UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1999
Commission File Number 1-11422
PENNCORP FINANCIAL GROUP, INC.
(Exact name of Registrant as specified in its charter)
Delaware
(State or other jurisdiction of 13-3543540
incorporation or organization) (I.R.S. employer identification no.)
c/o Southwestern Financial Services
Corporation
717 North Harwood Street
Dallas, Texas
(Address of principal executive 75201
offices) (Zip code)
Registrant's telephone number, including area code: (214) 954-7111
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
Name of Each Exchange
Title of Each Class on Which Registered
----------------------------------- --------------------------------
Common Stock, $.01 par value New York Stock Exchange
$3.375 Convertible Preferred Stock, New York Stock Exchange
$.01 par value
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
None
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months, (or for such shorter period that the Registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained to the best
of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendments to
this Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates of the
registrant as of March 29, 2000: $729,868.
The number of Common Stock shares outstanding as of March 29, 2000, was
29,194,731.
DOCUMENTS INCORPORATED BY REFERENCE
None.
<PAGE>
ANNUAL REPORT ON FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 1999
TABLE OF CONTENTS
Page
PART I
Item 1 Business 3
Item 2 Properties 21
Item 3 Legal Proceedings 21
Item 4 Submission of Matters to a Vote of Security Holders 22
PART II
Item 5. Market for the Registrant's Common Equity and Related
Shareholder Matters 23
Item 6. Selected Consolidated Financial Data 24
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations 25
Item 7A. Quantitative and Qualitative Disclosures about Market
Risk Exposures of Financial Instruments for the
Businesses Owned at December 31, 1999 48
Item 8. Financial Statements and Supplementary Data 52
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure 119
PART III
Item 10. Directors and Executive Officers of the Registrant 119
Item 11. Executive Compensation 120
Item 12. Security Ownership of Certain Beneficial Owners
and Management 122
Item 13. Certain Relationships and Related Transactions 123
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports
on Form 8-K 126
2
<PAGE>
PART I
Item 1. Business
GENERAL DESCRIPTION AND HISTORY
PennCorp Financial Group, Inc. ("PennCorp" or the "Company"), incorporated
in Delaware in 1989, is a holding company, the principal subsidiaries of which
are Southwestern Life Insurance Company ("Southwestern Life") and Security Life
and Trust Insurance Company ("Security Life"). The Company's insurance
subsidiaries market and underwrite life insurance, accumulation products and
fixed benefit accident and sickness insurance to lower and middle-income markets
throughout the United States and Canada. The Company's insurance products are
sold primarily through independent general agents. Prior to the sales of certain
subsidiaries, the Company sold products through several additional distribution
channels including, exclusive agents, payroll deduction programs and financial
institutions. During 1997 the Company restructured its operating units into
three primary business units: the Financial Services Division, the Payroll Sales
Division and the Career Sales Division.
As part of its effort to stabilize its capital structure, increase
liquidity and reduce indebtedness, the Company sold its Career Sales Division,
Payroll Sales Division and portions of its Financial Services Division in 1999
and the first two months of 2000. As a result of the material impact of the
companies sold during 1999 to the aggregate operating results of the Company,
this Annual Report on Form 10-K includes a discussion of these companies.
The Financial Services Division was comprised of Southwestern Life
Insurance Company ("Southwestern Life"), Security Life and Trust Insurance
Company ("Security Life") and United Life and Annuity Insurance Company ("United
Life") (sold April 30, 1999). The Payroll Sales Division was comprised of
Professional Insurance Company ("Professional") (sold March 31, 1999), Pioneer
Security Life Insurance Company ("Pioneer Security"), its subsidiary,
American-Amicable Life Insurance Company ("American-Amicable"),
American-Amicable's subsidiary, Pioneer American Insurance Company ("Pioneer
American") (Pioneer Security, American-Amicable and Pioneer American
collectively, "AA Life") and Occidental Life Insurance Company ("OLIC"). AA Life
and OLIC were sold on February 4, 2000. The Career Sales Division was comprised
of Pennsylvania Life Insurance Company ("PLIC") and PennCorp Life Insurance
Company (together with PLIC, "PennLife"), Union Bankers Insurance Company
("Union Bankers"), Constitution Life Insurance Company ("Constitution"),
Marquette National Life Insurance Company ("Marquette") and Peninsular Life
Insurance Company ("Peninsular"). The Career Sales Division was sold July 30,
1999. See "Organizational Changes".
The Career Sales Division together with Professional, United Life Assets
(consisting of United Life, UC Mortgage Corp. ("UC Mortgage"), Cyberlink
Development, Inc. ("Cyberlink") and certain assets of Marketing One, Inc.
("Marketing One")) (sold April 30, 1999) and KIVEX, Inc. ("KIVEX") (sold July
30, 1999), a non-insurance subsidiary and internet service provider, are
referred to as "Businesses Held for Sale".
On January 10, 2000, the Company announced that it had agreed to sell its
Payroll Sales Division to a company formed by Thoma Cressey Equity Partners for
approximately $102 million subject to certain adjustments. On February 4, 2000,
the Company consummated the sale of the Payroll Sales Division for cash proceeds
of approximately $103.3 million. As a result of the sale, the Company recognized
an impairment loss of $95.5 million which was recognized in the financial
statements for the year ended December 31, 1999.
Also on January 10, 2000, the Company announced that it had agreed to sell
its Financial Services Division to Reassure America Life Insurance Company
("Reassure America"), a subsidiary of Swiss Reinsurance Company of Zurich
("Swiss Re"), for $260 million subject to certain adjustments, and accomplish
such transaction through the filing of a voluntary petition for relief under
chapter 11 ("Chapter 11") of title 11 of the United States Bankruptcy Code (the
"Bankruptcy Code").
On February 7, 2000 (the "Petition Date"), PennCorp filed a voluntary
petition for relief under Chapter 11 of the Bankruptcy Code in the United States
Bankruptcy Court for the District of Delaware (the "Bankruptcy Court"). Since
the Petition Date, PennCorp has continued to operate and manage its assets and
business as a debtor in possession as authorized by provisions of the Bankruptcy
Code.
On February 28, 2000 the Bankruptcy Court issued an order scheduling a
hearing to consider approval of the sale agreement with Reassure America,
subject to higher or better offers, and establishing the procedures for the
submission of competing offers ("Sales Procedure Order").
3
<PAGE>
On March 15, 2000, the Company received a competing bid in the form of a
recapitalization plan submitted by Inverness/Phoenix Capital LLC ("Inverness")
and Vicuna Advisors, LLC ("Vicuna") on behalf of the unofficial ad hoc committee
of preferred stockholders, and Mr. Bernard Rapoport ("Rapoport") and Mr. John
Sharpe ("Sharpe") ("Recapitalization Plan"). On March 23, 2000 the Company's
Board of Directors selected the Recapitalization Plan as the final accepted
offer pursuant to the bidding procedures approved as part of the Sales Procedure
Order. On March 24, 2000, the Bankruptcy Court approved the Board of Director's
selection of the Recapitalization Plan.
The proposed Recapitalization Plan provides that the preferred
stockholders will receive one share of common stock of the reorganized company
for each share of outstanding preferred stock. In addition, the preferred
stockholders will have an opportunity, pursuant to a rights offering, to
purchase .3787 shares of common stock of the reorganized company for each share
of outstanding preferred stock owned at a purchase price of $12.50 per share.
Inverness and Vicuna have issued a standby commitment letter to the Company,
committing $24.5 million to fully underwrite the rights offering. In addition,
Rapoport and Sharpe have committed to purchase equity in the recapitalized
company amounting to $20.0 million and $3.0 million, respectively. The standby
commitment letter and the Rapoport and Sharpe investment are subject to certain
conditions.
Under the Recapitalization Plan, all existing shares of the Company's
common stock will be cancelled for no value, and the Company's existing senior
and subordinated debt, with principal aggregating approximately $180 million at
March 31, 2000, will be paid in full in cash. Any and all other claims and
liabilities of the Company will be paid in accordance with their terms.
Consummation of the recapitalization transaction is subject to certain
conditions including regulatory approvals, the consummation of a $95 million
credit facility, the consummation of a proposed transaction whereby Southwestern
Life and Security Life will reinsure substantially all of their existing
deferred annuity blocks of business, an order confirming the Company's plan of
reorganization that incorporates the proposed recapitalization transaction shall
have been entered by the Bankruptcy Court and such order shall be unstayed and
in full force and effect, and the closing of the recapitalization shall occur no
later than December 31, 2000. The definitive agreements for the credit facility
and the reinsurance transaction will contain conditions to consummation
including no material adverse change as defined in the proposed $95 million
credit agreement.
The Company has received irrevocable commitments from holders of
approximately 71 percent of the Company's two outstanding series of preferred
stock indicating that they will vote in favor of the Recapitalization Plan upon
solicitation by the Company which, when such shares are voted, will satisfy the
voting requirements for confirmation of a plan of reorganization. Inverness,
Vicuna, Rapoport and Sharpe have deposited an aggregate of $47.5 million into an
escrow account, such that those funds will be used to make their respective
committed equity investments in the recapitalized company once the
Recapitalization Plan is consummated. A portion of such funds may be forfeited
to the Company under certain circumstances.
The Company filed a plan of reorganization on April 5, 2000 and will seek
confirmation of the Recapitalization Plan by the Bankruptcy Court on June 5,
2000, with consummation expected to occur promptly thereafter. For additional
information see Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations-- Financial Condition, Liquidity and Capital
Resources and Notes 9 and 23 of Notes to Consolidated Financial Statements.
Following the filing of PennCorp's Chapter 11 petition, the New York Stock
Exchange ("NYSE") suspended all trading in the Company's listed securities and
has applied to the Securities and Exchange Commission for the removal of the
Company's common stock and $3.375 convertible preferred stock listing and
registration on the NYSE. See Item 5. Market for Registrant's Common Equity and
Related Shareholder Matters.
4
<PAGE>
ORGANIZATIONAL CHANGES
The Company has experienced significant changes in the past three years.
As a result of integration of acquired businesses and material changes to the
Company's operating platform, the Company began a strategic business evaluation
in the third quarter of 1996. The review resulted in the Company establishing
three divisional platforms, Career Sales Division, Payroll Sales Division and
Financial Services Division in 1997. On January 2, 1998, the Company consummated
the acquisition of the SW Financial Controlling Interest (the holdings of common
stock and/or common stock warrants of Southwestern Financial Corporation ("SW
Financial") from KB Investment Fund I, LP ("KB Fund") and Messrs. Steven F.
Fickes and David J. Stone, former executive officers and directors of the
Company.) On January 5, 1998, the Company consummated the acquisition of the
interest of Messrs. Fickes and Stone in KB Management, LLC ("KB Management"), KB
Fund and KB Consultants, LLC (the "Fickes and Stone Knightsbridge Interests").
In order to stabilize the Company's capital structure, increase liquidity and
materially reduce its indebtedness the Company sought to sell certain assets
during 1999. Professional was sold March 31, 1999, the United Life Assets were
sold April 30, 1999, KIVEX was sold June 30, 1999 and the Career Sales Division
was sold on July 30, 1999. On February 4, 2000 the Company consummated the sale
of the Payroll Sales Division.
The following chart summarizes the classification of the Company's
principal operating subsidiaries for the years ended December 31, 1999, 1998 and
1997:
<TABLE>
<CAPTION>
1999 1998 1997
------------------------- -------------------------- -------
Business Held Business Held
Ongoing for Sale Ongoing For Sale Ongoing
------- ------------- ------- ------------- -------
<S> <C> <C> <C> <C> <C>
Corporate
PennCorp X X X
KIVEX(1) X X X
KB Management(2) X X
Financial Services Division
Southwestern Life(3) X X
Security Life X X X
United Life(4) X X X
Payroll Sales Division
Professional(5) X X X
AA Life(6) X X X
OLIC(6) X X X
Career Sales Division
PennLife(7) X X X
Union Bankers(8) X X
Constitution(8) X X
Marquette(8) X X
Peninsular(7) X X X
</TABLE>
---------------
(1) Transferred to Businesses Held for Sale in 1998 and sold June 30,
1999.
(2) Acquired January 5, 1998.
(3) Remaining interests acquired with acquisition of SW Financial on
January 2, 1998.
(4) Transferred to Businesses Held for Sale in 1998 and sold April
30, 1999.
(5) Transferred to Businesses Held for Sale in 1998 and sold March
31, 1999.
(6) Sold February 4, 2000 (see pro forma effect of disposition in
Management's Discussion and Analysis of Financial Condition and
Results of Operations--General and Note 17 of Notes to
Consolidated Financial Statements.)
(7) Transferred to Businesses Held for Sale in 1998 and sold July 30,
1999.
(8) Remaining interests acquired with acquisition of SW Financial on
January 2, 1998; transferred to Businesses Held for Sale in 1998
and sold July 30, 1999.
5
<PAGE>
CURRENT STRUCTURE
In conjunction with the sale of the Payroll Sales Division on February 4,
2000, Security Life became a wholly-owned subsidiary of Pacific Life and
Accident Insurance Company ("PLAIC"). The current organization structure of the
Company after the sale of the Payroll Sales Division is as follows:
PennCorp
|
________________________________|_________________________________
| | |
Other | |
Non-insurance(1) PLAIC KB Management
|
_____________|______________
| |
Southwestern Security
Life Life
- ---------------
(1) Includes Marketing One, SW Financial, Southwestern Financial Services
Corporation ("SFSC"), PennCorp Financial Services, Inc. ("PCFS"), KB
Investment, LLC, American-Amicable Holdings Corporation ("AA Holdings") and
PennCorp Occidental Corp.
DISPOSITIONS
On March 31, 1999, the Company consummated the sale of Professional to GE
Financial Assurance Holdings, Inc. ("GE Financial") for cash proceeds of $47.5
million. The Company realized net cash proceeds of $40.2 million. Professional,
which previously was included in the Payroll Sales Division, provided individual
fixed benefit and life products utilizing a network of independent agents
primarily in the southeastern United States through employer-sponsored payroll
deduction programs. The Company realized a gain from the sale totaling $1.1
million. As a result of the sale, unrealized gains on securities available for
sale by Professional decreased by $488,000. On September 15, 1999, as a result
of certain settlement and consideration adjustment provisions included in the
purchase and sale agreement, the Company reduced the consideration received by
$1.2 million.
On April 30, 1999, the Company consummated the sale of the United Life
Assets to ING America Insurance Holdings, Inc. ("ING"). United Life, which
previously was included in the Financial Services Division, principally marketed
fixed and variable annuities through financial institutions and independent
general agents, primarily in the southern and western United States. The
purchase consideration totaled $154.1 million including a dividend of $2.1
million that was paid by United Life at closing. The cash consideration
ultimately was reduced as a result of the Company's obligation to purchase
certain mortgages and other assets as well as for transaction related costs at
closing. The Company received net cash proceeds of $136.5 million. The Company
realized a loss from the sale totaling $3.9 million. As a result of the sale,
unrealized gains on securities held for sale by United Life decreased $1.7
million. As of December 31, 1999, the Company has sold substantially all of the
mortgages retained by the Company as a part of the Sale of the United Life
Assets and received proceeds aggregating $8.0 million. The Company may be
obligated to repurchase certain of the mortgages sold. The amount of mortgages
the Company may be required to repurchase is not expected to exceed
approximately $1.6 million. At December 31, 1999, the Company has established a
$1.2 million liability related to these contingencies.
On June 30, 1999, the Company completed the sale of KIVEX, an internet
service provider, to Allegiance Telecom, Inc. for $34.5 million in cash. The net
proceeds to the parent company from the sale were $22.2 million after payment of
costs and fees associated with the transaction and after repayment of $10.2
million of intercompany borrowings to insurance company affiliates of PennCorp.
The Company recorded a gain of $30.9 million from the sale.
6
<PAGE>
On July 30, 1999, the Company consummated the sale of the Career Sales
Division to Universal American Financial Corp. ("Universal American"). The
Career Sales Division marketed and underwrote fixed benefit accident and
sickness products and, to a lesser extent, life products through a sales force
exclusive to the Company throughout the United States and Canada. The net cash
proceeds after transaction costs and fulfillment of contract obligations were
$82.0 million. The Company realized a foreign currency translation loss of $25.0
million which represented previously unrealized translation losses on the
Company's Canadian insurance operations, partially offset by a gain of $3.5
million on the disposition resulting in a net loss of $21.5 million. In
addition, as a result of the sale, unrealized gains on securities available for
sale and unrealized foreign currency translation losses decreased by $2.3
million and $25.0 million, respectively. On December 29, 1999, as a result of
certain settlement and consideration adjustment provisions included in the
purchase and sale agreement, the Company reduced the consideration received by
$2.6 million.
During 1999, the Company used $267.0 million of the net proceeds from
these sales to pay down the outstanding balance under the bank credit facility
(the "Bank Credit Facility"). In addition, the Company repaid an additional $2.0
million of indebtedness as a result of liquidity at the parent company above the
amounts prescribed in the Bank Credit Facility, as amended.
BUSINESSES OWNED AT DECEMBER 31, 1999
The remaining companies in the Financial Services Division market life
insurance and, to a lesser extent, annuity products through independent general
agents who sell directly to individuals primarily in the southeastern and
southwestern United States. In early 2000 the Company discontinued new life
sales at Security Life in order to reduce costs and concentrate its marketing
efforts at Southwestern Life.
The Payroll Sales Division, principally through AA Life, markets and
underwrites customized life insurance and accumulation products to U.S. military
personnel and government employees through a general agency force. OLIC provides
individual fixed benefit, accident and sickness products and life products
utilizing a network of independent agents primarily in the southeastern United
States through employer-sponsored payroll deduction programs. The Payroll Sales
Division was sold on February 4, 2000.
For purposes of the Company's separate disclosure of the Businesses Held
for Sale as described above, Security Life, Southwestern Life, OLIC, AA Life and
other non-life insurance corporate entities are collectively referred to herein
as the "Businesses Owned at December 31, 1999."
ACQUISITION OF SW FINANCIAL CONTROLLING INTEREST AND KB INTERESTS
On January 2, 1998, the Company consummated the acquisition, from KB Fund
(formerly Knightsbridge Capital Fund I, LP) and Messrs. Steven W. Fickes and
David J. Stone, former executive officers and directors of the Company, of the
SW Financial Controlling Interest for an aggregate purchase price of $73.7
million (not including acquisition expenses).
On January 5, 1998, the Company consummated the acquisition of the Fickes
and Stone Knightsbridge Interests for total consideration estimated to be $10.6
million (not including acquisition expenses). Under the terms of the
transaction, Mr. Fickes is to receive consideration in the form of estimated
annual interest payments, ranging from $301,000 to $330,000, on April 15 each
year through 2001 and is to be issued 173,160 shares of the Company's Common
Stock on April 15, 2001. The Company issued 173,160 shares to Mr. Stone in July
1998.
Further information regarding the SW Financial investment appears in Note
6 of Notes to Consolidated Financial Statements. Information relating to the
relationship between the Company and the KB Fund, the acquisition of the Fickes
and Stone Knightsbridge Interests and the Southwestern Financial Controlling
Interest appears in Notes 3 and 18 of Notes to Consolidated Financial
Statements, and in Item 13. Certain Relationships and Related Transactions
hereof.
7
<PAGE>
PRODUCTS
General
The Company's insurance subsidiaries underwrite a variety of insurance
products with the primary emphasis on modest premium policies in the life,
accumulation and fixed benefit product sectors. Life products are primarily low
face amount traditional whole life or universal life products which build cash
values that are available to the policyholder. Accumulation products include
various forms of annuity products which are utilized by policyholders primarily
as a means of tax deferred savings. Fixed benefit products include indemnity
insurance policies in which the benefit amounts are fixed at the time of policy
issue. Those products provide supplemental income payments directly to the
insured who is disabled and unable to work due to accident or sickness.
Product profitability is achieved through a pricing policy that is based
upon what the Company believes to be conservative actuarial assumptions, which
take into account the underwriting risks associated with the product being sold,
including lapse rates, mortality, morbidity and whether the product is
underwritten in the field or by the home office, as well as the administrative
expenses associated with the business. The Company, on an ongoing basis,
evaluates new products for use by its sales forces.
The Company believes that, because of the characteristics of the market it
serves and the nature of its products, the lapse rates for its products,
although stable, tend to be higher than those experienced by other life and
health insurance companies that operate in more affluent markets. The Company
prices its products to reflect these higher lapse rates. To encourage
policyholders to maintain their coverages with the Company, fixed benefit
products generally incorporate a small fixed annual increase in benefits. Early
surrender of accumulation and life products is discouraged by either their low
rate of accumulation of cash values or by high surrender charges.
The following table presents the historical percentages of consolidated
insurance operations revenues derived from these product types:
PERCENTAGE OF CONSOLIDATED
INSURANCE OPERATIONS
REVENUES FOR THE YEARS ENDED
DECEMBER 31,
--------------------------------------------
Pro forma Pro forma
INSURANCE PRODUCT TYPE 1997 1998 1998(1) 1999 1999(1)
----------------------------- ------ ------ -------- ------ -------
Fixed benefit................ 29.8% 30.4% 3.9% 21.0% 3.3%
Life......................... 43.1 48.7 79.7 63.6 82.5
Accumulation................. 27.1 20.9 16.4 15.4 14.2
------- ------- ------- ------- -------
Total...................... 100.0% 100.0% 100.0% 100.0% 100.0%
======= ======= ======= ======= =======
---------------
(1) Pro forma 1999 and 1998 ratios and amounts exclude the results of
Businesses Held for Sale as if Businesses Held for Sale were sold
January 1, 1998. Such pro forma information is provided for
comparative purposes only and does not purport to be indicative of
what would have occurred had the consummation of the sales
transactions occurred as of January 1, 1998, or future results of the
Businesses Owned at December 31, 1999.
The amount of annualized premium in force and policy activity by type of
business for the past three years is as follows:
<TABLE>
<CAPTION>
ANNUALIZED PREMIUM IN FORCE
AS OF DECEMBER 31,
-----------------------------------------
($ in thousands)
Pro forma(1)
INSURANCE PRODUCT TYPE 1997 1998 1998 1999
------------------------------------ ------ ------ ------ -----
<S> <C> <C> <C> <C>
Life(2)............................. $219,180 $496,712 $355,089 $316,976
Fixed benefit....................... 184,214 209,495 13,966 16,008
-------- -------- -------- --------
Total............................. $403,394 $706,207 $369,055 $332,984
======== ======== ======== ========
</TABLE>
---------------
(1) Pro forma 1998 ratios and amounts exclude the results of Businesses
Held for Sale as if Businesses Held for Sale were sold January 1,
1998. Such pro forma information is provided for comparative purposes
only and does not purport to be indicative of what would have occurred
had the consummation of the sales transactions occurred as of January
1, 1998, or future results of the Businesses Owned at December 31,
1999.
(2) Life annualized premium in force includes target premium for interest
sensitive products. Interest sensitive policy revenue may vary from
target premium as policyholders have no obligation to pay target
premium. Additionally, interest sensitive policy revenues are
determined based upon contractual charges assessed against
policyholder funds and are not determined by policy revenues
collected.
8
<PAGE>
The following discussion of the Company's principal products relates to
the Businesses Owned at December 31, 1999.
Life Insurance Products
Traditional Whole Life. The Company's whole life policies are permanent
insurance products that combine life insurance protection with a savings
component or cash value that gradually increases in amount. Typically, a
guaranteed fixed premium, which is higher than for comparable term coverage when
the policyholder is younger, but less than comparable term coverage as the
policyholder grows older, is paid over a period of years. A policyholder may
borrow against the policy's accumulated cash value, but the amount of any
outstanding loans decreases the death benefit under the policy. A policyholder
may surrender a policy and receive the accumulated net cash value. As of
December 31, 1999, for the Businesses Owned, there were approximately 212,000
whole life policies in force with $900 million in face amount of insurance and
$502.3 million in future policy benefit reserves.
Universal and Interest-Sensitive Life. The universal and
interest-sensitive life products offered by the Company provide whole life
insurance with adjustable rates of return related to current interest rates.
Universal life products permit policyholders to vary the frequency and size of
their premium payments, although policy benefits may also vary.
The majority of sales of individual life insurance products, measured by
premium volume, has been derived from universal and interest-sensitive life
insurance products. The Company's universal and interest-sensitive life products
provide advantages generally not available to its traditional whole life and
term life policyholders, such as flexibility in available coverages and
flexibility in the amount and timing of premium payments. In addition, the
Company's universal and interest-sensitive life products can, in some respects,
provide higher returns and greater cash values to policyholders as compared with
traditional whole life insurance products. The Company's universal life and
interest-sensitive life insurance products are marketed to individuals directly
and through qualified retirement plans, deferred compensation plans, and
employer sponsored payroll deduction plans. As of December 31, 1999, for the
Businesses Owned at December 31, 1999, there were approximately 217,000
universal and interest-sensitive life policies in force with $16.9 billion in
face amount of insurance and $1,353.2 million in account value.
Term Life. Term life products offer pure insurance protection for a
specified period of time, typically one, five or ten years. The Company offers a
variety of term life products that include some or all of the following
features: current and guaranteed premium rates that are level for a specified
number of years; preferred smoker, preferred nonsmoker, nonsmoker, and smoker
underwriting classes; and conversion to permanent insurance allowed to age 65
with premium credit. As of December 31, 1999, for the Businesses Owned at
December 31, 1999, there were approximately 115,000 term life policies in force
with $10.3 billion in face amount of insurance and $42.3 million in future
policy benefit reserves.
Total sales of individual life insurance by the Businesses Owned at
December 31, 1999 were approximately $43.8 million, $50.2 million and $46.8
million for the years ended December 31, 1999, 1998 and 1997, respectively.
Accumulation Products
The Company's accumulation products include single premium deferred
annuities, flexible premium deferred annuities and variable annuity products.
The principal annuity products marketed by the Company's insurance subsidiaries
owned at December 31, 1999 consist of flexible premium deferred annuities
("FPDAs") and single premium deferred annuities ("SPDAs").
9
<PAGE>
As of December 31, 1999, the guaranteed minimum crediting rates of the
Company's deferred annuity products for the Businesses Owned at December 31,
1999 were as follows:
Guaranteed Minimum Funds Under
Crediting Rate Management
------------------ ---------------
($ in millions)
3.00%...................... $ 46.5
3.50%...................... 2.1
4.00%...................... 377.6
4.50%...................... 76.0
5.00%...................... --
6.00%...................... 20.6
No guaranteed minimum.... 5.4
---------
$ 528.2
=========
At December 31, 1999, annuity liabilities were composed of $112.5 million
of SPDA liabilities and $415.7 million of FPDA liabilities and $192.0 million of
other annuity liabilities, for a total of $720.2 million of annuity liabilities.
Of such liabilities $219.3 million were subject to surrender charges averaging
7.0% as of December 31, 1999.
Total sales of annuities by the Businesses Owned at December 31, 1999 were
approximately $10.5 million, $31.8 million and $33.2 million for the years ended
December 31, 1999, 1998 and 1997, respectively.
Fixed Benefit Products
Fixed benefit products are sold in large volume and are characterized by
low average annual premiums. These products provide one or more of three
principal types of benefits: (i) fixed periodic payments to an insured who
becomes disabled and unable to work because of an accident and/or sickness, (ii)
fixed periodic payments to an insured who becomes hospitalized, and (iii) fixed
single payments that vary in amount generally for specified surgical or
diagnostic procedures. Because the benefits are fixed in amount at the time of
policy issuance and are not intended to provide reimbursement for medical and
hospital expenses, payment amounts are not affected by inflation or the rising
cost of health care services. Fixed benefit products, primarily those covering
inability to work due to an accident, provide payments while the insured is
disabled and unable to work, subject to the terms and conditions of the
applicable policy. Fixed benefit products under which payments are made to
insureds who are disabled and unable to work may be purchased with coverage for
either (i) specified types of accidents, (ii) all other types of accidents, or
(iii) a combination of accident and sickness. The Company's practice is to sell
products that together with other similar coverages, do not provide monthly
benefits in excess of $2,000 or 50% of the insured's income, if less.
Certain fixed benefit products, primarily those covering hospitalization
due to sickness, provide payments during the period the insured is hospitalized.
Most of the Company's fixed benefit products also provide additional fixed
periodic payments to an insured who becomes hospitalized. Payments under these
products are not designed to cover the actual costs of the insured's hospital
stay, but merely to provide the insured with a means of paying supplemental
expenses during the hospitalization period. The Company's practice is to provide
hospitalization benefits of not more than $250 per day ($1,000 if the insured
requires intensive care treatment).
The accident and sickness policies also may be purchased with riders
providing for fixed single payments that vary in amount generally for various
surgical and diagnostic procedures. The Company's practice is to sell riders
that do not provide benefit payments in excess of $5,000. If the covered
procedure is performed on an out-patient basis, the insured receives one-half of
the scheduled payment.
Historically, most of the Company's sales of fixed benefit products are
produced by Businesses Held for Sale. Total sales of fixed benefit products by
the Businesses Owned at December 31, 1999 were approximately $6.3 million, $3.7
million and $3.8 million for the years ended December 31, 1999, 1998 and 1997,
respectively.
10
<PAGE>
During 1998, Southwestern Life began marketing long-term care products
which are marketed to retirees, older self-employed individuals and other
persons in middle income levels. The Company believes that the market for
long-term care insurance products is attractive because of the general aging of
the United States population and the lack of savings resources to cover
prolonged illnesses or convalescent care. As of December 31, 1999, there were
2,487 long-term care policies in force representing $3.5 million in annualized
premiums and $300,000 in reserves. Total sales of long-term care products by
Southwestern Life during 1999 and 1998 were approximately $2.9 million and $1.0
million, respectively.
The following table provides certain information with respect to the
number of policies in force of various categories of insurance business in force
of the Company's insurance subsidiaries:
<TABLE>
<CAPTION>
1997 1998 1999
----------------------------- ------------------------------ -----------------------------
Fixed Accum- Fixed Accum- Fixed Accum-
Benefit Life ulation Benefit Life ulation Benefit Life ulation
-------- -------- ------- -------- -------- ------- -------- -------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Policies in force -
January 1 ........... 698,072 558,697 90,265 654,936 506,913 69,769 697,018 779,932 86,612
New issues .......... 84,286 62,449 5,012 89,218 72,080 8,715 9,932 90,921 1,189
Business acquired, net -- -- -- 112,098 301,537 35,511 -- -- --
Businesses sold(1), net -- -- -- -- -- -- (652,417) (212,718) (53,343)
Policies terminated . (127,422) (114,233) (25,508) (159,234) (100,598) (27,383) (9,514) (72,715) (6,140)
-------- -------- ------- -------- -------- ------- -------- -------- -------
Policies in force -
December 31 ....... 654,936 506,913 69,769 697,018 779,932 86,612 45,019 585,420 28,318
======== ======== ======= ======== ======== ======= ======== ======== =======
</TABLE>
(1) Reflects amounts as if Businesses Held for Sale were sold as of January 1,
1999.
MARKETING AND DISTRIBUTION
The Financial Services Division is licensed to market its insurance
products in 43 states, the District of Columbia, and in Guam. The Company
markets and distributes its products primarily through independent general
agents who sell on an individual basis.
The following tables illustrate, by direct cash premium collected, (as
reported to regulatory authorities) and relative percentages, the principal
states in which the Financial Services Division collected in excess of 4% of
policy revenues for the year ended December 31, 1999.
Direct Premium Collected
--------------------------------------------
Jurisdiction Amount Percentage
------------ ------ ----------
($ in thousands)
Texas .............. $ 47,657 30.4%
North Carolina ..... 17,369 11.1
California ......... 11,017 7.0
Georgia ............ 10,413 6.7
Florida ............ 8,330 5.3
Virginia ........... 6,649 4.3
-------- -----
Subtotal ......... 101,435 64.8
All Others ......... 55,170 35.2
-------- -----
Total ............ $156,605 100.0%
======== =====
The Payroll Sales Division is licensed to market its insurance products in
all states (other than New York) and in the District of Columbia, and in Puerto
Rico, Guam and certain Caribbean countries. In addition, the Payroll Sales
Division is authorized to sell its products to U.S. Military installations in
foreign countries. The Company markets and distributes its products primarily
through independent general agents who sell on an individual basis and
independent general agents who sell through payroll deduction programs.
The following tables illustrate, by direct cash premium collected, (as
reported to regulatory authorities) and relative percentages, the principal
states in which the Payroll Sales Division collected in excess of 4.0% of policy
revenues for the year ended December 31, 1999.
11
<PAGE>
Direct Premium Collected
--------------------------------------------
Jurisdiction Amount Percentage
------------ ------ ----------
($ in thousands)
Texas .............. $ 9,017 9.3%
California ......... 8,506 8.8
North Carolina ..... 6,850 7.1
Florida ............ 5,444 5.6
South Carolina ..... 4,020 4.1
Kansas ............. 3,883 4.0
------- -----
Subtotal ......... 37,720 38.9
All Others ......... 59,190 61.1
------- -----
Total ............ $96,910 100.0%
======= =====
Financial Services Division
The Financial Services Division markets products to individual customers
through leads developed over time. This division utilizes field marketing
directors, affiliations with independent marketing organizations, financial
institutions and financial planners to reach its customer base.
The sales agents for this division often make sales presentations on a
one-on-one basis with potential prospects. Sales representatives are often faced
with competition from other agents and/or products from other companies.
The following tables set forth information regarding the Financial
Services Division. Southwestern Life is included beginning in 1998. United Life
is excluded on a pro forma basis for 1998 and 1999 as it is included in
Businesses Held for Sale and was sold on April 30, 1999.
<TABLE>
<CAPTION>
Pro forma
------------------
FINANCIAL SERVICES DIVISION 1997 1998 1998 1999
------------------------------------------------- ------- --------- -------- --------
($ in thousands)
<S> <C> <C> <C> <C>
Agents under contract ........................... 7,730 19,254 16,607 14,663
Number of agents annually producing new business. 2,206 4,894 4,353 3,955
Submitted annualized new business premiums ...... $139,483 $160,258 $72,465 $39,849
Annualized new business premium per agent ....... $ 63.2 $ 32.7 $ 16.6 $ 10.1
</TABLE>
The revenue earned by the Financial Services Division by product type is
shown below:
Pro forma
------------------
INSURANCE PRODUCT TYPE 1997 1998 1998 1999
-------------------------------------- -------- -------- -------- --------
($ in millions)
Life.................................. $ 127.9 $ 249.3 $ 239.6 $ 244.3
Accumulation.......................... 166.9 167.8 65.7 54.7
Fixed benefit......................... 0.3 2.7 2.4 0.3
-------- -------- -------- --------
Total............................... $ 295.1 $ 419.8 $ 307.7 $ 299.3
======== ======== ======== ========
12
<PAGE>
The percentage of the Financial Services Division revenue to the Company's
total insurance operations revenue by insurance product is shown below:
Pro forma
------------
INSURANCE PRODUCT TYPE 1997 1998 1998 1999
----------------------------------------- ---- ---- ---- ----
Life .................................... 46.3% 60.2% 69.1% 68.2%
Fixed benefit ........................... 0.2 1.0 14.3 1.8
Accumulation ............................ 95.0 94.2 92.0 88.5
Total division revenue to the Company's
total insurance operations revenue ... 45.9 49.5 70.7 68.9
Payroll Sales Division
Each of the Payroll Sales Division's marketing units is divided into
regions utilizing a hierarchical approach to managing the sales representative.
Additionally, AA Life and OLIC also utilize field marketing directors and
independent marketing organizations to access potential policyholders.
The Payroll Sales Division markets products solely through the channels of
employer-sponsored payroll deduction or government-sponsored allotment programs.
Under those programs, the agent is permitted by the employer to meet on the
employer's premises with its employees and to make both group and individual
presentations implicitly endorsed by the employer concerning available products.
If an employee elects to purchase a policy, arrangements are made with the
employer to deduct the premiums from the employee's wages. The employer
therefore is able to provide its employees with insurance benefits without
incurring any premium costs. The Company's billing system can be integrated into
the employer's payroll system without additional cost to the employer, a feature
that facilitates the Company's access to employees of businesses that have not
previously participated in payroll deduction programs.
The following tables set forth information regarding the Payroll Sales
Division. Professional is excluded on a pro forma basis for 1998 and for 1999 as
it is included in Businesses Held for Sale and was sold on March 31, 1999:
<TABLE>
<CAPTION>
Pro forma
-----------------
PAYROLL SALES DIVISION 1997 1998 1998 1999
------------------------------------------------ ------- ------- ------- -------
($ in thousands)
<S> <C> <C> <C> <C>
Agents under contract .......................... 6,784 6,941 3,638 3,129
Number of agents annually producing new business 2,955 1,926 783 684
Submitted annualized new business premiums ..... $42,527 $44,100 $26,944 $23,786
Annualized new business premium per agent ...... $ 14.4 $ 22.9 $ 34.4 $ 34.8
</TABLE>
The revenue earned by the Payroll Sales Division by product type is shown
below:
<TABLE>
<CAPTION>
Pro forma
-------------------
INSURANCE PRODUCT TYPE 1997 1998 1998 1999
-------------------------------------- -------- -------- -------- --------
($ in millions)
<S> <C> <C> <C> <C>
Life................................ $ 116.4 $ 112.6 $ 107.0 $ 114.1
Fixed benefit....................... 48.9 48.0 14.6 13.8
Accumulation........................ 7.2 5.9 5.7 7.1
-------- -------- -------- --------
Total............................. $ 172.5 $ 166.5 $ 127.3 $ 135.0
======== ======== ======== ========
</TABLE>
13
<PAGE>
The percentage of the Payroll Sales Division revenue to the Company's
total insurance operations revenue by insurance product is shown below:
Pro forma
------------
INSURANCE PRODUCT TYPE 1997 1998 1998 1999
----------------------------------------- ---- ---- ---- ----
Life .................................... 42.2% 27.2% 30.9% 31.8%
Fixed benefit ........................... 25.5 18.6 85.7 98.2
Accumulation ............................ 4.1 3.3 8.0 11.5
Total division revenue to the Company's
total insurance operations revenue .. 26.8 19.5 29.3 31.1
INSURANCE UNDERWRITING
The Financial Services Division generally utilizes the underwriting manual
of a large reinsurer as a guide for risk selection. The Company considers its
underwriting philosophy to be in line with the majority of the life insurance
industry. If full underwriting is required, the Company reviews the policy
application and an attending physician's report and may require a paramedical
examination or complete physical examination depending on the age of the
applicant and the amount of coverage requested. If the total amount of coverage
applied for plus any coverage in force with the Company exceeds $100,000, a
prospective policyholder must submit a screening for antibodies related to
Acquired Immune Deficiency Syndrome ("AIDS") , to the extent permitted by law.
Life products that are specifically designed for simplified issue are priced for
the mortality risks associated with the Company's simplified underwriting
procedures.
Although the increasing incidence of AIDS is expected to affect mortality
adversely for the life insurance industry as a whole, the Company believes that
the impact of AIDS on its operations should not be material due to the small
average size of the life insurance policies sold. The Company requires and
considers AIDS information to the fullest extent permitted by law in
underwriting and pricing decisions. During the twelve months ended December 31,
1999 and 1998, the Company estimated its Businesses Owned at December 31, 1999
paid approximately $795,000 and $1.0 million, respectively, in death benefits
(representing less than 1% of total death benefits paid by the Company during
each such period) under individual life policies due to deaths believed by the
Company to be AIDS-related. The AIDS claims paid in 1997 were $2.1 million.
The Company has identified a block of approximately 283 policies with a
total face amount of approximately $27.8 million which it suspects could have
been issued on applications containing material misrepresentations, particularly
concerning the treatment for or the diagnosis of AIDS or HIV. The Company is
investigating each one of these policies and is taking steps to rescind any
contestable policy where material misrepresentations are found. Approximately
156 policies with a face amount totaling approximately $17.8 million have been
rescinded. The Company is also reviewing its underwriting guidelines to prevent
a recurrence of this situation and reviewing its current cost of insurance
charges to determine if current charges are sufficient to cover potentially
higher mortality associated with such policies.
INVESTMENT PORTFOLIO
The Company's investment portfolio (including total invested assets and
cash and cash equivalents) is managed with the objectives of maintaining high
credit quality and liquidity, maximizing current income within acceptable levels
of risk, minimizing market and credit risk and matching the anticipated
maturities of investments to the Company's liabilities. To achieve these
objectives, the portfolio consists primarily of investment-grade fixed maturity
securities, which accounted for approximately 84.4% of the Company's total
invested assets at December 31, 1999. The Company believes that the nature of
its life products, which limit the early accumulation of cash values, permit it
to utilize this conservative investment strategy.
At December 31, 1999, 51.6% of the Company's fixed maturity bonds were
rated AA or higher by Standard & Poor's and approximately 93.2% were rated BBB
or higher by Standard & Poor's, respectively. All dollar amounts or percentages
set forth in this discussion are based on carrying value unless otherwise
indicated.
Other than issues of the United States governments and government agencies
and authorities, no single issuer represented more than 0.9% of total invested
assets at December 31, 1999.
14
<PAGE>
The following table summarizes the Company's investments as of December
31, 1999:
<TABLE>
<CAPTION>
Percent of
Total
Amortized Fair Carrying Carrying
Cost Value(1) Value Value
---------- ---------- ---------- -----
($ in thousands)
<S> <C> <C> <C> <C>
Fixed maturities available for sale:
U.S. Government and agency bonds ...... $ 224,922 $ 213,628 $ 213,628 7.8%
Debt securities issued or guaranteed by
foreign governments ................. 23,677 22,518 22,518 0.8
Municipal bonds ....................... 54,480 45,880 45,880 1.6
Corporate bonds ....................... 1,210,492 1,150,001 1,150,001 41.8
Mortgage-backed bonds ................. 972,425 931,663 931,663 33.9
---------- ---------- ---------- -----
Total fixed maturity securities
available for sale ................. 2,485,996 2,363,690 2,363,690 85.9
Equity securities available for sale .. 2,008 2,008 2,008 0.1
Commercial mortgages .................. 20,032 20,285 20,032 0.7
Real estate ........................... 5,475 5,141 5,141 0.2
Policy loans .......................... 197,287 197,287 197,287 7.2
Other investments ..................... 17,667 21,429 21,429 0.8
---------- ---------- ---------- -----
Total invested assets ............... 2,728,465 2,609,840 2,609,587 94.9
Cash and cash equivalents ............. 141,636 141,636 141,636 5.1
---------- ---------- ---------- -----
Total investment portfolio .......... $2,870,101 $2,751,476 $2,751,223 100.0%
========== ========== ========== =====
</TABLE>
-----------------
(1) Fair values are obtained principally from the Company's investment
advisors.
The table set forth below indicates the composition of the Company's fixed
maturity portfolio by rating as of December 31, 1999:
Percent of
Total Total
Carrying Carrying
Rating Value Value
---------- -----
($ in thousands)
AAA(1) ...................... $1,056,879 44.7 %
AA .......................... 162,689 6.9
A ........................... 589,152 24.9
BBB ......................... 394,334 16.7
---------- -----
Total investment grade ..... 2,203,054 93.2
---------- -----
BB .......................... 84,930 3.6
B or below .................. 54,591 2.3
---------- -----
Total below-investment grade 139,521 5.9
---------- -----
Nonrated .................... 21,115 0.9
---------- -----
Total fixed maturities ..... $2,363,690 100.0%
========== =====
--------------------
(1) Includes approximately $213.6 million of United States
government and agency bonds.
15
<PAGE>
The following table reflects investment results for the Company for each
of the periods indicated. The pro forma amounts for 1998 and 1999 exclude the
Businesses Held for Sale.
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
--------------------------------------------------------
Pro forma
--------------------------
1997 1998 1998 1999
----------- ----------- ----------- -----------
($ in thousands)
<S> <C> <C> <C> <C>
End of period total investment portfolio(1) $ 3,339,979 $ 4,930,535 $ 2,956,254 $ 2,751,223
Net investment income(2) .................. 273,237 369,052 215,909 201,514
Net realized investment gains (losses)(3) . 17,487 14,068 4,956 (1,398)
Average annual yield ...................... 7.6% 7.2% 7.0% 7.1%
</TABLE>
-----------
(1) Consists of total investment portfolio, less amounts due to brokers for
securities committed to be purchased at end of period. For 1998, invested
assets of Businesses Held for Sale have been included in end of period
total invested assets. In the pro forma 1998, net investment income and
realized investment gains of Businesses Held for Sale have been excluded.
(2) Net investment income is net of investment expenses, excludes capital gains
or losses and is before income taxes. Net investment income for 1999
excludes income from Businesses Held for Sale that were sold during 1999.
(3) Amounts shown above are before income taxes, and include provisions for
impairments in value which are considered to be other than temporary. For
1999, amount excludes gains from Businesses Held for Sale that were sold
during 1999.
The Company's investments must comply with the insurance laws of the
states in which its insurance subsidiaries are domiciled and in which they are
licensed as well as applicable provisions of the Company's 9 1/4% Senior
Subordinated Notes due 2003. These laws and provisions prescribe the kind,
quality and concentration of investments that may be made by the Company and/or
its insurance subsidiaries.
REINSURANCE
In keeping with industry practice, the Company reinsures portions of its
life insurance exposure with unaffiliated insurance companies under traditional
indemnity reinsurance agreements. Some new insurance sales are reinsured above
prescribed limits and others are reinsured as a percentage of each dollar of
coverage up to prescribed limits; these do not require the reinsurer's prior
approval under contracts that are renewable on an annual basis. Generally, the
Company enters into indemnity reinsurance arrangements to assist in diversifying
its risk and to limit its maximum loss on risks that exceed the Company's policy
retention limits ranging from $25,000 to $500,000 per life, depending on insured
issue age, the product type and each insurance company's historical practice.
Generally, accidental death benefits in excess of $50,000 per life are reinsured
on a bulk basis. Long term care is 80% reinsured on a coinsurance basis.
Indemnity reinsurance does not fully discharge the Company's obligation to pay
policy claims on the reinsured business. The ceding insurer remains responsible
for policy claims to the extent the reinsurer fails to pay such claims.
The Businesses Owned at December 31, 1999 are currently in the process of
reviewing existing reinsurance programs. This review is expected to be completed
in 2000 and may affect retention limits, the cost of its reinsurance coverage
and other aspects of its reinsurance programs.
At December 31, 1999 and 1998, of the approximately $28.2 billion and
$36.5 billion of life insurance in force, approximately $5.5 billion and $6.4
billion had been ceded to reinsurers, respectively. As of December 31, 1999 the
Company's principal reinsurers are RGA Reinsurance Company, Allianz Life
Insurance Company, Life Reassurance Corp. of America, Swiss Re Life & Health
Insurance Company, Transamerica Occidental Life Insurance Company and
Reassurance Company of Hanover which collectively have reinsured approximately
69.6% of the ceded business.
YEAR 2000 ISSUES
Many computer and software programs were designed to accommodate only two
digit fields to represent a given year (e.g. "98" represents 1998). It was
highly likely that such systems could not have been able to accurately process
data containing date information for the year 2000 and beyond. The Company is
16
<PAGE>
highly reliant upon computer systems and software as are many of the businesses
with which the Company interacts. The Company's ability to service its
policyholders and agents is dependent upon accurate and timely transaction
processing. Transaction processing in turn is dependent upon the Company's
highly complex interdependent computer hardware, software, telecommunications
and desktop applications. The inability of the Company or any of its integral
business partners to continue processing transactions during 2000 could lead to
a significant business interruption. Such an interruption could have resulted in
a decline in current and long-term profitability and business franchise value.
The Company's overall year 2000 compliance initiatives, included the
following components: (i) assessment of all business critical systems (business
critical systems includes computer and other systems), processes and external
interfaces and dependancies; (ii) remediation or upgrading of business critical
systems; (iii) testing of both modified and updated systems as well as
integrated systems testing; (iv) implementation of modified and updated systems;
and (v) contingency planning. As a part of the process, the Company has written
letters and corresponded with its outside vendors and critical business partners
concerning year 2000 compliance efforts and has followed up periodically.
The Company engaged outside vendors and focused certain employees' full
time efforts to help in the full array of its year 2000 initiative. This
included systems assessment and monitoring advice, actual code remediation,
communication and consultation with critical business partners and additional
data center and testing resources. The Company originally projected to incur
internal and external costs associated with such expertise ranging from $10.6
million to $14.5 million, which were anticipated to be incurred primarily during
1998 and early 1999. The Company actually incurred internal and external costs
of $8.0 million during 1999. The Company estimates it has incurred internal and
external costs aggregating $13.4 million and $1.9 million for the years ended
December 31, 1998 and 1997, respectively.
Since December 31, 1999 the Company has not experienced any significant
disruption in the Company's business, or an increase in the cost of the Company
doing business related to the year 2000 issue.
The Company provided certain representations and warranties to each
respective purchaser of the businesses sold with respect to each entity's
ability to process date-sensitive information for the year 2000 and beyond.
Although the Company believes that it is in compliance with, and is not aware of
any breach of the year 2000 representations and warranties provided to the
respective purchasers, there can be no assurances that the Company is in
compliance with all such representations and warranties. A breach by the Company
of such representations and warranties could result in indemnification
obligations owed by the Company to the purchasers.
COMPETITION
The life insurance industry is highly competitive. Numerous life insurance
companies and other entities, including banks and other financial institutions,
compete with the Company, many of which have substantially greater capital and
surplus, higher A.M. Best Company ("A.M. Best") ratings, larger and more
diversified product portfolios, and access to larger agency sales forces. The
Company believes that the principal competitive factors in the sale of insurance
products are product features, price, commission structure, perceived stability
of the insurer, claims-paying ratings, value-added service and name recognition.
The Company's ability to compete for sales is dependent upon its ability to
address the competitive factors described above.
As a result of the high percentage of life and accumulation product
revenue as compared to total revenue, the Company faces a broad market of
competition. The sale of life insurance products, and to a greater extent, the
sale of accumulation products is very sensitive to an organization's A.M. Best
rating, its size and perceived financial strength and the competitiveness and
the financial performance of the products themselves. The Company believes that
its target market is not widely served by many of the large, national insurers,
but does face direct competition from smaller regional and niche-market focused
companies.
During 1998, each of the Company's insurance subsidiaries received
downgrades in their respective A.M. Best rating, primarily as a result of
concerns regarding the financial strength of the Company. The Company believes
that as a result of the rating action, certain insurance subsidiaries have
experienced slight declines in new business production and modest increases in
policyholder surrenders. Certain of the Company's insurance subsidiaries market
insurance products that are highly sensitive to competitive factors including
financial strength and ratings. Over time and without an improvement in the
financial strength of the Company, the Company believes that the rating decline
of its insurance subsidiaries will negatively impact their ability to market
certain products and to retain some customers and distribution channels. For
additional information on ratings see "Business-Ratings" included elsewhere
herein.
17
<PAGE>
REGULATORY MATTERS
Life insurance companies are subject to regulation and supervision by the
states in which they transact business. The laws of the various states establish
regulatory agencies with broad administrative and supervisory powers related to,
among other things, granting and revoking licenses to transact business,
regulating trade practices, establishing guaranty associations, licensing
agents, approving policy forms, filing premium rates on certain business,
setting reserve requirements, determining the form and content of required
financial statements, determining the reasonableness and adequacy of capital and
surplus and prescribing the type of permitted investments and the maximum
concentrations of certain classes of investments.
Most states have enacted legislation regulating insurance holding company
systems, including acquisitions of control of insurance companies, dividends,
the terms of surplus debentures, the terms of transactions with affiliates,
investments in subsidiaries and other related matters. Regulatory restrictions
on investments in subsidiaries and affiliates require the Company to continually
review and occasionally modify or restructure the insurance subsidiaries within
the insurance holding company system. Additionally, the Company has entered into
an agreement with the Texas Department of Insurance dated September 22, 1998
which establishes procedures resulting in greater oversight of the Company and
its insurance subsidiaries by the Texas Department of Insurance. The Company is
registered as an insurance holding company system in Texas (the domiciliary
state of its insurance companies), and routinely reports to other jurisdictions
in which its insurance subsidiaries are licensed.
There continues to be substantial scrutiny of the insurance regulatory
framework, and a number of state legislatures have enacted legislative proposals
that alter, and in many cases increase, state authority to regulate insurance
companies and their holding company systems. The National Association of
Insurance Commissioners ("NAIC") and state insurance regulators also have become
involved in a process of re-examining existing laws and regulations and their
application to insurance companies. In particular, this re-examination has
focused on insurance company investment and solvency issues and, in some
instances, has resulted in new interpretations of existing law, the development
of new laws and the implementation of internal guidelines. The NAIC has formed
committees to study and formulate regulatory proposals on such diverse issues as
the use of surplus debentures, accounting for reinsurance transactions,
assumption reinsurance, valuation of securities, the adoption of risk-based
capital rules, the codification of Statutory Accounting Principles, and the
regulation of various products offered by insurance companies.
In connection with its accreditation of states, the NAIC has encouraged
states to adopt model NAIC laws on specific topics, such as holding company
regulations and the definition of extraordinary dividends. Model legislation
proposed by the NAIC to control the amount of dividends that may be paid by
insurance companies without prior regulatory approval has been adopted in most
states and is being considered by the legislatures of the other states. Texas,
the state of domicile for the Company's insurance subsidiaries, has adopted
dividend tests that are substantially similar to that of the NAIC's model
legislation. Texas only allows dividends to be paid out of unassigned funds.
Texas law permits AA Life, OLIC, Pioneer American, Pioneer Security,
Pacific Life, Security Life and Southwestern Life to pay a dividend without
prior consent of the Texas Insurance Commissioner if the amount paid, together
with all other dividends paid in the preceding 12 months, does not exceed the
greater of: (i) 10% of its statutory surplus as of the end of the prior calendar
year or (ii) its net income from operations for the prior calendar year. Any
dividend above this amount would be considered an "extraordinary" dividend and
could not be paid until the earlier of: (i) 30 days after the Texas Insurance
Commissioner has received notice of the declaration thereof and has not within
such period disapproved such payment, or (ii) the Texas Insurance Commissioner
shall have approved such payment within the 30 day period.
On the basis of 1999 statutory financial statements filed with the state
insurance regulators, the NAIC calculates twelve financial ratios to assist
state regulators in monitoring the financial condition of insurance companies. A
"usual range" of results for each ratio is used as a benchmark. Departure from
the usual range on four or more of the ratios could lead to inquiries from
individual state insurance departments. The Company's businesses experienced the
departures from the usual ranges on the following ratios.
PLAIC had four ratios outside of the usual range established by the NAIC.
PLAIC is primarily a holding company for its principal assets, being the common
stock of certain of the Company's insurance subsidiaries. Security Life had
three ratios outside the usual range principally as a result of the exchange
program implemented during 1999 to holders of certain life insurance products.
For a description of the exchange program, see page 20. Southwestern Life had
none of the twelve ratios outside of the usual ranges.
18
<PAGE>
In the past, variances in the insurance companies' ratios have resulted in
inquiries from insurance departments to which the Company has responded. The
Company may receive inquiries from certain insurance departments concerning its
ratio results for 1999, and there can be no assurance that such insurance
departments will not take action against the insurance companies.
In December 1992, the NAIC adopted the Risk Based Capital ("RBC") for Life
and/or Health Insurers Model Act (the "Model Act"). The main purpose of the
Model Act is to provide a tool for insurance regulators to evaluate the capital
of insurers with respect to the risks assumed by them and determine whether
there is a need for possible corrective action with respect to them. To date,
neither the Model Act or similar legislation or regulation has been adopted in
Texas, the domiciliary states of the Company's insurance subsidiaries owned at
December 31, 1999.
The Model Act provides for four different levels of regulatory action with
respect to statutory financial statements for the calendar year 1994 and
thereafter, each of which may be triggered if an insurer's Total Adjusted
Capital (as defined in the Model Act) is less than a corresponding "level" of
RBC. The "Company Action Level" is triggered if an insurer's Total Adjusted
Capital is less than 200.0% of its "Authorized Control Level RBC" (as defined in
the Model Act) or less than 250.0% of its Authorized Control Level RBC and the
insurer has a negative trend. At the Company Action Level, the insurer must
submit a comprehensive plan to the regulatory authority, which discusses
proposed corrective actions to improve its capital position. The "Regulatory
Action Level" is triggered if an insurer's Total Adjusted Capital is less than
150.0% of its Authorized Control Level RBC. At the Regulatory Action Level, the
regulatory authority will perform a special examination of the insurer and issue
an order specifying corrective actions that must be followed. The "Authorized
Control Level" is triggered if an insurer's Total Adjusted Capital is less than
100.0% of its Authorized Control Level RBC, and at that level the regulatory
authority is authorized (although not mandated) to take regulatory control of
the insurer. The "Mandatory Control Level" is triggered if an insurer's Total
Adjusted Capital is less than 70.0% of its Authorized Control Level RBC, and at
that level the regulatory authority must take regulatory control of the insurer.
Regulatory control may lead to rehabilitation or liquidation of an insurer.
Calculations using the NAIC formula and the life insurance subsidiaries'
statutory financial statements as of December 31, 1999, indicate that each of
the insurance subsidiaries' capital exceeded Company Action Level RBC
requirements.
Of the Company's remaining insurance subsidiaries, Security Life has one
state license which is subject to limits on the amount of new business that may
be written. This license restriction has not had a material adverse effect on
the Company's results of operations and is not expected to have a material
adverse effect in the future. In some states, a license restriction, suspension
or revocation by another state may result in reciprocal regulatory action.
The Company's life insurance subsidiaries may be required, under the
solvency or guaranty laws of most states in which it does business, to pay
assessments (up to certain prescribed limits) to fund policyholder losses or
liabilities of insurance companies that become insolvent. Recent insolvencies of
insurance companies increase the possibility that such assessments may be
required. These assessments may be deferred or forgiven under most guaranty laws
if they would threaten an insurer's financial strength and, in certain
instances, may be offset against future premium taxes. The Company received a
refund of $223,000 in 1999. The Company paid $300,000 and $2.5 million for the
years ended December 31, 1998 and 1997, respectively, as a result of such
assessments. At December 31, 1999, the Company's life insurance subsidiaries had
accrued assessment liability totaling $1.8 million.
On March 16, 1998, the NAIC approved the codification of statutory
accounting practices. The codification will constitute the only source of
"prescribed" statutory accounting practices and is subject to adoption by the
Department of Insurance of the state of domicile. The Statements of Statutory
Accounting Principles established under the codification are generally effective
January 1, 2001. The Company has not fully determined the impact the adoption of
the codification will have on unassigned surplus of each insurance subsidiary
though the Company does not believe it will be material.
Although the federal government does not directly regulate the business of
insurance, federal legislation and administrative policies in several areas,
including pension regulation, age and sex discrimination, financial services
regulation and federal taxation can significantly affect the insurance business.
19
<PAGE>
There can be no assurance that existing insurance-related laws and
regulations will not become more restrictive in the future and thereby have a
material adverse effect on the operations of the Company and on the ability of
the insurance companies to pay dividends. Additionally, there can be no
assurance that existing insurance-related laws and regulations will not have a
material adverse effect on the ability of PLAIC to make payments on their
respective surplus debentures. For further information related to said surplus
debenture, see Item 7. Management's Discussion and Analysis of Results of
Operations and Financial Condition--Financial Condition, Liquidity and Capital
Resources and Note 14 of Notes to Consolidated Financial Statements.
Certain of the Company's insurance subsidiaries historically sold certain
interest sensitive life insurance contracts in which the determination of policy
reserves is highly sensitive to assumptions such as withdrawal rates, investment
earnings rates, mortality rates and premium persistency. Minor changes in such
assumptions could have a material impact on future statutory reserve
requirements. Significant increases in statutory reserves would result in lower
statutory earnings for the impacted insurance subsidiaries, which in turn would
reduce the dividend capacity of such subsidiaries ultimately reducing cash flow
available to the Company.
The Company is continually evaluating actuarial assumptions associated
with interest sensitive life insurance contracts in which the determination of
policy reserves is highly sensitive to assumptions such as withdrawal rates,
investment earnings rates, mortality rates, and premium persistency. Currently
reflected in the Company's financial statements are policy reserves and account
values associated with such contracts, which aggregated approximately $527.1
million and $525.4 million as of December 31, 1999 and 1998, respectively. If
developing trends were to continue, principally the less than expected level of
the lapses currently associated with such interest sensitive blocks of business,
the Company would be required to record additional reserves or reduce intangible
assets, which could have a material impact on the Company's financial position
and results of operations. A decrease of 1% in the assumed lapse rate would
increase policy reserves associated with such contracts by $9.0 million.
Management is also assessing the potential impact of future management actions,
which might mitigate the financial impact of these trends. Types of management
actions would likely include, but are not limited to, the redetermination of
non-guaranteed charges and/or benefits under the contracts, asset segmentation,
and reinsurance. There are risks associated with management action including
potential sales disruption and the threat of litigation. During 1999, the
Company modified certain assumptions associated with the blocks of business
including lowering the aggregate expected lapse rate. In addition, the Company
is pursuing a plan to continue charging certain expense loads associated with
certain interest sensitive life insurance contracts. As a result of the
aggregate impact of the changes in assumptions and management actions, the
Company increased the amount of reserves associated with these policies by
approximately $6.2 million during the fourth quarter of 1999.
The Company's insurance subsidiaries are required, at least annually, to
perform cash flow and "Asset Adequacy Analysis" under differing interest rate
scenarios. At December 31, 1999 and 1998, Southwestern Life failed certain of
those cash flow testing scenarios. As a result, Southwestern Life performed a
series of expanded tests. Based upon the results of these expanded tests,
Southwestern Life has determined that additional statutory reserves were not
needed at December 31, 1999 or 1998. Factors that may require Southwestern Life
to establish additional statutory reserves in future periods include changes in
interest rates, timing of the emergence of insurance profits, persistency of the
insurance in force, sales or reinsurance of blocks of insurance in force and
mortality experience. Management actions that may mitigate the need for these
additional reserves may include but are not limited to, new profitable business
being added to the insurance in force, reinsurance or actions that impact
persistency, mortality experience, interest spreads and costs to administer the
insurance in force. Southwestern Life periodically monitors these factors to
determine if additional statutory reserves will be required.
In January 1999, Security Life initiated management action in the form of
a new exchange program for certain policyholders of Security Life. The program
was offered to all policyholders who had certain policy forms in force as of
January 1, 1998. The program allowed the policyholder the following options in
exchange for terminating his or her policy and executing a release: (i) refund
of 115% of all premiums paid for the policy prior to January 1, 1999 and 100% of
premiums paid thereafter; (ii) exchange the policy, without proof of
insurability, for the same face amount in a universal life policy, or a new term
universal life policy. The policyholder also had the choice of not accepting the
exchange program and keeping the current policy in force. As of December 31,
1999, 66% of such policyholders completed the exchange offer. In November 1999,
a lawsuit was filed against Security Life regarding these matters (see Item 3.
Legal Proceedings).
RATINGS
A.M. Best Company ("A.M. Best") assigns fifteen letter ratings to insurance
companies, with the highest being "A++ (Superior)." A.M. Best ratings are based
upon factors relevant to policyholders and are not directed toward the
protection of investors, such as holders of the Common Stock. All of the
Company's life insurance subsidiaries carry a "B+ (Very Good)" rating from A. M.
Best. A "B+ (Very Good)" rating is the sixth highest letter rating.
20
<PAGE>
EMPLOYEES
At December 31, 1999, the Company had 484 full time employees. None of the
Company's employees were represented by any union.
Item 2. Properties
FACILITIES
The Company's primary administrative offices are located in Dallas, Texas.
