- ------------------------------------------------------------------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K/A
Amendment No. 1
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998
Commission File Number 1-11422
PENNCORP FINANCIAL GROUP, INC.
(Exact name of Registrant as specified in its charter)
Delaware 13-3543540
(State or other jurisdiction of
incorporation or organization (I.R.S. employer identification no.)
c/o Southwestern Financial Services Corporation 75201
717 North Harwood Street (Zip code)
Dallas, Texas
(Address of principal executive offices)
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, $.01 par value New York Stock Exchange
- -------------------------------------------------- --------------------------
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
None
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months, (or for such shorter period that the Registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained to the best
of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendments to
this Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates of the
registrant as of March 25, 1999: $14,520,796.
The number of Common Stock shares outstanding as of March 25, 1999, was
29,041,593.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the Annual Meeting of Shareholders scheduled
for May 13, 1999, is incorporated by reference into Part III hereof.
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1
<PAGE>
ANNUAL REPORT ON FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 1998
TABLE OF CONTENTS
Page
PART I
Item 1. Business 3
Item 2. Properties 22
Item 3. Legal Proceedings 22
Item 4. Submission of Matters to a Vote of Security Holders 23
PART II
Item 5. Market for the Registrant' Common Equity and Related
Shareholder Matters 24
Item 6. Selected Consolidated Financial Data 25
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 26
Item 7A. Quantitative and Qualitative Disclosures about
Market Risk Exposures of Financial Instruments
for the Retained Businesses 46
Item 8. Financial Statements and Supplementary Data 51
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 120
PART III
Item 10 Directors and Executive Officers of the Registrant 120
Item 11 Executive Compensation 120
Item 12 Security Ownership of Certain Beneficial Owners and
Management 120
Item 13 Certain Relationships and Related Transactions 120
PART IV
Item 14 Exhibits, Financial Statement Schedules, and Reports on
Form 8-K 121
2
<PAGE>
PART I
Item 1. Business
GENERAL DESCRIPTION AND HISTORY
PennCorp Financial Group, Inc. ("PennCorp" or the "Company"), incorporated
in Delaware in 1989, is a holding company, the principal subsidiaries of which
are insurance companies with operations in Dallas and Waco, Texas; Raleigh,
North Carolina; and Toronto, Canada. 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 through several
distribution channels including independent general agents, 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. Information relating to the Company's U.S. and Canadian operations
appears in Note 4 of "Notes to Consolidated Financial Statements." For more
information regarding the Company's markets, see "Insurance" and "Marketing and
Distribution" included herein.
BUSINESSES HELD FOR SALE
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.
The Career Sales Division is comprised in part of the operations of
Pennsylvania Life Insurance Company ("PLIC") and PennCorp Life Insurance Company
(together with PLIC, "Penn Life"). Penn Life markets and underwrites fixed
benefit accident and sickness products and, to a lesser extent, life products
through a sales force exclusive to the Company throughout the United States and
Canada. With the acquisition in January 1998 of Southwestern Financial
Corporation and its subsidiaries ("SW Financial"), the Company has integrated
Union Bankers Insurance Company ("Union Bankers"), Constitution Life Insurance
Company ("Constitution") and Marquette National Life Insurance Company
("Marquette") into the Career Sales Division. See "Acquisition of SW Financial
Controlling Interest and KB Interests." Peninsular Life Insurance Company
("Peninsular") is also part of the Career Sales Division.
On December 31, 1998, the Company entered into a definitive agreement to
sell the Career Sales Division and related assets to Universal American
Financial Corp. ("Universal American"). The purchase price of $175.0 million is
subject to adjustment based on the capital and surplus of the Career Sales
Division at the closing date. The purchase price consists of $136.0 million in
cash and $39.0 million initial principal amount, subject to adjustment, of
subordinated notes of Universal American. The subordinated notes will bear
interest at a rate of 8.0% per annum and will mature ten years from date of
issuance. The accreted value of the notes will be subject to offset in the event
of adverse development (or subject to increase in the event of positive
development) in the disability income reserves of PLIC and may be offset for
other indemnification claims under the purchase and sale agreement. In addition,
the Company is required under terms of the purchase and sale agreement to
deliver the Career Sales Division and related assets with certain minimum levels
of statutory capital and surplus, pay certain ongoing costs and other expenses
which the Company anticipates will result in its receiving net cash proceeds of
approximately $70.0 to $78.0 million. For additional information concerning the
disability insurance reserves of PLIC, see Note 8 of Notes to Consolidated
Financial Statements.
Also on December 31, 1998, the Company signed a definitive agreement to
sell Professional Insurance Company ("Professional"). Professional, which
previously was included in the Payroll Sales Division, 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. Pursuant to the purchase and sale agreement, Professional will be sold
to GE Financial Assurance Holdings, Inc. ("GEFAH") for $47.5 million in cash.
The purchase price is subject to adjustment based on Professional's capital and
surplus at the closing date. In addition, GEFAH will pay interest on the
purchase price from December 31, 1998 to the date of closing. The Company
currently estimates receiving net cash proceeds for the Professional sale of
approximately $40.0 million to $41.5 million.
On February 21, 1999, the Company signed a definitive agreement to sell
United Life & Annuity Insurance Company ("United Life") and its wholly-owned
subsidiary, United Variable Services, Inc., to ING America Insurance Holdings,
Inc. ("ING"). United Life, which previously was included in the Financial
Services Division, principally markets fixed and variable annuities through
financial institutions and independent general agents, primarily in the southern
and western United States. The sale of United Life to ING also includes the sale
of UC Mortgage Corp. ("UC"), Cyberlink Development, Inc. ("Cyberlink") and
certain assets of Marketing One, Inc. ("Marketing One"). The aggregate purchase
price consists of $152.0 million and a dividend payable by United Life at
closing, which the Company estimates will be approximately $2.1 million. The
3
<PAGE>
purchase consideration may be reduced as a result of the Company's obligation to
purchase certain mortgages from United Life at closing. Additionally, a portion
of the purchase price may be escrowed at closing to fund the Company's
obligation to purchase additional mortgages from United Life after closing.
United Life, including its subsidiary United Variable Services, Inc., UC,
Cyberlink and certain assets of Marketing One are referred to herein
collectively as the "United Life Assets." The Company anticipates receiving net
cash proceeds from the sale of the United Life Assets of approximately $140.0
million.
In the third quarter of 1998, the Company made the decision to sell KIVEX,
Inc. ("KIVEX"), an internet service provider. The Company has engaged the
investment banking firm of ING Barings Furman Selz in this regard and is
currently soliciting interest from prospective purchasers. To date, the Company
has not entered into a definitive agreement to sell KIVEX. In addition, the
Company has made the decision to sell Marketing One, excluding those assets
included with the sale of United Life.
As a result of the Company's agreements to sell the Career Sales Division,
Professional and the United Life Assets and the Company's intent to sell KIVEX
and Marketing One within a period not likely to exceed one year, the assets and
liabilities relating to the Career Sales Division, Professional, the United Life
Assets, KIVEX and Marketing One have been reported as "Assets of Businesses Held
for Sale" and "Liabilities of Businesses Held for Sale" in the Company's audited
Consolidated Balance Sheets included elsewhere herein. Because these assets and
liabilities have been aggregated for purposes of presentation in the Company's
financial statements, the Company has similarly separately aggregated such
assets and liabilities for purposes of much of the textual disclosures contained
herein. For this purpose, the assets and liabilities relating to the Career
Sales Division, Professional, the United Life Assets, KIVEX and Marketing One
are collectively referred to herein as the "Businesses Held for Sale."
Consummation of the Career Sales Division, Professional and United Life
Assets sales transactions is subject to regulatory approvals and other closing
conditions. Please refer to the reports on Form 8-K filed on January 11, 1999
and March 11, 1999 for more information on these sale transactions. Included as
Exhibits 2.1 and 2.2 on the Form 10-K are the definitive purchase and sale
agreements for the Career Sales Division and Professional, respectively. There
can be no assurances that the Career Sales Division, Professional or the United
Life Assets sales will be consummated or that the cash proceeds will be in the
amount anticipated by the Company.
RETAINED BUSINESS
After giving effect to the sale of the United Life Assets, the Financial
Services Division is comprised of Security Life and Trust Insurance Company
(formerly Integon Life Insurance Corporation) ("Security Life") and Southwestern
Life Insurance Company ("Southwestern Life"). Security Life markets life
insurance and, to a lesser extent, annuity products through independent general
agents who sell directly to individuals primarily in the southeastern United
States. Since its acquisition on January 2, 1998, Southwestern Life has been
integrated and managed as part of the Financial Services Division. Southwestern
Life markets life insurance and, to a lesser extent, annuity products through
independent general agents who sell directly to individuals primarily in the
southwestern United States.
After giving effect to the sale of Professional, the Payroll Sales
Division includes the operations of AA Life and Occidental Life Insurance
Company of North Carolina ("OLIC"). AA Life, comprised of Pioneer Security Life
Insurance Company ("Pioneer Security") and its subsidiaries, American-Amicable
Life Insurance Company of Texas ("American- Amicable") and Pioneer American
Insurance Company ("Pioneer American"), markets and underwrites customized life
insurance and accumulation products to U.S. military personnel and government
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.
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 "Retained Businesses."
ACQUISITION OF SW FINANCIAL CONTROLLING INTEREST AND KB INTERESTS
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, a former director, and David J. Stone, a
director 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
$73.7 million (not including acquisition expenses).
4
<PAGE>
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 $10.6 million (not including acquisition expenses). Mr. Fickes
will 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 will
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 appear in Notes 3, 18 and 19 of "Notes to Consolidated Financial
Statements," and in Item 13 hereof.
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
INSURANCE PRODUCT TYPE 1996 1997 1998 1998(1)
---------------------- ----- ----- ----- ----------
Fixed benefit......................... 34.1% 29.8% 30.4% 3.9%
Life.................................. 46.2 43.1 48.7 79.7
Accumulation.......................... 19.7 27.1 20.9 16.4
Total............................... 100.0% 100.0% 100.0% 100.0%
---------------
(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 results of the Retained
Businesses which may occur in the future.
5
<PAGE>
The amount of annualized premium in force and policy activity by type of
business for the past three years is as follows:
ANNUALIZED PREMIUM IN FORCE
AS OF DECEMBER 31,
-------------------------------------
($ in thousands)
Pro forma
INSURANCE PRODUCT TYPE 1996 1997 1998 1998(1)
---------------------- -------- -------- -------- ---------
Fixed benefit......................... $194,475 $184,214 $209,495 $ 13,966
Life(2)............................... 217,538 219,180 496,712 355,089
Total............................... $412,013 $403,394 $706,207 $369,055
---------------
(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 results of the Retained
Businesses which may occur in the future.
(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.
The following discussion of the Company's principal products relates to
the Retained Businesses.
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 cash value. As of December
31, 1998, for the Retained Businesses, there were approximately 221,000 whole
life policies in force with $2,289.1 million in face amount of insurance and
$441.0 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, 1998, for the
Retained Businesses, there were approximately 228,000 universal and
interest-sensitive life policies in force with $14,143.0 million in face amount
of insurance and $1,304.5 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, 1998, for the Retained Businesses, there
were approximately 118,000 term life policies in force with $6,006.7 million in
face amount of insurance and $45.4 million in future policy benefit reserves.
Total sales of individual life insurance by the Retained Businesses were
approximately $50.2 million, $46.8 million and $43.3 million for the years ended
December 31, 1998, 1997 and 1996, respectively.
6
<PAGE>
Accumulation Products
The Company's accumulation products include single premium deferred
annuities, flexible premium deferred annuities and variable annuity products.
The principal annuity products marketed by the Company's retained insurance
subsidiaries consist of flexible premium deferred annuities ("FPDAs") and single
premium deferred annuities ("SPDAs").
As of December 31, 1998, the guaranteed minimum crediting rates of the
Company's deferred annuity products for the Retained Businesses were as follows:
Guaranteed Minimum Funds Under
Crediting Rate Management
------------------ ---------------
($ in millions)
3.00%...................... $ 49.5
3.50%...................... 2.4
4.00%...................... 467.2
4.50%...................... 88.2
5.00%...................... --
6.00%...................... 20.5
No guaranteed minimum.... 6.6
---------
$ 634.4
=========
At December 31, 1998, annuity liabilities were composed of $136.1 million
of SPDA liabilities and $498.3 million of FPDA liabilities and $185.5 million of
other annuity liabilities, for a total of $819.9 million of annuity liabilities.
