,
respectively, the Company held approximately $12.2 million and $3.8 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, 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 $2.2 million, and (iii) the Company increased
certain policy reserves and claim 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.
For the year ended December 31, 1994, the Company determined: (i) it incurred
additional costs amounting to $1.9 million associated with the acquisition of AA
Life which resulted in a corresponding increase in costs in excess of net assets
acquired and (ii) the valuation of the Series A Preferred Stock issued in
conjunction with the AA Life acquisition should be increased by $4.0 million, as
a result of an independent appraisal, which resulted in a corresponding increase
to costs in excess of net assets acquired of $4.0 million.
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, 1996 and 1995,
the Company had total interest sensitive liabilities aggregating $2,685.7
million and $1,423.7 million, respectively and obtained a spread on such
liabilities of 2.1% and 1.4%, 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.
<PAGE> 38
M D & A continued
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 $152.1 million, $88.2 million and $5.6 million in
1996, 1995 and 1994, respectively. The positive cash flow from operating
activities is not necessarily indicative of the Company's cash flow as $(205.2)
million, $(53.2) million and $2.1 million of cash was (used) provided to fund
cash flows for interest sensitive life and accumulation products during 1996,
1995 and 1994, 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 48.6% of the Company's total policy revenues for the year ended
December 31, 1996, 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.
Pending Acquisition and Related Transactions. The Company intends to file with
the Securities and Exchange Commission ("SEC"), a preliminary proxy statement in
which the Company, pending final review by the SEC, will be soliciting
shareholder approval for the following: (i) the acquisition of the
Controlling Interest in SW Financial, (ii) the acquisition of the Fickes and
Stone Knightsbridge Interests, and (iii) other items including election of
Directors.
The acquisition of the Controlling Interest in SW Financial will expand the
Company's individual division operations with similar products, distribution
channels and asset mixes.
The following unaudited pro forma selected financial data represents the
Company's consolidated results of operations, as if the SW Financial
transaction, United Life acquisition and other financial transactions occurred
on January 1, 1996, and the pro forma financial position, as if such
transactions occurred as of December 31, 1996. The unaudited 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, 1996, or December 31, 1996, respectively, or the results of
operations or financial position which may occur in the future.
(AMOUNTS IN MILLIONS, EXCEPT SHARE INFORMATION)
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------
PRO FORMA ACTUAL
FOR THE YEAR ENDED DECEMBER 31, 1996 1996
- --------------------------------------------------------------------- ------------ ----------
<S> <C> <C>
Total revenues $ 984.7 $ 582.7
Income before income taxes, undistributed earnings in unconsolidated
affiliates and extraordinary charge 135.9 110.6
Net income before extraordinary charge applicable to common stock 76.9 90.7
Fully diluted net income before extraordinary charge per share
applicable to common stock 2.30 2.49
AS OF DECEMBER 31,
Total assets $ 6,919.5 $ 4,809.3
Insurance and other liabilities 5,609.2 3,736.7
Long-term debt 462.8 210.3
Mandatory redeemable preferred stock 18.1 32.9
Total shareholders' equity 829.4 829.4
</TABLE>
In anticipation of the acquisition of the Controlling Interest in SW Financial,
the Company recently consummated a five-year, $450 million revolving credit
facility ("revolver") with a syndicate of banks and terminated the Bank Credit
Agreement. The revolver provides the Company with sufficient capacity, (i) to
pay the consideration due to the controlling shareholders of SW Financial, (ii)
to provide amounts needed to refinance existing indebtedness at SW Financial,
and (iii) to provide liquidity for other general corporate purposes. Covenants
contained in the revolver may require the Company to raise additional equity
within 90 days of consummating the transactions noted above in order to maintain
certain financial ratios.
<PAGE> 39
M D & A continued
Borrowings under the revolver will carry variable rates of interest plus a
margin which varies with the Company's implied senior unsecured indebtedness
rating. Based upon PennCorp's current ratings, the revolver would reduce the
Company's current borrowing rates under the formerly outstanding bank facility
by approximately 35 basis points and would reduce the cost of indebtedness
outstanding at SW Financial by nearly 300 basis points.
The Company anticipates, pending regulatory and shareholder approval,
consummating the acquisition of the Controlling Interest in SW Financial, and
the acquisition of the Fickes and Stone Knightsbridge Interests in late 1997 or
early 1998.
New Accounting Pronouncements. The Financial Accounting Standard Board ("FASB")
released for comment an Exposure Draft of a proposed Statement of Financial
Accounting Standards, "Consolidated Financial Statements: Policy and Procedures"
(the "Proposed Statement"). The Proposed Statement provides new guidelines with
respect to the circumstances under which entities must report financial
information on a consolidated basis. The Proposed Statement, if issued, would
have been effective for fiscal years beginning after December 15, 1996. Although
the Company cannot predict if, and in what form, the Proposed Statement will be
issued, the Company believes that the Proposed Statement could require
consolidation of Southwestern Life and Union Bankers and certain other
transactions of the Company and Knightsbridge.
On March 3, 1997, the FASB issued Statement of Financial Accounting Standards
("SFAS") No. 128, "Earnings per Share," replacing Accounting Principles Board
("APB") Opinion No. 15, "Earnings per Share." SFAS No. 128 replaces "primary"
and "fully diluted" earnings per share ("EPS") under APB Opinion No. 15 with
"basic" and "diluted" EPS. Unlike primary EPS, basic EPS excludes the dilutive
effects of options, warrants and other convertible securities. Diluted EPS
reflects the potential dilution of securities that could share in the earnings
of an entity, similar to fully diluted EPS. However, under SFAS No. 128, the
Company would use the average market price for its stock during the reporting
period to determine the cost of options as opposed to the greater of the closing
price at the end of the period or the average market price during the period, as
currently required by APB Opinion No.
15. SFAS No. 128 is effective for years ending after December 15, 1997.
In March 1997, the FASB issued Financial Accounting Standards No. 129,
"Disclosures of Information About Capital Structure" ("SFAS No. 129"). SFAS No.
129 is effective for both interim and annual financial statements issued after
December 15, 1997, and clarifies the disclosure requirements related to the
type, and nature, of securities contained within the Company's capital
structure.
<PAGE> 40
M D & A continued
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 (excluding realized gains and losses on sale of investments and equity in
undistributed earnings of unconsolidated affiliates) are shown in the following
table:
<TABLE>
<CAPTION>
1996 1995 1994
- --------------------------------- ---- ---- ----
RATIOS TO REVENUES
<S> <C> <C> <C>
Total policy benefits 48.4% 38.9% 34.7%
Insurance expenses 14.0 20.0 19.9
Other operating expenses 14.8 16.8 17.6
Interest and amortization
of deferred debt 3.3 4.7 6.1
issuance costs
Pretax operating margin 19.5 19.6 21.7
</TABLE>
Operating Ratios. Pretax operating margin declined modestly to 19.5% of revenues
during 1996 from 19.6% and 21.7% in 1995 and 1994, respectively. The slight
reduction was primarily due to declines in all operating ratios except for
policy benefits, which offset such improvements. As the mix of insurance
products shifts toward life and accumulation products versus fixed benefit
products, management believes the 1996 ratios will be indicative of future
ratios.
The ratio of total policy benefits to revenues increased during 1996 to 48.4%
from 38.9% and 34.7% in 1995 and 1994, respectively. The increase in the ratio
of total policy benefits to revenues during 1996 was primarily attributable to
the continued increase in life products, relative to fixed benefit products,
since benefits for life insurance products are typically greater, as a
percentage of premium, than benefits for fixed benefit products. Additionally,
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 1996,
the Company 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. Also, during
1996, the Company refined the calculation certain of 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.
The refinement is anticipated to result in slightly larger increases in the
change in future policy benefits in near-term reporting periods. The increase in
the ratio of total policy benefits to revenues during 1995, as compared to 1994,
was the result of the shift in product mix, from fixed benefit accident and
sickness insurance, to accumulation and life insurance products as claims
incurred ratios remained consistent between periods.
Insurance expenses dropped during 1996 to 14.0% of revenues from 20.0% and 19.9%
during 1995 and 1994, respectively. The reduction resulted from increased
premium volume and persistency, which has been steadily improving over the past
two years, resulting in less amortization of insurance assets (primarily the
present value of insurance in force) as a percentage of revenues. In addition,
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 and 1994, due
to reduced short-term profit margins from adverse mortality. The Company
believes that the reduced profit margins will not impact the long-term
profitability. However, should such mortality experience continue, 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 14.8% during
1996, from 16.8% and 17.6% during 1995 and 1994, 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.
Interest costs fell to 3.3% of revenues during 1996, from 4.7% during 1995, and
6.1% during 1994. The Company's financings for each of its acquisitions have
impacted these ratios. During 1996, the Company utilized 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% and 9.3% for the years ended December 31,
1995, and 1994, respectively. 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.
<PAGE> 41
M D & A continued
Policy Revenues. Policy revenues increased to $348.1 million in 1996 from $301.9
and $244.4 million in 1995 and 1994, respectively. Fixed benefit policy revenues
decreased by 3.1% and 1.2% to $169.3 million and $174.7 million during 1996 and
1995, respectively, after increasing by 15.9% during 1994 to $176.9 million.
Increases in fixed benefit policy revenues during 1994 resulted primarily from
the acquisition of Professional. During 1996 and 1995, the Company's operating
focus was 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, as a result of higher than anticipated loss
ratios, which resulted in a $4.9 million decline in fixed benefit policy
revenues.
Life policy revenues increased 43.9%, 75.0% and 37.2% to $170.0 million, $118.1
million and $67.5 million for the years ended 1996, 1995 and 1994, 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. The inclusion of AA Life for the full year 1995 increased
life policy revenue by $29.1 million while AA Life provided an additional $13.7
million of life policy revenues during 1994. Partially offsetting some of these
increases were declines in Penn Life's policy revenues from closed blocks of
business of $1.1 million, $750,000 and $1.0 million during 1996, 1995 and 1994,
respectively.
Net Investment Income. The effects of a larger invested asset base and improved
average portfolio yields to 7.5% in 1996 from 7.3% during 1995 and 1994,
resulted in net investment income increasing 106.0%, 97.1% and 20.3% in 1996,
1995 and 1994, to $210.7 million, $102.3 million and $51.9 million,
respectively. The acquisitions of United Life, which added invested assets of
$1,492.9 million in July 1996, Integon Life, which added invested assets of
$1,339.1 million in July 1995, and AA Life, which added invested assets of
$204.3 million in August 1994, contributed to the increase in investment
income. During 1996, United Life added $49.3 million of investment income and
Integon Life incrementally added $57.6 million as a result of being included
for the entire year. During 1995, Integon Life and AA Life incrementally added
$40.1 million and $9.7 million to investment income, respectively. During 1994,
AA Life and Professional provided additional investment income to the Company
of $4.8 million and $2.5 million, respectively.
Other income. For purposes of presentation of the Summary of the Selected
Financial Information, "other income" includes undistributed earnings in
unconsolidated affiliates, income as a result of trading portfolio activity and
the income generated by the third party marketing activities of Marketing One.
During 1996 and 1995, income from unconsolidated affiliates aggregated $21.0
million and $4.7 million, respectively including $21.0 million and $910,000 as
a result of the Company's economic interest in SW Financial during 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
$1.3 million and $5.7 million during 1996 and 1995, respectively.
Revenues generated by Marketing One aggregated $20.0 million and $7.4 million
during 1996 and 1995, respectively. Marketing One was acquired by the Company
in August 1995.
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 1996, 1995 and 1994, resulted in the Company realizing gains
of $1.3 million, $3.8 million during 1996 and 1995, respectively, and losses of
$3.6 million during 1994. During 1995, the Company liquidated its holdings in
Conning & Co. which resulted in a realized gain of $3.2 million. (See Note 19
of Notes to Consolidated Financial Statements contained elsewhere herein).
<PAGE> 42
M D & A continued
Claims Incurred. Claims incurred increased 33.0%, 25.9% and 18.3% during 1996,
1995 and 1994, to $188.7 million, $141.9 million and $112.7 million,
respectively. 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 believes that the modest increase in claims at OLIC and Penn
Life are a statistical aberration and do not appear to be the result of poor
underwriting or anti-selection. 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. During 1994, the impact of the AA Life acquisition
and the inclusion of Professional for the entire year increased claims incurred
by $18.2 million.
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 8.9%, 41.2% and 0.3% to $91.0
million, $83.6 million and $59.2 million during 1996, 1995 and 1994,
respectively. During each of the periods the amortization of the present value
of insurance in force increased slightly as a result of acquisitions. During
1996, and 1995, the Company utilized deferral methods comparable to those
utilized in 1994 and thus the increase in amortization of deferred policy
acquisition costs was the result of the growth of the blocks of new business
issued since the acquisition of each subsidiary and related deferred costs. The
increased insurance related expenses were also the result of somewhat higher
commissions which totaled $34.7 million, $31.9 million and $30.7 million during
1996, 1995 and 1994, respectively.
Other Operating Expenses. Other operating expenses (including general operating,
overhead and policy maintenance expenses) increased during 1996 to $90.1 million
compared to $80.7 million during 1995 and $52.3 million during 1994. Excluding
the impact of the United Life acquisition in 1996 and the inclusion of Integon
Life, AA Life Marketing One for the full year period 1996 and 1995,
respectively, and a non and recurring restructuring charge of $3.9 million in
1995, primarily related to the relocation of the Company's operating facility,
other operating expenses decreased by $5.7 million or 11.2% during 1996 to $45.4
million for the Company's other insurance subsidiaries compared to $51.1 and
$46.4 million during 1995 and 1994, respectively. The modest increase in
expenses during 1995 as compared to 1994 was the result of the inclusion of AA
Life for a full year partially off set by the release of $1.4 million of expense
accruals originally established as part of the purchase allocations for
Professional. During 1995 Professional settled certain outstanding litigation
and incurred costs associated with relocation, each of which were substantially
less than anticipated at the purchase date.
Also included in other operating expense is the amortization of costs in excess
of net assets acquired which aggregated $8.6 million, $6.5 million and $5.2
million for 1996, 1995 and 1994, respectively.
Income Taxes. The effective tax rates for the years ended December 31, 1996,
1995 and 1994, were 37.0%, 35.0% and 36.5%, respectively. The 1996 effective
rate is higher than the statutory rate of 35% primarily due to non-deductible
amortization of costs in excess of net assets acquired. The decline of the
effective tax rate for 1995 as compared to 1996 and 1994 is due to previously
non-deductible operating losses becoming available to reduce tax on operating
earnings. Effective tax rates in 1994 are higher than the statutory rate
principally due to foreign taxes and non-deductible amortization of costs in
excess of net assets acquired.
<PAGE> 43
QUARTERLY CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED, IN THOUSANDS EXCEPT PER SHARE DATA)
(As restated)
In August 1997, PennCorp Financial Group, Inc. ("PennCorp", the
"Company") announced that it would likely be restating its financial
statements.
The Company has restated its quarterly consolidated statements of operations
for each of the three month periods in the two year period ended December 31,
1996. The restatement resulted from the Company reconsidering certain
accounting practices after discussions with the Securities and Exchange
Commission's Division of Corporation Finance.
The significant accounting practices incorporated in the restatement are as
follows:
(i) the methodology for determining deferrable acquisition costs;
(ii) the amortization methodology of deferred acquisition costs;
(iii) the recognition of reserve adjustments for interest sensitive products;
(iv) the allocation of purchase consideration associated with certain
acquisitions; and
(v) the consolidation of a majority-owned subsidiary.
In addition, the Company corrected immaterial errors identified in previously
issued financial statements.
The following is a summary of the quarterly consolidated statements of
income for the two years ended December 31, 1996 and 1995:
(Amounts in thousands, except per share information)
<TABLE>
<CAPTION>
(AS RESTATED)
- -------------------------------------------------------------------------------------------------------------
1996 QUARTER-ENDED MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Total revenues $ 131,358 $ 130,599 $ 153,496 $167,294
========== =========== ========== ========
Net income before extraordinary charge $ 18,664 $ 21,461 $ 23,260 $ 27,274
========== =========== ========== ========
Net income applicable to common stock $ 15,157 $ 18,572 $ 18,702 $ 21,030
========== =========== ========== ========
Net income per share of common stock - primary $ 0.60 $ 0.64 $ 0.63 $ 0.71
========== =========== ========== ========
Net income per share of common stock - fully diluted $ 0.56 $ 0.60 $ 0.60 $ 0.66
========== =========== ========== ========
- -------------------------------------------------------------------------------------------------------------
1995 QUARTER-ENDED MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
- -------------------------------------------------------------------------------------------------------------
Total revenues $ 87,225 $ 86,935 $ 123,271 $127,595
========== =========== ========== ========
Net income before extraordinary charge $ 11,083 $ 14,141 $ 18,896 $ 12,226
========== =========== ========== ========
Net income applicable to common stock $ 10,217 $ 13,279 $ 16,938 $ 9,369
========== =========== ========== ========
Net income per share of common stock - primary $ 0.50 $ 0.56 $ 0.71 $ 0.39
========== =========== ========== ========
Net income per share of common stock - fully diluted $ -- $ -- $ 0.66 $ 0.39
========== =========== ========== ========
</TABLE>
The following pages present the effects of the restatement.