Southwestern Financial Services Corporation ("SFSC") leases approximately
125,000 square feet in Dallas, Texas at an annual cost of $1.8 million. The
Company believes that the current make up of its properties is adequate for its
operations, and based on recent experience, that it will be able to find
suitable replacement properties on acceptable terms for properties the Company
chooses to replace or to which leases are terminated or not renewed.
Item 3. Legal Proceedings
During the third quarter of 1998, the first of ten class-action complaints
was filed in the United States District Court for the Southern District of New
York ("District Court") against the Company and certain of its current or former
directors and officers.
During a pre-trial conference on November 9, 1998, all parties agreed to
the consolidation of all of the actions and the Court appointed lead plaintiffs
on behalf of shareholders and noteholders. The Court also approved the selection
of three law firms as co-lead counsel for shareholders and noteholders. A
consolidated and amended complaint was filed on January 22, 1999. A First
Consolidated Amended Class Action Complaint naming, as defendants, the Company,
David J. Stone, formerly a director and Chairman and Chief Executive Officer,
and Steven W. Fickes, formerly a director and President and Chief Financial
Officer was filed on March 15, 1999 (the "Complaint").
The Complaint alleges that defendants violated the Securities Exchange Act
of 1934. Among other things, plaintiffs claim that defendants issued a series of
materially false and misleading statements and omitted material facts regarding
the Company's financial condition, including the value of certain of its assets,
and failed to timely disclose that it was under investigation by the Securities
and Exchange Commission (the "SEC").
Plaintiffs seek to recover damages in unspecified amounts on behalf of
themselves and all other purchasers of the Company's common stock and purchasers
of the Company's subordinated notes during the period of February 8, 1996,
through November 16, 1998.
During a conference on March 19, 1999, defendants sought and were granted
permission to file, and subsequently filed, a motion to dismiss the Complaint.
Although there are no assurances that the motion to dismiss will be granted,
management believes that there are meritorious defenses to the action that were
raised in connection with the motion, including whether the Complaint adequately
pleads scienter (i.e., intent to defraud) as required under the Private
Securities Litigation Reform Act of 1995.
The Company has notified its primary and excess carriers of directors and
officers liability insurance of the existence of the claims set forth in the
Complaint, and the total potential insurance available is $15.0 million of
primary and $10.0 million of excess coverage, respectively, for securities
claims. The primary insurance coverage requires the Company to bear 25% of: (i)
all expenses and (ii) any losses in excess of a $1.0 million retention amount.
The primary and excess carriers have reserved their rights under the policies
with respect to coverage of the claims set forth in the Complaint. As explained
below, the primary insurer has agreed in principle to contribute to a settlement
of the litigation.
Following settlement discussions with the Plaintiffs' counsel and
representatives of the primary insurance carrier and their counsel, the parties
to the Complaint entered into a Memorandum of Understanding dated November 11,
1999 (the "Memo") containing the essential terms of a settlement.
21
<PAGE>
The Memo states that $9.0 million of cash plus interest accruing through
the date of consummation of the settlement, will be paid in full and final
settlement of all claims set forth in the Complaint (the "Settlement"). Of that
sum, $1.5 million plus interest will be paid by the Company and $7.5 million
plus interest will be paid by the Company's outside directors and officers
liability insurance carrier. The Settlement is conditioned upon, among other
things, confirmatory discovery, execution of a definitive settlement agreement
and related documents, notice to the Company's shareholders of the Settlement
and final approval by the United States District Court (with all time to appeal
such approval having run or any appeals having been resolved in favor of
approval of the Settlement). During the three months ended December 31, 1999,
the Company paid the $1.5 million liability related to the settlement to an
escrow account.
The Company expects that this litigation will not affect its ability to
operate through 2000. While it is not feasible to predict or determine the final
outcome of these proceedings or to estimate the amounts or potential range of
loss with respect to these matters, management believes that if the Settlement
is not consummated and there is an adverse outcome with respect to such
proceedings, it would have a material adverse impact on the Company and affect
its ability to operate as is currently intended.
In May 1998, the North Carolina Attorney General's Office (the "NCAG")
initiated an inquiry concerning certain life insurance products historically
sold by Security Life and representations allegedly made by Security Life's
agents and officers with respect to not charging insurance charges after the
eighth policy year for non-smoker insureds. The NCAG indicated that Security
Life may be estopped to change its current practice of not charging the cost of
the insurance for non-smoking policyholders because of certain representations
made by agents and officers of Security Life. Although Security Life has not
charged the cost of insurance charges for non-smoker policyholders who reached
their ninth policy year, this practice is not guaranteed under the life
insurance contracts. The contracts specifically allow Security Life the right to
change the cost of insurance rates in accordance with the parameters set forth
in the insurance contracts. Security Life has responded to the NCAG's inquiry by
denying that it is estopped from changing the cost of insurance rates based on
the alleged representations, and continuing to reserve its contractual rights to
charge the cost of insurance rates in accordance with the parameters set forth
in the insurance contracts. In June 1998, the NCAG informed Security Life that
it could not adjudicate this matter and left it mutually unresolved. In June
1999, the North Carolina Department of Insurance ("NCDOI") asked Security Life
about the status of its current practice of not charging cost of insurance
charges after the eighth contract year for non-smokers on these same insurance
products and requested to be informed if Security Life changes its current
practice. Security Life has responded to the NCDOI's inquiry by verifying that
no decision has been made to date to change such current practice and such
practice has not changed; and affirming that the NCDOI would be notified in the
event this current practice changes. The Company has initiated an exchange
program which enables policyholders of such life insurance products to terminate
their policies and, in exchange for the termination of the original policy and a
release, obtain either (i) the refund of all premiums paid and other
consideration or (ii) another Security Life product. On November 5, 1999,
Security Life was served with an Original Petition filed in state court in
Dallas County, Texas, asserting a class action concerning such policies. The
petition alleges that Security Life has waived the right to charge cost of
insurance charges after the eighth year on such non-smoker policies and to
increase cost of insurance charges on such smoker policies. The petition alleges
Security Life made these waivers through its marketing pieces and signed
statements by its officers. The petition also alleges that not all of the facts
were outlined in the Company's communication to its policyholders outlining the
exchange program and therefore alleges Security Life's exchange program is
deceptive. The petition asks for declaratory judgment concerning the rights of
the Plaintiffs, and the class of policyholders of such policies and for
attorney's fees. It, among other things, asks for an injunction to prevent
Security Life from charging cost of insurance charges for such non-smoker
policies or increasing cost of insurance charges on such smoker policies after
the eighth contract year. It also asks the Court to rule the releases signed by
such policyholders under the exchange program be declared null and void and
those policyholders who signed the releases be given the option of reinstating
the prior policies. Security Life denies the allegations in the petition and
intends to vigorously defend this lawsuit. The trial court in which this case is
pending has granted class certification in at least one other lawsuit involving
similar types of claims. There can be no assurances that the exchange program
will be successful or that the Company will resolve these matters on such life
insurance products on a satisfactory basis, or at all, or that any such
resolution would not have a material adverse effect on the Company's financial
condition, results of operations or cash flows.
On July 30, 1998, the SEC notified the Company that it had commenced a
formal investigation into possible violations of the federal securities laws
including matters relating to the Company's restatement of its financial
statements for the first six months of 1997, and for the years ended December
31, 1994, 1995 and 1996. The Company and its management are fully cooperating
with the SEC in its investigation.
The Company is a party to various other pending or threatened legal
actions arising in the ordinary course of business, some of which include
allegations of insufficient policy illustration and agent misrepresentations.
Although the outcome of such actions is not presently determinable, management
does not believe that such matters, individually or in the aggregate, would have
a material adverse effect on the Company's financial position or results of
operations if resolved against the Company.
Item 4. Submission of Matters to a Vote of Security Holders
None.
22
<PAGE>
PART II
Item 5. Market for the Registrant's Common Equity and Related Shareholder
Matters
MARKET FOR COMMON STOCK
On January 8, 2000, the NYSE suspended trading in the Company's common
stock and applied to the Securities and Exchange Commission for the removal of
the Company's common stock and $3.375 convertible preferred stock listing and
registration on the NYSE. The shares of common stock of the Company are
currently traded in the over-the-counter market under the ticker symbol "PFGRQ."
The following table sets forth for the calendar periods indicated, the
high and low sales price per share of the Company's common stock as reported on
the NYSE and the quarterly cash dividends declared on the common stock with
respect to each quarter since January 1, 1998. The prices do not include
mark-ups, mark-downs, or commissions. As of March 29, 2000, there are
approximately 278 shareholders of record throughout the United States and
abroad.
The price history as provided by NYSE and dividends for the years ended
December 31, 1999 and 1998, are presented below:
SALES PRICE
--------------------- DIVIDEND
FOR THE YEAR ENDED DECEMBER 31, 1999 HIGH LOW DECLARED
------------------------------------ -------- -------- --------
Fourth quarter...................... $ 0.750 $ 0.312 $ --
Third quarter....................... 0.688 0.281 --
Second quarter...................... 0.750 0.438 --
First quarter....................... 1.312 0.500 --
SALES PRICE
--------------------- DIVIDEND
FOR THE YEAR ENDED DECEMBER 31, 1998 HIGH LOW DECLARED
------------------------------------ -------- -------- --------
Fourth quarter...................... $ 2.250 $ 0.500 $ --
Third quarter....................... 20.750 1.750 --
Second quarter...................... 28.688 20.125 0.05
First quarter....................... 35.938 27.813 0.05
(Remainder of Page Intentionally Left Blank)
23
<PAGE>
Item 6. Selected Consolidated Financial Data
<TABLE>
<CAPTION>
For the years ended December 31,
---------------------------------------------------------
1999 1998 1997 1996 1995
---------- --------- -------- -------- --------
(In thousands, except per share amounts)
<S> <C> <C> <C> <C> <C>
Revenues:
Policy revenues ................................ $ 338,874 $ 459,158 $345,566 $348,090 $301,889
Net investment income .......................... 257,600 369,052 273,237 210,734 102,291
Other income(1) ................................ 34,066 37,717 46,476 43,703 21,794
Net gains (losses) from the sale of investments (502) 14,068 17,487 1,257 3,770
Net gains from sales of subsidiaries(2) ........ 6,602 -- -- -- --
---------- --------- -------- -------- --------
Total revenues .............................. 636,640 879,995 682,766 603,784 429,744
---------- --------- -------- -------- --------
Benefits and expenses:
Claims incurred ................................ 223,658 308,432 202,472 188,727 141,876
Change in liability for future policy benefits and
other policy benefits ......................... 153,929 233,330 121,817 83,184 20,047
Insurance and other operating expenses ......... 236,826 376,941 264,607 181,678 164,126
Interest and amortization of deferred
debt issuance costs .......................... 40,222 42,960 23,355 18,579 19,520
Impairment of intangibles ...................... 95,522 -- -- -- --
Impairment provision associated with assets of
Businesses Held for Sale ...................... 58,486 342,960 -- -- --
----------- --------- -------- -------- --------
Total benefits and expenses. ................ 808,643 1,304,623 612,251 472,168 345,569
----------- --------- -------- -------- --------
Income (loss) before income taxes and extraordinary
charge ......................................... (172,003) (424,628) 70,515 131,616 84,175
Income taxes (benefits) ........................ 28,709 (3,369) 20,375 40,957 27,829
----------- --------- -------- -------- --------
Income (loss) before extraordinary charge ........ (200,712) (421,259) 50,140 90,659 56,346
Extraordinary charge, net of income taxes ...... -- (1,671) -- (2,372) --
----------- --------- -------- -------- --------
Net Income (loss) ................................ (200,712) (422,930) 50,140 88,287 56,346
Preferred stock dividend requirements .......... 17,825 18,273 19,533 14,646 6,540
----------- --------- -------- -------- --------
Net income (loss) applicable to common stock ..... $ (218,537) $(441,203) $ 30,607 $ 73,641 $ 49,806
=========== ========= ======== ======== ========
(1) Includes $19.0 million, $21.0 million and $4.7 million of equity in
earnings of unconsolidated affiliates for the years ended 1997, 1996 and
1995, respectively.
(2) Includes foreign currency translation losses of $24,978 realized on sale of
the Career Sales Division.
<CAPTION>
<S> <C> <C> <C> <C> <C>
Per Share Information:
Basic:
Net income (loss) applicable to common stock ... $ (7.44) $ (15.23) $ 1.09 $ 2.70 $ 2.26
Common shares used in computing basic earnings
per share ................................... 29,354 29,091 28,016 27,208 22,048
Diluted:
Net income (loss) applicable to common stock ... $ (7.44) $ (15.23) $ 1.07 $ 2.42 $ 2.12
Common shares used in computing diluted earnings
per share ................................... 29,354 29,091 28,645 35,273 25,216
Cash dividends declared .......................... $ -- $ 0.10 $ 0.20 $ 0.20 $ 0.06
<CAPTION>
As of December 31,
--------------------------------------------------------------
1999 1998 1997 1996 1995
---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Assets:
Investments and cash ............................. $2,751,223 $2,957,080 $3,340,114 $3,694,609 $2,288,979
Insurance assets ................................. 271,413 347,728 617,318 639,798 499,668
Other assets ..................................... 265,512 261,633 766,703 474,916 354,271
Assets of Businesses Held for Sale ............... -- 2,417,583 -- -- --
---------- ---------- ---------- ---------- ----------
Total assets ................................... $3,288,148 $5,984,024 $4,724,135 $4,809,323 $3,142,918
========== ========== ========== ========== ==========
Liabilities and shareholders' equity:
Insurance liabilities ............................ $2,756,957 $2,819,661 $3,289,925 $3,566,455 $2,221,161
Notes payable .................................... 279,646 550,923 359,755 210,325 307,271
Other liabilities ................................ 98,579 114,187 194,352 170,302 125,351
Liabilities of Businesses Held for Sale .......... -- 2,063,312 -- -- --
Redeemable preferred stock ....................... -- -- 19,867 32,864 30,007
Shareholders' equity ............................. 152,966 435,941 860,236 829,377 459,128
---------- ---------- ---------- ---------- ----------
Total liabilities and shareholders' equity ..... $3,288,148 $5,984,024 $4,724,135 $4,809,323 $3,142,918
========== ========== ========== ========== ==========
</TABLE>
24
<PAGE>
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
This "Management's Discussion and Analysis of Financial Condition and
Results of Operations" reviews the consolidated financial condition of the
Company as of December 31, 1999 and 1998, the consolidated results of operations
for the three years ended December 31, 1999, and where appropriate, factors that
may affect future financial performance.
The following discussion should be read in conjunction with the
accompanying consolidated financial statements and related notes of this Annual
Report on Form 10-K.
CAUTIONARY STATEMENT
Cautionary Statement for purposes of the Safe Harbor Provisions of the
Private Securities Litigation Reform Act of 1995. All statements, trend analyses
and other information contained in this report relative to markets for
PennCorp's products and trends in PennCorp's operations or financial results, as
well as other statements including words such as "anticipate," "believe,"
"plan," "estimate," "expect," "intend," and other similar expressions,
constitute forward-looking statements under the Private Securities Litigation
Reform Act of 1995. These forward-looking statements are subject to known and
unknown risks, uncertainties and other factors which may cause actual results to
be materially different from those contemplated by the forward-looking
statements. Such factors include, among other things: (1) general economic
conditions and other factors, including prevailing interest rate levels and
stock market performance, which may affect the ability of PennCorp to sell its
products, the market value of PennCorp's investments and the lapse rate and
profitability of insurance products; (2) PennCorp's ability to achieve
anticipated levels of operational efficiencies and cost-saving initiatives; (3)
customer response to new products, distribution channels and marketing
initiatives; (4) mortality, morbidity, and other factors which may affect the
profitability of PennCorp's insurance products; (5) changes in the Federal
income tax laws and regulations which may affect the relative tax advantages of
some of PennCorp's products; (6) increasing competition in the sale of insurance
and annuities; (7) regulatory changes or actions, including those relating to
regulation of insurance products and of insurance companies; (8) ratings
assigned to PennCorp'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; (9) PennCorp's
continued ability to address Year 2000 issues; (10) PennCorp's ability to
consummate the Recapitalization Plan; and (11) 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.
BANKRUPTCY PROCEEDINGS
On January 10, 2000 the Company announced that it had agreed to sell its
Financial Services Division to Reassure America for $260 million subject to
certain adjustments, and would accomplish such transaction through the filing of
a voluntary petition for relief under Chapter 11 of the Bankruptcy Code.
On February 7, 2000, PennCorp filed a voluntary petition for relief under
Chapter 11 of the United States Bankruptcy Code in the Bankruptcy Court. Since
the Petition Date, PennCorp has continued to operate and manage its assets and
business as a debtor in possession as authorized by provisions of the Bankruptcy
Code.
On February 28, 2000 the Bankruptcy Court issued an order scheduling a
hearing to consider approval of the sale agreement with Reassure America,
subject to higher or better offers, and establishing the procedures for the
submission of competing offers.
On March 15, 2000, the Company received a competing bid in the form of a
recapitalization plan submitted by Inverness and Vicuna on behalf of the
unofficial ad hoc committee of preferred stockholders, and Rapoport and Sharpe.
On March 23, 2000 the Company's Board of Directors selected the Recapitalization
Plan as the final accepted offer pursuant to the bidding procedures approved as
part of the Sales Procedure Order. On March 24, 2000, the Bankruptcy Court
approved the Board of Director's selection of the Recapitalization Plan.
25
<PAGE>
The proposed Recapitalization Plan provides that the preferred
stockholders will receive one share of common stock of the reorganized company
for each share of outstanding preferred stock. In addition, the preferred
stockholders will have an opportunity, pursuant to a rights offering, to
purchase .3787 shares of common stock of the reorganized company for each share
of outstanding preferred stock owned at a purchase price of $12.50 per share.
Inverness and Vicuna have issued a stand by commitment letter to the Company,
committing $24.5 million to fully underwrite the rights offering. In addition,
Rapoport and Sharpe have committed to purchase equity in the recapitalized
company amounting to $20.0 million and $3.0 million, respectively. The standby
commitment letter and the Rapoport and Sharpe investment, are subject to certain
conditions.
Under the Recapitalization Plan, all existing shares of the Company's
common stock will be cancelled for no value, and the Company's existing senior
and subordinated debt, with principal currently aggregating approximately $180
million, will be paid in full in cash. Any and all other claims and liabilities
of the Company will be paid in accordance with their terms.
Consummation of the recapitalization transaction is subject to certain
conditions including regulatory approvals, the consummation of a $95 million
credit facility, the consummation of a proposed transaction whereby Southwestern
Life and Security Life will reinsure substantially all of their existing
deferred annuity blocks of business, an order confirming the Company's plan of
reorganization that incorporates the proposed recapitalization transaction shall
have been entered by the Bankruptcy Court and such order shall be unstayed and
in full force and effect, and the closing of the recapitalization shall occur no
later than December 31, 2000. The definitive agreements for the credit facility
and the reinsurance transaction will contain conditions to consummation
including no material adverse change as defined in the proposed $95 million
credit agreement.
The Company has received irrevocable commitments from holders of
approximately 71 percent of the Company's two outstanding series of preferred
stock indicating that they will vote in favor of the Recapitalization Plan upon
solicitation by the Company which, when such shares are voted, will satisfy the
voting requirements for confirmation of a plan of reorganization. Inverness,
Vicuna, Rapoport and Sharpe have deposited an aggregate of $47.5 million into an
escrow account, such that those funds will be used to make their respective
committed equity investments in the recapitalized company once the
Recapitalization Plan is consummated. A portion of such funds may be forfeited
to the Company under certain circumstances.
The Company filed a plan of reorganization on April 5, 2000 and will seek
confirmation of the Recapitalization Plan by the Bankruptcy Court on June 5,
2000, with consummation expected to occur promptly thereafter. For additional
information, see Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations--Financial Condition, Liquidity and Capital
Resources and Notes 9 and 23 of Notes to Consolidated Financial Statements.
GENERAL
Historically, the Company, through its three operating divisions, provided
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 independent general agents, exclusive
agents, financial institutions and payroll deduction programs, and are targeted
primarily to lower and middle-income individuals in rural and suburban areas.
The Company's 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. During 1999, the Company disposed of
its Career Sales Division and certain operating subsidiaries. See "Dispositions
and Other Events" below. Each disposition impacted certain distribution channels
and related products historically utilized by the Company.
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.
Dispositions and Other Events. On July 30, 1999, the Company consummated
the sale of the Career Sales Division to Universal American. The net cash
proceeds after transaction costs and fulfillment of contract obligations were
$82.0 million. The Company realized a foreign currency translation loss of $25.0
million, which represented previously unrealized translation losses on the
Company's Canadian insurance operations, partially offset by a gain of $3.5
million resulting in a net loss of $21.5 million. In addition, as a result of
the sale, unrealized gains on securities available for sale and unrealized
foreign currency translation losses decreased by $2.3 million and $25.0 million,
respectively. On December 29, 1999, as a result of certain settlement and
consideration adjustment provisions included in the purchase and sale agreement
the Company reduced the consideration received by $2.6 million.
On June 30, 1999, the Company completed the sale of KIVEX to Allegiance
for $34.5 million in cash. The net proceeds to the parent company from the sale
were $22.2 million after payment of costs and fees associated with the
transaction and after repayment of $10.2 million of intercompany borrowings to
insurance company affiliates of PennCorp. The Company recorded a gain of $30.9
million from the sale.
26
<PAGE>
On April 30, 1999, the Company consummated the sale of the United Life
Assets to ING. The purchase consideration totaled $154.1 million including a
dividend of $2.1 million that was paid by United Life at closing. The cash
consideration ultimately was reduced as a result of the Company's obligation to
purchase certain mortgages and other assets as well as for transaction related
costs at closing. The Company received net cash proceeds of $136.5 million. The
Company realized a loss from the sale totaling $3.9 million. As a result of the
sale, unrealized gains on securities held for sale by United Life decreased $1.7
million. As of December 31, 1999, the Company sold substantially all of the
mortgages retained by the Company as a part of the sale of the United Life
Assets for aggregate consideration of $8.0 million. The Company may be obligated
to repurchase certain of the mortgages sold. The amount of mortgages the Company
may be required to repurchase is not expected to exceed approximately $1.6
million. At December 31, 1999, the Company has established a $1.2 million
liability related to these contingencies. In addition, the Company has been
notified by ING that it disputes certain federal income tax calculations under
the provisions in the purchase and sale agreement. Under the provision of the
purchase and sale agreement ING is to provide the Company with preliminary tax
returns in order for the Company to evaluate any potential differential in tax
amounts between closing and the final return preparation. To date ING has not
provided such preliminary tax returns and hence the Company has not been able to
fully evaluate the merits of ING's claim. At December 31, 1999, the Company has
established a liability of $1.2 million related to this contingency.
On March 31, 1999, the Company consummated the sale of Professional to GE
Financial for cash proceeds of $47.5 million. The Company realized net cash
proceeds of $40.2 million. Professional, which previously was included in the
Payroll Sales Division, provided individual fixed benefit and life products
utilizing a network of independent agents primarily in the southeastern United
States through employer-sponsored payroll deduction programs. The Company
realized a gain from the sale totaling $1.1 million. As a result of the sale,
unrealized gains on securities available for sale by Professional decreased by
$488,000. On September 15, 1999, as a result of certain settlement and
consideration adjustment provisions included in the purchase and sale agreement
the Company reduced the consideration received by $1.2 million.
The following unaudited selected pro forma financial information has been
prepared to illustrate the pro forma effects of the sales of Payroll Sales
Division (sold February 4, 2000) (see Notes 3 and 23 of Notes to Consolidated
Financial Statements), Career Sales Division (sold July 30, 1999), KIVEX (sold
June 30, 1999), the United Life Assets (sold April 30, 1999) and Professional
(sold March 31, 1999) . The pro forma statements of operations for the years
ended December 31, 1999 and 1998 give effect to such sales as if they had
occurred on January 1, 1998. The unaudited selected pro forma financial
information has been prepared for comparative purposes only and does not purport
to be indicative of what would have occurred had such purchases and sales been
made as of January 1, 1998, or results which may occur in the future.
<TABLE>
<CAPTION>
(Unaudited)
As Reported Pro Forma
1999 1999
--------- ---------
(In thousands, except
per share amounts)
<S> <C> <C>
Total revenues ............................................ $ 636,640 $ 318,467
Loss before extraordinary charge .......................... (200,712) (72,144)
Loss before extraordinary charge applicable to common stock (218,537) (89,969)
Per share information:
Net loss before extraordinary charge applicable to
common stock-basic ..................................... $ (7.44) $ (3.06)
Net loss before extraordinary charge applicable to
common stock-diluted ................................... (7.44) (3.06)
</TABLE>
27
<PAGE>
<TABLE>
<CAPTION>
(Unaudited)
As Reported Pro Forma
1998 1998
--------- ---------
(In thousands, except
per share amounts)
<S> <C> <C>
Total revenues ..................................................... $ 879,995 $ 340,498
Income (loss) before extraordinary charge .......................... (421,259) (70,282)
Income (loss) before extraordinary charge applicable to common stock (439,532) (88,555)
Per share information:
Net income (loss) before extraordinary charge applicable
to common stock-basic ........................................... $ (15.17) $ (3.04)
Net income (loss) before extraordinary charge applicable
to common stock-diluted ......................................... (15.17) (3.04)
</TABLE>
During 1999 the Company used $267.0 million of the net proceeds from these
sales to pay down the outstanding balance under the Bank Credit Facility. In
addition, the Company repaid an additional $2.0 million of indebtedness as a
result of liquidity at the parent company above the amounts prescribed in the
Bank Credit Facility, as amended.
Acquisitions and Other Transactions. On January 2, 1998, the Company
consummated the acquisition from KB Fund the SW Financial Controlling Interest
for an aggregate purchase price of $73.7 million (not including acquisition
expenses).
On January 5, 1998, the Company consummated the acquisition of the
interests of Fickes and Stone Knightsbridge Interests for total consideration
estimated to be $10.6 million (not including acquisition expenses). Under the
terms of the transaction, Mr. Fickes is to receive consideration in the form of
estimated annual interest payments, ranging from $301,000 to $330,000, on April
15 each year through 2001 and is to be issued 173,160 shares of the Company's
Common Stock on April 15, 2001. The Company issued 173,160 shares to Mr. Stone
in July 1998.
Restructuring and Other Costs. The Company has developed restructuring
plans to realign or consolidate certain operations resulting in restructuring
costs incurred during 1999, the fourth quarter of 1998, the first quarter of
1998 and 1997.
1999 Plan
As a result of the sale of the United Life Assets along with other
non-core operations, the Company announced a restructuring plan in June 1999 to
significantly reduce its Dallas-based staff and vacate certain office space. The
Company incurred restructuring costs aggregating $5.3 million for the year ended
December 31, 1999 associated with such restructuring.
The following reflects the impact of activity for the year ended December
31, 1999 on the restructuring accrual balances under the 1999 Plan (in
thousands):
<TABLE>
<CAPTION>
Paid or
Charged Balance at
1999 Against December 31,
Provision Liability Adjustments 1999
--------- --------- ----------- ------------
<S> <C> <C> <C> <C>
Severance and related benefits .............. $ 3,185 $ (663) $ (148) $ 2,374
Estimated holding costs of vacated facilities 2,122 -- -- 2,122
------- ------- ------- -------
$ 5,307 $ (663) $ (148) $ 4,496
======= ======= ======= =======
</TABLE>
The 1999 plan provided for the termination of 50 employees consisting of
divisional management and staff in Dallas over a nine month period. As of
December 31, 1999, the Company had paid and charged $663,000 against the accrual
for severance and related benefits for 32 terminated employees. Substantially
all of the remaining terminations occurred by March 31, 2000.
28
<PAGE>
The 1999 plan also provided for vacating additional floors of the
Company's Dallas leased offices. The restructuring provision of $2.1 million
represented the estimated net present value of the rent on the office space to
be vacated net of the estimated sublease rental income to be received by the
Company.
The Company anticipates realizing operating expense reductions and cash
savings of approximately $3.9 million and $3.4 million per year, respectively,
after implementing the 1999 restructuring plan.
4th Quarter 1998 Plan
In the fourth quarter of 1998, the Company recorded restructuring costs
aggregating approximately $9.3 million as a result of the decision to
consolidate or merge substantially all of the Company's corporate functions into
the Dallas infrastructure.
The following reflects the impact of activity for the years ended December
31, 1998 and 1999 on the restructuring accrual balances under the 4th Quarter
1998 Plan (in thousands):
<TABLE>
<CAPTION>
1998 Activities 1999 Activities
----------------------- -----------------------
Paid or Paid or
Charged Balance at Charged Balance at
1998 Against December 31, Against December 31,
Provision Liability Adjustments 1998 Liability Adjustments 1999
--------- --------- ----------- ------------ --------- ----------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Severance and related benefits ....... $ 6,259 $(3,985) $ -- $ 2,274 $(1,396) $ 189 $ 1,067
Estimated holding costs of
vacated facilities ................. 2,954 (2,954) -- -- -- -- --
Estimated contract terminations costs 61 (29) -- 32 (40) 8 --
------- ------- ------ ------- ------- ------- -------
$ 9,274 $(6,968) $ -- $ 2,306 $(1,436) $ 197 $ 1,067
======= ======= ====== ======= ======= ======= =======
</TABLE>
The fourth quarter 1998 plan provided for the termination of 43 employees
including substantially all of the executive and administrative employees in the
Company's Bethesda and New York offices, based on the decision to shut down the
Bethesda and New York offices by May 31, 1999. Substantially all of the
severance has been paid with the exception of one former executive officer whose
severance is to be paid monthly through April 2001. The Company had incurred
costs of $1.4 million and $4.0 million which were charged against the accrual
during 1999 and 1998, respectively, for terminated employees.
The fourth quarter 1998 plan recognized abandoned leasehold improvement
costs in connection with the Company's plan to sublease or vacate the New York
offices. The Company expensed $3.0 million principally as a result of abandoning
the New York leased property.
The fourth quarter 1998 restructuring plan is expected to result in
corporate operating expense reductions and cash savings of approximately $4.2
million annually.
1st Quarter 1998 Plan
On January 2, 1998, and January 5, 1998, respectively, the Company
acquired the SW Financial Controlling Interest and the Fickes and Stone
Knightsbridge Interest. The acquisition allowed the Company to complete its
divisional restructuring which began in 1997. As a result, the Company incurred
restructuring costs aggregating approximately $11.8 million for the year ended
December 31, 1998, associated with the divisional restructuring.
29
<PAGE>
The following reflects the impact of activity for the years ended December
31, 1999 and 1998 on the restructuring accrual balances under the 1st Quarter
1998 Plan (in thousands):
<TABLE>
<CAPTION>
1998 Activities 1999 Activities
----------------------- -----------------------
Paid or Paid or
Charged Balance at Charged Balance at
1998 Against December 31, Against December 31,
Provision Liability Adjustments 1998 Liability Adjustments 1999
--------- --------- ----------- ------------ --------- ----------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Severance and related benefits ....... $ 3,831 $(4,417) $1,205 $ 619 $ (297) $ (322) $ --
Estimated holding costs of
vacated facilities ................. 2,205 -- -- 2,205 (350) (41) 1,814
Write-off of certain fixed assets .... 1,131 (831) (300) -- -- -- --
Estimated contract terminations
costs .............................. 4,600 (3,247) (1,353) -- -- -- --
------- ------- ------- ------ ------ ------ ------
$11,767 $(8,495) $ (448) $2,824 $ (647) $ (363) $1,814
======= ======= ======= ====== ====== ====== ======
</TABLE>
Approximately 120 and 39 people, respectively, were estimated to be
terminated, as a result of the decision to transfer all operations of Union
Bankers to Raleigh and transfer operations of United Life from Baton Rouge to
Dallas. In addition, the Company also restructured certain of the operations in
Raleigh. Certain employees in the areas of customer services, information
technology, actuarial, legal, human resources and other policyholder service
areas, totaling 54 people were considered for termination under the Raleigh
portion of the restructuring plan. The Company recognized severance costs
totaling $3.8 million. The Company charged $297,000 and $4.4 million against the
severance accrual during 1999 and 1998, respectively, as the result of
termination payments. In addition, during 1999 and 1998 the Company adjusted the
severance accrual in the amount of $322,000 and $405,000, respectively, due to
the Company paying less severance costs as a result of natural attrition and
other factors such as inter-company transfers of employees. During 1998, the
Company also increased the severance accrual by $1.6 million as a result of the
decision to terminate all 54 of Security Life's Raleigh employees.
The first quarter 1998 restructuring plan provided for vacating certain
Dallas office space. In connection with the plan, the Company recorded estimated
holding costs of vacated facilities of $2.2 million which represented the net
present value of the rent on the office space to be vacated net of the estimated
sublease rent to be received. During 1999, the Company charged $350,000 of rent
expense on vacated office space against the accrual.
The first quarter 1998 plan also recognized impairment of certain
furniture, fixture and data processing equipment totaling $1.1 million which had
been utilized in the office space to be vacated. The Company charged $831,000 of
such assets against the accrual during 1998.
As part of the first quarter 1998 restructuring plan, the Company
terminated an information technology outsourcing agreement. The original
contract termination fee was $4.6 million. As a result of an amendment to the
termination agreement, the Company exited the agreement for a payment of $3.2
million and the remaining accrual was adjusted during 1998.
1997 Plan
The Company has experienced significant changes in the past three years.
As a result of integration of acquired businesses and material changes to the
Company's operating platform, the Company began a strategic business evaluation
in the third quarter of 1996. The review resulted in the Company establishing
three divisional platforms, Career Sales Division, Payroll Sales Division and
Financial Services Division.
As a result, the Company began to realign its existing operating companies
and incurred restructuring costs aggregating approximately $19.1 million during
the year ended December 31, 1997, directly and indirectly associated with the
initial divisional restructuring which had no future economic benefit.
30
<PAGE>
The following reflects the impact of activity for the years ended December
31, 1997 and 1998 on the restructuring accrual balances under the 1997 plan (in
thousands):
<TABLE>
<CAPTION>
1998 Activities 1999 Activities
----------------------- -----------------------
Paid or Paid or
Charged Balance at Charged Balance at
1998 Against December 31, Against December 31,
Provision Liability Adjustments 1998 Liability Adjustments 1999
--------- --------- ----------- ------------ --------- ----------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Severance and related benefits ....... $ 5,355 $ (2,411) $(1,008) $1,936 $ -- $(1,936) $ --
Estimated holding costs of
vacated facilities ................. 6,166 (1,916) -- 4,250 (841) (3,409) --
Write-off of certain fixed assets .... 1,526 (332) (847) 347 -- (347) --
Estimated contract termination
costs ............................. 24 -- -- 24 -- (24) --
Investment in foreign operations ..... 6,000 (5,555) (445) -- -- -- --
------- -------- ------- ------ ------- ------- -------
$19,071 $(10,214) $(2,300) $6,557 $ (841) $(5,716) $ --
======= ======== ======= ====== ======= ======= =======
</TABLE>
The 1997 plan provided for the termination of approximately 269 employees
in the Company's Raleigh offices and certain foreign operations and
substantially all of the employees of the Company's Waco operations, totaling
114. The 1997 plan anticipated a significant consolidation of operations into an
affiliate's Dallas offices over a twelve month period. As of December 31, 1997,
the Company had charged $2.4 million against the accrual for severance and
related benefits. The Company adjusted the remaining severance accrual by $1.0
million during 1997 due to natural attrition thus reducing the level of
severance required coupled with the decision to retain certain employees
indefinitely. As of December 31, 1997, the severance accrual was $1.9 million
which was adjusted during 1998 as a result of the decision not to merge the
Company's Waco operations into Dallas.
The plan also provided for vacating of certain leased facilities and
abandoning certain Company owned real estate. The Company accrued $6.2 million
for holding and abandonment costs associated with these facilities. During 1997,
the Company charged $1.9 million to such accrued lease costs. During 1998, the
Company further charged $841,000 to the accrued costs. As of December 31, 1998,
the remaining accrual was no longer necessary as a result of the decision to
retain the Waco operating platform.
In addition, the 1997 plan recognized the impairment of certain furniture,
fixture and data processing equipment of $1.5 million as a result of the
decision to abandon certain Company owned and leased facilities. During 1998 and
1997, the Company charged off furniture, fixtures and data processing equipment
totaling $-- and $332,000, respectively, and adjusted the original impairment
provision by $347,000 and $847,000, respectively.
Contract termination costs provided in the 1997 plan were adjusted to zero
during 1998 as a result of the ultimate settlement of certain contracts without
penalty.
Restructuring charges in the 1997 plan also included a $6.0 million
provision for the write-off of the Company's investment in certain foreign
operations, principally Argentina. In 1997, the Company disposed of the foreign
operations at a cost of $5.6 million and the balance of $449,000 was adjusted to
zero.
Other Costs
The Company did not incur incremental costs during 1999. The Company
incurred approximately $6.3 million and $4.7 million of pre-tax period costs
("period costs") associated with the corporate restructuring for the years ended
December 31, 1998 and 1997, respectively. Such costs are included in the
Company's Consolidated Statements of Operations and Comprehensive Income (Loss)
as underwriting and other administrative expenses.
On August 30, 1997, the merger agreement between Washington National
Corporation ("Washington National") and the Company terminated. The Company
incurred legal, accounting and financial advisory fees associated with the
merger. In addition, the Company had began to provide certain resources to
Washington National including personnel to perform policy administration and
claims processing function on Washington National's behalf. The aggregate
advisory and administrative costs incurred by the Company during 1997 were $7.6
million.
31
<PAGE>
For the years ended December 31, 1999 and 1998 the Company recorded an
impairment provisions aggregating $58.5 million and $343.0 million,
respectively. The Company recorded the impairment provisions in order to reflect
the difference in the Company's accounting basis in the Businesses Held for Sale
and the fair value of the consideration that the Company would likely receive
for such businesses. The fair value of the consideration likely to be received
has been primarily based upon the terms of definitive sales agreements. The
impairment provision of $58.5 million in 1999 was related to the disposition of
the Career Sales Division. The impairment provision recorded during 1998
aggregating $343.0 million reduced the Company's value of the Career Sales
Division, Professional and the United Life Assets in the amounts of $328.6
million, $3.3 million and $11.1 million, respectively.
The Company evaluated the recoverability of all intangible assets of the
Payroll Sales Division based upon the sales proceeds received from the
disposition of the remaining Payroll Sales Division companies on February 4,
2000. As a result, an impairment provision for certain intangible assets
aggregating $95.5 million was reflected in the Statement of Operations for the
year ended December 31, 1999. All remaining costs in excess of net assets
acquired in the Payroll Sales Division, totaling $19.3 million, were impaired.
In addition, the Company impaired all remaining present value of insurance in
force and a portion of deferred policy acquisition costs totaling $67.6 million
and $49.7 million, respectively, net of deferred taxes of $41.0 million.
YEAR 2000 ISSUES
Many computer and software programs were designed to accommodate only two
digit fields to represent a given year (e.g. "98" represents 1998). It was
highly likely that such systems could not have been able to accurately process
data containing date information for the year 2000 and beyond. The Company is
highly reliant upon computer systems and software as are many of the businesses
with which the Company interacts. The Company's ability to service its
policyholders and agents is dependent upon accurate and timely transaction
processing. Transaction processing in turn is dependent upon the Company's
highly complex interdependent computer hardware, software, telecommunications
and desktop applications. The inability of the Company or any of its integral
business partners to continue processing transactions during 2000 could lead to
a significant business interruption. Such an interruption could have resulted in
a decline in current and long-term profitability and business franchise value.
The Company's overall year 2000 compliance initiatives, included the
following components: (i) assessment of all business critical systems (business
critical systems includes computer and other systems), processes and external
interfaces and dependancies; (ii) remediation or upgrading of business critical
systems; (iii) testing of both modified and updated systems as well as
integrated systems testing; (iv) implementation of modified and updated systems;
and (v) contingency planning. As a part of the process, the Company has written
letters and corresponded with its outside vendors and critical business partners
concerning year 2000 compliance efforts and has followed up periodically.
The Company engaged outside vendors and focused certain employees' full
time efforts to help in the full array of its year 2000 initiative. This
included systems assessment and monitoring advice, actual code remediation,
communication and consultation with critical business partners and additional
data center and testing resources. The Company originally projected to incur
internal and external costs associated with such expertise ranging from $10.6
million to $14.5 million, which were anticipated to be incurred primarily during
1998 and early 1999. The Company actually incurred internal and external costs
of $8.0 million during 1999. The Company estimates it has incurred internal and
external costs aggregating $13.4 million and $1.9 million for the years ended
December 31, 1998 and 1997, respectively.
Since December 31, 1999 the Company has not experienced any significant
disruption in the Company's business, or an increase in the cost of the Company
doing business related to the year 2000 issue.
The Company provided certain representations and warranties to each
respective purchaser of the businesses sold with respect to each entity's
ability to process date-sensitive information for the year 2000 and beyond.
Although the Company believes that it is in compliance with, and is not aware of
any breach of the year 2000 representations and warranties provided to the
respective purchasers, there can be no assurances that the Company is in
compliance with all such representations and warranties. A breach by the Company
of such representations and warranties could result in indemnification
obligations owed by the Company to the purchasers.
32
<PAGE>
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
Parent Company
General. PennCorp ("parent company") is a legal entity, separate and
distinct from its subsidiaries and has no material business operations. The
parent company needs cash for: (i) principal and interest on debt; (ii)
dividends on preferred and common stock; (iii) holding company administrative
expenses; (iv) income taxes and (v) investments in subsidiaries. In September
1998, the Company suspended payment of preferred and common stock dividends. The
primary sources of cash to meet parent company obligations include statutorily
permitted payments from life insurance subsidiaries, including: (i) surplus
debenture interest and principal payments, (ii) dividend payments; and (iii) tax
sharing payments. The parent company may also obtain cash through the sale of
subsidiaries or other assets.
Since the February 7, 2000 bankruptcy petition filing, the Company has
been managing its assets as a "debtor-in-possession." In anticipation of the
filing of the Chapter 11 Case, the Company and the lenders party to the Bank
Credit Facility executed a forbearance agreement ("Forbearance Agreement")
whereby the lenders agreed to forbear from exercising their remedies under the
Bank Credit Facility as a result of the event of default that occurred under the
Bank Credit Facility when the Company commenced the Chapter 11 Case.
In addition, the Company and the lenders entered into a cash collateral
agreement ("Cash Collateral Agreement") which superseded the Bank Credit
Facility. The Cash Collateral Agreement provides a mechanism for the Company to
repay its currently outstanding borrowings and establishes certain covenants
with which the Company must comply until the Company's outstanding bank
borrowings and related interest are paid in full. Certain covenants strictly
define the Company's ability to utilize any and all cash that is maintained in a
collateral account held by the agent lender. As a result, the Company may
utilize cash from the cash collateral account for only predetermined types of
expenses and in specified amounts. The restrictions on cash only impacts
PennCorp as the debtor-in-possession and does not impact any of PennCorp's
subsidiaries. See Note 9 of Notes to Consolidated Financial Statements.
(Remainder of Page Intentionally Left Blank)
33
<PAGE>
The following table shows the cash sources and uses of the parent company
on a projected basis for 2000, assuming the consummation of the Recapitalization
Plan, and on an actual basis for the period January 1, 2000 to February 7, 2000
(prior to the Petition Date) and years ended December 31, 1999, 1998 and 1997:
<TABLE>
<CAPTION>
Period Period
February 8, January 1,
2000 to 2000 to Year ended December 31,
December 31, February 7, ---------------------------------
2000 (1) 2000 1999 1998 1997
------------ ----------- -------- --------- ---------
($ in thousands)
<S> <C> <C> <C> <C> <C>
Cash sources:
Cash from subsidiaries ...................... $ 64,800 $130,127 $349,881 $ 73,521 $ 34,839
Issuance of common stock .................... 47,500 -- -- -- --
Sale of directly owned subsidiaries ......... -- -- 5,989 -- --
Other investment income ..................... 238 44 754 2,865 3,547
Sale of equity securities ................... -- -- -- 30,500 --
Additional borrowings ....................... 90,000 -- -- 203,000 250,000
Sales of/collection on assets held .......... -- -- 11,642 -- --
Other, net .................................. -- 26 215 1,306 3,243
--------- -------- -------- --------- ---------
Total sources .......................... 202,538 130,197 368,481 311,192 291,629
--------- -------- -------- --------- ---------
Cash uses:
Acquisition of businesses ................... -- -- -- 73,858 --
Interest paid on debt ....................... 13,315 3,057 38,014 37,849 20,946
Operating expenses, including restructuring
charges ................................... 12,448 18,584 20,984 36,217 24,362
Purchase of treasury shares ................. -- -- -- -- 28,760
Reduction of notes payable .................. 180,021 100,000 269,000 126,015 100,000
Costs of recapitalization ................... 13,500 -- -- -- --
Capital contributions to subsidiaries ....... -- -- 27,668 7,853 14,889
Costs to dispose of Businesses Held for Sale -- -- 14,991 -- --
Purchase of equity securities ............... -- -- -- 5,000 20,000
Purchase of SW Financial note ............... -- -- -- -- 40,000
Redemption of preferred stock ............... -- -- -- -- 14,705
Dividends on preferred and common stock ..... -- -- -- 16,210 23,460
Other, net .................................. -- -- -- -- 2,142
--------- -------- -------- --------- ---------
Total uses ............................. 219,284 121,641 370,657 303,002 289,264
--------- -------- -------- --------- ---------
Increase (decrease) in cash and cash equivalents (16,746) 8,556 (2,176) 8,190 2,365
Cash and cash equivalents at beginning of period 19,034 10,478 12,654 4,464 2,099
--------- -------- -------- --------- ---------
Cash and cash equivalents at end of period ... $ 2,288 $ 19,034 $ 10,478 $ 12,654 $ 4,464
========= ======== ======== ========= =========
</TABLE>
- --------------
(1) Projected amounts are on pro forma basis which considers the impact of the
Recapitalization Plan as if such plan is consummated on June 15, 2000.
There can be no assurance that the Recapitalization Plan is consummated in
its current form or at all.
34
<PAGE>
Cash Sources
Cash from Subsidiaries. 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, Constitution
(sold July 30, 1999) and Pioneer Security (collectively, the "Surplus Note
Companies"). The surplus debentures issued by PLAIC and Constitution were repaid
in full in connection with the consummation of the sale of the Career Sales
Division. As part of a subsidiary realignment, PLAIC issued a new surplus
debenture to SW Financial in the amount of $150.0 million to acquire the common
stock of Southwestern Life. With respect to Constitution, Pioneer Security and
PLAIC (as to its surplus debenture issued as of July 30, 1999), the surplus
debenture payments are made to non-insurance intermediate holding companies and
paid to the Company in the form of dividends and tax sharing payments. The
amounts outstanding under the surplus debentures totaled $258.3 million and
$453.1 million as of December 31, 1999 and 1998, respectively. The surplus
debentures generally require (subject to availability of statutory capital and
surplus and in some instances, regulatory approval) principal and interest
payments to be made periodically in amounts sufficient to allow PennCorp to meet
its cash requirements.
The Surplus Note Companies rely upon dividends and tax sharing payments
from their respective insurance subsidiaries. Each of the insurance subsidiaries
is in turn subject to regulatory restrictions under the Texas Insurance Laws and
Regulations with respect to the maximum amount of dividends that can be paid to
the Surplus Note Companies within a twelve month period without prior regulatory
approval. Such dividend restrictions are generally the greater of 10% of
statutory capital and surplus or statutory earnings for the prior calendar year.
See Item 1. Business--Regulatory Matters for additional discussions of dividend
restrictions.
For the years ended December 31, 1999, 1998 and 1997, the Company received
surplus debenture interest and principal payments from PLAIC of $223.5 million,
$26.2 million and $16.4 million, respectively, and received dividends and tax
sharing payments from non-insurance intermediate holding companies of $126.4
million, $47.3 million and $ 18.4 million, respectively. Approximately $80.0
million of dividends and tax sharing payments from non-insurance intermediate
holding companies during 1999 were the direct result of proceeds received from
sales of Businesses Held for Sale. The Surplus Note Companies received $25.2
million, $69.5 million and $32.1 million in dividends and tax sharing payments
from their respective insurance subsidiaries.
Sale of Directly Owned Subsidiaries. During the year ended December 31,
1999, the Company sold certain directly owned subsidiaries in connection with
the disposition of the Businesses Held for Sale and received proceeds of $6.0
million.
Other Investment Income. During each of the years in the three year period
ended December 31, 1999, the Company received other investment income from
short-term invested assets.
Sales of Equity Securities. During 1998 the parent company liquidated its
common and preferred stock holdings in ACO Brokerage Holding Corp. ("ACO"), the
parent company of Acordia Inc. Total proceeds received from the sale of the
preferred and common stock aggregated $30.5 million. The Company had acquired
the preferred stock interests in ACO for $20.0 million during 1997 and the
common stock interests in January 1998 for $5.0 million as part of the Company's
and the KB Fund investment in ACO. See Note 18 of Notes to Consolidated
Financial Statements for additional information regarding the Company's
investment in ACO.
Sales of/Collection on Assets Held. During the year ended December 31,
1999, the Company received mortgage loan principal payments and distribution
from a limited partnership totaling $1.4 million. In addition, the Company sold
certain mortgage loans and the limited partnership interest held directly by the
parent company for proceeds aggregating $10.2 million.
Additional Borrowings. During 1998 and 1997 the Company borrowed under
then existing bank credit facilities to primarily fund acquisitions or repay
existing indebtedness. See "Cash Uses" below for the use of proceeds from the
additional borrowings.
Cash Uses
Acquisition of Businesses. During 1998, the Company acquired the
Controlling Interest in SW Financial for $73.7 million in cash and the Fickes
and Stone Knightsbridge Interests for $10.6 million of which $200,000 of the
consideration was paid in cash. To fund such acquisitions the Company utilized
borrowings under its existing credit facility. For additional information on the
acquisition of the Controlling Interest in SW Financial and the Fickes and Stone
Knightsbridge Interests, see Note 3 of Notes to Consolidated Financial
Statements.
Interest Paid on Indebtedness. During the three year period, the Company
utilized varying amounts of leverage in its capital structure. For the years
ended December 31, 1999, 1998 and 1997, the average indebtedness outstanding
aggregated $366.9 million, $452.6 million and $281.6 million, respectively. The
Company's weighted average costs of borrowings increased significantly during
1999 and 1998 as a result of the Company's increased leverage ratio and
projected weakness in future liquidity. For additional information regarding
indebtedness, see Note 9 of Notes to Consolidated Financial Statements and
Management's Discussion and Analysis of Financial Condition--Parent
Company--General.
35
<PAGE>
Operating Expenses Including Restructuring Charges. During 1999, 1998 and
1997 the parent company directly and indirectly, through charges from its
subsidiaries, incurred significant operating and restructuring charges. Total
restructuring charges paid by the parent company during 1999, 1998 and 1997
aggregated $1.8 million, $9.1 million and $11.5 million, respectively. During
1999 and 1998, the parent company also incurred legal, accounting and investment
banking fees associated with asset dispositions aggregating $2.4 million and
$1.5 million, respectively. Operating expenses incurred during 1999 and 1998
also include costs aggregating $1.6 and $1.6 million, respectively, associated
with shareholder litigation and the SEC's investigation into the Company's
historical accounting practices.
Purchase of Treasury Shares. During 1997 the Company utilized proceeds
from its existing credit facility to repurchase approximately 819,000 shares of
Common Stock for $28.8 million in accordance with an agreement with the former
owner of United Life.
Reduction of Notes Payable. During the year ended December 31, 1999, the
Company made repayments under the Bank Credit Facility aggregating $267.0
million upon the consummation of sales of Professional, the United Life Assets,
KIVEX and the Career Sales Division. An additional $2.0 million was repaid as a
result of liquidity at the parent company level above amounts prescribed in the
Bank Credit Facility, as amended.
In conjunction with the Company's 1998 acquisition of the SW Financial
Controlling interest, the Company borrowed under its existing $450 million Bank
Credit Facility to repay indebtedness of SW Financial aggregating $115.0 million
upon acquisition. In addition, during 1998 the Company used existing liquidity
to repay $11.0 million of indebtedness under the company's Bank Credit Facility.
During 1997, the Company utilized proceeds from the Bank Credit Facility to
retire indebtedness aggregating $100.0 million outstanding under a prior bank
credit agreement.
Capital Contributions to Subsidiaries. For the years ended December 31,
1999, 1998 and 1997, the Company made capital contributions to subsidiaries
totaling $27.7 million, $7.9 million and $14.9 million, respectively. During
1999, $3.3 million was contributed to PLAIC to make a subsequent capital
contribution to PLIC and $3.1 million was contributed to a non-life insurance
subsidiary. In addition, $21.3 million was contributed to subsidiaries to meet
certain target capital and surplus requirements as required by the purchase and
sale agreement for the Career Sales Division. The Company utilized funds from
proceeds from the Businesses Held for Sale to fund these contributions. During
1998 and 1997, contributions were primarily made to certain non-life insurance
subsidiaries, principally KIVEX, to fund expansion and for other corporate
purposes.
Purchase of Equity Securities. In conjunction with the acquisition of the
Fickes and Stone Knightsbridge Interests, the Company acquired Fickes' and
Stone's interest in the ACO Brokerage Common Stock for $5.0 million. During
1997, the Company invested $20.0 million in ACO Preferred Stock.
Purchase of SW Financial Note. During 1997, the Company acquired all of
the issued and outstanding convertible subordinated indebtedness of SW Financial
aggregating $40.0 million. Such indebtedness was previously held by the
creditors of ICH Corporation.
Redemption of Preferred Stock. In March 1997 the Company utilized proceeds
available under its then existing credit facility to redeem all of the
outstanding Series B Preferred Stock for $14.7 million.
Dividends of Preferred and Common Stock. During 1998 and 1997 the Company
paid common and preferred stock dividends aggregating $16.2 million and $23.5
million, respectively. The decrease in dividend payments during 1998 was due to
the Company's decision to halt common and preferred stock dividend payments as a
result of impending liquidity concerns.
Cash Sources and Uses for the Period January 1, 2000 to February 7, 2000
As part of series of restructuring transactions approved by the Texas
Department of Insurance, Security Life became a wholly-owned subsidiary of
PLAIC. In addition, PLAIC was permitted to prepay $20.4 million of principal and
interest on its surplus debenture to SW Financial, which then paid these funds
as a dividend to the Company. On February 4, 2000, AA Holdings sold the
companies in the Payroll Sales Division for $103.3 million. The net proceeds to
the parent company after repayment of intercompany borrowings to insurance
company affiliates of PennCorp was $97.0 million. In addition, the Company
received a $12.7 million dividend from AA Holdings. Of the proceeds, $100.0
million were used to repay a portion of the Company's Bank Credit Facility.
36
<PAGE>
For the period from January 1, 2000 to February 7, 2000, the Company paid
$10.0 million in employment contract obligations and $280,000 in transaction
bonuses ($8.3 million had been accrued and expensed prior to December 31, 1999)
under executive employment agreements with certain senior executives of the
Company and its subsidiaries (see Notes 15 and 23 of Notes to Consolidated
Financial Statements.) In addition, the Company paid $2.0 million for insurance
coverage, principally to cover possible indemnification claims arising from a
breach of the representations and warranties contained in each of the subsidiary
and asset sale agreements, $1.9 million in retainers to professional services
firms and $3.5 million for other professional and legal services. Interest
totaling $3.1 million was paid during the period in order to bring the Bank
Credit Facility current.
Cash Sources and Uses for the Period February 8, 2000 to December 31, 2000
The pro forma schedule of cash sources and uses of the parent company for
the period from February 8, 2000 to December 31, 2000, assumes the consummation
of the Recapitalization Plan in June of 2000. As part of this plan, additional
equity of $47.5 million would be contributed and the Company would enter into a
new $95.0 million credit facility of which $90.0 million is anticipated to be
drawn during 2000. Existing senior and subordinated debt with a principal
balance of $180.0 million would be repaid. The parent company would receive
approximately $55.0 million from PLAIC as principal repayment on the existing
surplus debenture. The $55.0 million would be made available to PLAIC from
proceeds received as the result of an extraordinary dividend from Southwestern
Life and Security Life, subject to final approval from the Texas Department of
Insurance. Such approval is contingent in part, upon the consummation of a
reinsurance transaction whereby Southwestern Life and Security Life would
reinsure substantially all of their existing deferred annuity blocks of business
to a non-affiliated reinsurer. Projected cash sources also include $9.8 million
in dividends and principal and interest payments on the surplus debenture.
Closing costs associated with the Recapitalization Plan are estimated to
aggregate $13.5 million.
Management believes the Company will likely have sufficient financial
flexibility and projected liquidity sources to meet all cash requirements until
the maturity of the cash collateral agreement on May 31, 2000. The Company is in
the process of proposing a plan of recapitalization to be filed with the
Delaware Bankruptcy Court which will provide for the repayment of such
indebtedness (see Note 23 of Notes to Consolidated Financial Statements). With
respect to current liquidity projections, there can be no assurances actual
liquidity sources will develop. In the event of a shortfall of actual liquidity
sources, and as a result of the necessity of the Company to establish a new
credit facility, the Company will explore options to generate any necessary
liquidity, such as: (i) the sale of subsidiaries and (ii) obtaining regulatory
approval for extraordinary dividends from its insurance subsidiaries (which is
unlikely at the present time). If the Company is unable to obtain sufficient
liquidity to meet its projected cash requirements, such failure could result in
a default on one or more obligations and the holders thereof would be entitled
to exercise certain remedies, including the acceleration of the maturity of the
entire indebtedness and commencing legal proceedings to collect the
indebtedness. In such event, the Company will examine and consider the range of
available alternatives to the Company at that time.
Subsidiaries, Principally Insurance Operations
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.
Cash Flow from Operating Activities. Cash flow from operating activities,
excluding the parent company, were $54.9 million, $34.2 million and $74.6
million, respectively, for the years ended December 31, 1999, 1998 and 1997. The
increasing trend in cash flow from operating activities for the year ended
December 31, 1999 principally resulted from decreasing costs associated with (i)
year 2000 remediation at all of the insurance subsidiaries, (ii) reduced costs
as a result of strategic business evaluations and associated restructuring of
the Company and (iii) sale of KIVEX, which used cash from operating activities
due to its rapid growth. The decreasing trend in cash flow from operating
activities for the year ended December 31, 1998, is primarily attributable to
the Company assuming 100% of the economic interest of KB Management during 1998.
Prior to the acquisition, the Company maintained a 45% economic interest in KB
Management. At the time of the acquisition, KB Management's operating and
administrative expenses were in excess of current fee income resulting in a cash
strain to the Company. Other factors impacting the decreasing trend in cash flow
from operating activities for 1998 were increasing costs associated with: (i)
Year 2000 remediation at all of the insurance subsidiaries, (ii) the strategic
business evaluations and associated restructuring of the Company and (iii) the
accelerating expansion and transition of KIVEX from a regional to a national
internet service provider.
37
<PAGE>
Cash Flow from Investing Activities. During the years ended December 31,
1999, 1998 and 1997, the Company's subsidiaries sold $603.5 million, $1,019.9
million and $801.1 million of fixed maturity and equity securities, and
purchased $814.2 million, $1,054.7 million and $1,021.5 million of fixed
maturity and equity securities, respectively. Such sales and purchases were
primarily effected in order to meet cash flow demands associated with
policyholder surrenders that in the aggregate increasingly exceeded policyholder
deposits as well as to improve the quality of the investment portfolio or avoid
prepayment risks.
Cash Flow from Financing Activities. Cash used by financing activities,
excluding the parent company, were $492.3 million, $391.4 million and $325.9
million for the years ended December 31, 1999, 1998 and 1997, respectively. The
majority of the cash outflow is attributable to policyholder surrenders
exceeding deposits by $191.7 million in 1999, $354.1 million in 1998 and $275.7
million in 1997. Cash outflows during 1999 also included dividends and surplus
debenture principal aggregating $326.3 million made to the parent company
compared to $44.3 million in 1998 and $14.7 million in 1997. Substantially all
of the increases in dividends and surplus debenture payments during 1999 were
the direct result of proceeds received by PLAIC from the disposition of
Businesses Held for Sale.
RESULTS OF OPERATIONS
For the years ended December 31, 1999, 1998 and 1997, the Company has
prepared the following unaudited selected pro forma financial information for
the Company's remaining operating divisions, the Financial Services Division
(Southwestern Life and Security Life) and the Payroll Sales Division (AA Life
and OLIC) and Businesses Held for Sale (Career Sales Division, Professional, the
United Life Assets and KIVEX). During the three months ended June 30, 1999, the
Company concluded that it would retain, and shut down over time, certain
remaining operations of Marketing One. Consequently, the results of operations
of Marketing One have been reclassified out of "Businesses Held for Sale" to
"Corporate" for all periods presented. The selected pro forma financial
information by operating division is defined as pre-tax income (loss) excluding
the impact of: (i) restructuring costs, (ii) gains or losses on the sale of
investments and (iii) the impact of the Company's decision to dispose of the
Businesses Held for Sale ((i), (ii) and (iii) collectively, "Operating Income
(Loss)"). The Company considers operating income (loss) to reflect a division's
"core earnings (loss)" and to be the most relevant and useful information to
evaluate trends impacting each of the Company's divisions. This information is
used by the Company's principal decision makers to evaluate the performance of
each division as it eliminates the impact of transactions that the Company
considers to be unrelated to the core operating results of the divisions. Other
companies that operate primarily in the life insurance industry may or may not
use similar measures. In addition, the 1997 unaudited selected pro forma
financial information considers the impact of the: (i) acquisition of the SW
Financial Controlling Interest, including the financing thereof, and (ii) the
acquisition of the Fickes and Stone Knightsbridge Interests, including the
financing thereof, as though each had occurred on January 1, 1997.
The Company has prepared such information as it believes that: (i) the
acquisition of the SW Financial Controlling Interest, (ii) the intended
disposition of the Businesses Held for Sale and (iii) the restructuring costs
are material enough to make historical comparative results not meaningful. In
addition, the Company believes that the pro forma financial information will
facilitate the subsequent discussion parallel with how management views and
evaluates the operations of the Company.
The following unaudited selected pro forma financial information has been
prepared for comparative purposes only and does not purport to be indicative of
what would have occurred had the acquisitions been made as of January 1, 1997,
or the results which may occur in the future.
38
<PAGE>
<TABLE>
SELECTED PRO FORMA FINANCIAL INFORMATION
<CAPTION>
Year ended December 31,
-------------------------------------
1999 1998 1997
--------- --------- ---------
($ in thousands)
<S> <C> <C> <C>
Financial Services Division:
Operating income .............................. $ 26,213 $ 19,018 $ 75,590
Net investment gains .......................... (737) 1,503 6,848
Restructuring costs ........................... (5,165) (3,803) --
Eliminate effects of including acquisition of
the SW Financial Controlling Interest and the
Fickes and Stone Knightsbridge Interests as
though each had occurred on January 1, 197 .. -- -- (49,816)
--------- --------- ---------
20,311 16,718 32,622
--------- --------- ---------
Payroll Sales Division:
Operating income (loss) ....................... 16,100 (3,501) 23,960
Net investment gains (losses) ................. (702) (36) 2,654
Impairment of intangibles ..................... (95,522) -- --
--------- --------- ---------
(80,124) (3,537) 26,614
--------- --------- ---------
Businesses Held for Sale:
Operating income (loss) ....................... 15,968 (16,541) 46,807
Net investment gains (losses) ................. 889 9,069 9,827
Restructuring costs ........................... 202 (2,643) --
Net gains from sale of subsidiaries (including
realized losses on foreign currency of
$24,978) ...... ............................. 6,602 -- --
Impairment provision associated with assets of
Businesses Held for Sale .................... (58,486) (342,960) --
Eliminate effects of including acquisition of
the SW Financial Controlling Interest and
the Fickes and Stone Knightsbridge Interests
as though each had occurred on January 1, 1997 -- -- (7,717)
--------- --------- ---------
(34,825) (353,075) 48,917
--------- --------- ---------
Corporate:
Interest and amortization of deferred debt
interest .................................... (40,222) (42,960) (38,653)
Corporate expenses, eliminations and other .... (37,161) (36,875) (25,311)
Net investment gains .......................... 48 3,532 (1)
Restructuring costs ........................... (30) (8,431) (16,771)
Eliminate effects of including acquisition of
the SW Financial Controlling Interest and
the Fickes and Stone Knightsbridge
Interests as though each had occurred on
January 1, 1997 ............................. -- -- 24,126
--------- --------- ---------
(77,365) (84,734) (56,610)
--------- --------- ---------
Income (loss) before income taxes and
extraordinary charge ........................ $(172,003) $(424,628) $ 51,543
========= ========= =========
</TABLE>
39
<PAGE>
BUSINESSES OWNED AT DECEMBER 31, 1999--FINANCIAL SERVICES DIVISION
The Financial Services Division includes the operations of Southwestern
Life and Security Life. Southwestern Life and Security Life market life
insurance and, to a lesser extent annuity products, through independent general
agents who sell directly to individuals primarily in the southwestern and
southeastern United States.