Of such liabilities $319.0 million were subject to surrender charges averaging
5.6% as of December 31, 1998.
Total sales of annuities by the Retained Businesses were approximately
$31.8 million, $33.2 million and $20.8 million for the years ended December 31,
1998, 1997 and 1996, 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 Retained Businesses were approximately $3.7 million, $3.8 million and $4.7
million for the years ended December 31, 1998, 1997 and 1996, respectively.
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
7
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to cover prolonged illnesses or convalescent care. As of December 31, 1998,
there were 701 long-term care policies in force representing $1.0 million in
annualized premiums and $.3 million in reserves. Total sales of long-term care
products by Southwestern Life during 1998 were approximately $1.0 million.
The following table provides certain information with respect to various
categories of insurance business in force for the Company's insurance
subsidiaries:
<TABLE>
<CAPTION>
1996 1997 1998
--------------------------- --------------------------- ---------------------------
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..... 733,893 562,620 34,854 698,072 558,697 90,265 654,936 506,913 69,769
New issues...................... 81,547 54,157 4,834 84,286 62,449 5,012 89,218 72,080 8,715
Business acquired, net.......... 15,664 67,731 64,210 -- -- -- 112,098 301,537 35,511
Policies terminated............. (133,032) (125,811) (13,633) (127,422) (114,233) (25,508) (159,234) (100,598) (27,383)
-------- -------- ------- -------- -------- ------- -------- -------- -------
Policies in force - December 31. 698,072 558,697 90,265 654,936 506,913 69,769 697,018 779,932 86,612
======== ======== ======= ======== ======== ======= ======== ======== =======
</TABLE>
MARKETING AND DISTRIBUTION
The Company's insurance subsidiaries collectively are licensed to market
the Company's insurance products in all states (other than New York) and in the
District of Columbia, all provinces of Canada and in Puerto Rico, Guam and
certain Caribbean countries. In addition, the Company is authorized to sell its
products at U.S. military installations in foreign countries.
The Company markets and distributes its products through four primary
distribution channels: agents contracted exclusively with the Company,
independent general agents who sell on an individual basis, independent general
agents who sell through payroll deduction programs and arrangements for
distribution through various financial institutions.
These market segments are further divided as follows:
Major Market Sub-Market
------------ ----------
Individual Low and moderate income households
U.S. military enlistees
Suburban and rural locales
Self-employed individuals
Government Employees of local governments and governmental
agencies
Employees of U.S. federal government
Each of the Company's market segments may be served by each of the primary
distribution channels. Additionally, though there are certain regions in which
all sales forces are active, the Company's sales forces generally operate in
geographically discrete regions.
The following tables illustrate, by direct cash premium collected, (as
reported to regulatory authorities) and relative percentages, the principal
marketing regions in which the Businesses Held for Sale and Retained Businesses
collected in excess of $10.0 million of policy revenues for the year ended
December 31, 1998.
8
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Businesses Held for Sale Direct Premium Collected
-------------------------------------------------
Jurisdiction Amount Percentage
------------ ------ ----------
($ in thousands)
Canada............... $ 60,094 11.7%
Texas................ 43,178 8.4
Indiana.............. 38,434 7.5
Florida.............. 38,328 7.5
Louisiana............ 36,905 7.2
Georgia.............. 27,875 5.4
Ohio................. 25,273 4.9
California........... 24,051 4.7
Wisconsin............ 21,628 4.2
Pennsylvania......... 16,848 3.3
Missouri............. 16,628 3.2
North Carolina....... 16,017 3.1
Oklahoma............. 13,411 2.6
Virginia............. 12,346 2.4
Illinois............. 12,051 2.4
-------- -----
Subtotal........... 403,067 78.5
All Others........... 110,226 21.5
-------- -----
Total.............. $513,293 100.0%
======== =====
Retained Businesses Direct Premium Collected
-------------------------------------------------
Jurisdiction Amount Percentage
------------ ------ ----------
($ in thousands)
Texas................ $ 58,512 20.2%
North Carolina....... 34,829 12.0
Georgia.............. 26,095 9.0
California........... 19,408 6.7
Florida.............. 13,702 4.7
Virginia............. 11,991 4.1
-------- -----
Subtotal........... 164,537 56.7
All Others........... 125,489 43.3
-------- -----
Total.............. $290,026 100.0%
======== =====
Financial Services Division
The Financial Services Division includes marketing units of Security Life,
United Life and Southwestern Life. The Financial Services Division markets
products to individual customers through leads developed over time. This
division utilizes field marketing directors, affiliations with independent
marketing organizations, financial institutions and financial planners to reach
its customer base.
The sales agents for this division often make sales presentations on a
one-on-one basis with potential prospects. Sales representatives are often faced
with competition from other agents and/or products from other companies.
The following tables set forth information regarding the Financial
Services Division. United Life is excluded on a pro forma basis for 1998 as it
is included in Businesses Held for Sale.
<TABLE>
<CAPTION>
Pro forma
FINANCIAL SERVICES DIVISION 1996 1997 1998 1998
--------------------------- -------- -------- -------- -------
($ in thousands)
<S> <C> <C> <C> <C>
Agents under contract.............................. 9,164 7,730 19,254 16,607
Number of agents annually producing new business... 2,842 2,206 4,894 4,353
Submitted annualized new business premiums......... $118,528 $139,483 $160,258 $72,465
Annualized new business premium per agent $ 41.7 $ 63.2 $ 32.7 $ 16.6
</TABLE>
9
<PAGE>
The revenue earned by the Financial Services Division by product type is
shown below:
<TABLE>
<CAPTION>
Pro forma
INSURANCE PRODUCT TYPE 1996 1997 1998 1998
---------------------- -------- -------- -------- -------
($ in millions)
<S> <C> <C> <C> <C>
Life............................................. $143.7 $127.9 $249.3 $239.6
Accumulation..................................... 102.2 166.9 167.8 65.7
Fixed benefit.................................... 5.3 0.3 2.7 2.4
Total.......................................... $251.2 $295.1 $419.8 $307.7
</TABLE>
The percentage of the Financial Services Division revenue to the Company's
total insurance operations revenue by insurance product is shown below:
<TABLE>
<CAPTION>
Pro forma
INSURANCE PRODUCT TYPE 1996 1997 1998 1998
---------------------- -------- -------- -------- -------
<S> <C> <C> <C> <C>
Life............................................ 55.1% 46.3% 60.2% 69.1%
Accumulation.................................... 91.9 95.0 94.2 92.0
Fixed benefit................................... 2.8 0.2 1.0 14.3
Total division revenue to the Company's
total insurance operations revenue........... 44.5 45.9 49.5 70.7
</TABLE>
Payroll Sales Division
The Payroll Sales Division includes marketing units of Professional, AA
Life and OLIC. Each of the marketing units is divided into regions utilizing a
hierarchical approach to managing the sales representative. Additionally, AA
Life and OLIC also utilize field marketing directors and independent marketing
organizations to access potential policyholders.
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 as it is
included in Businesses Held for Sale:
Pro forma
PAYROLL SALES DIVISION 1996 1997 1998 1998
---------------------- ------- ------- ------- -------
($ in thousands)
Agents under contract............... 7,539 6,784 6,941 3,638
Number of agents annually producing
new business...................... 2,750 2,955 1,926 783
Submitted annualized new business
premiums.......................... $39,069 $42,527 $44,100 $26,944
Annualized new business premium per
agent............................. $ 14.2 $ 14.4 $ 22.9 $ 34.4
The revenue earned by the Payroll Sales Division by product type is shown
below:
Pro forma
INSURANCE PRODUCT TYPE 1996 1997 1998 1998
---------------------- ------- ------- ------- -------
($ in millions)
Life................................ $ 84.1 $116.4 $112.6 $107.0
Fixed benefit....................... 39.5 48.9 48.0 14.6
Accumulation........................ 8.0 7.2 5.9 5.7
------- ------- ------- -------
Total............................. $131.6 $172.5 $166.5 $127.3
======= ======= ======= =======
10
<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 1996 1997 1998 1998
---------------------- ------- ------- ------- -------
Life.................................. 32.3% 42.2% 27.2% 30.9%
Fixed benefit......................... 20.5 25.5 18.6 85.7
Accumulation.......................... 7.2 4.1 3.3 8.0
Total division revenue to the
Company's total insurance
operations revenue................ 23.3 26.8 19.5 29.3
Career Sales Division
Penn Life's agents constitute substantially all of the sales force for the
Career Sales Division. The regional sales managers are responsible for
approximately 100 sales locations in the United States and Canada. Commissions
are shared among the regional and branch office managers and the writing agent.
Commissions allocated to the branch offices are used to pay "overwrite"
commissions to agents who train new agents and to pay the expenses of the branch
office. Any commissions allocated to the branch offices remaining after payment
of "overwrite" commissions and expenses, essentially the branch "profit," are
allocated among the senior sales managers (and the Company for Canadian Sales
Offices). Prior to 1998, the Company shared in the profits for all U.S. and
Canadian Sales Offices. The Company retained approximately $1.5 million, $2.6
million and $2.3 million during 1998, 1997 and 1996, respectively, in profit
sharing income, which is recorded as an offset to commissions. During 1997 the
Company worked closely with the U.S. based career sales force to develop and
implement a new compensation structure which resulted in the Company giving up
its rights to a portion of the profit participation associated with the branch
compensation structures. As a result, career sales force agents receive a lower
base commission structure on new business and fully absorb all field office
costs. The new compensation structure allows for bonuses to be paid to agents
based upon improving persistency and new sales growth. Additional consideration
has been granted to the field force in connection with the acquisition of the
Career Sales Division by Universal American. See Note 19 of "Notes to
Consolidated Financial Statements."
The Penn Life career sales force is a network of regional managers who
operate branch offices. Each office includes agents which focus on three
different marketing strategies: New Call, Special Services and Individual Life.
The target market for all products is primarily self-employed individuals, with
plans to expand into the senior market.
New Call. New Call agents make "cold call" door-to-door presentations and
market small denomination policies that provide scheduled payments in fixed
amounts to insureds who, as a result of specified types of accidents, become
unable to work or who become hospitalized.
Special Services. New Call policyholders are a significant source of leads
for the Special Services Division. A Special Services agent visits the
policyholder's residence to collect renewal premiums on products purchased for
the New Call representatives. The sales agent also delivers a standardized sales
presentation on more comprehensive policies. These policies either provide
scheduled payments to insureds who are disabled and unable to work as a result
of accident or sickness or scheduled payments to insureds who are required to be
hospitalized as the result of accident or sickness.
Individual Life. Existing policyholders are the primary source of leads
for the Individual Life representatives, which sell life products. The Company
has worked to restructure this division, expand its product portfolio and
aggressively recruit new agents. New product offerings include universal life,
term life and final expense products which have been widely accepted by the Penn
Life sales force.
With the addition of Union Bankers, Constitution and Marquette, the Career
Sales Division will have the opportunity to expand into the brokerage market
offering senior care products.