<PAGE> 44
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
For the three month periods ended
---------------------------------
March 31, 1995
---------------------------------
(As reported) (Restatement)
---------------- --------------
<S> <C> <C>
REVENUES:
Premiums, principally accident and sickness $ 60,756 $ 60,756
Interest sensitive policy product charges 11,149 11,149
Net investment income 15,616 15,616
Other income 145 145
Net gains/losses from sale of investments (441) (441)
-------- --------
Total revenues 87,225 87,225
-------- --------
BENEFITS AND EXPENSES:
Claims incurred 32,072 32,072
Change in liability for future policy benefits and other
policy benefits 2,729 3,210
Amortization of present value of insurance in force and
deferred policy acquisition costs 9,420 10,372
Amortization of costs in excess of net assets acquired 1,427 1,427
Underwriting and other administrative expenses 19,443 19,369
Interest and amortization of deferred debt issuance costs 5,603 5,603
Restructuring charge -- --
-------- --------
Total benefits and expenses 70,694 72,053
-------- --------
Income before income taxes, undistributed earnings of unconsolidated
affiliates and extraordinary charge 16,531 15,172
Income taxes 6,034 5,558
-------- --------
Net income before undistributed earnings in unconsolidated affiliates
and extraordinary charge 10,497 9,614
Undistributed earnings in unconsolidated affiliates 1,469 1,469
-------- --------
Net income before extraordinary charge 11,966 11,083
Extraordinary charge -- --
-------- --------
Net income 11,966 11,083
Preferred stock dividend requirements 866 866
-------- --------
Net income applicable to common stock $ 11,100 $ 10,217
======== ========
Primary:
Net income applicable to common stock before extraordinary
charge $ 0.54 $ 0.50
Extraordinary charge -- --
-------- --------
Net income applicable to common stock $ 0.54 $ 0.50
======== ========
Common shares used in computing primary earnings per share 20,455 20,455
======== ========
Fully diluted:
Net income applicable to common stock before extraordinary
charge
Extraordinary charge
Net income applicable to common stock
Common shares used in computing fully diluted earnings per share
<CAPTION>
For the three month periods ended
----------------------------------------------------
June 30, 1995 September 30, 1995
----------------------------------------------------
(As reported) (Restatement) (As reported) Restatement
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
REVENUES:
Premiums, principally accident and sickness $ 57,307 $ 57,307 $ 58,309 $ 58,309
Interest sensitive policy product charges 10,419 10,419 18,264 18,264
Net investment income 15,576 15,576 34,630 34,630
Other income 3,571 3,571 7,575 8,103
Net gains/losses from sale of investments 62 62 790 3,965
-------- -------- -------- --------
Total revenues 86,935 86,935 119,568 123,271
-------- -------- -------- --------
BENEFITS AND EXPENSES:
Claims incurred 29,674 29,674 38,903 38,903
Change in liability for future policy benefits and other
policy benefits (83) 397 8,667 9,147
Amortization of present value of insurance in force and
deferred policy acquisition costs 10,048 10,998 11,145 12,095
Amortization of costs in excess of net assets acquired 1,448 1,448 1,724 1,681
Underwriting and other administrative expenses 20,342 20,268 23,046 28,223
Interest and amortization of deferred debt issuance costs 4,403 4,403 4,488 4,423
Restructuring charge -- -- -- --
-------- -------- -------- --------
Total benefits and expenses 65,832 67,188 87,973 94,472
-------- -------- -------- --------
Income before income taxes, undistributed earnings of unconsolidated
affiliates and extraordinary charge 21,103 19,747 31,595 28,799
Income taxes 7,876 7,401 11,441 10,447
-------- -------- -------- --------
Net income before undistributed earnings in unconsolidated affiliates
and extraordinary charge 13,227 12,346 20,154 18,352
Undistributed earnings in unconsolidated affiliates 1,795 1,795 544 544
-------- -------- -------- --------
Net income before extraordinary charge 15,022 14,141 20,698 18,896
Extraordinary charge -- -- -- --
-------- -------- -------- --------
Net income 15,022 14,141 20,698 18,896
Preferred stock dividend requirements 862 862 1,958 1,958
-------- -------- -------- --------
Net income applicable to common stock $ 14,160 $ 13,279 $ 18,740 $ 16,938
======== ======== ======== ========
Primary:
Net income applicable to common stock before extraordinary
charge $ 0.60 $ 0.56 $ 0.79 $ 0.71
Extraordinary charge -- -- -- --
-------- -------- -------- --------
Net income applicable to common stock $ 0.60 $ 0.56 $ 0.79 $ 0.71
======== ======== ======== ========
Common shares used in computing primary earnings per share 23,721 23,721 23,797 23,797
======== ======== ======== ========
Fully diluted:
Net income applicable to common stock before extraordinary
charge $ 0.73 $ 0.66
Extraordinary charge -- --
-------- --------
Net income applicable to common stock $ 0.73 $ 0.66
======== ========
Common shares used in computing fully diluted earnings per share 27,682 27,682
======== ========
<CAPTION>
For the three month periods ended
---------------------------------
December 31, 1995
---------------------------------
(As reported) (Restatement)
---------------- --------------
<S> <C> <C>
REVENUES:
Premiums, principally accident and sickness $ 62,638 $ 62,638
Interest sensitive policy product charges 23,047 23,047
Net investment income 36,469 36,469
Other income 1,554 5,257
Net gains/losses from sale of investments 184 184
-------- --------
Total revenues 123,892 127,595
-------- --------
BENEFITS AND EXPENSES:
Claims incurred 41,227 41,227
Change in liability for future policy benefits and other 6,813 7,293
policy benefits
Amortization of present value of insurance in force and 17,119 18,070
deferred policy acquisition costs 1,958 1,930
Amortization of costs in excess of net assets acquired 26,498 34,302
Underwriting and other administrative expenses 5,286 5,091
Interest and amortization of deferred debt issuance costs 3,943 3,943
Restructuring charge -------- --------
102,844 111,856
Total benefits and expenses -------- --------
Income before income taxes, undistributed earnings of unconsolidated 21,048 15,739
affiliates and extraordinary charge 6,291 4,423
Income taxes -------- --------
Net income before undistributed earnings in unconsolidated affiliates 14,757 11,316
and extraordinary charge 910 910
Undistributed earnings in unconsolidated affiliates -------- --------
15,667 12,226
Net income before extraordinary charge -- --
Extraordinary charge -------- --------
15,667 12,226
Net income 2,857 2,857
Preferred stock dividend requirements -------- --------
$ 12,810 $ 9,369
Net income applicable to common stock ======== ========
Primary:
Net income applicable to common stock before extraordinary
charge $ 0.54 $ 0.39
Extraordinary charge -- --
-------- --------
Net income applicable to common stock $ 0.54 $ 0.39
======== ========
Common shares used in computing primary earnings per share 23,871 23,871
======== ========
Fully diluted:
Net income applicable to common stock before extraordinary
charge $ 0.51 $ 0.40
Extraordinary charge -- --
-------- --------
Net income applicable to common stock $ 0.51 $ 0.40
======== ========
Common shares used in computing fully diluted earnings per share 29,080 29,080
======== ========
</TABLE>
<PAGE> 45
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
For the three month periods ended
---------------------------------
March 31, 1996
---------------------------------
(As reported) (Restatement)
------------ ---------------
<S> <C> <C>
REVENUES:
Premiums, principally accident and sickness $ 64,421 $ 64,421
Interest sensitive policy product charges 22,669 22,669
Net investment income 41,334 39,834
Other income (37) 4,961
Net gains/losses from sale of investments (527) (527)
--------- ---------
Total revenues 127,860 131,358
--------- ---------
BENEFITS AND EXPENSES:
Claims incurred 44,326 44,326
Change in liability for future
policy benefits and other policy benefits 11,490 13,369
Amortization of present value of insurance in force and
deferred policy acquisition costs 14,859 13,939
Amortization of costs in excess of net assets acquired 2,030 2,137
Underwriting and other administrative expenses 23,632 28,654
Interest and amortization of deferred debt issuance costs 6,057 5,757
Restructuring charge -- --
--------- ---------
Total benefits and expenses 102,394 108,182
--------- ---------
Income before income taxes, undistributed earnings of unconsolidated
affiliates and extraordinary charge 25,466 23,176
Income taxes 9,630 8,846
--------- ---------
Net income before undistributed earnings in unconsolidated affiliates
and extraordinary charge 15,836 14,330
Undistributed earnings in unconsolidated affiliates 4,318 4,334
--------- ---------
Net income before extraordinary charge 20,154 18,664
Extraordinary charge (816) (816)
--------- ---------
Net income 19,338 17,848
Preferred stock dividend requirements 2,691 2,691
--------- ---------
Net income applicable to common stock $ 16,647 $ 15,157
========= =========
Primary:
Net income applicable to common stock before extraordinary
charge $ 0.69 $ 0.63
Extraordinary charge (0.03) (0.03)
--------- ---------
Net income applicable to common stock $ 0.66 $ 0.60
========= =========
Common shares used in computing primary earnings per share 25,483 25,483
========= =========
Fully diluted:
Net income applicable to common stock before extraordinary
charge $ 0.63 $ 0.59
Extraordinary charge (0.03) (0.03)
--------- ---------
Net income applicable to common stock $ 0.60 $ 0.56
========= =========
Common shares used in computing fully diluted earnings per share 30,593 30,593
========= =========
<CAPTION>
p For the three month periods ended
----------------------------------------------------
June 30,1996 September 30, 1996
----------------------------------------------------
(As reported) (Restatement) (As reported Restatement
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
REVENUES:
Premiums, principally accident and sickness $ 62,759 $ 62,759 $ 62,237 $ 62,237
Interest sensitive policy product charges 22,675 22,675 22,408 22,408
Net investment income 43,081 39,753 60,878 61,820
Other income 865 5,457 1,714 6,375
Net gains/losses from sale of investments 3,955 (45) (3,344) 656
--------- --------- --------- ---------
Total revenues 133,335 130,599 143,893 153,496
--------- --------- --------- ---------
BENEFITS AND EXPENSES:
Claims incurred 45,355 44,670 47,443 48,128
Change in liability for future policy benefits and other
policy benefits 10,251 10,130 24,719 24,441
Amortization of present value of insurance in force and
deferred policy acquisition costs 13,405 13,397 13,754 15,591
Amortization of costs in excess of net assets acquired 1,650 1,756 2,109 2,363
Underwriting and other administrative expenses 24,237 29,060 22,125 28,030
Interest and amortization of deferred debt issuance costs 4,321 4,221 4,781 4,781
Restructuring charge -- -- -- --
------ --------- --------- ---------
Total benefits and expenses 99,219 103,234 114,931 123,334
------ --------- --------- ---------
Income before income taxes, undistributed earnings of unconsolidated
affiliates and extraordinary charge 34,116 27,365 28,962 30,162
Income taxes 12,288 9,943 10,875 11,363
--------- --------- --------- ---------
Net income before undistributed earnings in unconsolidated affiliates
and extraordinary charge 21,828 17,422 18,087 18,799
Undistributed earnings in unconsolidated affiliates 4,089 4,039 4,477 4,461
--------- --------- --------- ---------
Net income before extraordinary charge 25,917 21,461 22,564 23,260
Extraordinary charge -- -- (322) (322)
--------- --------- --------- ---------
Net income 25,917 21,461 22,242 22,938
Preferred stock dividend requirements 2,709 2,709 4,236 4,236
--------- --------- --------- ---------
Net income applicable to common stock $ 23,208 $ 18,752 $ 18,006 $ 18,702
========= ========= ========= =========
Primary:
Net income applicable to common stock before extraordinary
charge $ 0.80 $ 0.64 $ 0.62 $ 0.64
Extraordinary charge -- -- (0.01) (0.01)
--------- --------- --------- ---------
Net income applicable to common stock $ 0.80 $ 0.64 $ 0.61 $ 0.63
========= ========= ========= =========
Common shares used in computing primary earnings per share 29,139 29,139 29,497 29,497
========= ========= ========= =========
Fully diluted:
Net income applicable to common stock before extraordinary
charge $ 0.73 $ 0.60 $ 0.59 $ 0.61
Extraordinary charge -- -- (0.01) (0.01)
--------- --------- --------- ---------
Net income applicable to common stock $ 0.73 $ 0.60 $ 0.58 $ 0.60
========= ========= ========= =========
Common shares used in computing fully diluted earnings per share 34,256 34,256 37,102 37,102
========= ========= ========= =========
<CAPTION>
For the three month periods ended
---------------------------------
December 31, 1996
---------------------------------
(As reported) (Restatement)
------------ -------------
<S> <C> <C>
REVENUES:
Premiums, principally accident and sickness $ 67,442 $ 67,442
Interest sensitive policy product charges 23,479 23,479
Net investment income 68,270 69,327
Other income 3,590 5,873
Net gains/losses from sale of investments 1,173 1,173
--------- ---------
Total revenues 163,954 167,294
--------- ---------
BENEFITS AND EXPENSES:
Claims incurred 51,603 51,603
Change in liability for future policy benefits and other
policy benefits 32,625 35,244
Amortization of present value of insurance in force and
deferred policy acquisition costs 10,859 13,543
Amortization of costs in excess of net assets acquired 2,201 2,392
Underwriting and other administrative expenses 27,691 30,816
Interest and amortization of deferred debt issuance costs 3,820 3,820
Restructuring charge -- --
--------- ---------
Total benefits and expenses 128,799 137,418
--------- ---------
Income before income taxes, undistributed earnings of unconsolidated
affiliates and extraordinary charge 35,155 29,876
Income taxes 12,625 10,805
--------- ---------
Net income before undistributed earnings in unconsolidated affiliates
and extraordinary charge 22,530 19,071
Undistributed earnings in unconsolidated affiliates 8,218 8,203
--------- ---------
Net income before extraordinary charge 30,748 27,274
Extraordinary charge (1,234) (1,234)
--------- ---------
Net income 29,514 26,040
Preferred stock dividend requirements 5,010 5,010
--------- ---------
Net income applicable to common stock $ 24,504 $ 21,030
========= =========
Primary:
Net income applicable to common stock before extraordinary
charge $ 0.87 $ 0.75
Extraordinary charge (0.04) (0.04)
--------- ---------
Net income applicable to common stock $ 0.83 $ 0.71
========= =========
Common shares used in computing primary earnings per share 29,728 29,728
========= =========
Fully diluted:
Net income applicable to common stock before extraordinary
charge $ 0.77 $ 0.69
Extraordinary charge (0.03) (0.03)
--------- ---------
Net income applicable to common stock $ 0.74 $ 0.66
========= =========
Common shares used in computing fully diluted earnings per share 38,964 38,964
========= =========
</TABLE>
<PAGE> 46
INDEPENDENT AUDITORS' REPORT
Board of Directors Southwestern Financial Corporation:
We have audited the accompanying consolidated balance sheet of Southwestern
Financial Corporation and subsidiaries as of December 31, 1996 and the related
consolidated statement of income, shareholders' equity, and cash flows for the
year 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 audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the 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, 1996 and the results
of their operations and their cash flows for the year then ended in conformity
with generally accepted accounting principles.
/s/ KPMG PEAT MARWICK LLP
Dallas, Texas
March 14, 1997
(except as to Note 19 which is as of November 14, 1997)
<PAGE> 47
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
as of December 31, 1996 and 1995
(In thousands, except share information)
(As restated)
<TABLE>
<CAPTION>
ASSETS 1996 1995
----------- -----------
(UNAUDITED)
<S> <C> <C>
Investments:
Fixed maturities available for sale at fair value (cost $1,270,507 and $1,165,724) ..... $ 1,255,270 $ 1,169,478
Equity securities available for sale at fair value (cost $959 and $2,173) .............. 1,129 2,149
Mortgage loans on real estate, net ..................................................... 59,993 99,969
Policy loans ........................................................................... 128,551 137,466
Cash and short-term investments ........................................................ 161,895 196,370
Collateral loans ....................................................................... 21,308 41,308
Investment in limited partnership ...................................................... -- 39,600
Real estate ............................................................................ 7,649 17,955
Other investments ...................................................................... 5,553 6,879
----------- -----------
Total investments .................................................................... 1,641,348 1,711,174
Due from reinsurers ...................................................................... 259,288 152,866
Accrued investment income ................................................................ 20,802 21,379
Accounts and notes receivable (net of allowance of $561 and $660) ........................ 13,773 2,509
Present value of insurance in force ...................................................... 71,333 115,831
Deferred policy acquisition costs ........................................................ 15,095 --
Deferred income taxes .................................................................... 47,954 55,277
Property and equipment, net .............................................................. 1,907 2,338
Other assets ............................................................................. 16,642 26,195
Costs in excess of net assets acquired ................................................... 119,760 123,890
----------- -----------
Total assets ......................................................................... $ 2,207,902 $ 2,211,459
=========== ===========
LIABILITIES
Policy liabilities and accruals:
Future policy benefits on traditional products ......................................... $ 584,179 $ 632,259
Universal life and investment contract liabilities ..................................... 1,088,335 1,106,447
Policy and contract claims ............................................................. 55,011 62,140
Other policyholder funds ............................................................... 17,635 20,446
----------- -----------
Total policy liabilities and accruals ................................................ 1,745,160 1,821,292
Federal income taxes payable ............................................................. 9,118 3,900
Notes payable ............................................................................ 159,750 160,000
Accrued expenses and other liabilities ................................................... 118,119 70,900
----------- -----------
Total liabilities .................................................................... 2,032,147 2,056,092
----------- -----------
Mandatorily redeemable preferred stock:
Series A 10%, $.01 par value, $100 redemption value; 500,000 shares
authorized, 232,890
and 210,990 issued and outstanding at December 31, 1996 and 1995, respectively ....... 23,289 21,099
5.5% preferred stock $.01 par value, $10,000 and $100 redemption value; 2,000 and
200,000 shares authorized, 1,059 and 100,260 shares issued and outstanding at
December 31, 1996 and 1995, respectively ............................................. 10,590 10,026
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 ............................................................... 120,626 120,626
Unrealized gains (losses) on securities available for sale,
net of tax (benefit) of ($4,224) and $1,300 ............................................ (8,081) 2,413
Retained earnings ........................................................................ 29,212 1,084
----------- -----------
Total shareholders' equity ........................................................... 141,876 124,242
----------- -----------
Total liabilities and shareholders' equity ........................................... $ 2,207,902 $ 2,211,459
=========== ===========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
<PAGE> 48
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF INCOME
for the Year Ended December 31, 1996
(In thousands)
(As restated)
<TABLE>
<S> <C>
Revenues:
Premiums....................................................................................... $ 152,803
Interest sensitive policy product charges...................................................... 44,109
Net investment income.......................................................................... 128,692
Net gains from sale of investments............................................................. 516
Other income, including $15,811 in earnings of limited partnership............................. 27,439
---------
Total revenues............................................................................... 353,559
---------
Benefits and expenses:
Policyholders benefits......................................................................... 197,844
Amortization of present value of insurance
in force and deferred policy acquisition costs............................................... 23,392
Amortization of costs in excess of net assets acquired......................................... 4,130
Underwriting and other administrative expenses................................................. 65,110
Interest and amortization of deferred debt issuance costs...................................... 14,052
---------
Total benefits and expenses.................................................................. 304,528
---------
Income before income taxes....................................................................... 49,031
Income taxes..................................................................................... 18,149
---------
Net income................................................................................... 30,882
Preferred stock dividend requirements............................................................ (2,754)
---------
Net income available to common shareholders.................................................. $ 28,128
=========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
<PAGE> 49
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
for the year ended December 31, 1996
(In thousands)
(As restated)
<TABLE>
<CAPTION>
UNREALIZED GAIN
(LOSS) ON
COMMON COMMONSTOCK ADDITIONAL PAID SECURITIES
STOCK CLASS B IN CAPITAL AVAILABLE RETAINED
CLASS A 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
==== ==== ========= ========= ======= =========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
<PAGE> 50
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
for the Year Ended December 31, 1996
(In thousands)
(As restated)
<TABLE>
<S> <C>
Cash flows from operating activities:
Net income..................................................................................... $ 30,882
Adjustments to reconcile net income to net cash provided (used) by operating activities:
Adjustments relating to universal life and investment products:
Interest credited to account balances...................................................... 56,203
Charges for mortality and administration................................................... (50,689)
Capitalization of deferred policy acquisition costs.......................................... (16,806)
Amortization of intangibles, depreciation and accretion, net................................. 29,427
Decrease in policy liabilities, accruals and other policyholder funds........................ (54,427)
Decrease in accrued expenses and other liabilities........................................... (7,477)
Increase in notes and accounts receivable and accrued
investment income.......................................................................... (3,000)
Increase in taxes payable.................................................................... 5,218
Deferred income taxes........................................................................ 12,847
Equity in undistributed earnings of limited partnership...................................... (15,811)
Net gains from sales of investments.......................................................... (516)
Other, net................................................................................... 7,916
----------
Net cash used by operating activities...................................................... (6,233)
----------
Cash flows from investing activities:
Sales of fixed maturities available for sale................................................... 178,306
Maturities and other redemptions of fixed maturities available for sale........................ 20,893
Sales and principal repayments of mortgages, real estate and other investments................. 61,965
Distributions from limited partnership......................................................... 53,520
Purchases of fixed maturities available for sale............................................... (323,585)
Purchases of other investments................................................................. (694)
----------
Net cash used by investing activities...................................................... (9,595)
----------
Cash flows from financing activities:
Receipts from interest sensitive products credited to policyholders' account balances.......... 99,409
Return of policyholders' account balances on interest sensitive products....................... (117,806)
Reduction of notes payable..................................................................... (250)
----------
Net cash used by financing activities...................................................... (18,647)
----------
Decrease in cash and short-term investments...................................................... (34,475)
Cash and short-term investments at beginning of period........................................... 196,370
----------
Cash and short-term investments at end of year................................................... $ 161,895
==========
Supplemental disclosures:
Income taxes paid.............................................................................. $ 84
Interest paid.................................................................................. 12,714
Non-cash financing activities:
Preferred stock issued as dividends............................................................ 2,754
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
<PAGE> 51
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996
(Data with respect to December 31, 1995 is unaudited)
(In thousands)
(As restated)
1. BASIS OF PRESENTATION
On December 14, 1995 (the acquisition date), Southwestern Financial Corporation
("SWF" the "Company"), a newly organized corporation, was formed by PennCorp
Financial Group, Inc. (PennCorp) and Knightsbridge Capital Fund I, L.P.
(Knightsbridge). Its wholly-owned subsidiary, Southwestern Life Acquisition
Corp. (SLAC), was formed to acquire 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.
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 24% 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 1996.
The accompanying consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiaries and ICH Funding. Minority interest in
ICH Funding, totaling $1,486 and $1,174 at December 31, 1996 and 1995,
respectively, are included in accrued expenses and other liabilities. All
significant intercompany accounts and transactions have been eliminated.
The financial statements and certain notes thereto have been restated as
discussed in Note 19.
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.
<PAGE> 52
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 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 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.
Investment in a limited partnership is reflected on the equity
method.
Collateral loans are carried at their aggregate unpaid
principal balances.
The Company regularly evaluates 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.
<PAGE> 53
(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 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 policy liability or
contract rate, over the years that such profits are
anticipated to be received in proportion to the estimated
gross profits.
(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 $3,309 and $4,110
which are net of accumulated amortization of $801 and $0 at
December 31, 1996 and 1995, 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 $4,130 and $0 at December 31, 1996 and
1995, respectively.
<PAGE> 54
(i) 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 as of the acquisition date. Adjustments resulting
from completion of the purchase allocation process will affect
the value of the assets and liabilities acquired.
(j) Property and Equipment
These assets consist of electronic data processing equipment,
furniture, and other equipment, and are carried at cost, less
accumulated depreciation. Depreciation is provided using the
straight-line method over the estimated useful lives of these
assets.
(k) 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.
(l) 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.
(m) 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 being netted against the related
account balances.
<PAGE> 55
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, 1996 and 1995 are listed below:
<TABLE>
<CAPTION>
1996 1995
--------------------------------- -----------------------------
PERCENT OF PERCENT OF
CARRYING SHAREHOLDERS' CARRYING SHAREHOLDERS'
VALUE EQUITY VALUE EQUITY
------------- ------------------- ------------ ----------------
<S> <C> <C> <C> <C>
James M. Fail and Stone Capital, Inc. (formerly
CFSB Corp.) Collateral loans ..................... $ 21,308 14.7% $ 41,308 32.6%
Fund America Investors Corp., Ser. 93-C,
Class B Certificates .............................. 16,250 11.2 10,908 8.6
GSSW Limited Partnership............................. -- -- 39,600 31.2
</TABLE>
The amortized cost and estimated fair value of investments in fixed maturities
available for sale at December 31, 1996 and 1995 by categories of securities are
as follows:
<TABLE>
<CAPTION>
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
-------------- --------------- --------------- -------------
<S> <C> <C> <C> <C>
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>
<TABLE>
<CAPTION>
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
-------------- --------------- --------------- -------------
<S> <C> <C> <C> <C>
December 31, 1995:
Mortgage-backed securities.................. $ 489,810 $ 1,222 $ (615) $ 490,417
U.S. Treasury securities and obligations of
U.S. Government corporations and agencies. 39,375 168 -- 39,543
Debt securities issued by states of the United States
and political subdivisions of the states. 15,812 -- -- 15,812
Debt securities issued by foreign governments 18,518 212 -- 18,730
Corporate debt securities................... 602,209 2,805 (38) 604,976
---------- ------- ------ ----------
Total fixed maturities available for sale. $1,165,724 $ 4,407 $ (653) $1,169,478
========== ======= ====== ==========
</TABLE>
Included in fixed maturities available for sale at December 31, 1996 and 1995
are investments with a fair value of $78,118 and $103,284, respectively, which
are not publicly traded. Included in fixed maturities available for sale at
December 31, 1996 and 1995, are below investment-grade securities with amortized
costs of $40,177 and $65,475, respectively, and fair values of $39,955 and
$66,253, respectively.