SELECTED PRO FORMA FINANCIAL INFORMATION
Year ended December 31,
------------------------------
1999 1998 1997
--------- --------- ---------
($ in thousands)
Revenues:
Policy revenues............................ $ 133,930 $ 129,241 $ 138,006
Net investment income...................... 161,841 179,433 201,483
Other income............................... 11,395 3,678 1,052
--------- --------- ---------
307,166 312,352 340,541
--------- --------- ---------
Benefits and expenses:
Total policyholder benefits................ 213,407 215,415 195,131
Insurance related expenses................. 28,653 29,591 32,893
Other operating expenses................... 38,893 48,328 36,927
--------- --------- ---------
280,953 293,334 264,951
--------- --------- ---------
Pre-tax operating income.................. $ 26,213 $ 19,018 $ 75,590
========= ========= =========
Policy Revenues. Policy revenues include: (i) premiums received on
traditional life products (ii) mortality and administrative fees earned on
universal life insurance and annuities and (iii) surrender charges on terminated
universal life and annuity products. In accordance with GAAP, premiums on
universal life and annuity products are accounted for as deposits to insurance
liabilities.
Premiums, net of reinsurance, by major product line for the years ended
December 31, 1999, 1998 and 1997 are as follows:
<TABLE>
<CAPTION>
Year ended December 31,
--------------------------------
1999 1998 1997
-------- -------- --------
($ in thousands)
<S> <C> <C> <C>
Life premiums:
Universal life (first year) ............................. $ 9,474 $ 11,146 $ 8,900
Universal life (renewal) ................................ 73,776 97,299 100,788
Yearly renewable term reinsurance on universal life ..... (8,980) (7,505) (6,987)
Traditional life (first year) ........................... 9,578 12,686 5,878
Traditional life (renewal) .............................. 32,969 36,655 37,308
-------- -------- --------
Life premiums collected, net of reinsurance ........... 116,817 150,281 145,887
-------- -------- --------
Annuity premiums ......................................... 8,678 16,189 29,331
-------- -------- --------
Fixed benefit premiums:
Long-term care premiums net of reinsurance ............ 254 456 --
-------- -------- --------
Premiums, net of reinsurance ............................. 125,749 166,926 175,218
Less premiums on universal life and annuities which are
recorded as additions to insurance liabilities ......... (91,928) (124,634) (139,019)
-------- -------- --------
Premiums on products with mortality or morbidity risk .... 33,821 42,292 36,199
Fees and surrender charges on interest sensitive products 100,109 86,949 101,807
-------- -------- --------
Policy revenues.............................. ......... $133,930 $129,241 $138,006
======== ======== ========
</TABLE>
40
<PAGE>
Policy revenues increased 3.6% during 1999 to $133.9 million compared with
1998. Policy revenues in 1998 decreased 6.4% to $129.2 million compared with
1997. Life premiums collected, net of reinsurance, were $116.8 million in 1999
compared with $150.3 million in 1998 and $145.9 million in 1997. First year
universal life premiums decreased 15.0% in 1999 to $9.5 million and first year
traditional life decreased 24.5% to $9.6 million. The decline in 1999 is
attributable to lower sales at Security Life. New sales at Security Life
declined significantly in 1999 reflecting the impact of ratings downgrades and
management changes in Security Life's marketing management. The Company
announced in the third quarter of 1999 it was discontinuing new life sales at
Security Life in order to reduce costs and concentrate its marketing efforts at
Southwestern Life. Partially offsetting the decline in first year premiums for
Security Life was an increase in first year universal life premium at
Southwestern Life which increased 21.1% to $7.3 million during 1999 compared
with 1998. Most of the increase in production during 1998 compared with 1997 was
attributable to Southwestern Life. The A.M. Best downgrades, which occurred
during the third quarter of 1998 continue to have a negative impact on new
business production levels.
Universal life and traditional life renewal premiums declined $27.2
million and $4.1 million or 20.3% and 3.0% for the years ended December 31, 1999
and 1998, respectively. This reflects the impact of certain management actions
instituted by Security Life and ratings downgrades. On January 1, 1999 Security
Life instituted an exchange or refund program for holders of certain types of
interest sensitive insurance contracts. This program resulted in a refund of
premiums of $23.0 million during 1999 (see below). Universal life and
traditional life renewal premiums declined $3.5 million and $653,000 for 3.5%
and 1.8% respectively for the year ended December 31, 1998 compared to the year
ended December 31, 1997. This reflects ratings downgrades and the impact of
certain management actions instituted by Southwestern Life in the third quarter
of 1997. Southwestern Life is implementing additional management actions during
2000 which may result in reduced renewal premiums in 2000 and subsequent years.
See "Total Policyholder Benefits" included herein.
Annuity premiums have declined 46.4% to $8.7 million in 1999 compared to
1998 after declining $13.1 million or 44.8% in 1998 compared to 1997. The sales
decline is attributable to a shift in the overall annuity market to sales of
variable products (which the Financial Services Division does not offer) from
fixed products due to historically low interest rates and consumer interest in
equities. Annuity sales are also typically more sensitive to Company financial
strength ratings than other insurance products. Annuity sales are likely to
continue to decline unless market conditions for fixed annuities become more
favorable and ratings of Southwestern Life improve.
In January 1999, Security Life initiated management action in the form of
an exchange program for certain policyholders of Security Life. The program was
offered to all policyholders who had certain policy forms in force as of January
1, 1998. The program allowed the policyholder the following options in exchange
for terminating his or her policy and executing a release: (i) refund of 115% of
all premiums paid for the policy prior to January 1, 1999 and 100% of premiums
paid thereafter; (ii) exchange the policy, without proof of insurability, for
the same face amount in a universal life policy, or a new term universal life
policy. The policyholder also had the choice of not accepting the exchange
program and keeping the current policy in force. As of December 31, 1999, 66% of
such policyholders completed the exchange. In November 1999, a lawsuit was filed
against Security Life regarding the exchange program and products. (See Item 3.
Legal Proceedings.)
Net Investment Income. Net investment income decreased 9.8% to $161.8
million in 1999 due to a decrease in invested assets and reduced yields on
investments. Average invested assets declined approximately $177.6 million in
1999 compared with 1998 and decreased $110.3 million from 1998 compared to 1997.
Most of this decrease resulted from the need to liquidate invested assets to
provide cash to fund surrenders of annuities and interest sensitive life
contracts, which totaled $265.1 million and $179.0 million in 1999 and 1998.
Most of the surrendered policies had reached the end of their surrender fee
period. A continued decline in the invested asset base and related investment
income is anticipated as surrenders are expected to remain high over the next
few years as more policies in force reach the end of the surrender fee periods.
The decrease in invested assets due to surrenders was partially offset by
premiums on new and existing life policies and investment income collected, less
commissions and operating expenses. Weighted average yields on invested assets
have decreased to 6.8% in 1999 compared to 7.1% in 1998 and 7.4% in 1997. The
decline reflects a decrease in higher yielding but less liquid asset classes
such as mortgages, real estate and collateral loans. Also impacting investments
yields were lower new money rates available to the Company to invest as a result
of extensive maturities and calls of higher yielding investments and slightly
higher investment expenses as a result of the decision in 1997 to utilize
outside investment managers.
Other Income. Other income increased $7.7 million in 1999 compared to 1998
and increased $2.6 million in 1998 compared to 1997. Included in 1999 was income
of $5.7 million from the distribution of assets of a joint venture investment
resulting from the sale of most of the operations and assets of the joint
venture. During 1998, the Company received approximately $1.0 million resulting
from a settlement associated with securities owned in the past. Most of the
remaining differences between the years reflect changes in consideration
received on supplemental contracts. Supplemental contract revenue is derived
from annuity contracts which have reached the annuitization period.
Consideration from supplemental contracts recognized as other income is offset
by policyholder benefits, resulting in no net effect on the Company's results of
operations.
41
<PAGE>
Total Policyholder Benefits. The following table shows the components of
total policyholder benefits for the year ended December 31, 1999, 1998 and 1997:
<TABLE>
<CAPTION>
Year ended December 31,
----------------------------------
1999 1998 1997
--------- --------- --------
($ in thousands)
<S> <C> <C> <C>
Death benefits .............................. $ 80,658 $ 87,578 $ 77,980
Other insurance policy benefits and change in
future policy benefits ..................... 132,749 127,837 117,151
--------- --------- --------
Total policyholder benefits ................. $ 213,407 $ 215,415 $195,131
========= ========= ========
</TABLE>
During 1999, policyholder benefits decreased 0.9% to $213.4 million
compared with 1998. Death benefits decreased $6.9 million or 7.9% compared with
1998. Death benefits may vary significantly from period to period. Change in
future policy benefits and other benefits increased 3.8% and 9.1% to $132.7
million and $127.8 million in 1999 and 1998, respectively. During 1999, future
policy benefits were increased approximately $6.2 million as a result of the
re-estimation of certain deficiency reserves on a block of Southwestern Life
interest sensitive business. Certain assumptions related to the expected future
experience for lapses, premiums, mortality and interest were adjusted to reflect
recent experience. In addition, management began implementing a plan that
included contractually allowable increases to expense charges. During 1997,
future policy benefits were reduced approximately $23.9 million related to the
adjustment of certain deficiency reserves on a block of Southwestern Life
interest sensitive business. During 1997, management began implementing a plan
intended to reduce the anticipated losses associated with these policies. Such
actions included contractually allowable reductions in credited rates and
increases in cost of insurance and expense charges.
The Company is continually evaluating actuarial assumptions associated
with interest sensitive life insurance contracts in which the determination of
policy reserves is highly sensitive to assumptions such as withdrawal rates,
investment earnings rates, mortality rates, and premium persistency. Currently
reflected in the Company's financial statements are policy reserves and account
values associated with such contracts, which aggregated approximately $527.1
million and $525.4 million as of December 31, 1999 and 1998, respectively. If
developing trends were to continue, principally the less than expected level of
the lapses currently associated with such interest sensitive blocks of business,
the Company would be required to record additional reserves or reduce intangible
assets, which could have a material impact on the Company's financial position
and results of operations. A decrease of 1% in the assumed lapse rate would
increase policy reserves associated with such contracts by $9.0 million.
Management is also assessing the potential impact of future management actions,
which might mitigate the financial impact of these trends. Types of management
actions would likely include, but are not limited to, the redetermination of
non-guaranteed charges and/or benefits under the contracts, asset segmentation,
and reinsurance. There are risks associated with management action including
potential sales disruption and the threat of litigation.
Insurance Related Expenses. During 1999, insurance related expenses
(including non-deferrable commissions, amortization of deferred policy
acquisition costs and amortization of present value of insurance in force)
decreased $938,000 to $28.7 million or 3.2% from $29.6 million during 1998.
Insurance related expenses decreased $3.3 million or 10.0% in 1998 compared to
1997. The small decrease in 1999 reflects reduced insurance expenses for
Security Life as a result of declining production of new business for several
years and a diminished block of in force business as a result of surrenders. The
decrease in 1998 compared to 1997 also reflects this trend. Also during 1998
amortization of deferred policy acquisition costs increased approximately $3.2
million as a result of writing off certain deferred costs for Security Life
which were unrecoverable from future profits as a result of shifts in the mix of
products sold during the year. This was offset by a $3.2 million decrease in the
amortization of present value of future profits at Southwestern Life in 1998
resulting from unlocking assumptions of future interest rates, lapses, expenses
and mortality which affect the estimated future profitability of certain
interest sensitive life insurance products.
42
<PAGE>
Other Operating Expenses. Other operating expenses (including general
operating, overhead and policy maintenance) decreased $9.4 million in 1999 from
$48.3 million in 1998, and increased $11.4 million in 1998 from $36.9 million in
1997. The decrease in 1999 is attributable to ongoing reductions in costs
associated with the restructuring of the Dallas operations, a reduction in
non-deferrable expenses associated with year 2000 remediation efforts and
systems conversions for Security Life. The decrease was also impacted by a
charge of $2.3 million during 1998 for uncollectible agents' debit balances at
Security Life. In addition, the liabilities held at Southwestern Life and
Security Life to reflect expected assessments to life and health guaranty
associations of states in which it is licensed to do business was reduced by
approximately $3.4 million as a result of completing these companies' evaluation
of third party guaranty fund assessment data on a corporate-wide basis,
including the impact of the disposition of the Businesses Held for Sale. The
1998 increase is attributable to several factors including: (i) Security Life
established an allowance for uncollectible agents' debit balances aggregating
approximately $2.3 million, (ii) approximately $4.9 million of remediation costs
associated with Year 2000 systems conversions and upgrades and (iii) additional
non-deferrable expenses such as consulting fees, appraisal costs and other costs
associated with the divisional realignment which are not considered
restructuring costs.
BUSINESSES OWNED AT DECEMBER 31, 1999--PAYROLL SALES DIVISION
The Payroll Sales Division includes the operations of AA Life and OLIC. AA
Life markets and underwrites customized life insurance and accumulation products
to U.S. military personnel and federal employees through a general agency force.
OLIC provides individual fixed benefit and life products utilizing a network of
independent agents primarily in the southeastern United States through
employer-sponsored payroll deduction programs.
SELECTED PRO FORMA FINANCIAL INFORMATION
Year ended December 31,
-----------------------------
1999 1998 1997
------- -------- --------
($ in thousands)
Revenues:
Policy revenues .......................... $ 92,029 $ 89,990 $ 89,698
Net investment income .................... 36,771 38,252 38,161
Other income (loss) ...................... 2,085 (1,691) 4,454
-------- -------- --------
130,885 126,551 132,313
-------- -------- --------
Benefits and expenses:
Total policyholder benefits .............. 62,617 64,708 64,622
Insurance related expenses ............... 35,244 42,135 29,377
Other operating expenses ................. 16,924 23,209 14,354
-------- -------- --------
114,785 130,052 108,353
-------- -------- --------
Pre-tax operating income (loss) ......... $ 16,100 $ 23,960 $ 23,960
======== ======== ========
Policy Revenues. Premiums received, net of reinsurance, by major product
line for the years ended December 31, 1999, 1998 and 1997 are as follows:
<TABLE>
<CAPTION>
Year ended December 31,
------------------------------
1999 1998 1997
-------- -------- --------
($ in thousands)
<S> <C> <C> <C>
Life premiums:
Universal life (first year) .......................... $ 803 $ 1,327 $ 5,248
Universal life (renewal) ............................. 25,914 29,573 30,808
Traditional life (first year) ........................ 15,878 17,718 16,139
Traditional life (renewal) ........................... 37,888 34,370 30,138
-------- -------- --------
Life premiums, net of reinsurance .................. 80,483 82,988 82,333
-------- -------- --------
Annuity premiums ...................................... 1,178 1,590 4,021
-------- -------- --------
Fixed benefit premiums:
Accident and Health (first year) ..................... 2,470 2,361 3,583
Accident and Health (renewal) ........................ 10,295 10,356 9,720
-------- -------- --------
Fixed benefit premiums, net of reinsurance ......... 12,765 12,717 13,303
-------- -------- --------
Premiums, net of reinsurance .......................... 94,426 97,295 99,657
Less premiums on universal life and annuities which are
recorded as additions to insurance liabilities ....... (27,895) (32,490) (45,084)
-------- -------- --------
Premiums on products with mortality or morbidity risk . 66,531 64,805 54,573
Fees and surrender charges on interest sensitive
products ............................................. 25,498 25,185 35,125
-------- -------- --------
Policy revenues .................................... $ 92,029 $ 89,990 $ 89,698
======== ======== ========
</TABLE>
43
<PAGE>
Total policy revenues increased 2.3% to $92.0 million in 1999 compared to
1998. Most of the increase was attributable to AA Life's increasing new business
sales during 1998 which resulted in higher traditional life renewal premiums
during 1999. Total policy revenues were consistent between 1998 and 1997. Policy
revenues increased $4.3 million for AA Life in 1998 but were offset by a
decrease of $4.1 million for OLIC. OLIC's decline was anticipated as a result of
the Company's decision to cease marketing products through any "non-payroll"
production sources during 1997.
Net Investment Income. Net investment income decreased 3.9% in 1999 from
1998 to $36.8 million and increased 0.2% in 1998 from 1997 to $38.3 million. The
decrease in net investment income is primarily a result of a decrease in
weighted average yields on invested assets which decreased to 7.0% in 1999 from
7.2% in 1998 and a decrease in average invested assets of $1.5 million in 1999.
The increase in net investment income in 1998 was primarily the result of an
increase in the average invested assets which increased approximately $14.9
million in 1998 compared to 1997. The increases in invested assets is primarily
attributed to modest increases in business in force at AA Life.
Other Income. Other income was $2.1 million in 1999 compared to a loss of
$1.7 million in 1998. Other income in 1998 decreased $6.1 million from 1997 and
resulted in a loss of $1.7 million in 1998 compared to income of $4.5 million in
1997. Supplemental contracts represent most of the other income in 1999 which
can fluctuate significantly from period to period but have little impact on
results of operations as proceeds are offset by change in reserves. Included in
other income in 1998 is a loss on the sale of OLIC's Guam book of business
totaling $2.6 million. In 1997, OLIC recorded a gain of $4.4 million on the sale
of its Panamanian business.
Total Policyholder Benefits. The following table shows the components of
total policyholder benefits for the year ended December 31, 1999, 1998 and 1997:
Year ended December 31,
------------------------------
1999 1998 1997
--------- --------- ---------
($ in thousands)
Death benefits............................. $ 22,137 $ 23,435 $ 23,282
Fixed benefit claims incurred.............. 8,477 7,929 10,114
Other insurance policy benefits and change
in future policy benefits................. 32,003 33,344 31,226
--------- --------- ---------
Total policyholder benefits................ $ 62,617 $ 64,708 $ 64,622
========= ========= =========
Policyholder benefits decreased $2.1 million or 3.2% during 1999 compared
with 1998. Death benefits decreased $1.3 million during 1999. Death benefits may
vary significantly from period to period. Other insurance policy benefits and
change in future policy benefits decreased $1.3 million during 1999 reflecting
decreases in life and fixed benefit health reserves at OLIC as a result of
reduced claims activity and a reduced inventory of open claims. Policyholder
benefits totaled $64.7 million in 1998, which was little changed compared to
1997.
Insurance Related Expenses. Insurance related expenses (including
non-deferrable commissions, amortization of deferred policy acquisition costs
and amortization of present value of insurance in force) decreased $6.9 million
in 1999 compared to 1998 and increased $12.8 million in 1998 compared to 1997.
The decrease in 1999 results principally from a decline in amortization of
deferred policy acquisition costs at OLIC of $10.2 million. During 1998, OLIC
accelerated amortization of deferred acquisition costs by $8.6 million primarily
as a result of refinements in persistency assumptions and unlocking of the
estimates of future profits. In addition, there was a small increase in 1999 in
the amortization of present value of insurance in force at OLIC. This was
partially offset by amortization of deferred policy acquisition costs at AA Life
which increased $2.4 million in 1999 when compared with 1998 primarily
reflecting the growing block of policies in force as a result of new business
sales subsequent to the Company's acquisition of AA Life. Amortization of
present value of insurance in force increased $280,000 in 1999. The increase in
1998 compared to 1997 primarily reflects the $8.6 million of accelerated
amortization of deferred policy acquisition costs at OLIC. In addition,
amortization of deferred policy acquisition costs at AA Life increased $2.7
million in 1998 compared to 1997 primarily reflecting the growing block of in
force policies sold since the Company's acquisition of AA Life.
Other Operating Expenses. Other operating expenses (including general
operating, overhead and policy maintenance) decreased $6.3 million during 1999
from 1998 and increased $8.9 million during 1998 from 1997. The decrease in 1999
operating expenses primarily reflects the consolidation of OLIC's operations
into Waco which occurred in the fourth quarter of 1998. The increase in 1998 is
attributable to several factors, including: (i) approximately $3.6 million of
remediation costs associated with Year 2000 systems conversions and upgrades,
(ii) approximately $2.0 million of acquisition costs at OLIC which were expensed
in 1998 as unrecoverable from future profits and (iii) additional non-deferrable
expenses such as consulting fees, appraisals and other costs associated with
divisional realignment which are not considered restructuring costs.
44
<PAGE>
BUSINESSES HELD FOR SALE
Businesses Held for Sale include the operations of the Career Sales
Division (sold July 30, 1999), KIVEX (sold June 30, 1999), Professional (sold
March 31, 1999) and the United Life Assets (sold April 30, 1999). As a result,
all of the Businesses Held for Sale were disposed of by July 30, 1999. The
Career Sales Division, which included the operations of Penn Life, marketed and
underwrote fixed benefit accident and sickness products and, to a lesser extent,
life products through a sales force exclusive to the Company throughout the
United States and Canada. With the January 2, 1998, consummation of the
acquisition of the SW Financial Controlling Interest, the Company integrated
Union Bankers, Marquette and Constitution with the Career Sales Division. KIVEX
was an internet service provider. Professional provided individual fixed benefit
and life products utilizing a network of independent agents primarily in the
southeastern United States through employer-sponsored payroll deduction
programs. United Life principally markets fixed and variable annuities through
financial institutions and independent general agents, primarily in the southern
and western United States.
SELECTED PRO FORMA FINANCIAL INFORMATION
Year ended December 31,
------------------------------
1999 1998 1997
--------- --------- ---------
($ in thousands)
Revenues:
Policy revenues............................ $ 112,915 $ 239,927 $ 263,680
Net investment income...................... 54,568 144,072 154,087
Other income............................... 13,015 20,984 20,138
--------- --------- ---------
180,498 404,983 437,905
--------- --------- ---------
Benefits and expenses:
Total policyholder benefits................ 101,565 261,639 230,818
Insurance related expenses................. 24,224 86,717 93,359
Other operating expenses................... 38,741 73,168 66,921
--------- --------- ---------
164,530 421,524 391,098
--------- --------- ---------
Pre-tax operating income (loss)........... $ 15,968 $ (16,541) $ 46,807
========= ========= =========
Policy Revenues. Policy revenues declined 52.9% or $127.0 million in 1999
compared to 1998 and 9.0% or $23.8 million to $239.9 million in 1998 compared to
1997. The decline in 1999 is primarily attributable to the sale of Professional,
the United Life Assets and the Career Sales Division on March 31, 1999, April
1999 and July 30, 1999, respectively. The decline in 1998 of $21.4 million is
primarily attributable to Union Bankers which discontinued sales of major
medical health products and its life insurance products and increased its
utilization of reinsurance. The remainder of the decrease is attributable to
Penn Life which experienced decreases in policy revenues of $3.8 million (2.6%)
in 1998 compared to 1997 principally as a result of lower first year sales.
Net Investment Income. Net investment income decreased $89.5 million
(62.1%) in 1999 compared to 1998 and decreased $10.0 million (6.5%) in 1998
compared to 1997. The decline in 1999 is primarily attributable to the sale of
Professional, the United Life Assets and the Career Sales Division on March 31,
1999, April 1999 and July 30, 1999, respectively. The decrease in 1998 is
primarily attributable to United Life, where net investment income decreased
$11.4 million in 1998 compared to 1997. United Life has experienced high
surrenders of fixed annuities in 1998 and 1997 reflecting low reinvestment rates
available as annuities reached the end of their surrender fee period. Surrenders
at United Life totaled $253.2 million in 1998 and $255.6 million in 1997. Such
surrenders resulted in a liquidation of approximately $168.9 million and $104.0
million of invested assets during 1998 and 1997, respectively, which caused the
declines in investment income. Partially offsetting the decline at United Life
are small increases for other companies, the largest of which related to
investment income earned by Marquette during 1998 from an assumed reinsurance
contract. This contract was terminated as of September 30, 1998.
Other Income. Other income decreased $8.0 million (38.0%) in 1999 compared
to 1998 and increased $846,000 (4.2%) to $21.0 million in 1998 compared to 1997.
The decrease in 1999 from 1998 is attributable to the sale of KIVEX on June 30,
1999. The increase in other income in 1998 compared to 1997 is attributable to
increases in revenue from KIVEX and increased fee income for United Life. These
increases in 1998 are partially offset by a decline in the amortization of Union
Bankers' deferred gain associated with a third party Medicare reinsurance
contract. The decrease in amortization is attributable to a decline in the
underlying premium in force subject to the reinsurance arrangement, over time,
which results in lower amortization of the gain.
45
<PAGE>
Total Policyholder Benefits. Policyholder benefits decreased $160.1
million (61.2%) in 1999 compared to 1998 and increased $30.8 million (13.4%) in
1998 compared to 1997. The decline in 1999 is primarily attributable to the sale
of Professional, the United Life Assets and the Career Sales Division on March
31, 1999, April 1999 and July 30, 1999, respectively. The policyholder benefits
of Penn life increased $43.0 million in 1998 compared to 1997. The increase was
primarily the result of specific increases in reserve estimates associated with
long term care products and certain claims reserves held by Penn Life. Policy
reserves and claims reserves increases associated with the changes in estimates
aggregated approximately $32.6 million.
The Company had been closely monitoring the development of its claim
reserve experience associated with the Career Sales Division. The historical
method of establishing claims reserves principally utilized claims lag factors.
Based on results of independent calculations of the claim lag factors, performed
annually, this methodology indicated a deterioration in the adequacy of claim
reserves associated with Penn Life's disability income products underwritten
prior to PennCorp's ownership of Penn Life. Disability claim adequacy analysis
included statutory claim information, independent third-party review of claim
lag method and factors and other claim tests. Previous results indicated no
reason to consider a new methodology as results appeared consistent between
periods and claim reserves appeared adequate. Once results of such analysis
began to vary outside an acceptable tolerance, the Company reviewed its methods
to determine the reasons for the variances.
The lag factor method (an actuarial method to estimate aggregate claims
reserves which utilize the ratio of actual claims paid to what is ultimately
paid as a function of time since the date incurred based upon historical
experience) is one method which utilized Penn Life's experience considering its
products and market. The Company believes that available industry data for
establishing claim reserves was not appropriate for Penn Life's products and
market. The utilization of a case reserve method (which estimates aggregate
claims reserves based on the total estimates of all cases outstanding) for Penn
Life required experience, in addition to that utilized by the lag factor method,
to create case reserves based on Penn Life's experience. This experience was not
sufficient until 1998. With system upgrades, Penn Life was able to obtain better
benefit data distinguishing disability benefits from other benefits which may be
payable under the same policy form. With the systems upgrades and more robust
experience the Company was able to consider a more refined claims methodology
such as seriatim case reserves (which estimates aggregate claims reserves based
upon the sum of estimates for each individual unsettled case). During 1998, Penn
Life implemented a method which substituted case reserves for most disability
claims. The new method utilizes more detailed information by policy and by line
of business resulting in a more refined estimate. As a result, the accident and
health claim reserve for Penn Life increased by $25.7 million during 1998. The
effect of the change in methodology is inseparable from the effect of the change
in accounting estimate and is accordingly reflected in operations for the year
ended December 31, 1998. See Notes 2 and 8 of Notes to Consolidated Financial
Statements. In determining the amount of the necessary increase in policy
reserve estimates associated with its long term care products, Penn Life
allocated approximately $11.2 million of previously identified redundant policy
reserves to long term care reserves, and additionally increased policy reserves
by approximately $7.6 million. This was partially offset by decreases of $16.9
million in Union Bankers policyholder benefits, reflecting less business in
force as a result of the decision to cease sales of major medical and life
business, the cession of the remaining 20% of the Medicare business and the
runoff of existing business.
Insurance Related Expenses. Insurance related expenses (including
commissions, amortization of deferred policy acquisition costs and amortization
of present value of insurance in force) decreased $62.5 million to $24.2 million
in 1999 compared to 1998 and decreased $6.6 million to $86.7 million in 1998
compared to 1997. The decline in 1999 is primarily attributable to the sale of
Professional, the United Life Assets and the Career Sales Division on March 31,
1999, April 1999 and July 30, 1999, respectively. Amortization of present value
of insurance in force decreased $11.6 million in 1998 principally as a result of
the Company recording an impairment provision associated with assets of
Businesses Held for Sale resulting in the elimination of substantially all
insurance assets subject to amortization. Specifically, Penn Life and Union
Bankers wrote off $98.1 million of present value of insurance in force in 1998
which reduced amortization. This was partially offset by an increase in
amortization of deferred policy acquisition costs of $5.3 million, which
included (i) an increase at Professional of $1.8 million in 1998 compared to
1997 as a result of higher than expected lapses on fixed benefit products, (ii)
an increase of $1.7 million for United Life as a result of unlocking future
assumptions regarding the profitability of certain annuity products and (iii) an
increase at Union Bankers of $1.9 million as a result of higher lapses.
Non-deferrable commissions decreased approximately $1.0 million at Union Bankers
principally due to the decision to stop writing new major medical and life
business.
46
<PAGE>
Other Operating Expenses. Other operating expenses (including general
operating, overhead and policy maintenance) decreased $34.4 million (47.1%) in
1999 compared to 1998 and increased $6.2 million (9.3%) in 1998 compared to
1997. The decline in 1999 is primarily attributable to the sale of Professional,
the United Life Assets and the Career Sales Division on March 31, 1999, April
1999 and July 30, 1999, respectively. In 1998, KIVEX's operating expenses
increased $7.4 million reflecting costs associated with its expansion into new
cities. In addition, the companies included in Businesses Held for Sale
experienced increased costs as a result of additional non-deferrable expenses
such as consulting, overhead and other costs associated with the divisional
realignment, which are not considered restructuring costs. Offsetting the
increases in operating expenses is reduced amortization of costs in excess of
net assets acquired associated with the assets of the Businesses Held for Sale.
During 1998, a total of $114.5 million of costs in excess of net assets acquired
were written off as part of the impairment provision, which decreased
amortization by approximately $2.8 million in 1998 compared to 1997.
GENERAL CORPORATE
Interest and Amortization of Deferred Debt Issuance Costs. Interest and
amortization of deferred debt issuance costs decreased $2.7 million in 1999
compared to 1998 and increased $4.3 million in 1998 compared to 1997. The
decrease in 1999 compared to 1998 is principally a result of principal
repayments under the bank credit facility. The Company repaid the outstanding
bank credit facility aggregating $267.0 million upon consummation of the sales
of Professional ($40.0 million), the United Life Assets ($127.0 million), KIVEX
($22.0 million) and the Career Sales Division ($78.0 million). In addition, the
Company repaid $2.0 million on September 23, 1999 as a result of liquidity at
the parent company above amounts prescribed in the bank credit facility, as
amended. The decrease during 1999 of the weighted average amount of principal
outstanding was partially offset by the higher borrowing costs, additional costs
associated with credit facility fees and costs incurred to amend the credit
agreement as a direct result of the Company's financial position. In addition,
during 1999, the Company accelerated amortization of certain deferred loan costs
in the amount of $2.1 million in accordance with Emerging Issue Task Force
("EITF") Issue No. 98-14, "Debtor's Accounting for Changes in Line-of-Credit or
Revolving-Debt-Arrangements," as a result of the amendment to the bank credit
facility. EITF Issue No. 98-14 requires the unamortized deferred loan costs to
be amortized in proportion to the impact of periodic changes in a credit
facility as compared with its original terms. The increase in 1998 compared to
1997 is the result of higher weighted average borrowing costs and additional
costs associated with credit facility fees and costs incurred to amend the
credit agreement.
Corporate Expenses. Corporate expenses, eliminations and other costs were
$37.2 million, $36.9 million, and $25.3 million for the years ended December 31,
1999, 1998 and 1997, respectively. The increase in 1999 compared to 1998,
despite the cost savings realized by the decision to close the Company's New
York and Bethesda offices and eliminate personnel located in such offices, is
principally attributable to additional amortization of costs in excess of net
assets acquired of approximately $7.6 million in 1999 associated with KB
Management. The accelerated amortization reflects the Board of Directors'
decision to terminate KB Fund, for which KB Management and KB Investment act as
administrator and general partner, respectively. The Company also incurred (i)
additional costs associated with efforts to develop recapitalization and
restructuring alternatives aggregating $2.2 million; (ii) additional consulting
and legal fees of $1.8 million associated with the negotiation and
implementation of, and compliance with, the amended Bank Credit Facility,
pending class action securityholder litigation and the SEC investigation; (iii)
additional deferred compensation of $3.2 million associated with the two year
employment agreements of the Company's senior executives which were entered into
in May 1998; and (iv) provisions of $2.3 million to settle shareholder and other
litigation.
The increase in 1998 compared to 1997 is directly attributable to two
factors as follows: (i) the economics of KB Management, and (ii) strategic
business evaluation and associated restructuring of the Company. During the
years ended December 31, 1997, the Company maintained a 45% economic interest in
KB Management. As of January 2, 1998, the Company purchased the remaining
interest in KB Management (see Note 3 of Notes to Consolidated Financial
Statements). From the formation of KB Management in 1995, KB Management provided
certain management and acquisition services to the Company. From its formation
through the year ended December 31, 1996, the transaction and management fees
derived by KB Management were sufficient to offset the majority of the
administrative costs which in turn minimized the costs associated with the
Company's 45% economic interest in KB Management. During 1997, KB Management
operating and administrative expenses grew disproportionately to the ability of
KB Management to engage and consummate acquisitions and other business
transactions which would generate fee income and the Company recognized a net
loss related to its 45% economic interest. With acquisition of the remaining
interest in KB Management on January 2, 1998, the Company recognized 100% of the
economic net loss derived by KB Management for the year ended December 31, 1998.
The strategic business evaluation and associated restructuring of the
Company that began in the early part of 1997 (see Note 21 of Notes to
Consolidated Financial Statements) was primarily funded by the Company on behalf
of the subsidiaries. As a result, a significant portion of the associated period
costs were funded by the Company. Period costs recognized by the Company
increased to $5.7 million for the year ended December 31, 1998, from $1.8
million for the year ended December 31, 1997. Included in expenses for the year
ended December 31, 1998 were $6.8 million associated with severance and other
employment agreements. In addition, the Company paid or expensed approximately
$3.0 million associated with the shut down of a small marketing entity in
anticipation of the sale of Professional.
47
<PAGE>
In addition, during the year ended December 31, 1997, the Company incurred
$7.6 million of one time pre-tax transaction costs associated with the
termination of the Washington National merger agreement.
Income Taxes. For the years ended December 31, 1999 and 1998, the Company
incurred income tax expense (benefit) of $28.7 million and ($3.4 million), on a
pretax loss of $172.0 million and $424.6 million, respectively. The unusual
effective tax rates for 1999 and 1998 are substantially due to the
non-deductibility of the reduction in carrying value of the assets associated
with the sale of the Payroll Sales Division and Businesses Held for Sale and an
increase in the tax valuation allowance. The valuation allowance associated with
tax assets is continually monitored by the Company in light of the dramatic
changes in the operating structure and financial results of the Company. As a
result of such analysis the Company increased the valuation allowances by $38.9
million and $23.5 million during 1999 and 1998, respectively. In each of the
periods, the valuation allowance was incurred as the result of the increased
likelihood that certain net operating losses and capital loss carryforwards
would not be utilized and the impact or potential impact of a "change in
control" as defined by the Internal Revenue Code Section 382. Change of control
provisions of Section 382 could limit the Company's ability to utilize certain
tax benefits including net operating loss carryforwards in future periods. For
the year ended December 31, 1997, the effective rate of 39.5% is higher than the
statutory rate of 35% primarily due to non-deductible amortization of costs in
excess of net assets acquired and foreign taxes in excess of foreign taxes
utilized.
Net Investment Gains (Losses). 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 resulted in the Company realizing gains (losses), of ($502,000),
$14.1 million and $19.3 million (including $1.8 million for SW Financial),
during 1999, 1998 and 1997, respectively. During 1999, 1998 and 1997, the
Company liquidated securities available for sale in order to meet cash flow
demands associated with policyholder surrenders that in the aggregate exceeded
policyholder deposits by $191.7 million, $354.1 million and $275.7 million,
respectively. In addition, during 1997, the Company liquidated most of its
equity holdings and private placement bond holdings.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk Exposures of
Financial Instruments for the Businesses Owned at December 31, 1999
The Company analyzes and reviews the risks arising from market exposures
of financial instruments. From an overall perspective, 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 minimal inflation risk.
By aggregating and monitoring the potential impact of market risk, the
Company attempts to optimize its risk adjusted earnings. In addition, these
risks are reviewed and managed individually by operating entity using analysis
prepared by the Company's actuaries. The exposures of financial instruments to
market risks, and the related risk management process, are most relevant to the
life insurance and annuity product lines. These product lines require most of
the invested assets to support accumulation and investment oriented insurance
products.
The Company has material exposures to market risks including interest rate
risk and default risk. Additional market exposures exist in the Company's other
insurance products and in its debt structure. The primary sources of interest
rate risk include (i) a sustained decrease in interest rates, and (ii) to a
lesser extent, near term increases in interest rates. As of December 31, 1999,
the Company is not utilizing derivatives in its asset liability matching
process. Each of these market risks is discussed in detail below. All of the
subsequent amounts and percentages exclude investments of the Payroll Sales
Division as of December 31, 1999 (sold February 4, 2000) and Businesses Held for
Sale as of December 31, 1998 (sold during 1999) unless noted otherwise.
48
<PAGE>
INTEREST RATE RISK
Accumulation and Investment Oriented Insurance Products. General account
assets supporting accumulation and investment oriented insurance products total
$1,726.8 million or 76.8% and $1,844.5 million or 77.4% of total invested assets
at December 31, 1999 and 1998, respectively. These insurance products include
single premium and flexible premium fixed deferred annuities and interest
sensitive life, primarily universal life. Fixed maturity and equity securities
are carried at fair value. Mortgage loans on real estate are recorded at cost,
adjusted by provision for loan loss, if necessary. Policy loans are recorded at
cost. Short-term investments, considered as cash equivalents, are recorded at
amortized cost. Policy liabilities are generally carried at policyholder account
values with an adjustment, when the policyholder account values are deemed
inadequate. With respect to these products, the Company seeks to earn a stable
and profitable spread between investment income and interest credited to
policyholder account values. As of December 31, 1999 and 1998, the weighted
average interest spread on interest sensitive insurance liabilities was 1.85%
and 2.03%. If the Company has adverse experience on investments that cannot be
passed onto its customers, its spreads are reduced. Alternately, the Company may
seek to maintain spreads which may result in non-competitive credited interest
rates to customers. This strategy could result in adverse surrender experience
and cause the Company to liquidate a portion of its portfolio to fund excess
cash surrender benefits. As a result of flexibility in adjusting crediting rate
levels and protection afforded by policy surrender charges, the Company does not
view the near term risk to spreads over the next twelve months to be material.
Fixed Deferred Annuities. Assets of $492.7 million and $599.6 million as
of December 31, 1999 and 1998, respectively, support a large category of
accumulation and investment oriented insurance products, fixed deferred
annuities. For these products, the Company may adjust renewal crediting rates
monthly, or in some cases less frequently, subject to guaranteed minimums
ranging from 3% to 6%. Generally, an annuity insurance policyholder has the
right to surrender a contract at account value less a surrender charge. Due to
the Company's ability to change crediting rates to track investment experience,
the interest rate risk of the underlying assets is assumed to be a good match
for the interest rate risk inherent in deferred annuity liabilities. This
assumption, however, may not be appropriate for either substantial increases or
decreases in interest rates.
Universal Life. Assets of $1,234.1 million and $1,244.9 million at
December 31, 1999 and 1998, respectively, support the largest category of
accumulation and investment oriented insurance products, universal and other
interest sensitive life products. For these contracts, the Company has the right
to adjust renewal-crediting rates subject to guaranteed minimums from 3.5% to
6.0%. Similar to annuities, universal life insurance policyholders have the
right to surrender their contracts at account value less a surrender charge.
Generally, the surrender charge protection ranges over a longer period of years
than those applicable to annuity policies, and in some cases may be much larger
in size relative to account values being surrendered. The Company limits
interest rate risk by analyzing projected liability cash flows and structuring
investment portfolios with similar cash flow characteristics.
Other Annuities. Assets aggregating $121.1 million and $132.1 million as
of December 31, 1999 and 1998, respectively, support immediate annuities,
traditional fixed benefit annuities, deposit funds and supplementary contracts.
Generally, the cash flows expected on these liabilities do not vary with
fluctuations in market interest rates and imputed rates of interest are not
adjustable by the Company. Accordingly, spreads will tend to fall below
expectations if experience is adverse relative to the assumptions used to price
these products at issue. The Company attempts to limit its exposure to these
products by being conservative in pricing, thereby limiting sales and lessening
the possibility of adverse experience. Many of these contracts are not
surrenderable at the option of the policyholder.
Other General Account Insurance Products. The Company had $400.2 million
and $407.2 million of assets as of December 31, 1999 and 1998, respectively,
supporting general account products, including traditional and term life
insurance, accidental and health insurance, and long-term care insurance. For
these products, the liability cash flows have actuarial uncertainty. However,
their amounts and timing do not vary significantly with changes in interest
rates.
Decreasing Interest Rates. Under scenarios in which interest rates fall
and remain at levels significantly lower than rates prevailing at December 31,
1999, minimum guarantees for annuity and universal life policies will cause the
spread between the portfolio yield and the interest rate credited to
policyholders to narrow. The earned rate on the annuity and universal life
insurance portfolios averaged 7.15% for the year ended December 31, 1999,
providing some cushion for further decline in earned interest rates before there
is insufficient margin to cover minimum guaranteed interest rates plus the
required spread for profitability. The maturity structure and call provisions of
the related investment portfolios also protect the imbedded interest rate
cushion for a period of time. However, spreads are at risk if interest rates
fall below current levels and remain lower for a sustained period of time. The
Company believes that the portfolios supporting its accumulation and investment
oriented insurance products have a prudent degree of call protection.
49
<PAGE>
The Company held $931.7 million and $1,188.7 million of mortgage-backed
bonds which represented 35.7% and 40.2% of total invested assets as of December
31, 1999 and 1998, respectively. The Company invests in mortgage-backed
securities in order to enhance portfolio yields and maintain a reliable cash
flow stream from the invested asset portfolio. The Company maintains
sophisticated models to measure the effective duration and option-adjusted
duration of the consolidated investment portfolio. These models are 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. Convexity is a measure of the responsiveness of the price of a
security to changes in yields and is normally a positive attribute of a
portfolio. The Company manages the portfolio convexity risk within the context
of the overall asset and liability model and the quantification of
disintermediation risk. Generally, disintermediation risk is a risk that net
cash outflows may occur at a time when the sale of assets can only be
accomplished at undesirable prices. Due to the combination of recent lower
interest rates and increased efficiency by mortgage holders in exercising their
prepayment options, the riskiness of these securities has increased without a
compensating adjustment to risk premiums. Accordingly, the Company may consider
reducing its exposure to the mortgage-backed bonds in future years, reducing its
ability to enhance yield with these types of securities.
Increasing Interest Rates. For both annuities and universal life
insurance, an increase in interest rates in the near term poses risks of either
deteriorating spreads or excess surrender activity. The portfolios supporting
these products have fixed assets with maturities ranging from one to twenty
years or more. Accordingly, the earned rate on each portfolio will not increase
as fast as market yields increase. Prepayments on mortgage-backed bonds will
likely slow as well, causing the earned rate to fall behind the market yield
even further. If the Company sets its renewal crediting rates at the desired
spread level, the difference between its renewal crediting rates and competitors
new money rates may be wide enough to cause increased surrender activity.
Alternatively, if the Company sets its renewal crediting rates at the
competitive level, its spread will narrow. The Company's actuaries evaluate
these risks by simulating asset and liability cash flows for numerous interest
rate scenarios. Nevertheless, the potential impact of a near term increase in
interest rates may be adverse thereby exceeding corporate risk tolerance levels.
The risk of increasing interest rates is reduced to the extent renewal premiums
are collected on periodic premium paying products.
RISK MANAGEMENT
The Company seeks to invest its available funds in a manner that will
maximize its investment return and fund future obligations to policyholders,
subject to appropriate risk considerations. The Company seeks to meet this
objective through investments that (i) have similar characteristics to the
liabilities they support; (ii) are diversified among industries, issuers and
geographic locations; and (iii) make up a predominantly investment-grade fixed
maturity securities portfolio. The Company's products incorporate surrender
charges, or other features to encourage persistency. Approximately 69.6% of the
total insurance liabilities at December 31, 1999, had surrender penalties or
other restrictions and approximately 6.5% are not subject to surrender.
The Company seeks to maximize the total return on its investments through
active investment management. Accordingly, management has determined the entire
portfolio of fixed maturity securities is available to be sold in response to
(i) changes in market interest rates; (ii) changes in relative values of
individual securities and asset sectors; (iii) changes in prepayment risks; (iv)
changes in credit quality outlook for certain securities; (v) liquidity needs;
and (vi) other factors.
The Company uses computer models to perform simulations of the cash flows
generated from existing business under various interest rate scenarios. These
simulations enable management to measure the potential gain or loss in fair
value of interest-rate sensitive financial instruments. In this analysis, the
fair value is measured as the present value of the projected statutory earnings
under a given interest rate scenario, discounted at the earned rates in that
scenario. It is standard industry practice to base fair value of insurance
businesses on statutory earnings. The two scenarios compare one with no change
in interest rates and one with an instantaneous parallel decrease in treasury
yields.
Selected fixed-income assets in the amount necessary to equal liabilities
are modeled individually. These assets include corporate bonds, asset and
mortgage-backed securities, and mortgage loans on real estate. All significant
insurance liabilities are grouped and modeled in representative liability cells.
The options embedded in the securities and their underlying collateral are
modeled directly, with the incidence of prepayments based on the type of
collateral and the level of interest rates in the scenarios tested. Defaults are
modeled based on published credit ratings. The policyholder options to borrow or
surrender are modeled, with exercise of the options determined by product design
and the level of rates which competitors would offer in the tested scenarios.
Other policyholder behavior is estimated from anticipated and recent actual
experience.
Although the traditional insurance liabilities could be excluded from this
analysis, they contain loan provisions which are interest sensitive in nature.
In addition, the risk of asset and liability mismatch in a decreasing interest
rate environment can become significant. In order to capture these risks, the
traditional insurance product liabilities were included.
If treasury yields were to decrease by 100 basis points from their
December 31, 1999 levels, the fair value of these insurance businesses, as
defined above, would be $8.5 million less than the fair value assuming no change
from the December 31, 1999 levels.
50
<PAGE>
The calculations involved in these computer simulations incorporate
numerous assumptions, require significant estimates, and assume an immediate
change in interest rates without any management of the investment portfolio in
reaction to such change. Consequently, potential changes in value of financial
instruments indicated by the simulations will likely be different from the
actual changes experienced under given interest rate scenarios, and the
difference may be material. Because the Company actively manages its investments
and liabilities, the actual change in fair value could be less than estimated
above.
DEBT STRUCTURE
Borrowed capital at December 31, 1999 includes outstanding principal of
$114.6 million of unsecured 9 1/4% Senior Subordinated Notes due 2003 and $165.0
million of a Bank Credit Facility maturing in May 2000. The senior subordinated
notes carry a fixed rate of interest. Based on the interest rate exposure and
prevalent rates at December 31, 1999, a relative 100 basis point decrease in
interest rates would increase the fair value of fixed rate borrowed capital by
approximately $3.3 million. Interest expense on the Bank Credit Facility, which
contains floating rate debt, will fluctuate as prevailing interest rates change.
At December 31, 1999, a relative 100 basis point increase in interest rates
would increase interest expense on a pre-tax basis by approximately $1.7
million.
INVESTMENTS AND RISK OF DEFAULT
The Company continuously evaluates its investment portfolio and the
conditions under which it might sell securities, including changes in interest
rates, changes in prepayment risks, liquidity needs, asset liability matching,
tax planning strategies and other economic factors. These 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 $2,363.7
million and $2,589.7 million at December 31, 1999 and 1998, respectively. Of
those securities available for sale, 93.2% and 93.0% were rated BBB or above by
Standard & Poor's at December 31, 1999 and 1998, respectively.
During the years ended December 31, 1999 and 1998, Southwestern Life and
Security Life sold $337.5 million and $705.1 million of fixed maturity and
equity securities, and purchased $461.3 million and $720.5 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.
Mortgage loans on real estate amounted to 0.8% and 1.2% of total invested
assets as of December 31, 1999 and 1998, respectively. The Company has
established a reserve for loan loss, which aggregated $682,000 and $4.3 million
as of December 31, 1999 and 1998. As of December 31, 1999, there were no
non-performing loans. As of December 31, 1998, the Company had a non-performing
loan amounting to $5.0 million. The Company foreclosed on this loan in 1999 and
is in the process of selling the property. The Company believes its current loan
loss provision is adequate to cover any future losses related to currently
performing and non-performing loans.
In assessing the risk that the rate of default losses may exceed pricing
expectations, the Company considers the entire investment portfolio. The Company
manages the risk of adverse default experience on these investments by applying
disciplined credit evaluation and underwriting standards, prudently limiting
allocations to lower quality, higher yielding investments, and diversifying
exposures by issuer, industry and region. The Company remains exposed to
occasional cyclical economic downturns, which may result in default rates
significantly higher than historical averages.
51
<PAGE>
Item 8. Financial Statements and Supplementary Data
Page
----
Management's Responsibility for Financial Statements ....... 53
PennCorp Financial Group, Inc. and Subsidiaries ............ 54
Southwestern Financial Corporation and Subsidiaries ........ 97
52
<PAGE>
MANAGEMENT'S RESPONSIBILITY FOR FINANCIAL STATEMENTS
The management of the Company is responsible for the preparation and fair
presentation of the consolidated financial statements, financial data and other
information in this annual report. They have been prepared in conformity with
generally accepted accounting principles appropriate in the circumstances and
include amounts based on the best estimates and judgment of management. The
Company's management is also responsible for the accuracy and consistency of
other financial information included in this annual report.
In recognition of its responsibility for the integrity and objectivity of
data in the financial statements, the Company maintains a system of internal
control over financial reporting which is designed to provide reasonable, but
not absolute, assurance with respect to the reliability of the Company's
financial statements. The concept of reasonable assurance is based on the notion
that the cost of the internal control system should not exceed the benefits
derived.
Internal auditors monitor and assess the effectiveness of the internal
control system and report their findings to management and the Board of
Directors throughout the year. The Company's independent auditors are engaged to
express an opinion on the financial statements and with the coordinated support
of the internal auditors, review the financial records and related data and test
the internal control system over financial reporting.
The Audit Committee of the Board of Directors, which is composed of
outside directors, serves in an oversight role to assure the integrity and
objectivity of the Company's financial reporting process. The committee meets
periodically with representatives of management, as well as the independent and
internal auditors, to review matters of a material nature related to financial
reporting and the planning, results and recommendations of audits. The
independent and internal auditors have free access to the Audit Committee,
without management present, to discuss any matter they believe should be brought
to the attention of the committee. The committee is also responsible for making
recommendations to the Board of Directors concerning the selection of the
independent auditors.
Keith A. Maib James P. McDermott
President, Chief Executive Officer Executive Vice President and
and Chief Operating Officer Chief Financial Officer
53
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Shareholders and Board of Directors of PennCorp Financial Group, Inc.
We have audited the accompanying consolidated balance sheets of PennCorp
Financial Group, Inc. and subsidiaries as of December 31, 1999 and 1998, and the
related consolidated statements of operations and comprehensive income (loss),
changes in shareholders' equity and cash flows for each of the years in the
three-year period ended December 31, 1999. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of PennCorp
Financial Group, Inc. and subsidiaries as of December 31, 1999 and 1998, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 1999, in conformity with generally accepted
accounting principles.
The accompanying 1999 consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. The Company suffered
losses from operations in 1999 and 1998. As discussed in Note 23 to the
consolidated financial statements, PennCorp Financial Group, Inc. filed a
voluntary petition for relief under chapter 11 of title 11 of the United States
Bankruptcy Code in the United States Bankruptcy Court for the District of
Delaware. The Company has filed a plan of reorganization and will seek
confirmation of the Recapitalization Plan by the Bankruptcy Court. Should the
recapitalization plan not be approved by the Bankruptcy Court, be materially
delayed or not be consummated, the Company may have to sell assets or otherwise
realize assets and liquidate or settle liabilities for amounts other than those
reflected in the consolidated financial statements or related notes. These
factors raise substantial doubt about the Company's ability to continue as a
going concern. The 1999 consolidated financial statements do not include any
adjustments that might result from the outcome of these uncertainties.
As discussed in Note 8, the Company changed its method of recording claim
reserves associated with disability income products of the Career Sales Division
during the year ended December 31, 1998. The effect of the change in methodology
is inseparable from the effect of the change in accounting estimates and is
accordingly reflected in operations as a change in accounting estimate for the
year ended December 31, 1998.
KPMG LLP
Dallas, Texas
April 10, 2000
54
<PAGE>
<TABLE>
PENNCORP FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
(In thousands, except per share amounts)
<CAPTION>
For the years ended December 31,
-----------------------------------------
1999 1998 1997
----------- ----------- -----------
<S> <C> <C> <C>
REVENUES:
Premiums ........................................................... $ 210,496 $ 337,685 $ 254,020
Interest sensitive policy product charges .......................... 128,378 121,473 91,546
Net investment income .............................................. 257,600 369,052 273,237
Other income ....................................................... 34,066 37,717 27,504
Net gains (losses) from the sale of investments .................... (502) 14,068 17,487
Net gains from sales of subsidiaries (including foreign currency
translation losses of $24,978 realized on sale) ................... 6,602 -- --
----------- ----------- -----------
Total revenues .................................................. 636,640 879,995 663,794
----------- ----------- -----------
BENEFITS AND EXPENSES:
Claims incurred .................................................... 223,658 308,432 202,472
Change in liability for future policy benefits and other policy
benefit ......................................................... 153,929 233,330 121,817
Amortization of present value of insurance in force and deferred
policy acquisition costs .......................................... 69,626 117,446 92,046
Amortization of costs in excess of net assets acquired and other
intangibles ..................................................... 13,316 15,121 9,545
Underwriting and other administrative expenses ..................... 148,891 229,497 146,245
Interest and amortization of deferred debt issuance costs .......... 40,222 42,960
23,355
Restructuring charge ............................................... 4,993 14,877 16,771
Impairment of intangibles .......................................... 95,522 -- --
Impairment provision associated with assets of Businesses Held for
Sale ............................................................ 58,486 342,960 --
----------- ----------- -----------
Total benefits and expenses ..................................... 808,643 1,304,623 612,251
----------- ----------- -----------
Income (loss) before income taxes (benefits), equity in earnings of
unconsolidated affiliates and extraordinary charge ................ (172,003) (424,628) 51,543
Income taxes (benefits) ........................................... 28,709 (3,369) 20,375
----------- ----------- -----------
Income (loss) before equity in earnings of unconsolidated affiliates
and extraordinary charge ........................................... (200,712) (421,259) 31,168
Equity in earnings of unconsolidated affiliates ................... -- -- 18,972
----------- ----------- -----------
Income (loss) before extraordinary charge ............................ (200,712) (421,259) 50,140
Extraordinary charge (net of income taxes of $--, $900 and $--) ... -- (1,671) --
Net income (loss) .................................................... (200,712) (422,930) 50,140
Preferred stock dividend requirements ............................. 17,825 18,273 19,533
----------- ----------- -----------
Net income (loss) applicable to common stock ......................... $ (218,537) $ (441,203) $ 30,607
=========== =========== ===========
PER SHARE INFORMATION:
Basic:
Net income (loss) applicable to common stock before extraordinary
charge ........................................................... $ (7.44) $ (15.17) $ 1.09
Extraordinary charge, net of income taxes ......................... -- (0.06) --
----------- ----------- -----------
Net income (loss) applicable to common stock ....................... $ (7.44) $ (15.23) $ 1.09
=========== =========== ===========
Common shares used in computing basic income (loss) per share ........ 29,354 29,091 28,016
=========== =========== ===========
Diluted:
Net income (loss) applicable to common stock before extraordinary
charge ............................................................ $ (7.44) $ (15.17) $ 1.07
Extraordinary charge, net of income taxes ......................... -- (0.06) --
----------- ----------- -----------
Net income (loss) applicable to common stock ....................... $ (7.44) $ (15.23) $ 1.07
=========== =========== ===========
Common shares used in computing diluted income (loss) per share ...... 29,354 29,091 28,645
=========== =========== ===========
COMPREHENSIVE INCOME (LOSS) INFORMATION:
Net income (loss) .................................................. $ (200,712) $ (422,930) $ 50,140
Change in unrealized foreign currency translation gains (losses),
net of income taxes .............................................. 1,713 (6,089) (5,641)
Decrease in unrealized foreign currency translation loss resulting
from sale of subsidiaries ......................................... 24,978 -- --
Change in unrealized gains (losses) on securities available for sale
of unconsolidated affiliate during the year ....................... -- -- 24,277
Change in unrealized holding gains (losses) arising during
the year on securities available for sale, net of income taxes
(benefits) of $(58,905), $4,818 and ($6,490) ..................... (109,035) 5,602 27,185
Reclassification adjustments for gains included in net income (loss) (418) (14,552) (15,890)
Decrease in unrealized holding gains resulting from the sale of
subsidiaries, net of income tax benefit of $4, in 1999 ............ 55 -- --
----------- ----------- -----------
Total comprehensive income (loss) applicable to common stock .... $ (283,419) $ (437,969) $ 80,071
=========== =========== ===========
See accompanying Notes to Consolidated Financial Statements
55
<PAGE>
<CAPTION>
PENNCORP FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share amounts)
As of December 31,
--------------------------
1999 1998
----------- -----------
<S> <C> <C>
ASSETS:
Investments:
Fixed maturities available for sale, at fair value
(amortized cost $2,485,996 in 1999 and $2,524,990 in 1998) $ 2,363,690 $ 2,589,714
Equity securities available for sale, at fair value
(cost $2,008 in 1999 and 1998) ........................... 2,008 2,035
Mortgage loans on real estate, net of allowance of $682
in 1999 and $4,295 in 1998 .............................. 20,032 36,882
Policy loans .............................................. 197,287 207,490
Other investments ......................................... 26,570 27,406
----------- -----------
Total investments ........................................ 2,609,587 2,863,527
Cash and cash equivalents ................................... 141,636 93,553
Accrued investment income ................................... 37,922 37,291
Accounts and notes receivable, net of allowance of $5,910
in 1999 and $6,201 in 1998 ............................... 11,935 16,468
Present value of insurance in force ......................... 119,766 170,729
Deferred policy acquisition costs ........................... 113,726 139,708
Costs in excess of net assets acquired ...................... 79,725 108,070
Income taxes, primarily deferred ............................ 111,517 45,451
Other assets ................................................ 62,334 91,644
Assets of Businesses Held for Sale (including cash and
cash equivalents of $131,531 in 1998) ..................... -- 2,417,583
----------- -----------
Total assets ............................................. $ 3,288,148 $ 5,984,024
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY:
Liabilities:
Policy liabilities and accruals ............................. $ 2,756,957 $ 2,819,661
Notes payable ............................................... 279,646 550,923
Accrued expenses and other liabilities ...................... 98,579 114,187
Liabilities of Businesses Held for Sale ..................... -- 2,063,312
----------- -----------
Total liabilities ........................................ 3,135,182 5,548,083
----------- -----------
Shareholders' equity:
$3.375 Convertible Preferred Stock, $.01 par value, $50
redemption value; authorized issued and outstanding
2,300,000 in 1999 and 1998 ................................ 120,216 112,454
$3.50 Series II Convertible Preferred Stock, $.01 par value,
$50 redemption value; authorized issued and outstanding
2,875,000 in 1999 and 1998 ................................ 151,736 141,673
Common stock, $.01 par value; authorized 100,000,000; issued
and outstanding 30,143,416 in 1999 and 30,072,344 in
1998 ...................................................... 303 301
Additional paid-in capital .................................. 428,974 430,321
Accumulated other comprehensive income, net of income taxes . (62,712) 19,995
Accumulated deficit ......................................... (453,487) (234,921)
Treasury shares (928,685 in 1999 and 1,105,369 in 1998) ..... (30,829) (32,391)
Notes receivable and other assets secured by common stock ... (1,235) (1,491)
----------- -----------
Total shareholders' equity ............................... 152,966 435,941
----------- -----------
Total liabilities and shareholders' equity ............... $ 3,288,148 $ 5,984,024
=========== ===========
See accompanying Notes to Consolidated Financial Statements
56
<PAGE>
<CAPTION>
PENNCORP FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(In thousands)
For the years ended December 31,
-------------------------------------
1999 1998 1997
--------- --------- ---------
<S> <C> <C> <C>
Convertible preferred stock:
Balance at beginning of year ..................... $ 254,127 $ 249,670 $ 249,670
Accrual of dividends in arrears .................. 17,825 4,457 --
--------- --------- ---------
Balance at end of year .......................... 271,952 254,127 249,670
--------- --------- ---------
Common stock:
Balance at beginning of year ..................... 301 289 286
Issuance of common stock ......................... 2 10 1
Exercise of stock options ........................ -- 2 2
--------- --------- ---------
Balance at end of year .......................... 303 301 289
--------- --------- ---------
Additional paid-in capital:
Balance at beginning of year ..................... 430,321 397,590 393,156
Issuance of common stock ......................... 100 30,717 1,697
Exercise of stock options ........................ -- 2,014 2,737
Reissuance of treasury stock ..................... (1,447) -- --
--------- --------- ---------
Balance at end of year .......................... 428,974 430,321 397,590
--------- --------- ---------
Accumulated other comprehensive income:
Unrealized foreign currency translation
losses:
Balance at beginning of year .................... (26,691) (20,602) (14,961)
Change in unrealized foreign currency
translation gains (losses)
during the year, net of income taxes .......... 1,713 (6,089) (5,641)
Decrease in unrealized foreign currency
translation loss resulting from sale of
subsidiary .................................... 24,978 -- --
--------- --------- ---------
Balance at end of year ....................... -- (26,691) (20,602)
--------- --------- ---------
Unrealized gains on securities available for
sale:
Balance at beginning of year .................... 46,686 55,636 20,064
Change in unrealized gains (losses) on securities
available for sale of unconsolidated affiliate
during the year ............................... -- -- 24,277
Change in unrealized holding gains (losses) on
securities available for sale during the
year, net of income taxes ..................... (106,453) 5,602 27,185
Reclassification adjustments for gains included
in net income (loss) .......................... (1,096) (14,552) (15,890)
Decrease in unrealized holding gains resulting
from sale of subsidiaries, net of income
taxes of $1,865 in 1999 ....................... (1,849) -- --
--------- --------- ---------
Balance at end of year ....................... (62,712) 46,686 55,636
--------- --------- ---------
Total other comprehensive income (losses) ... (62,712) 19,995 35,034
--------- --------- ---------
Retained earnings (deficit):
Balance at beginning of year ..................... (234,921) 211,055 186,032
Net income (loss) ................................ (200,712) 50,140
Dividends on common stock ........................ -- (2,860) (5,618)
Dividends on preferred stock ..................... (17,825) (18,273) (19,533)
Redemption of Series C preferred stock ........... -- (1,913) --
Earned portion of treasury stock awarded to
employees ..................................... (29) -- 34
--------- --------- ---------
Balance at end of year ........................ (453,487) (234,921) 211,055
--------- --------- ---------
Treasury shares:
Balance at beginning of year ..................... (32,391) (32,130) (3,370)
Purchases of treasury stock ...................... -- (261) (28,760)
Reissuance of treasury stock ..................... 1,562 -- --
--------- --------- ---------
Balance at end of year ........................ (30,829) (32,391) (32,130)
--------- --------- ---------
Notes receivable and other assets secured by
common stock: .................................... (1,235) (1,491) (1,272)
--------- --------- ---------
Total shareholders' equity .................... $ 152,966 $ 435,941 $ 860,236
========= ========= =========
See accompanying Notes to Consolidated Financial Statements
57
<PAGE>
<CAPTION>
PENNCORP FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
For the years ended December 31,
-----------------------------------------
1999 1998 1997
----------- ----------- -----------
<S> <C> <C> <C>
Cash flows from operating activities:
Income (loss) before equity in earnings of unconsolidated affiliates and
extraordinary charge ..................................................... $ (200,712) $ (421,259) $ 31,168
Adjustments to reconcile income (loss) before equity in earnings of
unconsolidated affiliates and extraordinary charge to net cash provided by
operating activities:
Impairment provision associated with assets of Businesses Held for Sale . 58,486 342,960 --
Impairment of intangibles ............................................... 95,522 -- --
Net gain from sales of subsidiaries ..................................... (6,602) -- --
Capitalization of deferred policy acquisition costs ..................... (75,109) (109,482)
Amortization of present value of insurance in force, deferred policy
acquisition costs, intangibles, depreciation and accretion, net ........ 76,242 123,310 91,902
Increase (decrease) in policy liabilities and accruals and other
policyholder funds .................................................... 15,984 57,730 (1,644)
Sales of trading securities ............................................. -- -- 29,914
Deferred income taxes ................................................... 29,868 7,884 13,002
Other, net .............................................................. 26,977 10,757 (1,577)
----------- ----------- -----------
Net cash provided (used) by operating activities ....................... 20,656 (7,210) 53,283
----------- ----------- -----------
Cash flows from investing activities:
Cash received from sales of subsidiaries, net of cash and short-term
investments of $138,902 of subsidiaries sold .............................. 138,718 -- --
Cash and short-term investments acquired in acquisition of businesses, net of
cash expended of $--, $82,771 and $--in 1999, 1998 and 1997 ............... -- 91,492 --
Purchases of fixed maturity securities available for sale .................. (814,215) (1,049,341) (993,768)
Purchases of equity securities available for sale .......................... -- (5,391) (27,776)
Maturities of fixed maturity securities available for sale ................. 354,346 304,122 439,938
Sales of fixed maturity securities available for sale ...................... 603,496 987,788 777,960
Sales of equity securities available for sale .............................. 21 32,062 23,121
Acquisitions and originations of mortgage loans ............................ (1,082) (36,965) (44,375)
Sales of mortgage loans .................................................... 15,129 20,867 13,643
Principal collected on mortgage loans ...................................... 34,069 50,794 54,145
Other, net ................................................................. 28,956 21,203 (49,712)
----------- ----------- -----------
Net cash provided by investing activities .............................. 359,438 416,631 193,176
----------- ----------- -----------
Cash flows from financing activities:
Additional borrowings ...................................................... -- 203,000 250,000
Issuance of common stock ................................................... -- 3 --
Purchases of treasury stock ................................................ -- -- (28,760)
Reduction of notes payable ................................................. (271,277) (126,839) (100,570)
Redemption of preferred stock .............................................. -- -- (14,705)
Receipts from interest sensitive products credited to policyholders' account
balances ................................................................. 181,322 251,627 186,166
Return of policyholders' account balances on interest sensitive products ... (372,977) (605,757) (461,888)
Cash transferred on reinsurance ceded to an affiliate ...................... -- -- (50,000)
Other, primarily dividends, net ............................................ 216 (16,210)
----------- ----------- -----------
Net cash used by financing activities .................................. (462,716) (294,176) (240,023)
----------- ----------- -----------
Net increase (decrease) in cash ........................................ (82,622) 115,245 6,436
Cash and cash equivalents at beginning of year (including $131,531 of cash and
cash equivalents classified as Businesses Held for Sale in 1999) ........... 224,258 109,013 102,577
----------- ----------- -----------
Cash and cash equivalents at end of year (including $131,531 of cash and
cash equivalents classified as assets of Businesses Held for Sale in 1998) . $ 141,636 $ 224,258 $ 109,013
=========== =========== ===========
Supplemental disclosures:
Income taxes paid (refunded) ............................................... $ (5,780) $ 5,814 $ (1,554)
Interest paid .............................................................. 38,014 38,017 20,946
Non-cash financing activities:
Redemption of Series C Preferred Stock ..................................... $ -- $ 22,227 $ --
Debt assumed with acquisition .............................................. -- 115,015 --
Issuance of common stock associated with the acquisition of the Fickes and
Stone Knightsbridge Interests ............................................ -- 8,500 --
Accrued and unpaid preferred stock dividends ............................... 17,825 4,457 --
Reissuance of treasury stock ............................................... 1,562 -- --
Other ...................................................................... -- 261 1,281
See accompanying Notes to Consolidated Financial Statements
</TABLE>
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PENNCORP FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) BASIS OF PRESENTATION
PennCorp Financial Group, Inc. ("PennCorp," or the "Company") is an
insurance holding company. Through its wholly-owned life insurance subsidiaries;
Pennsylvania Life Insurance Company ("PLIC") and its wholly-owned subsidiary,
PennCorp Life Insurance Company (collectively referred to as "Penn Life") (sold
July 30, 1999); Peninsular Life Insurance Company ("Peninsular") (sold July 30,
1999); Professional Insurance Corporation ("Professional") (sold March 31,
1999); 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"); Southwestern Financial Corporation ("SW
Financial") and its wholly-owned subsidiaries Southwestern Life Insurance
Company ("Southwestern Life"), Constitution Life Insurance Company
("Constitution") (sold July 30, 1999), Union Bankers Insurance Company ("Union
Bankers") (sold July 30, 1999), and Marquette National Life Insurance Company
("Marquette") (sold July 30, 1999); Security Life and Trust Insurance Company
("Security Life"); Occidental Life Insurance Company of North Carolina ("OLIC");
United Life & Annuity Insurance Company ("United Life") (sold April 30, 1999);
and Pacific Life and Accident Insurance Company ("PLAIC"), the Company offers a
broad range of accident and sickness, life, and accumulation insurance products
to individuals through a sales force that is contractually exclusive to certain
of the Company's subsidiaries and through general agents. Additionally, the
Company owns KB Management, LLC ("KB Management"), which provides management and
advisory services to the Company; Marketing One, Inc. ("Marketing One"), a third
party marketing organization; KIVEX, Inc. ("KIVEX") (sold June 30, 1999), an
internet service provider, UC Mortgage Corp. ("UC") (sold April 30, 1999) and
Cyberlink Development, Inc. ("Cyberlink") (sold April 30, 1999). As part of a
subsidiary realignment, Southwestern Life became a wholly-owned subsidiary of
PLAIC as of July 30, 1999.