11
<PAGE>
The following tables set forth information regarding the Career Sales
Division:
1996 1997 1998
-------- ------- -------
($ in thousands)
ACCIDENT & HEALTH
Agents under contract......................... 1,644 1,400 4,173
Weekly average agents producing new business.. 618 581 491
Submitted annualized new business premiums.... $40,433 $41,224 $46,770
Annualized new business premium per agent..... $ 65.4 $ 71.0 $ 95.3
INDIVIDUAL LIFE
Agents under contract......................... 197 182 119
Weekly average agents producing new business.. 91 78 41
Submitted annualized new business premiums.... $8,224 $7,006 $3,706
Annualized new business premium per agent..... $ 90.4 $ 89.8 $ 90.4
TOTAL ALL CAREER SALES DIVISIONS
Agents under contract......................... 1,841 1,582 4,292
Weekly average agents producing new business.. 709 659 532
Submitted annualized new business premiums.... $48,657 $48,230 $50,476
Annualized new business premium per agent..... $ 68.6 $ 73.2 $ 94.9
The revenue earned by the career sales distribution system by product type
is shown below:
INSURANCE PRODUCT TYPE 1996 1997 1998
---------------------- ------ ------ ------
($ in millions)
Fixed benefit................................ $148.1 $142.3 $207.3
Life......................................... 32.8 31.6 52.0
Accumulation................................. 1.0 1.6 4.4
------ ------ ------
Total...................................... $181.9 $175.5 $263.7
====== ====== ======
The percentage of Career Sales Division revenue to the Company's total
insurance operations revenue by product type is shown below:
INSURANCE PRODUCT TYPE 1996 1997 1998
---------------------- ------ ------ ------
Fixed benefit................................ 76.8% 74.3% 80.4%
Life......................................... 12.6 11.5 12.6
Accumulation................................. 0.9 0.9 2.5
Total division revenue to the Company's
total insurance operations revenue........ 32.2 27.3 31.0
INSURANCE UNDERWRITING
In general, the Company permits simplified underwriting of life products,
unless the amount of requested coverage is greater than specified levels between
$25,000 and $100,000, depending on the age of the applicant. If full
underwriting is required, the Company reviews the policy application and an
attending physician's report and may require a paramedical examination or
complete physical examination depending on the age of the applicant and the
amount of coverage requested. If the total amount of coverage applied for plus
any coverage in force with the Company exceeds $100,000, a prospective
policyholder must submit a screening for antibodies related to Acquired Immune
Deficiency Syndrome ("AIDS") , to the extent permitted by law. The life products
are specifically designed and priced for the mortality risks associated with the
Company's simplified underwriting procedures.
Although the increasing incidence of AIDS is expected to affect mortality
adversely for the life insurance industry as a whole, the Company believes that
the impact of AIDS on its operations should not be material due to the small
average size of the life insurance policies sold. The Company requires and
considers AIDS information to the fullest extent permitted by law in
underwriting and pricing decisions. During the twelve months ended December 31,
1998, 1997 and 1996, the Company estimated it paid approximately $1.2 million,
$2.1 million and $3.2 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.
12
<PAGE>
The Company has identified a block of approximately 290 policies with a
total face amount of approximately $30.0 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 taking steps to rescind any
contestable policy where material misrepresentations are found. 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), which as of December 31, 1998 excludes invested
assets of its Businesses Held for Sale, is managed with the objectives of
maintaining high credit quality and liquidity, maximizing current income within
acceptable levels of risk, minimizing market and credit risk and matching the
anticipated maturities of investments to the Company's liabilities. To achieve
these objectives, the portfolio consists primarily of United States and Canadian
government and investment-grade fixed maturity securities, which accounted for
approximately 84.1% of the Company's total invested assets at December 31, 1998.
The Company believes that the nature of its fixed benefit products, which have
minimal inflation risk, and its life products, which limit the early
accumulation of cash values, permit it to utilize this conservative investment
strategy.
At December 31, 1998, 54.1% of the Company's fixed maturity bonds were
rated AA or higher by Standard & Poor's and approximately 93.0% were rated BBB
or higher by Standard & Poor's, respectively. All dollar amounts or percentages
set forth in this discussion are based on carrying value unless otherwise
indicated.
Other than issues of the United States and Canadian governments and
government agencies and authorities, no single issuer represented more than 0.5%
of total invested assets at December 31, 1998.
The following table summarizes the Company's investments (excluding
investments of Businesses Held for Sale) as of December 31, 1998:
<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.......................$ 189,766 $ 202,700 $ 202,700 6.8%
Debt securities issued or
guaranteed by foreign
governments(2).............. 25,701 27,178 27,178 1.0
Municipal bonds............... 45,271 42,127 42,127 1.4
Corporate bonds............... 1,099,513 1,129,023 1,129,023 38.2
Mortgage-backed bonds......... 1,164,739 1,188,686 1,188,686 40.2
---------- ---------- ---------- -----
Total fixed maturity
securities available for
sale....................... 2,524,990 2,589,714 2,589,714 87.6
Equity securities available
for sale................... 2,008 2,035 2,035 0.1
Commercial mortgages.......... 36,382 38,865 36,382 1.3
Residential mortgages......... 500 500 500 --
Real estate................... 15,904 8,644 8,644 0.3
Policy loans.................. 207,490 207,490 207,490 7.0
Other investments............. 17,480 18,762 18,762 0.6
---------- ---------- ---------- -----
Total invested assets....... 2,804,754 2,866,010 2,863,527 96.9%
Cash and cash equivalents..... 92,727 92,727 92,727 3.1
---------- ---------- ---------- -----
Total investment portfolio.. $2,897,481 $2,958,737 $2,956,254 100.0%
========== ========== ========== =====
</TABLE>
--------------
(1) Fair values are obtained principally from the Company's investment
advisors.
(2) Consists principally of Canadian provincial government bonds and
bonds issued or guaranteed by the Canadian federal government (in U.S.
dollars).
13
<PAGE>
The table set forth below indicates the composition of the Company's fixed
maturity portfolio (excluding Businesses Held for Sale) by rating as of December
31, 1998:
Percent of
Total Total
Carrying Carrying
Rating Value Value
------ ---------- ----------
($ in thousands)
AAA(1)............................ $1,264,089 48.8%
AA................................ 137,090 5.3
A................................. 548,493 21.2
BBB............................... 458,551 17.7
---------- -----
Total investment grade........... 2,408,223 93.0
---------- -----
BB................................ 103,508 4.0
B or below........................ 59,744 2.3
---------- -----
Total below-investment grade..... 163,252 6.3
---------- -----
Nonrated.......................... 18,239 0.7
---------- -----
Total fixed maturities........... $2,589,714 100.0%
========== =====
--------------
(1) Includes approximately $202.7 million of United States
government and agency bonds and approximately $27.2 million of
Canadian provincial government bonds and bonds issued or
guaranteed by the Canadian federal government (in U.S. dollars).
The following table reflects investment results for the Company for each
of the periods indicated. The pro forma amounts for 1998 exclude the Businesses
Held for Sale.
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
----------------------------------------------
Pro forma
1996 1997 1998 1998
---------- ---------- ---------- ----------
($ in thousands)
<S> <C> <C> <C> <C>
End of period total investment
portfolio(1)...................... $3,673,504 $3,339,979 $4,930,535 $2,956,254
Net investment income(2)............ 210,734 273,237 369,052 215,909
Net realized investment gains(3).... 1,257 17,487 14,068 4,956
Average annual yield................ 7.5% 7.6% 7.2% 7.0%
</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.
(3) Amounts shown above are before income taxes, and include provisions for
impairments in value which are considered to be other than temporary.
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. Indemnity reinsurance does not fully discharge the Company's
obligation to pay policy claims on the reinsured
14
<PAGE>
business. The ceding insurer remains responsible for policy claims to the extent
the reinsurer fails to pay such claims. On September 30, 1998, Penn Life entered
into a financial reinsurance agreement which provided Penn Life with
approximately $20.0 million of statutory surplus. See Note 20 of Notes to
Consolidated Financial Statements for additional information regarding such
agreement.
The Retained Businesses are currently in the process of reviewing existing
reinsurance programs. This review is expected to be completed in 1999 and may
effect retention limits, the cost of its reinsurance coverage and other aspects
of its reinsurance programs.
At no time during the past ten years has any present reinsurer of any
continuing block of business ceded by any of the Company's insurance company
subsidiaries failed to pay any policy claims with respect to such ceded
business. At December 31, 1998 and 1997, of the approximately $36.5 billion and
$24.6 billion of life insurance in force, approximately $6.4 billion and $4.4
billion had been ceded to reinsurers, respectively. As of December 31, 1998 the
Company's principal reinsurers are Transamerica Occidental Life Insurance
Company, Reassurance Company of Hanover, Cologne Life Reinsurance Co., Life
Reassurance Corp. of America, RGA Reinsurance Company, Lincoln National Life
Insurance Company, Swiss Re Life & Health Insurance Company and Allianz Life
Insurance Company, which collectively have reinsured approximately 72.2% 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 is highly
likely that such systems will not be 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 lead to a significant business interruption. Such
an interruption could result in a decline in current and long-term profitability
and business franchise value.
The Company's overall year 2000 compliance initiatives, include 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 follows up periodically. Of those
parties that have responded, the Company's most significant third party vendors
and business partners have indicated that they have a plan for year 2000
compliance or believe that they are currently year 2000 compliant.
The Company has engaged outside vendors and focused certain employees'
full time efforts to help in the full array of its year 2000 initiative. This
includes systems assessment and monitoring advice, actual code remediation,
communication and consultation with critical business partners and additional
data center and testing resources. The Company 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. Based upon revised projections during the fourth quarter of
1998, the Company anticipates incurring internal and external costs of $5.0
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.
Each of the operating divisions is primarily responsible for its
remediation efforts with corporate oversight provided as necessary. The Company
believes that the Career Sales Division has substantially completed its year
2000 assessment and remediation efforts, which will be subject to ongoing tests
for the remainder of 1999. In addition, the Career Sales Division has committed
to a strategy of utilizing third party administrative experts, who have
indicated year 2000 compliance, to handle the processing of certain components
of its health insurance business, thus eliminating the need for the upgrade or
modification of certain existing health administration systems. The Payroll
Sales Division has completed the remediation of its largest administrative
platforms, except for AA Life, and anticipates successful remediation and
testing of the remaining sub-systems and system interfaces during 1999. The
Company believes that the Payroll Sales Division, other than AA Life, is 95.0%
complete with its compliancy effort for critical business systems. AA Life is in
the process of upgrading its policy administration system to a year 2000
compliant version. AA Life is relying on contracted vendor resources in order to
complete its upgrade process. Based upon similar internal metrics analysis, AA
Life has completed 90.0% of the total effort required for its critical business
systems to be year 2000 compliant. The efforts of the Company's Financial
Services Division are highly dependent
<PAGE>
on the utilization of outside resources. The Company believes that the Financial
Services Division has contracted with sufficient resources to be able to
remediate its essential business systems. Currently, the Company believes that
the Financial Services Division is 85.0% complete with remediation efforts
associated with its critical business systems. The Company believes that all of
its divisions will have completed their remediation efforts by May 1999, but
each division will continue to perform testing throughout 1999.
Although the Company believes that its operating divisions, outside
vendors and most critical business partners will be sufficiently compliant that
the year 2000 issue should not cause a material disruption in the Company's
business, there can be no assurance that there will not be material disruptions
to the Company's business or an increase in the cost of the Company doing
business. Although the Company believes that the year 2000 issues should not
cause a material disruption in the Company's business, the Company has developed
various contingency plans associated with remediation tasks which the Company
believes are at a higher risk for potential failure.
The Company has provided certain assurances to each respective purchaser
of the Businesses Held for Sale with respect to each entity's ability to process
date-sensitive information for the year 2000 and beyond. Although the Company
believes that it will be able to meet the year 2000 representations and
warranties provided to the respective purchasers, there can be no assurances.
Failure of the Company to meet such representations and warranties could result
in a decision by the purchaser not to consummate the transaction and/or
indemnification claims for breach of contract.
COMPETITION
The accident and health and life insurance industry is highly competitive.
PennCorp competes with many insurance companies and insurance holding company
systems that have substantially greater capital and surplus, higher A.M. Best
Company ("A.M. Best") ratings, larger and more diversified product portfolios,
and access to larger agency sales forces. In the United States, there are more
than 1,700 life and accident and health insurance companies, most of which
compete in the states in which PennCorp conducts business.
The Company's expansion of its product line to include a higher percentage
of life and accumulation product revenue as compared to total revenue has
resulted in a broadening of the markets in which the Company faces competition.
The sale of life insurance products, and to a greater extent, the sale of
accumulation products is very sensitive to an organization's A.M. Best rating,
its size and perceived financial strength and the competitiveness and the
financial performance of the products themselves. Like the market focus of its
fixed benefit products, the Company believes that its target market is not
widely served by many of the large, national insurers, but does face direct
competition from smaller regional and niche-market focused companies.
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 noted
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, 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.
REGULATORY MATTERS
Life insurance companies are subject to regulation and supervision by the
states in which they transact business. The laws of the various states establish
regulatory agencies with broad administrative and supervisory powers related to,
among other things, granting and revoking licenses to transact business,
regulating trade practices, establishing guaranty associations, licensing
agents, approving policy forms, filing premium rates on certain business,
setting reserve requirements, determining the form and content of required
financial statements, determining the reasonableness and adequacy of capital and
surplus and prescribing the type of permitted investments and the maximum
concentrations of certain classes of investments.