The Company had non-income producing investments at December 31, 1996 with an
amortized cost and fair value as follows:
<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------------
AMORTIZED FAIR
COST VALUE
--------------------------
<S> <C> <C>
Fixed maturities................................................................. $ 571 $ 405
Equity securities................................................................ 434 620
Mortgage loans................................................................... 1,141 1,141
Real estate...................................................................... 7,649 7,649
Other investments................................................................ 992 1,618
-------- --------
$ 10,787 $ 11,433
======== ========
</TABLE>
At December 31, 1996 net unrealized appreciation of equity securities of $170
consisted of gross unrealized gains of $207, less unrealized losses of $37. At
December 31, 1995 net unrealized depreciation of $24 consisted of gross
unrealized gains of $21, less unrealized losses of $45.
<PAGE> 56
Following is an analysis of net gains (losses) from sale of investments for the
year ended December 31, 1996:
<TABLE>
<S> <C>
Fixed maturities............................................................................... $ 1,385
Equity securities.............................................................................. (43)
Other investments.............................................................................. 1,736
Real estate.................................................................................... (125)
Mortgage loans................................................................................. (2,437)
--------
$ 516
========
</TABLE>
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 year ended December 31, 1996:
<TABLE>
<S> <C>
Investments carried at fair value:
Fixed maturities............................................................................... $ (18,991)
Equity securities.............................................................................. 194
Other investments.............................................................................. 1,652
---------
(17,145)
Less effect on other balance sheet accounts:
Value of business acquired and deferred acquisition costs...................................... 1,362
Deferred income taxes.......................................................................... 5,524
Minority interest in unrealized losses......................................................... (235)
---------
Change in unrealized investment gains and losses................................................. $ (10,494)
=========
</TABLE>
The amortized cost and estimated fair value of fixed maturities at December 31,
1996, by contractual maturity, are shown below:
<TABLE>
<CAPTION>
AMORTIZED ESTIMATED
COST FAIR VALUE
---------- ----------
<S> <C> <C>
Available for sale:
Due in one year or less....................................................... $ 25,515 $ 25,510
Due after one year through five years......................................... 126,895 126,285
Due after five years through ten years........................................ 250,592 245,188
Due after ten years........................................................... 257,912 247,845
---------- ----------
660,914 644,828
Mortgage-backed securities.................................................... 609,593 610,442
---------- ----------
$1,270,507 $1,255,270
========== ==========
</TABLE>
Expected maturities will differ from contractual maturities because borrowers
may have the right to call or prepay obligations with or without prepayment
penalties.
Investments with a fair value of $121,617 and $146,888 were on deposit with
certain regulatory authorities at December 31, 1996 and 1995, respectively.
Major categories of net investment income for the year ended December 31, 1996
consist of the following:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------
<S> <C>
Fixed maturities................................................................................. $ 87,348
Equity securities................................................................................ 58
Mortgage loans................................................................................... 11,156
Policy loans..................................................................................... 8,011
Short-term investments........................................................................... 7,738
Collateral loans................................................................................. 2,947
Real estate...................................................................................... 3,956
Investments held in trust under reinsurance treaty(a)............................................ 12,130
Other investments................................................................................ 1,503
Investment expenses.............................................................................. (6,155)
---------
$ 128,692
=========
</TABLE>
- ------------------------
(a) Investments held in trust by a reinsurer with carrying values of $121,016
and $133,742 as of December 31, 1996 and 1995, respectively, are included
in amounts due from reinsurers (see Note 12).
<PAGE> 57
At December 31, 1996 and 1995 the Company held mortgage loans principally
involving commercial real estate with carrying values and estimated fair values
of $59,993 and $99,969, respectively, net of an allowance for losses of $1,000
at December 31, 1996. The average outstanding loan balances are approximately
$955 and $1,134 at December 31, 1996 and 1995, respectively. At December 31,
1996 mortgage loan investments were concentrated in the following states:
<TABLE>
<CAPTION>
PERCENT OF TOTAL
CARRYING VALUE CARRYING TOTAL
-------------- ----------------
<S> <C> <C>
Texas....................................................... $ 30,319 50.5%
Illinois.................................................... 7,657 12.8
Oklahoma.................................................... 5,631 9.4
Florida..................................................... 3,161 5.3
Kansas...................................................... 3,105 5.2
All other................................................... 10,120 16.8
-------- -----
Balance, end of period...................................... $ 59,993 100.0%
======== =====
</TABLE>
4. INVESTMENT IN GSSW LIMITED PARTNERSHIP
At December 31, 1995, the limited partnership investment represented 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.
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, end of period........................................................................... $ 2,891
=========
</TABLE>
At December 31, 1996, the accounts of GSSW are consolidated into the
accompanying consolidated balance sheet.
5. BUSINESS SEGMENT INFORMATION
The Company's only reportable segment is life insurance. Within the life
insurance segment, the Company and its subsidiaries are principally engaged in
the sale and underwriting of individual life and health insurance, and
accumulation products, principally annuities.
Assets and related investment income are allocated based upon related insurance
reserves which are backed by such assets. Other operating expenses are allocated
to each segment based on a number of assumptions and estimates generally in
relation to the mix of related revenues. Total revenues and income before income
taxes by product for the year ended December 31, 1996 are as follows:
<TABLE>
<CAPTION>
<S> <C>
Total revenues:
Individual life products................................................................ $ 165,443
Individual health products.............................................................. 137,391
Accumulation products................................................................... 44,427
Corporate and eliminations.............................................................. 6,298
---------
$ 353,559
=========
Income before income taxes:
Individual life products................................................................ $ 27,738
Individual health products.............................................................. 18,744
Accumulation products................................................................... 16,118
Corporate and eliminations.............................................................. (13,569)
---------
$ 49,031
=========
</TABLE>
<PAGE> 58
Total assets by product as of December 31, 1996 and 1995 are as follows:
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------
1996 1995
---------- ----------
<S> <C> <C>
Total assets:
Individual life products....................................................... $1,201,302 $1,203,181
Individual health products..................................................... 332,118 292,942
Accumulation products.......................................................... 486,910 520,656
Corporate and eliminations..................................................... 187,562 194,680
---------- ----------
$2,207,902 $2,211,459
========== ==========
</TABLE>
6. 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.
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 reserves and claims are adequate, such estimates may be more or less than
the amounts ultimately paid when the claims are settled.
Total policy liabilities and accruals consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1996 1995
------------ ------------
<S> <C> <C>
Future policy benefits on traditional products:
Traditional life insurance contracts........................................... $ 344,520 $ 352,809
Traditional annuity products................................................... 105,246 114,333
Individual accident and health................................................. 104,071 132,091
Unearned premiums.............................................................. 30,342 33,026
---------- ----------
Total future policy benefits 584,179 632,259
---------- ----------
Universal life and investment contract liabilities:
Universal life and annuities................................................... 1,086,632 1,099,697
Guaranteed investment contracts................................................ 1,703 6,750
---------- ----------
Total universal and investment contract liabilities.......................... 1,088,335 1,106,447
---------- ----------
Policy and contract claims....................................................... 55,011 62,140
Other policyholder funds......................................................... 17,635 20,446
---------- ----------
Total policy liabilities and accruals........................................ $1,745,160 $1,821,292
========== ==========
</TABLE>
<PAGE> 59
The following table presents information on changes in the liability for policy
and contract claims for the year ended December 31, 1996:
<TABLE>
<S> <C>
Policy and contract claims at January 1.......................................................... $ 62,140
Less reinsurance recoverables.................................................................... 118
--------
Net balance at January 1....................................................................... 62,022
--------
Add claims incurred, net of reinsurance related to:
Current year................................................................................... 91,496
Prior years.................................................................................... (2,646)
--------
88,850
--------
Deduct claims paid, net of reinsurance related to:
Current year................................................................................... 52,240
Prior years.................................................................................... 43,774
--------
96,014
--------
Policy and contract claims, net of related reinsurance recoverables at December 31 54,858
Plus reinsurance recoverables.................................................................... 153
--------
Policy and contract claims at December 31........................................................ $ 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
$2,646 in 1996.
7. NOTES PAYABLE
The outstanding principal amounts of notes payable at December 31, 1996 and 1995
consist of the following:
<TABLE>
<CAPTION>
1996 1995
--------- --------
<S> <C> <C>
Revolving bank debt.............................................................. $ 95,000 $ 95,000
Bank debt with quarterly principal requirements 24,750 25,000
Convertible subordinated notes issued to ICH for
acquisition of insurance subsidiaries.......................................... 40,000 40,000
--------- --------
$ 159,750 $160,000
========= ========
</TABLE>
Interest costs under the revolving bank debt totaled $8,128 for the year ended
December 31, 1996. 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,
1996, the effective rate of the revolving loan was approximately 8.3%.
Interest costs under the bank term debt totaled $2,250 for the year ended
December 31, 1996. 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, 1996, the effective rate of the
term loans was approximately 8.8%.
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. On June 15, 1997, SWF will either (i) offer to repurchase any and
all notes then outstanding at 100% of the principal amount thereof plus accrued
and unpaid interest to the repurchase date (the "Interim Repurchase Offer") or
(ii) reset the interest rate on the Convertible Notes, immediately after such
adjustment, to have a bid price equal to 100% of the principal amount. If SWF
makes the Interim Repurchase Offer, there will be no interest rate reset on any
Convertible Notes not tendered to SWF for purchase pursuant to the Interim
Repurchase Offer. 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 year
ended December 31, 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, 1996 and December 31, 1995, restricted cash and
short-term investments totaled $5,959 and $8,400, respectively.
<PAGE> 60
The Company has pledged the stock of certain of its insurance subsidiaries as
collateral under the bank credit facilities. In addition, the bank loans contain
a number of covenants. These prohibit the Company from paying cash dividends on
its preferred or common stock without the banks' consent. In addition, except
for transactions in the ordinary course of business, the Company and its
subsidiaries can not loan or borrow monies, acquire assets in excess of
specified limits, grant liens or generally take any other action which would
result in any material change in the Company or its subsidiaries without prior
written consent of such banks. The Company is also required to maintain a
specified minimum net worth and comply with certain financial ratios. The
Company was in compliance with all applicable covenants as of December 31, 1996.
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,
1996, three-month LIBOR was 5.56%.
The aggregate maturities of notes payable during each of the five years after
December 31, 1996 are as follows:
<TABLE>
<S> <C>
1997........................................................................ $ 5,000
1998........................................................................ 13,788
1999........................................................................ 13,291
2000........................................................................ 11,711
2001........................................................................ 10,692
2002 and thereafter......................................................... 105,268
---------
$ 159,750
=========
</TABLE>
8. 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. 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 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 year ended December 31, 1996, 21,900
additional shares were issued with a redemption value of $2,190 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 SLAC, 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 year ended
December 31, 1996, 59 additional shares were issued with a redemption value of
$590 in lieu of cash to satisfy dividend requirements of $564 in 1996 and $26 in
1995.
In conjunction with the acquisition of its insurance subsidiaries on December
14, 1995, SWF issued warrants to the shareholders of SWF for the purchase of up
to an additional 1,785,000 shares of Class B voting common stock at an exercise
price of $10.00 per share. The warrants are exercisable at any time until their
expiration on December 15, 2005.
<PAGE> 61
9. INCOME TAXES
The Company and its non-insurance subsidiaries file a consolidated federal
income tax return. The Company's life insurance subsidiaries also file federal
income tax returns as a consolidated group.
Total income taxes for the year ended December 31, 1996 are as follows:
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------
<S> <C>
Current .................................................................... $ 5,302
Deferred . .................................................................. 12,847
----------
$ 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 year ended December 31, 1996, as follows:
<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------
<S> <C>
Tax expense computed at statutory rate.................................. $ 17,161
Amortization of costs in excess of net assets acquired.................. 1,445
Change in deferred tax asset valuation allowance........................ (183)
Other................................................................... (274)
--------
$ 18,149
========
</TABLE>
Temporary differences 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, 1996 and 1995 relate to the following:
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------
1996 1995
--------- ---------
<S> <C> <C>
Deferred tax assets:
Deferred policy acquisition costs.............................................. $ 10,407 $ 12,334
Future policy benefits......................................................... 112,408 132,330
Invested assets, subject to capital gains treatment............................ 16,770 18,446
Unrealized loss................................................................ 4,224 --
--------- ---------
143,809 163,110
--------- ---------
Deferred tax liabilities:
Present value of insurance in force............................................ (24,967) (40,541)
Other assets and liabilities................................................... (50,280) (45,201)
Unrealized gain................................................................ -- (1,300)
--------- ---------
(75,247) (87,042)
--------- ---------
Net deferred tax asset......................................................... 68,562 76,068
Valuation allowance............................................................ (20,608) (20,791)
--------- ---------
$ 47,954 $ 55,277
========= =========
</TABLE>
The valuation allowance at December 31, 1996, is 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, 1996.
At December 31, 1996, the Company has net operating loss carryovers available of
$561 related to the non-life consolidated return, of which $250 expires in 2010
and $311 expires in 2011.
<PAGE> 62
10. 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
year ended December 31, 1996 is as follows:
<TABLE>
<S> <C>
Policy acquisition costs deferred:
Commissions................................................................ $ 11,810
Underwriting and issue costs............................................... 4,996
Released by 80% coinsurance of Medicare business (see Note 12)............... (1,243)
Policy acquisition costs amortized........................................... (503)
Unrealized investment loss adjustment........................................ 35
--------
Unamortized deferred policy acquisition costs at period end.................. $ 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.
Information related to the present value of insurance in force for the year
ended December 31, 1996 is as follows:
<TABLE>
<S> <C>
Balance at December 31, 1995.................................................. $ 115,831
Released by 80% coinsurance of Medicare business (see Note 12)................ (22,936)
Accretion of interest......................................................... 4,415
Amortization.................................................................. (27,304)
Unrealized investment loss adjustment......................................... 1,327
---------
Balance at December 31, 1996................................................ $ 71,333
=========
</TABLE>
<PAGE> 63
Expected gross amortization, based upon current assumptions and accretion of
interest at a policy liability or contract rate ranging from 0% 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> <C>
1997........................... $71,333 $ 15,749 $ 3,584 $ 12,165
1998........................... 59,168 13,043 2,978 10,065
1999........................... 49,103 10,317 2,491 7,826
2000........................... 41,277 8,314 2,110 6,204
2001........................... 35,073 6,977 1,802 5,175
</TABLE>
11. 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, 1996 was $177,510, of
which $159,074 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 net gain from operations for the year ended December
31, 1996, approximately $19,000 of dividends could 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 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, 1996 and 1995 totaled
approximately $177,510 and $128,729, respectively. Statutory net income of the
Company's life insurance subsidiaries as reported to regulatory authorities
totaled $24,919 for the year ended December 31, 1996.
<PAGE> 64
12. 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 year ended December 31, 1996 is as follows:
<TABLE>
<S> <C>
Direct policy revenues and amounts assessed against policyholders............ $ 255,352
Reinsurance assumed.......................................................... 3,483
Reinsurance ceded............................................................ (61,923)
---------
Net premiums and amounts earned.............................................. $ 196,912
=========
Policyholder benefits ceded.................................................. $ 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. Since July 1, 1996, $6,445 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 has ceded a block of annuities under a reinsurance agreement
with Employees Reassurance Corporation (ERC). Such reinsurance is accounted for
as a financing arrangement and is not reflected in the accompanying financial
statements except for the risk fees paid to ERC. Statutory surplus provided by
this treaty totaled $8,714 and $13,074 at December 31, 1996 and 1995,
respectively. Risk fees paid to the reinsurer were 2% of the net amount of
surplus provided and totaled $222 for the year ended December 31, 1996.
Amounts due from reinsurers included amounts due from ERC of $121,016 and
$133,742 at December 31, 1996 and 1995, respectively. The underlying assets held
by ERC had carrying values of $121,016 and $133,742 and fair values of $122,639
and $139,222 at December 31, 1996 and 1995, respectively.
13. 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, 1996 amounted to $696.
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 $1,700 under
this plan during the year ended December 31, 1996.
<PAGE> 65
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 health and welfare benefits is unfunded. Following is an analysis
of the change in the liability for accrued postretirement benefits for the year
ended December 31, 1996:
<TABLE>
<S> <C>
Accrued postretirement benefits, beginning of year.......................... $ 12,821
--------
Recognition of components of net periodic postretirement benefit cost:
Service cost.............................................................. 244
Interest cost............................................................. 834
--------
Net periodic postretirement benefit cost.................................. 1,078
Benefit payments............................................................ (1,213)
--------
Net change.................................................................. (135)
--------
Accrued postretirement benefits, end of year................................ $ 12,686
========
</TABLE>
The liability for accrued postretirement benefits includes the following at
December 31, 1996:
<TABLE>
<S> <C>
Accumulated postretirement benefit obligation:
Retirees.................................................................. $ 10,884
Active eligible........................................................... 1,194
Active ineligible......................................................... 831
--------
12,909
Unrecognized actuarial loss................................................. (223)
--------
Accrued postretirement benefits............................................. $ 12,686
========
</TABLE>
For measurement purposes, an 6.5% annual rate increase in the health care cost
trend rate was assumed for 1997; the rate was assumed to decrease gradually to
4.5% 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, 1996 by $645 and the aggregate
of the service and interest components of net periodic postretirement health
care benefit cost for 1996 by $127. The weighted average discount rate used in
determining the accumulated postretirement benefit obligation was 7.5%.
14. RELATED PARTY TRANSACTIONS
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 year ended December 31, 1996, fees incurred totaled
$1,658.
The Company agreed to pay PennCorp, a shareholder, $1,000 in conjunction with
the GSSW transaction (see Note 4).
<PAGE> 66
15. OTHER COMMITMENTS AND CONTINGENCIES
The Company and its subsidiaries are obligated under operating leases, primarily
for office space. Rent expense, net of sublease income, was $2,058 in 1996.
Minimum lease commitments are:
<TABLE>
<S> <C>
1997......................................................................... $ 1,720
1998......................................................................... 148
1999......................................................................... 148
2000......................................................................... 148
2001......................................................................... 136
-------
Total minimum payments required............................................ $ 2,300
=======
</TABLE>
The Company's office lease expires November 1997. The Company is currently
negotiating a new ten year lease arrangement.
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 $1,357 in 1996. Based on information currently
available, the insurance subsidiaries have accrued $3,194 at December 31, 1996
for future assessments, net of future premium tax reductions.
16. OTHER OPERATING INFORMATION
Underwriting and other administrative expenses for the year ended December 31,
1996 are as follows:
<TABLE>
<S> <C>
Non-deferrable commission expense....................................... $ 22,437
Taxes, licenses and fees................................................ 9,214
General and administrative expenses..................................... 39,241
Expense allowance on reinsurance ceded.................................. (5,782)
--------
Underwriting and other administrative expenses........................ $ 65,110
========
</TABLE>
<PAGE> 67
17. FINANCIAL INSTRUMENTS
The following is a summary of the carrying value and estimated fair value of the
Company's financial instruments at December 31, 1996 and 1995:
<TABLE>
<CAPTION>
1996 1995
------------------------- --------------------------
ESTIMATED ESTIMATED
CARRYING FAIR CARRYING FAIR
VALUE VALUE VALUE VALUE
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Assets:
Cash and short-term investments............................. $ 161,895 $ 161,895 $ 196,370 $ 196,370
Fixed maturities............................................ 1,255,270 1,255,270 1,169,478 1,169,478
Equity securities........................................... 1,129 1,129 2,149 2,149
Mortgage loans.............................................. 59,993 59,993 99,969 99,969
Policy loans................................................ 128,551 128,551 137,466 137,466
Collateral loans............................................ 21,308 21,308 41,308 41,308
Investment in limited partnership........................... -- -- 39,600 39,600
Other investments........................................... 5,553 5,553 6,879 6,879
Interest rate cap........................................... 145 -- 218 --
Agent and premium receivables............................... 13,773 13,773 2,509 2,509
Liabilities: .................................................
Notes payable................................. ............. 159,750 159,750 160,000 160,000
Universal life and investment contract liabilities ......... 1,088,335 1,088,335 1,106,447 1,106,447
</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.
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.
Investment in limited partnership: Fair values of the Company's investments
in limited partnership at December 31, 1995 is based on the estimated fair
value of the partnership assets and liabilities, assuming a liquidation of
the partnership and distribution of proceeds to the partners.
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.
<PAGE> 68
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 note payable to ICH Corporation is based on the Company's implicit
incremental borrowing rate from the fair value of the Company's bank
obligations.
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.
18. SUBSEQUENT EVENTS (UNAUDITED)
In early 1997, PennCorp entered into an agreement to acquire all of the
outstanding SWF common stock held by Knightsbridge and certain other parties.
Assuming completion of the transaction, SWF would become a wholly-owned
subsidiary of PennCorp. The transaction is subject to the approval of the
shareholders of PennCorp.
In August 1997, PennCorp acquired from ICH the Company's 7.0% Convertible
Subordinated Notes in the aggregate principal amount of $40,000. In addition,
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.
19. RESTATEMENT OF CONSOLIDATED FINANCIAL STATEMENTS
The Company has restated its financial statements for the year ended December
31, 1996. The restatement resulted from the Company reconsidering certain
accounting practices.
The significant accounting practices incorporated in the restatement are as
follows:
(i) the recognition of investment income (approximately $182 reduction in net
income for the year ended December 31, 1996); and
(ii) the allocation of purchase consideration (approximately $99 increase in net
income for the year ended December 31, 1996).