As a result of the Company's announcement of its decision to sell the
Career Sales Division (the Career Sales Division is comprised of the operations
of Penn Life, Peninsular, Union Bankers, Constitution and Marquette), KIVEX,
Professional and the United Life Assets (the United Life Assets is comprised of
the operations of United Life, UC, Cyberlink and certain assets of Marketing
One), within a period not likely to exceed one year (see Notes 3 and 16), the
assets and liabilities of the Career Sales Division, KIVEX, Professional and the
United Life Assets, (collectively the "Businesses Held for Sale") were reported
as "Assets of Businesses Held for Sale" and "Liabilities of Businesses Held for
Sale" at December 31, 1998. As of July 30, 1999, sales of all the Businesses
Held for Sale had been completed.
The Businesses Owned at December 31, 1999 includes the Payroll Sales
Division (the Payroll Sales Division is comprised of AA Life and OLIC) and the
Financial Services Division (the Financial Services Division is comprised of
Southwestern Life and Security Life).
The accompanying consolidated financial statements include the accounts of
the Company and its subsidiaries. All significant intercompany accounts and
transactions have been eliminated. All dollar amounts presented hereafter,
except share amounts, are stated in thousands.
The financial statements are prepared in accordance with generally
accepted accounting principles ("GAAP"). These principles are established
primarily by the Financial Accounting Standards Board ("FASB") and the American
Institute of Certified Public Accountants ("AICPA"). 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 as well as revenues and expenses. Accounts that the Company deems to
be acutely sensitive to changes in estimates include deferred policy acquisition
costs, policy liabilities and accruals, present value of insurance in force,
costs in excess of net assets acquired, the fair value of assets and liabilities
classified as held for sale and deferred taxes. In addition, the Company must
determine the requirements for disclosure of contingent assets and liabilities
as of the date of the financial statements based upon estimates. As additional
information becomes available, or actual amounts are determinable, the recorded
estimates may be revised and reflected in operating results. Although some
variability is inherent in these estimates, management believes the amounts
provided are adequate. In all instances, actual results could differ from
estimates.
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(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Investments
Fixed maturities and equity securities classified as available for sale
are recorded at fair value, as they may be sold in response to changes in
interest rates, prepayment risk, liquidity needs, the need or desire to increase
income, capital or other economic factors. Fair values are determined based on
quoted market prices, where available. For fixed maturities and equity
securities 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. Changes in unrealized gains and losses related to
securities available for sale are recorded as accumulated other comprehensive
income, a separate component of shareholders' equity, net of applicable income
taxes and amount attributable to deferred policy acquisition costs and present
value of insurance in force related to universal life and accumulation products.
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. During 1997, the
Company carried its investment in SW Financial and its wholly-owned subsidiaries
on the equity basis of accounting as a result of its percentage ownership and
lack of voting control. Mortgage-backed fixed maturity securities held for
investment or available for sale are amortized using the interest method
including anticipated prepayments at the date of purchase. Significant changes
in estimated cash flows from original assumptions are reflected in the period of
such change. Mortgage loans on real estate are recorded at cost, adjusted for
amortization of premium or discount and provision for loan loss, if necessary.
Policy loans and short-term investments are recorded at cost. Other invested
assets include investments in limited partnerships stated at cost and adjusted
for contributions, distributions and undistributed income and other
miscellaneous investments carried at cost.
As a result of the Company's decision to exit the private placement bond
sector, the Company transferred all of its remaining assets in the fixed
maturities held for investment portfolio aggregating $49,384 to its fixed
maturities available for sale portfolio as of April 1, 1997. In accordance with
Statement of Financial Accounting Standards ("SFAS") 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 $1,800.
The Company regularly evaluates the carrying value of its 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 estimated 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 net income.
Cash and Cash Equivalents
Cash and cash equivalents include cash on hand and investments with
original maturities of three months or less.
Accounts and Notes Receivable
Accounts and notes receivable consist primarily of agents' balances and
premiums receivable from agents and policyholders. Agents' balances are
partially secured by commissions due to agents in the future and premiums
receivable are secured by policy liabilities. An allowance for doubtful accounts
is established, based upon specific identification and general provision, for
amounts which the Company estimates will not ultimately be collected. During
1999, 1998 and 1997, the Company wrote off receivables totaling $1,541, $1,960
and $6,605, respectively.
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Intangible Assets
The Company continually monitors the recoverability of the carrying value
of intangible assets using the methodology prescribed in Statement of Financial
Accounting Standards ("SFAS") No. 121 and Accounting Principles Board ("APB")
No. 17 "Intangible Assets." The Company evaluates long-lived assets and the
related intangible assets for impairment whenever events or changes in
circumstances indicate the carrying amounts of these assets may not be
recoverable. Recoverability of these assets is determined by comparing a
forecast of the undiscounted net cash flows of the entity to the asset carrying
amount. If the entity is determined to be unable to recover the carrying amount
of its assets, intangible assets are written down initially, followed by the
other long-lived assets of the operation, to fair value. Fair value is
determined based upon discounted cash flows or appraised values, depending on
the nature of the associated assets.
During 1999 and 1998, the Company recognized an aggregate $58,486 and
$342,960, respectively, non-cash charges related to the fair value of
consideration to be received upon disposition of certain operating companies
which are aggregated for purposes of presentation of the Company's financial
information as "assets and liabilities of Businesses Held for Sale."
In accordance with SFAS No. 121, the Company recorded the impairment
provision in order to reflect the difference in the Company's accounting basis
in the Businesses Held for Sale and the fair value of the consideration that the
Company would likely receive for such businesses. The fair value of the
consideration likely to be received has been primarily based upon the terms of
definitive sales agreements.
The Company evaluated the recoverability of all intangible assets of the
Payroll Sales Division based upon the sales proceeds received from the sale
which was entered into on January 8, 2000 and consummated February 4, 2000 (see
Notes 3 and 23). As a result, an impairment provision of $95,522 was reflected
in the Statement of Operations for the year ended December 31, 1999.
Deferred Policy Acquisition Costs
Estimated costs of acquiring new business which vary with, and are
primarily related to, the production of new business, have been deferred to the
extent that such costs are deemed recoverable from future revenues. Such
estimated costs include commissions, certain costs of policy issuance,
underwriting, certain variable agency and marketing expenses and other costs
directly associated with these functions to the extent such costs are determined
to vary with and are primarily related to the production of new business. Costs
deferred associated with accident and sickness and traditional life policies are
amortized, with interest, over the anticipated premium-paying period of the
related policies in proportion to the ratio of annual premium revenue to
expected total premium revenue to be received over the life of the policies.
Expected premium revenue is estimated by using the same mortality, morbidity and
withdrawal assumptions used in computing liabilities for future policy benefits.
For interest sensitive products and limited pay life products, policy
acquisition costs are amortized in relation to the emergence of anticipated
gross profits over the life of the policies.
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 $119,313
and $96,273 as of December 31, 1999 and 1998, respectively.
Costs in Excess of Net Assets Acquired
Costs in excess of the fair value of net assets acquired are primarily
amortized on a straight-line basis ranging from 5 to 30 years. Accumulated
amortization was $32,921 and $31,024 as of December 31, 1999 and 1998,
respectively. In 1999, unamortized costs in excess of net assets acquired in the
amount of $19,287 was impaired due to the evaluation of recoverability of
intangible assets of the Payroll Sales Division as a result of its sale on
February 4, 2000 (see Notes 3 and 23). During 1999, costs in excess of net
assets acquired of a non-insurance subsidiary in the amount of $7,635 was
written off as the result of the decision to cease operations. During 1998,
unamortized costs in excess of net assets acquired in the amount of $22,792 were
transferred to assets of Businesses Held for Sale and $114,514 was written off
in connection with the impairment provision associated with assets of Businesses
Held for Sale.
For the year ended December 31, 1998, the Company made a valuation
determination with respect to certain preacquisition contingencies. The Company
reduced tax liabilities and associated costs in excess of net assets acquired
associated with the SW Financial and United Life acquisitions by $6,407 and
$647, respectively, as a result of the Company resolving certain acquisition
date contingencies.
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<PAGE>
For the year ended December 31, 1997, the Company determined the following
with respect to certain material acquisition contingencies or allocations: (i)
the Company increased deferred tax assets and reduced associated costs in excess
of net assets acquired associated with the Security Life acquisition by $19,600
as a result of the Company resolving certain acquisition date tax contingencies,
(ii) the Company reduced both deferred tax liabilities and associated costs in
excess of net assets acquired associated with the Marketing One acquisition by
$1,100 as a result of the Company resolving certain acquisition date tax
contingencies, and (iii) the Company reduced costs in excess of net assets
acquired and increased certain mortgage loan values by $1,100, associated with
the acquisition of United Life, as a result of final appraisals becoming
available.
Policy Liabilities
Future policy benefits for traditional life insurance products generally
have been computed on the net level premium method, based on estimated future
investment yield, mortality, morbidity and withdrawals. Estimates used are based
on experience adjusted to provide for possible adverse deviation. These
estimates are periodically reviewed and compared with actual experience. Future
policy benefits for interest sensitive products include the balance that accrues
to the benefit of the policyholders and amounts that have been assessed to
compensate the life insurance subsidiaries for services to be provided in the
future.
Policy and contract claims represent estimates of both reported claims and
claims incurred but not reported based on experience. Prior to disposition, the
Company had been closely monitoring the development of claims reserve experience
for Penn Life. The methodology previously utilized has experienced, what
appeared to be, a deterioration of the adequacy of claims reserves associated
with disability income products sold prior to the Company's ownership. During
1998, the Company changed its methodology in recording these reserves. The
effect of the change in methodology is inseparable from the effect of the change
in accounting estimate and is accordingly reflected in operations as a change in
accounting estimate for 1998.
Income Taxes
Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to temporary differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases as well as operating loss and tax credit carryforwards.
Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in income in the
period that includes the enactment date.
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.
Treasury Shares
Shares purchased are recorded at cost as a reduction of shareholders'
equity. Shares abandoned by the associated shareholders are recorded at no cost.
The cost basis of shares reissued from treasury are determined on the basis of
specific identification.
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.
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Net Income (Loss) per Common Share
Net income (loss) per common share is computed in accordance with SFAS No.
128, "Earnings Per Share." Basic earnings (loss) per share excludes dilution and
is computed by dividing income (loss) applicable to common shareholders by
weighted average number of common shares outstanding for the period. Diluted
earnings (loss) per share represents the potential dilution that could occur if
all convertible securities, warrants and stock options were exercised and
converted into common stock, if the effect of doing so is dilutive. The diluted
earnings per share calculation assumes that the proceeds received upon the
conversion of all dilutive options and warrants are used to repurchase the
Company's common shares at the average market price of such shares during the
period.
The Company utilized the requirements of SFAS No. 123, "Accounting for
Stock-Based Compensation," when accounting for stock options and other stock
based compensation. This statement provides a choice for the accounting of
employee stock compensation plans. A company may elect to use a new fair-value
methodology, under which compensation cost is measured and recognized in results
of operations, or continue to account for these plans under APB No. 25,
"Accounting for Stock Issued to Employees," and related Interpretations. Note 13
contains a summary of the pro forma effects to reported net income applicable to
common stock and earnings per share for 1999, 1998 and 1997, as if the Company
had elected to account for employee stock compensation plans utilizing the fair
value methodology prescribed by SFAS No. 123.
Business Combinations
Business combinations accounted for as a purchase result in the allocation
of the purchase consideration to the fair values of the assets and liabilities
acquired establishing such fair values as the new accounting bases. Purchase
consideration in excess of the fair value of net assets acquired is allocated to
"costs in excess of net assets acquired." Should the fair value of the net
assets acquired exceed the purchase consideration, such excess is utilized to
reduce certain intangible assets, primarily "present value of insurance in
force." Allocation of purchase price is performed in the period in which the
purchase is consummated and may be preliminary. Adjustments resulting from
completion of the purchase allocation process affect the value of the assets and
liabilities acquired.
Foreign Currency Translation
The financial statement accounts of the Company's Canadian operations
(sold July 30, 1999), 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 accumulated other
comprehensive income, a separate component of shareholders' equity, and (ii)
revenues, expenses and cash flows, expressed in Canadian dollars, are translated
using a weighted average of exchange rates for each of the periods presented.
Reinsurance
Financial reinsurance that does not transfer significant insurance risk is
accounted for as deposits. The cost of reinsurance related to long-duration
contracts is accounted for over the life of the underlying reinsured policies.
Balances due to, or from, reinsurers have been reflected as assets and
liabilities rather than being netted against the related account balances.
Realized gains on retroactive reinsurance arrangements are deferred and
amortized into net income over the estimated duration of the reinsured business.
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Accounting Pronouncements Not Yet Adopted
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 133 defines derivative instruments
and provides comprehensive accounting and reporting standards for the
recognition and measurement of derivative and hedging activities (including
certain instruments embedded in other contracts). It requires derivatives to be
recorded in the Consolidated Balance Sheet at fair value and establishes
criteria for hedges of changes in the fair value of assets, liabilities or firm
commitments, hedges of variable cash flows of forecasted transactions, and
hedges of foreign currency exposures of net investments in foreign operations.
Changes in the fair value of derivatives not meeting specific hedge accounting
criteria would be recognized in the Consolidated Statement of Operations. SFAS
No. 133 was originally effective for all fiscal quarters of all years beginning
after June 15, 1999. In June 1999, the FASB deferred the effective date until
fiscal years beginning after June 15, 2000. The Company will adopt SFAS No. 133
on January 1, 2001. The Company is currently evaluating SFAS No.133 but does not
expect its adoption to have a material effect on the consolidated financial
statements.
Reclassifications
Certain prior year amounts have been reclassified to conform to the
current year presentation.
(3) ACQUISITIONS, DISPOSITIONS AND OTHER EVENTS
Acquisitions of SW Financial Controlling Interest, Knightsbridge Interests
and United Life
On January 2, 1998, following shareholder approval at the Company's 1997
annual meeting of shareholders, the Company consummated the acquisition, from KB
Investment Fund I, LP (formerly Knightsbridge Capital Fund I, LP) (the "KB
Fund") and Messrs. Steven W. Fickes and David J. Stone, former executive
officers and directors of the Company, of their respective holdings of common
stock and, in the case of the KB Fund, common stock warrants of SW Financial
(collectively, the "SW Financial Controlling Interest") for an aggregate
purchase price of $73,658 (not including acquisition expenses). The fair value
of net assets acquired amounted to $45,520 resulting in $28,138 of costs in
excess of net assets acquired which will be amortized over 30 years. As part of
the acquisition of the SW Financial Controlling Interest on January 2, 1998, SW
Financial Subordinated Notes in the amount of $40,000 previously purchased by
the Company were reclassified to purchase consideration for SW Financial. The
acquisition of the SW Financial Controlling Interest has been accounted for as a
step purchase transaction in accordance with generally accepted accounting
principles, and accordingly, fair values of assets and liabilities acquired have
been determined as of January 2, 1998.
On January 5, 1998, following shareholder approval at the 1997 annual
meeting of shareholders, the Company consummated the acquisition of the
interests of Messrs. Fickes and Stone in KB Management, KB Fund and KB
Consultants LLC (formerly known as Knightsbridge Consultants LLC) (collectively,
the "Fickes and Stone Knightsbridge Interests") for total consideration
estimated to be $10,564 (not including acquisition expenses). Under the
transaction terms, Mr. Fickes is to receive consideration in the form of
estimated annual interest payments, ranging from $301 to $330, on April 15 each
year through 2001 and is to be issued 173,160 shares of the Company's Common
Stock on April 15, 2001. Mr. Stone was issued his 173,160 shares in July 1998
which he pledged to financial institutions in connection with his appeal of a
judgment awarded against him and his spouse. The fair value of net assets
acquired amounted to ($1,701) resulting in $12,294 of costs in excess of net
assets acquired which will be amortized over seven years. The acquisition of the
Fickes and Stone Knightsbridge Interests has been accounted for as a purchase
transaction in accordance with generally accepted accounting principles, and
accordingly, preliminary fair values of assets and liabilities acquired were
recorded as of the acquisition date which became the new accounting basis.
Disposition of Businesses
On February 18, 1998, the Company announced it had engaged the investment
banking firms Salomon Smith Barney, Inc. and Fox-Pitt, Kelton Inc. to review
strategic alternatives for maximizing shareholder value, including the sale of
the Company's Career Sales Division and certain other non-strategic
subsidiaries.
In addition, in February 1999, the Company engaged the firm of
Wasserstein, Perella & Co. ("Wasserstein Perella") to review the Company's
capital structure and develop recapitalization and restructuring alternatives.
The Company, with Wasserstein Perella, has been exploring with interested
parties, a sale of the Company or certain of its subsidiaries and, on a parallel
track, a restructuring or recapitalization transaction (see Notes 3 and 23).
On March 31, 1999, the Company consummated the sale of Professional to GE
Financial Assurance Holdings, Inc. ("GE Financial"). The operating results of
Professional are included in the consolidated operating results through March
31, 1999. The Company realized a gain from the sale totaling $1,054. As a result
of the sale, unrealized gains on securities available for sale by Professional
decreased by $488. On September 15, 1999, as a result of certain settlement and
consideration adjustment provisions included in the purchase and sale agreement
the Company reduced the consideration received by $1,237.
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On April 30, 1999, the Company consummated the sale of United Life Assets
to ING America Insurance Holdings, Inc. ("ING"). The operating results of United
Life Assets are included consolidated operating results through April 30, 1999.
The Company realized a loss from the sale totaling $3,877. As a result of the
sale, unrealized gains on securities held for sale by United Life decreased
$1,726. The purchase and sale agreement includes certain settlement and
consideration adjustment provisions relating to certain mortgages retained by
the Company and federal income tax calculations (see Note 19).
On June 30, 1999, the Company completed the sale of KIVEX to Allegiance
Telecom, Inc. The operating results of KIVEX are included in the consolidated
operating results through June 30, 1999. The Company recorded a gain of $30,881
on the sale.
On July 30, 1999, the Company consummated the sale of the Career Sales
Division to Universal American Financial Corp. ("Universal American"). During
1999 and prior to the consummation of the sale, the Company incurred an
additional impairment provision of $58,486 related to the Career Sales Division.
This resulted from the decrease in the nominal purchase consideration of $38,000
partially offset by an estimated discount to the stated value of the note to be
received. In addition, impairment provision included the impact of the true-up
of statutory capital and surplus of the Career Sales Division companies to
levels specified in the sale agreement which aggregated approximately $24,218.
Other factors modestly impacting the impairment provision included additional
transaction costs, changes in unrealized gains and losses of securities, foreign
currency translation and net income not considered in the determination of sale
consideration. The operating results of the Career Sales Division are included
in the consolidated operating results through July 30, 1999. The Company
realized a foreign currency transaction loss on the sale of the Career Sales
Division totaling $24,978, which represented previously unrealized translation
losses on the Company's Canadian insurance operations, partially offset by a
gain of $3,522 on the disposition resulting in a net loss of $21,456. In
addition, as a result of the sale, unrealized gains on securities available for
sale and unrealized foreign currency translation losses decreased by $2,268 and
$24,978, respectively. On December 29, 1999, as a result of certain settlement
and consideration adjustment provisions, included in the purchase and sale
agreement the Company reduced the consideration received by $2,550.
The Company used $267,000 of the net proceeds from these sales to pay down
the outstanding balance under the bank credit facility (the "Bank Credit
Facility"). In addition, the Company repaid an additional $2,000 of indebtedness
as a result of liquidity at the parent company above the amounts prescribed in
the Bank Credit Facility, as amended.
In January 2000, the Company announced it had agreed to sell the Payroll
Sales Division to a company formed by Thoma Cressey Equity Partners for
approximately $102,000, subject to adjustment. The sale was consummated on
February 4, 2000 (see Note 23). The operating results of the Payroll Sales
Division are included in the consolidated operating results through December 31,
1999. The Company recorded impairment provision totaling $95,522 to reflect the
difference in the Company's accounting basis in the Payroll Sales Division and
the consideration the Company is to receive for such businesses. The Company
fully impaired the costs in excess of net assets acquired aggregating $19,287.
In addition, the Company fully impaired the present value of insurance in force
and partially impaired deferred policy acquisition costs resulting in charges of
$67,617 and $49,668 respectively, net of related deferred taxes of $41,050.
(4) BUSINESS SEGMENT INFORMATION
The Company has adopted SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information" which requires that companies disclose
segment data on a basis that is used internally by management for evaluating
segment performance and allocating resources to segments. The Company defines
its operating divisions based on the distribution channels of its products. The
Company has three reportable operating segments: (i) Financial Services
Division, which is based in Dallas, Texas, and markets life insurance and fixed
annuities through independent general agents; (ii) Payroll Sales Division, which
is based in Waco, Texas, and markets and underwrites customized life insurance
and accumulation products to U.S. military personnel and federal employees
through a general agency force and provides individual fixed benefit and life
products through employer-sponsored payroll deduction programs; and (iii)
Businesses Held for Sale.
The Company's Chief Executive Officer evaluates performance of each
segment based on profit or loss from operations excluding (i) restructuring
costs, (ii) net gains on the sale of investments, (iii) net gains from sales of
subsidiaries, (iv) impairment valuation associated with Businesses Held for
Sale, (v) interest expense, (vi) income taxes and (vii) equity in earnings of
unconsolidated subsidiaries. The accounting policies of segments are the same as
those described in the summary of significant accounting policies (see Note 2).
Segment data for 1998 and 1997 have been restated to conform to the 1999
presentation.
65
<PAGE>
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------------------
1999 1998 1997
--------- --------- ---------
<S> <C> <C> <C>
Premiums and policy product charges:
Financial Services Division ............ $ 133,930 $ 129,241 $ 69,831
Payroll Sales Division ................. 92,029 89,990 89,698
Businesses Held for Sale (United States) 85,045 194,997 141,834
Businesses Held for Sale (Canada) ...... 27,870 44,930 44,203
--------- --------- ---------
$ 338,874 $ 459,158 $ 345,566
========= ========= =========
Net investment income:
Financial Services Division ............ $ 161,841 $ 179,433 $ 90,787
Payroll Sales Division ................. 36,771 38,252 38,161
Businesses Held for Sale ............... 54,568 144,072 138,355
Corporate .............................. 4,420 7,295 5,934
--------- --------- ---------
$ 257,600 $ 369,052 $ 273,237
========= ========= =========
Operating profit (loss):
Financial Services Division ............ $ 26,213 $ 19,018 $ 27,785
Payroll Sales Division ................. 16,100 (3,501) 23,960
Businesses Held for Sale ............... 15,968 (16,541) 38,915
--------- --------- ---------
$ 58,281 $ (1,024) $ 90,660
========= ========= =========
Amortization of present value of insurance
in force and deferred policy acquisition
costs:
Financial Services Division ......... $ 29,589 $ 26,122 $ 19,469
Payroll Sales Division .............. 30,551 37,978 24,271
Businesses Held for Sale ............ 9,486 53,346 48,306
--------- --------- ---------
$ 69,626 $ 117,446 $ 92,046
========= ========= =========
<CAPTION>
As of December 31,
-----------------------
1999 1998
---------- ----------
<S> <C> <C>
Total assets:
Financial Services Division ................... $2,645,337 $2,823,007
Payroll Sales Division ........................ 598,011 648,400
Businesses Held for Sale (United States) ...... -- 2,290,724
Businesses Held for Sale (Canada) ............. -- 126,859
---------- ----------
$3,243,348 $5,888,990
========== ==========
</TABLE>
66
<PAGE>
Reconciliations of segment data to the Company's consolidated data are as
follows:
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------------------
1999 1998 1997
--------- --------- ---------
<S> <C> <C> <C>
Total revenues:
Segments--premiums and policy product charges ........... $ 338,874 $ 459,158 $ 345,566
Segments--net investment income ......................... 257,600 369,052 273,237
Other income ............................................ 34,066 37,717 27,504
Net gains (losses) from sale of investments ............. (502) 14,068 17,487
Net gains from sales of subsidiaries (including realized
losses on foreign currency of $24,978) ................ 6,602 -- --
--------- --------- ---------
$ 636,640 $ 879,995 $ 663,794
========= ========= =========
Income (loss) before taxes, equity in earnings of
unconsolidated affiliates and extraordinary charge:
Segments ................................................ $ 58,281 $ (1,024) $ 90,660
Corporate expenses and eliminations ..................... (30,559) (36,875) (16,478)
Impairment of intangibles ............................... (95,522) -- --
Impairment provision associated with
assets of Businesses Held for Sale .................... (58,486) (342,960) --
Interest and amortization of deferred debt
issuance costs ........................................ (40,222) (42,960) (23,355)
Net gains (losses) on the sale of investments ........... (502) 14,068 17,487
Restructuring costs ..................................... (4,993) (14,877) (16,771)
--------- --------- ---------
$(172,003) $(424,628) $ 51,543
========= ========= =========
</TABLE>
<TABLE>
<CAPTION>
As of December 31,
-----------------------
1999 1998
---------- ----------
Total assets:
<S> <C> <C>
Segments ................................................ $3,243,348 $5,888,990
Corporate and other ..................................... 44,800 95,034
---------- ----------
$3,288,148 $5,984,024
========== ==========
</TABLE>
(5) INVESTMENTS
The amortized cost and fair value of investments in fixed maturities
available for sale were as follows as of December 31:
<TABLE>
<CAPTION>
1999
--------------------------------------------------
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 ........... $ 972,425 $ 5,922 $(46,684) $ 931,663
U.S. Treasury securities and obligations of
U.S. Government corporations and agencies ......... 279,402 2,236 (22,130) 259,508
Debt securities issued by foreign governments ...... 23,677 101 (1,260) 22,518
Corporate securities ............................... 1,210,492 3,999 (64,490) 1,150,001
---------- ---------- ---------- ----------
$2,485,996 $ 12,258 $ (134,564) $2,363,690
========== ========== ========== ==========
</TABLE>
67
<PAGE>
<TABLE>
<CAPTION>
1998
-------------------------------------------------
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 ........... $1,164,739 $ 33,930 $ 9,983 $1,188,686
U.S. Treasury securities and obligations of
U.S. Government corporations and agencies ......... 235,037 15,849 6,059 244,827
Debt securities issued by foreign governments ...... 25,701 1,477 -- 27,178
Corporate securities ............................... 1,099,513 41,723 12,213 1,129,023
---------- ---------- ---------- ----------
$2,524,990 $ 92,979 $ 28,255 $2,589,714
========== ========== ========== ==========
</TABLE>
The amortized cost and fair value of fixed maturities available for sale
as of December 31, 1999, by contractual maturity, are shown below:
Amortized Fair
Cost Value
---------- ----------
Due in one year or less ....................... $ 72,287 $ 72,405
Due after 1 through 5 years ................... 409,061 399,277
Due after 5 through 10 years .................. 567,644 542,233
Due after 10 years ............................ 464,579 418,112
Mortgage-backed securities, principally
obligations of U.S. Government agencies ...... 972,425 931,663
---------- ----------
$2,485,996 $2,363,690
========== ==========
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 available for sale as of December 31, 1999
and 1998, are below investment-grade securities with an amortized cost of
$161,785 and $177,263 and a fair value of $139,521 and $163,252, respectively.
Included in fixed maturities available for sale as of December 31, 1999, are
unrated securities with an amortized cost of $33,041 and a fair value of
$21,115. Included in fixed maturities available for sale as of December 31, 1998
are unrated securities with an amortized cost of $18,211 and a fair value of
$18,239. Investments in a single entity, other than obligations of the U.S.
government or agencies thereof, totaling in excess of 10% of the Company's
equity at December 31, 1999 consisted of an investment in Episode IV Loan Trust
with carrying value and fair value of $25,000.
As of December 31, 1999, there was no unrealized appreciation or loss in
equity securities available for sale. As of December 31, 1998, net unrealized
appreciation in equity securities available for sale consisted of gross
unrealized gains of $27.
The Company's commercial and residential mortgage portfolios had net
carrying values $20,032 and $36,882, respectively, and, fair values of $20,285
and $38,865, respectively, as of December 31, 1999 and 1998.
68
<PAGE>
As of December 31, 1999, commercial and residential mortgage loan
investments were concentrated in the following states:
Percent of Total
Carrying Value Carrying Value
-------------- --------------
Texas............................... $10,070 50.3%
Kansas.............................. 1,946 9.7
Illinois............................ 1,787 8.9
Nevada.............................. 1,719 8.6
Alabama............................. 1,673 8.4
Louisiana........................... 1,187 5.9
All other (less than 4% individually) 1,650 8.2
------- -----
$20,032 100.0%
======= =====
Investments with a carrying value of $216,629 and $146,385 were on deposit
with certain regulatory authorities as of December 31, 1999 and 1998,
respectively. Amounts on deposit are temporarily approximately $100,000 higher
as a result of a change in custodians.
Realized, and changes in unrealized gains and losses on investments were
as follows for the years ended December 31:
<TABLE>
<CAPTION>
1999 1998 1997
--------- --------- ---------
<S> <C> <C> <C>
Realized gains (losses) on dispositions of investments:
Securities available for sale:
Gross gains from sales .......................................... $ 6,853 $ 20,509 $ 22,076
Gross losses from sales ......................................... (6,435) (5,960) (6,186)
Net gains (losses) from redemptions ............................. -- 3 --
--------- --------- ---------
418 14,552 15,890
Mortgage loans ................................................... 38 (6,545) (284)
Other investments ................................................ (958) 6,061 1,881
--------- --------- ---------
Net realized gains (losses) ................................... $ (502) $ 14,068 $ 17,487
========= ========= =========
Change in unrealized gains (losses):
Securities held for investment ................................... $ -- $ -- $ (2,429)
========= ========= =========
Securities available for sale .................................... $(219,314) $ (27,038) $ 44,627
Securities available for sale of
unconsolidated affiliate ...................................... -- -- 24,277
Less effect on other balance sheet accounts:
Value of business acquired, deferred acquisition costs and other,
principally unearned revenue on interest sensitive products ... 50,956 13,270 (26,842)
Deferred income (taxes) benefits ................................ 58,905 4,818 (6,490)
Decrease in unrealized holding gains resulting from the sale
of subsidiaries ............................................... 55 -- --
--------- --------- ---------
Net change in unrealized gains (losses) ...................... $(109,398) $ (8,950) $ 35,572
========= ========= =========
Trading portfolio:
Net gains (losses) from sales .................................... $ -- $ -- $ (142)
Net change in unrealized gains (losses) .......................... -- -- 1,258
--------- --------- ---------
Total net trading gains ....................................... $ -- $ -- $ 1,116
========= ========= =========
</TABLE>
As a result of the Company's decision to exit the private placement bond
sector, the Company transferred all of its remaining assets in the fixed
maturities held for investment portfolio aggregating $49,384 to its fixed
maturity available for sale as of April 1, 1997. In accordance with SFAS No.
115, the Company adjusted all transferred assets to fair value resulting in a
net increase in shareholders' equity of $1,800, net of applicable income taxes.
69
<PAGE>
Major categories of net investment income consisted of the following for
the years ended December 31:
1999 1998 1997
-------- -------- --------
Fixed maturity securities ................... $231,196 $310,798 $231,867
Mortgage loans on real estate ............... 9,610 27,773 26,498
Policy loans ................................ 13,996 16,235 9,037
Cash and cash equivalents ................... 7,548 9,016 6,366
Other investments ........................... 2,422 13,553 9,177
-------- -------- --------
Gross investment income ................... 264,772 377,375 282,945
Less: investment expenses ................... 7,172 8,323 9,708
-------- -------- --------
Net investment income ..................... $257,600 $369,052 $273,237
======== ======== ========
The Company had non-income producing investments at December 31, 1999 with
an amortized cost and fair value as follows:
Amortized Fair
Cost Value
---- -----
Preferred stock.............................. $ 6,656 $ 5,063
Other investments............................ 19,351 23,113
-------- -------
$ 26,007 $28,176
======== =======
(6) SOUTHWESTERN LIFE INVESTMENT
On December 14, 1995, SW Financial (see Note 18) purchased SW Life, Union
Bankers 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 owned, at December 31,
1997, 74.8% of SW Financial's outstanding common stock, including 100% of SW
Financial's non-voting common stock, 14.3% of SW Financial's voting common
stock, and 100% of SW Financial preferred stock. PennCorp is also a 16.3%
limited partner in KB Fund. As a result, the Company had an economic interest in
SW Financial aggregating 78.0 percent. Retained earnings of the Company included
undistributed earnings of SW Financial aggregating $40,919 as of December 31,
1997.
On January 2, 1998, the Company acquired the SW Financial Controlling
Interest (see Note 3).
The Company accounted for its investment in SW Financial utilizing the
equity method for the year ended December 31, 1997. The consolidated condensed
results of operations for the years ended December 31, 1997 are provided below:
Revenues:
Policy revenues ......................................... $ 145,818
Net investment income ................................... 126,427
Other income ............................................ 16,039
Net gains from the sale of investments .................. 1,841
---------
Total revenues ..................................... 290,125
---------
Benefits and expenses:
Claims incurred ......................................... 201,385
Change in liability for future policy benefits and
other policy benefits ................................. (35,103)
Insurance and other operating expenses .................. 66,319
Interest and amortization of deferred debt issuance costs 13,773
---------
Total benefits and expenses .......................... 246,374
---------
Income before income taxes .............................. 43,751
Income taxes .......................................... 16,416
---------
Net income .............................................. 27,335
Preferred stock dividend requirements ................. 3,012
---------
Net income applicable to common stock ................... $ 24,323
=========
70
<PAGE>
(7) DEFERRED POLICY ACQUISITION COSTS AND PRESENT VALUE OF INSURANCE IN FORCE
Information relating to deferred policy acquisition costs is as follows
for the years ended December 31:
<TABLE>
<CAPTION>
1999 1998 1997
-------- -------- --------
<S> <C> <C> <C>
Balance as of January 1 ....................................... $139,708 $310,117 $252,428
Policy acquisition costs deferred:
Commissions .................................................. 41,504 86,441 59,238
Underwriting and issue costs ................................. 13,435 42,151 50,244
Addition due to acquisition, including $171 of unrealized loss -- 30,606 --
-------- -------- --------
194,647 469,315 361,910
Policy acquisition costs amortized ............................ (37,100) (79,291) (44,323)
Unrealized investment (gain) loss adjustment .................. 5,348 (1,213) (2,344)
Transfer pursuant to reinsurance transaction .................. 499 -- --
Foreign currency translation adjustment ....................... -- (1,038) (1,482)
Reduction due to sale of blocks of business ................... -- (4,129) (3,644)
Impairment for Businesses Held for Sale ....................... -- (191,595) --
Impairment related to recoverability analysis associated with
subsequent sale of Payroll Sales Division .................... (49,668) -- --
Amounts transferred to assets of Businesses Held for Sale ..... -- (52,341) --
-------- -------- --------
Balance as of December 31 .................................... $113,726 $139,708 $310,117
======== ======== ========
</TABLE>
As a part of the purchase accounting for the Company's acquisitions, a
present value of insurance in force 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.
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 utilizing expected future cash
flows. 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, "Accounting and Reporting by Insurance
Enterprises for Certain Long-Duration Contracts and for Realized Gains and
Losses from Sales of Investments." To the extent that these variances indicate
that future cash flows will differ from those included in the original scheduled
amortization of the present value of insurance in force, future amortization may
be adjusted.
71
<PAGE>
Information related to the present value of insurance in force is as
follows:
<TABLE>
<CAPTION>
1999 1998 1997
-------- -------- --------
<S> <C> <C> <C>
Balance as of January 1 ........................................ $170,729 $263,889 $339,010
Addition due to acquisition, including $1,235 of unrealized loss -- 58,564 --
Accretion of interest .......................................... 14,497 4,693 20,371
Amortization ................................................... (37,537) (42,848) (68,094)
Transfer pursuant to reinsurance transaction ................... 5,144 -- (2,291)
Impairment for Business Held for Sale .......................... -- (98,164) --
Impairment related to recoverability analysis associated with
subsequent sale of Payroll Sales Division .................... (67,617) -- --
Unrealized investment (gain) loss adjustment ................... 34,550 14,025 (24,444)
Foreign currency translation adjustment ........................ -- (333) (663)
Amounts transferred to assets of Businesses Held for Sale ...... -- (25,987) --
Reduction due to sale of block of business and other ........... -- (3,110) --
-------- -------- --------
Balance as of December 31 .................................... $119,766 $170,729 $263,889
======== ======== ========
</TABLE>
Expected gross amortization of the present value of insurance in force,
based upon current assumptions and accretion of interest at a policy liability
or contract rate ranging from 3.5 to 14.5 percent, for the next five years is as
follows:
Beginning Gross Accretion Net
Balance Amortization of Interest Amortization
------- ------------ ----------- ------------
2000 .............. $119,766 $ 19,743 $ 5,871 $ 13,872
2001 .............. 105,894 16,799 5,162 11,637
2002 .............. 94,257 14,583 4,519 10,064
2003 .............. 84,193 12,751 3,943 8,808
2004 .............. 75,385 11,031 3,441 7,590
(8) FUTURE POLICY BENEFITS
The liability for future policy benefits consists of reserves for fixed
benefit, life and accumulation products. For interest sensitive life and annuity
products, the liability for future policy benefits is equal to the accumulated
fund value. Fund values are equal to the premium received and interest credited
to the fund value less deductions for mortality costs and expense charges.
Current declared interest rates credited range from 4.0 to 6.75 percent.
Mortality costs and expense charges are established by the Company based upon
its experience and cost structure and in accordance with policy terms.
For traditional life products, the liability for future policy benefits is
based primarily upon Commissioners' Standard Ordinary Tables with interest rates
ranging from 2.5 to 6.0 percent. Fixed benefit products establish a liability
for future policy benefits equal to the excess of the present value of future
benefits to or on behalf of the policyholder over the future net premium
discounted at interest rates ranging primarily from 4.5 to 8.0 percent.
Traditional life products and fixed benefit products future policy benefits may
also be determined using Company experience as to mortality, morbidity and
lapses with a provision for adverse deviation. The Company may vary assumptions
by year of policy issue.
72
<PAGE>
The Company is continually evaluating actuarial assumptions associated
with interest sensitive life insurance contracts in which the determination of
policy reserves is highly sensitive to assumptions such as withdrawal rates,
investment earnings rates, mortality rates, and premium persistency. Currently
reflected in the Company's financial statements are policy reserves and account
values associated with such contracts, which aggregated approximately $527.1
million and $525.4 million as of December 31, 1999 and 1998, respectively. If
developing trends were to continue, principally the less than expected level of
the lapses currently associated with such interest sensitive blocks of business,
the Company would be required to record additional reserves or reduce intangible
assets, which could have a material impact on the Company's financial position
and results of operations. A decrease of 1% in the assumed lapse rate would
increase policy reserves associated with such contracts by $9.0 million.
Management is also assessing the potential impact of future management actions,
which might mitigate the financial impact of these trends. Types of management
actions would likely include, but are not limited to, the redetermination of
non-guaranteed charges and/or benefits under the contracts, asset segmentation,
and reinsurance. There are risks associated with management action including
potential sales disruption and the threat of litigation. During 1999, the
Company modified certain assumptions associated with the blocks of business
including lowering the aggregate expected lapse rate. In addition, the Company
is pursuing a plan to continue charging certain non-guaranteed expense loads
associated with certain interest sensitive life insurance contracts. As a result
of the actions, the Company increased the amount of reserves associated with
these policies by approximately $6,200 during the fourth quarter of 1999.
Total future policy benefits consist of the following as of December 31,
1999 and 1998:
1999 1998
---------- ----------
Future policy benefits on traditional products:
Traditional life insurance contracts ........ $ 736,931 $ 670,321
Health ...................................... 13,629 10,824
Unearned premiums ........................... 1,809 730
Other policyholder funds .................... 73,411 69,247
---------- ----------
825,780 751,122
Interest sensitive products:
Universal life .............................. 1,353,224 1,420,306
Annuities ................................... 528,184 609,915
---------- ----------
1,881,408 2,030,221
Policy and contract claims:
Health ...................................... 13,231 13,073
Life and other .............................. 36,538 25,245
---------- ----------
Total future policy benefits ............... $2,756,957 $2,819,661
========== ==========
The following table presents information on changes in the liability for
health claims for the years ended December 31:
<TABLE>
<CAPTION>
1999 1998 1997
-------- -------- --------
<S> <C> <C> <C>
Claim liability as of January 1 ........................ $ 14,463 $125,005 $130,392
Less reinsurance recoverables ........................ 1,390 5,848 2,242
-------- -------- --------
Net balance as of January 1 ......................... 13,073 119,157 128,150
-------- -------- --------
Addition due to acquisition ............................ -- 26,229 --
-------- -------- --------
Add claims incurred during the year related to:
Current year ......................................... 8,125 116,170 60,727
Prior years .......................................... 1,217 31,545 6,344
-------- -------- --------
Total claims incurred ............................... 9,342 147,715 67,071
-------- -------- --------
Less claims paid during the year related to:
Current year ......................................... 3,687 57,370 28,268
Prior years .......................................... 5,497 65,736 47,796
-------- -------- --------
Total claims paid ................................... 9,184 123,106 76,064
-------- -------- --------
Less reduction for liabilities of Business Held for Sale -- 156,922 --
Net balance as of December 31 .......................... 13,231 13,073 119,157
Plus reinsurance recoverables ........................ 678 1,390 5,848
-------- -------- --------
Claim liability as of December 31 ................... $ 13,909 $ 14,463 $125,005
======== ======== ========
</TABLE>
As a result of changes in estimates of insured events in prior years and
changes in methodology (described below), the liability for health policy and
contract claims increased net of reinsurance by $1,217 in 1999, $31,545 in 1998
and $6,344 in 1997.
73
<PAGE>
The Company closely monitored the development of its claim reserve
experience associated with the Career Sales Division. The historical method of
establishing claims reserves principally utilized claims lag factors. Based on
results of independent calculations of the claim lag factors, performed
annually, this methodology indicated a deterioration in the adequacy of claim
reserves associated with Penn Life's disability income products underwritten
prior to PennCorp's ownership of Penn Life. Disability claim adequacy analysis
included statutory claim information, independent third-party review of claim
lag method and factors and other claim tests. Previous results indicated no
reason to consider a new methodology as results appeared consistent between
periods and claim reserves appeared adequate. Once results of such analysis
began to vary outside an acceptable tolerance, the Company reviewed its methods
to determine the reasons for the variances.
The lag factor method (an actuarial method to estimate aggregate claims
reserves which utilizes the ratio of actual claims paid to what is ultimately
paid as a function of time since the date incurred based upon historical
experience) is one method which utilized Penn Life's experience considering its
products and market. The Company believes that available industry data for
establishing claim reserves was not appropriate for Penn Life's products and
market. The utilization of a case reserve method (which estimates aggregate
claims reserves based on the total estimates of all cases outstanding) for Penn
Life required experience, in addition to that utilized by the lag factor method,
to create case reserves based on Penn Life's experience. This experience was not
sufficient until 1998. With system upgrades, Penn Life was able to obtain better
benefit data distinguishing disability benefits from other benefits which may be
payable under the same policy form. With the systems upgrades and more robust
experience the Company was able to consider a more refined claims methodology
such as seriatim case reserves (which estimates aggregate claims reserves based
upon the sum of estimates for each individual unsettled case). During 1998, Penn
Life implemented a method which substituted case reserves for most disability
claims. The new method utilizes more detailed information by policy and by line
of business resulting in a more refined estimate. As a result, the accident and
health claim reserve for Penn Life increased by $25,691 during 1998. The effect
of the change in methodology is inseparable from the effect of the change in
accounting estimate and is accordingly reflected in operations for the year
ended December 31, 1998.
(9) NOTES PAYABLE
The outstanding principal amounts of the notes payable consist of the
following as of December 31:
<TABLE>
<CAPTION>
1999 1998
-------- --------
<S> <C> <C>
Unsecured 9 1/4% Senior Subordinated Notes due 2003(a) $114,646 $114,646
Bank Credit Facility maturing 2000(b) ................ 165,000 434,000
Other ................................................ -- 2,277
-------- --------
$279,646 $550,923
======== ========
</TABLE>
--------------
(a) Interest costs under the Unsecured 9 1/4% Senior Subordinated Notes
due 2003 (the "Notes") totaled $10,605, $10,622 and $11,461 during
1999, 1998 and 1997, respectively. As of December 31, 1999, the
effective rate for the Notes was approximately 9 1/4%.
(b) Interest costs under the $450,000 credit facility totaled $25,523,
$30,680 and $9,188 during 1999, 1998 and 1997. The effective rate of
interest as of December 31, 1999 was approximately 10.4%. In addition,
the Company pays facility fees of $15 per month. During 1997, the
Company had a $175,000 bank credit facility for which it incurred
interest costs of $1,855.
The aggregate maturities of notes payable during each of the five years
after December 31, 1999, are as follows: 2000, $165,000; and 2003, $114,646.
Covenants and Liquidity. The Notes and the bank credit agreement (the
"Bank Credit Facility") impose certain covenants on the Company, including
covenants restricting the amount of additional indebtedness the Company may
incur, limit its ability to engage in future acquisitions and certain other
business transactions, and the amount of dividends the Company may declare and
pay (see Note 12), and requires the Company to maintain specified financial
ratios and meet specified financial tests.
On March 31, April 30, May 14, June 25 and June 30, 1999, the Company
entered into amendments (the "amendments") to its existing Bank Credit Facility.
The amendments included additional covenants and revised certain financial
covenants to the Bank Credit Facility. In addition, the amendments changed,
among other things, the maturity date of the Bank Credit Facility to May 2000,
extensions of dates for cash sweeps, principal payments and certain available
commitments.
74
<PAGE>
Significant additional covenants included in the March 31 and June 25,
1999 amendments required the Company to repay indebtedness at specified dates
and amounts throughout 1999. The timing and required debt reduction were as
follows:
Date Amount
---- ------
Upon sale of Professional $ 40,000
Upon sale of United Life Assets 127,000
Upon sale of KIVEX 22,000
Upon sale of Career Sales Division 78,000
The required debt reduction of $40,000 was made on April 1, 1999, with
proceeds from the sale of Professional, and the required debt reduction of
$127,000 was made on April 30, 1999, with proceeds from the sale of the United
Life Assets. Additional debt reduction of $22,000 was made on June 30, 1999,
upon the completion of the sale of KIVEX. The Company repaid the final $78,000
of debt reduction requirements on July 30, 1999, upon the completion of the sale
of the Career Sales Division. On September 23, 1999, the Company repaid an
additional $2,000 of indebtedness as a result of liquidity at the parent company
above amounts prescribed in the Bank Credit Facility, as amended.
In anticipation of the filing of the Chapter 11 case, the Company and the
lenders party to the Bank Credit Facility executed a forbearance agreement
("Forbearance Agreement") whereby the lenders agreed to forbear from exercising
their remedies under the Bank Credit Facility as a result of the event of
default that occurred under the Bank Credit Facility when the Company commenced
the Chapter 11 case. In connection with the commencement of the Chapter 11 Case,
the Bank Credit Facility was superseded by a Cash Collateral Agreement dated as
of February 8, 2000 (as amended, the "Cash Collateral Agreement"), by and among
the Company, the lenders from time to time party thereto and The Bank of New
York, as administrative agent. The Cash Collateral Agreement provides a
mechanism for the Company to repay its currently outstanding borrowings and
establishes certain covenants with which the Company must comply until all of
the Company's outstanding loans (plus interest thereon) are repaid. Certain
covenants strictly define the Company's ability to utilize any and all cash that
is maintained in the cash collateral account held by the agent lender. As a
result, the Company may utilize cash from the cash collateral account for only
predetermined types of expenses and in specified amounts. On February 10, 2000,
the Company, the lenders party thereto and The Bank of New York, as
administrative agent, executed Amendment No. 1 to Cash Collateral Agreement
("Amendment No. 1"), in order to provide for the establishment of a custody
account to provide for the investment of the Company's funds which are in the
possession of The Bank of New York (and over which it has a lien) through a
custody account maintained at The Bank of New York, all as required by the
Bankruptcy Court.
Management believes the Company will likely have sufficient financial
flexibility and projected liquidity sources to meet all cash requirements until
the maturity of the cash collateral agreement on May 31, 2000. The Company is in
the process of a plan of reorganization which was filed with the Delaware
Bankruptcy Court on April 5, 2000 which provides for the repayment of such
indebtedness (see Note 23). With respect to current liquidity projections, there
can be no assurances actual liquidity sources will develop. In the event of a
shortfall of actual liquidity sources, and as a result of the necessity of the
Company to establish a new credit facility, the Company will explore options to
generate any necessary liquidity, such as: (i) the sale of subsidiaries and (ii)
obtaining regulatory approval for extraordinary dividends from its insurance
subsidiaries (which is unlikely at the present time). If the Company is unable
to obtain sufficient liquidity to meet its projected cash requirements, such
failure could result in a default on one or more obligations and the holders
thereof would be entitled to exercise certain remedies, including the
acceleration of the maturity of the entire indebtedness and commencing legal
proceedings to collect the indebtedness. In such event, the Company will examine
and consider the range of available alternatives to the Company at that time
(see Notes 3 and 23).
Extraordinary Charges. For the year ended December 31, 1998, the Company
realized an after-tax extraordinary charge of $1,671 which represents the
write-off of the deferred financing costs associated with the refinance of a SW
Financial existing note that the Company assumed as a part of the acquisition of
SW Financial Controlling Interest.
(10) INCOME TAXES (BENEFITS)
The Company and a number of its non-insurance subsidiaries file a
consolidated federal income tax return. The life insurance subsidiaries file
federal income tax returns with either PLAIC, or Pioneer Security, or
Constitution (sold July 30, 1999) as the parent of the particular consolidated
life insurance company tax group.
75
<PAGE>
Total income taxes (benefits) were allocated as follows for the years
ended December 31:
<TABLE>
<CAPTION>
1999 1998 1997
------- -------- --------
<S> <C> <C> <C>
Income (loss) before income taxes, equity in
earnings of unconsolidated affiliates and
extraordinary charge ...................... $28,709 $ (3,369) $ 20,375
Extraordinary charge ....................... -- (900) --
------- -------- --------
$28,709 $ (4,269) $ 20,375
======= ======== ========
</TABLE>
The provisions for income tax expense (benefit) attributable to income
(loss) before income taxes, equity in earnings of unconsolidated affiliates and
extraordinary charge are as follows for the years ended December 31:
1999 1998 1997
-------- -------- --------
Current U.S. ................. $ (2,226) $(12,031) $ 3,775
Current foreign .............. 1,067 778 3,598
Deferred U.S. ................ 30,934 10,108 10,984
Deferred foreign ............. (1,066) (2,224) 2,018
-------- -------- --------
Income tax expense (benefit) $ 28,709 $ (3,369) $ 20,375
======== ======== ========
Taxes (benefits) computed using the federal statutory rate of 35% are
reconciled to the Company's actual income tax expense (benefit) attributable to
income (loss) before extraordinary charge as follows for the years ended
December 31:
<TABLE>
<CAPTION>
1999 1998 1997
--------- --------- ---------
<S> <C> <C> <C>
Tax expense (benefit) computed at statutory rate .................. $ (60,201) $(148,620) $ 18,040
Dividends received deduction ...................................... (216) (268) (1,450)
Amortization of costs in excess of net assets acquired ............ 4,661 3,678 3,341
Impairment of intangibles related to sale of Payroll Sales Division 33,432 -- --
Impairment on assets held for sale ................................ 20,292 116,886 --
Change in valuation allowance ..................................... 38,890 23,492 (525)
Foreign taxes net of U.S. tax benefit ............................. -- (181) 263
Sale of subsidiaries .............................................. (13,360) -- --
Other ............................................................. 5,211 1,644 706
--------- --------- ---------
Income tax expense (benefit) .................................... $ 28,709 $ (3,369) $ 20,375
========= ========= =========
</TABLE>
Temporary differences between the financial statement carrying amounts and
tax bases of assets and liabilities that give rise to the deferred tax assets
and liabilities relate to the following as of December 31:
<TABLE>
<CAPTION>
1999 1998
------------------------ ----------------------
Deferred Deferred Deferred Deferred
Tax Tax Tax Tax
Assets Liabilities Assets Liabilities
--------- ----------- --------- -----------
<S> <C> <C> <C> <C>
Deferred policy acquisition costs ................ $ -- $ 10,758 $ -- $ 21,536
Present value of insurance in force .............. -- 35,447 -- 55,248
Future policy benefits ........................... 92,164 -- 106,212 --
Net operating losses ............................. 47,462 -- 41,081 --
Capital losses ................................... 41,428 -- 2,630 --
Unrealized gain/loss on investment securities .... 33,765 -- -- 16,890
Other ............................................ 22,798 -- 33,132 --
--------- --------- --------- ---------
237,617 46,205 183,055 93,674
Valuation allowance .............................. (83,674) -- (44,784 --
--------- --------- --------- ---------
$ 153,943 $ 46,205 $ 138,271 $ 93,674
========= ========= ========= =========
</TABLE>
76
<PAGE>
The valuation allowance for deferred tax assets as of December 31, 1999
and 1998, was $83,674 and $44,784, respectively. The net change in the total
valuation allowance for the years ended December 31, 1999 and 1998, was an
increase of $38,890 and $23,492, respectively. The valuation allowance
associated with tax assets is continually monitored by the Company in light of
the dramatic changes in the operating structure and financial results of the
Company. As a result of such analysis the Company increased the valuation
allowances by $38,890 and $23,492 during 1999 and 1998, respectively. In each of
the periods, the valuation allowance was incurred as the result of the increased
likelihood that certain net operating losses and capital loss carryforwards
would not be utilized and the impact or potential impact of a "change in
control" as defined by the Internal Revenue Code Section 382. Change of control
provisions of Section 382 could limit the Company's ability to utilize certain
tax benefits including net operating loss carryforwards in future periods.
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. Management believes it is
more likely than not that the Company will realize the remaining benefits of
these deductible differences, net of the existing valuation allowance as of
December 31, 1999.
As of December 31, 1999, a valuation allowance has not been established
for the deferred tax asset relating to the unrealized loss on investment
securities. Management believes that the recognition of these unrealized losses
can be managed through a tax planning strategy of holding the investment
securities to maturity or until market conditions improve.
The Company's recording of impairment provisions associated with the sale
of the Payroll Sales Division results in a reduction in deferred tax liabilities
of $41,050 during 1999 related to such assets. The Company's recording of
impairment provisions associated with the Businesses Held for Sale results in a
reduction in deferred tax liabilities of $95,137 during 1998 related to such
assets.
As of December 31, 1999, the Company has life consolidated net operating
loss carryforwards of approximately $55,681 for tax return purposes which, if
not utilized, will begin to expire in 2004. The Company has life consolidated
capital loss carryforwards of approximately $13,545 which, if not utilized, will
begin to expire in 2000. In addition, Pioneer Security has acquired net
operating loss carryforwards of approximately $8,693. The utilization of
acquired net operating loss carryforwards is limited in any one year to the
lesser of (i) the Pioneer Security life insurance group's consolidated taxable
income or (ii) OLIC's taxable income computed on a separate return basis. The
acquired net operating loss carryforwards will begin to expire in 2003.
As of December 31, 1999, the Company has non-life consolidated net
operating loss carryforwards of approximately $71,232 for tax purposes which, if
not utilized, will begin to expire in 2012. As of December 31, 1999, the Company
also has non-life consolidated capital loss carryforwards of approximately
$104,820 for tax purposes which, if not utilized, will expire in 2004.
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. In addition, on February 7, 2000, the
Clinton administration released its Fiscal Year 2001 Budget which included a
revenue raising provision that would require life insurance companies to include
the balance of these special deductions in income over a five year period as of
the beginning of the first taxable year starting after the date of enactment. At
this time, it is uncertain whether this provision will be included in any
legislation proposed by Congress, and if included, whether such provision would
be enacted into law. As it is not currently considered likely that a tax would
become due on any such balances, no deferred income taxes have been provided.
However, if such tax were to become payable, it would amount to approximately
$14,805.