The Company's insurance subsidiaries are subject to periodic examinations
by state regulatory authorities. Current examinations are described below:
Business Held for Sale
The Texas Department of Insurance is conducting its regularly scheduled
triennial examinations of Constitution, Marquette, Professional and Union
Bankers, which are Texas domestic insurers.
<PAGE>
The Pennsylvania Department of Insurance is in the process of completing
its examination of PLIC as of December 31, 1996. The Department has
indicated that PLIC's historical method of calculating statutory claims
reserves may not provide the most accurate determination of claims reserve
estimates. PLIC is evaluating differing methods for determining its claims
estimates on a statutory basis. Such differing methods could likely
produce materially different claims reserves estimates. Based upon
preliminary findings, PLIC increased its statutory claim estimates above
historical levels by approximately $20 million during the year ended
December 31, 1998. To offset the impact of such reserve increases on
PLIC's statutory capital and surplus, PLIC entered into a financial
reinsurance agreement, which allows PLIC to maintain marginally sufficient
statutory capital and surplus. Should PLIC need to substantially increase
its claims reserves estimates further it is likely that PLIC's risk-based
capital ("RBC") ratios would decline, without further management action,
to a level which could require certain actions be taken by the
Pennsylvania Department of Insurance. The Company and PLIC continue to
closely monitor PLIC's risk-based capital ratios.
For the years ended December 31, 1998 and 1999, PLIC has received a
permitted statutory accounting practice allowing PLIC to utilize its own
experience and other modification factors in the determination of
statutory disability income claims reserves. If PLIC were to utilize the
model regulation for the determination of disability income claims
reserves, management estimates that the amount of additional statutory
claims reserves necessary to be recorded would be approximately $16.2
million. If PLIC were to record such additional reserves on a statutory
basis, its risk based capital would be reduced significantly which in turn
could lead to regulatory action. For the year ended December 31, 1999,
PLIC will be required, in the event of the non-completion of the Career
Sales Division divestiture, to increase its disability claims reserves by
approximately $5.3 million and receive capital contributions of at least
$5.3 million to offset such reserve increases.
Retained Business
The Texas Department of Insurance is conducting its regularly scheduled
triennial examinations of American-Amicable, OLIC, Pacific Life and
Accident Insurance Company ("PLAIC"), Pioneer American, Pioneer Security,
Security Life and Southwestern Life, which are Texas domestic insurers.
The Company's insurance subsidiaries are required, at least annually, to
perform cash flow and "Asset Adequacy Analysis" under differing interest rate
scenarios. 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 associated with impacted insurance subsidiaries,
which in turn would reduce the dividend capacity of such subsidiaries ultimately
reducing cash flow available to the Company. 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 North Carolina, Pennsylvania and Texas (the
domiciliary states of its insurance companies), and routinely reports to other
jurisdictions in which its insurance subsidiaries are licensed.
There continues to be substantial scrutiny of the insurance regulatory
framework, and a number of state legislatures have enacted legislative proposals
that alter, and in many cases increase, state authority to regulate insurance
companies and their holding company systems. The National Association of
Insurance Commissioners ("NAIC") and state insurance regulators also have become
involved in a process of re-examining existing laws and regulations and their
application to insurance companies. In particular, this re-examination has
focused on insurance company investment and solvency issues and, in some
instances, has resulted in new interpretations of existing law, the development
of new laws and the implementation of internal guidelines. The NAIC has formed
committees to study and formulate regulatory proposals on such diverse issues as
the use of surplus debentures, accounting for reinsurance transactions,
assumption reinsurance, valuation of securities, the adoption of RBC 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. North
Carolina, Pennsylvania and Texas,
<PAGE>
the states of domicile for the Company's insurance subsidiaries, have adopted
dividend tests that are substantially similar to that of the NAIC's model
legislation. Most states only allow dividends to be paid out of unassigned
funds. State laws affecting dividends by the Businesses Held for Sale and
Retained Businesses are described below.
Business Held for Sale
Pursuant to the laws of Pennsylvania (PLIC's and Peninsular's domiciliary
state), a dividend may be paid by PLIC and Peninsular if the amount of
such dividend together with all dividends made in the preceding twelve
months does not exceed the greater of: (i) 10% of its statutory surplus as
of the end of the prior calendar year or (ii) its net income for the prior
calendar year. Any dividend above the prescribed amount is an
"extraordinary" dividend, and a Pennsylvania insurer may not pay an
"extraordinary" dividend to its stockholders until the earlier of: (i) 30
days after the Pennsylvania Insurance Commissioner has received written
notice of the declaration thereof and has not within such period
disapproved such payment, or (ii) the receipt of approval from the
Pennsylvania Insurance Commissioner.
Texas law permits its domestic insurers which include Constitution,
Marquette, Professional, Union Bankers and United Life (effective December
18, 1998, United Life was redomesticated to Texas from Louisiana) 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 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.
Retained Business
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 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 1998 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:
Business Held for Sale
PLIC had three of the twelve ratios outside of the usual range. PLIC's
variances were caused primarily as a result of examination adjustments
required by the Pennsylvania Department of Insurance. Remedial action was
taken by the Company in 1997 and 1998. Constitution had six ratios outside
the usual ranges primarily attributable to realized losses on sales of
investments and the recapture of a reinsurance contract with an affiliate.
Union Bankers had four ratios outside the usual ranges, primarily
resulting from a loss on an affiliated investment and effects from the
amortization of a deferred gain on a reinsurance contract. Marquette had
two ratios outside the usual ranges primarily resulting from the recapture
of a reinsurance contract. Professional had two ratios outside the usual
range. Professional's variances were caused primarily as a result of
statutory losses. Peninsular also had two ratios outside the range.
Peninsular's variances were caused primarily as a result of increased
reinsurance between OLIC and Peninsular. United Life had one of the twelve
ratios outside of the usual ranges as a result of reserve changes in its
life business. United Life is primarily an annuity insurer and the life
business is a small component of its operations.
Retained Business
OLIC had four of the twelve ratios outside the usual ranges. OLIC's
variances were caused primarily as a result of increased reinsurance
between OLIC and Peninsular. PLAIC had three ratios and Pioneer Security
<PAGE>
had two ratios outside of the usual range established by the NAIC. PLAIC
and Pioneer Security are primarily holding companies for their principal
assets, being the common stock of certain of the Company's insurance
subsidiaries. Security Life had one ratio outside the usual range as a
result of an increase in policy surrenders. American-Amicable, Pioneer
American and Southwestern Life had none of the twelve ratios outside of
the usual ranges.
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 1998, 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 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, either the Model Act or similar
legislation or regulation has been adopted in all the domiciliary states of the
Company's insurance subsidiaries.
The Model Act provides for four different levels of regulatory action with
respect to statutory financial statements for the calendar year 1994 and
thereafter, each of which may be triggered if an insurer's Total Adjusted
Capital (as defined in the Model Act) is less than a corresponding "level" of
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, 1998, indicate that each of
the insurance subsidiaries' capital exceeded RBC requirements, except for PLIC
(see Note 20 of Notes to Consolidated Financial Statements).
Certain licenses of the Company's insurance company subsidiaries are
subject to limits on the amount of new business that may be written in various
states. Of these license restrictions, most were imposed prior to the
acquisition of the relevant insurance subsidiary by PennCorp, or relate to
events occurring prior to those acquisitions. These license restrictions have
not had a material adverse effect on the Company's results of operations and are
not expected to have a material adverse effect in the future. In some states, a
license restriction, suspension or revocation by another state may result in
reciprocal regulatory action.
The Company may be required, under the solvency or guaranty laws of most
states in which it does business, to pay assessments (up to certain prescribed
limits) to fund policyholder losses or liabilities of insurance companies that
become insolvent. Recent insolvencies of insurance companies increase the
possibility that such assessments may be required. These assessments may be
deferred or forgiven under most guaranty laws if they would threaten an
insurer's financial strength and, in certain instances, may be offset against
future premium taxes. The Company paid approximately $300,000, $2.5 million and
$2.6 million for the years ended December 31, 1998, 1997 and 1996, respectively,
as a result of such assessments.
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 determined the impact the adoption of the
codification will have on unassigned surplus of each insurance subsidiary.
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.
<PAGE>
In addition, there were proposals under consideration since 1994 at the
federal and state levels regarding reforms to the health care system in the
United States. Although these proposals were not adopted at the federal level,
many states have adopted some form of health care reform since then. These
reforms have focused on the increasing cost of health care and insurance plans
that reimburse insureds or health care providers for medical and related costs.
Because the Company's fixed benefit products provide supplemental income
payments directly to the insured and are not designed to reimburse health care
providers, the Company does not expect such reforms to have a material adverse
effect on its business.
There can be no assurance that existing insurance-related laws and
regulations will not become more restrictive in the future and thereby have a
material adverse effect on the operations of the Company and on the ability of
the insurance companies to pay dividends. Additionally, there can be no
assurance that existing insurance-related laws and regulations will not have a
material adverse effect on the ability of Constitution to make payments on its
respective surplus debentures. For further information related to said surplus
debentures, see "Management's Discussion and Analysis of Results of Operations
and Financial Condition--Financial Condition, Liquidity and Capital
Resources--Surplus Debentures and Dividend Restrictions" and Note 14 of "Notes
to Consolidated Financial Statements." Furthermore, there can be no assurance
that existing insurance-related laws and regulations will not have a material
adverse effect on the ability of PLAIC and Pioneer Security to make payments on
their respective surplus debentures. For further information related to said
surplus debenture, see "Management's Discussion and Analysis of Results of
Operations and Financial Condition--Financial Condition, Liquidity and Capital
Resources--Surplus Debentures and Dividend Restrictions" and Note 14 of "Notes
to Consolidated Financial Statements."
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 $525.4
million and $504.6 million as of December 31, 1998 and 1997, 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 approximately $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.
In January 1999, Security Life initiated management action in the form of
a new exchange program for certain policyholders of Security Life. The program
is being offered to all policyholders who had certain policy forms in force as
of January 1, 1998. The program allows 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 has the choice of not accepting the
exchange program and keeping the current policy in force.
The exchange program is not expected to have a material effect on the
Company's financial position or results of operations. However, statutory
surplus of Security Life could be reduced by approximately $12.5 million on a
pre-tax basis if every eligible policyholder elects the exchange option.
The Company is continuing to refine its actuarial estimates, likely
management action plans and associated sensitivity testing of such
interdependencies on policy reserves associated with these contracts which could
result in changes in such estimates in the future.
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, except Peninsular and Marquette, carry a
"B+ (Very Good)" rating from A. M. Best. A "B+ (Very Good)" rating is the sixth
highest letter rating. These ratings reflect a downgrade during 1998 from A-
(two letter ratings) for United Life and AA Life, and from B++ (one letter
rating) for Southwestern Life, Security Life, OLIC, Professional, PLIC, Union
Bankers and Constitution. A.M. Best also has a "Not Assigned" category, which
contains nine classifications for companies not assigned or not eligible for an
A.M. Best rating. The A.M. Best rating for Peninsular is "NA-9," which is a "no
rating at the company's request." This classification was requested by the prior
owner of Peninsular. The Company does not intend to seek a letter rating at this
time for Peninsular from A.M. Best as Peninsular is not currently a direct
writer of insurance products. The A.M. Best rating for Marquette is "NA- 3,"
which is "inapplicable" as the Company is not currently a direct writer of
insurance products and has limited activity. The purchase and sale contract for
the Career Sales Division requires PLIC, Union Bankers and Constitution to
maintain or be assured of an A.M. Best rating of at least B+ as of the closing
date.
EMPLOYEES
At December 31, 1998, the Company had 1,247 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 New York, New
York; Dallas, Texas; and Raleigh, North Carolina. The Company owns and occupies
a home office facility comprising approximately 165,000 rentable square feet, in
Raleigh, North Carolina. The Company subleases a portion of its prior Raleigh
home office facility which has a lease term expiring in 1999 and requires annual
lease payments of approximately $1.1 million.