<PAGE> 69
PENNCORP FINANCIAL GROUP, INC. AND SUBSIDIARIES
INDEX TO FINANCIAL STATEMENTS AND SCHEDULES
Financial Statements:
Reference is made to data appearing in Exhibit 99.1, and to the Independent
Auditors' Report appearing therein.
<TABLE>
<CAPTION>
SCHEDULES: *
----------------------------------------------------------------
Independent Auditors' Report - Financial Statement Schedules
<S> <C>
Schedule I Summary of Investments -
Other than Investments in Related Parties........
Schedule II Condensed Financial Information of Registrant....
Schedule III Supplementary Insurance Information..............
Schedule IV Reinsurance......................................
Schedule V Valuation and Qualifying Accounts................
</TABLE>
* 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.
<PAGE> 70
SCHEDULE I
PENNCORP FINANCIAL GROUP, INC.
Summary of Investments - Other Than Investments in Related Parties
December 31, 1996
(Dollars in thousands)
(As restated)
<TABLE>
<CAPTION>
AMOUNT AT
WHICH SHOWN
MARKET IN THE
TYPE OF INVESTMENT COST VALUE BALANCE SHEET
- ---------------------------------------------------- ----------- ---------- -------------
<S> <C> <C> <C>
Fixed Maturities held for investment:
Bonds:
United States Government agencies and authorities $ -- $ -- $ --
States, municipals and political subdivisions -- -- --
Foreign governments -- -- --
Other Special Revenue -- -- --
Public Utilities -- -- --
All other corporate bonds 87,330 89,759 87,330
Redeemable preferred stock -- -- --
----------- ---------- ----------
Total fixed maturities held for investments $ 87,330 $ 89,759 $ 87,330
----------- ---------- ----------
Fixed maturities held for sale:
Bonds:
United States Government agencies and authorities 915,300 928,640 928,640
States, municipals and political subdivisions 77,661 78,285 78,285
Foreign governments 80,491 88,670 88,670
Other Special Revenue 720,208 729,204 729,204
Public Utilities 101,858 105,253 105,253
All other corporate bonds 1,044,980 1,063,107 1,063,107
Redeemable preferred stock 770 766 766
----------- ---------- ----------
Total fixed maturities held for sale $ 2,941,268 $2,993,925 $2,993,925
----------- ---------- ----------
Fixed maturities trading:
Bonds:
Other Special Revenue 31,021 31,140 31,140
Equity securities 17,511 20,867 20,867
Mortgage loans and real estate 264,732 269,141 264,732
Policy Loans 145,976 145,976 145,976
Short term investments 63,113 63,113 63,113
Other investments 48,062 48,062 48,062
----------- ---------- ----------
Total investments $ 3,599,013 $3,661,983 $3,655,145
=========== ========== ==========
</TABLE>
See accompanying independent auditors' report
<PAGE> 71
SCHEDULE II
PENNCORP FINANCIAL GROUP, INC.
(PARENT COMPANY ONLY)
CONDENSED STATEMENTS OF INCOME
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
(Dollars in thousands)
(As restated)
<TABLE>
<CAPTION>
1996 1995 1994
--------- -------- --------
Revenue:
<S> <C> <C> <C>
Interest income from subsidiaries $ 35,525 $ 27,680 $ 9,773
Other interest income 2,428 638 30
Other income 423 3,985 288
-------- -------- --------
Total revenue 38,376 32,303 10,091
-------- -------- --------
Operating expenses:
General and administrative expenses 2,493 2,257 784
Interest and amortization of deferred debt issuance costs 17,920 15,938 16,756
-------- -------- --------
Total operating expenses 20,413 18,195 17,540
-------- -------- --------
Income (loss) before income taxes, equity in undistributed
earnings of subsidiaries and extraordinary charge 17,963 14,108 (7,449)
Income tax expense (benefit) 251 4,139 (2,507)
-------- -------- --------
Net income (loss) before equity in undistributed earnings of
subsidiaries and extraordinary charge 17,712 9,969 (4,942)
Equity in undistributed earnings of subsidiaries 72,305 46,377 43,432
-------- -------- --------
Net income before extraordinary charge 90,017 56,346 38,490
Extraordinary charge, net of tax benefit of ($932, $ - ,$ - ) (1,730) -- --
-------- -------- --------
Net Income $ 88,287 $ 56,346 $ 38,490
======== ======== ========
</TABLE>
See accompanying independent auditors' report
<PAGE> 72
SCHEDULE II
PENNCORP FINANCIAL GROUP, INC.
(PARENT COMPANY ONLY)
CONDENSED BALANCE SHEETS
AS OF DECEMBER 31, 1996 AND 1995
(Dollars in thousands)
(As restated)
<TABLE>
<CAPTION>
1996 1995
----------- ---------
<S> <C> <C>
ASSETS
Investments:
Investment in subsidiaries $ 830,946 $ 560,736
Notes receivable from subsidiaries 235,146 183,364
----------- ---------
Total investments 1,066,092 744,100
Cash and short term investments 2,099 1,713
Accrued investment income due from subsidiaries 3,918 18,808
Deferred debt issuance costs 2,482 3,824
Furniture and fixtures 463 499
Other assets 10,728 5,217
----------- ---------
$ 1,085,782 $ 774,161
=========== =========
LIABILITIES
Notes payable 206,646 250,000
Due to subsidiaries 12,778 13,322
Accrued expenses and other liabilities 4,117 21,704
----------- ---------
Total liabilities 223,541 285,026
----------- ---------
Mandatory redeemable preferred stock, Series B 14,689 13,307
Mandatory redeemable preferred stock, Series C 18,175 16,700
SHAREHOLDERS' EQUITY
$3.375 Convertible preferred stock 110,513 110,513
$3.50 Series II convertible preferred stock 139,157 --
Common stock 286 229
Additional paid in capital 393,156 220,482
Treasury stock (3,370) (3,370)
Retained earnings 186,032 117,987
Unrealized foreign currency translation adjustment (14,961) (15,529)
Unrealized gains on securities available for sale 20,064 30,353
Notes receivable from officers and employees for stock purchases (1,500) (1,537)
----------- ---------
Total shareholders' equity 829,377 459,128
----------- ---------
Total liabilities and shareholders' equity $ 1,085,782 $ 774,161
=========== =========
</TABLE>
See accompanying independent auditors' report
<PAGE> 73
SCHEDULE II
PENNCORP FINANCIAL GROUP, INC.
(PARENT COMPANY ONLY)
CONDENSED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
(Dollars in thousands)
(As restated)
<TABLE>
<CAPTION>
1996 1995 1994
---------- ---------- -------
Cash flows from operating activities:
<S> <C> <C> <C>
Net earnings $ 88,287 $ 56,346 $ 38,490
Adjustments to reconcile net earnings to net cash
provided (used) in operating activities:
Amortization of intangibles and depreciation 1,238 1,121 786
Equity in undistributed earnings of subsidiaries (72,305) (46,377) (43,432)
Increase (decrease) in liabilities and due
to subs (544) 7,898 (24,532)
Other 79 (23,754) (733)
---------- ---------- ---------
Net cash provided (used) by operations 16,755 (4,766) (29,421)
---------- ---------- ---------
Cash flows from investing activities:
Cash expended in acquisition of business -- (18,363) (47,343)
Purchase of affiliate -- (115,454) --
Cash provided from sale of business -- -- 27,107
Issuance of surplus note to subsidiary (155,000) -- (19,732)
Principal payment on surplus note 100,000 -- --
Dividend received from subsidiary 11,283 1,603 1,200
Capital contribution to subsidiary (208,708) (54,399) (15,601)
Other -- -- 1,004
---------- ---------- ---------
Net cash used by investing activities (252,425) (186,613) (53,365)
---------- ---------- ---------
Cash flows from financing activities:
Issuance of notes payable 230,000 101,500 30,000
Issuance of common stock 155,450 51,210 --
Issuance of preferred stock 139,157 110,513 33,034
Purchase of treasury stock -- (2,984) (232)
Reduction of notes payable (273,353) (30,000) (1,500)
Redemption of preferred stock -- (33,415) --
Dividends paid (15,198) (4,950) (765)
Cost of debt refinancing -- -- (159)
---------- ---------- ---------
Net cash provided by financing activities 236,056 191,874 60,378
---------- ---------- ---------
Increase (decrease) in cash 386 495 (22,408)
Cash at beginning of year 1,713 1,218 23,626
========== ========== =========
Cash at end of year $ 2,099 $ 1,713 $ 1,218
========== ========== =========
Supplemental Disclosure:
Interest paid $ 16,921 $ 15,308 $ 14,310
========== ========== =========
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 --
========== ========== =========
</TABLE>
See accompanying independent auditors' report
<PAGE> 74
SCHEDULE III
PENNCORP FINANCIAL GROUP, INC.
SUPPLEMENTARY INSURANCE INFORMATION
Years ended December 31, 1996, 1995 and 1994
(In thousands)
(As restated)
<TABLE>
<CAPTION>
FUTURE POLICY OTHER BENEFITS, AMORTIZATION
DEFERRED BENEFITS, POLICY CLAIMS, LOSSES OF DEFERRED
POLICY LOSSES, CLAIMS CLAIMS AND NET AND, POLICY OTHER
ACQUISITION AND LOSS BENEFITS PREMIUM INVESTMENT SETTLEMENT ACQUISITION OPERATING
SEGMENT COSTS EXPENSES PAYABLE REVENUE INCOME EXPENSES COSTS EXPENSES
- -------------- ----------- -------------- ---------- ---------- --------- ---------- ----------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
1994
Fixed benefit $ 79,100 $ 299,137 $ 2,080 $ 176,950 $ 22,018 $ 89,377 $ 6,791 $ 54,959
Life 51,906 451,363 35,643 67,472 29,832 13,944 3,147 22,858
--------- ---------- -------- --------- --------- --------- -------- --------
Total $ 131,006 $ 750,500 $ 37,723 $ 244,422 $ 51,850 $ 103,321 $ 9,938 $ 77,817
========= ========== ======== ========= ========= ========= ======== ========
1995
Fixed benefit $ 93,735 $ 286,977 $ 3,179 $ 174,708 $ 22,946 $ 64,465 $ 15,580 $ 52,240
Life 80,243 1,093,922 4,453 119,062 55,457 77,468 9,741 47,144
Accumulation 11,592 801,251 31,379 8,119 23,888 19,890 3,686 6,721
--------- ---------- -------- --------- --------- --------- -------- --------
Total $ 185,570 $2,182,150 $ 39,011 $ 301,889 $ 102,291 $ 161,923 $ 29,007 $106,105
========= ========== ======== ========= ========= ========= ======== ========
1996
Fixed benefit $ 127,091 $ 291,281 $ 2,787 $ 169,311 $ 22,730 $ 60,931 $ 16,446 $ 55,161
Life 105,063 1,207,775 4,599 169,974 88,220 135,134 12,010 48,706
Accumulation 20,274 2,026,970 33,043 8,805 99,784 67,648 2,288 12,693
--------- ---------- -------- --------- --------- --------- -------- --------
Total $ 252,428 $3,526,026 $ 40,429 $ 348,090 $ 210,734 $ 271,911 $ 30,744 $116,560
========= ========== ======== ========= ========= ========= ======== ========
</TABLE>
See accompanying independent auditors' report
<PAGE> 75
SCHEDULE IV
PENNCORP FINANCIAL GROUP, INC.
REINSURANCE
Years ended December 31, 1996, 1995 and 1994
(In thousands)
<TABLE>
<CAPTION>
PERCENTAGE
CEDED TO ASSUMED OF AMOUNT
GROSS OTHER FROM OTHER ASSUMED
AMOUNT COMPANIES COMPANIES NET AMOUNT TO NET
---------- ---------- ----------- ----------- -------------
<S> <C> <C> <C> <C> <C>
Year ended December 31, 1994:
Life insurance in force $13,460,398 $1,079,869 $ 436,615 $12,817,144
=========== ========== =========== ===========
Premiums:
Accident and health insurance $ 177,512 $ 562 $ 0 $ 176,950 0.0%
Life insurance/accumulation 72,655 5,948 765 67,472 1.1%
----------- ---------- ----------- -----------
$ 250,167 $ 6,510 $ 765 $ 244,422
=========== ========== =========== ===========
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
=========== ========== =========== ===========
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 $ 0 $ 169,311 0.0%
Life insurance/accumulation 189,098 11,639 1,320 178,779 0.7%
----------- ---------- ----------- -----------
$ 358,825 $ 12,055 $ 1,320 $ 348,090
=========== ========== =========== ===========
</TABLE>
See accompanying independent auditors' report
<PAGE> 76
SCHEDULE V
PENNCORP FINANCIAL GROUP, INC.
VALUATION AND QUALIFYING ACCOUNTS
Years ended December 31, 1996, 1995 and 1994
(in thousands)
(As restated)
<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>
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
1994:
Accounts and notes receivable 8,182 873 663 8,392
(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
<PAGE> 77
PENNCORP FINANCIAL GROUP, INC.
STATEMENT RE RATIO OF EARNINGS TO FIXED CHARGES AND
PREFERRED STOCK DIVIDEND REQUIREMENTS
For the Years Ended December 31, 1996, 1995 and 1994
(As restated)
<TABLE>
<CAPTION>
1996 1995 1994
-------- -------- -------
<S> <C> <C> <C>
Income before income taxes, undistributed earnings in
unconsolidated affiliates and extraordinary charge.... $110,579 $ 79,457 $60,653
Adjustments to earnings:
Fixed charges......................................... 21,333 23,236 20,650
Interest capitalized.................................. -- -- --
Preferred stock dividend requirements
of majority owned subsidiaries................... -- -- --
-------- -------- -------
Total earnings and fixed charges........................... $131,912 $102,693 $81,303
======== ======== =======
Fixed charges:
Interest expensed..................................... $ 17,741 $ 18,729 $17,404
Amortization of deferred debt costs and
original issue discount.......................... 1,238 1,051 870
Rental expense........................................ 2,354 3,456 2,375
-------- -------- -------
Total fixed charges........................................ $ 21,333 $ 23,236 $20,550
======== ======== =======
Preferred Stock Requirements:
Preferred stock dividends............................. $ 14,646 $ 6,540 $ 1,151
Gross up for taxes.................................... 7,710 3,174 582
-------- -------- -------
Total preferred stock requirements......................... $ 22,356 $ 9,714 $ 1,733
======== ======== =======
Ratio of earnings to fixed charges......................... 6.18% 4.42% 3.94%
-------- -------- -------
Combined ratio of earnings to fixed charges
and preferred stock dividend requirements............. 3.02% 3.12% 3.63%
-------- -------- -------
</TABLE>
<PAGE> 78
PENNCORP FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED BALANCE SHEETS
(AMOUNTS IN THOUSANDS, EXCEPT SHARE INFORMATION)
(As restated)
<TABLE>
<CAPTION>
(UNAUDITED)
----------- -----------
MARCH 31, DECEMBER 31,
1997 1996
----------- -----------
<S> <C> <C>
ASSETS:
Investments:
Fixed maturities:
Held for investment, at amortized cost $ 49,384 $ 87,330
Available for sale, at fair value 2,924,941 2,993,925
Equity securities available for sale, at fair value 22,647 20,867
Trading securities, at market -- 31,140
Mortgage loans on real estate 269,106 264,732
Policy loans 145,232 145,976
Short term investments 142,976 63,113
Other investments 53,868 48,062
----------- ----------
Total investments 3,608,154 3,655,145
Cash 5,386 39,464
Accrued investment income 41,263 48,360
Accounts and notes receivable 54,734 47,295
Investments in unconsolidated affiliates 130,382 140,526
Present value of insurance in force 343,853 339,010
Deferred policy acquisition costs 273,940 252,428
Costs in excess of net assets acquired 146,103 148,080
Other assets 139,225 139,015
----------- ----------
Total assets $ 4,743,040 $4,809,323
=========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY:
Liabilities:
Policy liabilities and accruals $ 3,511,800 $3,566,455
Notes payable 245,186 210,325
Income taxes, primarily deferred 44,163 55,840
Accrued expenses and other liabilities 146,724 114,462
----------- ----------
Total liabilities 3,947,873 3,947,082
----------- ----------
Mandatorily redeemable preferred stock:
Series B, $.01 par value, $100 initial redemption value; authorized, issued and
outstanding -0- at March 31, 1997, and 127,500 at December 31, 1996 -- 14,689
Series C, $.01 par value, $100 initial redemption value; authorized,
issued and outstanding 178,500 at March 31, 1997, and December 31, 1996 18,584 18,175
Shareholders' Equity:
$3.375 Convertible Preferred Stock, $.01 par value, $50 redemption value;
authorized issued and Outstanding 2,300,000 at March 31, 1997, and
December 31, 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 at March 31, 1997,
and December 31, 1996 139,157 139,157
Common stock, $.01 par value; authorized 50,000,000; issued and outstanding
28,766,055 at March 31, 1997, and 28,647,714 at December 31, 1996 288 286
Additional paid-in capital 394,020 393,156
Unrealized foreign currency translation losses (16,788) (14,961)
Unrealized gains (losses) on securities available for sale (34,245) 20,064
Retained earnings 192,045 186,032
Treasury shares (6,907) (3,370)
Notes receivable secured by common stock (1,500) (1,500)
----------- ----------
776,583 829,377
----------- ----------
$ 4,743,040 $4,809,323
=========== ==========
</TABLE>
SEE ACCOMPANYING NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS.
<PAGE> 79
PENNCORP FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE INFORMATION)
(UNAUDITED)
(As restated)
<TABLE>
<CAPTION>
THREE MONTH PERIODS ENDED
MARCH 31,
1997 1996
----------- -----------
<S> <C> <C>
REVENUES:
Premiums, principally accident and sickness $ 66,477 $ 64,421
Interest sensitive product policy charges 23,226 22,669
Net investment income 68,546 39,834
Other income 6,040 4,961
Net gains (losses) from sale of investments 3,827 (527)
----------- -----------
Total revenues 168,116 131,358
----------- -----------
BENEFITS AND EXPENSES:
Claims incurred 44,655 44,326
Change in liability for future policy benefits and
other policy benefits 30,108 13,369
Amortization of present value of insurance in force
and deferred policy acquisition costs 20,819 13,939
Amortization of costs in excess of net assets
acquired 2,278 2,137
Underwriting and other administrative expenses 30,536 28,654
Interest and amortization of deferred debt issuance costs 4,387 5,757
Restructuring charge 19,071 --
----------- -----------
Total benefits and expenses 151,854 108,182
----------- -----------
Income before income taxes, undistributed earnings in
unconsolidated affiliates and extraordinary charge 16,262 23,176
Income taxes 7,557 8,846
----------- -----------
Net income before undistributed earnings in unconsolidated
affiliates and extraordinary charge 8,705 14,330
Undistributed earnings in unconsolidated affiliates 3,658 4,334
----------- -----------
Net income before extraordinary charge 12,363 18,664
Extraordinary charge -- (816)
----------- -----------
Net income 12,363 17,848
Preferred stock dividend requirements 4,927 2,691
----------- -----------
Net income applicable to common stock $ 7,436 $ 15,157
=========== ===========
PER SHARE INFORMATION:
Primary:
Net income applicable to common stock before extraordinary
charge $ 0.25 $ 0.63
Extraordinary charge, net of income taxes -- (0.03)
----------- -----------
Net income applicable to common stock $ 0.25 0.60
=========== ===========
Common shares used in computing primary earnings per share 29,703 25,483
=========== ===========
Fully diluted:
Net income applicable to common stock before extraordinary
charge $ 0.25 $ 0.59
Extraordinary charge, net of income taxes -- (0.03)
----------- -----------
Net income applicable to common stock $ 0.25 $ 0.56
=========== ===========
Common shares used in computing fully diluted earnings per share 29,703 30,593
=========== ===========
</TABLE>
SEE ACCOMPANYING NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS.
<PAGE> 80
PENNCORP FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(AMOUNTS IN THOUSANDS)
(UNAUDITED)
(As restated)
<TABLE>
<CAPTION>
-----------------------------
THREE MONTH PERIODS ENDED
MARCH 31,
-----------------------------
1997 1996
----------- -----------
<S> <C> <C>
Net cash provided (used) by operating activities $ 88,907 $ (3,619)
----------- -----------
Cash flows from investing activities:
Purchases of invested assets (327,134) (426,683)
Sales of invested assets 302,420 246,015
Maturities of invested assets 47,474 39,495
Other, primarily short term investments, net (89,068) 127,764
----------- -----------
Net cash used by investing activities (66,308) (13,409)
----------- -----------
Cash flows from financing activities:
Issuance of common stock 866 155,759
Treasury stock purchase (3,538) --
Additional borrowings 135,000 --
Reduction in notes payable (100,139) (137,000)
Redemption of preferred stock (14,706) --
Dividends on preferred and common stock (5,879) (3,332)
Receipts from interest sensitive policies credited to
policyholder account Balances 51,380 27,644
Return of policyholder account balances on interest
sensitive products (116,787) (42,378)
Other, net (2,874) --
----------- -----------
Net cash provided (used) by financing activities (56,677) 693
----------- -----------
Decrease in cash (34,078) (16,335)
Cash at beginning of period 39,464 40,325
----------- -----------
Cash at end of period $ 5,386 $ 23,990
=========== ===========
Supplemental disclosures:
Income taxes paid $ 1,820 $ 829
=========== ===========
Interest paid $ 2,275 $ 2,757
=========== ===========
</TABLE>
SEE ACCOMPANYING NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS.