77
<PAGE>
(11) COMPUTATION OF EARNINGS (LOSS) PER SHARE
The following is a reconciliation of net income (loss) applicable to
common stock as well as common stock used to compute basic and diluted earnings
(loss) per share for the years ended December 31:
<TABLE>
<CAPTION>
1999 1998 1997
--------- --------- ---------
<S> <C> <C> <C>
Reconciliation of net income (loss) applicable to common stock:
Basic net income (loss) applicable to common stock:
Net income (loss) applicable to common stock before
extraordinary charge ..................................... $(218,537) $(439,532) $ 30,607
Redemption of Series C Preferred Stock ..................... -- (1,913) --
--------- --------- ---------
(218,537) (441,445) 30,607
Extraordinary charge .................................... -- (1,671) --
--------- --------- ---------
$(218,537) $(443,116) $ 30,607
========= ========= =========
Diluted net income (loss) applicable to common stock:
Net income (loss) applicable to common stock before
extraordinary charge ..................................... $(218,537) $(439,532) $ 30,607
Redemption of Series C Preferred Stock ..................... -- (1,913) --
--------- --------- ---------
(218,537) (441,445) 30,607
Extraordinary charge .................................... -- (1,671) --
--------- --------- ---------
$(218,537) $(443,116) $ 30,607
========= ========= =========
<CAPTION>
1999 1998 1997
------- ------- -------
<S> <C> <C> <C>
Common stock used to compute basic and diluted earnings (loss)
per share:
Basic:
Shares outstanding beginning of period ...................... 30,072 28,860 28,648
Incremental shares applicable to Stock Warrants/Stock Options 68 374 143
Acquisition of the Fickes and Stone Knightsbridge Interests . 173 346 --
Redemption of Series C Preferred Stock ...................... -- 521 --
Treasury shares ............................................. (959) (1,010) (775)
------- ------- -------
29,354 29,091 28,016
======= ======= =======
Diluted:
Shares outstanding beginning of period ...................... 30,072 28,860 28,648
Incremental shares applicable to Stock Warrants/Stock Options 68 374 772
Acquisition of the Fickes and Stone Knightsbridge Interests . 173 346 --
Redemption of Series C Preferred Stock ...................... -- 521 --
Treasury shares ............................................. (959) (1,010) (775)
------- ------- -------
29,354 29,091 28,645
======= ======= =======
</TABLE>
(12) COMMON AND PREFERRED STOCK
At December 31, 1999 the Company had 100,000,000 shares of $.01 par value
common stock authorized and 30,143,416 shares issued and outstanding. The common
stock has no preemptive or other subscription rights and there are no conversion
rights, redemption or sinking fund provisions with respect to such shares.
A portion of the consideration for the acquisition of the Fickes and Stone
Knightsbridge Interests included 173,160 shares of the Company's Common Stock
due each of Messrs. Fickes and Stone on April 15, 2001. As a result of the
acquisition, common stock and additional paid in capital increased $3 and
$8,497, respectively, for the year ended December 31, 1998. Common shares due
Mr. Stone were issued during 1998.
During the year ended December 31, 1999, the Company issued 188,235 shares
of treasury stock to the Chairman of the Board of Directors as a part of a
special bonus award. The result was to decrease additional paid in capital and
treasury shares by $1,447 and $1,562, respectively. In addition, the Company
recorded compensation expense of $115.
78
<PAGE>
During 1999, the Company issued 71,072 shares to certain members of the
Board of Directors as compensation. During the year ended December 31, 1998,
certain employees exercised stock options and warrants resulting in the issuance
of 616,572 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 $2,014,
respectively.
During the year ended December 31, 1998, 83,260 stock options were
exercised and issued to certain employees as discounted restricted common stock
of the Company with vesting periods of three and four years. During the year
ended December 31, 1998, the Company recognized $2,751 of deferred compensation,
associated with the issuance of this common stock. For the years ended December
31, 1999 and 1998, the Company recognized $180 and $2,267, respectively, of
compensation expense. As of December 31, 1999, the balance of deferred
compensation was $304 and was recorded as a reduction to shareholders' equity.
Associated with the restructuring and the consolidation of all corporate
functions into the Company's Dallas location, certain employees were severed.
For the year ended December 31, 1998, notes receivable secured by 7,500 shares
of common stock were discharged and 9,051 and 88,280 shares of common stock were
abandoned as a result of the severance during 1999 and 1998, respectively. The
result was to increase treasury stock, and decrease notes receivable secured by
common stock, $261. During 1999, the Company reversed previously accrued
interest on notes receivable secured by common stock totaling $146.
The Company has issued 2,875,000 shares of $50 redemption value
(liquidation preference, $50 plus accrued and unpaid dividends) $3.50 Series II
Convertible Preferred Stock (the "Series II Convertible Preferred Stock"). 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. As of December 31, 1999, the
estimated fair value of the Series II Convertible Preferred Stock, based upon
market-maker quotes, was $35,765 or $12.44 per share.
The Company has issued 2,300,000 shares of $50 redemption value
(liquidation preference, $50 plus accrued and unpaid dividends) $3.375
Convertible Preferred Stock (the "Convertible Preferred Stock"). 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. As of December 31, 1999, the estimated fair value
of the Convertible Preferred Stock, based upon active market quotes, was $27,600
or $12 per share.
As of December 31, 1999 and 1998, the cumulative accrued and unpaid
dividends on the $3.375 Convertible Preferred Stock amounted to $11,321 and
$3,558, respectively. As of December 31, 1999 and 1998, the cumulative accrued
and unpaid dividends on the $3.50 Convertible Preferred Stock amounted to
$14,255 and $4,193, respectively.
The Company suspended the payment of cash dividends during the third
quarter of 1998 on its outstanding $3.375 Convertible Preferred Stock, $3.50
Series II Convertible Preferred Stock and Common Stock. Under the amended terms
of the Company's Bank Credit Facility the Company may not pay dividends on its
Common Stock or Preferred Stock issues. Under the terms of the two series of
convertible preferred stock, if dividends are in arrears for six or more
quarterly dividend periods (whether or not consecutive), the holders of the
convertible preferred stock, voting as a single class, will have the right to
elect two directors of the Company. In addition, for as long as there are
dividend arrearages on the convertible preferred stock, the Company will be
prohibited from paying dividends on the Common Stock or purchasing, redeeming or
otherwise acquiring Common Stock.
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 Security Life purchase price. The Series B Preferred Stock and
the Series C Preferred Stock were mandatorily redeemable on or before June 30,
1997 and June 30, 1998, respectively. On March 15, 1997, the Company redeemed
all of the previously outstanding Series B preferred stock at its stated
redemption value of $14,705. Effective March 31, 1998, the Company redeemed all
of the outstanding Series C Preferred Stock into 691,528 shares of the Company's
Common Stock under provisions of the Series C Preferred Stock certificate of
designation. The result of such redemption was to increase common stock and
additional paid in capital by $7 and $22,220, respectively, as well as reduce
retained earnings by $1,913 reflecting the difference between the reported and
redemption amounts of the Series C Preferred Stock. Such difference is reflected
in both the basic and diluted earnings per share calculation for the year ended
December 31, 1998.
(13) STOCK OPTIONS AND WARRANTS
79
<PAGE>
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 warrant 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 agreements effective July 1998, the Company issued to the
Chairman of the Board of Directors as well as the three senior officers of the
Company, an aggregate of 1,550,000 stock appreciation rights at $3.88 per share.
The stock appreciation rights provide compensation to each individual in an
amount equal to the excess of the fair value of each stock appreciation right
over the fair value of each stock appreciation right at the date of grant.
Compensation, if any, is payable in either shares of common stock of the Company
or cash, at the election of the recipient. As of December 31, 1999, there has
been no compensation expense accrued associated with these stock appreciation
rights.
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 and as such no compensation is
recorded.
The Company had established in 1995 a U.S. Sales Manager incentive stock
option plan in which the senior sales manager of one of the Company's former
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 vested 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 and as such no compensation
expense is recorded.
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>
1999 1998 1997
-------------------- -------------------- -------------------
<S> <C> <C> <C> <C> <C> <C>
Number of shares subject to option/warrant:
Outstanding at beginning of year ........ 3,429,477 $ 24.70 3,344,477 $ 21.73 1,984,049 $ 11.56
Granted ................................. -- $ -- 1,244,072 $ 29.93 1,565,500 $ 32.34
Expired/cancelled ....................... (895,717) $ 28.81 (542,500) $ 30.11 (46,303) $ 11.41
Exercised ............................... -- $ -- (616,572) $ 14.36 (158,769) $ 7.97
--------- ------- --------- ------- --------- -------
Outstanding at end of year ............. 2,533,760 $ 22.40 3,429,477 $ 24.70 3,344,477 $ 21.73
========= ========= =========
Exercisable at end of year ................ 2,369,006 $ 21.71 2,649,446 $ 22.47 2,037,067 $ 15.38
========= ========= =========
Available for future grant at end of year . 1,550,937 726,292 1,488,460
========= ========= =========
</TABLE>
The following table summarizes information concerning outstanding and
exercisable options and warrants as of December 31, 1999:
<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>
$ 4.00 - $ 4.00 570,760 0.64 $ 4.00 570,760 $ 4.00
$15.00 - $23.50 505,000 2.65 $16.75 505,000 $16.75
$27.25 - $38.40 1,458,000 1.11 $31.56 1,293,246 $31.46
--------- ---------
2,533,760 2,369,006
========= =========
</TABLE>
80
<PAGE>
As allowed under the provisions of SFAS No. 123, the Company utilizes APB
Opinion No. 25 and related Interpretations in accounting for its stock option
and warrant plans and, accordingly, does not recognize compensation cost based
on fair value as a component of net income applicable to common stock. If the
Company had elected to recognize compensation cost based on the fair value of
the options and warrants as of the grant date, estimated utilizing the
Black-Scholes multiple options approach prescribed by SFAS No. 123, the
Company's net income (loss) applicable to common stock as well as earnings
(loss) per share would have been reduced by the pro forma amounts indicated in
the following table:
<TABLE>
<CAPTION>
1999 1998 1997
--------- --------- ---------
<S> <C> <C> <C>
Reconciliation of net income (loss) applicable to common stock:
Basic net income (loss) applicable to common stock:
Net income (loss) applicable to common stock before
extraordinary charge (as reported) ........................... $(218,537) $(439,532) $ 30,607
Redemption of Series C Preferred Stock ..................... -- (1,913) --
--------- --------- ---------
(218,537) (441,445) 30,607
Extraordinary charge ....................................... -- (1,671) --
--------- --------- ---------
Net income (loss) applicable to common
stock (as reported) ..................................... (218,537) (443,116) 30,607
Pro forma compensation expense, net of tax benefits ........ (2,269) (10,836) (10,229)
--------- --------- ---------
Net income (loss) applicable to common stock (pro forma) .. $(220,806) $(453,952) $ 20,378
========= ========= =========
Diluted net income (loss) applicable to common stock:
Net income (loss) applicable to common stock before
extraordinary charge (as reported) .......................... $(218,537) $(439,532) $ 30,607
Redemption of Series C Preferred Stock ..................... -- (1,913) --
--------- --------- ---------
(218,537) (441,445) 30,607
Common stock equivalents:
Convertible preferred stock dividend requirements ......... -- -- --
--------- --------- ---------
(218,537) (441,445) 30,607
Extraordinary charge ....................................... -- (1,671) --
--------- --------- ---------
Net income (loss) applicable to common
stock (as reported) ..................................... (218,537) (443,116) 30,607
Pro forma compensation expense, net of tax benefits ........ (2,269) (10,836) (10,229)
--------- --------- ---------
Net income (loss) applicable to common stock (pro forma) .. $(220,806) $(453,952) $ 20,378
========= ========= =========
Per share information:
Basic net income (loss) applicable to common stock:
Net income (loss) applicable to common stock before
extraordinary charge (as reported) ........................... $ (7.44) $ (15.17) $ 1.09
Extraordinary charge ....................................... -- (0.06) --
--------- --------- ---------
Net income (loss) applicable to common
stock (as reported) ..................................... (7.44) (15.23) 1.09
Pro forma compensation expense ............................. (0.08) (0.37) (0.37)
--------- --------- ---------
Net income (loss) applicable to common stock (pro forma) .. $ (7.52) $ (15.60) $ 0.72
========= ========= =========
Common shares used in computing basic earnings (loss) per share . 29,354 29,091 28,016
========= ========= =========
Diluted net income (loss) applicable to common stock:
Net income (loss) applicable to common stock before
extraordinary charge (as reported) ........................... $ (7.44) $ (15.17) $ 1.07
Extraordinary charge ....................................... -- (0.06) --
--------- --------- ---------
Net income (loss) applicable to common
stock (as reported) ..................................... (7.44) (15.23) 1.07
Pro forma compensation expense ............................. (0.08) (0.37) (0.36)
--------- --------- ---------
Net income (loss) applicable to common stock (pro forma) .. $ (7.52) $ (15.60) $ 0.71
========= ========= =========
Common shares used in computing diluted earnings (loss) per share 29,354 29,091 28,645
========= ========= =========
</TABLE>
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The fair value of each option and warrant grant used to determine the pro
forma amounts indicated in the previous table is estimated on the date of grant
using the following weighted average assumptions for 1999, 1998 and 1997:
1999 1998 1997
------ ------ ------
Weighted average risk-free interest rate..... -- % 6.06% 6.34%
Weighted average dividend yields............. -- % -- % -- %
Volatility factors........................... -- 0.83 .61
Weighted average expected life (years)....... -- 1.90 4.50
Weighted average fair value per share........ $ -- $ 15.02 $ 15.67
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options having no vesting restrictions and
are fully transferable. In addition, option valuation models require the input
of highly subjective assumptions including the expected stock price volatility.
As employee stock options and warrants have characteristics significantly
different from those of traded options, and because changes in subjective
assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not provide a reliable single measure of the
fair value of employee stock options and warrants. As SFAS No. 123 is effective
only for awards granted after January 1, 1995, the pro forma disclosures
provided above may not be representative of the effects on reported net income
for future years.
(14) 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, Constitution (sold July 30, 1999) and
Pioneer Security (collectively, the "Surplus Note Companies"). The surplus
debentures issued by PLAIC and Constitution were paid in full in connection with
the consummation of the sale of the Career Sales Division. In connection with
the acquisition of Southwestern Life from SW Financial which was part of a
subsidiary realignment, PLAIC issued a new surplus debenture to SW Financial in
the amount of $150,000. With respect to Constitution, Pioneer Security and PLAIC
(as a result of its surplus debenture issued as of July 30, 1999), the surplus
debenture payments have been made to non-insurance intermediate holding
companies and paid to the Company in the form of dividends and tax sharing
payments. The amounts outstanding under the surplus debentures totaled $258,335
and $453,118 as of December 31, 1999 and 1998, respectively. These surplus
debentures generally require (subject to availability of statutory capital and
surplus and in some instances, regulatory approval) principal and interest
payments to be made quarterly.
Statutes in Texas, the domiciliary state of the Company's insurance
subsidiaries owned at December 31, 1999, restrict the payment of dividends by
insurance companies to the available surplus funds derived from their net
profits. The maximum amount of cash dividends that may be declared without
regulatory approval in any twelve-month period is the greater of ten percent
(10%) of the insurer's statutory surplus, as shown by its last annual statement
on file with the Texas Department of Insurance, or one hundred percent (100%) of
statutory net gain from operations for the preceding year. In addition,
dividends may only be paid from earned surplus. After considering the
extraordinary dividends of $21,897 paid on January 31, 2000, Southwestern Life
and Security Life, the Company's principal insurance subsidiaries (excluding the
Payroll Sales Division which was sold on February 4, 2000), will be able to pay
$2,244 in dividends in 2000 to PLAIC, without prior regulatory approval.
Statutory capital and surplus of the Company's life insurance subsidiaries
as reported to regulatory authorities at December 31, 1999 and 1998, totaled
$253,435 and $399,766, respectively. Statutory net income (loss) of the
Company's life insurance subsidiaries as reported to regulatory authorities
totaled $116,134, ($44,563) and $18,776 for the years ended December 31, 1999,
1998 and 1997, respectively. The 1999 statutory net income included gains on
sales of subsidiaries totaling $127,435. Surplus note interest expense of
$34,599, $40,531 and $34,758 for the years ended December 31, 1999, 1998 and
1997, respectively, is included in statutory net income (loss).
In December 1992, the NAIC adopted the RBC for Life and/or Health Insurers
Model Act (the "Model Act"). The main purpose of the Model Act is to provide a
tool for insurance regulators to evaluate the capital of insurers with respect
to the risks assumed by them and determine whether there is a need for possible
corrective action with respect to them. To date, neither the Model Act or
similar legislation or regulation has been adopted by Texas.
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The Company's insurance subsidiaries are required, at least annually, to
perform cash flow and "Asset Adequacy Analysis" under differing interest rate
scenarios. At December 31, 1999 and 1998, Southwestern Life failed certain of
those cash flow testing scenarios. As a result, Southwestern Life performed a
series of expanded tests. Based upon the results of these expanded tests,
Southwestern Life has determined that additional statutory reserves were not
needed at December 31, 1999 or 1998. Factors that may require Southwestern Life
to establish additional statutory reserves in future periods include changes in
interest rates, timing of the emergence of insurance profits, persistency of the
insurance in force, sales or reinsurance of blocks of insurance in force and
mortality experience. Management actions that may mitigate the need for these
additional reserves may include but are not limited to, new profitable business
being added to the insurance in force, reinsurance or actions that impact
persistency, mortality experience, interest spreads and costs to administer the
insurance in force. Southwestern Life monitors these factors to determine if
additional statutory reserves will be required.
Calculations using the NAIC formula and the life insurance subsidiaries'
statutory financial statements as of December 31, 1999, indicate that each of
the insurance subsidiaries' capital exceeded Company Action Level RBC
requirements.
(15) RETIREMENT AND PROFIT SHARING PLANS
During 1998, the Company implemented SFAS No. 132, "Employer's Disclosures
about Pensions and Other Postretirement Benefits." This accounting standard
revised the disclosure requirements for pensions and other postretirement
benefit plans, but does not change the measurement or financial statement
recognition of such plans.
On October 1, 1990, the Company established the PennCorp Financial, Inc.
Retirement and Savings Plan, a defined contribution retirement plan, for
eligible employees. This plan and the Marketing One Incorporated 401(k) Profit
Sharing Plan merged with the Southwestern Financial Services Corporation Savings
Investment Plan effective January 1, 1998 and the name of the plan was changed
to the PennCorp Financial Group, Inc. Retirement and Savings Plan ("the PennCorp
Plan"). Employees are eligible to participate in the plan after six months of
employment in which they are credited with 500 hours of service. Participants
may contribute from 1 to 15% of pre-tax compensation and/or from 1 to 10% of
after tax compensation. Each subsidiary participating in the plan matches each
pay-period, 50% of pre-tax contributions up to 6% of compensation. If approved
by the Board of Directors, each subsidiary may make a discretionary profit
sharing contribution annually on behalf of employees eligible to participate in
the plan based on their compensation for the prior plan year. Employee
contributions are fully vested at all times. The employer matching contributions
made for employees who participated in the PennCorp Plan prior to January 1,
1998 vest at the rate of 50% per calendar year of service. The employer matching
contributions made for all other participants and the employer discretionary
contribution vests at the rate of 20% per year of service. All participants are
fully vested at death, disability or attainment of age 65. The assets of each
account are invested at the direction of the participant. Eleven funds with
various investment objectives are available to the participants. Distributions
are normally made in a lump sum. Participants of the PennCorp Plan prior to
January 1, 1998 may elect to receive an annuity in various forms of payment.
Expenses related to this plan for years ended December 31, 1999, 1998 and 1997
amounted to $1,468, $3,341 and $1,483. During 1999 and 1998, the sales of
Businesses Held for Sale and restructuring constituted a partial plan
termination of the PennCorp Plan. As a result, terminated employees became fully
vested.
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 achievement of
specified operating objectives and the performance of eligible participants. The
Company recognized expense of $1,875, $3,390 and $1,417 under this plan during
the years ended December 31, 1999, 1998 and 1997, respectively.
In May 1998, the three senior executives of the Company entered into two
year employment agreements with the Company which have various annual bonus,
deferred payment and termination provisions. As of December 31, 1999, the
Company had accrued liabilities aggregating $1,800 for the annual 1999 bonus and
$8,252 for deferred compensation provisions, respectively associated with these
employment agreements. The deferred compensation provisions are payable upon the
earliest of: expiration of the employment agreement; termination of the
executive by the Company without cause; or termination by the executive for
"good reason" as defined in the employment agreements (see Note 23).
The Company and certain of its subsidiaries provide certain postretirement
benefits to eligible retirees. The plans provide 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 benefits is unfunded. Following is an
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<PAGE>
analysis of the accumulated benefit obligation and the liability for accrued
postretirement benefits for the year ended December 31, 1999 and 1998:
1999 1998
------ ------
Benefit obligation at beginning of year...... $26,602 $10,380
Service cost................................. 283 184
Interest cost................................ 1,384 1,533
Plan participants' contributions............. 238 364
Actuarial (gain) loss........................ (2,826) 1,975
Acquisition/sale............................. (4,717) 14,827
Benefit paid................................. (2,342) (2,661)
------- -------
Benefit obligation at end of year........... $18,622 $26,602
======= =======
The liability for accrued benefit obligation includes the following at
December 31, 1999 and 1998:
1999 1998
------ ------
Accumulated benefit obligation............... $18,622 $26,602
Unrecognized prior service cost.............. 108 162
Unrecognized transition obligation........... (2,029) (5,185)
Unrecognized actuarial loss.................. 4,290 827
------- -------
Benefit obligation at end of year........... $20,991 $22,406
======= =======
At December 31, 1998, the accumulated benefit obligation and the liability
for accrued postretirement benefits included $4,717 and $933, respectively,
related to Businesses Held for Sale.
Components of net periodic benefit cost include the following for the year
ended December 31, 1999 and 1998:
1999 1998
------ ------
Service cost................................. $ 229 $ 130
Interest cost................................ 1,407 1,533
Amortization of transition obligation........ 158 657
Recognized net actuarial loss................ (125) (108)
------- -------
Net periodic benefit cost................... $ 1,669 $ 2,212
======= =======
For measurement purposes, an annual rate increase ranging from 5.5% to 7%
in the health care cost trend rate was assumed for 1999; the rate was assumed to
decrease gradually to 4% by year 2015 and remain at that level thereafter. The
weighted average discount rates used in determining the accumulated
postretirement benefit obligation ranged from 6.5% to 7.5%. The health care cost
trend rate assumption has a significant effect on the amounts reported. A
one-percentage-point change in assumed health care cost trend rates would have
the following effects:
One One
Percentage Percentage
Point Point
Increase Decrease
---------- ----------
Effect on total of service and interest cost components.. $ 160 $ (142)
Effect on postretirement benefit obligation.............. 1,014 (917)
(16) ASSETS AND LIABILITIES OF BUSINESSES HELD FOR SALE
As a result of the Company's announcement of its decision to sell the
Career Sales Division, KIVEX, Professional and the United Life Assets within a
period not likely to exceed one year, the assets and liabilities of the Career
Sales Division, KIVEX, Professional and the United Life Assets were reported as
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<PAGE>
"Assets of Businesses Held for Sale" and "Liabilities of Businesses Held for
Sale" at December 31, 1998 in the accompanying consolidated balance sheet (see
Note 3). The assets and liabilities of Businesses Held for Sale at December 31,
1998 were as follows:
Invested assets.............................. $1,842,749
Insurance assets............................. 329,950
Other assets................................. 244,884
----------
Total assets............................... $2,417,583
==========
Insurance liabilities........................ $1,853,163
Other liabilities............................ 210,149
----------
Total liabilities.......................... $2,063,312
==========
During 1999 and 1998 the Company recorded impairment provisions
aggregating $58,486 and $342,960, respectively, associated with Businesses Held
for Sale. The Company recorded an impairment provision in order to reflect the
difference in the Company's accounting basis in the Businesses Held for Sale and
the fair value of the consideration that the Company would be likely to receive
for such businesses.
The fair value of the consideration likely to be received was based
primarily upon the terms of definitive sales agreements. The impairment
provisions recorded in 1999 for the Career Sales Division resulted from a
renegotiation of the purchase and sell agreement which included a decrease in
the nominal purchase consideration of $38,000 which was partially offset by an
estimated discount to the stated value of the note to be received. In addition,
impairment provision included the impact of the true-up of statutory capital and
surplus of the Career Sales Division companies to levels specified in the sale
agreement which aggregated approximately $24,218. Other factors modestly
impacting the impairment provision included additional transaction costs,
changes in unrealized gains and losses of securities, foreign currency
translation and net income not considered in the determination of sale
consideration. The Company realized a foreign currency transaction loss on the
sale of the Career Sales Division totaling $24,978, which represented previously
unrealized translation losses on the Company's Canadian insurance operations,
partially offset by a gain of $3,126 on the disposition resulting in a net loss
of $21,852.
The Company impaired costs in excess of net assets acquired for the Career
Sales Division, Professional and the United Life Assets in 1998 by $100,138,
$3,263 and $11,113, respectively. To the extent that the impairment provision
exceeded the balance of costs in excess of net assets acquired associated with
each company to be disposed, additional impairment was necessary, as was the
case for the Career Sales Division, the Company reduced other intangible assets
in accordance with APB No. 17. As a result, the Company fully impaired the
present value of insurance in force and deferred policy acquisition costs
resulting in charges of $98,164 and $191,595, respectively, net of related
deferred taxes of $95,137. Additionally, the Company established a liability
aggregating $33,824 for the remaining impairment as a result of all monetary
assets of the Career Sales Division being recorded at fair value.
As of July 30, 1999, sales of all of the Businesses Held for Sale had been
completed. During the three months ended June 30, 1999, the Company concluded
that it would retain, and shut down over time, certain remaining operations of
Marketing One. The related financial statement accounts of Marketing One which
included assets and liabilities of $4,221 and $3,242, respectively, at December
31, 1998 have been reclassified out of Assets and Liabilities of Businesses Held
for Sale.
(17) PRO FORMA FINANCIAL INFORMATION
The following unaudited selected pro forma financial information has been
prepared to illustrate the pro forma effects of the sales of Payroll Sales
Division (sold February 4, 2000) (see Notes 3 and 23), Career Sales Division
(sold July 30, 1999), KIVEX (sold June 30, 1999), the United Life Assets (sold
April 30, 1999) and Professional (sold March 31, 1999) . The pro forma
statements of operations for the years ended December 31, 1999 and 1998 give
effect to such sales as if they had occurred on January 1, 1998. The unaudited
selected pro forma financial information has been prepared for comparative
purposes only and does not purport to be indicative of what would have occurred
had such purchases and sales been made as of January 1, 1998, or results which
may occur in the future.
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<PAGE>
(Unaudited)
---------
As Reported Pro Forma
1999 1999
----------- ---------
(In thousands, except
per share amounts)
Total revenues................................. $ 636,640 $ 318,467
Loss before extraordinary charge............... (200,712) (72,144)
Loss before extraordinary charge applicable
to common stock............................. (218,537) (89,969)
Per share information:
Net loss before extraordinary charge
applicable to common stock-basic........... $ (7.44) $ (3.06)
Net loss before extraordinary charge
applicable to common stock-diluted......... (7.44) (3.06)
(Unaudited)
---------
As Reported Pro Forma
1998 1998
----------- ---------
(In thousands, except
per share amounts)
Total revenues................................. $ 879,995 $ 340,498
Income (loss) before extraordinary charge...... (421,259) (70,282)
Income (loss) before extraordinary charge
applicable to common stock................... (439,532) (88,555)
Per share information:
Net income (loss) before extraordinary
charge applicable to common stock-basic.... $ (15.17) $ (3.04)
Net income (loss) before extraordinary charge
applicable to common stock-diluted......... (15.17) (3.04)
(18) RELATED PARTY TRANSACTIONS
Related party transactions described herein include those transactions not
included elsewhere in the Notes to Consolidated Financial Statements.
Southwestern Life owns 66,555 shares of redeemable preferred stock of
Portsmouth Financial Group, Inc. ("Portsmouth") with a carrying value of $5,063
as of December 31, 1999 as of December 31, 1999. Portsmouth underwrites,
acquires and ultimately receives the benefits payable under life insurance
contacts covering individuals facing terminal illnesses. Portsmouth's common
equity was owned by KB Fund and its affiliates and certain former and current
executive officers of the Company.
As of December 31, 1999 and 1998, the Company had invested a total of
$13,462 and $12,641, respectively, in transactions sponsored by Wand Partners
L.L.C. ("Wand Partners") in which a director of the Company is a managing
member. The Company has committed to invest up to an additional $7,038 in future
transactions sponsored by Wand Partners.
During 1999, 1998 and 1997, the Company's insurance subsidiaries paid
management and commitment fees aggregating $488, $718 and $444, respectively, to
investment funds managed by a former member of the Board of Directors.
On September 1, 1997, the Company, through its insurance subsidiaries,
purchased $25,000 of ACO Acquisition Corp. (subsequently re-named Acordia, Inc.
("Acordia") subordinated indebtedness and the Company purchased $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. Acordia was 28.6% owned by KB
Investment Fund I, LP (formerly Knightsbridge Capital Fund I, L.P.) (the "KB
Fund"). PennCorp received fees aggregating $1,100 in 1997 from Acordia for its
underwriting and participation in the subordinated notes and preferred stock
offering. Knightsbridge Management, L.L.C. ("KM") received sponsor fees and
other fees aggregating $1,714 in 1997 from Acordia for its role in consummating
the Acordia acquisition. During 1998 the Company liquidated its common and
preferred stock holdings in ACO. Total proceeds received from the sale of the
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<PAGE>
preferred and common stock aggregated $30,500. The Company had acquired the
common stock interest in January 1998 for $5,000 as part of the Company's and
the KB Fund investment in ACO.
For the year ended December 31, 1997 (prior to the purchase of the Fickes
and Stone Knightsbridge Interests in January 1998), PennCorp paid or accrued
$2,385 in transaction fees and expenses to KM related to the Washington
National, United Life and SW Financial transactions, respectively. During 1997,
certain of the Company's affiliates and subsidiaries paid management fees to KM
amounting to $5,325. SW Financial and United Life incurred KM investment
advisory fees totaling $4,358 during 1997.
During 1997, payments aggregating $250 were made for actuarial services
provided in connection with the Company's acquisition activity to a company,
whose chairman is a shareholder and director of the Company.
(19) 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 $2,769,
$5,299 and $ 5,178 in 1999, 1998 and 1997, respectively.
Minimum lease commitments for the Businesses Owned at December 31, 1999
are:
2000......................................... $ 2,724
2001......................................... 2,576
2002......................................... 2,568
2003......................................... 2,376
2004......................................... 2,242
2005 and thereafter.......................... 6,118
-------
Total minimum payments required........... $18,604
=======
During the third quarter of 1998, the first of ten class-action complaints
was filed in the United States District Court for the Southern District of New
York ("District Court") against the Company and certain of its current or former
directors and officers.
During a pre-trial conference on November 9, 1998, all parties agreed to
the consolidation of all of the actions and the Court appointed lead plaintiffs
on behalf of shareholders and noteholders. The Court also approved the selection
of three law firms as co-lead counsel for shareholders and noteholders. A
consolidated and amended complaint was filed on January 22, 1999. A First
Consolidated Amended Class Action Complaint naming, as defendants, the Company,
David J. Stone, formerly a director and Chairman and Chief Executive Officer,
and Steven W. Fickes, formerly a director and President and Chief Financial
Officer was filed on March 15, 1999 (the "Complaint").
The Complaint alleges that defendants violated the Securities Exchange Act
of 1934. Among other things, plaintiffs claim that defendants issued a series of
materially false and misleading statements and omitted material facts regarding
the Company's financial condition, including the value of certain of its assets,
and failed to timely disclose that it was under investigation by the Securities
and Exchange Commission (the "SEC").
Plaintiffs seek to recover damages in unspecified amounts on behalf of
themselves and all other purchasers of the Company's common stock and purchasers
of the Company's subordinated notes during the period of February 8, 1996,
through November 16, 1998.
During a conference on March 19, 1999, defendants sought and were granted
permission to file, and subsequently filed, a motion to dismiss the Complaint.
Although there are no assurances that the motion to dismiss will be granted,
management believes that there are meritorious defenses to the action that were
raised in connection with the motion, including whether the Complaint adequately
pleads scienter (i.e., intent to defraud) as required under the Private
Securities Litigation Reform Act of 1995.
The Company has notified its primary and excess carriers of directors and
officers liability insurance of the existence of the claims set forth in the
Complaint, and the total potential insurance available is $15,000 of primary and
$10,000 of excess coverage, respectively, for securities claims. The primary
insurance coverage requires the Company to bear 25% of: (i) all expenses and
(ii) any losses in excess of a $1,000 retention amount. The primary and excess
87
<PAGE>
carriers have reserved their rights under the policies with respect to coverage
of the claims set forth in the Complaint. As explained below, the primary
insurer has agreed in principle to contribute to a settlement of the litigation.
Following settlement discussions with the Plaintiffs' counsel and
representatives of the primary insurance carrier and their counsel, the parties
to the Complaint entered into a Memorandum of Understanding dated November 11,
1999 (the "Memo") containing the essential terms of a settlement.
The Memo states that $9,000 of cash plus interest accruing through the
date of consummation of the settlement, will be paid in full and final
settlement of all claims set forth in the Complaint (the "Settlement"). Of that
sum, $1,500 plus interest will be paid by the Company and $7,500 plus interest
will be paid by the Company's outside directors and officers liability insurance
carrier. The Settlement is conditioned upon, among other things, confirmatory
discovery, execution of a definitive settlement agreement and related documents,
notice to the Company's shareholders of the Settlement and final approval by the
United States District Court (with all time to appeal such approval having run
or any appeals having been resolved in favor of approval of the Settlement).
During the three months ended December 31, 1999, the Company paid the $1,500
liability related to the settlement to an escrow account.
The Company expects that this litigation will not affect its ability to
operate through 2000. While it is not feasible to predict or determine the final
outcome of these proceedings or to estimate the amounts or potential range of
loss with respect to these matters, management believes that if the Settlement
is not consummated and there is an adverse outcome with respect to such
proceedings, it would have a material adverse impact on the Company and affect
its ability to operate as is currently intended.
In May 1998, the North Carolina Attorney General's Office (the "NCAG")
initiated an inquiry concerning certain life insurance products historically
sold by Security Life and representations allegedly made by Security Life's
agents and officers with respect to not charging insurance charges after the
eighth policy year for non-smoker insureds. The NCAG indicated that Security
Life may be estopped to change its current practice of not charging the cost of
the insurance for non-smoking policyholders because of certain representations
made by agents and officers of Security Life. Although Security Life has not
charged the cost of insurance charges for non-smoker policyholders who reached
their ninth policy year, this practice is not guaranteed under the life
insurance contracts. The contracts specifically allow Security Life the right to
change the cost of insurance rates in accordance with the parameters set forth
in the insurance contracts. Security Life has responded to the NCAG's inquiry by
denying that it is estopped from changing the cost of insurance rates based on
the alleged representations, and continuing to reserve its contractual rights to
charge the cost of insurance rates in accordance with the parameters set forth
in the insurance contracts. In June 1998, the NCAG informed Security Life that
it could not adjudicate this matter and left it mutually unresolved. In June
1999, the North Carolina Department of Insurance ("NCDOI") asked Security Life
about the status of its current practice of not charging cost of insurance
charges after the eighth contract year for non-smokers on these same insurance
products and requested to be informed if Security Life changes its current
practice. Security Life has responded to the NCDOI's inquiry by verifying that
no decision has been made to date to change such current practice and such
practice has not changed; and affirming that the NCDOI would be notified in the
event this current practice changes. The Company has initiated an exchange
program which enables policyholders of such life insurance products to terminate
their policies and, in exchange for the termination of the original policy and a
release, obtain either (i) the refund of all premiums paid and other
consideration or (ii) another Security Life product. On November 5, 1999,
Security Life was served with an Original Petition filed in state court in
Dallas County, Texas, asserting a class action concerning such policies. The
petition alleges that Security Life has waived the right to charge cost of
insurance charges after the eighth year on such non-smoker policies and to
increase cost of insurance charges on such smoker policies. The petition alleges
Security Life made these waivers through its marketing pieces and signed
statements by its officers. The petition also alleges that not all of the facts
were outlined in the Company's communication to its policyholders outlining the
exchange program and therefore alleges Security Life's exchange program is
deceptive. The petition asks for declaratory judgment concerning the rights of
the Plaintiffs, and the class of policyholders of such policies and for
attorney's fees. It, among other things, asks for an injunction to prevent
Security Life from charging cost of insurance charges for such non-smoker
policies or increasing cost of insurance charges on such smoker policies after
the eighth contract year. It also asks the Court to rule the releases signed by
such policyholders under the exchange program be declared null and void and
those policyholders who signed the releases be given the option of reinstating
the prior policies. Security Life denies the allegations in the petition and
intends to vigorously defend this lawsuit. The trial court in which this case is
pending has granted class certification in at least one other lawsuit involving
similar types of claims. There can be no assurances that the exchange program
will be successful or that the Company will resolve these matters on such life
insurance products on a satisfactory basis, or at all, or that any such
resolution would not have a material adverse effect on the Company's financial
condition, results of operations or cash flows.
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On July 30, 1998, the SEC notified the Company that it had commenced a
formal investigation into possible violations of the federal securities laws
including matters relating to the Company's restatement of its financial
statements for the first six months of 1997, and for the years ended December
31, 1994, 1995 and 1996. The Company and its management are fully cooperating
with the SEC in its investigation.
The Company is a party to various other pending or threatened legal
actions arising in the ordinary course of business, some of which include
allegations of insufficient policy illustration 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.
The life insurance subsidiaries of the Company 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 in accordance with
Statement of Position 97-3 issued by the AICPA, "Accounting by Insurance and
Other Enterprises for Insurance-Related Assessments." The Company periodically
evaluates the accruals for future assessments net of future premium tax
reductions at its life insurance subsidiaries. During 1999, the Company reduced
the accrual approximately $3,500 as a result of completing its evaluation of
third party guaranty fund assessment data on a corporate-wide basis, including
the impact of the dispositions of the Businesses Held for Sale.
Many computer and software programs were designed to accommodate only two
digit fields to represent a given year (e.g. "98" represents 1998). It was
highly likely that such systems could not have been able to accurately process
data containing date information for the year 2000 and beyond. The Company is
highly reliant upon computer systems and software as are many of the businesses
with which the Company interacts. The Company's ability to service its
policyholders and agents is dependent upon accurate and timely transaction
processing. Transaction processing in turn is dependent upon the Company's
highly complex interdependent computer hardware, software, telecommunications
and desktop applications. The inability of the Company or any of its integral
business partners to complete year 2000 remediation efforts associated with
these highly complex and interdependent systems could have led to a significant
business interruption. Such an interruption could have resulted in a decline in
current and long-term profitability and business franchise value.
The Company's overall year 2000 compliance initiatives, included the
following components: (i) assessment of all business critical systems (business
critical systems includes computer and other systems), processes and external
interfaces and dependancies; (ii) remediation or upgrading of business critical
systems; (iii) testing of both modified and updated systems as well as
integrated systems testing; (iv) implementation of modified and updated systems;
and (v) contingency planning. As a part of the process, the Company has written
letters and corresponded with its outside vendors and critical business partners
concerning year 2000 compliance efforts and has followed up periodically.
The Company engaged outside vendors and focused certain employees' full
time efforts to help in the full array of its year 2000 initiative. This
included systems assessment and monitoring advice, actual code remediation,
communication and consultation with critical business partners and additional
data center and testing resources. The Company originally projected to incur
internal and external costs associated with such expertise ranging from $10,600
to $14,500, which were anticipated to be incurred primarily during 1998 and
early 1999. The Company actually incurred internal and external costs of $8,000
million during 1999. The Company estimates it has incurred internal and external
costs aggregating $13,400 and $1,900 million for the years ended December 31,
1998 and 1997, respectively.
Since December 31, 1999 the Company has not experienced any significant
disruption in the Company's business, or an increase in the cost of the Company
doing business related to the year 2000 issue.
The Company provided certain representations and warranties to each
respective purchaser of the businesses sold with respect to each entity's
ability to process date-sensitive information for the year 2000 and beyond.
Although the Company believes that it is in compliance with, and is not aware of
any breach of the year 2000 representations and warranties provided to the
respective purchasers, there can be no assurances that the Company is in
compliance with all such representations and warranties. A breach by the Company
of such representations and warranties could result in indemnification
obligations owed by the Company to the purchasers.
Each of the definitive purchase and sale agreements the Company has
consummated for Professional, the United Life Assets, KIVEX, the Career Sales
Division and the Payroll Sales Division, contain indemnification provisions
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<PAGE>
which survive the closing of each sales transaction for varying periods of time.
The indemnification provisions would be invoked by the purchasers should the
Company be found in breach of certain representation and warranty provisions or
upon the occurrence of specified events contained in the purchase and sale
agreements. The Company has purchased representations and warranty insurance to
cover potential indemnification claims arising under each of the definitive
purchase and sale agreements in an aggregate amount of $20,000 for all
indemnification claims.
At December 31, 1999, the Company's insurance subsidiaries had outstanding
commitments to invest up to $10,185 in various limited partnership funds and
other investments.
As of December 31, 1999, the Company sold substantially all of the
mortgages originally held by United Life but retained by the Company as a part
of the Sale of the United Life Assets. The Company may be obligated to
repurchase certain of the mortgages sold. The amount of mortgages the Company
may be required to repurchase is not expected to exceed approximately $1,600. At
December 31, 1999, the Company has established a $1,200 liability related to
these contingencies.
In addition, the Company has been notified by ING that it disputes certain
federal income tax calculations under the provisions of the related purchase and
sale agreement. Under the provisions of the purchase and sale agreement ING is
to provide the Company with preliminary tax returns in order for the Company to
evaluate any potential differential in tax amounts between closing and the final
return preparation. To date ING has not provided such preliminary tax returns
and hence the Company has not been able to fully evaluate the merits of ING's
claim. At December 31, 1999, the Company has established a liability of $1,151
related to this contingency.
At December 31, 1999, the Company had a contingent obligation for mortgage
loans previously sold aggregating $4,884 as a result of the Company acting as a
servicing conduit.
(20) 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. 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:
1999 1998 1997
------- ------- -------
Direct policy revenues and amounts assessed
against policyholders...................... $423,030 $586,317 $375,538
Reinsurance assumed.......................... 2,492 6,018 2,527
Reinsurance ceded............................ (86,648) (133,177) (32,499)
-------- -------- -------
Net premiums and amounts earned............ $338,874 $459,158 $345,566
======== ======== ========
Policyholder benefits ceded.................. $ 70,397 $109,079 $33,612
======== ======== ========
Fees incurred for financial reinsurance were approximately $372, $675, and
$145 during 1999, 1998 and 1997, respectively.
(21) RESTRUCTURING AND OTHER COSTS
The Company has developed restructuring plans to realign or consolidate
certain operations resulting in restructuring costs incurred during 1999, the
fourth quarter of 1998, the first quarter of 1998 and 1997.
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1999 Plan
As a result of the sale of the United Life Assets along with other
non-core operations, the Company announced a restructuring plan in June 1999 to
significantly reduce its Dallas-based staff and vacate certain office space. The
Company incurred restructuring costs aggregating $5,307 for the nine months
ended September 30, 1999 associated with such restructuring.
The following reflects the impact of activity for the year ended December
31, 1999 on the restructuring accrual balances under the 1999 Plan:
<TABLE>
<CAPTION>
Paid or
Charged Balance at
1999 Against December 31,
Provision Liability Adjustments 1999
--------- --------- ----------- -----------
<S> <C> <C> <C> <C>
Severance and related benefits................. $ 3,185 $ (663) $ (148) $ 2,374
Estimated holding costs of vacated facilities.. 2,122 -- -- 2,122
-------- ------- ------- -------
$ 5,307 $ (663) $ (148) $ 4,496
======== ======= ======= =======
</TABLE>
The 1999 plan provided for the termination of 50 employees consisting of
divisional management and staff in Dallas over a nine month period. As of
December 31, 1999, the Company had paid and charged $663 against the accrual for
severance and related benefits for 32 terminated employees. Substantially all of
the remaining terminations will occur by March 31, 2000.
The 1999 plan also provided for vacating additional floors of the
Company's Dallas leased offices. The restructuring provision of $2,122
represented the estimated net present value of the rent on the office space to
be vacated net of the estimated sublease rental income to be received by the
Company.
4th Quarter 1998 Plan
In the fourth quarter of 1998, the Company recorded restructuring costs
aggregating approximately $9,274 as a result of the decision to consolidate or
merge substantially all of the Company's corporate functions into the Dallas
infrastructure.
The following reflects the impact of activity for the years ended December
31, 1999 on the restructuring accrual balances under the 4th Quarter 1998 Plan:
<TABLE>
<CAPTION>
1998 Activities 1999 Activities
--------------------- ----------------------
Paid or Paid or
Charged Balance at Charged Balance at
1998 Against December 31, Against December 31,
Provision Liability Adjustments 1998 Liability Adjustments 1999
--------- --------- ----------- ------------ --------- ----------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Severance and related benefits....... $6,259 $(3,985) $ -- $ 2,274 $(1,396) $ 189 $ 1,067
Estimated holding costs of
vacated facilities................ 2,954 (2,954) -- -- -- -- --
Estimated contract terminations
costs............................. 61 (29) -- 32 (40) 8 --
------ ------- ------ ------- ------- ------ -------
$9,274 $(6,968) $ -- $ 2,306 $(1,436) $ 197 $ 1,067
====== ======= ====== ======= ======= ====== =======
</TABLE>
The fourth quarter 1998 plan provided for the termination of 43 employees
including substantially all of the executive and administrative employees in the
Company's Bethesda and New York offices, based on the Company's decision to shut
down the Bethesda and New York offices by May 31, 1999. Substantially all of the
severance has been paid with the exception of one former executive officer whose
severance is to be paid monthly through April 2001. The Company had incurred
costs of $1,396 and $3,985 which were charged against the accrual during 1999
and 1998, respectively, for terminated employees.
The fourth quarter 1998 plan recognized abandoned leasehold improvement
costs in connection with the Company's plan to sublease or vacate the New York
offices. The Company expensed $2,954 principally as a result of abandoning the
New York leased property.
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<PAGE>
1st Quarter 1998 Plan
On January 2, 1998, and January 5, 1998, respectively, the Company
acquired the SW Financial Controlling Interest and the Fickes and Stone
Knightsbridge Interest. The acquisition allowed the Company to complete its
divisional restructuring which began in 1997. As a result, the Company incurred
restructuring costs aggregating approximately $11,767 for the year ended
December 31, 1998, associated with the divisional restructuring.
The following reflects the impact of activity for the years ended December
31, 1999 and 1998 on the restructuring accrual balances under the 1st Quarter
1998 Plan:
<TABLE>
<CAPTION>
1998 Activities 1999 Activities
--------------------- ----------------------
Paid or Paid or
Charged Balance at Charged Balance at
1998 Against December 31, Against December 31,
Provision Liability Adjustments 1998 Liability Adjustments 1999
--------- --------- ----------- ------------ --------- ----------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Severance and related benefits....... $3,831 $(4,417) $ 1,205 $ 619 $ (297) $ (322) $ --
Estimated holding costs of
vacated facilities................ 2,205 -- -- 2,205 (350) (41) 1,814
Write-off of certain fixed assets... 1,131 (831) (300) -- -- -- --
Estimated contract terminations
costs............................. 4,600 (3,247) (1,353) -- -- -- --
------- ------- ------ ------ ------ ------ ------
$11,767 $(8,495) $ (448) $2,824 $ (647) $ (363) $1,814
======= ======= ====== ====== ====== ====== ======
</TABLE>
Approximately 120 and 39 people, respectively, were estimated to be
terminated, as a result of the decision to transfer all operations of Union
Bankers to Raleigh and transfer operations of United Life from Baton Rouge to
Dallas. In addition, the Company also restructured certain of the operations in
Raleigh. Certain employees in the areas of customer services, information
technology, actuarial, legal, human resources and other policyholder service
areas, totaling 54 people were considered for termination under the Raleigh
portion of the restructuring plan. The Company recognized severance costs
totaling $3,831. The Company charged $297 and $4,417 against the severance
accrual during 1999 and 1998, respectively, as the result of termination
payments. In addition, during 1999 and 1998 the Company adjusted the severance
accrual in the amount of $322 and $405, respectively, due to the Company paying
less severance costs as a result of natural attrition and other factors such as
inter-company transfers of employees. During 1998, the Company also increased
the severance accrual by $1,610 as a result of the decision to terminate all 54
of Security Life's Raleigh-based employees.
The first quarter 1998 restructuring plan provided for vacating certain
Dallas office space. In connection with the plan, the Company recorded estimated
holding costs of vacated facilities of $2,205 which represented the net present
value of the rent on the office space to be vacated net of the estimated
sublease rent to be received. During 1999, the Company charged $350 of rent
expense on vacated office space against the accrual.
The first quarter 1998 plan also recognized impairment of certain
furniture, fixture and data processing equipment totaling $1,131 which had been
utilized in the office space to be vacated. The Company charged $831 of such
assets against the accrual during 1998.
As part of the first quarter 1998 restructuring plan, the Company
terminated an information technology outsourcing agreement. The original
contract termination fee was $4,600. As a result of an amendment to the
termination agreement, the Company exited the agreement for a payment of $3,247
and the remaining accrual was adjusted during 1998.
1997 Plan
The Company has experienced significant changes in the past three years.
As a result of integration of acquired businesses and material changes to the
Company's operating platform, the Company began a strategic business evaluation
in the third quarter of 1996. The review resulted in the Company establishing
three divisional platforms, Career Sales Division, Payroll Sales Division and
Financial Services Division.
As a result, the Company began to realign its existing operating companies
and incurred restructuring costs aggregating approximately $19,071 during the
year ended December 31, 1997, directly and indirectly associated with the
initial divisional restructuring which had no future economic benefit.
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<PAGE>
The following reflects the impact of activity for the years ended December
31, 1997 and 1998 on the restructuring accrual balances under the 1997 plan:
<TABLE>
<CAPTION>
1997 Activities 1998 Activities
--------------------- ----------------------
Paid or Paid or
Charged Balance at Charged Balance at
1997 Against December 31, Against December 31,
Provision Liability Adjustments 1997 Liability Adjustments 1998
--------- --------- ----------- ------------ --------- ----------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Severance and related benefits ....... $ 5,355 $ (2,411) $ (1,008) $ 1,936 $ -- $(1,936) $ --
Estimated holding costs of
vacated facilities ................. 6,166 (1,916) -- 4,250 (841) (3,409) --
Write-off of certain fixed assets .... 1,526 (332) (847) 347 -- (347) --
Estimated contract termination
costs ............................. 24 -- -- 24 -- (24) --
Investment in foreign operations ..... 6,000 (5,555) (445) -- -- -- --
------- -------- ------- ------- -------- ------- -------
$19,071 $(10,214) $(2,300) $ 6,557 $ (841) $(5,716) $ --
======= ======== ======= ======= ======== ======= =======
</TABLE>
The 1997 plan provided for the termination of approximately 269 employees
in the Company's Raleigh offices and certain foreign operations and
substantially all of the employees of the Company's Waco operations, totaling
114. The 1997 plan anticipated a significant consolidation of operations into an
affiliate's Dallas offices over a twelve month period. As of December 31, 1997,
the Company had charged $2,411 against the accrual for severance and related
benefits. The Company adjusted the remaining severance accrual by $1,008 during
1997 due to natural attrition thus reducing the level of severance required
coupled with the decision to retain certain employees indefinitely. As of
December 31, 1997, the severance accrual was $1,936 which was adjusted during
1998 as a result of the decision not to merge the Company's Waco operations into
Dallas.
The plan also provided for vacating of certain leased facilities and
abandoning certain Company owned real estate. The Company accrued $6,166 for
holding and abandonment costs associated with these facilities. During 1997, the
Company charged $1,916 to such accrued lease costs. During 1998, the Company
further charged $841 to the accrued costs. As of December 31, 1998, the
remaining accrual was no longer necessary as a result of the decision to retain
the Waco operating platform.
In addition, the 1997 plan recognized the impairment of certain furniture,
fixture and data processing equipment of $1,526 as a result of the decision to
abandon certain Company owned and leased facilities. During 1998 and 1997, the
Company charged off furniture, fixtures and data processing equipment totaling
$-- and $332, respectively, and adjusted the original impairment provision by
$347 and $847, respectively.
Contract termination costs provided in the 1997 plan were adjusted to zero
during 1998 as a result of the ultimate settlement of certain contracts without
penalty.
Restructuring charges in the 1997 plan also included a $6,000 provision
for the write-off of the Company's investment in certain foreign operations,
principally Argentina. In 1997, the Company disposed of the foreign operations
at a costs of $5,555 and the balance of $445 was adjusted to zero.
Other Costs
The Company did not incur incremental costs during 1999. The Company
incurred approximately $6,296 and $4,652 of pre-tax period costs ("period
costs") associated with the corporate restructuring for the years ended December
31, 1998 and 1997, respectively. Such costs are included in the Company's
Consolidated Statements of Operations and Comprehensive Income (Loss) as
underwriting and other administrative expenses.
On August 30, 1997, the merger agreement between Washington National
Corporation ("Washington National") and the Company terminated. The Company
incurred legal, accounting and financial advisory fees associated with the
merger. In addition, the Company had began to provide certain resources to
Washington National including personnel to perform policy administration and
claims processing function on Washington National's behalf. The aggregate
advisory and administrative costs incurred by the Company during 1997 were
$7,646.
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<PAGE>
(22) FINANCIAL INSTRUMENTS
The following is a summary of the carrying value and fair value of the
Company's financial instruments at December 31, 1999 and 1998:
<TABLE>
<CAPTION>
1999 1998
---------------------- ----------------------
Carrying Fair Carrying Fair
Value Value Value Value
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Assets:
Cash and cash equivalents ........................ $ 141,636 $ 141,636 $ 92,727 $ 92,727
Fixed maturities ................................. 2,363,690 2,363,690 2,589,714 2,589,714
Equity securities ................................ 2,008 2,008 2,035 2,035
Mortgage loans ................................... 20,032 20,285 36,882 38,865
Policy loans ..................................... 197,287 197,287 207,490 207,490
Other investments ................................ 26,570 26,570 27,406 27,406
Accounts and notes receivable .................... 11,935 11,935 14,319 14,319
Liabilities:
Notes payable .................................... 279,646 262,441 550,923 497,039
Universal life and investment contract liabilities 1,881,408 1,650,444 2,063,823 1,756,762
</TABLE>
The following methods and assumptions are used by the Company in
estimating its fair value disclosures for financial instruments:
Cash and Cash Equivalents, Accounts and Notes Receivable: The carrying
value approximates their fair value due to the short-term maturity of
these instruments.
Fixed Maturities Available for Sale and Equity Securities: The 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 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 Loans: The fair values 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.
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.
Other Investments: Other investments consist primarily of limited
partnerships and joint ventures. These are evaluated periodically.
Carrying value represents the underlying equity of the limited
partnerships or joint ventures of their cost which approximates fair
value.
Notes Payable: The carrying value for outstanding notes payable other than
the senior subordinated notes approximates the fair value as they carry
variable interest 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.
Universal Life and Investment Contract Liabilities: The fair value
of accumulation products approximates their cash surrender value.
(23) SUBSEQUENT EVENTS
On January 10, 2000, the Company announced that it had agreed to sell its
Payroll Sales Division to a company formed by Thoma Cressey Equity Partners for
approximately $102,000 subject to certain adjustments. On February 4, 2000, the
Company consummated the sale of the Payroll Sales Division for cash proceeds of
approximately $103,000. The Company used $100,000 of the proceeds to repay the
Bank Credit Facility. As a result of the sale, the Company recognized an
impairment loss of $95,522 which was recognized in the financial statements for
the year ended December 31, 1999.
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<PAGE>
Also on January 10, 2000, the Company announced that it had agreed to sell
its Financial Services Division to Reassure America Life Insurance Company
("Reassure America"), a subsidiary of Swiss Reinsurance Company of Zurich
("Swiss Re"), for $260,000 subject to certain adjustments, and accomplish such
transaction through the filing of a voluntary petition for relief under Chapter
11 ("Chapter 11") of title 11 of the United States Bankruptcy Code (the
"Bankruptcy Code").
On February 7, 2000 (the "Petition Date"), PennCorp filed a voluntary
petition for relief under Chapter 11 of the Bankruptcy Code in the United States
Bankruptcy Court for the District of Delaware (the "Bankruptcy Court"). Since
the Petition Date, PennCorp has continued to operate and manage its assets and
business as a debtor in possession as authorized by provisions of the Bankruptcy
Code.
On February 28, 2000 the Bankruptcy Court issued an order scheduling a
hearing to consider approval of the sale agreement with Reassure America,
subject to higher or better offers, and establishing the procedures for the
submission of competing offers ("Sales Procedure Order").
On March 15, 2000, the Company received a competing bid in the form of a
recapitalization plan submitted by Inverness/Phoenix Capital LLC ("Inverness")
and Vicuna Advisors, LLC ("Vicuna") on behalf of the unofficial ad hoc committee
of preferred stockholders, and Mr. Bernard Rapoport ("Rapoport") and Mr. John
Sharpe ("Sharpe") ("Recapitalization Plan"). On March 23, 2000 the Company's
Board of Directors selected the Recapitalization Plan as the final accepted
offer pursuant to the bidding procedures approved as part of the Sales Procedure
Order. On March 24, 2000, the Bankruptcy Court approved the Board of Director's
selection of the Recapitalization Plan.
The proposed Recapitalization Plan provides that the preferred
stockholders will receive one share of common stock of the reorganized company
for each share of outstanding preferred stock. In addition, the preferred
stockholders will have an opportunity, pursuant to a rights offering, to
purchase .3787 shares of common stock of the reorganized company for each share
of outstanding preferred stock owned at a purchase price of $12.50 per share.
Inverness and Vicuna have issued a standby commitment letter to the Company,
committing $24,500 to fully underwrite the rights offering. In addition,
Rapoport and Sharpe have committed to purchase equity in the recapitalized
company amounting to $20,000 and $3,000, respectively. The standby commitment
letter and the Rapoport and Sharpe investment are subject to certain conditions.
Under the Recapitalization Plan, all existing shares of the Company's
common stock will be cancelled for no value, and the Company's existing senior
and subordinated debt, with principal aggregating approximately $179,646 at
March 31, 2000, will be paid in full in cash. Any and all other claims and
liabilities of the Company will be paid in accordance with their terms.
Consummation of the recapitalization transaction is subject to certain
conditions including regulatory approvals, the consummation of a $95,000 credit
facility, the consummation of a proposed transaction whereby Southwestern Life
and Security Life will reinsure substantially all of their existing deferred
annuity blocks of business, an order confirming the Company's plan of
reorganization that incorporates the proposed recapitalization transaction shall
have been entered by the Bankruptcy Court and such order shall be unstayed and
in full force and effect, and the closing of the recapitalization shall occur no
later than December 31, 2000. The definitive agreements for the credit facility
and the reinsurance transaction will contain conditions to consummation
including no material adverse change as defined in the proposed $95,000 credit
agreement.
The Company has received irrevocable commitments from holders of
approximately 71 percent of the Company's two outstanding series of preferred
stock indicating that they will vote in favor of the Recapitalization Plan upon
solicitation by the Company which, when such shares are voted, will satisfy the
voting requirements for confirmation of a plan of reorganization. Inverness,
Vicuna, Rapoport and Sharpe have deposited an aggregate of $47,500 into an
escrow account, such that those funds will be used to make their respective
committed equity investments in the recapitalized company once the
Recapitalization Plan is consummated. A portion of such funds may be forfeited
to the Company under certain circumstances.
The Company filed plan of reorganization on April 5, 2000 and will seek
confirmation of the Recapitalization Plan by the Bankruptcy Court on June 5,
2000, with consummation expected to occur promptly thereafter.
Following the filing of PennCorp's Chapter 11 petition, the New York Stock
Exchange ("NYSE") suspended all trading in the Company's listed securities and
has applied to the Securities and Exchange Commission for the removal of the
Company's common stock and $3.375 convertible preferred stock listing and
registration on the NYSE.
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<PAGE>
In the first quarter of 2000, Portsmouth was reorganized and merged into
ROP Financial Group, a wholly-owned subsidiary of Southwestern Life. The common
equity was terminated with no value.
As part of a series of transactions approved by the Texas Department of
Insurance, Security Life became a wholly-owed subsidiary of PLAIC. In addition,
Southwestern Life and Security Life paid extraordinary dividends consisting of
affiliate notes and securities aggregating $15,461 and $14,167, respectively.
As a result of the agreements to sell the Payroll Sales Division,
Southwestern Life and Security Life, the three senior executives of the Company
became entitled to terminate their existing employment agreements for "Good
Reason" (as defined therein). In order to ensure the continued services of the
executives, on January 28, 2000, the Company entered into an agreement with each
executive, pursuant to which the Company and each executive terminated their
existing employment agreements and entered into new executive employment
agreements. As a result, the Company paid a total of $10,034 in employment
contract obligations to the three senior executives of the Company.
(24) UNAUDITED QUARTERLY FINANCIAL DATA
The following is a summary of the quarterly results of operations for the
years ended December 31, 1999 and 1998:
<TABLE>
<CAPTION>
(In thousands, except per share amounts)
1999 Quarter-ended March 31 June 30 September 30 December 31
- -------------------------------------------- ----------- ----------- ------------ -----------
<S> <C> <C> <C> <C>
Total revenues ............................. $ 214,099 $ 205,171 $ 112,806 $ 104,564
Net income (loss) applicable to common stock $ (46,111) $ (23,674) $ (32,554) $ (116,198)
Net income (loss) per share of common
stock - basic ............................ $ (1.58) $ (0.81) $ (1.11) $ (3.95)
Net income (loss) per share of common
stock - diluted .......................... $ (1.58) $ (0.81) $ (1.11) $ (3.95)
<CAPTION>
1998 Quarter-ended March 31 June 30 September 30 December 31
- -------------------------------------------- ----------- ----------- ------------ -----------
<S> <C> <C> <C> <C>
Total revenues ............................. $ 232,651 $ 227,888 $ 225,682 $ 193,774
Net income (loss) applicable to common stock $ (3,686) $ (163,904) $ (165,088) $ (108,525)
Net income (loss) per share of common
stock - basic ............................ $ (0.20) $ (5.60) $ (5.64) $ (3.71)
Net income (loss) per share of common
stock - diluted .......................... $ (0.20) $ (5.60) $ (5.64) $ (3.71)
</TABLE>
The Company's fourth quarter 1999 reported loss primarily resulted from
the impairment of intangibles totaling $95,522. The Company evaluated the
intangible assets of the Payroll Sales Division based upon the proceeds received
from the sale of the Payroll Sales Division on February 4, 2000 (see Notes 3 and
23). The Company increased the valuation allowances associated with tax assets
by $17,900 as the result of the increased likelihood that certain operating
losses and capital loss carryforwards would not be utilized and the impact or
potential impact of a "change in control" as defined by the Internal Revenue
Code Section 382.
The Company's fourth quarter 1998 reported loss primarily resulted from an
additional impairment provision associated with assets of Businesses Held for
Sale totaling $57,475. The Company unlocked actuarial assumptions of future
interest rates, lapses, expenses and mortality on interest sensitive blocks of
business (principally interest sensitive and deferred annuity products)
resulting in additional amortization of deferred policy acquisition costs and
present value of insurance in force amounting to approximately $16,250. Such
unlocking was necessary principally as a result of deteriorating persistency
associated with certain blocks of business in the Payroll Sales Division which
aggregated approximately $8,575. The remaining amortization resulted from the
application of current period assumptions (unlocking) for expenses and
persistency for the Financial Services Division. In addition, the Company
incurred restructuring costs of $7,228.