The Company leases approximately 100 offices throughout its sales
territories and has a separate Canadian business office facility that includes
office and storage space. Southwestern Financial Services Corporation ("SFSC")
leases approximately 125,000 square feet in Dallas, Texas at an annual cost of
$1.8 million. American-Amicable owns its home office facility in Waco, Texas.
The Company believes that the current makeup of its properties is adequate for
its operations and, based on its recent experience, that it will be able to find
suitable replacement properties on acceptable terms for properties the Company
chooses to replace or for which leases are terminated or not renewed.
Item 3.Legal Proceedings
On August 25, 1998, the first of ten class-action complaints were filed in
the United States District Court for the Southern District of New York 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. Pursuant
to a schedule agreed to at the conference, 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 Chairman
and Chief Executive Officer, and Steven W. Fickes, formerly 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 a motion to dismiss the Complaint. Although there are not
assurances that the motion to dismiss will be granted, management believes that
there are meritorious defenses to the action that will be 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 million of primary
and $10 million of excess coverage, respectively, for securities claims. The
primary insurance coverage requires the Company to bear 25% of all expenses and
any losses in excess of the $1 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.
The Company expects that this litigation will not affect its ability to
operate through December 31, 1999. 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 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.
<PAGE>
On July 30, 1998, the SEC notified the Company that it has 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 nine 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 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.
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 changing 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 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 recently 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 change 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. No further
communications from the NCAG have been received to date. The Company has
initiated an exchange program which enables policyholders of such life insurance
products to terminate their policies and obtain either (i) the refund of all
premiums paid and other consideration or (ii) another Security Life product. See
Item 1. Business -- Regulatory Matters. There can be no assurances that the
exchange program will be successful or that the Company will resolve these
matters on such life insurance product 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.
Item 4.Submission of Matters to a Vote of Security Holders
None.
<PAGE>
PART II
Item 5.Market for the Registrant's Common Equity and Related Shareholder Matters
MARKET FOR COMMON STOCK
The shares of Common Stock of the Company are listed on the New York Stock
Exchange ("NYSE") under the ticker symbol "PFG." The following table sets forth
for the calendar periods indicated, the high and low sales price per share of
the Company's Common Stock as reported on the NYSE and the quarterly cash
dividends declared on the Common Stock with respect to each quarter since
January 1, 1997. The prices do not include mark-ups, mark-downs, or commissions.
As of February 28, 1999, there are approximately 260 shareholders of record
throughout the United States and abroad.
The price history as provided by NYSE and dividends for the years ended
December 31, 1998 and 1997, are presented below:
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
SALES PRICE DIVIDEND
FOR THE YEAR ENDED DECEMBER 31, 1997 HIGH LOW DECLARED
------------------------------------ ------- ------- --------
Fourth quarter...................... $35.875 $30.188 $0.05
Third quarter....................... 40.375 29.500 0.05
Second quarter...................... 38.500 30.125 0.05
First quarter....................... 39.000 32.000 0.05
(Remainder of Page Intentionally Left Blank)
<PAGE>
Item 6.Selected Consolidated Financial Data
<TABLE>
<CAPTION>
For the years ended December 31, 1998 1997 1996 1995 1994
---------- -------- -------- -------- --------
(In thousands, except per share amounts)
<S> <C> <C> <C> <C> <C>
Revenues:
Policy revenues................ $ 459,158 $345,566 $348,090 $301,889 $244,422
Net investment income.......... 369,052 273,237 210,734 102,291 51,850
Other income(1)................ 37,717 46,476 43,703 21,794 1,056
Net gains (losses) from the sale
of investments............... 14,068 17,487 1,257 3,770 (3,556)
---------- -------- -------- -------- --------
Total revenues.............. 879,995 682,766 603,784 429,744 293,772
---------- -------- -------- -------- --------
Benefits and expenses:
Claims incurred................ 308,432 202,472 188,727 141,876 112,650
Change in liability for future
policy benefits and other
policy benefits.............. 233,330 121,817 83,184 20,047 (9,329)
Insurance and other operating
expenses..................... 376,941 264,607 181,678 164,126 111,524
Interest and amortization of
deferred debt issuance costs. 42,960 23,355 18,579 19,520 18,274
Impairment provision associated
with assets of Businesses
Held for Sale............... 342,960 -- -- -- --
---------- -------- -------- -------- --------
Total benefits and expenses. 1,304,623 612,251 472,168 345,569 233,119
---------- -------- -------- -------- --------
Income (loss) before income taxes
and extraordinary charge....... (424,628) 70,515 131,616 84,175 60,653
Income taxes (benefits)........ (3,369) 20,375 40,957 27,829 22,163
---------- -------- -------- -------- --------
Income (loss) before extraordinary
charge......................... (421,259) 50,140 90,659 56,346 38,490
Extraordinary charge, net of
income taxes................. (1,671) -- (2,372) -- --
---------- -------- -------- -------- --------
Net Income (loss)................ (422,930) 50,140 88,287 56,346 38,490
Preferred stock dividend
requirements................. 18,273 19,533 14,646 6,540 1,151
---------- -------- -------- -------- --------
Net income (loss) applicable to
common stock................. $ (441,203) $ 30,607 $ 73,641 $ 49,806 $ 37,339
========== ======== ======== ======== ========
</TABLE>
(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.
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C>
Per Share Information:
Basic:
Net income (loss) applicable to
common stock................. $ (15.23) $ 1.09 $ 2.70 $ 2.26 $ 1.95
Common shares used in computing
basic earnings per share..... 29,091 28,016 27,208 22,048 19,112
Diluted:
Net income (loss) applicable to
common stock................. (15.23) $ 1.07 $ 2.42 $ 2.12 $ 1.88
Common shares used in computing
diluted earnings per share... 29,091 28,645 35,273 25,216 19,851
Cash dividends declared.......... $ 0.10 $ 0.20 $ 0.20 $ 0.06 $ 0.04
As of December 31,
Assets:
Investments and cash............. $2,956,254 $3,340,114 $3,694,609 $2,288,979 $ 822,778
Insurance assets................. 347,728 617,318 639,798 499,668 342,547
Other assets..................... 305,615 766,703 474,916 354,271 144,244
Assets of Businesses Held for Sale 2,421,804 -- -- -- --
---------- ---------- ---------- ---------- ----------
Total assets................... $6,031,401 $4,724,135 $4,809,323 $3,142,918 $1,309,569
========== ========== ========== ========== ==========
Liabilities and shareholders' equity:
Insurance liabilities............ $2,867,038 $3,289,925 $3,566,455 $2,221,161 $ 788,223
Notes payable.................... 550,923 359,755 210,325 307,271 229,041
Other liabilities................ 110,945 194,352 170,302 125,351 58,903
Liabilities of Businesses Held for
Sale........................... 2,066,554 -- -- -- --
Redeemable preferred stock....... -- 19,867 32,864 30,007 37,256
Shareholders' equity............. 435,941 860,236 829,377 459,128 196,146
---------- ---------- ---------- ---------- ----------
Total liabilities and shareholders'
equity....................... $6,031,401 $4,724,135 $4,809,323 $3,142,918 $1,309,569
========== ========== ========== ========== ==========
</TABLE>
(2) During 1995, the Company incurred restructuring charges aggregating $3.9
million.
<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, 1998 and 1997, the consolidated results of operations
for the three years ended December 31, 1998, 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 and
to meet cash requirements based upon projected liquidity sources; (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 ability to successfully
complete its year 2000 remediation efforts, (10) the ultimate realizable value
and sales proceeds to be received from the Businesses Held for Sale 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.
GENERAL
The Company, through its three operating divisions, provides 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.
These products are primarily small premium accident and sickness insurance
policies with defined fixed benefit amounts, traditional whole life and
universal life insurance with low face amounts, and accumulation products such
as single premium deferred annuities.
The Company's financial condition and results of operations for the
periods covered by this and future "Management's Discussion and Analysis of
Financial Condition and Results of Operations" are or will be affected by
several common factors, each of which is discussed below.
Planned Dispositions. On February 18, 1998, the Company announced it had
engaged investment banking firms Salomon Smith Barney and Fox-Pitt, Kelton Inc.
to review strategic alternatives for maximizing shareholder value, including the
sale of the Company's Career Sales Division. The Company's decision to dispose
of the Career Sales Division, within a period not likely to exceed one year,
resulted in the assets and liabilities of the Career Sales Division to be
considered "assets and liabilities of Businesses Held for Sale."
On December 31, 1998, the Company entered into an agreement to sell the
Career Sales Division and related assets to Universal American. The purchase
price of $175.0 million is subject to adjustment based on the capital and
surplus of the Career Sales Division at the closing date. The purchase price
consists of $136.0 million in cash, subject to adjustment and $39.0 million
initial principal amount of subordinated notes of Universal American. The
subordinated notes bear interest at a rate of 8.0% per annum and mature ten
years from date of issuance. The accreted value of the notes will be subject to
offset in the event of adverse development (or subject to increase in the event
of positive development) in the disability income reserves of PLIC and may be
offset for other indemnification claims under the purchase and sale agreement.
In addition, the Company is required under terms of the purchase and sale
agreement to deliver the Career Sales Division and related assets with certain
minimum levels of statutory capital and surplus, pay certain ongoing costs and
other expenses which the Company anticipates will result in its receiving net
cash proceeds of approximately $70.0 to $78.0 million.
<PAGE>
In addition, on December 31, 1998, the Company entered into an agreement
to sell Professional to GEFAH for $47.5 million in cash plus interest through
the closing date. The purchase price is subject to an adjustment based on
Professional's capital and surplus at the closing date. The Company currently
estimates receiving net cash proceeds for the Professional Sale of approximately
$40.0 million to $41.5 million.
On February 21, 1999, the Company signed a definitive agreement to sell
the United Life Assets. The purchase price consists of $152.0 million and a
dividend payable by United Life at closing, which the Company estimates will be
approximately $2.1 million. The purchase consideration may be reduced as a
result of the Company's obligation to purchase certain mortgages from United
Life at closing. Additionally, a portion of the purchase price may be escrowed
at closing to fund the Company's obligation to purchase additional mortgages
from United Life after closing. The Company anticipates receiving net cash
proceeds from the sale of the Untied Life Assets of approximately $140.0
million.
The purchase and sale agreements for the Career Sales Division,
Professional and United Life Assets are subject to regulatory approvals and
other closing conditions.
In the third quarter of 1998, the Company made the decision to dispose of
KIVEX, an internet service provider. The Company has engaged the investment
banking firm of ING Barings Furman Selz in this regard and is currently
soliciting interest from prospective purchasers. To date, the Company has not
entered into a definitive agreement to sell KIVEX. In addition, the Company has
made the decision to sell Marketing One, excluding those assets included with
the sale of United Life.
The Company's decision to dispose of the Career Sales Division,
Professional, KIVEX, United Life Assets and Marketing One, within a period not
likely to exceed one year resulted in the assets and liabilities of the Career
Sales Division, Professional, KIVEX, United Life Assets and Marketing One to be
considered "assets and liabilities held for sale," and as such were segregated
from those of the Retained Businesses for purposes of presentation of the
Company's financial information.
The Company has recently engaged Wasserstein, Perella & Co. ("Wasserstein
Perella") to review the Company's capital structure and its recapitalization and
restructuring alternatives. Wasserstein Perella is presently evaluating the
Company's business plan alternatives and capital structure and will advise and
assist it with developing strategies, tactics and timetables to effectuate
financing, refinancing, sale, recapitalization or restructuring transactions, as
appropriate. These transactions may take the form of: (i) a restructuring or
recapitalization of the Company's equity (including preferred or preference
shares), debt securities or other indebtedness or obligations, including an
exchange transaction or otherwise; (ii) a sale of the Company or any subsidiary;
and (iii) a sale or placement of the Company's equity or debt securities or
obligations with one or more lenders or investors or any loan or financing, or
rights offering. There can be no assurance: (i) the Company will be successful
in developing and implementing one or more of these transactions; (ii) the form
the transactions will ultimately take; or (iii) the timing to complete the
process.
Acquisitions and Other Transactions. On January 2, 1998, following
shareholder approval at the Company's 1997 annual meeting of shareholders, 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, following shareholder approval at the 1997 annual
meeting of shareholders, 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). Mr. Fickes
will 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 will
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 the fourth quarter of 1998, the first quarter of 1998 and
1997. The restructuring was necessary as a result of the tremendous growth of
the Company and the resulting diversification of the underlying businesses.