<PAGE> 81
PENNCORP FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(As restated)
(1) BASIS OF PRESENTATION
PennCorp Financial Group. Inc. (the "Company" or "PennCorp") is an insurance
holding company. The Company commenced operations with the acquisition of
Pennsylvania Life Insurance Company ("PLIC") and Executive Fund Life Insurance
Company (which was merged into PLIC effective July 1, 1996) and Pacific Life and
Accident Insurance Company ("PLAIC") on August 23, 1990. Through its
wholly-owned life insurance subsidiaries, 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"), Salem Life Insurance
Corporation ("Salem Life") and its wholly-owned subsidiaries Integon Life
Insurance Corporation ("ILIC"), Georgia International Life Insurance Company and
Occidental Life Insurance Company of North Carolina ("OLIC") (Salem Life and its
wholly-owned subsidiaries collectively referred to as "Integon Life"), United
Life and Annuity Insurance Company ("United Life"), Marketing One, Inc.
("Marketing One"), a third party marketing organization, and 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. The accompanying financial statements reflect all
adjustments which are, in the opinion of management, necessary to a fair
statement of the results for the periods presented. Such adjustments are of a
normal and recurring nature. All significant intercompany accounts and
transactions have been eliminated. All dollar amounts presented hereafter,
except share information, are stated in thousands.
The financial statements and notes thereto have been restated as discussed in
Note 8.
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 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) PENDING ACQUISITION AND RELATED TRANSACTIONS
The Company, pending final review by the Securities and Exchange Commission
("SEC") of the Joint Proxy Statement and Prospectus, will be soliciting
shareholder approval for the following: (i) the merger of the Company and
Washington National Corporation, (ii) the acquisition of the Controlling
Interest in Southwestern Financial Corporation and Subsidiaries ("SW
Financial"), (iii) the acquisition of the Fickes and Stone Knightsbridge
Interests, and (iv) other items.
Under the terms of the restated merger agreement, Washington National
Corporation shareholders will receive the right to receive $29.50 per share of
consideration in the form of cash, PennCorp Common Stock, or a combination of
cash and PennCorp Common Stock. The aggregate consideration to be received by
the Washington National Corporation shareholders will be approximately $377,000,
of which $100,000, with the right by PennCorp to increase the portion of the
purchase price consideration to a maximum of 45% of the transaction value, will
be subject to cash elections
PennCorp will receive its right to acquire the SW Financial through the
assignment by Fickes and 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 $67,500 to $69,600 (not including expenses) depending upon the
outcome of certain contingencies.
In addition, PennCorp has proposed to acquire the Fickes and Stone Knightsbridge
Interests for total consideration in the form of estimated annual payments of
$330 due April 15, 1997, each year through 2001 and the issuance by PennCorp of
173,160 shares of PennCorp Common Stock to each of Fickes and Stone on April 15,
2001.
It is anticipated that PennCorp common shareholders will vote on the above
transactions in July 1997, and, subject to shareholder approval, the Company
intends to consummate such transactions as expeditiously as possible (see Note
7).
<PAGE> 82
(3) SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
Through its direct and indirect investment in SW Financial, accounted for
utilizing the equity method, the Company owns 78.0% of the economic interest in
SW Financial.
Financial information for SW Financial is provided below:
CONSOLIDATED CONDENSED BALANCE SHEET
<TABLE>
<CAPTION>
(AS RESTATED)
- ----------------------------------------------------------------------------------------------
MARCH 31, 1997 DECEMBER 31, 1996
-------------- -----------------
(UNAUDITED)
<S> <C> <C>
ASSETS:
Invested assets $ 1,599,081 $ 1,641,348
Insurance assets 359,671 107,230
Other assets 205,508 459,324
------------ ------------
Total assets $ 2,164,260 $ 2,207,902
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY:
Policy liabilities $ 1,734,438 $ 1,745,160
Long-term debt 158,500 159,750
Other liabilities 109,175 127,237
Mandatory redeemable preferred stock 34,607 33,879
Shareholders' equity 127,540 141,876
------------ ------------
Total liabilities and shareholders' equity $ 2,164,260 $ 2,207,902
============ ============
</TABLE>
CONSOLIDATED CONDENSED STATEMENT OF INCOME
(UNAUDITED)
<TABLE>
<CAPTION>
(AS RESTATED)
- ------------------------------------------------------------------------------------
THREE MONTHS ENDED
-----------------------------------
MARCH 31, 1997 MARCH 31, 1996
-------------- --------------
<S> <C> <C>
REVENUES:
Policy revenues $ 37,500 $ 62,708
Net investment income 31,895 32,950
Net gains from sale of investments 15 511
Other income 6,184 3,664
------------- -------------
Total revenues 75,594 99,833
------------- -------------
BENEFITS AND EXPENSES:
Policyholder benefits 45,282 64,930
Amortization 6,022 6,014
Underwriting and other administrative
expenses 11,578 15,107
Interest and related debt costs 3,436 3,575
------------- -------------
Total benefits and expenses 66,318 89,626
------------- -------------
Income before income taxes 9,276 10,207
Income tax expense 3,653 3,788
------------- -------------
Net income 5,623 6,419
Preferred stock dividend 728 667
------------- -------------
requirements
Net income applicable to common stockholders $ 4,895 $ 5,752
============= =============
</TABLE>
<PAGE> 83
(4) RESTRUCTURING CHARGES
In the third quarter of 1996, the Company initiated a strategic business
evaluation designed to realign the underlying business units into operating
divisions.
The evaluation considered each of the current operating companies, including the
anticipated merger of the Company and Washington National Corporation and the
purchase of the Controlling Interest in SW Financial, and (a) their impact on
the Company's current and long-term profitability potential, (b) the ability to
absorb operations related to future acquisitions, and (c) market focus.
As a result of this effort, at the end of the first quarter of 1997 management
authorized and committed the Company to implement the new divisional structure,
including the closure of all foreign operations except for Canada, and recorded
a cumulative pre-tax restructuring charge of $19,071. It is probable that the
final determination of the pending merger of the Company and Washington National
Corporation and the purchase of the Controlling Interest in Southwestern
Financial Corporation and Subsidiaries will result in certain additional charges
which cannot be definitively determined at this time.
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 ($23), and
(e) the Company's investment in certain foreign operations which will be closed
($6,001). As of March 31, 1997, $346 of severance and related benefits has been
charged against these restructuring accruals.
The Company estimates approximately $1,981 of pre-tax incremental costs
associated with the restructuring were incurred during the three months ended
March 31, 1997, and estimates an additional $3,300 will be incurred through
March 31, 1998. These incremental costs will benefit future operations and do
not qualify for accrual. Examples of these incremental costs include employee
travel, relocation and training, and the physical move of fixed assets.
(5) REDEMPTION OF PREFERRED STOCK AND CERTAIN EQUITY TRANSACTIONS
On March 15, 1997, the Company redeemed all of the previously outstanding Series
B Mandatory redeemable preferred stock at its stated redemption value of
$14,705.
During the period certain employees and agents exercised stock options and
warrants resulting in the issuance of 118,341 shares of the Company's Common
Stock. The result of such exercises was to increase common stock and additional
paid in capital by $2 and $864, respectively. On January 11, 1997, the Company
repurchased 100,000 shares for an aggregate purchase price of $35.38 per share
resulting in a $3,538 increase in the value of treasury stock held.
As part of an amended purchase agreement, effective February 12, 1997, with the
former parent company of United Life, PennCorp committed to purchase 483,839
shares of the Company's Common Stock at a price to be determined.
<PAGE> 84
(6) NEW ACCOUNTING PRONOUNCEMENTS
In February 1997, the Financial Accounting Standards Board ("FASB") issued
Financial Accounting Standards No. 128, "Earnings Per Share" ("SFAS No. 128").
SFAS No. 128 supersedes and simplifies the existing computation, presentation
and disclosure requirements for earnings per share outlined under Accounting
Principles Board Opinion No. 15, "Earnings Per Share". Under the new
methodology, "basic" earnings per share will replace "primary" earnings per
share and will exclude the dilutive effect of common stock equivalents. SFAS No.
128 also revises the calculation of "fully diluted" earnings per share with
"diluted" earnings per share. This change is not anticipated to have a material
impact on reported fully diluted earnings per share calculated under the
Company's current capital structure.
SFAS No. 128 is effective for both interim and annual financial statements
issued after December 15, 1997. At that time, the Company will be required to
change the method currently used to compute earnings per share and restate all
prior periods presented. Earlier application is not permitted, however
disclosure of pro forma earnings per share amounts computed utilizing the
standards established by SFAS No. 128 is permitted in the notes to the financial
statements for periods ending prior to the effective date. Pro forma earnings
per share for the three month periods ended March 31, 1997 and 1996, are as
follows:
<TABLE>
<CAPTION>
MARCH 31, 1997 MARCH 31, 1996
-------------- --------------
<S> <C> <C>
Basic $ 0.26 $ 0.63
Diluted $ 0.25 $ 0.56
</TABLE>
In March 1997, the FASB issued Financial Accounting Standards No. 129,
"Disclosures of Information About Capital Structure" ("SFAS No. 129"). SFAS No.
129 is effective for both interim and annual financial statements issued after
December 15, 1997, and clarifies the disclosure requirements related to the
type, and nature, of securities contained within the Company's capital
structure.
<PAGE> 85
7. SUBSEQUENT EVENTS
The Company completed its purchase from UCFC, the former parent of United Life,
483,839 shares of the Company's Common Stock for an aggregate purchase price of
$17,902 plus accrued interest through the closing date, June 9, 1997, of $295.
The value of treasury shares held increased $17,902 as a result of this
transaction.
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 in
anticipation of the acquisition of the Controlling Interest in SW Financial.
Interest due under the SW Financial Notes is currently set at 7.0%, per annum.
On August 30, 1997, the Washington National Merger agreement terminated.
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. PennCorp received fees
aggregating $1,100 from Acordia for its underwriting and participation in the
subordinated notes and preferred stock. KM received sponsor fees and other fees
aggregating $1,714 from Acordia for its role in consummating the Acordia
acquisition.
On November 14, 1997, the Company filed, on Form 8-K, restated financial
statements for the years ended December 31, 1994, 1995 and 1996 and the three
month period ended March 31, 1997 and the three month and six month periods
ended June 30, 1997. For additional information see Note 8.
<PAGE> 86
8. RESTATEMENT OF CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
The Company has restated its consolidated condensed financial statements for
three month periods ended March 31, 1997 and 1996, as well as each of the years
in the three year period ended December 31, 1996. The restatement resulted from
the Company reconsidering certain accounting practices after discussions with
the Securities and Exchange Commission's Division of Corporation Finance.
The significant accounting practices incorporated in the restatement are as
follows:
(i) the methodology for determining deferrable acquisition costs;
(ii) the amortization methodology of deferred acquisition costs;
(iii) the recognition of reserve adjustments for interest sensitive
products;
(iv) the allocation of purchase consideration associated with certain
acquisitions, and
(v) the consolidation of a majority-owned subsidiary.
In addition, the Company corrected immaterial errors identified in previously
issued financial statements.
The following page presents the effects of the restatement for the three month
periods ended March 31, 1997, and 1996.
<PAGE> 87
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
For the three month periods ended
-----------------------------------------------------
March 31, 1997 March 31, 1996
-----------------------------------------------------
(As reported) (Restatement) (As reported) (Restatement)
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
REVENUES:
Premiums, principally accident and sickness $ 66,477 $ 66,477 $ 64,421 $ 64,421
Interest sensitive policy product charges 23,226 23,226 22,669 22,669
Net investment income 68,894 68,546 41,334 39,834
Other income 6,040 6,040 (37) 4,961
Net gains/losses from sale of investments 3,827 3,827 (527) (527)
-------- --------- --------- ---------
Total revenues 168,464 168,116 127,860 131,358
-------- --------- --------- ---------
BENEFITS AND EXPENSES:
Claims incurred 44,655 44,655 44,326 44,326
Change in liability for future policy benefits and other
policy benefits 29,706 30,108 11,490 13,369
Amortization of present value of insurance in force and
deferred policy acquisition costs 19,369 20,819 14,859 13,939
Amortization of costs in excess of net assets acquired 2,064 2,278 2,030 2,137
Underwriting and other administrative expenses 30,849 30,536 23,632 28,654
Interest and amortization of deferred debt issuance costs 4,387 4,387 6,057 5,757
Restructuring charge 19,071 19,071 -- --
-------- --------- --------- ---------
Total benefits and expenses 150,101 151,854 102,394 108,182
-------- --------- --------- ---------
Income before income taxes, undistributed earnings of unconsolidated
affiliates and extraordinary charge 18,363 16,262 25,466 23,176
Income taxes 8,217 7,557 9,630 8,846
-------- --------- --------- ---------
Net income before undistributed earnings in unconsolidated affiliates
and extraordinary charge 10,146 8,705 15,836 14,330
Undistributed earnings in unconsolidated affiliates 3,741 3,658 4,318 4,334
-------- --------- --------- ---------
Net income before extraordinary
charge 13,887 12,363 20,154 18,664
Extraordinary charge -- -- (816) (816)
-------- --------- --------- ---------
Net income 13,887 12,363 19,338 17,848
Preferred stock dividend requirements 4,927 4,927 2,691 2,691
-------- --------- --------- ---------
Net income applicable to common stock $ 8,960 $ 7,436 $ 16,647 $ 15,157
======== ========= ========= =========
Primary:
Net income applicable to common stock before extraordinary
charge $ 0.30 $ 0.25 $ 0.69 $ 0.63
Extraordinary charge -- -- (0.03) (0.03)
-------- --------- --------- ---------
Net income applicable to common stock $ 0.30 $ 0.25 $ 0.66 $ 0.60
======== ========= ========= =========
Common shares used in computing primary earnings per share 29,703 29,703 25,483 25,483
======== ========= ========= =========
Fully diluted:
Net income applicable to common stock before extraordinary
charge $ 0.30 $ 0.25 $ 0.63 $ 0.59
Extraordinary charge -- -- (0.03) (0.03)
-------- --------- --------- ---------
Net income applicable to common stock $ 0.30 $ 0.25 $ 0.60 $ 0.56
======== ========= ========= =========
Common shares used in computing fully diluted earnings per share 29,703 29,703 30,593 30,593
======== ========= ========= =========
</TABLE>
CONSOLIDATED CONDENSED BALANCE SHEET
<TABLE>
<CAPTION>
----------------------------
As of March 31, 1997
----------------------------
(As reported) (Restatement)
----------- -----------
<S> <C> <C>
ASSETS:
Investments and cash $3,748,405 $3,743,922
Insurance assets 689,376 659,056
Other assets 331,834 340,062
---------- ----------
Total assets $4,769,615 $4,743,040
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY:
Insurance liabilities $3,507,425 $3,511,800
Long-term debt 245,186 245,186
Other liabilities 204,682 190,887
Redeemable preferred stock 18,584 18,584
Shareholders' equity 793,738 776,583
---------- ----------
Total liabilities and shareholders' equity $4,769,615 $4,743,040
========== ==========
</TABLE>
<PAGE> 88
REVIEW BY INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
The March 31, 1997 and 1996, financial statements included in this filing have
been reviewed by KPMG Peat Marwick LLP., independent certified public
accountants, in accordance with established professional standards and
procedures for such a review.
The report of KPMG Peat Marwick LLP commenting upon their review is included on
the following page.
[REST OF PAGE INTENTIONALLY LEFT BLANK]
<PAGE> 89
Independent Auditors' Review Report
The Board of Directors and Shareholders of PennCorp Financial Group, Inc.
We have reviewed the accompanying consolidated condensed balance sheet of
PennCorp Financial Group, Inc. and subsidiaries as of March 31, 1997, and the
related consolidated statements of income and consolidated condensed statements
of cash flows for the three-month periods ended March 31, 1997 and 1996. These
financial statements are the responsibility of the Company's management.
We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial
information consists principally of applying analytical procedures to financial
data and making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in accordance
with generally accepted auditing standards, the objective of which is the
expression of an opinion regarding the financial statements taken as a whole.
Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should
be made to the financial statements referred to above for them to be in
conformity with generally accepted accounting principles.
We have previously audited, in accordance with generally accepted auditing
standards, the consolidated balance sheet of PennCorp Financial Group, Inc. as
of December 31, 1996, and the related consolidated statements of income,
shareholders' equity, and cash flows for the year then ended (not presented
herein); and in our report dated February 28, 1997 (except as to Note 19 which
is as of November 14, 1997), we expressed an unqualified opinion on those
consolidated financial statements. In our opinion, the financial information set
forth in the accompanying consolidated condensed balance sheet as of December
31, 1996 is fairly presented, in all material respects, in relation to the
consolidated balance sheet from which it has been derived.
/s/ KPMG PEAT MARWICK LLP
Raleigh, North Carolina
May 15, 1997
(except as to Note 8 which is
as of November 14, 1997)
<PAGE> 90
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS. (As restated)
This "Management's Discussion and Analysis of Financial Condition and Results of
Operations" should be read in conjunction with the comparable discussion filed
as Exhibit 99.3 to this Form 8-K.
The following discussion should also be read in conjunction with the preceding
unaudited consolidated condensed financial statements and related notes.
INTRODUCTION
In August 1997, PennCorp Financial Group, Inc. ("PennCorp", the "Company")
announced that it would likely be restating its financial statements for each of
the years in the three year period ended December 31, 1996. The discussion below
reflects the restated amounts for the periods presented. Further information
regarding the restatement is provided in Note 8 of the Notes to Unaudited
Consolidated Condensed Financial Statements contained elsewhere herein.
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 (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.
Restructuring Charges. 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. During the period ended March 31, 1997, the
Company completed its review of the existing business units and commenced a plan
to fully establish operating divisions. The Company thoughtfully considered the
impact the pending merger with Washington National Corporation and the
acquisition of the Controlling Interest in Southwestern Financial Corporation
and Subsidiaries may have on the divisional structure. However, certain portions
of the Company's restructuring plan will not be definitive until the
consummation of the pending merger, acquisition and related transactions. As a
result, it is probable that this Company may incur certain additional
restructuring charges as the final determination of the time of consummation of
the merger with Washington National Corporation and the acquisition of the
Controlling Interest in Southwestern Financial Corporation and Subsidiaries ("SW
Financial") are known (See Note 7 of the Notes to Unaudited Consolidated
Condensed Financial Statements contained elsewhere herein).
During the first quarter of 1997 management authorized and committed the Company
to implement the new divisional structure, including the closure of all foreign
operations except for Canada. As a result the Company recorded a cumulative
pre-tax restructuring charge of $19.1 million. The restructuring charge
recognizes: (a) severance and related benefits incurred due to staff reductions
($5.4 million), (b) estimated holding costs of vacated facilities ($6.2
million), (c) the write-off of certain fixed assets and other impaired assets
($1.5 million), (d) estimated contract termination costs ($23,000), and (e) the
Company's investment in certain foreign operations which will be closed ($6.0
million). As of March 31, 1997, $346,000 of severance and related benefits has
been charged against these restructuring accruals.
<PAGE> 91
The Company estimates approximately $2.0 of pre-tax incremental costs associated
with the restructuring were incurred during the three months ended March 31,
1997, and estimates an additional $3.3 million will be incurred through March
31, 1998. These incremental costs will benefit future operations and do not
qualify for accrual. Examples of these incremental costs include employee
travel, relocation and training, and the physical move of fixed assets.
For the period ended March 31, 1997, the following table eliminates from the
reported results of the Company the related impact of the restructuring charges
which the Company believes to be material in order to improve the comparability
of such information.
<TABLE>
<CAPTION>
(AS RESTATED)
- ---------------------------------------------------------------------------------------------------------------------------------
THREE MONTHS ENDED THREE MONTHS ENDED
MARCH 31, 1997 MARCH 31, 1996
---------------------------------------------- --------------
RESTRUCTURING AS REPORTED
AS REPORTED COSTS (NET) AS REPORTED
----------- ------------- ------------ -----------
<S> <C> <C> <C>
OPERATING INFORMATION:
Total revenues $ 168,116 $ 168,116 $ 131,358
--------- --------- ---------
Benefits and expenses
Claims incurred 44,655 44,655 44,326
Change in liability for future policy benefits
and other policy benefits 30,108 30,108 13,369
Amortization of present value of insurance in
force and deferred policy acquisition costs 20,819 20,819 13,939
Amortization of costs in excess of net assets acquired 2,278 2,278 2,137
Underwriting and other administrative expenses 30,536 1,981 28,555 28,654
Interest and amortization of deferred debt issuance costs 4,387 4,387 5,757
Restructuring charge 19,071 19,071 - -
--------- --------- ---------
Total benefits and expenses 151,854 130,802 108,182
--------- --------- ---------
Income before income taxes, undistributed
earnings in unconsolidated affiliates and
extraordinary charge 16,262 37,314 23,176
Income tax expense 7,557 13,857 8,846
--------- --------- ---------
Net income before undistributed earnings in
unconsolidated affiliates and extraordinary charge 8,705 23,457 14,330
Undistributed earnings in unconsolidated affiliates 3,658 3,658 4,334
--------- --------- ---------
Net income before extraordinary charge 12,363 27,115 18,664
Extraordinary charge, net of income taxes - - (816)
--------- --------- ---------
Net income 12,363 27,115 17,848
Preferred stock dividend requirements 4,927 4,927 2,691
--------- --------- ---------
Net income applicable to common stock $ 7,436 $ 22,188 $ 15,157
========= ========= =========
</TABLE>
Pending Merger, Acquisition and Related Transactions. On January 22, 1997, the
Company filed with the Securities and Exchange Commission ("SEC"), a preliminary
PennCorp Financial Group, Inc. and Washington National Corporation Joint Proxy
Statement and Prospectus ("Joint Proxy Statement") in which the Company, pending
final review by the SEC, will be soliciting shareholder approval for the
following transactions: (i) the merger with Washington National Corporation,
(ii) the acquisition of the Controlling Interest in Southwestern Financial
Corporation and Subsidiaries, (iii) the acquisition of the Fickes and Stone
Knightsbridge Interests, and (iv) other items.