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<PAGE>
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, 1997 and the related
consolidated statements 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 audits.
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, 1997 and the results
of their operations and their cash flows for the year then ended in conformity
with generally accepted accounting principles.
KPMG Peat Marwick LLP
Dallas, Texas
March 19, 1998
97
<PAGE>
<TABLE>
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
as of December 31, 1997
(In thousands, except share information)
<CAPTION>
<S> <C>
ASSETS
Investments:
Fixed maturities available for sale at fair value
(cost $1,643,769) ........................................... $1,677,508
Equity securities available for sale at fair value
(cost $688) ................................................ 1,079
Mortgage loans on real estate, net of allowance of $680 ....... 51,070
Policy loans .................................................. 123,041
Short-term investments ........................................ 157,140
Real estate ................................................... 1,893
Other investments ............................................. 8,461
----------
Total investments ............................................ 2,020,192
Cash ............................................................ 6,576
Due from reinsurers ............................................. 109,051
Accrued investment income ....................................... 25,224
Accounts and notes receivable, net of allowance of $181 ......... 5,507
Present value of insurance in force ............................. 58,565
Deferred policy acquisition costs ............................... 30,606
Deferred income taxes, net ...................................... 34,746
Other assets .................................................... 19,025
Costs in excess of net assets acquired .......................... 115,388
----------
Total assets ................................................. $2,424,880
==========
LIABILITIES
Policy liabilities and accruals:
Future policy benefits on traditional products ................ $ 554,998
Universal life and investment contract liabilities ............ 1,315,496
Policy and contract claims .................................... 57,517
Other policyholder funds ...................................... 14,203
----------
Total policy liabilities and accruals ........................ 1,942,214
Federal income taxes payable .................................... 1,298
Notes payable ................................................... 154,750
Accrued expenses and other liabilities .......................... 97,211
----------
Total liabilities ............................................ 2,195,473
----------
Mandatorily redeemable preferred stock:
Series A 10%, $.01 par value, $100 redemption value; 500,000
shares authorized, 257,070 issued and outstanding ........... 25,707
5.5% preferred stock $.01 par value, $10,000 redemption
value; 2,000 shares authorized, 1,118 shares issued and
outstanding ................................................. 11,184
SHAREHOLDERS' EQUITY
Common Stock, Class A, $.01 par value; 18,000,000 shares
authorized; 3,500,000 shares issued and outstanding ........... 35
Common Stock, Class B, non-voting $.01 par value; 10,000,000
shares authorized; 8,400,000 shares issued and outstanding .... 84
Additional paid in capital ...................................... 116,992
Unrealized gains on securities available for sale,
net of tax of $11,776 ......................................... 21,870
Retained earnings ............................................... 53,535
----------
Total shareholders' equity ................................... 192,516
----------
Total liabilities and shareholders' equity ................... $2,424,880
==========
See accompanying Notes to Consolidated Financial Statements.
</TABLE>
98
<PAGE>
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF INCOME
for the Year Ended December 31, 1997
(In thousands)
Revenues:
Premiums ...................................................... $ 103,138
Interest sensitive policy product charges ..................... 42,680
Net investment income ......................................... 126,427
Net gains from sale of investments ............................ 1,841
Other income .................................................. 16,039
---------
Total revenues ............................................... 290,125
---------
Benefits and expenses:
Policyholder benefits incurred ................................ 201,385
Change in liability for future policy benefits and other
policy benefits ............................................. (35,103)
Amortization of present value of insurance
in force and deferred policy acquisition costs ............... 21,589
Amortization of costs in excess of net assets acquired ........ 4,130
Underwriting and other administrative expenses ................ 40,600
Interest and amortization of deferred debt issuance costs ..... 13,773
---------
Total benefits and expenses .................................. 246,374
---------
Income before income taxes ...................................... 43,751
Income taxes ................................................. 16,416
---------
Net income ...................................................... 27,335
Preferred stock dividend requirements ........................ 3,012
---------
Net income available to common shareholders ..................... $ 24,323
=========
See accompanying Notes to Consolidated Financial Statements.
99
<PAGE>
<TABLE>
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
for the Year Ended December 31, 1997
(In thousands)
<CAPTION>
Unrealized
Gain (Loss)
Common Common Additional on Securities
Stock Stock Paid in Available Retained
Class A Class B Capital for Sale, Net Earnings Total
--------- --------- --------- ------------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1996 ..... $ 35 $ 84 $ 120,626 $ (8,081) $ 29,212 $ 141,876
Net income ....................... -- -- -- 27,335 27,335
Preferred dividends .............. -- -- -- (3,012) (3,012)
Deemed dividend to eliminate
effects of reinsurance contract
with affiliate ................. -- -- (3,634) 4,161 -- 527
Unrealized gain on securities
available for sale, net ........ -- -- -- 25,790 -- 25,790
--------- --------- --------- --------- --------- ---------
Balance at December 31, 1997 ..... $ 35 $ 84 $ 116,992 $ 21,870 $ 53,535 $ 192,516
========= ========= ========= ========= ========= =========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
100
<PAGE>
<TABLE>
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
for the Year Ended December 31, 1997
(In thousands)
<CAPTION>
<S> <C>
Cash flows from operating activities:
Net income ................................................................... $ 27,335
Adjustments to reconcile net income to net cash used by operating activities:
Adjustments relating to universal life and investment products:
Interest credited to account balances ..................................... 55,135
Charges for mortality and administration .................................. (50,687)
Capitalization of deferred policy acquisition costs ......................... (24,808)
Amortization of intangibles, depreciation and accretion, net ................ 26,545
Decrease in policy liabilities, accruals and other policyholder funds ....... (24,319)
Decrease in accrued expenses and other liabilities .......................... (19,673)
Decrease in notes and accounts receivable and
accrued investment income ................................................. 3,844
Decrease in taxes payable ................................................... (7,820)
Deferred income taxes ....................................................... (836)
Net gains from sales of investments ......................................... (1,841)
Other, net .................................................................. 5,330
---------
Net cash used by operating activities ..................................... (11,795)
---------
Cash flows from investing activities:
Sales of fixed maturities available for sale ................................. 201,402
Maturities and other redemptions of fixed maturities available for sale ...... 129,600
Sales of mortgages, real estate and other investments ........................ 7,512
Principal collected on mortgage loans and collateral loans ................... 28,030
Change in short-term investments, net ........................................ (21,929)
Purchases of fixed maturities available for sale ............................. (419,525)
Purchases of other investments ............................................... (764)
---------
Net cash used by investing activities ..................................... (75,674)
---------
Cash flows from financing activities:
Receipts from interest sensitive products credited to
policyholders' account balances ............................................. 103,243
Return of policyholders' account balances on interest sensitive products ..... (102,112)
Cash provided by reinsurance recapture ....................................... 21,222
Cash provided by assumed reinsurance with affiliate .......................... 50,000
Reduction of notes payable ................................................... (5,000)
---------
Net cash provided by financing activities ................................. 67,353
---------
Decrease in cash ............................................................... (20,116)
Cash at beginning of year ...................................................... 26,692
---------
Cash at end of year ............................................................ $ 6,576
=========
Supplemental disclosures:
Income taxes paid ............................................................ $ 25,072
Interest paid ................................................................ 12,305
Non-cash financing activities:
Preferred stock issued as dividends .......................................... 3,012
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
101
<PAGE>
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997
(In thousands)
1. Basis of Presentation
On December 14, 1995 (the acquisition date), Southwestern Financial Corporation
(SWF or the Company), a newly organized corporation, was formed by PennCorp
Financial Group, Inc. (PennCorp) and Knightsbridge Capital Fund I, L.P.
(Knightsbridge). A wholly-owned subsidiary of SWF acquired from I.C.H.
Corporation (ICH), Southwestern Life Insurance Company (Southwestern Life) and
its wholly-owned subsidiary, Constitution Life Insurance Company (Constitution)
and its 83% owned subsidiary, ICH Funding Corp. (ICH Funding), and Union Bankers
Insurance Company (Union Bankers) and its wholly-owned subsidiary, Marquette
National Life Insurance Company (Marquette). In addition, a wholly-owned
subsidiary of SWF acquired from ICH substantially all of the assets and
liabilities of Facilities Management Installation, Inc. (FMI), which had
provided management services to ICH's insurance companies. The acquisition was
accounted for as a purchase in accordance with generally accepted accounting
principles (GAAP) and, accordingly, the purchase price was allocated to assets
and liabilities acquired based on estimates of their fair value as of the
acquisition date, which became the new cost basis. Subsequently, the insurance
companies were reorganized such that Constitution became the parent of
Southwestern Life and Union Bankers. Effective January 2, 1998, PennCorp
acquired Knightsbridge's interest in SWF and SWF became a wholly-owned
subsidiary of PennCorp. (See Note 16).
In August 1997, the Company acquired from ICH the remaining 17% interest in ICH
Funding and certain other assets and released ICH from indemnification
obligations relative to certain tax, litigation and other matters.
SWF and its subsidiaries market and underwrite a broad range of life insurance,
annuities and accident and health products to individuals through a sales force
of independent agents. The insurance subsidiaries are licensed to write business
in 48 states, the District of Columbia and Guam. Approximately 27.4% of the
total direct premium of the Company's insurance subsidiaries was generated from
business written in Texas. No other states accounted for more than 10% of the
direct premium of the Company in 1997.
The accompanying consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiaries. All significant intercompany accounts
and transactions have been eliminated.
The preparation of financial statements in conformity with GAAP requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and the reported amounts of revenues and expenses during
the reporting period. Accounts that the Company deems to be acutely sensitive to
changes in estimates include deferred policy acquisition costs, future policy
benefits, policy and contract claims and present value of insurance in force. In
addition, the Company must determine requirements for disclosure of contingent
assets and liabilities as of the date of the financial statements based upon
estimates. In all instances, actual results could differ from estimates.
2. Summary of Significant Accounting Policies
(a) Investments
Fixed maturity and equity securities classified as available for sale are
recorded at fair value, as they may be sold in response to changes in
interest rates, prepayment risk, liquidity needs, the need or desire to
increase income or capital and other economic factors. Changes in
unrealized gains and losses related to securities available for sale are
recorded as a separate component of shareholders' equity, net of
applicable taxes and amount attributable to deferred policy acquisition
costs and present value of insurance in force related to universal life
and investment-type products. Mortgage-backed securities are amortized
using the interest method including anticipated prepayments at the date of
purchase. Significant changes in estimated cash flows from original
assumptions are reflected in the period of such change. Mortgage loans on
real estate are recorded at cost, adjusted for the provision for loan
losses, if necessary. Policy loans are recorded at cost. Short-term
investments purchased with maturities generally less than three months are
recorded at cost, which approximates market. All short-term investments
are considered to be cash equivalents.
102
<PAGE>
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. Summary of Significant Accounting Policies (Continued)
Real estate, substantially all of which was acquired through foreclosure,
is recorded at the lower of fair value, minus estimated costs to sell, or
cost. If the fair value of the foreclosed real estate minus estimated
costs to sell is less than cost, a valuation allowance is provided for the
deficiency. Increases in the valuation allowance are charged to income.
Collateral loans are carried at their aggregate unpaid principal balances.
The Company regularly evaluates the carrying value of their investments
based on current economic conditions, past credit loss experience and
other circumstances. A decline in net realizable value that is other than
temporary is recognized as a realized investment loss and a reduction in
the cost basis of the investment. The Company discounts expected cash
flows in the computation of net realizable value of its investments, other
than certain mortgage-backed securities. In those circumstances where the
expected cash flows of residual interest and interest-only mortgage-backed
securities, discounted at a risk-free rate of return, result in an amount
less than the carrying value, a realized loss is reflected in an amount
sufficient to adjust the carrying value of a given security to its fair
value.
Realized investment gains and losses and declines in value which are other
than temporary, determined on the basis of specific identification, are
included in the determination of net income.
(b) Insurance Revenue Recognition
Accident and health insurance premiums are recognized as revenue ratably
over the time period to which premiums relate. Revenues from traditional
life insurance policies represent premiums which are recognized as earned
when due. Benefits and expenses are associated with earned premiums so as
to result in recognition of profits over the lives of the policies. This
association is accomplished by means of the provision for liabilities for
future policy benefits and the deferral and amortization of policy
acquisition costs.
Revenues for interest sensitive products such as universal life and
annuity contracts represent charges assessed against the policyholders'
account balance for the cost of insurance, surrenders and policy
administration. Benefits charged to expenses include benefit claims
incurred during the period in excess of policy account balances and
interest credited to policy account balances.
(c) Policy Liabilities and Accruals
Liabilities for future policy benefits for traditional life products
generally have been computed on the net level premium method, based on
estimated future investment yield, mortality, and withdrawals. For
accident and health products, liabilities for future policy benefits are
established equal to the excess of the present value of future benefits to
or on behalf of policyholders over discounted net future premiums.
Estimates used are based on the Company's experience adjusted to provide
for possible adverse deviation. These estimates are periodically 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
103
<PAGE>
2. Summary of Significant Accounting Policies (Continued)
receivable are secured by policy liabilities. An allowance for doubtful
accounts is established, based upon specific identification and general
provision, for amounts which the Company estimates will not ultimately be
collected.
(e) Deferred Policy Acquisition Costs
Estimated costs of acquiring new business which vary with, and are
primarily related to, the production of new business, have been deferred
to the extent that such costs are deemed recoverable from future revenues.
Such estimated costs include commissions and certain costs of policy
issuance and underwriting. Costs deferred on accident and health and
traditional life policies are amortized, with interest, over the
anticipated premium-paying period of the related policies in proportion to
the ratio of annual premium revenue to expected total premium revenue to
be received over the life of the policies. Expected premium revenue is
estimated by using the same mortality, morbidity and withdrawal
assumptions used in computing liabilities for future policy benefits. For
interest sensitive products and limited pay life products, policy
acquisition costs are amortized in relation to the emergence of
anticipated gross profits over the life of the policies.
(f) Present Value of Insurance In Force
The present value of insurance in force represents the anticipated gross
profits to be realized from future revenues on insurance in force at the
date such insurance was purchased, discounted to provide an appropriate
rate of return and amortized, with interest, based on credited rate, over
the years that such profits are anticipated to be received in proportion
to the estimated gross profits. Accumulated amortization was $35,386.
(g) Deferred Debt Issuance Costs
Deferred debt issuance costs, which are included in other assets,
represent costs incurred in connection with obtaining long-term debt
financing which have been capitalized and are being amortized on an
interest yield method over the terms of the respective debt. Deferred
costs totaled $2,530 which is net of accumulated amortization of $1,580.
(h) Costs in Excess of Net Assets Acquired
Costs in excess of the fair value of net assets acquired are amortized on
a straight-line basis over 30 years. Accumulated amortization totaled
$8,260.
(i) Recoverability of Long-lived Assets
The Company continually monitors long-lived assets and certain intangible
assets, such as costs in excess of net assets acquired and present value
of insurance in force, for impairment. An impairment loss is recorded in
the period in which the carrying value of the assets exceeds the fair
value or expected future cash flows. Any amounts deemed to be impaired are
charged, in the period in which such impairment was determined, as an
expense against earnings. For the period presented there was no charge to
earnings for the impairment of long-lived assets.
(j) Income Taxes
Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to (i) temporary differences between the
financial statement carrying amounts of existing assets and liabilities
and their respective tax bases, and (ii) operating losses and tax credit
carryforwards. Deferred tax assets and liabilities are measured using
enacted tax rates expected to apply to taxable income in the years in
which the temporary differences are expected to be recovered or settled.
The effect
104
<PAGE>
2. Summary of Significant Accounting Policies (Continued)
on deferred tax assets and liabilities of a change in tax rates is
recognized in income in the period that includes the enactment date.
(k) Reinsurance
Financial reinsurance that does not transfer significant insurance risk is
accounted for as a deposit and is reflected as a component of due from
reinsurers. The cost of reinsurance related to long-duration contracts is
accounted for over the life of the underlying reinsurance policies.
Balances due to, or from, reinsurers have been reflected as assets and
liabilities rather than reducing the related account balances.
3. Investments
Investments in a single entity, other than obligations of the U.S. Government or
agencies thereof, totaling in excess of 10% of total shareholders equity at
December 31, 1997 included Fund America Investors Corp., Ser. 93-C, Class B
Certificates which had a carrying value of $19,271 (10%) of shareholders equity.
The amortized cost and fair value of investments in fixed maturities available
for sale at December 31, 1997 by categories of securities are as follows:
<TABLE>
<CAPTION>
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
December 31, 1997:
Mortgage-backed securities .......................... $ 820,837 $ 22,791 $ (1,434) $ 842,194
U.S. Treasury securities and obligations of
U.S. Government corporations and agencies ......... 27,492 91 (12) 27,571
Debt securities issued by states of the United States
and political subdivisions of the states ......... 22,469 365 (130) 22,704
Debt securities issued by foreign governments ....... 20,525 821 -- 21,346
Corporate debt securities ........................... 752,446 14,664 (3,417) 763,693
---------- ---------- ---------- ----------
Total fixed maturities available for sale ......... $1,643,769 $ 38,732 $ (4,993) $1,677,508
========== ========== ========== ==========
</TABLE>
The amortized cost and fair value of fixed maturities at December 31, 1997, by
contractual maturity, are shown below:
Amortized Fair
Cost Value
---------- ----------
Available for sale:
Due in one year or less......................... $ 28,929 $ 28,921
Due after one year through five years........... 234,776 236,677
Due after five years through ten years.......... 272,127 275,248
Due after ten years............................. 287,100 294,468
---------- ----------
822,932 835,314
Mortgage-backed securities...................... 820,837 842,194
---------- ----------
$1,643,769 $1,677,508
========== ==========
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 $119,695 were on deposit with certain
regulatory authorities at December 31, 1997.
105
<PAGE>
3. Investments (Continued)
Included in fixed maturities available for sale at December 31, 1997, are below
investment-grade securities with amortized costs of $71,467 and fair values of
$74,227. Included in fixed maturities available for sale as of December 31,
1997, are unrated securities with an amortized cost and fair value of $11,811.
During 1997, the Company purchased $7,650 of subordinated indebtedness of ACO
Acquisition Corp., which was subsequently re-named Acordia, Inc. (Acordia). The
Acordia subordinated notes pay interest on a current basis at 12.5% per annum,
payable in semi-annual installment. Acordia is an insurance broker specializing
in the marketing of commercial property and casualty programs. Acordia is 28.6%
owned by Knightsbridge.
In addition, during 1997, the Company acquired 41,605 shares of redeemable
preferred stock of Portsmouth Financial Group, Inc. (Portsmouth) for $4,161. The
preferred stock pays dividends of 18.0% of which 12.5% is in cash with the
remainder in the form of additional preferred stock. The shares are mandatorily
redeemable on June 30, 2002. Portsmouth underwrites, acquires, and holds to
receipt of benefits, life insurance contracts covering individuals facing
terminal illnesses. Portsmouth is owned by Knightsbridge and its affiliates. The
Company has agreed, subject to required regulatory approvals to make up to a
$10,000 preferred equity investment in Portsmouth.
The Company had non-income producing investments at December 31, 1997 with an
amortized cost and fair value as follows:
Amortized
Cost Fair Value
---------- ----------
Fixed maturities ........................ $ 487 $ 66
Equity securities ....................... 688 1,079
Other investments ....................... 5,778 5,791
---------- ----------
$ 6,953 $ 6,936
========== ==========
At December 31, 1997 net unrealized appreciation of equity securities of $391
consisted of gross unrealized gains of $415, less unrealized losses of $24.
Following is an analysis of net gains (losses) from sale of investments for the
year ended December 31, 1997:
Fixed maturities....................... $ 553
Other investments...................... 1,146
Real estate............................ 134
Short-term investments................. 8
---------
$ 1,841
=========
For the year ended December 31, 1997, net realized gains on sale of fixed
maturities consisted of gross gains of $2,779 and gross losses of $2,226.
106
<PAGE>
3. Investments (Continued)
Following are changes in unrealized appreciation (depreciation) on investments
for the year ended December 31, 1997:
Investments carried at fair value:
Fixed maturities...................................... $ 48,976
Equity securities..................................... 221
Other investments..................................... (713)
---------
48,484
Eliminate effects from reinsurance contract with
affiliate ........................................... (4,161)
Less effect on other balance sheet accounts:
Value of business acquired and deferred acquisition
costs .............................................. (2,768)
Deferred income taxes................................. (16,000)
Minority interest in unrealized losses................ 235
---------
Change in unrealized investment gains and losses........ $ 25,790
=========
Major categories of net investment income for the year ended December 31, 1997
consist of the following:
Fixed maturities...................................... $ 98,906
Mortgage loans........................................ 5,490
Policy loans.......................................... 7,621
Short-term investments................................ 4,442
Collateral loans...................................... 2,218
Real estate........................................... 441
Investments held in trust under reinsurance treaty(a). 9,617
Other investments..................................... 1,250
Investment expenses................................... (3,558)
---------
$ 126,427
=========
--------------------
(a)Investments held in trust by a reinsurer with carrying values of $121,016
as of December 31, 1996, are included in amounts due from reinsurers. This
contract was recaptured during 1997 (see Note 10).
At December 31, 1997 the Company held mortgage loans principally involving
commercial real estate with carrying value of $51,070, net of an allowance for
losses of $680. Estimated fair values of mortgage loans totaled $51,816 at
December 31, 1997. The average outstanding loan balance was approximately
$1,027. At December 31, 1997 mortgage loan investments were concentrated in the
following states:
Carrying Percent of Total
Value Carrying Total
-------- --------------
Texas....................................... $23,832 46.7 %
Illinois.................................... 7,029 13.8
Oklahoma.................................... 4,915 9.6
Florida..................................... 3,180 6.2
Kansas...................................... 2,527 4.9
All other................................... 9,587 18.8
------- -----
Balance, end of period...................... $51,070 100.0 %
======= =====
107
<PAGE>
4. Policy Liabilities and Accruals
For interest sensitive life products and annuity products, the liability for
future policy benefits is equal to the accumulated fund value. Fund values are
equal to the excess premium received and interest credited to the fund value
less deductions for mortality costs and expense charges. Current interest rates
credited range from 4% to 8%. Mortality costs and expense charges are
established by the Company based upon its experience and cost structure.
For traditional life products, the liability for future policy benefits has been
computed by the net level premium method based on estimated future investment
yield, mortality, and withdrawal experience. Reserve interest assumptions are
graded and range from 6.25% to 7.375%. For accident and health products,
liabilities for future policy benefits are established equal to the excess of
the present value of future benefits to or on behalf of policyholders over
future net premiums discounted at interest rates ranging primarily from 6.5% to
8.0%. The future policy benefits of traditional life products and accident and
health products are determined using mortality, morbidity and withdrawal
assumptions that reflect the experience of the Company modified as necessary to
reflect anticipated trends and to include provisions for possible unfavorable
deviations. The assumptions vary by plan, year of issue and duration.
The Company has carefully monitored a block of interest sensitive life policies
where overall financial performance was not satisfactory. During the third
quarter of 1997, management implemented certain corrective actions. These
actions included reduction in credited interest rates, increased monthly expense
charges and cost of insurance increases on selected policy forms. As a result,
reserves on this block were reduced approximately $17,000.
Policy and contract claims include provisions for reported claims in process of
settlement, valued in accordance with the terms of the related policies and
contracts, as well as provisions for claims incurred and unreported based on the
Company's prior experience.
While management believes the estimated amounts included in financial statements
for policy liabilities and accruals are adequate, such estimates may be more or
less than the amounts ultimately paid when the claims are settled. In addition,
the Company is involved in certain litigation regarding policyholder benefits.
The Company intends to vigorously defend its position relative to these claims;
however, if unsuccessful, the level of reserves currently provided could be
adversely effected.
Total policy liabilities and accruals consist of the following as of December
31, 1997:
Future policy benefits on traditional products:
Traditional life insurance contracts ............... $ 335,283
Traditional annuity products ....................... 105,663
Individual accident and health ..................... 87,152
Unearned premiums .................................. 26,900
----------
Total future policy benefits ...................... 554,998
----------
Universal life and investment contract liabilities:
Universal life and annuities ....................... 1,315,333
Guaranteed investment contracts .................... 163
----------
Total universal and investment contract liabilities 1,315,496
----------
Policy and contract claims ........................... 57,517
Other policyholder funds ............................. 14,203
----------
Total policy liabilities and accruals ............. $1,942,214
==========
108
<PAGE>
4. Policy Liabilities and Accruals (Continued)
The following table presents information on changes in the liability for policy
and contract claims for the year ended December 31, 1997:
Policy and contract claims at January 1 .................... $ 55,011
Less reinsurance recoverables .............................. 153
--------
Net balance at January 1 ................................. 54,858
--------
Add claims incurred, net of reinsurance related to:
Current year ............................................. 81,168
Prior years .............................................. (6,012)
--------
75,156
Deduct claims paid, net of reinsurance related to:
Current year ............................................. 58,658
Prior years .............................................. 13,839
--------
72,497
Policy and contract claims at December 31 .................. $ 57,517
========
As a result of changes in estimates of insured events in prior years, the
liability for policy and contract claims decreased, net of reinsurance, by
$6,012 in 1997.
5. Notes Payable
The outstanding principal amounts of notes payable at December 31, 1997 consist
of the following:
Revolving bank debt ........................................ $ 90,250
Bank debt with quarterly principal requirements ............ 24,500
7.0% convertible subordinated note ......................... 40,000
--------
$154,750
========
Interest costs under the revolving bank debt totaled $7,860 for the year ended
December 31, 1997. The interest rate of the debt is based on, at the Company's
option, either a floating rate (based on the base rate of the First National
Bank of Chicago) plus a margin of 1.75% or a Eurodollar rate (based on the
London Interbank Offered Rate or LIBOR) plus a margin of 2.75%. At December 31,
1997, the effective rate of the revolving loan was approximately 9.13%. The
revolving bank debt was repaid on January 2, 1998.
Interest costs under the bank term debt totaled $2,229 for the year ended
December 31, 1997. The interest rate of the term debt is based on, at the
Company's option, either a floating rate (based on the base rate of the First
National Bank of Chicago) plus a margin of 2.25% or a Eurodollar rate (based on
LIBOR) plus a margin of 3.25%. At December 31, 1997, the effective rate of the
term loans was approximately 9.63%. The bank term debt was repaid on January 2,
1998.
As part of the consideration for the acquisition of Southwestern Life, Union
Bankers, Constitution and Marquette from ICH, the Company issued to ICH a
$40,000 aggregate principal amount of SWF's 7.0% Convertible Subordinated Notes
due 2005. The notes are convertible into an aggregate 3,200,000 shares of common
stock of SWF, of which 800,000 will be Class B non-voting common stock. In the
aggregate the shares upon conversion represent approximately 21.2% of SWF's
fully diluted shares at closing before giving effect to certain warrants
outstanding. During 1997, PennCorp acquired the notes from the liquidating trust
for the creditors of ICH for $40,000 plus accrued interest. The Convertible
Notes are unsecured obligations and are subordinate in right of payment to SWF's
bank debt and all of the indebtedness of SWF. Interest costs
109
<PAGE>
5. Notes Payable (Continued)
under the Convertible Notes totaled $2,800 for the year ended December 31, 1997.
The Company agreed to maintain sufficient cash and cash equivalents to fund the
interest payments on the Convertible Notes for the first three years. At
December 31, 1997 restricted cash and short-term investments totaled $3,339.
In conjunction with the bank debt, the Company entered into interest rate
protection agreements in the form of a series of interest rate caps in the
notional amount of $62,500 which expire May 1998. These entitle the Company to
revenue should three-month LIBOR exceed the cap rate of 7.5%. At December 31,
1997, three-month LIBOR was 5.81%.
6. Preferred and Common Stock
On December 14, 1995, the Company issued 210,000 shares of Series A preferred
stock with a liquidation value of $21,000 to PennCorp and one of its
subsidiaries. The Series A preferred stock accrues dividends at a rate of 10.0%
per annum, compounded quarterly and is mandatorily redeemable at December 31,
2005. Dividends on the Series A preferred stock are payable in cash, or at SWF's
option, are payable in kind. The Series A preferred stock is not redeemable at
the option of the Company but at maturity will be required to be redeemed for
approximately $56 million in cash assuming no cash dividend distributions. If
the Company fails to satisfy its mandatory redemption obligation, the holders of
the Series A preferred stock 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, 1997, 24,180 additional shares were issued with a
redemption value of $2,418 in lieu of cash to satisfy dividend requirements.
In addition, certain of PennCorp's insurance subsidiaries purchased $10,000
liquidation value of 5.5% Mandatorily Redeemable Preferred Stock, par value
$0.01 per share (the 5.5% Preferred Stock) of Southwestern Life Acquisition
Corporation, a wholly-owned subsidiary of SWF. During 1996 SLAC was dissolved
and the 5.5% Preferred Stock was exchanged for 5.5% Preferred Stock of
Southwestern Life Companies, Inc. (SLC), also a wholly-owned subsidiary of SWF.
The 5.5% Preferred Stock accrues dividends payable in cash or, subject to
certain conditions, through the issuance of additional shares of 5.5% Preferred
Stock. The 5.5% Preferred Stock is not subject to optional redemption and
matures on December 31, 2005. If SLC fails to satisfy its mandatory redemption
obligation or if dividends payable on the 5.5% Preferred Stock are in arrears
for four or more quarterly dividend periods, the holders of the 5.5% Preferred
Stock will be entitled to elect 49.0% of the members of the Board of Directors
of SLC and, upon receipt of regulatory approval, a majority of the Board of
Directors of SLC. The 5.5% Preferred Stock is the only preferred stock of SLC
authorized for issuance. The holders of the 5.5% Preferred Stock are entitled to
class voting rights under certain circumstances, including in connection with a
merger of SLC or a sale of all or substantially all its assets or the
authorization or issuance of senior pari passu preferred stock, and as otherwise
provided by law. For the year ended December 31, 1997, 59 additional shares were
issued with a redemption value of $594 in lieu of cash to satisfy dividend
requirements.
7. Income Taxes
The Company and its non-insurance subsidiaries file a consolidated federal
income tax return. The Company's life insurance subsidiaries also file a
consolidated federal income tax return.
Total income taxes for the year ended December 31, 1997 are as follows:
Current..................................... $ 17,252
Deferred.................................... (836)
---------
$ 16,416
=========
110
<PAGE>
7. Income Taxes (Continued)
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, 1997, as follows:
Tax expense computed at statutory rate ..................... $ 15,313
Amortization of costs in excess of net assets acquired ..... 1,445
Change in deferred tax asset valuation allowance ........... 364
Other ...................................................... (706)
--------
$ 16,416
========
Temporary differences, including $1,956 in 1997 of deferred tax assets
transferred in association with a reinsurance contract with an affiliate,
between the financial statement carrying amounts and tax bases of assets and
liabilities that give rise to the deferred tax assets (liabilities) at December
31, 1997 relate to the following:
Deferred tax assets:
Deferred policy acquisition costs ........................ $ 9,548
Future policy benefits ................................... 73,660
Invested assets, subject to capital gains treatment ...... 24,907
---------
108,115
Deferred tax liabilities:
Present value of insurance in force ...................... (20,498)
Other assets and liabilities ............................. (20,123)
Net unrealized gain ...................................... (11,776)
---------
(52,397)
Net deferred tax asset ................................... 55,718
Valuation allowance ...................................... (20,972)
---------
$ 34,746
=========
The valuation allowance at December 31, 1997 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, 1997.
111
<PAGE>
8. Deferred Policy Acquisition Costs and Present Value of Insurance in Force
Deferred policy acquisition costs represent commissions and certain costs of
policy issuance and underwriting. Information relating to these costs for the
year ended December 31, 1997, is as follows:
Balance at beginning of period ............................... $ 15,095
Policy acquisition costs deferred:
Commissions ................................................ 17,443
Underwriting and issue costs ............................... 7,366
Policy acquisition costs amortized ........................... (9,092)
Unrealized investment (gain) loss adjustment ................. (206)
--------
Unamortized deferred policy acquisition costs at period end .. $ 30,606
========
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, 1997 is as follows:
Balance at beginning of year ................................. $ 71,333
Accretion of interest ........................................ 3,806
Amortization ................................................. (16,303)
Transferred on assumed reinsurance contract with affiliate ... 2,291
Unrealized investment (gain) loss adjustment ................. (2,562)
--------
Balance at end of year ..................................... $ 58,565
========
112
<PAGE>
8. Deferred Policy Acquisition Costs and Present Value of Insurance in Force
(Continued)
Expected amortization, based upon current assumptions and accretion of interest
at a policy liability or contract rate ranging from 5.5% to 6.6% for the next
five years of the present value of insurance in force is as follows:
<TABLE>
<CAPTION>
Beginning Gross Accretion Net
Balance Amortization of Interest Amortization
---------- ------------ ---------- ------------
<S> <C> <C> <C> <C>
1998 ............... $ 58,565 $ 12,805 $ 3,226 $ 9,579
1999 ............... 48,986 7,806 2,719 5,087
2000 ............... 43,899 8,374 2,315 6,059
2001 ............... 37,840 6,957 1,989 4,968
2002 ............... 32,872 5,673 1,724 3,949
</TABLE>
9. Statutory Accounting and Dividend Restrictions
Pursuant to the terms of the surplus debenture issued by Constitution to the
benefit of SLC, a non-insurance subsidiary of SWF, Constitution may make
principal and interest payments to the extent that Constitution's surplus,
excluding the statutory carrying value of Southwestern Life and Union Bankers,
exceeds $1,200. Constitution's surplus at December 31, 1997 was $174,715, of
which $161,098 was attributable to its ownership of Southwestern Life and Union
Bankers.
The Company's cash flow is derived principally from dividends and principal and
interest payments owed on the surplus debenture by Constitution. The principal
source of repayment of the surplus debenture is dividends from Constitution's
subsidiaries, Southwestern Life and Union Bankers. Generally, the net assets of
the insurance subsidiaries available for transfer to the Company are limited to
the greater of the subsidiary net gain from operations during the preceding year
or 10% of the subsidiary net statutory surplus as of the end of the preceding
year as determined in accordance with accounting practices prescribed or
permitted by insurance regulatory authorities. Payment of dividends in excess of
such amounts would generally require approval by the regulatory authorities.
Based upon Constitution's earned surplus at December 31, 1997, no dividends can
be paid to its parent without prior regulatory approval.
The insurance subsidiaries prepare their statutory financial statements in
accordance with accounting practices prescribed or permitted by their respective
state insurance departments. Prescribed statutory accounting practices include
state laws, regulations, and general administrative rules, as well as a variety
of publications of the National Association of Insurance Commissioners (NAIC).
Permitted statutory accounting practices encompass all accounting practices that
are approved by insurance regulatory authorities; such practices differ from
state to state, and may differ from company to company within a state, and may
change in the future. Furthermore, the NAIC has a project to codify statutory
accounting practices, the result of which is expected to constitute the only
source of "prescribed" statutory accounting practices. Accordingly, that
project, will likely change to some extent prescribed statutory accounting
practices, and may result in changes to the accounting practices that insurance
enterprises use to prepare their statutory financial statements.
Statutory capital and surplus of the Company's life insurance subsidiaries as
reported to regulatory authorities at December 31, 1997 totaled approximately
$174,715. Statutory net loss of the Company's life insurance subsidiaries as
reported to regulatory authorities totaled $2,521 for the year ended December
31, 1997.
10. Reinsurance
In the normal course of business, the Company reinsures portions of certain
policies that it underwrites to limit disproportionate risks. The Company
retains varying amounts of individual insurance up to a maximum retention of
$500 on any life. Amounts not retained are ceded to other insurance enterprises
or reinsurers on an automatic or facultative basis.
Reinsurance contracts do not relieve the Company from its obligations to
policyholders. Therefore, the Company is contingently liable for recoverable
unpaid claims and policyholder liabilities ceded to reinsurers in the unlikely
event that assuming reinsurers are unable to meet their obligations. The Company
evaluates the financial condition of its reinsurers to
113
<PAGE>
10. Reinsurance (Continued)
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, 1997 is as follows:
Direct policy revenues and amounts assessed
against policyholders .................................... $ 252,656
Reinsurance assumed ........................................ 1,182
Reinsurance ceded .......................................... (108,020)
---------
Net premiums and amounts earned ............................ $ 145,818
=========
Policyholder benefits ceded ................................ $ 78,767
=========
Effective July 1, 1996, Union Bankers entered into reinsurance agreements with
Cologne Life Reinsurance Company ("Cologne") to coinsure 80% of its Medicare
supplement business in force on July 1, 1996 and to coinsure 80% of its Medicare
policies issued on or after July 1, 1996. The Company recorded a deferred gain
on the transaction of $53,893 as of July 1, 1996, which is being amortized into
income over the life of the business. For the year ended December 31, 1997
$14,222 of the deferred gain has been recognized and is included in other
income. The Company is not subject to any negative experience adjustments if the
ceded business is unprofitable; however, the Company may participate in a
portion of future earnings from the ceded business after Cologne recovers its
initial ceding commission plus interest at a specified rate. Union Bankers
retained administration for the ceded block of business and is reimbursed by
Cologne for administrative costs at the rate of 8.5% of ceded renewal premiums
and 11.5% of ceded first year premiums.
Southwestern Life previously ceded a block of annuities under a reinsurance
agreement with Employees Reassurance Corporation (ERC). Such reinsurance,
accounted for as a financing arrangement, is not reflected in the accompanying
financial statements except for the risk fees paid to ERC. The reinsurance
agreement was terminated as of November 30, 1997. Risk fees paid to the
reinsurer were 2% of the net amount of surplus provided, but not less than a
minimum fee of $40 per quarter, and totaled $110 for the year ended December 31,
1997.
At December 31, 1997, Southwestern Life entered into a reinsurance agreement
with Integon Life Insurance Corporation (Integon), an indirect wholly-owned
subsidiary of PennCorp, to coinsure certain annuities which had GAAP policy
liabilities of $256,673. Cash of $50,000 and securities were transferred at a
cost basis of $198,793 which had fair values equal to statutory policy
liabilities of $255,195. The present value of insurance in force which Integon
had recorded on these policies was estimated to be $2,291. Because Southwestern
Life and Integon are affiliates, the historical GAAP book value of the
securities and the present value of insurance in force at Integon was retained
by Southwestern Life. Rather than record a loss of $3,634, which is net of taxes
of $1,956, on a GAAP basis, Southwestern Life recorded a "deemed dividend" of
this amount as a direct charge to its paid in capital. In addition, the change
in unrealized investment gain (loss) associated with the transferred securities
is recorded as an adjustment to prior unrealized gains.
11. Retirement and Profit Sharing Plans
The Company has a defined contribution retirement plan (Defined Contribution
Plan) for all employees who have attained age 21 and completed a year of
service. Contributions to the Plan are made pursuant to salary deferral
elections by participants in an amount equal to 1% to 15% of their annual
compensation. In addition, the Company makes matching contributions in an amount
equal to 50% of each participant's salary deferral to a maximum of 3% of annual
compensation. The Defined Contribution Plan also provides for a discretionary
employer profit sharing contribution, which is determined annually by the Board
of Directors for the succeeding plan year. Profit sharing contributions are
credited to participant's accounts on the basis of their respective
compensation. Salary deferral contribution accounts are at all times fully
vested, while matching contribution and profit sharing contribution accounts
vest ratably from one to five years of service. All participant accounts are
fully vested at death, disability or attainment of age 65. Payment of vested
benefits under the Defined Contribution Plan may be elected by a participant in
a variety of forms of payment. Expenses related to this plan for the year ended
December 31, 1997 amounted to $936.
114
<PAGE>
11. Retirement and Profit Sharing Plans (Continued)
In addition, the Company has a bonus plan for certain key officers. The amount
available to pay awards for any year is determined by a committee of senior
executives of the Company and is subject to approval of the Board of Directors
of the Company. Awards are based on the performance of the Company and the
performance of eligible participants. The Company accrued or paid $1,350 under
this plan during the year ended December 31, 1997.
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, 1997:
Accrued postretirement benefits, beginning of year $ 12,686 Recognition of
components of net periodic postretirement benefit cost:
Service cost ................................ 269
Interest cost................................ 930
---------
Net periodic postretirement benefit cost..... 1,199
Benefit payments.............................. (1,290)
---------
Net change.................................... (91)
---------
Accrued postretirement benefits, end of year.. $ 12,595
=========
The liability for accrued postretirement benefits includes the following at
December 31, 1997:
Accumulated postretirement benefit obligation:
Retirees..................................... $ 11,167
Active eligible.............................. 1,076
Active ineligible............................ 944
---------
13,187
Unrecognized actuarial loss................... (592)
---------
Accrued postretirement benefits............... $ 12,595
=========
For measurement purposes, an 5.5% annual rate increase in the health care cost
trend rate was assumed for 1998; the rate was assumed to decrease gradually to
4.0% by the year 2015 and remain at that level thereafter. The health care cost
trend rate assumption has a significant effect on the amounts reported. To
illustrate, increasing the assumed health care cost trend rates by one
percentage point in each year would increase the accumulated postretirement
health care benefit obligation as of December 31, 1997 by $767 and the aggregate
of the service and interest components of net periodic postretirement health
care benefit cost for 1997 by $127. The weighted average discount rate used in
determining the accumulated postretirement benefit obligation was 7.0%.
12. Related Party Transactions
Related party transactions described herein include those transactions not
included elsewhere in the Notes to Consolidated Financial Statements.
The Company and its subsidiaries have management and services agreements with
entities affiliated with Knightsbridge, a shareholder. In connection with an
Advisory and Management Services Agreement with Knightsbridge Management,
L.L.C., the Company pays an annual fee of $1,500 plus expenses. Each insurance
subsidiary has an Investment Management Agreement with Knightsbridge
Consultants, L.L.C. For the year ended December 31, 1997, fees incurred totaled
$1,871.
The Company paid interest of $1,400 in 1997 in conjunction with PennCorp's
acquisition of the Company's 7.0% convertible subordinated note.
115
<PAGE>
12. Related Party Transactions (Continued)
The Company provides services for a wholly-owned subsidiary of PennCorp. The
Company charges the subsidiary for its direct costs and a share of overhead
costs based upon time and utilization studies. These costs totaled approximately
$5,178 during 1997.
13. Other Commitments and Contingencies
The Company and its subsidiaries are obligated under operating leases, primarily
for office space. Rent expense was $2,169 in 1997. There was no significant
sublease income.
Minimum lease commitments are:
1998...................................... $ 2,381
1999...................................... 2,685
2000...................................... 2,666
2001...................................... 2,652
2002...................................... 2,497
2003 and thereafter....................... 10,704
-------
Total minimum payments required......... $23,585
=======
Certain lawsuits have been brought against the Company's life insurance
subsidiaries in the normal course of the insurance business involving the
settlement of various matters and seeking compensatory and in some cases
punitive damages. Management believes that the ultimate settlement of all such
litigation will not have a materially adverse effect on the Company's
consolidated financial position or results of operation.
The life insurance companies are required to be members of various state
insurance guaranty associations in order to conduct business in those states.
These associations have the authority to assess member companies in the event
that an insurance company conducting business in that state is unable to meet
its policyholder obligations. In some states, these assessments can be partially
recovered through a reduction in future premium taxes. The insurance
subsidiaries paid assessments of $980 in 1997. Based on information currently
available, the insurance subsidiaries have accrued $3,194 at December 31, 1997
for future assessments, net of future premium tax reductions.
14. Other Operating Information
Underwriting and other administrative expenses for the year ended December 31,
1997 are as follows:
Non-deferrable commission expense ..................... $ 19,746
Commission allowances on reinsurance ceded ............ (12,696)
Taxes, licenses and fees .............................. 7,492
General and administrative expenses ................... 34,467
Expense allowance on reinsurance ceded ................ (8,409)
--------
Underwriting and other administrative expenses ....... $ 40,600
========
116
<PAGE>
15. Financial Instruments
The following is a summary of the carrying value and fair value of the Company's
financial instruments at December 31, 1997:
<TABLE>
<CAPTION>
Carrying Fair
Value Value
---------- ----------
<S> <C> <C>
Assets:
Cash and short-term investments .................. $ 163,716 $ 163,716
Fixed maturities ................................. 1,677,508 1,677,508
Equity securities ................................ 1,079 1,079
Mortgage loans ................................... 51,070 51,816
Policy loans ..................................... 123,041 123,041
Other investments ................................ 8,461 8,461
Interest rate cap ................................ 41 --
Agent and premium receivables .................... 5,507 5,507
Liabilities:
Notes payable .................................... 154,750 154,750
Universal life and investment contract liabilities 1,315,496 1,315,496
</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.
Mortgages: The fair values for mortgages are estimated using discounted
cash flow analyses, based on interest rates currently being offered for
similar loans to borrowers with similar credit ratings. Loans with similar
characteristics are aggregated for purposes of the calculations.
Other Investments: The fair value of Company's investment in residual
interests in mortgage-backed securities was obtained from an independent
broker-dealer. The fair values of other miscellaneous invested assets have
not been estimated due to their relative immateriality.
Interest rate cap: The fair value of the interest rate cap is $0 as the
current interest rate is below the cap rate.
Policy Loans: Policy loans are an integral part of life insurance policies
which the Company has in force and, in the Company's opinion, cannot be
valued separately. These loans typically carry an interest rate that is
tied to the crediting rate applied to the related policy and contract
reserves.
Notes Payable: Fair values of the Company's bank obligations approximate
carrying values due to the variable interest structure. The fair value of
the Company's convertible note payable is not valued at December 31, 1997
as it was owned by PennCorp and canceled in February 1998.
117
<PAGE>
15. Financial Instruments (Continued)
Universal Life and Investment Contract Liabilities: The carrying value and
fair values for the Company's liabilities under universal life and
investment-type insurance contracts are the same as the interest rates
credited to these products are periodically adjusted by the Company to
reflect market conditions. The fair values of liabilities under all
insurance contracts are taken into consideration in the overall management
of interest rate risk, which minimizes exposure to changing interest rates
through the matching of investment maturities with amounts due under
insurance contracts.
16. Subsequent Event
On January 2, 1998, PennCorp acquired all of the outstanding common stock held
by Knightsbridge and certain other parties for aggregate cash consideration
ranging from $73,777 to $77,444 (excluding anticipated acquisition expenses)
depending upon the outcome of certain contingencies. As a result, SWF became a
wholly-owned subsidiary of PennCorp. After the acquisition of the common stock,
PennCorp repaid SWF's bank revolving debt in the amount of $90,250 and its bank
term debt in the amount of $24,500. Consequently, the Company will realize an
extraordinary charge in 1998 for the write-off of deferred costs of $2,571
associated with these loans. In addition, PennCorp canceled the $40,000 SWF note
it acquired from ICH.
On February 18, 1998, PennCorp announced that it had engaged investment banking
firms to review strategic alternatives for maximizing shareholder value,
including the sale of certain divisions, which include Union Bankers,
Constitution, Marquette and affiliated service providing companies ("SW
Financial Businesses Held for Sale"). As of and for the year ended December 31,
1997, the total assets, excess of liabilities over assets, total revenues and
net loss of the SW Financial Businesses Held for Sale aggregated $530,866,
$49,697, $109,387 and $5,201, respectively.
118
<PAGE>
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
PART III
Item 10. Directors and Executive Officers of the Registrant
Name Age Position
- ---- --- --------
David C. Smith 58 Chairman of the Board
Keith A. Maib 41 President, Chief Executive Officer and Director
Thomas A. Player 60 Director
Allan D. Greenberg 55 Director
Bruce W. Schnitzer 55 Director
James P. McDermott 38 Executive Vice President and Chief Financial
Officer
Scott D. Silverman 41 Executive Vice President, Chief Administrative
Officer, General Counsel and Secretary
David C. Smith has served as Non-Executive Chairman of the Board since August
21, 1998 and has been a director of the Company since September 1994. Since 1993
he has been a management consultant. Mr. Smith was with KPMG from 1964 until his
retirement in 1993, having served as Vice Chairman-Tax from 1987 until 1993. He
also served on the Board of Directors and the Management Committee of KPMG. Mr.
Smith is a member of the American Institute of Certified Public Accountants. He
currently serves on the Board of Governors of Citizens' Scholarship Foundation
of America.
Keith A. Maib was elected as a director and Chief Operating Officer of the
Company on June 11, 1998. On August 21, 1998, he became President and Chief
Executive Officer. From June 1996 to June 1998, Mr. Maib served as Executive
Vice President and Chief Financial Officer of Acordia, Inc., where he was
involved in the repositioning of the company, including the privatization
transaction and the leveraged acquisition of the brokerage operations, which was
co-sponsored by Knightsbridge Investment, an affiliate of the Company. He
continued to serve as a Director of ACO, the parent company of Acordia, Inc.
until December 1998. From March 1995 to June 1996 Mr. Maib was a partner in the
Dallas and New York offices of Coopers & Lybrand, L.L.P., where he was primarily
responsible for the firm's southern United States corporate finance practice.
From March 1994 to March 1995 he held the position of Chief Operating Officer of
Borland International, Inc., at the time, one of the world's largest PC software
developers. As Chief Operating Officer, he managed the company's worldwide
operations and was responsible for planning and implementing a successful
turnaround for the company. Prior to joining Borland, Mr. Maib was employed by
Price Waterhouse, L.L.P. from June 1991 to March 1994, and from June 1993 to
March 1994 was a partner in the corporate recovery services practice of Price
Waterhouse, L.L.P. Mr. Maib also serves as a director of Sagent Technology,
Inc., a publicly traded technology company.
Thomas A. Player has been a director of the Company since August 1990. From June
1974 to June 1995, Mr. Player served as a founding partner of Neely & Player,
P.C., a law firm located in Atlanta, Georgia. In June 1995, Mr. Player became a
senior partner in the law firm of Morris, Manning & Martin, an Atlanta based
commercial law firm having offices in Washington, D.C. Mr. Player currently
serves as a director for Amerisure, Inc. Mr. Player is the author of a paper for
the Organization of Economic Cooperation and Development concerning insurer
reorganization. Mr. Player has over 30 years experience in the insurance
industry.
Allan D. Greenberg served as Vice Chairman of the Board and as a director of the
Company from August 1990 through 1997. Mr. Greenberg also serves as Chairman of
the Board of ADG Insurance Advisors Inc. ("ADG"), a private consulting firm
specializing in life insurance actuarial and acquisition services. From 1981 to
1988, Mr. Greenberg was Vice President, Chief Actuary and a director of Geneve
Capital Group, Inc., and from 1984 to 1988 he also served as Executive Vice
President of Standard Security Life Insurance Company of New York. Mr. Greenberg
is a Fellow of the Society of Actuaries, a Fellow of the Canadian Institute of
Actuaries and a Member of the American Academy of Actuaries. Mr. Greenberg has
more than 28 years experience in the insurance industry. ADG provided consulting
services to the Company prior to January 1, 1998.
119
<PAGE>
Bruce W. Schnitzer has been a director of the Company since August 1990. Since
1985, Mr. Schnitzer has served as Chairman of the Board of Wand Partners Inc.
(or predecessor investment activities), a private investment firm located in New
York, New York. Mr. Schnitzer also serves as a director of the following U.S.
companies with publicly quoted securities: AMRESCO Inc. (a manager of real
estate assets) and Nestor, Inc. (a technology company). From 1983 to 1985, Mr.
Schnitzer served as President and Chief Executive Officer of Marsh & McLennan,
Incorporated, an insurance brokerage firm.
James P. McDermott joined the Company in November 1992 as Vice President and
Controller of the Company's insurance subsidiaries. He was elected Senior Vice
President of the Company in September 1995, and on June 11, 1998 he was elected
Executive Vice President and Chief Financial Officer. From January 1985 until
November 1992, Mr. McDermott was employed by KPMG, serving as a Senior Manager
in the firm's insurance practice prior to joining the Company. Mr. McDermott has
more than 6 years experience in the insurance industry.
Scott D. Silverman joined the Company in March 1992 and was elected Vice
President, General Counsel and Secretary of the Company in January 1994. Mr.
Silverman was elected a Senior Vice President of the Company in September 1995,
and on June 11, 1998 he was elected Executive Vice President and Chief
Administrative Officer in addition to his position of General Counsel and
Secretary. From 1990 to March 1992, he served as Vice President -- Legal and
Secretary of Independence Holding Company and from 1988 to March 1992, he served
as Vice President, Counsel and Secretary of Standard Security Life Insurance
Company of New York, a subsidiary of Independence Holding Company. Mr. Silverman
has more than 15 years experience in the insurance industry.
Item 11. Executive Compensation
SUMMARY OF EXECUTIVE COMPENSATION
The following table sets forth, for the fiscal years ended December 31, 1997,
1998 and 1999, the compensation earned by the Company's current Chief Executive
Officer and the two other most highly compensated executive officers of the
Company (comprising all of the Company's current executive officers),
(collectively, the "Named Executive Officers") for those years.
<TABLE>
<CAPTION>
Long-Term Compensation
------------------------
Annual Compensation Other Restricted Securities
-------------------------- Annual Stock Underlying All Other
Year Salary Bonus(1) Compensation Awards(2) Options/SARs Compensation(3)
---- -------- -------- ------------ --------- ------------ ---------------
<S> <C> <C> <C> <C> <C> <C> <C>
Keith A. Maib-- 1999 $449,992 $545,000 $ -- $ -- $ -- $ 9,600
President and Chief 1998 235,641 600,000 -- -- 600,000 268,426
Executive Officer 1997 -- -- -- -- -- --
James P. McDermott-- 1999 400,008 575,000 -- -- -- 9,600
Executive Vice President 1998 337,083 677,000 -- -- 475,817 17,388
and Chief Financial Officer 1997 225,000 18,750 -- 46,601 10,000 11,869
Scott D. Silverman--
Executive Vice President, 1999 400,008 575,000 -- -- -- 9,600
Chief Administrative Officer 1998 337,821 727,000 -- -- 475,000 17,388
General Counsel and Secretary 1997 225,000 18,750 -- 42,150 10,000 66,120
</TABLE>
- ---------------
(1) The amounts reflected for 1998 include bonuses of $100,000 and $77,000 paid
to Messrs. McDermott and Silverman in connection with their assistance in
the Knightsbridge and Acordia transactions. See Item 13. Certain
Relationship and Related Transactions.
(2) Represents the value of restricted stock awards granted based on the
closing price of the Company's Common Stock on the date of grant, as
reported by the New York Stock Exchange. Amounts reflected do not include
dividends on prior restricted stock award grants paid in additional shares
of restricted stock.
(3) For 1997, includes matching and profit sharing contributions made to each
Named Executive Officer (other than Mr. Maib) pursuant to the Company's
401(k) retirement and profit sharing plan of $4,750 and $7,119 (other than
for Mr. Silverman who received a matching contribution of $2,816 and a
profit sharing contribution of $7,119 in each such year). For 1998,
includes matching and profit sharing contributions made to each Named
Executive Officer (other than Mr. Maib) pursuant to the Company's 401(k)
retirement and profit sharing plan of $9,750 and $7,638. In the case of Mr.
Maib, the amount reflected for 1998 consists of the reimbursement of
relocation expenses of $268,426 and does not include a $100,000 advance
made to Mr. Maib in connection with his relocation, which was repaid on
March 16, 1999. See Indebtedness of Executive Officers. In the case of Mr.
Silverman, the amount reflected for 1997 also includes reimbursement of
relocation expenses of $56,185.
Option/SAR Grants in Last Fiscal Year
There were no option/SAR grants made to the Named Executive Officers during the
year ended December 31, 1999.
120
<PAGE>
Aggregated Option Exercises in Last Fiscal Year-End/SAR Option Values
No options were exercised by the Named Executive Officers during the year ended
December 31, 1999.
<TABLE>
<CAPTION>
Number of
Securities Underlying Value of Unexercised
Unexercised Options at In-the-Money Options at
Fiscal Year-End Fiscal Year-End (1)
Acquired Value --------------------------- ---------------------------
on Exercise Realized Exercisable Unexercisable Exercisable Unexercisable
----------- -------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Keith A. Maib -- $ -- -- 600,000 $ -- $ --
James P. McDermott -- -- 35,815 500,002 $ -- $ --
Scott D. Silverman -- -- 34,998 500,002 $ -- $ --
</TABLE>
- ---------------
(1) Based on the closing price of the Common Stock of $0.44 per share on
December 31, 1999, as reported by the NYSE.
Employment Agreements
Pursuant to the Stock Purchase Agreement dated as of January 10, 2000, by and
between Reassure America and the Company, Messrs. Maib, McDermott and Silverman
became entitled to terminate their then existing employment agreements. As a
result thereof, the amounts of $3,403,467, $2,983,335 and $3,062,930 became due
and owing to Messrs. Maib, McDermott and Silverman, respectively. In order to
ensure the continued service of each executive, on January 28, 2000, the Company
entered into an Agreement with each of Messrs. Maib, McDermott and Silverman,
pursuant to which the Company entered into new Executive Employment Agreements
with each executive (the "New Employment Agreements") and paid each executive
the amount indicated above. Under the terms of the New Employment Agreements,
Mr. Maib is entitled to receive an annual base salary of $250,000. Messrs.
McDermott and Silverman are entitled to receive annual base salaries of
$200,000. Additionally, under the terms of their employment agreements, Mr. Maib
has the opportunity to earn up to $300,000 and Messrs. McDermott and Silverman
have the opportunity to earn up to $200,000 in performance bonus payments. Such
performance bonuses shall be determined solely at the discretion of the Board of
Directors of the Company and are payable upon termination of the executive's
employment under his New Employment Agreement.
SUMMARY OF DIRECTOR COMPENSATION
Directors of the Company are entitled to reimbursement of their reasonable
out-of-pocket expenses in connection with their travel to and attendance at
meetings of the Board of Directors or committees thereof. In addition, each
director of the Company who is not also an officer or salaried employee of the
Company (a "Non-Employee Director") receives an annual fee of $30,000 and a fee
of $2,000 for each meeting of the Board of Directors (except for the first four
meetings in each calendar year for which no fee will be paid) at which such
director is present. Each Non-Employee Director who is a member of a committee
of the Board of Directors also receives a fee of $1,000 for each meeting of such
committee at which such director is present. Committee chairmen receive an
additional annual fee of $5,000. As a result of serving as Chairman of the Board
of the Company, Mr. Smith is entitled to receive an annual fee of $200,000. Mr.
Smith also received a grant of 50,000 phantom options, the value of which is
determined by the increase in market value of the Company's Common Stock above
$3.88, which was 115% of the closing price of the Common Stock on the date of
grant. During 1998, Mr. Player received a special fee of $25,000 for his
services rendered in 1997. In 1999, Mr. Smith was awarded a special bonus of
$115,000 in shares of the Company's Common Stock for his services rendered in
1998. Also in 1999, Mr. Greenberg received a special fee of $50,000 for his
services rendered in 1998.
In addition to the foregoing, the Warrant Plan granted each Non-Employee
Director (other than Mr. Greenberg) a ten-year warrant to purchase up to 3,000
shares of Common Stock upon his election to the Board of Directors. The exercise
price of such warrants with respect to each share of underlying Common Stock was
equal to the fair market value of the Common Stock on the date of grant. Each
warrant vested and became exercisable in three equal annual installments
commencing on the first anniversary date after the date of the grant provided
that the Non-Employee Director was serving as a director of the Company on such
anniversary date. On November 5, 1992, each of Messrs. Schnitzer and Player were
granted warrants to purchase up to 3,000 shares of Common Stock at an exercise
price of $14.19 per share. On April 1, 1993, Mr. Roman received a warrant to
purchase up to 3,000 shares of Common Stock at an exercise price of $19.06 per
share. On September 1, 1994, Mr. Smith received a warrant to purchase up to
3,000 shares of Common Stock at an exercise price of $15.63 per share. No
further awards will be made under the Warrant Plan.
121
<PAGE>
Pursuant to an amendment to the Stock Plan approved by the Company's
stockholders on December 31, 1997, Messrs. Schnitzer, Player and Smith exercised
these Warrants for which they received 1977, 1444, and 1819 shares of restricted
common stock, respectively. The shares of restricted stock are subject to
forfeiture if any of these Non-Employee Directors ceases to be a director for
any reason other than as a result of a change of control or ownership of the
Company, the failure to be re-elected by the Company's shareholders or the
Non-Employee Director's death or disability (as defined in the Stock Plan). Each
of these Non-Employee Directors was also granted an option to purchase 3,000
shares of Common Stock at the exercise price of $32.25 (the closing price of the
Common Stock on March 31, 1997, the effective date of the grant).
Under the Stock Plan Non-Employee Directors are entitled to receive an annual
stock option to purchase 7,500 shares of Common Stock. Option grants are made on
the date of each annual stockholders meeting and are exercisable eighteen months
after the date of the grant at the fair market value (as defined in the Stock
Plan) of PennCorp's Common Stock on the grant date. Additionally, the Stock Plan
generally enables Non-Employee Directors to receive all or a portion of their
annual fees in Common Stock. Messrs. Player and Smith elected to receive Common
Stock in lieu of 50% of their annual fee for 1998.
Item 12. Security Ownership of Certain Beneficial Owners and Management
OWNERS AND MANAGEMENT
Except as otherwise noted below, the following table sets forth, as of March 29,
2000, the ownership of the outstanding shares of Common Stock (including shares
of Common Stock issuable upon conversion of shares of the Company's $3.375
Convertible Preferred Stock ("Preferred Stock") and the Company's $3.50 Series
II Preferred Stock ("Series II Preferred")) held by persons known by the Company
to own beneficially more than 5% of the outstanding shares of Common Stock, by
all directors of the Company, by the Named Executive Officers, and by the
executive officers and directors of the Company as a group, and the percentage
of the Common Stock represented thereby. Except as otherwise noted below, the
Company believes that each director, Named Executive Officer, and over 5%
stockholder shown below has sole voting and sole investment power with respect
to all shares beneficially owned by them.
<TABLE>
<CAPTION>
Amount and Nature
of Beneficial
Name and Address of Beneficial Owner Ownership Percent of Class
------------------------------------ --------- ----------------
<S> <C> <C>
Brown's Dock, L.L.C.(1) .......................... 3,301,266 10.2
56 Prospect Street
Hartford, Connecticut 06115
NBT of Delaware, Inc.(2) ......................... 1,787,472 6.0
1209 Orange Street, Room 123
Wilmington, Delaware 19801
Allan D. Greenberg(3) ............................ 409,253 1.4
Keith A. Maib .................................... -- --
James P. McDermott(4) ............................ 81,726 *
Thomas A. Player(5) .............................. 33,918 *
Bruce W. Schnitzer(6) ............................ 51,698 *
Scott D. Silverman(7) ............................ 84,605 *
David C. Smith(8) ................................ 231,313 *
All directors and executive officers as a group(9) 892,513 3.1
</TABLE>
- ----------------
* Represents less than 1%.
122
<PAGE>
(1) The following information was provided by Brown's Dock, L.L.C. ("Brown's
Dock") on behalf of its "group" of reporting persons: Brown's Dock, Phoenix
Home Life Mutual Insurance Company, Phoenix Investment Partners, Ltd.,
Inverness Management Fund I LLC, WMD LLC, W. McComb Dunwoody, J.C. Comis
LLC, James C. Comis III, Inverness/Phoenix Partners LP, Executive Capital
Partners I LP, Inverness/Phoenix Capital LLC, and DCPM Holdings, Inc.
(collectively, the "Inverness Persons"). As of January 19, 2000, based on a
Schedule 13D filed by the Inverness Persons with the SEC on January 19,
2000, the Inverness Persons have shared voting power and shared dispositive
power as to 1,346,600 shares of Preferred Stock and 224,800 shares of
Series II Preferred. The Company's Preferred Stock is convertible into
2.2124 shares of the Company's Common Stock, and the Company's Series II
Preferred is convertible into 1.4326 shares of the Company's Common Stock.