4th Quarter 1998 Plan
The Company recorded in the fourth quarter of 1998 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 year ended December
31, 1998 on the restructuring accrual balances under the 4th Quarter 1998 Plan
(in thousands):
<PAGE>
1998 Activities
----------------------
Paid or
Charged 1998
1998 Against Ending
Provision Liability Adjustments Balance
--------- --------- ----------- -------
Severance and related benefits... $ 6,259 $ (3,985) $ -- $ 2,274
Estimated holding costs of
vacated facilities............. 2,954 (2,954) -- --
Estimated contract terminations
costs.......................... 61 (29) -- 32
--------- --------- ----------- -------
$ 9,274 $ (6,968) $ -- $ 2,306
========= ========= =========== =======
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. It is anticipated that all
severance will be paid by September 30, 1999 with the exception of one former
executive officer whose severance will be paid monthly through December 2003.
The Company had incurred costs of $4.0 million which were charged against the
accrual during 1998 for terminated employees.
The fourth quarter 1998 plan recognized abandoned leasehold improvement
costs in connection with the Company's plan to shut down 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.
The following reflects the impact of activity for the year ended December
31, 1998 on the restructuring accrual balances under the 1st Quarter 1998 Plan
(in thousands):
1998 Activities
----------------------
Paid or
Charged 1998
1998 Against Ending
Provision Liability Adjustments Balance
--------- --------- ----------- -------
Severance and related benefits... $ 3,831 $ (4,417) $ 1,205 $ 619
Estimated holding costs of
vacated facilities............. 2,205 -- -- 2,205
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
========= ========= =========== =======
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 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 $4.4 million against the severance accrual during
1998 as the result of termination payments. In addition, during 1998 the Company
increased the severance accrual by $1.6 million as a result of the decision to
terminate all 54 of Security Life's remaining Raleigh employees. This increase
was partially offset in the amount of $405,000, due to the Company paying less
severance costs as a result of natural attrition and other factors such as
inter-company transfers of 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.
<PAGE>
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
As a result of the tremendous growth of the Company and the
diversification of the underlying business units resulting from acquisition over
time, 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.
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.
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>
1997 Activities 1998 Activities
----------------------- -----------------------
Paid or Paid or
Charged 1997 Charged 1998
1997 Against Ending Against Ending
Provision Liability Adjustments Balance Liability Adjustments Balance
--------- --------- ----------- ------- --------- ----------- -------
<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.
<PAGE>
Other Costs
The Company incurred approximately $6.3 million and $4.7 million of
pre-tax incremental 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.
Impairment Provision Associated with Assets of Businesses Held for Sale.
For the year ended December 31, 1998 the Company recorded an impairment
provision aggregating $343.0 million. 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 impairment
provisions for the Career Sales Division, Professional and the United Life
Assets were $328.6 million, $3.3 million and $11.1 million, respectively.
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 is highly
likely that such systems will not be 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 lead to a significant business interruption. Such
an interruption could result in a decline in current and long-term profitability
and business franchise value.
The Company's overall year 2000 compliance initiatives, include 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 follows up periodically. Of those
parties that have responded, the Company's most significant third party vendors
and business partners have indicated that they have a plan for year 2000
compliance or believe that they are currently year 2000 compliant.
The Company has engaged outside vendors and focused certain employees'
full time efforts to help in the full array of its year 2000 initiative. This
includes systems assessment and monitoring advice, actual code remediation,
communication and consultation with critical business partners and additional
data center and testing resources. The Company 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. Based upon revised projections during the fourth quarter of
1998, the Company anticipates incurring internal and external costs of $5.0
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.
Each of the operating divisions is primarily responsible for its
remediation efforts with corporate oversight provided as necessary. The Company
believes that the Career Sales Division has substantially completed its year
2000 assessment and remediation efforts, which will be subject to ongoing tests
for the remainder of 1999. In addition, the Career Sales Division has committed
to a strategy of utilizing third party administrative experts, who have
indicated year 2000 compliance, to handle the processing of certain components
of its health insurance business, thus eliminating the need for the upgrade or
modification of certain existing health administration systems. The Payroll
Sales Division has completed the remediation of its largest administrative
platforms, except for AA Life, and anticipates successful remediation and
testing of the remaining sub-systems and system interfaces during 1999. The
Company believes that the Payroll Sales Division, other than AA Life, is 95.0%
complete with its compliancy effort for critical business systems. AA Life is in
the process of upgrading its policy administration system to a year 2000
compliant version. AA Life is relying on contracted vendor resources in order to
complete its upgrade
<PAGE>
process. Based upon similar internal metrics analysis, AA Life has completed
90.0% of the total effort required for its critical business systems to be year
2000 compliant. The efforts of the Company's Financial Services Division are
highly dependent on the utilization of outside resources. The Company believes
that the Financial Services Division has contracted with sufficient resources to
be able to remediate its essential business systems. Currently, the Company
believes that the Financial Services Division is 85.0% complete with remediation
efforts associated with its critical business systems. The Company believes that
all of its divisions will have completed their remediation efforts by May 1999,
but each division will continue to perform testing throughout 1999.
Although the Company believes that its operating divisions, outside
vendors and most critical business partners will be sufficiently compliant that
the year 2000 issue should not cause a material disruption in the Company's
business, there can be no assurance that there will not be material disruptions
to the Company's business or an increase in the cost of the Company doing
business. Although the Company believes that the year 2000 issues should not
cause a material disruption in the Company's business, the Company has developed
various contingency plans associated with remediation tasks which the Company
believes are at a higher risk for potential failure.
The Company has provided certain assurances to each respective purchaser
of the Businesses Held for Sale with respect to each entity's ability to process
date-sensitive information for the year 2000 and beyond. Although the Company
believes that it will be able to meet the year 2000 representations and
warranties provided to the respective purchasers, there can be no assurances.
Failure of the Company to meet such representations and warranties could result
in a decision by the purchaser not to consummate the transaction and/or
indemnification claims for breach of contract.
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 these 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.
<PAGE>
The following table shows the cash sources and uses of the parent company
on a projected basis for 1999 and on an actual basis for the years ended
December 31, 1998, 1997 and 1996:
<TABLE>
<CAPTION>
Year ended December 31,
--------------------------------------------------
Projected
1999 1998 1997 1996
--------- --------- --------- ---------
($ in thousands)
<S> <C> <C> <C> <C>
Cash sources:
Cash from subsidiaries.......... $ 283,670 $ 73,521 $ 34,839 $ 143,244
Other investment income......... -- 2,865 3,547 2,428
Sale of equity securities....... -- 30,500 -- --
Issuance of preferred and common
stock......................... -- 3 -- 294,607
Additional borrowings........... -- 203,000 250,000 230,000
Other, net...................... 5,630 1,303 3,243 2,705
--------- --------- --------- ---------
Total sources.............. 289,300 311,192 291,629 672,984
--------- --------- --------- ---------
Cash uses:
Acquisition of businesses....... -- 73,858 -- --
Interest paid on debt........... 39,727 37,849 20,946 16,921
Operating expenses, including
restructuring charges......... 19,882 36,217 24,362 1,136
Purchase of treasury shares..... -- -- 28,760 --
Reduction of notes payable...... 237,000 126,015 100,000 273,353
Capital contributions to
subsidiaries.................. 1,500 7,853 14,889 208,708
Purchase of equity securities... -- 5,000 20,000 --
Purchase of SW Financial note... -- -- 40,000 --
Issuance of surplus note to
subsidiary.................... -- -- -- 155,000
Redemption of preferred stock... -- -- 14,705 --
Dividends on preferred and common
stock......................... -- 16,210 23,460 17,480
Other, net...................... 1,550 -- 2,142 --
--------- --------- --------- ---------
Total uses................. 299,659 303,002 289,264 672,598
--------- --------- --------- ---------
Increase (decrease) in cash and
short-term investments........ (10,359) 8,190 2,365 386
Cash and short-term investments
at beginning of year.......... 12,654 4,464 2,099 1,713
--------- --------- --------- ---------
Cash and short-term investments
at end of year................ $ 2,295 $ 12,654 $ 4,464 $ 2,099
========= ========= ========= =========
</TABLE>
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
and Pioneer Security (collectively, the "Surplus Note Companies"). With respect
to Constitution and Pioneer Security, 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 $453.1 million and $358.3 million as of December 31, 1998 and
1997, respectively. The surplus debentures generally require (subject to
availability of statutory capital and surplus and in some instances, regulatory
approval) principal and interest payments to be made periodically in amounts
sufficient to allow PennCorp to meet its cash requirements.
The Surplus Note Companies rely upon dividends and tax sharing payments
from their respective insurance subsidiaries. Each of the insurance subsidiaries
is in turn subject to regulatory restrictions with respect to the maximum amount
of dividends that can be paid to the Surplus Note Companies 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. See Business-Regulatory Matters for additional discussions of dividend
restrictions.
For the years ended December 31, 1998, 1997 and 1996, the Company received
surplus debenture interest and principal payments from PLAIC of $26.2 million,
$16.4 million and $132.0 million, respectively, and received dividends and tax
sharing payments of $47.3 million, $18.4 million and $11.3 million,
respectively. The Surplus Note Companies received $69.5 million, $32.1 million
and $25.8 million in dividends and tax sharing payments from their respective
insurance subsidiaries.
<PAGE>
Other Investment Income. During each of the years in the three year period
ended December 31, 1998, the Company received other investment income from
short-term invested assets held by the parent company.
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 Capital Fund I investment in ACO. See Note 18 to Notes to Financial
Statements for additional information regarding the Company's investment in ACO.
Issuance of Preferred and Common Stock. In August 1996 the Company issued
2,875,000 shares of $3.50 Series II Convertible Preferred Stock ("Series II
Convertible Preferred Stock") for net proceeds of $139.2 million. In addition,
in February 1996 PennCorp completed the sale of 5,131,000 shares of Common
Stock, netting proceeds of $155.5 million ("February 1996 Common Stock
Offering"). See Cash Uses below for the use of proceeds from the Series II
Convertible Preferred Stock and February 1996 Common Stock Offerings.
Additional Borrowings. During each of the years in the three year period
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
borrowing 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. During 1996, the Company acquired United Life for $110.1 million and
contributed additional capital to United Life of approximately $57.3 million.
The Company effectuated the acquisition and capital contribution by providing
funds to PLAIC in the form of a surplus note aggregating $155.0 million from
proceeds raised under the Series II Convertible Preferred Offering. For
additional information on the acquisition of United Life 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, 1998, 1997 and 1996, the average indebtedness outstanding
aggregated $452.6 million, $281.6 million and $257.0 million, respectively. The
Company's weighted average costs of borrowings increased significantly during
1998 as a result of the Company's increased leverage ratio and projected
weakness in future liquidity. The Company anticipates higher interest costs to
continue for the year ended 1999. For additional information regarding
indebtedness, see Note 9 of Notes to Consolidated Financial Statements and
Results of Operations-Interest and Amortization of Deferred Debt Costs.
Operating Expenses Including Restructuring Charges. During 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 1998 and 1997 aggregated
$9.1 million and $11.5 million, respectively. During 1999, the parent company
anticipates funding $5.0 million of restructuring charges. During 1998, the
parent company also incurred legal, accounting and investment banking fees
associated with asset dispositions aggregating $1.5 million. Operating expenses
also include costs aggregating $1.8 million associated with shareholder
litigation and the SEC's investigation into the Company's historical accounting
practices. The Company anticipates incurring additional amounts of such costs
during 1999.
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 in Notes Payable. In conjunction with the Company's 1998
acquisition of the SW Financial Controlling interest, the Company borrowed under
its existing $450 million revolving bank credit facility (the "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. The Company utilized proceeds from its February 1996 Common
Stock Offering to repay approximately $137.0 million of subsidiary indebtedness.
Also during 1996, the Company entered into a new $175 million credit facility
and utilized $100.0 million to repay a bridge loan facility entered into to
effectuate the SW Financial investment in December 1995 and repurchase $35.4
million of principal amount of the Company's 9 1/4% Senior Subordinated
Debenture due 2003 (the "Notes").