The merger with Washington National Corporation and the acquisition of the
Controlling Interest in Southwestern Financial Corporation and Subsidiaries will
expand the Company's individual and payroll sales division operations with
similar products, distribution channels and asset mixes.
The Company anticipates, pending regulatory and shareholder approval,
consummating the merger with Washington National Corporation, the acquisition of
the Controlling Interest in Southwestern Financial Corporation and Subsidiaries,
and the acquisition of the Fickes and Stone Knightsbridge Interests in July 1997
(See Note 7 of the Notes to Unaudited Consolidated Condensed Financial
Statements contained elsewhere herein).
<PAGE> 92
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.
During the three month period ended March 31, 1997 the Company received $2.7
million in interest payments or dividends from its subsidiary and paid $4.6
million and $1.4 million in interest on preferred stock and common stock
dividends respectively. The Company utilized funds available under its revolving
credit facility to fund the shortfall. For periods beginning in 1998, under
current statutory limitations, the Company believes that it will receive
sufficient cash flow from the Surplus Note Companies and their respective
subsidiaries to satisfy its cash requirements. As a result of the Company's
decision to retain capital and surplus at the insurance subsidiary level, and
with the contemplated realignment of the insurance subsidiaries into operating
divisions, the Company believes that 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 $50.0 million to $60.0 million to PennCorp, subject to
applicable regulatory approvals.
During the three months ended March 31, 1997, cash provided by operations was
$88.9 million compared to cash used by operations of $3.6 million for the
three-month period ended March 31, 1996. United Life provided $26.4 million,
consisting primarily of investment income. When including interest sensitive
products cash flows for both periods and excluding the effect of United Life,
cash used by operations was $2.9 million for the three month period ended March
31, 1997 compared to cash used by operations of $18.3 million for the three
month period ended March 31, 1996. The improvement in cash flows from
operations resulted primarily from improvements at Integon Life.
RESULTS OF OPERATIONS
Policy Revenue. Total policy revenue for the three months ended March 31, 1997,
increased 3% to $89.7 million from $87.1 million for the comparable period ended
March 31, 1996. The increase is primarily the result of the acquisition of
United Life which added $1.3 million of life policy revenues. The Company
continues to focus on balancing life policy revenues with those of fixed benefit
products.
Net Investment Income. Net investment income for the three months ended March
31, 1997 was $68.5 million compared to $39.8 million for the three months ended
March 31, 1996. Of the $28.7 million increase in investment income, $28.0
million of the increase was attributable to the addition of United Life.
Other Income. Other income for the three-month periods ended March 31, 1997 and
1996, includes revenues derived primarily from Marketing One. In addition, for
the three-month period ended March 31, 1996 included in other income were losses
aggregating $500,000 as a result of the Company's investment trading activities.
Claims Incurred. Claims incurred for the three months ended March 31, 1997
increased slightly to $44.7 million from $44.3 million for the three-month
period ended March 31, 1996. The increase in claims incurred is attributable to
$2.0 million of claims from United Life. In addition to United Life, additional
claims incurred resulted from a modest deterioration in fixed benefit product
claims for Penn Life and OLIC resulting in $2.6 million increase. Offsetting
such increase were declines for its life insurance lines of business of $4.2
million. The Company considers such minor deviations between periods to be
normal.
Underwriting and Other Administrative Expenses. For the three-month period ended
March 31, 1997, underwriting and other administrative expenses increased 6.3% to
$30.5 million from $28.7 million for the three months ended March 31, 1996. The
increase is primarily attributable to the inclusion of $3.0 million of expenses
from United Life costs associated with the restructuring. Expenses for all other
operating subsidiaries combined dropped $2.4 million as the result of an expense
base that was nearly unchanged despite the growth in policy revenues.
<PAGE> 93
Interest and Related Debt Costs. For the three-month period ended March 31,
1997, interest and amortization of deferred debt issuance costs declined to $4.4
million from $5.8 million for the comparable 1996 period. This decline was the
result of the repayment of $100.0 million of bridge financing and $37.0 million
of subsidiary debt financing in March, 1996 from proceeds from the Company's
February, 1996 Common Stock offering. Weighted average indebtedness outstanding
for the three-month period ended March 31, 1997 was approximately $34.0 million
less at an interest cost that was approximately 150 basis points less than the
comparable 1996 period. The Company has utilized its less costly revolving bank
credit facility to repurchase approximately $38.0 million of Senior Subordinated
Notes, resulting in a 220 basis point arbitrage.
Income Taxes. The effective tax rate for the three months ended March 31, 1997
was 46.5% compared to 38.2% for the three months ended March 31, 1996. Excluding
the impact of $19.1 million in restructuring charges, which derived tax benefits
totaling $6.3 million, the Company's effective tax rate would have been 37.1%
for the three months ended March 31, 1997. The modest decline in the adjusted
effective tax rate of 37.1% is less than the comparable prior period as the
result of less foreign source income, which is taxed at a higher statutory rate,
to the Company's total pre-tax income.
[REST OF PAGE INTENTIONALLY LEFT BLANK]
<PAGE> 94
COMPUTATION OF EARNINGS PER SHARE
(Amount in Thousands)
(As restated)
<TABLE>
<CAPTION>
-----------------------------
THREE MONTH PERIODS ENDED
MARCH 31,
-----------------------------
1997 1996
----------- -----------
<S> <C> <C>
Primary net income applicable to common stock:
Net income applicable to common stock $ 7,436 $ 15,157
Extraordinary charge -- 816
----------- -----------
$ 7,436 $ 15,973
=========== ===========
Fully diluted net income applicable to common stock:
Net income applicable to common stock $ 7,436 $ 15,157
Extraordinary charge -- 816
Common stock equivalents:
Convertible preferred stock dividend requirements -- 1,941
----------- -----------
$ 7,436 $ 17,914
=========== ===========
</TABLE>
<TABLE>
<CAPTION>
-----------------------------
THREE MONTH PERIODS ENDED
MARCH 31,
-----------------------------
1997 1996
----------- -----------
<S> <C> <C>
Primary:
Shares outstanding beginning of period 28,648 22,880
Issuance of 5,131 shares on March 5, 1996 -- 1,466
Incremental shares applicable to Stock Warrants/Stock Options 1,335 1,327
Treasury shares (280) (190)
----------- -----------
29,703 25,483
=========== ===========
Fully diluted:
Shares outstanding beginning of period 28,648 22,880
Issuance of 5,131 shares on March 5, 1996 -- 1,466
Incremental shares applicable to Stock Warrants/Stock Options 1,335 1,349
Treasury shares (280) (190)
Conversion of 2,300 shares of $3.375 Convertible Preferred
Stock at a rate of 2.2123 common shares to 1 preferred share -- 5,088
Conversion of 2,875 shares of $3.50 Series II Convertible Preferred
Stock at a rate of 1.4327 common shares to 1 preferred share -- --
----------- -----------
29,703 30,593
=========== ===========
</TABLE>
<PAGE> 95
PENNCORP FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED BALANCE SHEETS
(AMOUNTS IN THOUSANDS, EXCEPT SHARE INFORMATION)
(As restated)
<TABLE>
<CAPTION>
(UNAUDITED)
-------------- ----------
JUNE 30, DECEMBER 31,
1997 1996
-------------- ----------
<S> <C> <C>
ASSETS:
Investments:
Fixed maturities:
Held for investment, at amortized cost $ -- $ 87,330
Available for sale, at fair value 3,065,548 2,993,925
Equity securities available for sale, at fair value 13,398 20,867
Trading securities, at fair value -- 31,140
Mortgage loans on real estate 258,344 264,732
Policy loans 146,127 145,976
Short-term investments 83,589 63,113
Other investments 45,151 48,062
---------- ----------
Total investments 3,612,157 3,655,145
Cash 4,172 39,464
Accrued investment income 47,282 48,360
Accounts and notes receivable 56,610 47,295
Investment in unconsolidated affiliate 142,640 140,526
Present value of insurance in force 318,800 339,010
Deferred policy acquisition costs 288,181 252,428
Costs in excess of net assets acquired 142,170 148,080
Other assets 177,625 139,015
---------- ----------
Total assets $4,789,637 $4,809,323
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY:
Liabilities:
Policy liabilities and accruals $3,459,180 $3,566,455
Notes payable 270,046 210,325
Income taxes, primarily deferred 68,401 55,840
Other liabilities 148,105 114,462
---------- ----------
Total liabilities 3,945,732 3,947,082
---------- ----------
Mandatorily redeemable preferred stock:
Series B, $.01 par value, $100 initial redemption value;
authorized, issued and outstanding -0- at June 30, 1997,
and 127,500 at December 31, 1996 -- 14,689
Series C, $.01 par value, $100 initial redemption value;
authorized, issued and outstanding 178,500 at June 30,
1997, and December 31, 1996 19,002 18,175
Shareholders' Equity:
$3.375 Convertible Preferred Stock, $.01 par value, $50
redemption value; authorized issued and outstanding
2,300,000 at June 30, 1997, and December 31, 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 at June 30, 1997, and
December 31, 1996 139,157 139,157
Common stock, $.01 par value; authorized 50,000,000;
Issued and outstanding 28,800,631 at June 30, 1997,
And 28,647,714 at December 31, 1996 288 286
Additional paid-in capital 396,651 393,156
Unrealized foreign currency translation losses (16,918) (14,961)
Unrealized gains on securities available for sale 16,544 20,064
Retained earnings 204,977 186,032
Treasury shares (24,809) (3,370)
Notes receivable secured by common stock (1,500) (1,500)
---------- ----------
Total shareholders' equity 824,903 829,377
---------- ----------
Total liabilities and shareholders' equity $4,789,637 $4,809,323
========== ==========
</TABLE>
SEE ACCOMPANYING NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS.
<PAGE> 96
PENNCORP FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF INCOME
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE INFORMATION)
(UNAUDITED)
(As restated)
<TABLE>
<CAPTION>
---------------------------- ---------------------------
THREE MONTH PERIODS ENDED SIX MONTH PERIODS ENDED
JUNE 30, JUNE 30,
---------------------------- ---------------------------
1997 1996 1997 1996
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
REVENUES:
Premiums, principally accident and sickness $ 62,243 $ 62,759 $ 128,720 $ 127,180
Interest sensitive product policy charges 23,050 22,675 46,276 45,344
Net investment income 68,218 39,753 136,764 79,587
Other income 5,391 5,457 11,431 10,418
Net gains from sale of investments 4,706 (45) 8,533 (572)
--------- --------- --------- ---------
Total revenues 163,608 130,599 331,724 261,957
--------- --------- --------- ---------
BENEFITS AND EXPENSES:
Claims incurred 50,555 44,670 95,210 88,996
Change in liability for future policy benefits and
other policy benefits 24,344 10,130 54,452 23,499
Amortization of present value of insurance in force
and deferred policy acquisition costs 20,735 13,397 41,554 27,336
Amortization of costs in excess of net assets
acquired 2,617 1,756 4,895 3,893
Underwriting and other administrative expenses 29,707 29,060 60,243 57,714
Interest and amortization of deferred debt issuance costs 5,430 4,221 9,817 9,978
Restructuring charge -- -- 19,071 --
--------- --------- --------- ---------
Total benefits and expenses 133,388 103,234 285,242 211,416
--------- --------- --------- ---------
Income before income taxes, undistributed earnings in
Unconsolidated affiliates and extraordinary charge 30,220 27,365 46,482 50,541
Income taxes 10,897 9,943 18,454 18,789
--------- --------- --------- ---------
Net income before undistributed earnings in unconsolidated
affiliates and extraordinary charge 19,323 17,422 28,028 31,752
Undistributed earnings (losses) in unconsolidated
affiliates (1,240) 4,039 2,418 8,373
--------- --------- --------- ---------
Net income before extraordinary charge 18,083 21,461 30,446 40,125
Extraordinary charge -- -- -- (816)
--------- --------- --------- ---------
Net income 18,083 21,461 30,446 39,309
Preferred stock dividend requirements 4,874 2,709 9,801 5,400
--------- --------- --------- ---------
Net income applicable to common stock $ 13,209 $ 18,752 $ 20,645 $ 33,909
========= ========= ========= =========
ER SHARE INFORMATION:
Primary:
Net income applicable to common stock before
extraordinary charge $ 0.46 $ 0.64 $ 0.71 $ 1.27
Extraordinary charge -- -- -- (0.03)
--------- --------- --------- ---------
Net income applicable to common stock $ 0.46 $ 0.64 $ 0.71 $ 1.24
========= ========= ========= =========
Common shares used in computing primary earnings per share
(in thousands) 28,860 29,139 28,991 27,301
========= ========= ========= =========
Fully diluted:
Net income applicable to common stock before
extraordinary charge $ 0.46 $ 0.60 $ 0.71 $ 1.19
Extraordinary charge -- -- -- (0.03)
--------- --------- --------- ---------
Net income applicable to common stock $ 0.46 $ 0.60 $ 0.71 $ 1.16
========= ========= ========= =========
Common shares used in computing fully diluted earnings per share
(in thousands) 28,860 34,256 28,991 32,419
========= ========= ========= =========
</TABLE>
SEE ACCOMPANYING NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS.
<PAGE> 97
PENNCORP FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(AMOUNTS IN THOUSANDS)
(UNAUDITED)
(As restated)
<TABLE>
<CAPTION>
SIX MONTH PERIODS ENDED JUNE 30,
------------------------------------------
1997 1996
-------------------- --------------------
<S> <C> <C>
Net cash provided by operating activities $ 46,710 $ 18,788
--------- ---------
Cash flows from investing activities:
Purchases of invested assets (782,317) (665,393)
Sales of invested assets 663,906 369,328
Maturities of invested assets 123,594 45,515
Other, primarily short term investments, net 16,119 262,413
--------- ---------
Net cash provided by investing activities 21,302 11,863
--------- ---------
Cash flows from financing activities:
Issuance of common stock 3,497 155,759
Treasury stock purchase (21,440) --
Additional borrowings 160,000 20,000
Reduction in notes payable (100,139) (157,000)
Redemption of preferred stock (14,706) --
Dividends on preferred stock and common stock (11,762) (8,186)
Receipts from interest sensitive policies credited to policyholder account
balances 106,379 51,695
Return of policyholder account balances on interest sensitive products (229,378) (117,352)
Other, net 4,245 2,249
--------- ---------
Net cash used by financing activities (103,304) (52,835)
--------- ---------
Decrease in cash (35,292) (22,184)
Cash at beginning of period 39,464 40,325
--------- ---------
Cash at end of period $ 4,172 $ 18,141
========= =========
Supplemental disclosures:
Income taxes paid $ 2,427 $ 3,183
========= =========
Interest paid $ 8,061 $ 9,418
========= =========
</TABLE>
SEE ACCOMPANYING NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS.
<PAGE> 98
PENNCORP FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(As restated)
(1) BASIS OF PRESENTATION
PennCorp Financial Group. Inc. (the "Company" or "PennCorp") is an insurance
holding company. The Company commenced operations with the acquisition of
Pennsylvania Life Insurance Company ("PLIC") and Executive Fund Life Insurance
Company (which was merged into PLIC effective July 1, 1996) and Pacific Life and
Accident Insurance Company ("PLAIC") on August 23, 1990. Through its
wholly-owned life insurance subsidiaries, 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"), Salem Life Insurance
Corporation ("Salem Life") and its wholly-owned subsidiaries Integon Life
Insurance Corporation ("ILIC"), Georgia International Life Insurance Company and
Occidental Life Insurance Company of North Carolina ("OLIC") (Salem Life and its
wholly-owned subsidiaries collectively referred to as "Integon Life"), United
Life and Annuity Insurance Company ("United Life"), Marketing One, Inc.
("Marketing One"), a third party marketing organization, and 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. The accompanying financial statements reflect all
adjustments which are, in the opinion of management, necessary to a fair
statement of the results for the periods presented. Such adjustments are of a
normal and recurring nature. All significant intercompany accounts and
transactions have been eliminated. All dollar amounts presented hereafter,
except share information, are stated in thousands.
The financial statements and certain notes thereto have been restated as
discussed in Note 8.
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 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.
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
No. 115, the 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 $1.8 million.
(2) PENDING MERGER, ACQUISITION, AND RELATED TRANSACTIONS
On November 25, 1996, the Company and Washington National Corporation
("Washington National") entered into a merger agreement. Under the agreement,
Washington National will become a wholly-owned subsidiary of PennCorp and each
holder of Washington National common stock will receive common stock of
PennCorp, subject to the right to elect to receive a portion of the merger
consideration in cash. The merger agreement expires by its terms on August 30,
1997.
As of August 14, 1997, the Company has not yet received clearance from the
Securities and Exchange Commission ("SEC") to release the Joint Proxy Statement
and Prospectus to shareholders of PennCorp and Washington National for approval
of the merger. Accordingly, it is not possible to mail the proxy statement to
the respective shareholders, hold the required special meetings of
stockholders, and complete the merger by August 30, 1997. However, the Company
and Washington National are holding discussions concerning an extension of the
August 30, 1997, expiration date for completion of the merger (See Note 7).
The Company's pending acquisitions of the Controlling Interest in Southwestern
Financial Corporation and Subsidiaries ("SW Financial") and the Fickes and Stone
Knightsbridge Interests, as well as the annual stockholder's meeting, are also
being delayed pending completion of the SEC's Preliminary Joint Proxy Statement
and Prospectus review process relating to those transactions, including a review
of the Company's historical financial statements.
<PAGE> 99
(3) SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
Through its direct and indirect investment in SW Financial, accounted for
utilizing the equity method, the Company owns approximately 78.0% of the
economic interest in SW Financial.
Financial information for SW Financial is provided below:
CONSOLIDATED CONDENSED BALANCE SHEETS
<TABLE>
<CAPTION>
(AS RESTATED)
- --------------------------------------------------------------------------------------------
JUNE 30, 1997 DECEMBER 31, 1996
----------------------- ---------------------
(UNAUDITED)
<S> <C> <C>
ASSETS:
Invested assets $1,623,291 $1,641,348
Insurance assets 109,631 107,230
Other assets 432,433 459,324
---------- ----------
Total assets $2,165,355 $2,207,902
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Policy liabilities $1,727,559 $1,745,160
Long-term debt 157,250 159,750
Other liabilities 102,263 127,237
Mandatory redeemable preferred
Stock 35,351 33,879
Shareholders' equity 142,932 141,876
---------- ----------
Total liabilities and
shareholders' equity $2,165,355 $2,207,902
========== ==========
</TABLE>
CONSOLIDATED CONDENSED STATEMENTS OF INCOME
(UNAUDITED)
<TABLE>
<CAPTION>
(AS RESTATED)
- --------------------------------------------------------------------------------------------------------------------------------
THREE MONTH PERIODS ENDED SIX MONTH PERIODS ENDED
--------------------------------------------- ---------------------------------------------
JUNE 30, 1997 JUNE 30, 1996 JUNE 30, 1997 JUNE 30, 1996
---------------------- ---------------------- ---------------------- ---------------------
<S> <C> <C> <C> <C>
REVENUES:
Policy revenues $ 36,118 $ 62,108 $ 73,618 $124,816
Net investment income 31,333 31,633 63,228 64,583
Net gains (losses) from sale of
investments 535 (520) 550 (9)
Other income 5,514 3,851 11,698 7,515
-------- -------- -------- --------
Total revenues 73,500 97,072 149,094 196,905
-------- -------- -------- --------
BENEFITS AND EXPENSES:
Policyholder benefits 54,960 63,459 100,242 128,389
Amortization 5,865 5,951 11,887 11,965
Underwriting and other
administrative expenses 10,234 14,683 21,812 29,790
Interest and related debt costs 3,444 3,435 6,880 7,010
-------- -------- -------- --------
Total benefits and expenses 74,503 87,528 140,821 177,154
-------- -------- -------- --------
Income (loss) before income taxes (1,003) 9,544 8,273 19,751
Income taxes 146 3,418 3,799 7,206
-------- -------- -------- --------
Net income (loss) (1,149) 6,126 4,474 12,545
Preferred stock dividend
requirements 744 680 1,472 1,347
-------- -------- -------- --------
Net income (loss) applicable to
common stock $ (1,893) $ 5,446 $ 3,002 $ 11,198
======== ======== ======== ========
</TABLE>
<PAGE> 100
(4) RESTRUCTURING CHARGE
As a result of the 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.
For the three month and six month periods ended June 30, 1997, $1,898 and
$2,393, respectively, of severance and related benefits as well as holding costs
of vacated facilities have been charged against the restructuring accrual.
The Company estimates approximately $1,595 and $3,576 of pre-tax incremental
costs associated with the restructuring were incurred during the three month and
six month periods ended June 30, 1997, respectively, and included in the
Company's results of operations.
(5) REDEMPTION OF PREFERRED STOCK AND CERTAIN EQUITY TRANSACTIONS
On March 15, 1997, the Company redeemed all of the previously outstanding Series
B mandatory redeemable preferred stock at its stated redemption value of
$14,706.
During the six month period ended June 30, 1997, certain employees and agents
exercised stock options and warrants resulting in the issuance of 164,644 shares
of the Company's Common Stock. The result of such exercises was to increase
common stock and additional paid in capital by $2 and $3,495, respectively.