(2) The following information was provided by National Bancshares Corporation
of Texas and NBT of Delaware, Inc. (collectively, "NBT"). As of November
24, 1999, based on a Schedule 13D filed by NBT, NBT beneficially owned
1,299,200 shares of the Company's Common Stock, 177,100 shares of Preferred
Stock and 67,330 shares of Series II Preferred. The Company's Preferred
Stock is convertible into 2.2124 shares of the Company's Common Stock, and
the Company's Series II Preferred is convertible into 1.4326 shares of the
Company's Common Stock.
(3) Consists of (i) 168,753 shares of Common Stock owned of record by Mr.
Greenberg, (ii) 225,000 shares of Common Stock that may be purchased
pursuant to a presently exercisable Management Warrant, (iii) 7,500 shares
of Common Stock that may be purchased pursuant to presently exercisable
stock options awarded to Mr. Greenberg pursuant to the 1996 Stock Option
Plan and (iv) 8,000 shares of Common Stock owned of record by a trust for
the benefit of Mr. Greenberg's minor children over which Mr. Greenberg's
wife has sole voting power. Mr. Greenberg disclaims beneficial ownership of
Common Stock not held of record by him.
(4) Consists of (i) 11,933 shares of Common Stock owned of record by Mr.
McDermott, (ii) 7,295 shares of restricted Common Stock, (iii) 37,498
shares of Common Stock subject to a presently exercisable stock option and
(iv) 25,000 shares of Common Stock that may be purchased pursuant to a
presently exercisable Management Warrant.
(5) Consists of (i) 6,128 shares of Common Stock owned of record by Mr. Player,
(ii) 1,995 shares of restricted Common Stock, (iii) 7,500 shares of Common
Stock that may be purchased pursuant to presently exercisable stock options
awarded to Mr. Player pursuant to the 1996 Stock Option Plan and (iv)
18,295 shares of Common Stock owned by Mr. Player's wife. Mr. Player
disclaims beneficial ownership of Common Stock not held of record by him.
(6) Consists of (i) 23,497 shares of Common Stock owned of record by Mr.
Schnitzer, (ii) 18,706 shares owned of record by Magical Corporation, of
which Mr. Schnitzer is the sole owner, (iii) 1,995 shares of restricted
Common Stock and (iv) 7,500 shares of Common Stock that may be purchased
pursuant to presently exercisable stock options awarded to Mr. Schnitzer
pursuant to the 1996 Stock Option Plan.
(7) Consists of (i) 15,500 shares of Common Stock owned of record jointly by
Mr. Silverman and his wife, (ii) 6,607 shares of restricted Common Stock,
(iii) 37,498 shares of Common Stock subject to a presently exercisable
stock option and (iv) 25,000 shares of Common Stock that may be purchased
pursuant to a presently exercisable Management Warrant.
(8) Consists of 33,742 shares of Common Stock owned of record jointly by Mr.
Smith and his wife, (ii) 190,071 shares of restricted Common Stock, 188,235
of which are subject to restriction pursuant to Rule 144 of the Securities
and Exchange Act of 1934, as amended, (iii) 7,500 shares of Common Stock
that may be purchased pursuant to presently exercisable stock options
awarded to Mr. Smith pursuant to the 1996 Stock Option Plan.
(9) Assumes the exercise of warrants or options to purchase 379,996 shares of
Common Stock and includes shares of restricted Common Stock that do not
(absent certain contingencies) vest until March 31, 2001 or March 31, 2000
in the case of restricted stock held by Messrs. Player, Schnitzer and
Smith.
123
<PAGE>
Item 13. Certain Relationships and Related Transactions
INDEBTEDNESS OF EXECUTIVE OFFICERS
On September 8, 1997, the Company loaned each of Messrs. James P. McDermott and
Scott D. Silverman, executive officers of the Company, $310,380, to finance
their purchase of 10,000 shares each of the Company's Common Stock. Each of the
above loans were due and payable (absent the earlier occurrence of certain
specified contingencies) on September 8, 2002, bear interest at the rate of
6.23% per annum and were secured by a pledge of the shares of Common Stock
purchased with the loan proceeds. These loans were made on a non-recourse basis.
As of December 31, 1999, each of Messrs. McDermott and Silverman owed $355,093
in unpaid principal and accrued interest. In February 2000, pursuant to the
terms of their employment, the Company accepted from each of Mr. McDermott and
Mr. Silverman 10,000 shares of the Company's Common Stock in full and complete
extinguishment of the outstanding principal and accrued interest on these loans.
At the time of such surrender, the fair market value of Messrs. McDermott's and
Silverman's 10,000 shares was $350.
On July 9, 1998, the Company advanced Mr. Keith A. Maib, the current President
and Chief Executive Officer of the Company, $100,000 against the guaranteed
portion of his annual incentive bonus. See "Executive Compensation - Employment
Agreements." The purpose of this advance was to assist Mr. Maib in his
relocation from Indianapolis, Indiana to Dallas, Texas. This advance was repaid
on March 16, 1999.
On September 30, 1997, the Company loaned Mr. Silverman $100,000. The loan bears
interest at the rate of 6.34% per annum, was due and payable on September 30,
2002, and was secured by a second mortgage on Mr. Silverman's residence. On
December 31, 1999, the outstanding principal and accrued interest on Mr.
Silverman's loan was $114,278. On January 27, 1995, the Company loaned $30,000
to Mr. McDermott, which loan bears interest at the rate of 7.2% per annum and
was due and payable on demand. On December 31, 1999, the outstanding principal
and accrued interest on Mr. McDermott's loan was $40,646. These loans were made
as part of the relocations of Messrs. Silverman and McDermott. Pursuant to the
terms of their employment agreements, Mr. McDermott's and Mr. Silverman's
outstanding loans were forgiven in January 2000, the date of the termination of
their employment agreements. The total amount forgiven was $62,433 and $173,294
for Messrs. McDermott and Silverman, respectively, which included accrued
interest as of January 28, 2000 and cash payments made to cover tax liabilities.
On March 5, 1998, Knightsbridge Management loaned each of Messrs. McDermott and
Silverman $146,250 to be used to pay tax obligations on stock awards made to
each of them on October 31, 1997. These loans bear interest at a rate of 5.39%
per annum and were due and payable on March 5, 2001, with interest payable in
arrears starting on March 5, 1999. The unpaid principal and accrued interest as
of December 31, 1999 was $160,634 for Messrs. McDermott and Silverman. Pursuant
to the terms of their employment agreements, Mr. McDermott and Mr. Silverman's
outstanding loans were forgiven in January 2000, the date of the termination of
their employment agreements. The total amount forgiven was $246,713 and $243,488
for Messrs. McDermott and Silverman, respectively, which included accrued
interest as of January 2000, and cash payments made to cover tax liabilities.
For more information concerning Messrs. McDermott's and Silverman's employment
agreements and the termination thereof, see "Executive Compensation--Employment
Agreements."
INTERESTS OF CERTAIN DIRECTORS
Bruce W. Schnitzer, a director of the Company, is a managing member of Wand
Partners, and an owner of Wand Partners Inc., a private investment firm. Two
limited partnerships controlled by Wand Partners and Wand (Acordia) Partners
L.L.C. invested an aggregate of $28,000,000 in the common stock of ACO as part
of the Acordia transaction. Wand Partners Inc. received aggregate commitment and
financial advisory fees of approximately $2,000,000 from ACO in connection with
that transaction. In addition, the Company is a limited partner in a partnership
controlled by Wand Partners (the "Wand Fund"), and invested (through one of its
subsidiaries) $2,000,000 in ACO through the Wand Fund. The general partner of
the Wand Fund is entitled to receive 20% of the profits earned by its limited
partners, including the Company, on their investment in ACO, after they have
been repaid their capital contributions to the partnership, assuming a 9%
preferred rate of return has been achieved on their capital. Pursuant to a
"promote" agreement between Messrs. Stone and Fickes and Wand Partners, which
was assumed by the Company, Wand Partners received a performance bonus payment
of $280,000 upon the sale by the Company of its ACO common stock.
In 1999 the Company invested a total of $4,355,016 in transactions sponsored by
Wand Partners. The Company has committed to invest up to an additional
$7,038,000 in future transactions sponsored by the Wand Fund. In addition, as of
December 31, 1999, the Company has invested approximately $13,462,000 in limited
partnership interests in limited partnerships affiliated with Wand Partners. The
Company paid fees of approximately $386,718 to Wand Partners and related
entities for the period from January 1, 1999 through December 31, 1999.
On July 30, 1999, the Company consummated the sale of its career sales division
and related assets to Universal American Financial Corp. ("Universal American")
for net cash proceeds, after transaction costs and fulfillment of contract
obligations, of $82.0 million. Bruce W. Schnitzer (through the Wand Fund) and
Allan D. Greenberg, directors of the Company, are minority shareholders of
Universal American. Mr. Schnitzer and Mr. Greenberg did not vote at the meeting
of the Company's Board of Directors at which the Board of Directors authorized
the Company to enter into the definitive purchase and sale agreement relating to
its career sales division.
124
<PAGE>
David C. Smith, the Chairman of the Board of the Company is an investor in
Executive Capital Partners I LP. Such fund, along with certain of its affiliates
including Inverness/Phoenix Capital, LLC, Inverness/Phoenix Partners, L.P., and
Partners Management I, LP (collectively "Inverness"), controls and manages
approximately 30% of the outstanding preferred stock of the Company. Mr. Smith's
investment in the Fund is less than 1% of the aggregate investments in the
Inverness. Additionally, Mr. Smith has been excluded from participation in
Inverness' investment in the Company. The Company is currently pursuing a
recapitalization transaction in which Inverness and its affiliates will own
between 30%-36% of the post-recapitalization capital stock of the Company.
(Remainder of Page Intentionally Left Blank)
125
<PAGE>
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) Documents
1. The financial statements of PennCorp Financial Group, Inc. and
Subsidiaries set forth on pages 55 through 96, and the Independent
Auditors Report set forth on page 54 hereof are in response to the
information required by this Item.
2. An index to the financial statement schedules required to be filed
by Item 8 of this Report on Form 10-K is set forth immediately
before the attached financial statement schedules on page 135 of
this filing.
Exhibits
2.1 Amended and Restated Purchase Agreement dated as of July 2, 1999,
among Universal American Financial Corp., PennCorp Financial
Group, Inc., Pacific Life and Accident Insurance Company,
Pennsylvania Life Insurance Company, Southwestern Financial
Corporation, Constitution Life Insurance Company, and PennCorp
Financial Services, Inc. (5)
2.2 Stock Purchase Agreement dated as of December 31, 1998 between GE
Financial Assurance Holdings, Inc. and Pacific Life and Accident
Insurance Company. (23)
2.3 Agreement dated as of December 31, 1998 between GE Financial
Assurance Holdings, Inc. and PennCorp Financial Group, Inc. (23)
2.4 Purchase Agreement dated February 21, 1999, among ING America
Insurance Holdings, Inc., PennCorp Financial Group, Inc., Pacific
Life and Accident Insurance Company, marketing One Financial
Corporation and Marketing One, Inc. (18)
2.5 Purchase Agreement dated June 11, 1999, by and between PennCorp
Financial Services, Inc. and Allegiance Telecom, Inc. (25)
2.6 First Amendment to Stock Purchase Agreement dated as of June 30,
1999, by and between PennCorp Financial Services, Inc. and
Allegiance Telecom, Inc. (5)
2.7 Stock Purchase Agreement, dated as of January 8, 2000, by and
between Pioneer-Occidental Holdings Company and American-Amicable
Holdings Corporation (26)
2.8 Amendment to Stock Purchase Agreement dated as of February 4,
2000, by and between American-Amicable Holdings Corporation and
Pioneer-Occidental Holdings Company. (27)
2.9 Stock Purchase Agreement, dated as of January 7, 2000, between
Reassure America Life Insurance Company and PennCorp Financial
Group, Inc. (26)
3.1 Restated By-Laws of PennCorp Financial Group, Inc. (9)
3.2 Third Restated Certificate of Incorporation of PennCorp Financial
Group, Inc. (17)
4.1 Corrected Certificate of Designation of $3.375 Convertible
Preferred Stock. (4)
4.2 Certificate of Designation of $3.50 Series II Convertible
Preferred Stock. (3)
4.3 Indenture between PennCorp Financial Group, Inc. and The Bank of
New York, as trustee, with respect to 9 1/4% Senior Subordinate
Notes due 2003. (8)
126
<PAGE>
MANAGEMENT COMPENSATION
RELATED AGREEMENTS
10.1 Executive Employment Agreement dated January 28, 2000, by and
between PennCorp Financial Group, Inc. and Keith A. Maib. (27)
10.2 Agreement dated January 28, 2000, by and between PennCorp
Financial Group, Inc. and Keith A. Maib. (27)
10.3 Executive Employment Agreement dated January 28, 2000, by and
between PennCorp Financial Group, Inc. and James P. McDermott.
(27)
10.4 Agreement dated January 28, 2000, by and between PennCorp
Financial Group, Inc. and James P. McDermott. (27)
10.5 Executive Employment Agreement dated January 28, 2000, by and
between PennCorp Financial Group, Inc. and Scott D. Silverman.
(27)
10.6 Agreement dated January 28, 2000, by and between PennCorp
Financial Group, Inc. and Scott D. Silverman. (27)
10.7 Agreement dated September 9, 1999 between David C. Smith,
chairman of the Board of the Company and PennCorp Financial
Group, Inc. (28)
10.8 PennCorp Financial, Inc. Retirement and Savings Plan. (10)
10.9 PennCorp Financial Group, Inc. Retirement and Savings Plan. (2)
10.10 PennCorp Financial Group, Inc. 1992 Stock Option Plan. (10)
10.11 PennCorp Financial Group, Inc. Senior Management Warrant
Award Program. (10)
10.12 Form of Restricted Stock Agreement by and between PennCorp
Financial Group, Inc. and certain participants, effective as of
April 1, 1994. (6)
10.13 PennCorp Financial Group, Inc. 1996 Stock Award and Stock Option
Plan. (11)
10.14 Amendment Number One to PennCorp Financial Group, Inc. 1996
Stock Award and Stock Option Plan. (17)
10.15 Amendment Number Two to PennCorp Financial Group, Inc. 1996
Stock Award and Stock Option Plan. (2)
10.16 Executive Employment Agreement dated May 22, 1998 by and between
PennCorp Financial Group, Inc. and James P. McDermott. (19)
10.17 Executive Retention Agreement dated May 22, 1998 by and between
PennCorp Financial Group, Inc. and James P. McDermott. (19)
10.18 Executive Employment Agreement dated May 22, 1998 by and between
PennCorp Financial Group, Inc. and Scott D. Silverman. (19)
10.19 Executive Retention Agreement dated May 22, 1998 by and between
PennCorp Financial Group, Inc. and Scott D. Silverman. (19)
10.20 Executive Employment Agreement dated July 1, 1998 by and between
PennCorp Financial Group, Inc. and Keith A. Maib. (19)
127
<PAGE>
10.21 Executive Retention Agreement dated July 1, 1998 by and between
PennCorp Financial Group, Inc. and Keith A. Maib. (19)
10.22 Letter Agreement dated May 21, 1998 for Option to Purchase
Shares of ACO Brokerage Holdings Corporation by and between
PennCorp Financial Group, Inc. and James P. McDermott. (2)
10.23 Letter Agreement dated May 21, 1998 for Option to Purchase
Shares of ACO Brokerage Holdings Corporation by and between
PennCorp Financial Group, Inc. and Scott D. Silverman (2)
10.24 Credit Agreement dated March 12, 1997 by and among PennCorp
Financial Group, Inc. and The Chase Manhattan Bank, The First
National Bank of Chicago, and NationsBank, NA., as Managing
Agents, Fleet National Bank, Mellon Bank, N.A., Bank of Montreal,
CIBC Inc., and Dresdner Bank AG, New York Branch and Grand Cayman
Branch as Co-Agents and The Bank of New York, as Administrative
Agent. (13)
10.25 Amendment No. 1 and Waiver dated as of June 13, 1997 to Credit
Agreement dated as of March 12, 1997 by and among PennCorp
Financial Group, Inc., lenders signatory to the Credit Agreement
and The Bank of New York. (19)
10.26 Amendment No. 2 and Waiver dated as of April 17, 1998 to Credit
Agreement dated as of March 12, 1997 by and among PennCorp
Financial Group, Inc., lenders signatory to the Credit Agreement
and The Bank of New York. (19)
10.27 Waiver dated as of August 14, 1998 to Credit Agreement dated as
of March 12, 1997 by and among PennCorp Financial Group, Inc.,
lenders signatory to the Credit Agreement and The Bank of New
York. (2)
10.28 Amendment No. 3 dated as of September 11, 1998 to Credit
Agreement dated as of March 12, 1997 by and among PennCorp
Financial Group, Inc., lenders signatory to the Credit Agreement
and The Bank of New York. (20)
10.29 Amendment No. 4 and Waiver dated as of November 16, 1998 to
Credit Agreement dated as of March 12, 1997 by and among PennCorp
Financial Group, Inc., lenders signatory to the Credit Agreement
and The Bank of New York. (22)
10.30 Amendment No. 5 dated as of December 31, 1998 to Credit
Agreement dated as of March 12, 1997 by and among PennCorp
Financial Group, Inc., lenders signatory to the Credit Agreement
and The Bank of New York. (23)
10.31 United Life Consent Agreement dated as of March 5, 1999 by and
among PennCorp Financial Group, Inc., lenders signatory to the
Credit Agreement dated as of March 12, 1997 and The Bank of New
York. (24)
10.32 Amendment No. 6 dated as of March 31, 1999 to Credit Agreement,
among the Company, the lenders signatory thereto, the Managing
Agents and the Co-Agents named therein and The Bank of New York,
as administrative agent. (18)
10.33 Amendment No. 7 dated as of April 30, 1999, to Credit Agreement,
among the Company, the lenders signatory thereto, the Managing
Agents and the Co-Agents named therein and The Bank of New York,
as administrative agent. (5)
10.34 Amendment No. 8 dated as of May 14, 1999, to Credit Agreement,
among the Company, the lenders signatory thereto, the Managing
Agents and the Co-Agents named therein and The Bank of New York,
as administrative agent. (5)
128
<PAGE>
10.35 Amendment No. 9 dated as of June 25, 1999, to Credit Agreement,
among the Company, the lenders signatory thereto, the Managing
Agents and the Co-Agents named therein and The bank of New York,
as administrative agent. (5)
10.36 Amendment No. 10 dated as of June 30, 1999, to Credit Agreement,
among the Company, the lenders signatory thereto, the Managing
Agents and the Co-Agents named therein and The Bank of New York,
as administrative agent. (5)
10.37 Amendment No. 11 dated as of November 26, 1999, to Credit
Agreement, among the Company, the lenders signatory thereto, the
Managing Agents and the Co-Agents named therein and The Bank of
New York, as administrative agent. (1)
10.38 Waco Consent and Waiver and Amendment dated as of January 31,
2000, to Credit Agreement, among the Company, the lenders
signatory thereto, the Managing Agents and the Co-Agents named
therein and The bank of New York, as administrative agent. (1)
10.39 Swiss Re Consent dated as of January 31, 2000, to Credit
Agreement, among the Company, the lenders signatory thereto, the
managing Agents and the Co-Agents named therein and The Bank of
New York, as administrative agent. (1)
10.40 Other Consent dated as of January 31, 2000, to Credit Agreement,
among the Company, the lenders signatory thereto, the managing
Agents and the Co-Agents named therein and The Bank of New York,
as administrative agent. (1)
10.41 Forbearance Agreement dated as of February 4, 2000 among
American-Amicable Holdings Corporation, Southwestern Financial
Corporation, Southwestern Financial Services Corporation,
PennCorp Occidental Corp., KB Investment L.L.C., KB Management
L.L.C. and the lenders signatory to the Credit Agreement, the
Managing Agents and the Co-Agents named therein and The Bank of
New York, as administrative agent ans collateral agent under the
Security Agreements. (29)
10.42 Cash Collateral Agreement dated as of February 8, 2000, among
the Company as Debtor and Debtor-in-Possession, the lenders
signatory thereto, and The Bank of New York, as administrative
agent. (29)
10.43 Amendment No. 1 to Cash Collateral Agreement dated as of
February 10, 2000, among the Company as Debtor and
Debtor-in-Possession, the lenders signatory thereto, and The Bank
of New York, as administrative agent. (29)
10.44 Revision Agreement, dated as of May 30, 1997, by and among
United Companies Financial Corporation, PennCorp Financial Group,
Inc., Pacific Life and Accident Insurance Company and each
additional party set forth on the signature pages thereto. (14)
10.45 Amendment to Surplus Debenture in the original principal amount
of $73,000,000 issued by Pioneer Security Life Insurance Company
to American-Amicable Holdings Corporation, dated May 17, 1996.
(14)
10.46 Second Amendment to Surplus Debenture in the original principal
amount of $73,000,000 issued by Pioneer Security Life Insurance
Company to American-Amicable Holdings Corporation, effective
January 1, 1997. (14)
10.47 Third Amendment to Surplus Debenture in the original principal
amount of $73,000,000 issued by Pioneer Security Life Insurance
Company to American-Amicable Holdings Corporation, effective May
14, 1997. (14)
10.48 Surplus Debenture Number Four in the original principal amount
of $162,539,890, issued by Pacific Life and Accident Insurance
Company to PennCorp Financial Group, Inc., dated January 1, 1994.
(7)
129
<PAGE>
10.49 Amendment to Surplus Debenture Number Four in the original
principal amount of $162,539,890, issued by Pacific Life and
Accident Insurance Company to PennCorp Financial Group, Inc.,
effective January 1, 1997. (14)
10.50 Second Amendment to Surplus Debenture Number Four in the
original principal amount of $162,539,890, issued by Pacific Life
and Accident Insurance Company to PennCorp Financial Group, Inc.,
effective May 14, 1997. (14)
10.51 Surplus Debenture Number Five in the original principal amount
of $17,606,203, issued by Pacific Life and Accident Insurance
Company to PennCorp Financial Group, Inc., dated September 29,
1994. (12)
10.52 Amendment to Surplus Debenture Number Five in the original
principal amount of $17,606,203, issued by Pacific Life and
Accident Insurance Company to PennCorp Financial Group, Inc.,
effective January 1, 1997. (14)
10.53 Second Amendment to Surplus Debenture Number Five in the
original principal amount of $17,606,203, issued by Pacific Life
and Accident Insurance Company to PennCorp Financial Group, Inc.,
effective May 14, 1997. (14)
10.54 Surplus Debenture Number Six in the original principal amount of
$55,000,000, issued by Pacific Life and Accident Insurance
Company to PennCorp Financial Group, Inc., dated July 24, 1996.
(11)
10.55 Amendment to Surplus Debenture Number Six in the original
principal amount of $55,000,000, issued by Pacific Life and
Accident Insurance Company to PennCorp Financial Group, Inc.,
effective January 1, 1997. (14)
10.56 Second Amendment to Surplus Debenture Number Six in the original
principal amount of $55,000,000, issued by Pacific Life and
Accident Insurance Company to PennCorp Financial Group, Inc.,
effective May 14, 1997. (14)
10.57 Amendment to Surplus Debenture dated December 14, 1995 in the
original principal amount of $80,000,000 issued by Constitution
Life Insurance Company to Southwestern Financial Corporation.
(19)
10.58 Amendment to Surplus Debenture dated January 1, 1996 in the
original principal amount of $40,000,000 issued by Constitution
Life Insurance Company to Southwestern Financial Corporation.
(19)
10.59 Surplus Debenture Number Seven in the original principal amount
of $150,000,000, issued by Pacific Life and Accident Insurance
Company to Southwestern Financial Corporation, dated as of July
30, 1999. (30)
10.60 Surplus Debenture Number Eight in the original principal amount
of $35,000,000, issued by Pacific Life and Accident Insurance
Company to Southwestern Financial Corporation, dated January 31,
2000. (1)
10.61 Note Purchase, Release and Settlement Agreement, dated July 13,
1997, executed by Lone Star Liquidating Trust, PennCorp Financial
Group, Inc. and Southwestern Financial Corporation . (15)
10.62 Amended and Restated Assignment Agreement dated as of January 2,
1998 by and between PennCorp Financial Group, Inc. and
Knightsbridge Capital Fund I, L.P. (16)
130
<PAGE>
10.63 Amended and Restated Assignment Agreement dated as of January 2,
1998 by and between PennCorp Financial Group, Inc., David J.
Stone, Steven W. Fickes, the Steven Wayne Fickes, Jr. Trust dated
December 21, 1995 and the Kathryn Elizabeth Fickes Trust dated
December 21, 1995. (16)
10.64 Agreement dated September 22, 1998 by PennCorp Financial Group,
Inc. and certain subsidiaries signatory to the Agreement and the
Texas Department of Insurance. (21)
12 Computation of ratio of earnings to fixed charges. (1)
21 List of subsidiaries of the Registrant. (1)
23.1 Auditors consent. (1)
23.2 Auditors consent. (1)
27 Financial Data Schedule. (1)
(1) Filed herewith.
(2) Such exhibit is incorporated by reference to the Annual Report on Form 10-K
for the fiscal year ended December 31, 1998 of PennCorp Financial Group,
Inc.
(3) Such exhibit is incorporated by reference to the Registration Statement on
Form S-3 (Registration No. 333- 13285) of PennCorp Financial Group, Inc.
filed with the Securities and Exchange Commission on October 10, 1996.
(4) Such exhibit is incorporated by reference to the Annual Report on Form 10-K
for the fiscal year ended December 31, 1995 of PennCorp Financial Group,
Inc.
(5) Such exhibit is incorporated by reference to the Form 8-K dated June 25,
1999 which was filed with the Securities and Exchange Commission by
PennCorp Financial Group, Inc. on July 13, 1999 relating to the sale of the
Career Sales Division and related assets, First Amendment to Stock Purchase
Agreement; and Amendment No's. 7, 8, 9 and 10 to Credit Agreement.
(6) Such exhibit is incorporated by reference to the Quarterly Report on Form
10-Q for the three months ended September 30, 1994 of PennCorp Financial
Group, Inc.
(7) Such exhibit is incorporated by reference to the Quarterly Report on Form
10-Q for the three months ended June 30, 1994 of PennCorp Financial Group,
Inc.
(8) Such exhibit is incorporated by reference to the Annual Report on Form 10-K
for the fiscal year ended December 31, 1993 of PennCorp Financial Group,
Inc.
(9) Such exhibit is incorporated by reference to the Annual Report on Form 10-K
for the fiscal year ended December 31, 1992 of PennCorp Financial Group,
Inc.
(10) Such exhibit is incorporated by reference to the Registration Statement on
Form S-1 (Registration No. 33-50530) of PennCorp Financial Group, Inc.
filed on August 6, 1992.
(11) Such exhibit is incorporated by reference to the Annual Report on Form 10-K
for the fiscal year ended December 31, 1996 of PennCorp Financial Group,
Inc.
(12) Such exhibit is incorporated by reference to Amendment Number 2 to the
Annual Report on Form 10-K for fiscal year ended December 31, 1996 of
PennCorp Financial Group, Inc.
(13) Such exhibit is incorporated by reference to the Amendment Number 1 to
Annual Report on Form 10-K for the fiscal year ended December 31, 1996 of
PennCorp Financial Group, Inc.
(14) Such exhibit is incorporated by reference to the Quarterly Report on Form
10-Q for the three months ended June 30, 1997 of PennCorp Financial Group,
Inc.
131
<PAGE>
(15) Such exhibit is incorporated by reference to the Quarterly Report on Form
10-Q for the three months ended September 30, 1997 of PennCorp Financial
Group, Inc.
(16) Such exhibit is incorporated by reference to the Form 8-K dated January 13,
1998 which was filed with the Securities and Exchange Commission by
PennCorp Financial Group, Inc. on January 13, 1998 relating to the
acquisition of common stock and common stock warrants of Southwestern
Financial Corporation not previously owned by PennCorp Financial Group,
Inc.
(17) Such exhibit is incorporated by reference to the Registration Statement on
Form S-8 (Registration No. 333-48629) of PennCorp Financial Group, Inc.
filed on March 24, 1998.
(18) Such exhibit is incorporated by reference to the Form 8-K dated March 31,
1999 which was filed with the Securities and Exchange Commission by
PennCorp Financial Group, Inc. on April 5, 1999 relating to the sale of the
United Life & Annuity Insurance Company, CyberLink Development, Inc., UC
Mortgage Corp., United Variable Services, Inc. and certain assets of
Marketing One, Inc.; and Amendment No. 6 to Credit Agreement
(19) Such exhibit is incorporated by reference to the Quarterly Report on Form
10-Q for the three months ended June 30, 1998 of PennCorp Financial Group,
Inc.
(20) Such exhibit is incorporated by reference to the Form 8-K dated September
15, 1998 which was filed with the Securities and Exchange Commission by
PennCorp Financial Group, Inc. on September 15, 1998 relating to Amendment
No. 3 to Credit Agreement.
(21) Such exhibit is incorporated by reference to the Quarterly Report on Form
10-Q for the three months ended September 30, 1998 of PennCorp Financial
Group, Inc.
(22) Such exhibit is incorporated by reference to the Form 8-K dated November
17, 1998 which was filed with the Securities and Exchange Commission by
PennCorp Financial Group, Inc. on November 17, 1998 relating to Amendment
No. 4 and Waiver of Credit Agreement.
(23) Such exhibit is incorporated by reference to the Form 8-K dated January 11,
1999 which was filed with the Securities and Exchange Commission by
PennCorp Financial Group, Inc. on January 11, 1999 relating to the
acquisition of Pennsylvania Life Insurance Company, Union Bankers Insurance
Company and related entities, the acquisition of Professional Insurance
Company, and Amendment No. 5 to Credit Agreement.
(24) Such exhibit is incorporated by reference to the Form 8-K dated March 11,
1999 which was filed with the Securities and Exchange Commission by
PennCorp Financial Group, Inc. on March 11, 1999 relating to the United
Life Consent Agreement by and among PennCorp Financial Group, Inc. lenders
signatory to the Credit Agreement dated as of March 12, 1997 and The Bank
of New York.
(25) Such exhibit is incorporated by reference to the Form 8-K dated June 11,
1999 which was filed with the Securities and Exchange Commission by
PennCorp Financial Group, Inc. on June 18, 1999 relating to the sale of
Kivex, Inc.
(26) Such exhibit is incorporated by reference to the Form 8-K dated January 10,
2000 which was filed with the Securities and Exchange Commission by
PennCorp Financial Group, Inc. on January 10, 2000 relating to the sale of
Pioneer Security Life Insurance Company, Occidental Life Insurance Company,
American-Amicable Life Insurance Company of Texas and Pioneer American
Insurance Company; and the sale of Southwestern Life Insurance Company and
Security Life & Trust Insurance Company.
(27) Such exhibit is incorporated by reference to the Form 8-K dated February 4,
2000 which was filed with the Securities and Exchange Commission by
PennCorp Financial Group, Inc. on February 11, 2000 relating to the sale of
Pioneer Security Life Insurance Company, Occidental Life Insurance Company,
American-Amicable Life Insurance Company of Texas and Pioneer American
Insurance Company; and new Agreements and Executive Employment Agreements
for Keith A. Maib, James P. McDermott and Scott D. Silverman.
(28) Such exhibit is incorporated by reference to the Quarterly Report on Form
10-Q for the three months ended June 30, 1999 of PennCorp Financial Group,
Inc.
132
<PAGE>
(29) Such exhibit is incorporated by reference to the Form 8-K dated February 4,
2000 which was filed with the Securities and Exchange Commission by
PennCorp Financial Group, Inc. on February 29, 2000 relating to the
Forbearance Agreement, Cash Collateral Agreement and Amendment No. 1 to
Cash Collateral Agreement.
(30) Such exhibit is incorporated by reference to the Quarterly Report on Form
10-Q for the three months ended September 30, 1999 of PennCorp Financial
Group, Inc.
(b) Reports on Form 8-K.
None
133
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or Section 15(d) of the
Securities Exchange Act of 1934, PennCorp Financial Group, Inc. has duly caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
PENNCORP FINANCIAL GROUP, INC.
(Registrant)
By:/s/ Keith A. Maib
-------------------------------------
Keith A. Maib
President and Chief Executive Officer
Date: April 13, 2000
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
/s/ Keith A. Maib /s/ Thomas A. Player
- ------------------------------------ ----------------------------------
Keith A. Maib Thomas A. Player
Director Director
Date: April 13, 2000 Date: April 13, 2000
/s/ Allan D. Greenberg /s/ Bruce W. Schnitzer
- ------------------------------------ ----------------------------------
Allan D. Greenberg Bruce W. Schnitzer
Director Director
Date: April 13, 2000 Date: April 13, 2000
/s/ David C. Smith
- ------------------------------------
David C. Smith
Chairman of the Board and Director
Date: April 13, 2000
134
<PAGE>
PENNCORP FINANCIAL GROUP, INC. AND SUBSIDIARIES
INDEX TO FINANCIAL STATEMENTS AND SCHEDULES
Financial Statements:
Reference is made to data appearing on pages 50 through 89, and to the
Independent Auditors' Report appearing on page 49 hereof.
Schedules:* Page
--------- ----
Independent Auditors' Report - Financial Statement Schedules ....... 136
Schedule II Condensed Financial Information of Registrant ........ 137
Schedule III Supplementary Insurance Information .................. 140
Schedule IV Reinsurance .......................................... 141
Schedule V Valuation and Qualifying Accounts .................... 142
* 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.
135
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Shareholders and Board of Directors of PennCorp Financial Group, Inc.
Under date of April 10, 2000, we reported on the consolidated balance
sheets of PennCorp Financial Group, Inc. and subsidiaries as of December 31,
1999 and 1998, and the related consolidated statements of operations and
comprehensive income (loss), changes in shareholders' equity and cash flows for
each of the years in the three-year period ended December 31, 1999, as contained
in the annual report on Form 10-K for the year 1999. In connection with our
audits of the aforementioned consolidated financial statements, we also audited
the related consolidated financial statement schedules as listed in the
accompanying index. These financial statement schedules are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these financial statement schedules based on our audits.
In our opinion, such financial 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.
The accompanying 1999 financial statement schedules have been prepared
assuming that the Company will continue as a going concern. The Company suffered
losses from operations in 1999 and 1998. As discussed in Note 23 of the Notes to
the Consolidated Financial Statements, PennCorp Financial Group, Inc. filed a
voluntary petition for relief under chapter 11 of title 11 of the United States
Bankruptcy Code in the United States Bankruptcy Court for the District of
Delaware. The Company has filed a plan of reorganization and will seek
confirmation of the Recapitalization Plan by the Bankruptcy Court. Should the
recapitalization plan not be approved by the Bankruptcy Court, be materially
delayed or not be consummated, the Company may have to sell assets or otherwise
realize assets and liquidate or settle liabilities for amounts other than those
reflected in the consolidated financial statements or related notes. These
factors raise substantial doubt about the Company's ability to continue as a
going concern. The 1999 financial statement schedules do not include any
adjustments that might result from the outcome of these uncertainties.
KPMG LLP
Dallas, Texas
April 10, 2000
136
<PAGE>
<TABLE>
SCHEDULE II
PENNCORP FINANCIAL GROUP, INC.
(PARENT COMPANY ONLY)
CONDENSED STATEMENTS OF INCOME (LOSS) For the years ended
December 31, 1999, 1998 and 1997
(In thousands)
<CAPTION>
1999 1998 1997
--------- --------- --------
<S> <C> <C> <C>
Revenue:
Interest income from subsidiaries .......................... $ 19,349 $ 19,663 $ 21,173
Other interest income ...................................... 754 2,865 3,547
Net gains from sale of investments ......................... -- 577 --
Net loss from sale of subsidiaries ......................... (1,898) -- --
Other income ............................................... 143 589 249
--------- --------- --------
Total revenue ........................................... 18,348 23,694 24,969
--------- --------- --------
Operating expenses:
General and administrative expenses ........................ 20,116 19,429 36,939
Interest and amortization of deferred debt issuance costs .. 40,176 42,730
23,103
Restructuring charges ...................................... 30 4,529 --
Impairment provision associated with assets of
Businesses Held for Sale .................................. -- 9,000 --
--------- --------- --------
Total operating expenses ................................ 60,322 75,688 60,042
--------- --------- --------
Loss before income tax benefits, equity in earnings of
subsidiaries .............................................. (41,974) (51,994) (35,073)
Income tax benefit ........................................ (1,249) (3,132) (8,689)
--------- --------- --------
Loss before equity in losses of subsidiaries ................. (40,725) (48,862) (26,384)
Equity in earnings (losses) of subsidiaries. .............. (145,987) (374,068) 76,524
--------- --------- --------
Net income (loss) ............................................ (200,712) (422,930) 50,140
Preferred stock dividend requirement ...................... 17,825 18,273 19,533
--------- --------- --------
Net income (loss) applicable to common stock ................. $(218,537) $(441,203) $ 30,607
========= ========= ========
See accompanying independent auditors' report.
137
<PAGE>
<CAPTION>
SCHEDULE II
PENNCORP FINANCIAL GROUP, INC.
(PARENT COMPANY ONLY)
CONDENSED BALANCE SHEETS
As of December 31, 1999 and 1998
(In thousands)
1999 1998
--------- -----------
<S> <C> <C>
ASSETS
Investments:
Investment in subsidiaries ............................. $ 435,077 $ 730,436
Notes receivable from subsidiaries ..................... 7,665 257,442
--------- -----------
Total investments .................................... 442,742 987,878
Cash and cash equivalents ............................... 10,478 12,654
Deferred debt issuance costs ............................ 2,051 4,896
Other assets ............................................ 221 1,145
--------- -----------
Total assets ......................................... $ 455,492 $ 1,006,573
========= ===========
LIABILITIES
Notes payable ........................................... $ 279,646 $ 548,646
Due to subsidiaries ..................................... 2,552 --
Accrued expenses and other liabilities .................. 20,328 21,986
--------- -----------
Total liabilities .................................... 302,526 570,632
--------- -----------
SHAREHOLDERS' EQUITY
$3.375 Convertible preferred stock ...................... 120,216 112,454
$3.50 Series II convertible preferred stock ............. 151,736 141,673
Common stock ............................................ 303 301
Additional paid in capital .............................. 428,974 430,321
Accumulated other comprehensive income .................. (62,712) 19,995
Accumulated deficit ..................................... (453,487)
Treasury shares ......................................... (30,829) (32,391)
Notes receivable and other assets secured by common stock (1,235) (1,491)
--------- -----------
Total shareholders' equity ........................... 152,966 435,941
--------- -----------
Total liabilities and shareholders' equity ........... $ 455,492 $ 1,006,573
========= ===========
See accompanying independent auditors' report.
138
<PAGE>
<CAPTION>
SCHEDULE II
PENNCORP FINANCIAL GROUP, INC.
(PARENT COMPANY ONLY)
CONDENSED STATEMENTS OF CASH FLOWS For the years ended
December 31, 1999, 1998 and 1997
(In thousands)
1999 1998 1997
--------- --------- ---------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss) ............................................. $(200,712) $(422,930) $ 50,140
Adjustments to reconcile net income (loss) to net cash
provided (used) in operating activities:
Amortization of intangibles and depreciation ............... 4,010 1,966 1,389
Impairment provision associated with assets of
Businesses Held for Sale .................................. -- 9,000 --
Equity in (earnings) losses of subsidiaries ................ 159,987 374,068 (76,524)
Increase (decrease) in liabilities and due to subs ......... (1,839) (6,164) 12,870
Loss on sale of subsidiaries ............................... 1,898 -- --
Other, net ................................................. 3,914 2,644 (9,227)
--------- --------- ---------
Net cash used by operations ............................... (32,742) (41,416) (21,352)
--------- --------- ---------
Cash flows from investing activities:
Acquisition of businesses ..................................... -- (73,858) --
Purchase of equity security ................................... -- (5,000) (20,000)
Sale of equity security ....................................... -- 30,500 --
Settlement on sale of subsidiaries ............................ (9,002) -- --
Collections on mortgage loans ................................. 1,238 -- --
Sale of mortgage loans and limited partnerships ............... 10,238 -- --
Principal payment on notes receivable from subsidiaries ....... 204,211 -- --
Dividend received from subsidiary ............................. 120,549 44,327 14,677
Capital contribution to subsidiary ............................ (27,668) (7,853) (14,889)
Other, net .................................................... -- 712 (42,142)
--------- --------- ---------
Net cash provided (used) by investing activities ........... 299,566 (11,172) (62,354)
--------- --------- ---------
Cash flows from financing activities:
Issuance of notes payable ..................................... -- 203,000 250,000
Issuance of common stock ...................................... -- 3 --
Purchase of treasury stock .................................... -- -- (28,760)
Reduction of notes payable .................................... (269,000) (126,015)
Redemption of preferred stock ................................. -- -- (14,705)
Other, primarily dividends, net ............................... -- (16,210) (20,464)
--------- --------- ---------
Net cash provided by financing activities................... (269,000) 60,778 86,071
--------- --------- ---------
Net increase in cash ............................................ (2,176) 8,190 2,365
Cash and cash equivalents at beginning of year .................. 12,654 4,464 2,099
--------- --------- ---------
Cash and cash equivalents at end of year ........................ $ 10,478 $ 12,654 $ 4,464
========= ========= =========
Supplemental Disclosure:
Interest paid ................................................. $ 38,014 $ 37,849 $ 20,946
Taxes paid (refunded) ......................................... (55) (213) --
Non-cash financing activities:
Redemption of Series C Preferred Stock ........................ -- 22,227 --
Debt assumed with acquisition ................................. -- 115,015 --
Issuance of common stock associated with the acquisition of the
Fickes and Stone Knightsbridge Interests ..................... -- 8,500 --
Accrued and unpaid preferred stock dividends .................. 17,825 4,457 --
Reissuance of treasury stock .................................. 1,562 -- --
Other ......................................................... -- 261 1,281
See accompanying independent auditors' report.
139
<PAGE>
<CAPTION>
SCHEDULE III
PENNCORP FINANCIAL GROUP, INC.
SUPPLEMENTARY INSURANCE INFORMATION
For the years ended December 31, 1999, 1998 and 1997
(In thousands)
Future
Policy Amorti-
Benefits Benefits, zation of
Deferred Losses, Claims, Deferred
Policy Claims Net Losses & Policy Other
Acquisition & Loss Premium Investment Settlement Acquisition Operating
Costs Expenses Revenue Income Expenses Costs Expenses
----------- ---------- -------- ---------- ----------- ----------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
1999
- ---------------
Fixed benefit . $ 456 $ 27,503 $106,411 $ 14,559 $ 74,079 $ 6,957 $ 53,537
Life .......... 109,042 2,061,540 225,976 160,218 242,903 35,107 78,102
Accumulation .. 4,228 667,914 6,487 82,823 60,605 2,992 17,252
----------- ---------- -------- ---------- ----------- ----------- ---------
Total ........ $ 113,726 $2,756,957 $338,874 $ 257,600 $ 377,587 $ 45,056 $ 148,891
=========== ========== ======== ========== =========== =========== =========
1998
- ---------------
Fixed benefit . $ -- $ 24,190 $216,219 $ 25,826 $ 160,135 $ 27,251 $ 107,772
Life .......... 136,420 2,064,035 234,540 174,249 267,074 49,265 98,906
Accumulation .. 3,288 731,436 8,399 168,977 114,553 2,775 22,819
----------- ---------- -------- ---------- ----------- ----------- ---------
Total ....... $ 139,708 $2,819,661 $459,158 $ 369,052 $ 541,762 $ 79,291 $ 229,497
=========== ========== ======== ========== =========== =========== =========
1997
- ---------------
Fixed benefit . $ 160,974 $ 175,524 $168,974 $ 19,206 $ 54,630 $ 19,386 $ 73,488
Life .......... 122,376 1,342,563 169,518 94,442 164,878 24,154 59,879
Accumulation .. 26,767 1,771,838 7,074 159,589 104,781 783 12,878
----------- ---------- -------- ---------- ----------- ----------- ---------
Total ....... $ 310,117 $3,289,925 $345,566 $ 273,237 $ 324,289 $ 44,323 $ 146,245
=========== ========== ======== ========== =========== =========== =========
See accompanying independent auditors' report
140
<PAGE>
<CAPTION>
SCHEDULE IV
PENNCORP FINANCIAL GROUP, INC.
REINSURANCE
For the years ended December 31, 1999, 1998, and 1997
(In thousands)
Percentage
Ceded to Assumed Of Amount
Gross Other from Other Net Assumed
Amount Companies Companies Amount to Net
----------- ---------- ------------ ----------- ----------
<S> <C> <C> <C> <C> <C>
Year ended December 31, 1999:
Life insurance in force .................. $29,573,138 $5,511,902 $ 1,090,479 $25,151,715
=========== ========== ============ ===========
Premiums:
Accident and health insurance ............ $ 162,027 $ 55,376 $ (9) $ 106,642 --%
Life insurance/accumulation .............. 261,003 31,272 2,501 232,232 1.1%
----------- ---------- ------------ -----------
$ 423,030 $ 86,648 $ 2,492 $ 338,874
=========== ========== =========== ===========
Year ended December 31, 1998:
Life insurance in force .................. $35,350,735 $5,501,096 $ 1,325,067 $31,174,706
=========== ========== =========== ===========
Premiums:
Accident and health insurance ............ $ 310,477 $ 96,770 $ 2,047 $ 215,754 0.9%
Life insurance/accumulation .............. 275,840 36,407 3,971 243,404 1.6%
----------- ---------- ------------ -----------
$ 586,317 $ 133,177 $ 6,018 $ 459,158
=========== ========== =========== ==========
Year ended December 31, 1997:
Life insurance in force .................. $24,618,960 $4,366,266 $ 1,251,538 $21,504,232
=========== ========== =========== ===========
Premiums:
Accident and health insurance ............ $ 172,511 $ 2,537 $ -- $ 169,974 --%
Life insurance/accumulation .............. 203,027 29,962 2,527 175,592 1.4%
----------- ---------- ------------ -----------
$ 375,538 $ 32,499 $ 2,527 $ 345,566
=========== ========== =========== ===========
See accompanying independent auditors' report.
141
<PAGE>
<CAPTION>
SCHEDULE V
PENNCORP FINANCIAL GROUP, INC.
VALUATION AND QUALIFYING ACCOUNTS For the years ended
December 31, 1999, 1998 and 1997
(In thousands)
Balance at Charge to Charge to Balance at
Beginning Cost and Other End of
Of Period Expenses Accounts Deductions Period
--------- --------- --------- ----------- ----------
<S> <C> <C> <C> <C> <C>
1999:
Mortgage loans on real estate ..... $ 4,295 $ -- $ 3,494 $ 7,107 $ 682
Accounts and notes receivable ..... 6,201 1,250 -- 1,541 5,910
1998:
Mortgage loans on real estate ..... $ 6,721(a) $ 11,425 $ -- $ 13,851(b) $ 4,295
Unearned loan charges ............. 1,569 -- -- 1,569(b) --
Accounts and notes receivable ..... 9,205(a) 4,449 -- 7,453(b) 6,201
1997:
Mortgage loans on real estate ..... $ 4,211 $ 2,106 $ -- $ 276 $ 6,041
Allowance for bond losses ......... 189 -- -- 189 --
Unearned loan charges ............. 266 1,806 -- 503 1,569
Accounts and notes receivable ..... 6,528 9,102 -- 6,605 9,025
- --------------
(a) Includes amounts recorded as a purchase GAAP adjustment in conjunction with
the acquisition of SW Financial.
(b) Includes amounts transferred to assets of Businesses Held for Sale.
See accompanying independent auditors' report.
142
</TABLE>
EXECUTION COPY
AMENDMENT NO. 11
Dated as of November 26, 1999
to
CREDIT AGREEMENT
Dated as of March 12, 1997
PENNCORP FINANCIAL GROUP, INC., a Delaware corporation (the "Company"),
the lenders signatory to the Credit Agreement referred to below (the "Banks"),
the Managing Agents and the Co-Agents named therein (the "Agents") and THE BANK
OF NEW YORK, as administrative agent for the Banks (the "Administrative Agent"),
hereby agree as follows:
I.
CREDIT AGREEMENT
1. Credit Agreement. (a) Reference is hereby made to the Credit Agreement,
dated as of March 12, 1997, among the Company, the Banks, the Agents and the
Administrative Agent (as amended, modified or waived prior to the date hereof,
the "Credit Agreement"). Terms used in this Amendment No. 11 (this "Amendment")
that are defined in the Credit Agreement and are not otherwise defined herein
are used herein with the meanings therein ascribed to them.
(b) The Credit Agreement as amended by this Amendment is and shall continue
to be in full force and effect and is hereby in all respects confirmed, approved
and ratified.
2. Amendments to the Credit Agreement. Upon and after the Amendment No. 11
Effective Date (as defined below), the Credit Agreement shall be amended as
follows:
(a) Section 1.01 is hereby amended (i) to add, in alphabetical order, the
following new definitions:
"Amendment No. 11" shall mean Amendment No. 11, dated as of November __,
1999, to the Agreement.
"Amendment No. 11 Effective Date" shall have the meaning ascribed to that
term in Amendment No. 11.
"American Amicable Holdings Corporation Management Contracts" shall mean
each of the following: (i) Service Agreement dated April 1, 1999 between
American Amicable Holdings Corporation and Pennsylvania Life Insurance Company,
(ii) Service Agreement dated
1
<PAGE>
April 1, 1999 between the American Amicable Holdings Corporation and
American-Amicable Life Insurance Company of Texas, (iii) Service Agreement dated
April 1, 1999 between the American Amicable Holdings Corporation and Pioneer
American Life Insurance Company, and (iv) Service Agreement dated April 1, 1999
between the American Amicable Holdings Corporation and Pioneer Security Life
Insurance Company.
"American Amicable Holdings Corporation Operating Expenses" shall mean
expenses incurred by American Amicable Holdings Corporation in the performance
of its obligations under the American Amicable Holdings Corporation Management
Contracts.
"Executive Director Escrow Amount" shall mean the $994,879 to be paid by
the Company to fund the escrow account established pursuant to ss.3.3 of the
Release and Indemnity Agreement dated December 24, 1998 among the Company,
Pennsylvania Life Insurance Company, PennCorp Life Insurance Company and the
individual set forth on the signature pages thereto (the "Executive Director")
and attached hereto as Exhibit A, as such agreement may be amended or modified
from time to time after the Amendment No. 11 Effective Date, provided that that
any such amendment or modification was, in the sound business judgment of the
Company and its Board of Directors, in the best interests of the Company, and
was consented to in writing by the Majority Banks.
"KB Investment" shall mean KB Investment L.L.C., a New York limited
liability company.
"KB Management Service Contracts" shall mean each of the following: (i)
Amended and Restated Investment Agreement dated January 1, 1997, between KB
Management L.L.C. and Southwestern Life Insurance Company, (ii) the Investment
Management Agreements dated January 1, 1998 between KB Management L.L.C. and
American-Amicable Life Insurance Company of Texas, (iii) the Investment
Management Agreements dated January 1, 1998 between KB Management L.L.C. and
Integon Life Insurance Corporation (now known as Security Life and Trust
Insurance Company), (iv) the Investment Management Agreements dated January 1,
1998 between KB Management L.L.C. and Pacific Life and Accident Insurance
Company, (v) the Investment Management Agreements dated January 1, 1998 between
KB Management L.L.C. and Occidental Life Insurance Company of North Carolina,
(vi) the Investment Management Agreements dated January 1, 1998 between KB
Management L.L.C. and Pioneer American Insurance Company, (vii) Investment
Management Agreement dated January 1, 1998 between KB Management L.L.C. and
Pioneer Security Life Insurance Company, (viii) Advisory and Management Services
Agreement effective as of January 1, 1998 by and among KB Management L.L.C. and
American-Amicable Life Insurance Company of Texas, Integon Life Insurance
Corporation (now known as Security Life and Trust Insurance Company), Pacific
Life and Accident Insurance Company, Pioneer American Insurance Company, Pioneer
Security Life Insurance Company, Southwestern Life Insurance Company and
Occidental Life Insurance Company, and (ix) Employee Benefit Cost Sharing and
Service Agreement effective as of September 1, 1998 by and among KB Management
L.L.C., Southwestern Financial Services Corporation, American-Amicable Life
Insurance Company of Texas, Marketing One, Inc., Occidental Life Insurance
Company of North Carolina, PennCorp Financial Group, Inc. and PennCorp Financial
Services, Inc.
2
<PAGE>
"KB Management Operating Expenses" shall mean operating expenses incurred
by KB Management L.L.C. in the performance of its obligations under the KB
Management Service Contracts.
"Shareholder Litigation Settlement Amount" shall mean the $1,500,000 to be
paid by the Company to settle In re PennCorp Financial Group, Inc. Securities
Litigation, Master File No. 98 Civ. 5998 (LAP) (the "Shareholder Litigation"
pursuant to the Memorandum of Understanding dated November 11, 1999, a copy of
which is attached as Exhibit B to Amendment No. 11, as such form may be amended
or modified from time to time or as such may be more fully documented in a
settlement agreement after the Amendment No. 11 Effective Date, provided that
that any such amendment, modification. or documentation was, in the sound
business judgment of the Company and its Board of Directors, in the best
interests of the Company, and was consented to in writing by the Majority Banks.
(ii) to amend the following existing definitions to read as follows:
"Commitment" shall mean (i) the amount set opposite each Bank's name on the
signature pages of Amendment No. 11 under the caption "Reduced Commitment", or,
in the case of a Bank that becomes a Bank pursuant to an assignment, the amount
of the assignor's Commitment assigned to such Bank (in either case as the same
may be terminated or reduced at any time or from time to time pursuant to
Section 2.04, canceled pursuant to Section 9 or increased or reduced at any time
or from time to time pursuant to assignments made in accordance with Section
11.06) or (ii) as the context may require, the obligation of each Bank to make
RC Loans in an aggregate unpaid principal amount not exceeding such amount.
"Commitment Stepdown Date" shall mean the Amendment No. 11 Effective Date.
"Operating Bank Account" shall mean a Bank Account of an Operating Bank
Account Subsidiary that is listed on Amended Schedule 8.29(a) to Amendment No.
11.
"Permitted Operating Account Withdrawal" shall mean a withdrawal from an
Operating Bank Account to make a payment listed or described on Amended Schedule
8.29(b) to Amendment No. 11, subject to any limitations there set forth.
"Reduced Commitment" shall mean, as applied to any Bank, the amount set
forth opposite such Bank's name under the caption "Reduced Commitment" on the
signature pages of Amendment No. 11.
(b) Section 2.04(b)(iv) of the Credit Agreement shall be amended and
restated as follows:
"on the Commitment Stepdown Date, the Commitments
shall be reduced to the amounts set forth under the
caption "Reduced Commitment," on the signature pages
attached to Amendment No. 11 (the aggregate of the
reduction totaling $2,000,000);"
3
<PAGE>
(c) Section 8.19(b) shall be amended by
(i) changing "(vi)" to "(viii)" and by adding the following after
subclause (v):
", (vi) withdrawing the Shareholder Litigation Settlement Amount
provided that such payment shall not exceed $1,500,000 and provided further
that, pursuant to this Section 8.19(b), should the Company become entitled
to and receive any portion of the Shareholder Litigation Settlement Amount
such amount shall be immediately deposited in the Collateral Account, (vii)
withdrawing the Executive Director Escrow Amount provided that such payment
shall not exceed $994,875, and, provided further that, pursuant to this
Section 8.19(b), should the Company become entitled to and receive any
portion of the Executive Director Escrow Amount such amount shall be
immediately deposited in the Collateral Account,"
(ii) by adding the following sentence at the end thereof:
"The fact that a particular current or future expenditure has been
identified to the Administrative Agent, the Banks or their advisors
pursuant to information furnished by the Company under this Agreement does
not mean that the Banks have approved of such expenditure or that funds may
be withdrawn from the Collateral Account for such expenditure."
(d) Section 8.29 shall be amended by
(i) amending Section 8.29(b)(i)(C) by inserting "(1)" after "(C)" and
by deleting the "." at the end of that Section and replacing it with the
following:
"; and (2) Operating Bank Account Subsidiary Indebtedness may be
repaid by the Company only to permit the Operating Bank Account Subsidiary
to which such Indebtedness is owed to fund Permitted Operating Bank Account
Withdrawals, and then only to the extent such payments have not otherwise
been funded, including a funding with funds that constitute Excluded Funds.
Any withdrawal by the Company from the Collateral Account for the payment
of Operating Bank Account Subsidiary Indebtedness shall be deemed a
representation and warranty by the Company made at the time of such
withdrawal that such withdrawal is in accordance with the immediately
preceding sentence."
(ii) amending Section 8.29(b)(ii)(A) to read as follows:
"(A) Funds determined to be Excluded Funds by the Majority Banks,
pursuant to Section 8.29(b)(i)(D) hereof, are set forth on Amended Schedule
8.29(b)(ii)(A). Funds referred to in the proviso to the definition of
"Excluded Funds" shall constitute "Excluded Funds", whether or not
specified in such Schedule.
4
<PAGE>
II.
GENERAL
1. Representations and Warranties.
In order to induce the Banks to execute and deliver this Amendment No. 11,
the Company hereby represents and warrants as follows:
(a) The Company has the power, and has taken all necessary action
(including any necessary stockholder action) to authorize, to execute, deliver
and perform in accordance with their respective terms, this Amendment and the
Credit Agreement. This Amendment has been duly executed and delivered by the
duly authorized officers of the Company and is, as amended by this Amendment,
the legal, valid and binding obligation of the Company enforceable in accordance
with its terms, except as enforceability may be limited by any applicable
bankruptcy, insolvency, reorganization, moratorium or similar laws affecting the
enforcement of creditors' rights generally. The execution, delivery and
performance in accordance with their respective terms by the Company of this
Amendment and the Credit Agreement, as amended by this Amendment do not and
(absent any change in any Applicable Law or applicable Contract) will not (A)
require any Governmental Approval (hereinafter defined) or any other consent or
approval, including any consent or approval of the stockholders of the Company
or of any Subsidiary, to have been obtained, or any Governmental Registration
(hereinafter defined) to have been made, other than Governmental Approvals and
other consents and approvals and Governmental Registrations that have been
obtained or made, are final and not subject to review on appeal or to collateral
attack, are in full force and effect, or (B) violate, conflict with, result in a
breach of, constitute a default under, or result in or require the creation of
any Lien (other than the Security Interests) upon any assets of the Company or
any Subsidiary under (1) any Contract to which the Company, or any Subsidiary is
a party or by which the Company, or any Subsidiary or any of their respective
properties may be bound, or (2) any Applicable Law. As used herein,
"Governmental Approval" shall mean any authority, consent, approval, license (or
the like) or exemption (or the like) of any governmental unit; "Governmental
Registration" shall mean any registration or filing (or the like) with, or
report or notice (or the like) to, any governmental unit.
(b) The payment of the Executive Director Escrow Amount is the only
remaining specific cash Liability of the Company in connection with the Release
and Indemnity Agreement that is attached hereto as Exhibit A.
2. Conditions to Effectiveness; Amendment No. 11 Effective Date.
This Amendment No. 11 shall be effective as of the date first written above,
but shall not become effective as of such date until the time (such time, the
"Amendment No. 11 Effective Date") as:
(a) this Amendment No. 11 has been executed and delivered by the
Company, each of the Banks and the Administrative Agent; and
(b) all amounts payable pursuant to Section 11.03 of the Credit Agreement
for which invoices have been delivered to the Company on or prior to such date,
have been paid in full.
5
<PAGE>
3. Governing Law. The rights and duties of the Company, the Agent and the
Banks under this Amendment shall, pursuant to New York General Obligations Law
Section 5-1401, be governed by the law of the State of New York.
4. Counterparts. This Amendment may be signed in any number of
counterparts, each of which shall be an original, with the same effect as if the
signatures thereto were upon the same instrument.
5. Headings. Section headings in this Amendment are included herein for
convenience and reference only and shall not constitute a part of this Amendment
for any other purpose.
6
<PAGE>
IN WITNESS WHEREOF, the parties hereto have caused this Amendment No. 11
to be duly executed as of the day and year first above written.
PENNCORP FINANCIAL GROUP, INC.
By: /s/Scott D. Silverman
-------------------------------------
Name: Scott D. Silverman
Title: Executive Vice President
THE BANK OF NEW YORK, as Administrative
Agent, Collateral Agent and as a Bank
$17,233,333.38 Reduced Commitment
By: /s/Peter W. Helt
-------------------------------------
Name: Peter W. Helt
Title: Vice President
THE CHASE MANHATTAN BANK, as a Managing
Agent and as a Bank
$15,399,999.99 Reduced Commitment
By: /s/Elizabeth A. Kelley
-------------------------------------
Name: Elizabeth A. Kelley
Title: Managing Director
FIRST NATIONAL BANK OF CHICAGO, as a
Managing Agent and as a Bank
$15,399,999.99 Reduced Commitment
By:
-------------------------------------
Name:
Title:
BANK OF AMERICA, N.A., formerly known as
Nations Bank, N.A., as a Managing
Agent and as a Bank
$15,399,999.99 Reduced Commitment
By: /s/William E. Livingstone IV
-------------------------------------
Name: William E. Livingston IV
Title: Managing Director
FLEET NATIONAL BANK, as a
Co-Agent and as a Bank
$16,866,666.67 Reduced Commitment
By: /s/Donald R. Nicholson
-------------------------------------
Name: Donald R. Nicholson
Title: Senior Vice President
MELLON BANK, N.A., as a Co-Agent
and as a Bank
$13,200,000.00 Reduced Commitment
By: /s/Gary A. Saul
-------------------------------------
Name: Gary A. Saul
Title: First Vice President
BANK OF MONTREAL, as a Co-Agent
and as a Bank
$11,000,000.01 Reduced Commitment
By: /s/Thomas E. McGraw
-------------------------------------
Name: Thomas E. McGraw
Title: Director
CIBC INC., as a Co-Agent and as a Bank
$11,000,000.01 Reduced Commitment
By: /s/Gerald Girardi
-------------------------------------
Name: Gerald Girardi
Title: Execuitve Director
CIBC World Markets Corp,
As Agent
7
<PAGE>
DRESDNER BANK AG, NEW YORK AND
GRAND CAYMAN BRANCHES, as a Co-Agent
and as a Bank
$11,000,000.01 Reduced Commitment
By: /s/Lloyd C. Stevens
-------------------------------------
Name: Lloyd C. Stevens
Title: Vice President
By: /s/Anthony C. Valencourt
-------------------------------------
Name: Anthony C. Valencourt
Title: Senior Vice President
SUNTRUST BANK, CENTRAL FLORIDA NATIONAL
ASSOCIATION
$7,333,333.32 Reduced Commitment
By: /s/T. Michael Logan
-------------------------------------
Name: T. Michael Logan
Title: Managing Director
FIRST UNION NATIONAL BANK
$7,333,333.33 Reduced Commitment
By: /s/Thomas L. Stitchberry
-------------------------------------
Name: Thomas L. Stitchberry
Title: Senior Vice President
BANK ONE TEXAS, NA
$7,333,333.32 Reduced Commitment
By:
-------------------------------------
Name:
Title:
BEAR STEARNS & CO., INC.