<PAGE>
Capital Contributions to Subsidiaries. For the years ended December 31,
1998, 1997 and 1996, the Company made capital contributions to subsidiaries
totaling $7.9 million, $14.9 million and $208.7 million, respectively. During
1998, 1997 and 1996, these contributions were primarily made to certain non-life
insurance subsidiaries, principally KIVEX, to fund expansion and for other
corporate purposes. During 1996, the Company contributed $100.0 million to PLAIC
in connection with the acquisition of United Life.
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.
Issuance of Surplus Notes to Subsidiaries. The Company issued a $155.0
million surplus note to PLAIC in order to provide funding to PLAIC for the
purchase and capital contributions necessary to effectuate the United Life
acquisition.
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, 1997 and 1996 the
Company paid common and preferred stock dividends aggregating $16.2 million,
$23.5 million and $17.5 million, respectively. The increase in amounts paid
during 1997 as compared to 1996 was the result of the $3.50 Series II
Convertible Preferred Stock being outstanding for the entire year. The drop 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.
Projected Cash Sources and Uses in 1999
During 1999, the Company anticipates receiving approximately $25.2 million
in the form of principal and interest payments or dividends and tax sharing
payments for the Surplus Note Companies as a result of the ordinary dividend
flow from the Surplus Notes Companies insurance subsidiaries. In addition, the
Company anticipates receiving principal payments under the surplus debentures as
a result of the sales of the Career Sales Division, Professional and the United
Life Assets by the Surplus Note Companies. Total cash proceeds anticipated by
the Company from such sales aggregates approximately $258.5 million. The Company
anticipates utilizing $237.0 million to repay indebtedness and the remainder of
such proceeds to fund interest costs and operating expenses of the parent
company. Consummation of the Career Sales Division, Professional and the United
Life Assets sales transactions is subject to regulatory approvals and other
material closing conditions. Please refer to the reports on Form 8-K filed on
January 11, 1999 and March 11, 1999 for more information on these sale
transactions. Included as Exhibits 2.1 and 2.2 on the Form 10-K are the
definitive purchase and sale agreements for the Career Sales Division and
Professional, respectively. There can be no assurances that the Career Sales
Division, Professional or the United Life Assets sales will be consummated or
that the cash proceeds will be in the amount anticipated by the Company.
The Company's ability to receive principal and interest payments above
$25.2 million under the surplus notes is contingent upon the Company's ability
to consummate each of the sales transactions of the Businesses Held for Sale
currently under contract. The Company has currently estimated net cash proceeds
after required debt reduction under the Company's Bank Credit Facility of $21.1
million. Such liquidity is necessary for the Company to fund interest payments
under the Bank Credit Facility and the notes and to fund operating expenses of
the Company. Though the Company has the obligation to consummate the sales of
the Businesses Held for Sale and to prepay the loans to certain covenanted
levels, the Company may not have the requisite ability to effectuate the sale as
a result of the restrictive covenants contained in the Amended Bank Credit
Facility. The accessibility of the cash proceeds of the Businesses Held for Sale
are the subject of regulatory approval. While certain regulatory filings with
respect to the sale of the Businesses Held for Sale have been made, not all
filings have been so made and the final structure by which such proceeds will be
upstreamed to the Company have not yet been finalized. The Amended Credit
Agreement provides that the Company and its subsidiaries are limited from
entering into certain mergers, consolidations, amalgamations, liquidations,
winding up or dissolutions, incurring certain indebtedness and liabilities,
making disposition, prepaying certain indebtedness, declaring dividends, or
issuing, redeeming, purchasing, retiring, exchanging or converting capital
securities, in each case with very limited or scheduled exceptions. While the
Company believes it has scheduled or otherwise provided for a great majority of
the possible combinations it will take to effectively upstream the cash proceeds
of the sales of the Businesses Held for Sale, it is not possible to foresee all
combinations. Accordingly, the mechanism to upstream to the Company the
necessary cash to pay the covenanted prepayment under the Amended Credit
Agreement may be subject to the approval of the majority banks which, if not
given, would result in an event of default under the Amended Bank Credit
Agreement. With the consummation of the March 31, 1999 amendment, the Company
and its subsidiaries were in compliance with all applicable covenants, as
amended at December 31, 1998. Should the sale transactions not close within
<PAGE>
specified time periods, the Company may face difficulty in meeting its existing
and estimated cash obligations and would be in default of certain covenants
under the Bank Credit Facility.
The net proceeds available to the Company from the asset sales may vary
significantly from current estimates as a result of (i) minimum levels of
statutory capital and surplus required to be delivered at closing for certain
insurance subsidiaries, (ii) amounts to be held in escrow, (iii) valuation of
certain consideration to be received by the Company, (iv) the timing of the
closing and (v) various indemnification obligations included in each purchase
and sale agreement. Specifically, the purchase and sale agreement for the Career
Sales Division requires the purchaser to be satisfied with disability claims
reserve liabilities and other active life reserves. The Company has engaged an
actuarial consulting firm to provide analysis to the purchaser regarding such
reserves. The Company is aware of potential deficiencies aggregating
approximately $16.2 million in the statutory determination of disability claims
reserves that will likely impact the total consideration the Company is to
receive. The Company and the purchaser have not engaged in discussions to
resolve the disability claims reserve issue. In addition, the purchase and sale
agreement for the United Life Assets requires the Company to purchase certain
residential mortgage loans from United Life, should the loans not meet specified
criteria under the purchase and sale agreement or should United Life not be able
to provide clear title to the loans. The residential loans are part of a
servicing agreement with United Companies Financial Corporation, the "servicer,"
which has recently filed for bankruptcy. The servicer currently maintains within
its control all applicable loan documents. Should the Company be unable to
obtain satisfactory control of all of the applicable documents, the Company's
anticipated net proceeds from the United Life Asset sale could be reduced by
approximately $12.6 million. Such reduction would have a material impact on the
liquidity of the Company.
In addition to the above proceeds, there exists $7.0 million of unused
commitments under the Company's existing credit facility that are available only
for the purpose of payments of interests, should the Company not have sufficient
liquidity from other sources. Upon consummation of the Career Sales Division
divestiture the commitment will be reduced to $5.0 million.
As a result of these anticipated actions, management believes the Company
will likely have sufficient financial flexibility and projected liquidity
sources to meet all cash requirements for 1999. However, there can be no
assurances actual liquidity sources will develop as currently projected. In the
event of a shortfall of actual liquidity sources, the Company will explore
options to generate any necessary liquidity such as: (i) the sale of
non-strategic subsidiaries and (ii) obtain 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 $34.2 million, $74.6 million and $135.4
million, respectively, for the years ended December 31, 1998, 1997 and 1996. The
decreasing trend in cash flow from operating activities for the years ended
December 31, 1998, 1997 and 1996, is primarily attributable to the accounting
treatment for KB Management. During the years ended December 31, 1997 and 1996,
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
net loss derived by KB Management for the year ended December 31, 1998, was
effectively recognized as a 100% economic interest by the Company. Supplemental
factors to the decreasing trend in cash flow from operating activities 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.
<PAGE>
During 1995, the Company established a portfolio of "trading securities" to
provide the Company with the opportunity to undertake interest rate hedging
strategies, to participate in short-term relative value trades and to invest in
special situations with the goal of generating short-term trading profits. As of
December 31, 1997, the Company held no investments in its trading portfolio.
Cash Flow from Investing Activities. The Company's investment portfolio is
managed with the objectives of maintaining high credited 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 a conservative investment strategy
fits the nature of its insurance products which have little or no inflation risk
and limited build-up of cash accumulation values in earlier years.
The Company continuously evaluates its investment portfolio and the
conditions under which it might sell securities, including changes in interest
rates, changes in prepayment risk, liquidity needs, asset liability matching,
tax planning strategies and other economic factors. Those securities that the
Company believes would be subject to sale prior to the specified maturity date
are included in "securities available for sale," which amounted to $2,589.7
million, $2,719.0 million and $2,993.9 million at December 31, 1998, 1997 and
1996, respectively. Of those securities available for sale, 93.0%, 92.5% and
92.1% were rated BBB or above by Standard & Poor's at December 31, 1998, 1997
and 1996, respectively.
During the years ended December 31, 1998, 1997 and 1996, the Company sold
$1,019.9 million, $801.1 million and $373.7 million of fixed maturity and equity
securities, and purchased $1,054.7 million, $1,021.5 million and $955.8 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 improve the quality of the investment portfolio or avoid
prepayment risks.
As a result of the Company's decision to exit the private placement bond
sector, the Company transferred all of its remaining assets in the fixed
maturities held for investment portfolio to its fixed maturities available for
sale portfolio as of April 1, 1997. During 1996, the Company sold one security
in its held for investment portfolio aggregating $4.9 million as a result of a
dramatic deterioration in its credit rating and realized a loss of $28,000.
Mortgage loans on real estate amounted to 1.2%, 7.2% and 7.2% of total
invested assets as of December 31, 1998, 1997 and 1996, respectively. United
Life is the Company's only subsidiary which actively originates new mortgage
loans. United Life invests in first mortgage loans and provides a mortgage loan
warehousing facility for its former parent as a means of obtaining higher
invested asset yields necessary to support competitively priced annuity
products.
Cash Flow from Financing Activities. Cash used by financing activities,
excluding the parent company, were $391.4 million, $325.9 million and $62.0
million for the years ended December 31, 1998, 1997 and 1996, respectively. The
majority of the cash outflow is attributable to policyholder surrenders
exceeding deposits by $354.1 million in 1998, $275.7 million in 1997 and $205.2
million in 1996.
RESULTS OF OPERATIONS
For the years ended December 31, 1998, 1997 and 1996, the Company has
prepared the following unaudited selected pro forma financial information for
the Company's remaining operating divisions, the Financial Services Division
(excluding the United Life Assets) and the Payroll Sales Division (excluding
Professional) and Businesses Held for Sale (Career Sales Division, Professional,
the United Life Assets, KIVEX and Marketing One). The 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 and 1996 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.
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.
<PAGE>
The unaudited selected pro forma financial information for the years ended
December 31, 1997 and 1996, gives effect to the acquisition of the SW Financial
Controlling Interest and the Fickes and Stone Knightsbridge Interests as though
each had occurred on January 1, 1996.
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, 1996,
or the results which may occur in the future.