On January 11, 1997, the Company repurchased 100,000 shares of the Company's
Common Stock for an aggregate purchase price of $35.38 per share resulting in a
$3,538 increase in the value of treasury shares held.
Effective February 12, 1997, the Company purchased from United Companies
Financial Corporation ("UCFC"), the former parent of United Life, 483,839 shares
of the Company's Common Stock for an aggregate purchase price of $17,902 plus
accrued interest through the closing date, June 9, 1997, of $295. The value of
treasury shares held increased $17,902 as a result of this transaction.
<PAGE> 101
(6) NEW ACCOUNTING PRONOUNCEMENTS
In February 1997, the Financial Accounting Standards Board ("FASB") issued
Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share" ("SFAS No.
128"). SFAS No. 128 supersedes and simplifies the existing computation,
presentation and disclosure requirements for earnings per share outlined under
Accounting Principles Board Opinion No. 15, "Earnings Per Share".
SFAS No. 128 is effective for both interim and annual financial statements
issued after December 15, 1997. At that time, the Company will be required to
change the method currently used to compute earnings per share and restate all
prior periods presented. Earlier application is not permitted, however
disclosure of pro forma earnings per share amounts computed utilizing the
standards established by SFAS No. 128 is permitted in the notes to the financial
statements for periods ending prior to the effective date. Pro forma earnings
per share for the three month and six month periods ended June 30, 1997 and
1996, are as follows:
<TABLE>
<CAPTION>
THREE MONTH PERIOD ENDED SIX MONTH PERIOD ENDED
- ------------------------------------------------- ------------------------------
JUNE 30, 1997 JUNE 30, 1996 JUNE 30, 1997 JUNE 30, 1996
- ------------------------------------------------- ------------------------------
<S> <C> <C> <C> <C>
Basic $ 0.47 $ 0.67 $ 0.73 $ 1.30
====== ====== ====== ======
Diluted $ 0.45 $ 0.60 $ 0.71 $ 1.17
====== ====== ====== ======
</TABLE>
In March 1997, the FASB issued Financial Accounting Standards No. 129,
"Disclosures of Information About Capital Structure" ("SFAS No. 129"). SFAS No.
129 is effective for both interim and annual financial statements issued after
December 15, 1997, and clarifies the disclosure requirements related to the
type, and nature, of securities contained within the Company's capital
structure. The Company anticipates no changes to present disclosures will be
required under SFAS No. 129.
The FASB issued SFAS No. 130, "Reporting Comprehensive Income", in June 1997.
SFAS No. 130 is effective for annual and interim periods ending after December
15, 1997, although early adoption is permitted. 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 that will
be included in the Company's presentation of comprehensive income, in addition
to net income, are unrealized foreign currency translation gains and losses as
well as unrealized gains and losses on securities available for sale. The
Company is currently evaluating the necessary changes to its disclosures.
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information", was also issued in June 1997 and is effective for annual and
interim periods ending after December 31, 1997, although early adoption is
permitted. This statement establishes standards for the methodology public
entities use to report information about operating segments in annual financial
statements and selected information about operating segments in interim
financial reports issued to shareholders. Operating segments are components of
an enterprise about which separate operating information is available and is
periodically evaluated by management. The statement requires that companies
disclose operating segment data on the same basis utilized internally for
evaluating segment performance and determining the allocation of corporate
resources. Disclosure requirements include operating segment profit or loss,
certain specific revenue and expense items, operating segment assets, as well as
various reconciliations of total operating segment information to amounts in the
consolidated financial statements. The Company is currently evaluating the
appropriate disclosure changes in conjunction with the implementation of the
operating division structure initiated in the first quarter of 1997.
<PAGE> 102
(7) SUBSEQUENT EVENTS
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 in
anticipation of the acquisition of the Controlling Interest in SW Financial.
Interest due under the SW Financial Notes is currently set at 7.0%, per annum.
On August 30, 1997, the Washington National Merger agreement terminated.
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. PennCorp received fees
aggregating $1,100 from Acordia for its underwriting and participation in the
subordinated notes and preferred stock. KM received sponsor fees and other fees
aggregating $1,714 from Acordia for its role in consummating the Acordia
acquisition.
On November 14, 1997, the Company filed, on Form 8-K, restated financial
statements for the years ended December 31, 1994, 1995 and 1996 and the three
month period ended March 31, 1997 and the three month and six month periods
ended June 30, 1997. For additional information see Note 8.
<PAGE> 103
(8) RESTATEMENT OF CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
The Company has restated its consolidated condensed financial statements for
three and six month periods ended June 30, 1997 and 1996, as well as each of the
years in the three year period ended December 31, 1996. The restatement resulted
from the Company reconsidering certain accounting practices after discussions
with the Securities and Exchange Commission's Division of Corporation Finance.
The significant accounting practices incorporated in the restatement are as
follows:
(i) the methodology for determining deferrable acquisition costs;
(ii) the amortization methodology of deferred acquisition costs;
(iii) the recognition of reserve adjustments for interest sensitive products;
(iv) the allocation of purchase consideration associated with certain
acquisitions; and
(v) the consolidation of a majority-owned subsidiary.
In addition, the Company corrected immaterial errors identified in previously
issued financial statements.
The following page presents the effects of the restatement for the three and six
month periods ended June 30, 1997, and 1996.
<PAGE> 104
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------------------
For the three month periods ended
June 30, 1997 June 30, 1996
---------------------- -----------------------
(As reported) (Restatement)(As reported)(Restatement)
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
REVENUES:
Premiums, principally accident and sickness $ 62,243 $ 62,243 $ 62,759 $ 62,759
Interest sensitive policy product charges 23,050 23,050 22,675 22,675
Net investment income 68,218 68,218 43,081 39,753
Other income 5,391 5,391 865 5,457
Net gains/losses from sale of investments 4,706 4,706 3,955 (45)
---------------------- ---------------------
Total revenues 163,608 163,608 133,335 130,599
---------------------- ---------------------
BENEFITS AND EXPENSES:
Claims incurred 50,555 50,555 45,355 44,670
Change in liability for future policy benefits and other
policy benefits 23,902 24,344 10,251 10,130
Amortization of present value of insurance in force and
deferred policy acquisition costs 19,611 20,735 13,405 13,397
Amortization of costs in excess of net assets acquired 3,056 2,617 1,650 1,756
Underwriting and other administrative expenses 30,020 29,707 24,237 29,060
Interest and amortization of deferred debt issuance costs 5,430 5,430 4,321 4,221
Restructuring charge -- -- -- --
---------------------- ---------------------
Total benefits and expenses 132,574 133,388 99,219 103,234
---------------------- ---------------------
Income before income taxes, undistributed earnings of unconsolidated
affiliates and extraordinary charge 31,034 30,220 34,116 27,365
Income taxes 11,268 10,897 12,288 9,943
---------------------- ---------------------
Net income before undistributed earnings in unconsolidated affiliates
and extraordinary charge 19,766 19,323 21,828 17,422
Undistributed earnings in unconsolidated affiliates (1,181) (1,240) 4,089 4,039
---------------------- ---------------------
Net income before extraordinary charge 18,585 18,083 25,917 21,461
Extraordinary charge -- -- -- --
---------------------- ---------------------
Net income 18,585 18,083 25,917 21,461
Preferred stock dividend requirements 4,874 4,874 2,709 2,709
---------------------- ---------------------
Net income applicable to common stock $ 13,711 $ 13,209 $ 23,208 $ 18,752
====================== =====================
Primary:
Net income applicable to common stock before extraordinary
charge $ 0.48 $ 0.46 $ 0.80 $ 0.64
Extraordinary charge -- -- -- --
---------------------- ---------------------
Net income applicable to common stock $ 0.48 $ 0.46 $ 0.80 $ 0.64
====================== =====================
Common shares used in computing primary earnings per share 28,860 28,860 29,139 29,139
====================== =====================
Fully diluted:
Net income applicable to common stock before extraordinary
charge $ 0.48 $ 0.46 $ 0.73 $ 0.60
Extraordinary charge -- -- -- --
---------------------- ---------------------
Net income applicable to common stock $ 0.48 $ 0.46 $ 0.73 $ 0.60
====================== =====================
Common shares used in computing fully diluted earnings per share 28,860 28,860 34,256 34,256
====================== =====================
</TABLE>
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------------
For the six month periods ended
June 30, 1997 June 30, 1996
---------------------- -----------------------
(As reported) (Restatement)(As reported)(Restatement)
- -----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
REVENUES:
Premiums, principally accident and sickness $ 128,720 $ 128,720 $ 127,180 $ 127,180
Interest sensitive policy product charges 46,276 46,276 45,344 45,344
Net investment income 137,112 136,764 84,415 79,587
Other income 11,431 11,431 828 10,418
Net gains/losses from sale of investments 8,533 8,533 3,428 (572)
--------------------- ----------------------
Total revenues 332,072 331,724 261,195 261,957
--------------------- ----------------------
BENEFITS AND EXPENSES:
Claims incurred 95,210 95,210 89,681 88,996
Change in liability for future policy benefits and other
policy benefits 53,608 54,452 21,741 23,499
Amortization of present value of insurance in force and
deferred policy acquisition costs 38,980 41,554 28,264 27,336
Amortization of costs in excess of net assets acquired 5,120 4,895 3,680 3,893
Underwriting and other administrative expenses 60,869 60,243 47,869 57,714
Interest and amortization of deferred debt issuance costs 9,817 9,817 10,378 9,978
Restructuring charge 19,071 19,071 -- --
--------------------- ----------------------
Total benefits and expenses 282,675 285,242 201,613 211,416
--------------------- ----------------------
Income before income taxes, undistributed earnings of unconsolidated
affiliates and extraordinary charge 49,397 46,482 59,582 50,541
Income taxes 19,485 18,454 21,918 18,789
--------------------- ----------------------
Net income before undistributed earnings in unconsolidated affiliates
and extraordinary charge 29,912 28,028 37,664 31,752
Undistributed earnings in unconsolidated affiliates 2,560 2,418 8,407 8,373
--------------------- ----------------------
Net income before extraordinary charge 32,472 30,446 46,071 40,125
Extraordinary charge -- -- (816) (816)
--------------------- ----------------------
Net income 32,472 30,446 45,255 39,309
Preferred stock dividend requirements 9,801 9,801 5,400 5,400
--------------------- ----------------------
Net income applicable to common stock $ 22,671 $ 20,645 $ 39,855 $ 33,909
===================== ======================
Primary:
Net income applicable to common stock before extraordinary
charge $ 0.78 $ 0.71 $ 1.49 $ 1.27
Extraordinary charge -- -- (0.03) (0.03)
--------------------- ----------------------
Net income applicable to common stock $ 0.78 $ 0.71 $ 1.46 $ 1.24
===================== ======================
Common shares used in computing primary earnings per share 28,991 28,991 27,301 27,301
===================== ======================
Fully diluted:
Net income applicable to common stock before extraordinary
charge $ 0.78 $ 0.71 $ 1.37 $ 1.19
Extraordinary charge -- -- (0.03) (0.03)
--------------------- ----------------------
Net income applicable to common stock $ 0.78 $ 0.71 $ 1.34 $ 1.16
===================== ======================
Common shares used in computing fully diluted earnings per share 28,991 28,991 32,419 32,419
===================== ======================
</TABLE>
CONSOLIDATED CONDENSED BALANCE SHEET
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------
As of June 30, 1997
--------------------------
(As reported) (Restatement)
- -----------------------------------------------------------------------
<S> <C> <C>
ASSETS:
Investments and cash $3,762,745 $3,758,969
Insurance assets 678,871 654,263
Other assets 383,040 376,405
--------------------------
Total assets $4,824,656 $4,789,637
==========================
LIABILITIES AND SHAREHOLDERS' EQUITY:
Insurance liabilities $3,466,029 $3,459,180
Long-term debt 270,046 270,046
Other liabilities 227,010 216,506
Redeemable preferred stock 19,002 19,002
Shareholders' equity 842,569 824,903
--------------------------
Total liabilities and
shareholders' equity $4,824,656 $4,789,637
==========================
</TABLE>
<PAGE> 105
REVIEW BY INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
The June 30, 1997 and 1996, financial statements included in this filing have
been reviewed by KPMG Peat Marwick LLP, independent certified public
accountants, in accordance with established professional standards and
procedures for such a review.
The report of KPMG Peat Marwick LLP commenting upon their review is included on
the following page.
[REST OF PAGE INTENTIONALLY LEFT BLANK]
<PAGE> 106
Independent Auditors' Review Report
The Board of Directors and Shareholders of PennCorp Financial Group, Inc.
We have reviewed the accompanying consolidated condensed balance sheet of
PennCorp Financial Group, Inc. and subsidiaries as of June 30, 1997, the
consolidated condensed statements of income for the three and six-month periods
ended June 30, 1997 and 1996, and the consolidated condensed statements of cash
flows for the six-month periods ended June 30, 1997 and 1996. These financial
statements are the responsibility of the Company's management.
We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial
information consists principally of applying analytical procedures to financial
data and making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in accordance
with generally accepted auditing standards, the objective of which is the
expression of an opinion regarding the financial statements taken as a whole.
Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should
be made to the financial statements referred to above for them to be in
conformity with generally accepted accounting principles.
We have previously audited, in accordance with generally accepted auditing
standards, the consolidated balance sheet of PennCorp Financial Group, Inc. as
of December 31, 1996 and the related consolidated statements of income,
shareholders' equity, and cash flows for the year then ended (not presented
herein); and in our report dated February 28, 1997 (except as to Note 19 which
is as of November 14, 1997), we expressed an unqualified opinion on those
consolidated financial statements. In our opinion, the financial information set
forth in the accompanying consolidated condensed balance sheet as of December
31, 1996 is fairly presented, in all material respects, in relation to the
consolidated balance sheet from which it has been derived.
/s/KPMG PEAT MARWICK LLP
Raleigh, North Carolina
August 14, 1997
(except as to Note 8
which is as of November 14, 1997)
<PAGE> 107
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS. (As restated)
This "Management's Discussion and Analysis of Financial Condition and Results of
Operations" should be read in conjunction with the comparable discussion filed
as Exhibit 99.3 to this Form 8-K.
The following discussion should also be read in conjunction with the preceding
consolidated condensed financial statements and related notes.
INTRODUCTION
In August 1997, PennCorp Financial Group, Inc. ("PennCorp", the "Company")
announced that it would likely be restating its financial statements for each of
the years in the three year period ended December 31, 1996. The discussion below
reflects the restated amounts for the periods presented. Further information
regarding the restatement is provided in Note 8 of the Notes to Unaudited
Consolidated Condensed Financial Statements contained elsewhere herein.
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 (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.
Restructuring Charges. 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. During the period ended March 31, 1997, the
Company completed its review of the existing business units and commenced a plan
to fully establish operating divisions. The Company thoughtfully considered the
impact the pending merger with Washington National Corporation and the
acquisition of the Controlling Interest in Southwestern Financial Corporation
and Subsidiaries may have on the divisional structure. However, certain portions
of the Company's restructuring plan will not be definitive until the
consummation of the pending merger, acquisition and related transactions. As a
result, it is probable that the Company will incur certain additional
restructuring charges as the final determination of the time of consummation of
the merger with Washington National Corporation and the acquisition of the
Controlling Interest in Southwestern Financial Corporation and Subsidiaries ("SW
Financial") are known (see Note 7 of Notes to Unaudited Consolidated Condensed
Financial Statements contained elsewhere herein).
As a result of the initiative to implement an operating division structure, the
Company recorded a cumulative pre-tax restructuring charge of $19.1 million
during the three month period ended March 31, 1997.
For the three month and six month periods ended June 30, 1997, $1.9 million and
$2.4 million, respectively, of severance and related benefits as well as holding
costs of vacated facilities have been charged against the restructuring accrual.
The Company estimates approximately $1.6 million and $3.6 million of pre-tax
incremental costs associated with the restructuring were incurred during the
three month and six month periods ended June 30, 1997, respectively, and
included in the Company's results of operations.
<PAGE> 108
The following tables reflect pro forma results of operations eliminating the
impact of the restructuring costs incurred by the Company for the three month
and six month periods ended June 30, 1997:
<TABLE>
<CAPTION>
(AS RESTATED)
- -----------------------------------------------------------------------------------------------------------------
THREE MONTH
THREE MONTH PERIOD ENDED PERIOD ENDED
JUNE 30, 1997 JUNE 30, 1996
------------------------------------------------------- -----------------
RESTRUCTURING
AS REPORTED COSTS AS REPORTED (NET) AS REPORTED
----------------- ---------------- ----------------- -----------------
<S> <C> <C> <C> <C>
Operating Information:
Total revenues: $163,608 $163,608 $130,599
-------- -------- --------
Benefits and expenses:
Claims incurred 50,555 -- 50,555 44,670
Change in liability for
future policy benefits and other
policy benefits 24,344 -- 24,344 10,130
Amortization of present value of
insurance in force and deferred
policy acquisition costs 20,735 -- 20,735 13,397
Amortization of costs in excess of
net assets acquired 2,617 -- 2,617 1,756
Underwriting and other administrative
expenses 29,707 1,595 28,112 29,060
Interest and amortization of deferred
debt issuance costs 5,430 -- 5,430 4,221
Restructuring charge -- -- -- --
-------- -------- --------
Total benefits and expenses 133,388 131,793 103,234
-------- -------- --------
Income before income taxes,
undistributed earnings in
unconsolidated affiliates and
extraordinary charge 30,220 31,815 27,365
Income taxes 10,897 11,558 9,943
-------- -------- --------
Net income before undistributed
earnings in unconsolidated affiliates
and extraordinary charge 19,323 20,257 17,422
Undistributed earnings in
unconsolidated affiliates (1,240) -- (1,240) 4,039
--------- --------- --------
Net income before extraordinary charge 18,083 19,017 21,461
Extraordinary charge -- -- -- --
-------- -------- --------
Net income 18,083 19,017 21,461
Preferred stock dividend
requirements 4,874 4,874 2,709
-------- -------- --------
Net income applicable to common stock $ 13,209 $ 14,143 $ 18,752
======== ======== ========
Per Share Information:
Primary:
Net income applicable to common
stock before extraordinary
charge $ 0.46 $ 0.49 $ 0.64
Extraordinary charge -- -- --
-------- -------- --------
Net income applicable to
common stock $ 0.46 $ 0.49 $ 0.64
======== ======== ========
Weighted average primary
shares outstanding (in
thousands) 28,860 28,860 29,139
======== ======== ========
Fully diluted:
Net income applicable to
common stock before extra-
ordinary charge $ 0.46 $ 0.49 $ 0.60
Extraordinary charge -- -- --
-------- -------- --------
Net income applicable to
common stock 0.46 $ 0.49 $ 0.60
======== ======== ========
Weighted average fully diluted
shares outstanding (in
thousands) 28,860 38,203 34,256
======== ======== ========
</TABLE>
<PAGE> 109
<TABLE>
<CAPTION>
(AS RESTATED)
- -----------------------------------------------------------------------------------------------------------------
SIX MONTH
SIX MONTH PERIOD ENDED PERIOD ENDED
JUNE 30, 1997 JUNE 30, 1996
------------------------------------------------------- -----------------
RESTRUCTURING
AS REPORTED COSTS AS REPORTED (NET) AS REPORTED
----------------- ---------------- ----------------- -----------------
<S> <C> <C> <C> <C>
Operating Information:
Total revenues: $331,724 $331,724 $261,957
-------- -------- --------
Benefits and expenses:
Claims incurred 95,210 -- 95,210 88,996
Change in liability for
future policy benefits and other
policy benefits 54,452 -- 54,452 23,499
Amortization of present value of
insurance in force and deferred
policy acquisition costs 41,554 -- 41,554 27,336
Amortization of costs in excess of
net assets acquired 4,895 -- 4,895 3,893
Underwriting and other administrative
expenses 60,243 3,576 56,667 57,714
Interest and amortization of deferred
debt issuance costs 9,817 -- 9,817 9,978
Restructuring charge 19,071 19,071 -- --
-------- -------- --------
Total benefits and expenses 285,242 -- 262,595 211,416
-------- -------- --------
Income before income taxes,
undistributed earnings in
unconsolidated affiliates and
extraordinary charge 46,482 69,129 50,541
Income taxes 18,454 25,341 18,789
-------- -------- --------
Net income before undistributed
earnings in unconsolidated affiliates
and extraordinary charge 28,028 43,788 31,752
Undistributed earnings in
unconsolidated affiliates 2,418 -- 2,418 8,373
-------- -------- --------
Net income before extraordinary charge 30,446 46,206 40,125
Extraordinary charge -- -- -- (816)
-------- -------- --------
Net income 30,446 46,206 39,309
Preferred stock dividend
requirements 9,801 -- 9,801 5,400
-------- -------- --------
Net income applicable to common stock $ 20,645 $ 36,405 $ 33,909
======== ======== ========
Per Share Information:
Primary:
Net income applicable to common
stock before extraordinary
charge $ 0.71 $ 1.26 $ 1.27
Extraordinary charge -- -- (0.03)
-------- -------- --------
Net income applicable to
common stock $ 0.71 $ 1.26 $ 1.24
======== ======== ========
Weighted average primary
shares outstanding (in
thousands) 28,991 28,991 27,301
======== ======== ========
Fully diluted:
Net income applicable to
common stock before extra-
ordinary charge $ 0.71 $ 1.18 $ 1.19
Extraordinary charge -- -- (0.03)
-------- -------- --------
Net income applicable to
common stock $ 0.71 $ 1.18 $ 1.16
======== ======== ========
Weighted average fully diluted
shares outstanding (in
thousands) 28,991 38,303 32,419
======== ======== ========
</TABLE>
<PAGE> 110
Preacquisition Contingencies and Allocations. In June 1997, the Company settled
various outstanding contingencies arising out of the purchase of United Life
with its former owner United Companies Financial Corporation ("UCFC"). As a
result of such settlement, UCFC will repurchase certain residential mortgage
loans originated by UCFC and currently warehoused by United Life upon the
occurrence of foreclosure on the underlying property. Under terms of the
arrangement, UCFC will repurchase the foreclosed properties for the full value
of the underlying principal and accrued interest.