$12,833,333.31 Reduced Commitment
By: /s/Gregory A. Hanley
-------------------------------------
Name: Gregory A. Hanley
Title: Senior Managing Director
SG COWEN SECURITIES CORPORATION
$1,833,333.34 Reduced Commitment
By:
-------------------------------------
Name:
Title:
8
<PAGE>
ING (U.S.) CAPITAL CORPORATION
$1,833,333.33 Reduced Commitment
By:
-------------------------------------
Name:
Title:
9
<PAGE>
<TABLE>
<CAPTION>
Amended Schedule 8.29(a)
OPERATING BANK ACCOUNTS
Operating Bank Operating Bank
Account Subsidiary Accounts Depositary Bank
- ------------------ --------------- ---------------
<S> <C> <C>
KB Management LLC 890-0324-708 Bank of New York,
(ZBA Disb) NY, NY
890-0168-935 Bank of New York,
(DDA) NY, NY
1574898050 (DDA) Bank One Texas,
(DDA) Dallas, Texas
KB Investment LLC 890-0169-060 Bank of New York,
(DDA) NY, NY
American Amicable Holdings 15606 Provident Inst.,
Corp. (Money Market) Wilmington, DE
890-0168-897 Bank of New York,
(DDA) NY, NY
Southwestern Financial 890-0169-192 Bank of New York,
Corporation (DDA) NY, NY
</TABLE>
10
<PAGE>
<TABLE>
<CAPTION>
Amended Schedule 8.29(b)
PERMITTED OPERATING ACCOUNT WITHDRAWALS
(Capitalized terms used in this Amended Schedule 8.29(b)
that are not defined in the Credit Agreement are
defined on Annex A hereto.)
Operating Bank Operating Bank
Account Subsidiary Accounts Payments Permitted to be Funded
- ------------------ --------------- -------------------------------
<S> <C> <C>
KB Management LLC 890-0168-935 (DDA) KB Management
Operating Expenses, to (BNY)
the extent not otherwise Funded.
American-Amicable 890-0168-897 American-Amicable Holdings
Holdings Corporation (DDA) Corporation Operating Expenses,
(BNY) to the extent not otherwise
Funded.
15606 Payments, to the extent not otherwise
(Money Market) funded, required to pay dividends to
(Provident Inst.) the Company, as described in the Weil
Letter, provided, that such dividend
is, in fact, paid on the date of such
withdrawal.
Southwestern Financial 890-0169-192 Southwestern Financial Corporation
Corporation (DDA) Operating Expenses, to the extent not
(BNY) otherwise Funded.
</TABLE>
11
<PAGE>
<TABLE>
<CAPTION>
Amended Schedule 8.29(b)(ii)(A)
SCHEDULE OF EXCLUDED FUNDS
(Numbered Footnote references are to the attached Footnote
Appendix. Such Footnote Appendix and the Footnotes there set
forth are an integral part of this Schedule.)
Operating Bank Operating Bank
Account Subsidiary Accounts Depositary Bank Excluded Funds
- ------------------ -------- --------------- --------------
<S> <C> <C> <C>
KB Management LLC 890-0324-708 Bank of New York, NY, NY 100%(1)
(ZBA Disb)
890-0168-935 Bank of New York, NY, NY 0%(3)
(DDA)
1574898050 (DDA) Bank One Texas, Dallas, 100%(2)
Texas
KB Investment LLC 890-0169-060 Bank of New York, NY, NY 0%(3)
(DDA)
American Amicable 15606 Provident Inst., 100%(4)
Holdings Corp. (Money Market) Wilmington, DE
890-0168-897 Bank of New York, NY, NY 0%(3)
(DDA)
Southwestern Financial 890-0169-192 Bank of New York, NY, NY 0%(1)
Corporation (DDA)
</TABLE>
12
<PAGE>
FOOTNOTE APPENDIX
TO SCHEDULE OF EXCLUDED FUNDS
1. Balances in this account shall constitute Excluded Funds only if, to the
extent, and so long as, deposits in this account are used for the purposes
specified in the letter dated, November 24, from Angela L. Fontana to
Charles Vejvoda (the "Weil Letter") attached hereto as Exhibit C.
2. Balances in this account shall constitute Excluded Funds until this
account is closed, provided that this account is closed promptly upon
finalization of the necessary paperwork referenced in the Weil Letter, but
in any event no later than January 31, 2000, or such later date as the
Administrative Agent may agree to.
3. Balances shall constitute Excluded Funds only to the extent they represent
amounts required for gross payroll and employee benefits, provided that
such amounts are deposited in the applicable payroll and benefit accounts
on the day received. For this purpose, "gross" payroll shall include
withholding taxes, and "employee benefits" shall include medical, dental
and the like employee benefits.
4. Balances in this account shall constitute Excluded Funds only if, and to
the extent, and so long as balances in this account are required to
demonstrate liquidity in an amount necessary to maintain the intercompany
notes referred to in the Weil Letter as admitted assets ("Liquidity
Balances").
Balances in excess of such amounts shall not constitute Excluded Funds,
but the Operating Bank Account Indebtedness resulting from the transfer of
such balances to the Company, pursuant to Section 8.29(b) of the Credit
Agreement, may be repaid on each date that a dividend in the amount of the
repayment is paid to the Company, provided that such dividend is, in fact,
paid on such date.
If, for regulatory purposes, it is necessary to maintain the Liquidity
Balances in a separate account, this account should be divided into two
accounts, one containing Liquidity Balances, and the other containing all
other balances.
13
WACO
CONSENT
and
WAIVER
and
AMENDMENT
Dated as of January 31, 2000
under
CREDIT AGREEMENT
Dated as of March 12, 1997
PENNCORP FINANCIAL GROUP, INC., a Delaware corporation (the "Company"), the
lenders signatory to the Credit Agreement referred to below that are parties
hereto, the Managing Agents and the Co-Agents named therein (the "Agents") and
THE BANK OF NEW YORK, as administrative agent for the Banks (the "Administrative
Agent"), hereby agree as follows (with certain terms used herein being defined
in, or incorporated by reference pursuant to, Section 2 hereof):
1. CREDIT AGREEMENT. (a) Reference is hereby made to the Credit Agreement,
dated as of March 12, 1997, among the Company, the Banks, the Agents and the
Administrative Agent (as amended, modified or waived prior to the date hereof,
the "Credit Agreement").
2. DEFINITIONS. (a) All terms defined in the Credit Agreement are used
herein with the meanings therein ascribed to them.
(b) For purposes of this Consent:
"AMERICAN-AMICABLE" means American-Amicable Holdings Corporation, a
Delaware corporation.
"AMERICAN-AMICABLE BALANCE SHEET" means the balance sheet of
American-Amicable attached hereto as Exhibit A.
"CHAPTER 11 CASE" has the meaning assigned to it in Section 4(c).
"EXECUTIVE EMPLOYMENT AGREEMENT" shall mean the (i) Employment Agreement
dated January 28, 2000 between the Company and Keith Maib, (ii) Employment
Agreement dated January 28, 2000 between the Company and Scott Silverman, and
(iii) Employment
1
<PAGE>
Agreement dated January 28, 2000 between the Company and James McDermott, in
each case, as amended and as in effect on the Waco Consent Effective Date.
"PIONEER LIFE" means Pioneer Security Life Insurance Company, a Texas
insurance company.
"PIONEER LIFE BALANCE SHEET" means the balance sheet of Pioneer Life
attached hereto as Exhibit B.
"SPECIFIED TRANSACTION" shall mean the Transactions numbered 1 and 4 on
Schedule 1 hereto.
"SWISS RE SALE CONTRACT" means the Stock Purchase Agreement, dated January
7, 2000, between Reassure America Life Insurance Company, an Illinois insurance
company, and the Company, as such form may be AMENDED OR MODIFIED FROM TIME TO
TIME AFTER THE SWISS RE CONSENT EFFECTIVE DATE, PROVIDED, that any such
amendment or modification was, in the sound business judgment of the Company and
its Board of Directors, in the BEST INTERESTS OF THE COMPANY, AND, PROVIDED,
FURTHER, that any such amendment or modification of Section 2.1 of the Swiss Re
Sale Contract, which reduces the total consideration payable to the Company, was
consented to in writing by the Majority Bank except for any amendment or
modification to allow for the assumption of transaction bonuses in an amount not
greater than $1,400,000.
"TRANSACTION" means a transaction listed on Schedule 1.
"TRANSFER" means a transfer, as a repayment of Indebtedness, a dividend, or
a capital CONTRIBUTION, OF PROPERTY UNDER A TRANSACTION. "TRANSFER", when used
as a verb, has a correlative meaning.
"TRANSFEROR" means a Person that Transfers any Property in a Transaction.
"WACO CASH PROCEEDS" has the meaning assigned to it in Section 7(a).
"WACO CONSENT EFFECTIVE DATE" means the date on which each of the
conditions specified in Section 8 hereof shall have been fulfilled.
"WACO SALE CONTRACT" means the (a) Stock Purchase Agreement, dated January
8, 2000, between Pioneer-Occidental Holdings Company, a Delaware corporation,
and American-Amicable, in the form attached hereto as Exhibit C, as such form
may be amended or modified from time to time after the Waco Consent Effective
Date, PROVIDED, that such amendment or modification was, in the sound business
judgment of the Company and its Board of DIRECTORS, IN THE BEST INTERESTS OF THE
COMPANY, AND, PROVIDED, FURTHER, that any amendment or modification of Section
2.2 of the Waco Sale Contract, which reduces the total consideration to be paid
to American-Amicable and its Subsidiaries, was consented to in writing by the
Majority Banks, except for any amendment or modification to allow for the
assumption of transaction bonuses in an amount not greater than $400,000, and
(b) Transactions related thereto.
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3. CONSENT. (a) Upon the Waco Consent Effective Date, the Majority Banks
hereby consent, under the sections of the Credit Agreement and to the extent
specified in Section 3(b) hereof, to the consummation of the Transactions.
(b) The consent under Section 3(a) is limited to Sections 8.06(b) and (c),
8.08(b), 8.15, 8.17, 8.18, 8.21(b), 8.22, 8.23, 8.24 and 8.29 of the Credit
Agreement, and then only to the extent necessary to avoid a violation of such
Section or Sections as may be applicable to such Transfer.
4. WAIVERS. (a) The Majority Banks hereby waive compliance with Section
8.06(c) of the Credit Agreement to the extent that any non-compliance results
solely from the sale of Property pursuant to the Waco Sale Contract, and the
Security Interest in such Property shall be deemed to have been released upon
the receipt by the Administrative Agent of the Waco Cash Proceeds (as defined in
Section 7(a) hereof).
(b) The Majority Banks hereby waive the application of and the Company's
obligation to comply with Section 2.04(b) of the Credit Agreement; provided that
the waiver granted in this Section 4(b) shall cease to be effective, and Section
2.04(b) shall thereupon again be effective, if the Swiss Re Sale Contract is
terminated pursuant to Section 9.2(b)(i) thereof; and
(c) The Majority Banks hereby waive the Event of Default under Section 9(g)
of the Credit Agreement to the extent that such Event of Default results from
and only from (a) the resolution by the Company's Board of Directors determining
to file a petition commencing a case (the "Chapter 11 Case") under Chapter 11 of
Title 11 of the United States Code, as contemplated by the Swiss Re Sale
Contract, and (b) the Company's actions (other than the actual filing of such a
petition) in furtherance of such a filing (whether taken before or after such
resolution). The Majority Banks expressly do not waive the Event of Default
under Section 9(g) of the Credit Agreement to the extent that such an Event of
Default results from the filing by the Company of a petition commencing the
Chapter 11 Case.
(d) The Majority Banks hereby waive until February 11, 2000 any
non-compliance by the Company with Sections 8.10, 8.11, 8.12 and 8.13, to the
extent that such non-compliance results from and solely from the Transactions
and the sale of Property pursuant to the Waco Sale Contract.
5. (a) AMENDMENTS TO THE CREDIT AGREEMENT. Upon and after the Waco Consent
Effective Date, the Credit Agreement shall be amended as follows:
(i) Section 1.01 is hereby amended (A) to add, in alphabetical order, the
following new definition:
"FORBEARANCE AGREEMENT" means, when and if the same becomes effective, the
Forbearance Agreement among American-Amicable Holdings Corporation, Southwestern
Financial Corporation, Southwestern Financial Services Corporation, PennCorp
Occidental Corp., KB Investment L.L.C., KB Management L.L.C., the Banks that are
signatories thereto, the Agents and the Administrative Agent and Collateral
Agent in the form attached hereto as Exhibit D, with such changes thereto as may
have been approved in writing by the Majority Banks.
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(B) to amend the following existing definition to read as follows:
"LOAN DOCUMENTS" shall mean (i) this Agreement and the Notes and, from and
after the execution and delivery thereof by each Securing Party, the Security
Agreements, (ii) the Forbearance Agreement and (iii) all other agreements,
documents and instruments with, for the benefit of or in favor of the
Administrative Agent or any Bank, relating to, arising out of, delivered
pursuant to or in any way connected with (A) any agreement, document or
instrument referred to in clause (i) or clause (ii) or (B) any of the
transactions contemplated by any agreement, document or instrument referred to
in clause (i) or clause (ii).
(B) AMENDMENTS TO THE SECURITY AGREEMENTS. Upon and after the Waco Consent
Effective Date, Section 4.01(c) of each of the Security Agreements (as defined
in the Credit Agreement) shall be amended to read as follows:
"(C) SALE OF COLLATERAL. Except during the continuance of an Event of
Default, the Company may, solely to the extent permitted by the Loan Documents,
sell or otherwise dispose of the Collateral."
6. REPRESENTATIONS AND WARRANTIES. In order to induce the Majority Banks to
grant the consents, releases and waiver effected hereunder, the Company hereby
represents and warrants as follows:
(a) The Company has the power, and has taken all necessary action
(including, if a corporation, any necessary stockholder action) to authorize it,
to execute, deliver and perform in accordance with its terms this Consent. This
Consent has been duly executed and delivered by the Company and is a legal,
valid and binding obligation of the Company, enforceable against the Company in
accordance with its terms, except as enforceability may be limited by applicable
bankruptcy, insolvency, reorganization, moratorium or similar laws affecting the
enforcement of creditors' rights generally, whether at law or in equity
(including principles of good faith and fair dealing). The execution, delivery
and performance in accordance with its respective terms by the Company of this
Consent do not and (absent any change in any Applicable Law or applicable
Contract) will not (i) require any Governmental Approval or any other consent or
approval (including any consent or approval of the stockholders of the Company)
to have been obtained by the Company or any of its Affiliates, other than
Governmental Approvals and other consents and approvals that have been obtained,
are final and not subject to review on appeal or to collateral attack, are in
full force and effect, or (ii) violate, conflict with, result in a breach of,
constitute a default under, or result in or require the creation of any Lien
(other than the Security Interest) upon any assets of any such Person under, (A)
any Contract to which any such Person is a party or by which any such Person or
any of its properties may be bound or (B) any Applicable Law.
(b) (i) The copy of the Waco Sale Contract attached as Exhibit C hereto (i)
is in substantially the form approved by the Company's Board of Directors at the
meeting of the Board of Directors of the Company held on January 6, 2000, (ii)
is in the form executed by the parties thereto, and (iii) has not been
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amended or modified subsequent to its having been furnished to the
Administrative Agent and prior to the Waco Effective Date, except by amendments
and modifications of which the Administrative Agent have been furnished copies.
(ii) The copies of the Executive Employment Agreements attached hereto in
the respective forms of Exhibits D-1, D-2 and D-3 are in the forms in which such
Contracts exist on the Waco Consent Effective Date.
(c) (i) Either (A) each Transferor will, under its Transfer, receive not
less than the reasonable equivalent Value of the assets being Transferred by it
thereunder, or (B) both before and after giving effect to each Transaction (1)
both the Fair Value and the Present Fair Saleable Value of the remaining assets
of the Transferor transferring assets thereunder will be greater than the total
amount of such Transferor's Debts, (2) the Present Fair Saleable Value of the
remaining assets of such Transferor will exceed the amount that will be required
to pay the probable liability of such Transferor's on its Debts as they become
absolute and mature and (3) such Transferor (aa) will be able to realize upon
its assets and pay its Debts as they mature in the normal course of business,
and (bb) will not be engaged in a business or a transaction, nor be about to
engage in a business or a transaction, (I) for which its property would
constitute unreasonably small capital or (II) in relation to which its assets
would be unreasonably small;
(ii) Each Transferor transferring assets under a Transaction, at the time
of such transfer, (A) will not intend to or believe that it will incur Debts
that will be beyond its ability to pay as such Debts mature and (B) will not
intend, in consummating such Transaction, to hinder, delay or defraud either
present or future creditors or any other Person to which any of its Debts is or
will become owing.
(iii) As used herein, "Value" means (A) "value" as defined under Section
548(d)(2)(A) of the Bankruptcy Code; (B) "fair consideration" within the meaning
of Section 3 of the Uniform FRAUDULENT CONVEYANCE ACT AND (C) "VALUE" WITHIN THE
MEANING OF THE UNIFORM FRAUDULENT TRANSFER ACT; "DEBT" means any Liability that
constitutes "debt" or "Debt" under Section 101(11) of the Bankruptcy Code or
under the Uniform FRAUDULENT CONVEYANCE ACT, THE UNIFORM FRAUDULENT TRANSFER ACT
OR ANY ANALOGOUS APPLICABLE LAW; "FAIR VALUE" means, with respect to any asset,
the amount that an independent willing buyer would pay an independent willing
seller for such asset on a going concern basis, each having reasonable knowledge
of the relevant facts and neither being under any compulsion to act, but with
the transaction to be consummated within one year; and "PRESENT FAIR SALEABLE
VALUE" means, with respect to any asset, the amount that an independent willing
buyer would pay an independent willing seller for such asset on a going concern
basis, each having reasonable knowledge of the relevant facts and neither being
under any compulsion to act, but with the transaction to be consummated within
six months.
(d) Each of the American-Amicable Balance Sheet and the Pioneer Life
Balance Sheet presents fairly, in all material respects, in accordance with
GAAP, the respective financial positions of American-Amicable and Pioneer Life
at their respective dates, and except as disclosed or reflected in such
financial statements, as at the Waco Consent Effective Date, neither such Person
had any Liability, contingent or otherwise, or any unrealized or anticipated
loss, that, singly or in the aggregate, has had or might have a Material Adverse
Effect on such Person.
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<PAGE>
(e) Each of the foregoing representations and warranties shall constitute
representations and warranties subject to Section 9(d) of the Credit Agreement
and shall be made at and as of the Waco Consent Effective Date and, in the case
of the representations and warranties made pursuant to Section 6(c), at and as
of the time of each Transaction.
7. EVENTS OF DEFAULT. Each of the following shall, for all purposes of the
Credit Agreement and Security Agreements constitute an Event of Default (in
addition to any Event of Default set forth in such agreements), whatever the
reason for such event and whether it shall be voluntary or involuntary, or
within or without the control of the Company, any Subsidiary or any other Loan
Party, or be effected by operation of law or pursuant to any judgment or order
of any court or any order, rule or regulation of any governmental or
nongovernmental body:
(a) contemporaneously with the Closing (as that term is defined in the Waco
Sale Contract) American-Amicable shall not have paid to the Administrative
Agent, by wire transfer to a specified account with The Bank of New York (such
account to be specified to American-Amicable no later than two (2) Business Days
prior to the Closing), the net cash proceeds due pursuant to the Waco Sale
Contract, minus the deductions identified in Schedule 2 hereto, in a total
amount of not less than $95,000,000 (the "Waco Cash Proceeds"), such amount to
be applied first to interest which is then due and payable and then to the
payment of principal amount of the Loans; PROVIDED that it is understood that
Transaction number 2 on Schedule 1 hereto is not a part of the Waco Cash
Proceeds from the Waco Sale Contract;
(b) any representation and warranty made under Section 5 hereof shall at
any time prove to have been incorrect or misleading in any material respect at
any time when such representation and warranty was made;
(c) any Property that is (i) the subject of a Specified Transaction, (ii)
Collateral under a Security Agreement under which the Person receiving such
Property is the Pledgor, and (iii) of a type with respect to which the
applicable Security Interests may be perfected by possession, shall not have
been delivered to the applicable Secured Party within four Business Days of its
receipt, endorsed in blank if such Property is an instrument, or accompanied by
appropriate blank stock or bond powers, if such Property is a certificated
security, in each case after the completion of the Specified Transaction to the
extent the same is not disposed of pursuant to the Waco Sale Contract; or
(d) The Waco Sale Contract shall be terminated by the Company for any
reason other than in connection with the Company's acceptance of a Superior
Proposal (as defined in the Waco Sale Contract) to which the Majority Banks have
consented.
8. CONDITIONS TO EFFECTIVENESS. This Consent shall be effective as of the
date first written above, but shall not become effective as of such date until
the time as:
(a) this Consent has been executed and delivered by the Company, the
Majority Banks and the Administrative Agent;
(b) all amounts payable pursuant to Section 11.03 of the Credit Agreement
for which invoices have been delivered to the Company on or prior to such date,
have been paid in full; and
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(c) the Administrative Agent shall have received a copy of the no action
letters of the Texas Department of Insurance with respect to the transfer of
$20,400,000 in the aggregate, to the Company.
9. TERMINATION OF COMMITMENTS; ACCELERATION OF LOAN. (a) Simultaneously
with the payment to the Administrative Agent contemplated by Section 7(a), the
Commitments shall be terminated in full, and this Section 9(a) shall be deemed
to be a notice of termination that complies with the provisions of Sections 2.04
and 4.05 of the Credit Agreement.
(b) Simultaneously with the payment to the Administrative Agent
contemplated by Section 7(a), the Loans (a) shall be deemed to have become due
in the amount of such payment, and this Section 9(b) shall be deemed to be a
notice of prepayment, that complies with Sections 3.03(a) and 4.05 of the Credit
Agreement.
10. GOVERNING LAW. This Consent shall be governed by, and construed in
accordance with, the law of the State of New York.
11. COUNTERPARTS. This Consent may be executed in any number of
counterparts, all of which taken together shall constitute one and the same
instrument and any of the parties hereto may execute this Consent by signing any
such counterpart.
[REMAINDER OF THIS PAGE IS INTENTIONALLY BLANK)
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<PAGE>
IN WITNESS WHEREOF, the parties hereto have caused this Waco Consent to
be duly executed as of the day and year first above written.
PENNCORP FINANCIAL GROUP, INC.
By: /s/Scott D. Silverman
--------------------------------------
Name: Scott D. Silverman
Title: Executive Vice President
THE BANK OF NEW YORK, as
Administrative Agent, Collateral Agent and
as a Bank
By: /s/Peter W. Helt
--------------------------------------
Name: Peter W. Helt
Title: Vice President
THE CHASE MANHATTAN BANK, as a Managing
Agent and as a Bank
By: /s/Glenn R. Meyer
--------------------------------------
Name: Glenn R. Meyer
Title: M.D.
BANK OF AMERICA, N.A., formerly known as
Nations Bank, N.A., as a Managing
Agent and as a Bank
By: /s/William E. Livingstone IV
--------------------------------------
Name: William E. Livingston IV
Title: Managing Director
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<PAGE>
FLEET NATIONAL BANK, as a
Co-Agent and as a Bank
By: /s/Donald R. Nicholson
--------------------------------------
Name: Donald R. Nicholson
Title: SVP
MELLON BANK, N.A., as a Co-Agent
and as a Bank
By: /s/Gary A. Saul
--------------------------------------
Name: Gary A. Saul
Title: First Vice President
BANK OF MONTREAL, as a Co-Agent
and as a Bank
By: /s/Thomas E. McGraw
--------------------------------------
Name: Thomas E. McGraw
Title: Director
CIBC INC., as a Co-Agent and as a Bank
By: /s/ Gerald Girardi
--------------------------------------
Name: Gerald Girardi
Title: Executive Director
CIBC World Markets Corp,
as Agent
DRESDNER BANK AG, NEW YORK AND
GRAND CAYMAN BRANCHES, as a Co-Agent
and as a Bank
By: /s/Anthony C. Valencourt
--------------------------------------
Name: Anthony C. Valencourt
Title: Senior Vice President
By: /s/George T. Ferguson, IV
--------------------------------------
Name: George T. Ferguson, IV
Title: Assistant Vice President
FIRST UNION NATIONAL BANK
By: /s/Thomas L. Stitchberry
--------------------------------------
Name: Thomas L. Stitchberry
Title: Senior Vice President
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<PAGE>
BEAR STEARNS & CO., INC.
By: /s/Gregory A. Hanley
--------------------------------------
Name: Gregory A. Hanley
Title: Senior Managing Director
DK ACQUISITION PARTNERS, L.P.
By: /s/Michael J. Leffell
--------------------------------------
Name: Michael J. Leffell
Title: General Partner
ING (U.S.) CAPITAL CORPORATION
By: /s/Mary Forstner
--------------------------------------
Name: Mary Forstner
Title: Senior Associate
10
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Schedule 1
TRANSACTIONS
1. The dividend and partial payment of interest on its Surplus Note by
Pioneer Security Life Insurance Company ("Pioneer Life") to American-Amicable of
all of the issued and outstanding shares of the capital stock of Occidental Life
Insurance Company of North Carolina, a Texas insurance corporation
("Occidental").
2. The dividend by Pioneer Life to American-Amicable of its capital
and surplus in excess of $1,200,000.
3. The purchase by American-Amicable from A-A Texas and Pioneer
American Life Insurance Company ("Pioneer American"), of all of the issued and
outstanding shares of Preferred Stock of Southwestern Financial Corporation, a
Delaware corporation (the "SFC Stock") owned by each of A-A Texas and Pioneer
American.
4. The dividend by American-Amicable of cash and the SFC Stock to the
Company.
EXECUTION COPY
SWISS RE
CONSENT
Dated as of January 31, 2000
under
CREDIT AGREEMENT
Dated as of March 12, 1997
PENNCORP FINANCIAL GROUP, INC., a Delaware corporation (the "Company"),
the lenders signatory to the Credit Agreement referred to below that are parties
hereto, the Managing Agents and the Co-Agents named therein (the "Agents") and
THE BANK OF NEW YORK, as administrative agent for the Banks (the "Administrative
Agent"), hereby agree as follows (with certain terms used herein being defined
in, or incorporated by reference pursuant to, Section 2 hereof):
1. Credit Agreement. Reference is hereby made to the Credit Agreement,
dated as of March 12, 1997, among the Company, the Banks, the Agents and the
Administrative Agent (as amended, modified or waived prior to the date hereof,
the "Credit Agreement").
2. Definitions. (a) All terms defined in the Credit Agreement are used
herein with the meanings therein ascribed to them.
(b) For purposes of this Consent:
"American-Amicable" means American-Amicable Holdings Corporation, a
Delaware corporation.
"American-Amicable Balance Sheet" means the balance sheet of
American-Amicable attached hereto as Exhibit A.
"Pacific Life" means Pacific Life and Accident Insurance Company, a Texas
insurance company.
"Pacific Life Balance Sheet" means the balance sheet of Pacific Life,
attached hereto as Exhibit B.
"Pioneer Life" means Pioneer Security Life Insurance Company, a Texas
insurance company.
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"Pioneer Life Balance Sheet" means the balance sheet of Pioneer Life
attached hereto as Exhibit C.
"Security Life" shall mean Security Life and Trust Insurance Company, a
Texas insurance company.
"Southwestern Financial" shall mean Southwestern Financial Corporation, a
Delaware corporation.
"Southwestern Life" shall mean Southwestern Life Insurance Company, a Texas
insurance company.
"Specified Transaction" shall mean the Transactions numbered 4, 6, 12 and
13 on Schedule 1 hereto.
"Swiss Re Consent Effective Date" means the date on which the condition
specified in Section 7 hereof shall have been fulfilled.
"Swiss Re Sale Contract" means the (a) Stock Purchase Agreement, dated
January 7, 2000, between Reassure America Life Insurance Company, an Illinois
insurance company, and the Company, in the form attached hereto as Exhibit D, as
such form may be amended or modified from time to time after the Swiss Re
Consent Effective Date, provided, that any such amendment or modification was,
in the sound business judgment of the Company and its Board of Directors, in the
best interests of the Company, and, provided, further, that any such amendment
or modification of Section 2.1 of the Swiss Re Sale Contract, which reduces the
total consideration payable to the Company, was consented to in writing by the
Majority Banks, except for any amendment or modification to allow for the
assumption of transaction bonuses in an amount not greater than $1,400,000, and
(b) the Transactions related thereto.
"Transaction" means a transaction listed on Schedule 1.
"Transfer" means a transfer, whether as a payment, a dividend, a capital
contribution or otherwise, of Property under a Transaction. "Transfer", when
used as a verb, has a correlative meaning.
"Transferor" means a Person that Transfers any Property in a Transaction.
"Waco Consent" means the Waco Consent and Waiver and Amendment, dated as of
January 31, 2000 under the Credit Agreement.
3. Consent. (a) Upon the Swiss Re Consent Effective Date, the Majority
Banks hereby consent, under the sections of the Credit Agreement and to the
extent specified in Section 3(b) hereof, to (i) the consummation of the
Transactions and (ii) to the release from any applicable Security Interest of
the Properties that are the subjects of such Transactions.
(b) The consent under Section 3(a)(i) is limited to Sections 8.06(b) and
(c), 8.08, 8.15, 8.17, 8.18, 8.21, 8.22, 8.23, 8.24 and 8.29 of the Credit
Agreement, and then only to the extent necessary to avoid a violation of such of
such Section or Sections as may be applicable
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<PAGE>
to such Transfer, and the release under Section 3(a)(ii) is limited to the
Properties that are the subjects of the Transactions.
4. Waiver. The Majority Banks hereby waive until February 11, 2000 any
non-compliance by the Company with Sections 8.10, 8.11, 8.12 and 8.13, to the
extent that such non-compliance results from and solely from the Transactions.
5. Representations and Warranties. In order to induce the Majority Banks to
grant the consents, releases and waiver effected hereunder, the Company hereby
represents and warrants as follows:
(a) The Company has the power, and has taken all necessary action
(including, if a corporation, any necessary stockholder action) to authorize it,
to execute, deliver and perform in accordance with its terms this Consent. This
Consent has been duly executed and delivered by the Company and is a legal,
valid and binding obligation of the Company, enforceable against the Company in
accordance with its terms, except as enforceability may be limited by applicable
bankruptcy, insolvency, reorganization, moratorium or similar laws affecting the
enforcement of creditors' rights generally, whether at law or in equity
(including principles of good faith and fair dealing). The execution, delivery
and performance in accordance with its respective terms by the Company of this
Consent do not and (absent any change in any Applicable Law or applicable
Contract) will not (i) require any Governmental Approval or any other consent or
approval (including any consent or approval of the stockholders of the Company)
to have been obtained by the Company or any of its Affiliates, other than
Governmental Approvals and other consents and approvals that have been obtained,
are final and not subject to review on appeal or to collateral attack, are in
full force and effect, or (ii) violate, conflict with, result in a breach of,
constitute a default under, or result in or require the creation of any Lien
(other than the Security Interest) upon any assets of any such Person under, (A)
any Contract to which any such Person is a party or by which any such Person or
any of its properties may be bound or (B) any Applicable Law.
(b) The copy of the Swiss Re Sale Contract attached as Exhibit D hereto (i)
is in substantially the form approved by the Company's Board of Directors at the
meeting of the Board of Directors of the Company held on January 6, 2000, (ii)
is in the form executed by the parties thereto, and (iii) has not been amended
or modified subsequent to its having been furnished to the Administrative Agent
and prior to the Swiss Re Effective Date, except by amendments and modifications
of which the Banks have been furnished copies.
(c) (i) Either (A) each Transferor will, under its Transfer, receive not
less than the reasonable equivalent Value of the assets being Transferred by it
thereunder, or (B) both before and after giving effect to each Transaction (1)
both the Fair Value and the Present Fair Saleable Value of the remaining assets
of the Transferor transferring assets thereunder will be greater than the total
amount of such Transferor's Debts, (2) the Present Fair Saleable Value of the
remaining assets of such Transferor will exceed the amount that will be required
to pay the probable liability of such Transferor's on its Debts as they become
absolute and mature and (3) such Transferor (aa) will be able to realize upon
its assets and pay its Debts as they mature in the normal course of business,
and (bb) will not be engaged in a business or a transaction, nor be
3
<PAGE>
about to engage in a business or a transaction, (I) for which its property would
constitute unreasonably small capital or (II) in relation to which its assets
would be unreasonably small.
(ii) Each Transferor transferring assets under a Transaction, at the time
of such transfer, (A) will not intend to or believe that it will incur Debts
that will be beyond its ability to pay as such Debts mature and (B) will not
intend, in consummating such Transaction, to hinder, delay or defraud either
present or future creditors or any other Person to which any of its Debts is or
will become owing.
(iii) As used herein, "Value" means (A) "value" as defined under Section
548(d)(2)(A) of the Bankruptcy Code; (B) "fair consideration" within the meaning
of Section 3 of the Uniform Fraudulent Conveyance Act and (C) "value" within the
meaning of Section 3 of the Uniform Fraudulent Transfer Act; "Debt" means any
Liability that constitutes "debt" or "Debt" under Section 101(11) of the
Bankruptcy Code or under the Uniform Fraudulent Conveyance Act, the Uniform
Fraudulent Transfer Act or any analogous Applicable Law; "Fair Value" means,
with respect to any asset, the amount that an independent willing buyer would
pay an independent willing seller for such asset on a going concern basis, each
having reasonable knowledge of the relevant facts and neither being under any
compulsion to act, but with the transaction to be consummated within one year;
and "Present Fair Saleable Value" means, with respect to any asset, the amount
that an independent willing buyer would pay an independent willing seller for
such asset on a going concern basis, each having reasonable knowledge of the
relevant facts and neither being under any compulsion to act, but with the
transaction to be consummated within six months.
(d) Each of the American-Amicable Balance Sheet and the Pioneer Life
Balance Sheet presents fairly, in all material respects, in accordance with
GAAP, the respective financial positions of American-Amicable and Pioneer Life
at their respective dates, and except as disclosed or reflected in such
financial statements, as at the Swiss Re Consent Effective Date, neither such
Person had any Liability, contingent or otherwise, or any unrealized or
anticipated loss, that, singly or in the aggregate, has had or might have a
Material Adverse Effect on such Person.
(e) Each of the foregoing representations and warranties shall constitute
representations and warranties subject to Section 9(d) of the Credit Agreement
and shall be made at and as of the Swiss Re Consent Effective Date and, in the
case of the representations and warranties made pursuant to Section 5(c), at and
as of the time of each Transaction.
6. Events of Default. Each of the following shall, for all purposes of the
Credit Agreement and the Security Agreement, constitute an Event of Default (in
addition to any Event of Default set forth in such agreement), whatever the
reason for such event and whether it shall be voluntary or involuntary, or
within or without the control of the Company, any Subsidiary or any other Loan
Party, or be effected by operation of law or pursuant to any judgment or order
of any court or any order, rule or regulation of any governmental or
nongovernmental body:
(a) any representation and warranty made under Section 5 hereof shall at
any time prove to have been incorrect or misleading in any material respect at
any time when such representation and warranty was made;
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<PAGE>
(b) any Property that is (i) the subject of a Specified Transaction, (ii)
Collateral under a Security Agreement under which the Person receiving such
Property is the Pledgor, and (iii) of a type with respect to which the
applicable Security Interests may be perfected by possession, shall not have
been delivered to the applicable Secured Party within two Business Days of its
receipt, endorsed in blank if such Property is an instrument, or accompanied by
appropriate blank stock or bond powers, if such Property is a certificated
security, in each case after the completion of the Specified Transaction to the
extent the same is not sold pursuant to the Swiss Re Contract.
7. Condition to Effectiveness. This Consent shall be effective as of the
date first written above, but shall not become effective as of such date until
the time as:
(a) this Consent has been executed and delivered by the Company, the
Majority Banks and the Administrative Agent; and
(b) the Waco Consent shall have been executed and delivered by the Company,
the Majority Banks and the Administrative Agent.
8. Governing Law. This Consent shall be governed by, and construed in
accordance with, the law of the State of New York.
9. Counterparts. This Consent may be executed in any number of
counterparts, all of which taken together shall constitute one and the same
instrument and any of the parties hereto may execute this Consent by signing any
such counterpart.
[REMAINDER OF THIS PAGE IS INTENTIONALLY BLANK]
5
<PAGE>
IN WITNESS WHEREOF, the parties hereto have caused this Swiss Re Consent to
be duly executed as of the day and year first above written.
PENNCORP FINANCIAL GROUP, INC.
By: /s/Scott D. Silverman
-------------------------------------
Name: Scott D. Silverman
Title: EVP
THE BANK OF NEW YORK, as Administrative
Agent, Collateral Agent and as a Bank
By: /s/Peter W. Helt
-------------------------------------
Name: Peter W. Helt
Title: Vice President
THE CHASE MANHATTAN BANK, as a Managing
Agent and as a Bank
By: /s/Glenn R. Meyer
-------------------------------------
Name: Glenn R. Meyer
Title: M.D.
BANK OF AMERICA, N.A., formerly known as
Nations Bank, N.A., as a Managing
Agent and as a Bank
By: /s/William E. Livingstone IV
-------------------------------------
Name: William E. Livingstone IV
Title: Managing Director
FLEET NATIONAL BANK, as a
Co-Agent and as a Bank
By: /s/Donald R. Nicholson
-------------------------------------
Name: Donald R. Nicholson
Title: SVP
MELLON BANK, N.A., as a Co-Agent
and as a Bank
By: /s/Gary A. Saul
-------------------------------------
Name: Gary A. Saul
Title: First Vice President
6
<PAGE>
BANK OF MONTREAL, as a Co-Agent
and as a Bank
By: /s/Thomas E. McGraw
-------------------------------------
Name: Thomas E. McGraw
Title: Director
CIBC INC., as a Co-Agent and as a Bank
By: /s/Gerald Girardi
-------------------------------------
Name: Gerald Girardi
Title: Executive Director
CIBC World Markets Corp,
as Agent
DRESDNER BANK AG, NEW YORK AND
GRAND CAYMAN BRANCHES, as a Co-Agent
and as a Bank
By: /s/Anthony C. Valencourt
-------------------------------------
Name: Anthony C. Valencourt
Title: Assistant Vice President
By: /s/George T. Ferguson, IV
-------------------------------------
Name: George T. Ferguson, IV
Title: Assistant Vice President
FIRST UNION NATIONAL BANK
By: /s/Thomas L. Stitchberry
-------------------------------------
Name: Thomas L. Stitchberry
Title: Senior Vice President
BEAR STEARNS & CO., INC.
By: /s/Gregory A. Hanley
-------------------------------------
Name: Gregory A. Hanley
Title: Senior Managing Director
DK ACQUISITION PARTNERS, L.P.
By: M.H. Davidson & Co.,
its General Director
By: /s/Michael J. Leffell
-------------------------------------
Name: Michael J. Leffell
Title: General Partner
ING (U.S.) CAPITAL CORPORATION
By: /s/Mary Forstner
-------------------------------------
Name: Mary Forstner
Title: Senior Associate
7
<PAGE>
Schedule 1
TRANSACTIONS
1) The transfer by Pioneer Life of the shares of Security Life to
American-Amicable as a dividend and a repayment on its Surplus Note.
2) The transfer by Security Life of its note from American-Amicable to
American-Amicable.
3) The transfer by American-Amicable of the shares of Security Life to the
Company as a dividend.
4) The transfer by Security Life of the preferred shares of Southwestern
Financial to the Company.
5) The transfer by the Company of the shares of Security Life to Pacific Life
in return for a Surplus Note of approximately $35,000,000 (the "PLAIC
Note") and a capital contribution by the Company to Pacific Life of
approximately $56,000,000.
6) The transfer by the Company of the PLAIC Note to Southwestern Financial.
7) The dividend by Southwestern Life of its note from American-Amicable to
Pacific Life for an approximate value of $15,300,000 (the
"American-Amicable Note").
8) The transfer by Pacific Life of the American-Amicable Note to Southwestern
Financial as partial repayment of its Surplus Note.
9) The transfer by Southwestern Financial of the American-Amicable Note to the
Company as a dividend.
10) The cancellation by the Company of the American-Amicable Note (and all
other notes made by American-Amicable and held by the Company) as a capital
contribution by the Company to American-Amicable.
11) The repayment by Pacific Life of its Surplus Note to Southwestern Financial
by transferring the Common Stock of Southwestern Life to Southwestern
Financial.
12) The dividend by Southwestern Financial of the common stock of Southwestern
Life to the Company.
13) The transfer by Pacific Life of the shares of Security Life as a dividend
to the Company.
8
EXECUTION COPY
OTHER
CONSENT
Dated as of January 31, 2000
under
CREDIT AGREEMENT
Dated as of March 12, 1997
PENNCORP FINANCIAL GROUP, INC., a Delaware corporation (the "Company"), the
lenders signatory to the Credit Agreement referred to below that are parties
hereto, the Managing Agents and the Co-Agents named therein (the "Agents") and
THE BANK OF NEW YORK, as administrative agent for the Banks (the "Administrative
Agent"), hereby agree as follows (with certain terms used herein being defined
in, or incorporated by reference pursuant to Section 2 hereof):
1. Credit Agreement. (a) Reference is hereby made to the Credit Agreement,
dated as of March 12, 1997, among the Company, the Banks, the Agents and the
Administrative Agent (as amended, modified or waived prior to the date hereof,
the "Credit Agreement").
2. Definitions. (a) All terms defined in the Credit Agreement are used
herein with the meanings therein ascribed to them.
(b) For purposes of this Consent:
"Other Consent Effective Date" means the date on which the condition
specified in Section 5 hereof shall have been fulfilled.
"Transferor" means a Person that Transfers any property in a Transaction.
"Transaction" means a transaction listed on Schedule 1.
"Transfer" means a transfer, as a repayment of Indebtedness, a dividend, a
capital contribution, or a merger, of Property under a Transaction. "Transfer",
when used as a verb, has a correlative meaning.
3. Consent. (a) Upon the Other Consent Effective Date, the Majority Banks
hereby consent, under the sections of the Credit Agreement and to the extent
specified in Section 3(b) hereof, to (i) the consummation of the Transactions
and (ii) to the release from any applicable Security Interest of the Properties
that are the subjects of such Transactions.
1
<PAGE>
(b) The consent under Section 3(a)(i) is limited to Sections 8.04, 8.06,
8.15, 8.17, 8.19(b) (but only in the case of the last Transaction listed on
Schedule 1), 8.21(b), 8.23 and 8.29 of the Credit Agreement, and then only to
the extent necessary to avoid a violation of such of such Section or Sections as
may be applicable to such Transfer, and the release under Section 3(a)(ii) is
limited to the Properties that are the subjects of the Transactions.
4. Representations and Warranties. In order to induce the Majority Banks to
grant the consents, releases and waiver effected hereunder, the Company hereby
represents and warrants as follows:
(a) The Company has the power, and has taken all necessary action
(including, if a corporation, any necessary stockholder action) to authorize it,
to execute, deliver and perform in accordance with its terms this Consent. This
Consent has been duly executed and delivered by the Company and is a legal,
valid and binding obligation of the Company, enforceable against the Company in
accordance with its terms, except as enforceability may be limited by applicable
bankruptcy, insolvency, reorganization, moratorium or similar laws affecting the
enforcement of creditors' rights generally whether at law or in equity
(including principles of good faith and fair dealing). The execution, delivery
and performance in accordance with its respective terms by the Company of this
Consent do not and (absent any change in any Applicable Law or applicable
Contract) will not (i) require any Governmental Approval or any other consent or
approval (including any consent or approval of the stockholders of the Company)
to have been obtained by the Company or any of its Affiliates, other than
Governmental Approvals and other consents and approvals that have been obtained,
are final and not subject to review on appeal or to collateral attack, are in
full force and effect or (ii) violate, conflict with, result in a breach of,
constitute a default under, or result in or require the creation of any Lien
(other than the Security Interest) upon any assets of any such Person under, (A)
any Contract to which any such Person is a party or by which any such Person or
any of its properties may be bound or (B) any Applicable Law.
(b) The organizational chart attached hereto as Schedule 2 is a true and
correct representation of the corporate structure of Pacific Life and Accident
Insurance Company and Marketing One Financial Corporation as of January 30,
2000.
(c) Each of the foregoing representations and warranties shall constitute
representations and warranties subject to Section 9(d) of the Credit Agreement
and shall be made at and as of the Other Consent Effective Date.
5. Condition to Effectiveness. This Consent shall be effective as of the
date first written above, but shall not become effective as of such date until
the time as this Consent has been executed and delivered by the Company, the
Majority Banks and the Administrative Agent.
6. Governing Law. This Consent shall be governed by, and construed in
accordance with, the law of the State of New York.
7. Counterparts. This Consent may be executed in any number of
counterparts, all of which taken together shall constitute one and the same
instrument and any of the parties hereto may execute this Consent by signing any
such counterpart.
2
<PAGE>
IN WITNESS WHEREOF, the parties hereto have caused this Other Consent to
be duly executed as of the day and year first above written.
PENNCORP FINANCIAL GROUP, INC.
By: /s/Scott D. Silverman
-------------------------------------
Name: Scott D. Silverman
Title: EVP
THE BANK OF NEW YORK, as Administrative
Agent, Collateral Agent and as a Bank
By: /s/Peter W. Helt
-------------------------------------
Name: Peter W. Helt
Title: Vice President
THE CHASE MANHATTAN BANK, as a Managing
Agent and as a Bank
By: /s/Glenn R. Meyer
-------------------------------------
Name: Glenn R. Meyer
Title: M.D.
BANK OF AMERICA, N.A., formerly known as
Nations Bank, N.A., as a Managing
Agent and as a Bank
By: /s/William E. Livingston IV
-------------------------------------
Name: William E. Livingston IV
Title: Managing Director
3
<PAGE>
FLEET NATIONAL BANK, as a
Co-Agent and as a Bank
By: /s/Donald R. Nicholson
-------------------------------------
Name: Donald R. Nicholson
Title: SVp
MELLON BANK, N.A., as a Co-Agent
and as a Bank
By: /s/Gary A. Saul
-------------------------------------
Name: Gary A. Saul
Title: First Vice President
BANK OF MONTREAL, as a Co-Agent
and as a Bank
By: /s/Thomas E. McGraw
-------------------------------------
Name: Thomas E. McGraw
Title: Director
CIBC INC., as a Co-Agent and as a Bank
By: /s/Gerald Girardi
-------------------------------------
Name: Gerald Girardi
Title: Executive Director
CIBC World Markets Corp.,
as Agent
DRESDNER BANK AG, NEW YORK AND
GRAND CAYMAN BRANCHES, as a Co-Agent
and as a Bank
By: /s/Anthony C. Valencourt
-------------------------------------
Name: Anthony C. Valencourt
Title: Senior Vice President
By: /s/George T. Ferguson, IV
-------------------------------------
Name: George T. Ferguson, IV
Title: Assistant Vice President
4
<PAGE>
FIRST UNION NATIONAL BANK
By: /s/Thomas L. Stitchberry
-------------------------------------
Name: Thomas L. Stitchberry
Title: Senior Vice President
BEAR STEARNS & CO., INC.
By: /s/Gregory A. Hanley
-------------------------------------
Name: Gregory A. Hanley
Title: Senior Managing Director
DK ACQUISITION PARTNERS, L.P.
By: M.H. Davidson & Co.,
its General Partner
By: /s/Michael J. Leffell
-------------------------------------
Name: Michael J. Leffell
Title: General Partner
ING (U.S.) CAPITAL CORPORATION
By: /s/Mary Forstner
-------------------------------------
Name: Mary Forstner
Title: Senior Associate
5
<PAGE>
Schedule 1
TRANSACTIONS
1. Dissolution of Quail Creek Recreation, Inc.
2. Dissolution of the Subsidiaries of Marketing One, Inc.
a. Marketing One of Alabama, Inc.
b. Marketing One Investment Services Corporation
c. Marketing One Securities, Inc.
d. Premier One, Inc.
e. Tax Savers Agency, Inc.
3. Creation and incorporation of ROP Financial Group, Inc. by
Southwestern Life Insurance Company;
4. Merger of ROP Financial Group, Inc., a subsidiary of Southwestern
Life Insurance Company, with and into Portsmouth Financial Group,
Inc.
5. At the option of the Company, either:
(a) the sale by Southwestern Life Insurance Company of ROP
Financial Group, Inc.; or
(b) dividend by Southwestern Life Insurance Company of ROP
Financial Group, Inc., to the Company.
6. The Amendment by Pacific Life and Accident Insurance Company of
its bylaws to change its name therein from "RDI Life Insurance
Company" to "Pacific Life and Accident Insurance Company to
accurately reflect its legal name.
7. Withdrawal of cash from the Collateral Account for the payment of
interest owing on the Executive Director Escrow Amount in an
amount not greater than $25,000.
6
PACIFIC LIFE AND ACCIDENT INSURANCE COMPANY
SURPLUS DEBENTURE NO. 8
$ 35,000,000.00 January 31,2000
FOR VALUE RECEIVED, Pacific Life and Accident Insurance Company, a Texas life
insurance corporation ("Pacific"), subject to the terms, conditions,
restrictions, and limitations contained herein, promises to pay to the order of
PennCorp Financial Group, Inc., a Delaware Corporation ("PennCorp"), or to any
subsequent holder hereof (the "Holder"), the principal sum of Thirty-Five
Million Dollars ($35,000,000.00) together with interest on the unpaid balance
thereof at a rate (the "Rate") equal to the greater of (i) ten percent (10%) per
annum, or (ii) two hundred (200) basis points above the rate of the outstanding
senior debt (if any) of PennCorp Financial Group, Inc,. Each change in the rate
of the outstanding senior debt of PennCorp Financial Group, Inc. that would
cause a corresponding change in the calculation of the Rate, shall be effective
as of the time and date of such change, without any notice to Pacific or further
action by the Holder.
Interest on this Surplus Debenture will be payable each quarter on the day in
which Pacific's financial statements are finalized for the prior quarter (each,
a "Payment Date") and continuing until the principal amount of this Surplus
Debenture is paid full. Both principal and interest on this Surplus Debenture
will be due and payable in the following manner at the offices of Holder:
1. On or before each Payment Date, Pacific will calculate the Surplus of
Pacific (as hereinafter defined) as of the most recent date practicable,
but in no event prior to the end of the immediately preceding calendar
quarter (each such date being hereinafter referred to as a "Calculation
Date").
2. On each Payment Date, Pacific will pay the Holder the amount of accrued but
unpaid interest on the unpaid principal balance of this Surplus Debenture
to the extent the Surplus of Pacific exceeds $1.2 million as of the
Calculation Date immediately prior to such Interest Payment Date.
3. If, as of any Calculation Date, the Surplus of Pacific does not exceed $1.2
million by an amount sufficient to pay all accrued but unpaid interest on
this Surplus Debenture, the remaining accrued but unpaid interest (together
with interest thereon at the Rate) shall be payable on the next Payment
Date to the extent the Surplus of Pacific exceeds $1.2 million as of the
Calculation Date immediately prior to such next Payment Date.
4. Pacific will pay principal payments to the Holder on a quarterly basis on
the Payment Date in accordance with the principal amortization schedule
1
<PAGE>
attached hereto as Exhibit A, to the extent the Surplus of Pacific exceeds
$1.2 million as of the most recent Calculation Date.
5. If on a Payment Date, the Surplus of Pacific does not exceed $1.2 million
by an amount sufficient to pay the Holder the principal amount due,
together with all accrued but unpaid interest on this Surplus Debenture,
the remaining unpaid portion of such principal amount and such interest
shall be payable thereafter at such time or from time to time as the
Surplus of Pacific exceeds $1.2 million.
6. For purposes of this Surplus Debenture, the term "Surplus of Pacific" shall
mean the remainder obtained after subtracting the carrying value of the
insurance subsidiaries of Pacific from the sum of:
(a) "common capital stock" of Pacific;
(b) "gross paid-in and contributed surplus" of Pacific;
(c) "unassigned surplus" of Pacific;
(d) "special surplus" of Pacific;
(e) any amounts required to be carried as liabilities with respect to
outstanding surplus debentures issued by Pacific; and
(f) surplus evidenced by surplus debentures of Pacific which is not
included in clauses a-e of this paragraph 6.
The items listed in clauses a-f of this paragraph 6 will be calculated in
accordance with the accounting practices required or permitted by the Texas
Department of Insurance ("Texas Department") for inclusion in the Annual
Statement of Pacific filed with the Texas Department as of December 31, of
each year.
7. The obligation of Pacific to pay this Surplus Debenture will not otherwise
be or constitute a liability of Pacific or a claim against any of its
assets except in the event of the liquidation of Pacific, and in no event
will this Surplus Debenture be considered or treated as a current or fixed
liability or obligation of Pacific under the Texas insurance laws and the
regulations thereunder except to the extent that a payment of principal or
interest becomes due and payable hereunder or to the extent otherwise
required by Texas law.
8. In event of the liquidation of Pacific, this Surplus Debenture will become
immediately due and payable and will be superior to and in preference of
the rights and claims of the shareholders of Pacific; provided, however,
2
<PAGE>
that to the extent required by applicable law, all obligations, rights and
claims hereunder are expressly subordinated to the claims of (a)
policyholders, insureds, and beneficiaries under insurance contracts or
policies issued by Pacific and (b) any supervisor, conservator or receiver
of Pacific appointed by the Commissioner of Insurance of the State of
Texas.
9. All payments made hereunder will be credited first to accrued but unpaid
interest, if any, and the balance of such payment will be credited to the
principal amount hereof.
10. As a condition to the consolidation or merger of Pacific into another
corporation or the sale of all or substantially all of Pacific's assets to
any other corporation, the corporation into which Pacific is consolidated
or merged or to which the assets of Pacific are transferred shall
unconditionally assume the liability of Pacific hereunder.
11. By acceptance and as a part of the consideration for the issuance hereof,
the Holder expressly acknowledges that it has been informed and has
knowledge that this Surplus Debenture has not been registered under the
Securities Act of 1933, as amended, or the securities laws of any state and
that Pacific has issued this Surplus Debenture for investment purposes and
not with a view toward a public distribution hereof and that this Surplus
Debenture may not be sold or otherwise transferred in the absence of an
effective registration statement with respect hereto or an exemption from
registration under the Securities Act of 1933, as amended, or any other
applicable securities laws.
12. If this Surplus Debenture is collected through judicial proceedings,
Pacific agrees, subject to conditions and restrictions contained herein, to
pay all reasonable legal fees and disbursements incurred by the Holder in
connection with such collection.
13. This Surplus Debenture may be prepaid in whole or in part at any time or
from time to time without premium or penalty to the extent that the Surplus
of Pacific exceeds $1.2 million on the most recent Calculation Date before
the date of any proposed prepayment.
14. This Surplus Debenture will be governed by and construed in accordance with
the laws of the State of Texas.
15. It being the intention of the parties hereto to conform strictly to the
applicable usury laws of the State of Texas, all agreements between Pacific
and PennCorp and any other Holder whether now or hereafter arising and
whether written or oral, are here expressly limited so that in no event,
whether by reason of acceleration of the maturity of any amount
3
<PAGE>
owed hereunder or otherwise, shall the amount paid or agreed to be paid to
PennCorp or any other Holder for the use, forbearance or retention of money
hereunder or otherwise exceed the maximum amount permissible under
applicable law (the "Maximum Lawful Amount"). If fulfillment of any
provision hereof, at the time performance of such provision shall be due,
shall cause the amount of interest applicable to this Surplus Debenture to
exceed the Maximum Lawful Amount, then, ipso facto, the obligation to be
fulfilled shall be reduced to the extent necessary to cause the amount of
interest applicable to this Surplus Debenture not to exceed the Maximum
Lawful Amount; and if the Holder of this Surplus Debenture shall ever
receive anything of value deemed interest under applicable law that would
cause the interest applicable to this Surplus Debenture to exceed the
Maximum Lawful Rate, an amount equal to the portion of such interest in
excess of the Maximum Lawful Rate shall be applied to the reduction of the
principal amount owing hereunder and not to the payment of interest, or if
such excessive interest exceeds the unpaid principal amount hereof, such
excess shall be promptly refunded to Pacific by the Holder hereof. All sums
paid or agreed to be paid to the Holder of this Surplus Debenture for the
use, forbearance or retention of the indebtedness of Pacific shall, to the
extent permitted by applicable law, be amortized, prorated, allocated and
spread throughout the full term of such indebtedness until payment in full
so that interest on account of such indebtedness is uniform throughout the
full term thereof. The provisions of this paragraph shall control
agreements between Pacific and the holder of this Surplus Debenture.
16. PennCorp may assign its rights hereunder to any person or entity without
the consent of Pacific. This Surplus Debenture will inure to the benefit of
Pacific and its successors and assignees. Notwithstanding the above, this
Surplus Debenture is registered as to both principal and any stated
interest with Pacific and transfer of the Surplus Debenture may be effected
either by surrender of the old instrument and the reissuance by Pacific of
a new instrument to the new Holder or the written acknowledgment by Pacific
of the transfer of the Surplus Debenture to the new Holder. No transfer of
any ownership interest in this Surplus Debenture shall be made unless such
transfer is permitted under Texas insurance law and Pacific and PennCorp
shall comply with all regulatory and legal limitations and requirements in
connection with any transfer of this Surplus Debenture.
17. The occurrence of any one or more of the following events shall constitute
an Event of Default (herein so called) hereunder:
(a) The Company shall fail to make any payment of interest on this Surplus
Debenture when due and payable or declared due and payable, and such
failure shall have remained unremedied for a period of 5 days.
4
<PAGE>
(b) The Company shall fail to make any payment of principal of this
Surplus Debenture when due and payable or declared due and payable.
(c) The Company shall (i) be the subject of a petition seeking relief
under any state liquidation, rehabilitation, conservation, or
supervision law or other similar state or federal laws, or any
delinquency proceeding or to the appointment of or taking possession
by a custodian, receiver, liquidator, assignee, trustee or similar
official of any substantial part of its properties, (ii) fail
generally to pay is debts as such debts become due, or (iii) take any
corporate action in furtherance of any action.
If, at any time, any Event of Default has occurred and is continuing, the
Holder hereof may, without further action, declare the entire principal
amount under this Surplus Debenture to be due and payable, and such
principal amount, together with all accrued but unpaid interest hereon,
shall be paid to the Holder hereof by the Company to the extent the Surplus
of the Company exceeds $1.2 million on the date of such declaration by the
Holder hereof or at any time thereafter.
18. To the extent required by Texas law, Pacific will notify the Texas
Department of the payment of principal and interest under this Surplus
Debenture. Pacific will take all actions reasonably necessary to maintain
the enforceability of this Surplus Debenture.
IN WITNESS WHEREOF, Pacific has caused this Surplus Debenture to be duly
executed as of January 31, 2000.
PACIFIC LIFE AND ACCIDENT INSURANCE COMPANY
By: /s/Joan E. Olson
Name: Joan E. Olson
Title: Assistant Vice President
5
<TABLE>
EXHIBIT 12
PENNCORP FINANCIAL GROUP, INC.
STATEMENT RE RATIO OF EARNINGS (LOSS) TO FIXED CHARGES AND
PREFERRED STOCK DIVIDEND REQUIREMENTS
For the Years Ended December 31, 1999, 1998, 1997, 1996 and 1995
($ in thousands)
<CAPTION>
1999 1998 1997 1996 1995
--------- --------- ------- --------- ---------
<S> <C> <C> <C> <C> <C>
Income (loss) before income taxes,
equity in earnings of unconsolidated
affiliates and extraordinary charge ....... $(172,003) $(424,628) $51,543 $ 110,579 $ 79,457
Adjustments to earnings (loss):
Fixed charges .............................. 40,145 42,265 25,081 21,756 22,581
Interest capitalized ....................... -- -- -- (400) (260)
Preferred stock dividend requirements ...... -- -- -- -- --
--------- --------- ------- --------- ---------
Total earnings (loss) and fixed charges ...... $(131,858) $(382,363) $76,624 $ 131,935 $ 101,778
========= ========= ======= ========= =========
Fixed charges:
Interest expense ........................... $ 36,167 $ 41,491 $22,497 $ 17,741 $ 18,729
Amortization of deferred debt issuance costs 3,970 723 858 1,238 1,051
Rental expense ............................. 8 51 1,726 2,777 2,801
--------- --------- ------- --------- ---------
Total fixed charges .......................... $ 40,145 $ 42,265 $25,081 $ 21,756 $ 22,581
========= ========= ======= ========= =========
Preferred stock dividend requirements:
Preferred stock dividends .................. $ 17,825 $ 18,273 $19,533 $ 14,646 $ 6,540
Gross-up for taxes ......................... 10,469 10,732 12,769 8,616 3,525
--------- --------- ------- --------- ---------
Total preferred stock dividend requirements .. $ 28,294 $ 29,005 $32,302 $ 23,262 $ 10,065
========= ========= ======= ========= =========
Ratio of earnings to fixed charges ........... -- -- 3.27 6.06 4.51
========= ========= ======= ========= =========
Combined ratio of earnings to fixed charges
and preferred stock dividend requirements .. -- -- 1.34 2.93 3.12
========= ========= ======= ========= =========
Amount of deficiency in loss to fixed charges $ 172,003 $ 424,628 $ -- $ -- $ --
========= ========= ======= ========= =========
Amount of deficiency in loss to combined
fixed charges and preferred stock dividend
requirements ............................... $ 200,297 $ 453,633 $ -- $ -- $ --
========= ========= ======= ========= =========
</TABLE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT AUDITORS
The Board of Directors
PennCorp Financial Group, Inc.:
We consent to the incorporation by reference in the registration statements (No.
333-13285) on Form S-3 and (Nos. 333-48629, 333-48631 and 333-48637) on Form S-8
of PennCorp Financial Group, Inc. of our reports included herein relating to the
consolidated balance sheets of PennCorp Financial Group, Inc. and subsidiaries
as of December 31, 1999 and 1998, and the related consolidated statements of
operations and comprehensive income (loss), changes in shareholders' equity, and
cash flows for each of the years in the three-year period ended December 31,
1999, and all related schedules, and to the reference to our firm under the
heading "Experts" in the prospectus related to the Form S-3 registration
statement.
Our report dated April 10, 2000 contains an explanatory paragraph that states
that PennCorp Financial Group, Inc. filed a voluntary petition for relief under
chapter 11 of title 11 of the United States Bankruptcy Code in the United States
Bankruptcy Court for the District of Delaware. PennCorp Financial Group, Inc.
has filed a plan of reorganization and will seek confirmation of the
Recapitalization Plan by the Bankruptcy Court. Should the recapitalization plan
not be approved by the Bankruptcy Court, be delayed or not be consummated,
PennCorp Financial Group, Inc. may have to sell assets or otherwise realize
assets and liquidate or settle liabilities for amounts other than those
reflected in the consolidated financial statements or related notes. These
factors raise substantial doubt about PennCorp Financial Group, Inc.'s ability
to continue as a going concern. The 1999 consolidated financial statements and
the financial statement schedules do not include any adjustments that might
result from the outcome of these uncertainties.
KPMG LLP
Dallas, Texas
April 10, 2000
EXHIBIT 23.2
CONSENT OF INDEPENDENT AUDITORS
The Board of Directors
PennCorp Financial Group, Inc.:
We consent to the incorporation by reference in the registration statements (No.
333-13285) on Form S-3 and (Nos. 333-48629, 333-48631 and 333-48637) on Form S-8
of PennCorp Financial Group, Inc. of our report dated March 19, 1998, relating
to the consolidated balance sheet of Southwestern Financial Corporation and
subsidiaries as of December 31, 1997, and the related consolidated statements of
income, shareholders' equity, and cash flows for the year then ended, which
report appears in the December 31, 1999 annual report on Form 10-K of PennCorp
Financial Group, Inc.
KPMG LLP
Dallas, Texas
April 10, 2000
<TABLE> <S> <C>
<ARTICLE> 7
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
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0
271,952
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338,874
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