In addition, as part of the settlement the Company repurchased 483,839 shares of
PennCorp Common Stock held by UCFC for $17.9 million.
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
Liquidity. 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.
During the six month period ended June 30, 1997 the Company received $21.2
million in interest payments or dividends from its subsidiaries and paid $8.1
million, $8.9 million and $2.8 million in interest and preferred stock and
common stock dividends, respectively. For the remainder of 1997, the Company
believes that it may need to utilize funds available under its revolving credit
facility to fund a modest shortfall in available cash. For periods beginning in
1998, under current statutory limitations, the Company believes that it will
receive sufficient cash flow from its subsidiaries to satisfy its cash
requirements. As a result of the Company's decision to retain capital and
surplus at the insurance subsidiary level, and with the realignment of the
insurance subsidiaries into operating divisions, the Company believes that 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 $50.0 million to
$60.0 million to PennCorp, subject to applicable regulatory approvals.
Cash Flow. During the six-month period ended June 30, 1997, cash provided by
operations was $46.7 million compared to $18.8 million for the six month period
ended June 30, 1996. United Life provided $45.2 million in 1997, consisting
primarily of investment income. Excluding United Life for the six month period
of 1997, cash flow from operations declined by $17.3 million when compared to
the six month period ended June 30, 1996. This decline was primarily the result
of payments associated with restructuring costs and higher claim payments during
the period as compared to the six month period ended June 30, 1996.
Pending Merger, Acquisition, and Related Transactions. On November 25, 1996, the
Company and Washington National entered into a merger agreement. Under the
agreement, Washington National will become a wholly-owned subsidiary of PennCorp
and each holder of Washington National common stock will receive common stock of
PennCorp, subject to the right to elect to receive a portion of the merger
consideration in cash. The merger agreement expires by its terms on August 30,
1997.
As of August 14, 1997, the Company has not yet received clearance from the SEC
to release the Joint Proxy Statement and Prospectus to shareholders of PennCorp
and Washington National for approval of the merger. Accordingly, it is not
possible to mail the proxy statement to the respective shareholders, hold the
required special meetings of stockholders, and complete the merger by August
30, 1997. However, the Company and Washington National are holding discussions
concerning an extension of the August 30, 1997, expiration date for completion
of the merger (see note 7 of Notes to Unaudited Consolidated Condensed
Financial Statements contained elsewhere herein).
The Company's pending acquisitions of the Controlling Interest in SW Financial
and Fickes and Stone Knightsbridge Interests, as well as the annual
stockholder's meeting, are also being delayed pending completion of the SEC's
Preliminary Joint Proxy Statement and Prospectus review process relating to
those transactions, including a review of the Company's historical financial
statements.
<PAGE> 111
RESULTS OF OPERATIONS
Policy Revenue. Total policy revenue for the six-month period ended June 30,
1997, increased 1.4% to $175.0 million from $172.5 million for the comparable
period ended June 30, 1996. Life product revenue increased $2.9 million as a
result of the inclusion of United Life which added $4.1 of additional life
revenue while fixed benefit accident and sickness product revenue declined
modestly. The decline in policy revenue from accident and sickness products was
primarily attributable to the Company's decision during 1995 to discontinue new
business production of certain disability income products. Policy revenue from
foreign operations (primarily Canada) increased 7.1% or approximately $1.5
million. Policy revenue expressed in Canadian dollars increased 7.6% or $2.1
million (Canadian).
For the three month period ended June 30, 1997 total policy revenues were
relatively constant at $85.3 million compared to $85.4 million for the
three-month period ended June 30, 1996. For the three month period ended June
30, 1997, United Life added $2.0 million of policy revenues. Policy revenues
from fixed benefit products offset the increases in life products as policy
revenues from Penn Life and Professional declined $1.4 million.
Net Investment Income. Net investment income for the six months ended June 30,
1997, was $136.8 million compared to $79.6 million for the six months ended
June 30, 1996. Of the $57.2 million increase in investment income, $55.3
million of the increase was attributable to the addition of United Life.
Offsetting the increase as a result of the United Life acquisition was the loss
of investment income at Integon Life as the result of the liquidation of assets
resulting from surrenders on a closed block of accumulation products. In the
aggregate, the Company liquidated $123.0 million of assets to fund surrender
activity. Yield based upon weighted average amount of invested assets
outstanding each period was approximately 7.5% and 7.6% for the six month
periods ended June 30, 1997 and 1996, respectively. Offsetting the minor
decline in investment yield was earnings on a slightly larger investment asset
base resulting in $1.8 million of additional income.
Net investment income for the three-month period ending June 30, 1997,
increased substantially to $68.2 million from $39.8 million for the comparable
period in 1996. Substantially all the increase was attributable to United Life
which positively impacted investment income by $27.6 million. Offsetting the
impact of United Life were declines in Integon Life investment income of $4.7
million. In addition, slightly higher yields on the portfolio, excluding United
Life, which increased to 7.7% from 7.3% resulting in approximately $1.4 million
of additional investment income for the three month period ended June 30, 1997,
compared to the three month period ended June 30, 1996.
Other income. Included in other income for the three month and six month
periods ended June 30, 1997, was income resulting from the Company's bank
marketing distribution channel, Marketing One. Such revenue amounted to $4.9
million and $10.1 million for the three month and six month periods ended June
30, 1997, as compared to $5.0 million and $9.6 million for comparable 1996
periods.
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. Included in other income for the six and three
month periods ended June 30, 1996, are gains and (losses) of ($219,000) and
$295,000 resulting from such activities. The Company substantially liquidated
its trading portfolio during 1997 and had no gains or losses associated with the
liquidation.
Claims Incurred. Claims incurred for the six month period ended June 30, 1997
increased 7.0% to $95.2 million from $89.0 million for the six-month period
ended June 30, 1996, primarily as the result of the inclusion of United Life
which resulted in $3.9 million of additional claims. In addition, OLIC life
claims increased $3.0 million and fixed benefit product claims increased
$700,000 during the first six months of 1997 when compared to the first six
months of 1996. Although OLIC continues to incur higher life claims than
historical averages, the Company does not believe that current claim patterns
indicate permanent adverse mortality, but rather a short term elevation in the
incidence of mortality. During the period, OLIC ceased actively marketing new
business on an individual basis. Integon Life claims declined $2.6 million for
the six month period ended June 30, 1997 when compared to the comparable period
for 1996. During 1996 Integon Life realized higher than anticipated mortality
primarily as a result of business underwritten during the two year period prior
to acquisition by PennCorp.
For the three month period ended June 30, 1997, claims incurred increased 13.2%
to $50.6 million from $44.7 million for the comparable period in 1996. As noted
above, the increase in claims was primarily the result of United Life, $1.8
million and OLIC, $1.9 million. Other modest increases in incurred claims for
Professional and Penn Life were partially offset by a decline in Integon Life
incurred claims.
<PAGE> 112
Underwriting and Other Administrative Expenses. Excluding the impact of the
restructuring charges incurred during the six month period ended June 30, 1997,
underwriting and other administrative expenses declined slightly to $56.7
million from $57.7 million for the six-month period ended June 30, 1996. The
decline is primarily attributable to the inclusion of $5.6 million of expenses
as a result of the acquisition of United Life, offset by the decline in the
Company's Raleigh-based operations expense structure of $6.6 million. The
decline is a result of the savings emerging from the restructuring of
Professional, OLIC and Integon Life.
Excluding the impact of the restructuring charges, underwriting and other
administrative expenses decreased by $948,000 to $28.1 million for the three
month period ended June 30, 1997 when compared to $29.1 million for the same
period of 1996. Approximately $3.1 million was attributable to the inclusion of
United Life. Offsetting the increases was a decline in the Company's
Raleigh-based operations expense structure of $5.9 million. As stated above, the
decline is the result of the savings emerging from the divisional restructuring.
In addition, during the three month period ended June 30, 1997, certain
non-insurance subsidiaries incurred additional expenses of approximately $1.8
million primarily associated with administrative systems conversion costs.
Interest and Related Debt Costs. For the six-month period ended June 30, 1997,
interest and amortization of deferred debt issuance costs decreased to $9.8
million from $10.0 million for the comparable 1996 period. This decrease was the
result of the Company eliminating subsidiary indebtedness which carried
significantly higher cost of funds than credit facility borrowings available to
the Company at the parent company level. In addition, the Company utilized funds
available under its revolving credit facility to repurchase approximately $35.0
million of its 9 1/4% Senior Subordinated Notes due 2003 (the "Notes") resulting
in a positive interest arbitrage of approximately 180 basis points. The actions
noted above result in the Company realizing approximately $345,000 in interest
cost savings. During the six month period ended June 30, 1996, the Company had
weighted average borrowings of $8.5 million more than the comparable period
ended June 30, 1997. Such additional borrowings resulted in additional interest
costs of $255,000.
For the three month period ended June 30, 1997 and 1996, interest costs were
$5.4 million and $4.2 million respectively. The increase in costs as a result of
the increase in average borrowings outstanding amounted to approximately
$836,000. In addition, as a result of the final settlement of contingencies
arising out of the acquisition of United Life, the Company incurred $295,000 of
interest costs due to delays in repurchasing the Company's Common Stock held by
UCFC. Also impacting interest costs were the subsidiary refinancings and the
repurchase of the $35.0 million of Notes which resulted in an aggregate decline
of $160,000 in interest costs.
Income Taxes. The effective tax rates for the three month and six month periods
ended June 30, 1997, were approximately 36.1% and 39.7%, respectively, compared
to 36.3% and 37.2% for the three month and six month periods ended June 30,
1996, respectively. Excluding the impact of $19.1 million of restructuring
charges as well as incremental costs associated with the restructuring of $3.6
million, which combined derived an income tax benefit of $6.9 million, the
Company's effective tax rate would have been 36.7% for the six month period
ended June 30, 1997. The effective rate for all periods presented is higher than
the statutory tax rate primarily due to the non-deductibility of the
amortization of costs in excess of net assets acquired.
Equity in Undistributed Earnings of Unconsolidated Affiliates. For the six month
periods ended June 30, 1997 and 1996, the Company recognized $2.4 million and
$8.4 million of earnings as a result of its economic interest in SW Financial.
During the period, SW Financial suffered losses on certain health lines of
business aggregating $10.0 million. In addition, for the six month period ended
June 30, 1997, SW Financial's operating results were negatively impacted by $1.3
million and $1.1 million due to increased goodwill amortization as a result of
final purchase allocations made during 1996 and lost investment income resulting
from declining reinvestment rates, respectively.
For the three month periods ended June 30, 1997 and 1996, the Company recognized
a loss of $1.2 million as compared to a gain of $4.0 million from SW Financial.
Three month variances trend with six month variances as SW Financial primarily
realized the impacts described above during the three month period ended June
30, 1997.
<PAGE> 113
SW Financial continues to monitor emerging losses on certain of its health
products and anticipates that it will likely incur additional losses for the
remainder of 1997. Management of SW Financial is currently evaluating various
action plans with respect to this business in order to mitigate the emerging
loss experience. In addition, SW Financial intends to continue to implement its
action plan to reduce losses on certain interest sensitive product portfolios
and closely monitor the impact of such actions relative to anticipated results.
The Company believes that such action will likely positively impact SW
Financial's results of operations, as a result of a reduction in future policy
benefits, by approximately $20.0 million during the remainder of 1997.
Pro Forma Analysis of the Results of Operations. The following pro forma results
of operations has been prepared to aid in comparative analysis of the six month
periods ended June 30, 1997 and 1996. The pro forma results contained on the
following page eliminate the impact of certain losses and non-comparative
charges associated with the Company's economic interest in SW Financial. Also
included is the reclassification of amortization of the present value of
insurance in force and deferred policy acquisition costs associated with gains
on the sale of invested assets during the six month period ended June 30, 1997.
The Company did not "unlock" amortization of present value of insurance in force
or deferred policy acquisition costs during 1996 for realized investment gains.
<PAGE> 114
<TABLE>
<CAPTION>
------------------------------------------------------------------------
SIX MONTH PERIOD ENDED
JUNE 30, 1997
------------------------------------------------------------------------
AS
RESTRUCTURING REPORTED COMPARATIVE COMPARATIVE
AS REPORTED COSTS (NET) ADJUSTMENTS PRO FORMA
----------- ------------ --------- ----------- ---------
<S> <C> <C> <C> <C> <C>
OPERATING INFORMATION:
Revenues:
Premiums, principally accident
and sickness $ 128,720 -- $ 128,720 -- $ 128,720
Interest sensitive product
policy charges 46,276 -- 46,276 -- 46,276
Net investment income 136,764 -- 136,764 -- 136,764
Other income 11,431 -- 11,431 -- 11,431
Net gains from sale of investments 8,533 -- 8,533 1,902 6,631
--------- --------- ---------
Total revenues: $ 331,724 $ 331,724 $ 329,822
--------- --------- ---------
Benefits and expenses:
Claims incurred 95,210 -- 95,210 -- 95,210
Change in liability for future
policy benefits and other
policy benefits 54,452 -- 54,452 -- 54,452
Amortization of present value of
insurance in force and deferred
policy acquisition costs 41,554 -- 41,554 1,902 39,652
Amortization of costs in excess
of net assets acquired 4,895 -- 4,895 -- 4,895
Underwriting and other administrative
expenses 60,243 3,576 56,667 -- 56,667
Interest and amortization of deferred
debt issuance costs 9,817 -- 9,817 -- 9,817
Restructuring charge 19,071 19,071 -- -- --
--------- --------- ---------
Total benefits and expenses 285,242 262,595 260,693
--------- --------- ---------
Income before income taxes, undistributed
earnings in unconsolidated affiliates
and extraordinary charge 46,482 69,129 69,129
Income taxes 18,454 -- 25,341 -- 25,341
--------- --------- ---------
Net income before undistributed earnings
in unconsolidated affiliates and
extraordinary charge 28,028 43,788 43,788
Undistributed earnings in
unconsolidated affiliates 2,418 -- 2,418 7,084 9,502
--------- --------- ---------
Net income before extraordinary charge 30,446 46,206 53,290
Extraordinary charge -- -- -- -- --
--------- --------- ---------
Net income 30,446 46,206 53,290
Preferred stock dividend
requirements 9,801 -- 9,801 -- 9,801
========= ========= =========
Net income applicable to common stock $ 20,645 $ 36,405 $ 43,489
========= ========= =========
PER SHARE INFORMATION:
Primary:
Net income applicable to common
stock before extraordinary charge $ 0.71 $ 1.26 $ 1.50
Extraordinary charge -- -- --
========= ========= =========
Net income applicable to common stock $ 0.71 $ 1.26 $ 1.50
========= ========= =========
Weighted average primary shares
outstanding (in thousands) 28,991 28,991 28,991
========= ========= =========
Fully diluted:
Net income applicable to common stock
before extraordinary charge $ 0.71 $ 1.18 $ 1.37
Extraordinary charge -- -- --
========= ========= =========
Net income applicable to common stock $ 0.71 $ 1.18 $ 1.37
========= ========= =========
Weighted average fully diluted shares
outstanding (in thousands) 28,991 38,303 38,303
========= ========= =========
</TABLE>
<TABLE>
<CAPTION>
----------------------
SIX MONTH PERIOD ENDED
JUNE 30, 1996
----------------------
AS REPORTED
----------------------
<S> <C>
OPERATING INFORMATION:
Revenues:
Premiums, principally accident
and sickness $ 127,180
Interest sensitive product
policy charges 45,344
Net investment income 79,587
Other income 10,418
Net gains from sale of investments (572)
---------
Total revenues: $ 261,957
---------
Benefits and expenses:
Claims incurred 88,996
Change in liability for future
policy benefits and other
policy benefits 23,499
Amortization of present value of
insurance in force and deferred
policy acquisition costs 27,336
Amortization of costs in excess
of net assets acquired 3,893
Underwriting and other administrative
expenses 57,714
Interest and amortization of deferred
debt issuance costs 9,978
Restructuring charge --
---------
Total benefits and expenses 211,416
---------
Income before income taxes, undistributed
earnings in unconsolidated affiliates
and extraordinary charge 50,541
Income taxes 18,789
---------
Net income before undistributed earnings
in unconsolidated affiliates and
extraordinary charge 31,752
Undistributed earnings in
unconsolidated affiliates 8,373
---------
Net income before extraordinary charge 40,125
Extraordinary charge (816)
---------
Net income 39,309
Preferred stock dividend
requirements 5,400
=========
Net income applicable to common stock $ 33,909
=========
PER SHARE INFORMATION:
Primary:
Net income applicable to common
stock before extraordinary charge $ 1.27
Extraordinary charge (0.03)
=========
Net income applicable to common stock $ 1.24
=========
Weighted average primary shares
outstanding (in thousands) 27,301
=========
Fully diluted:
Net income applicable to common stock
before extraordinary charge $ 1.19
Extraordinary charge (0.03)
=========
Net income applicable to common stock $ 1.16
=========
Weighted average fully diluted shares
outstanding (in thousands) 32,419
=========
</TABLE>
<PAGE> 115
During the period SW Financial incurred losses aggregating approximately $10.0
million as the result of additional analysis on certain health insurance lines
of business. SW Financial anticipates it may incur additional losses for the
remainder of 1997 on the health line of business until its policy conversion and
rate increase program is fully implemented. During the six month period ended
June 30, 1997, SW Financial increased, by $2.1 million, policy liabilities on
interest sensitive policies above such amounts for the comparative period ended
June 30, 1996. As the result of the initiation of a management action plan
associated with this block of business, it is highly unlikely that such reserves
will be necessary to cover future losses. In addition, SW Financial incurred
$1.3 million of additional goodwill amortization during the six month period
ended June 30, 1997, as compared to the six month period ended June 30, 1996.
Such amortization was the result of final purchase allocations by SW Financial.
The aggregate impact of such items was to reduce SW Financial's income from
operations by $13.4 million resulting in the Company's results of operations
being negatively impacted by $7.1 million.
<PAGE> 116
STATEMENT REGARDING COMPUTATION OF EARNINGS PER SHARE
(AMOUNTS IN THOUSANDS)
(As restated)
<TABLE>
<CAPTION>
------------------------------------- ------------------------------
THREE MONTH PERIODS ENDED SIX MONTH PERIODS ENDED
JUNE 30, JUNE 30,
------------------------------------- ------------------------------
1997 1996 1997 1996
----------------- ----------------- ----------------- -----------
<S> <C> <C> <C> <C>
Primary net income applicable to common stock:
Net income applicable to common stock $13,209 $18,752 $20,645 $33,909
Extraordinary charge -- -- -- 816
------- ------- ------- -------
$13,209 $18,752 $20,645 $34,725
======= ======= ======= =======
Fully diluted net income applicable to common stock:
Net income applicable to common stock $13,209 $18,752 $20,645 $33,909
Extraordinary charge -- -- -- 816
Common stock equivalents:
Convertible preferred stock dividend requirements -- 1,941 -- 3,882
------- ------- ------- -------
$13,209 $20,693 $20,645 $38,607
======= ======= ======= =======
<CAPTION>
------------------------------------- -------------------------------
THREE MONTH PERIODS ENDED SIX MONTH PERIODS ENDED
JUNE 30, JUNE 30,
------------------------------------- -------------------------------
1997 1996 1997 1996
----------------- ----------------- ----------------- ------------
<S> <C> <C> <C> <C>
Primary:
Shares outstanding beginning of period 28,648 22,880 28,648 22,880
Issuance of 5,131 shares on March 5, 1996 -- 5,131 -- 3,299
Incremental shares applicable to Stock Warrants/Stock Options 975 1,318 987 1,312
Treasury shares (763) (190) (644) (190)
-------- -------- -------- --------
28,860 29,139 28,991 27,301
======== ======== ======== ========
Fully diluted:
Shares outstanding beginning of period 28,648 22,880 28,648 22,880
Issuance of 5,131 shares on March 5, 1996 -- 5,131 -- 3,299
Incremental shares applicable to Stock Warrants/Stock Options 975 1,347 987 1,342
Treasury shares (763) (190) (644) (190)
Conversion of 2,300 shares of $3.375 Convertible Preferred
Stock at a rate of 2.2123 common shares to 1 preferred share -- 5,088 -- 5,088
Conversion of 2,875 shares of $3.50 Series II Convertible
Preferred Stock at a rate of 1.4327 common shares to 1
preferred share -- -- 987 --
-------- -------- -------- --------
28,860 34,256 28,991 32,419
======== ======== ======== ========
</TABLE>
<PAGE> 1
EXHIBIT 99.2
CONSENT OF INDEPENDENT AUDITORS
The Board of Directors
PennCorp Financial Group, Inc.:
We consent to the use of our reports on PennCorp Financial Group, Inc. and
subsidiaries included herein.
KPMG PEAT MARWICK LLP
Raleigh, North Carolina
March 3, 1998
<PAGE> 1
EXHIBIT 99.3
CONSENT OF INDEPENDENT AUDITORS
The Board of Directors
PennCorp Financial Group, Inc.:
We consent to the use of our report on Southwestern Financial Corporation and
Subsidiaries included herein.
KPMG PEAT MARWICK LLP
Dallas, Texas
March 3, 1998