SELECTED PRO FORMA FINANCIAL INFORMATION
Year ended December 31,
--------------------------------
1998 1997 1996
--------- --------- ---------
($ in thousands)
[S] [C] [C] [C]
Financial Services Division:
Operating income.......................... $ 23,206 $ 75,555 $ 79,438
Net investment gains...................... 1,503 6,848 2,055
Restructuring costs....................... (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, 1996...................... -- (49,816) (41,490)
--------- --------- ---------
20,906 32,587 40,003
--------- --------- ---------
Payroll Sales Division:
Operating income (loss)................... (2,728) 23,960 22,796
Net investment gains (losses)............. (36) 2,654 (176)
Restructuring costs....................... -- -- --
--------- --------- ---------
(2,764) 26,614 22,620
--------- --------- ---------
Businesses Held for Sale:
Operating income (loss)................... (18,323) 45,371 89,879
Net investment gains (losses)............. 9,068 9,827 (1,690)
Restructuring costs....................... (2,643) -- --
Impairment valuation...................... (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, 1996......................... -- (7,717) (23,755)
--------- --------- ---------
(354,858) 47,481 64,434
--------- --------- ---------
Corporate:
Interest and amortization of deferred debt
interest cost........................... (42,960) (38,653) (36,130)
Corporate expenses, eliminations and other (40,054) (23,842) (267)
Net investment gains...................... 3,533 1 8
Restructuring costs....................... (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, 1996......................... -- 24,126 19,911
--------- --------- ---------
(87,912) (55,139) (16,478)
--------- --------- ---------
Income (loss) before income taxes and
extraor$inary charge..................... $(424,628) $ 51,543 $ 110,579
========= ========= =========
<PAGE>
RETAINED BUSINESS--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,
------------------------------
1998 1997 1996
--------- --------- ---------
($ in thousands)
Revenues:
Policy revenues............................ $ 129,242 $ 138,006 $ 138,957
Net investment income...................... 183,618 201,483 204,392
Other income............................... 3,677 1,052 16,521
--------- --------- ---------
316,537 340,541 359,870
--------- --------- ---------
Benefits and expenses:
Total policyholder benefits................ 215,414 195,119 218,647
Insurance related expenses................. 29,592 32,940 24,510
Other operating expenses................... 48,325 36,927 37,275
--------- --------- ---------
293,331 264,986 280,432
--------- --------- ---------
Pre-tax operating income.................. $ 23,206 $ 75,555 $ 79,438
========= ========= =========
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, 1998, 1997 and 1996 are as follows:
<TABLE>
<CAPTION>
Year ended December 31,
---------------------------------
1998 1997 1996
--------- -------- --------
($ in thousands)
<S> <C> <C> <C>
Life premiums collected:
Universal life (first year).................... $ 18,459 $ 11,800 $ 10,538
Universal life (renewal)....................... 83,419 92,150 97,695
Traditional life (first year).................. 7,821 4,333 3,876
Traditional life (renewal)..................... 34,636 36,646 33,899
--------- -------- --------
Life premiums collected, net of reinsurance.. 144,335 144,929 146,008
--------- -------- --------
Annuity premiums collected:
Traditional fixed (first year)................. 9,205 24,761 16,098
Traditional fixed (renewal).................... 1,947 2,718 3,099
--------- -------- --------
Annuity premiums collected, net of
reinsurance................................ 11,152 27,479 19,197
--------- -------- --------
Fixed benefit premiums collected:
Long-term care premiums (all first year)....... 455 -- --
Accident and Health (all renewal).............. 12 300 249
--------- -------- --------
Fixed benefit premiums collected, net of
reinsurance................................ 467 300 249
--------- -------- --------
Premiums collected, net of reinsurance.......... 155,954 172,708 165,454
Less premiums on universal life and annuities
which are recorded as additions to insurance
liabilities and other premium adjustments..... (113,662) (129,393) (122,298)
--------- -------- --------
Premiums on products with mortality or morbidity
risk.......................................... 42,292 43,315 43,156
Fees and surrender charges on interest sensitive
products...................................... 86,950 94,691 95,801
--------- -------- --------
Policy revenues................................. $129,242 $138,006 $138,957
========= ======== ========
</TABLE>
Policy revenues decreased 6.4% during 1998 to $129.2 million compared with
1997. Policy revenues in 1997 decreased less than 1% compared with 1996. Life
premiums collected, net of reinsurance, were $144.3 million in 1998 compared
with $144.9 million in 1997 and $146.0 million in 1996. First year universal
life premiums increased 56.4% in 1998 to $18.5 million and first year
traditional life increased 80.5% to $7.8 million. Most of the increase in
production was attributable to
<PAGE>
Southwestern Life. The Company expects the A.M. Best downgrades, which occurred
during the third quarter of 1998 to negatively impact 1999 new business
production levels relative to 1998. New life sales were also strong at Security
Life in the first half, of 1998 but declined in the third and fourth quarters
reflecting the impact of ratings downgrades and management changes in Security
Life's marketing management. The increase in first year life premiums was mostly
offset by decreases in life renewal premiums, which declined 8.3% in 1998 from
1997 compared to a decrease of 2.1% in 1997 compared with 1996. This reflects
ratings downgrades and the impact of certain management actions instituted by
Southwestern Life in the third quarter of 1997. Additional management actions
are planned or are being considered with respect to certain interest sensitive
life insurance contracts. Such plans, if implemented, would likely result in
reduced renewal premiums in 1999 and subsequent years. See Managements'
Discussion and Analysis of Financial Condition and Results of Operations-Total
Policyholder Benefits, included herein. Annuity premiums have declined 59.4% to
$11,152 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 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 and
Security Life improve.
Net Investment Income. Net investment income decreased 8.9% to $183.6
million in 1998 due to a decrease in invested assets and reduced yields on
investments. Average invested assets declined approximately $110.3 million in
1998 compared with 1997 and decreased $1.7 million from 1997 compared to 1996.
Most of this decrease resulted from the need to liquidate invested assets to
provide cash to fund surrenders of annuities issued by Security Life, which
totaled $179.0 million in 1998. Most of these annuities 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 annuities 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 7.1% in 1998 compared to 7.4% in
1997 and 7.5% in 1996. 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 $2.6 million in 1998 compared to
1997. During 1998, the Company received approximately $1.0 million resulting
from a settlement received associated with securities owned in the past. Most of
the remaining differences between the years reflect changes in consideration
received on supplemental contracts. Supplemental contract revenue is derived
from annuity contracts which have reached the annuitization period.
Consideration from supplemental contracts recognized as other income is offset
by policyholder benefits, resulting in no net effect on the Company's results of
operations.
Total Policyholder Benefits. The following table shows the components of
total policyholder benefits for the year ended December 31, 1998, 1997 and 1996:
Year ended December 31,
------------------------------
1998 1997 1996
--------- --------- ---------
($ in thousands)
Death benefits............................. $ 87,578 $ 77,980 $ 77,648
Other insurance policy benefits and change
in future policy benefits................ 127,836 117,139 140,999
--------- --------- ---------
Total policyholder benefits................ $ 215,414 $ 195,119 $ 218,647
========= ========= =========
During 1998, policyholder benefits increased 10.4% to $215.4 million
compared with 1997. Death benefits increased $9.6 million or 12.3% compared with
1997. Most of this increase was due to higher incidence of mortality at
Southwestern Life during the first half of 1998 compared to prior periods. Death
benefits may vary significantly from period to period. Change in future policy
benefits and other benefits increased 9.1% to $127.8 million in 1998. 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 $525.4
million and $504.6 million as of December 31, 1998 and 1997, respectively. If
developing trends were to continue, principally the less than expected level of
<PAGE>
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 approximately $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.
In January 1999, Security Life initiated management action in the form of
a new exchange program for certain policyholders of Security Life. The program
is being offered to all policyholders who had certain policy forms in force as
of January 1, 1998. The program allows 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 has the choice of not accepting the
exchange program and keeping the current policy in force.
The exchange program is not expected to have a material effect on the
Company's financial position or results of operations. However, statutory
surplus of Security Life could be reduced by approximately $12.5 million on a
pre-tax basis if every eligible policyholder elects the exchange option.
The Company is continuing to refine its actuarial estimates, likely
management action plans and associated sensitivity testing of such
interdependencies on policy reserves associated with these contracts which could
result in changes in such estimates in the future.
Insurance Related Expenses. For 1998, insurance related expenses
(including commissions, amortization of deferred policy acquisition costs and
amortization of present value of insurance in force) decreased to $29.6 million
in 1998 from $32.9 million in 1997. Insurance related expenses increased $8.4
million in 1997 compared to 1996. Amortization of deferred policy acquisition
costs increased $7.2 million in 1998 compared to 1997 and increased $4.8 million
in 1997 compared with 1996. These increases principally reflect the growing
block of policies in force, which have been sold subsequent to the Company's
acquisitions of Security Life and Southwestern Life. Also included in the $7.2
million increase in amortization is approximately $3.2 million of 1998 deferred
costs for Security Life which was written off as unrecoverable from future
profits as a result of shifts in the mix of products sold during the year.
Amortization of present value of future profits decreased $10.8 million to $12.9
million in 1998. This decrease resulted from unlocking assumptions of future
interest rates, lapses, expenses and mortality which effect the estimated future
profitability of certain interest sensitive life insurance products at
Southwestern Life and from lower amortization associated with blocks of
pre-purchase business. Amortization of present value of future profits increased
$5.3 million in 1997 compared to 1996. This increase resulted from unlocking
assumptions of future interest rates, lapses and mortality which effect the
estimated future profitability of certain interest sensitive life insurance
products of Security Life.
Other Operating Expenses. For 1998, other operating expenses (including
general operating, overhead and policy maintenance) increased $11.4 million from
1997. Other operating expenses were consistent between 1997 and 1996. The 1998
increase is attributable to several factors: (i) Security Life established an
allowance for uncollectible agents' debit balances aggregating approximately
$2.3 million, (ii) approximately $4.9 million of remediation costs associated
with Year 2000 systems conversions and upgrades and (iii) additional
non-deferrable expenses such as consulting fees, appraisal costs and other costs
associated with the divisional realignment which are not considered
restructuring costs.
<PAGE>
RETAINED BUSINESS--PAYROLL SALES DIVISION
The Payroll Sales Division includes the operations of AA Life and OLIC. AA
Life markets and underwrites customized life insurance and accumulation products
to U.S. military personnel and federal employees through a general agency force.
OLIC provides individual fixed benefit and life products utilizing a network of
independent agents primarily in the southeastern United States through
employer-sponsored payroll deduction programs.
SELECTED PRO FORMA FINANCIAL INFORMATION
Year ended December 31,
------------------------------
1998 1997 1996
--------- --------- ---------
($ in thousands)
Revenues:
Policy revenues............................ $ 89,991 $ 89,698 $ 83,722
Net investment income...................... 39,046 38,161 36,023
Other income (loss)........................ (1,967) 4,454 (85)
--------- -------- ---------
127,070 132,313 119,660
--------- -------- ---------
Benefits and expenses:
Total policyholder benefits................ 64,457 64,622 63,642
Insurance related expenses................. 42,131 29,377 18,843
Other operating expenses................... 23,210 14,354 14,379
--------- -------- ---------
129,798 108,353 96,864
--------- -------- ---------
Pre-tax operating income (loss)........... $ (2,728) $ 23,960 $ 22,796
========= ======== =========
Policy Revenues. Premiums received, net of reinsurance, by major product
line for the years ended December 31, 1998, 1997 and 1996 are as follows:
Year ended December 31,
------------------------------
1998 1997 1996
--------- --------- ---------
($ in thousands)
Life premiums collected:
Universal life (first year)............... $ 1,336 $ 5,248 $ 8,153
Universal life (renewal).................. 33,045 30,808 27,168
Traditional life (first year)............. 17,708 16,139 13,461
Traditional life (renewal)................ 30,899 30,138 22,787
--------- --------- ---------
Life premiums collected, net of
reinsurance........................... 82,988 82,333 71,569
--------- --------- ---------
Annuity premiums collected:
Traditional fixed (first year)............ 331 2,526 5,517
Traditional fixed (renewal)............... 1,259 1,495 1,448
--------- --------- ---------
Annuity premiums collected, net of
reinsurance.......................... 1,590 4,021 6,965
--------- --------- ---------
Fixed benefit premiums collected:
Accident and Health (first year).......... 2,361 3,583 3,149
Accident and Health (renewal)............. 10,356 9,720 9,220
Fixed benefit premiums collected, net
--------- --------- ---------
of reinsurance........................ 12,717 13,303 12,369
--------- --------- ---------
Premiums collected, net of reinsurance..... 97,295 99,657 90,903
Less premiums on universal life and annuities
which are recorded as additions to
insurance liabilities and other
premium adjustments....................... (37,031) (45,084) (43,050)
--------- --------- ---------
Premiums on products with mortality or
morbidity risk........................... 60,264 54,573 47,853
Fees and surrender charges on interest
sensitive products....................... 29,727 35,125 35,869
--------- --------- ---------
Policy revenues............................ $ 89,991 $ 89,698 $ 83,722
========= ========= =========
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
<PAGE>
decision to cease marketing products through any "non-payroll" production
sources during 1997. Policy revenues increased in 1997 compared to 1996
primarily as a result of new business sales for AA Life.
Net Investment Income. Net investment income increased 2.3% in 1998 from
1997 to $39.0 million and increased 5.9% in 1997 compared to 1996. The increase
in net investment income was primarily the result of an increase in the average
invested assets which increased approximately $14.9 million in 1998 compared to
1997 and increased $16.6 million in 1997 compared to 1996. The increases in
invested assets is primarily attributed to modest increases in business in force
at AA Life.
Other Income. Other income decreased $6.4 million from 1997 and resulted
in a loss of $2.0 million in 1998 compared to income of $4.5 million in 1997.
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 $4.4 million on
the sale of its Panamanian business.
Total Policyholder Benefits. The following table shows the components of
total policyholder benefits for the year ended December 31, 1998, 1997 and 1996:
Year ended December 31,
------------------------------
1998 1997 1996
--------- --------- ---------
($ in thousands)
Death benefits............................. $ 23,435 $ 23,282 $ 25,213
Fixed benefit claims incurred.............. 7,929 10,114 7,427
Other insurance policy benefits and change
in future policy benefits................. 33,093 31,226 31,002
--------- --------- ---------
Total policyholder benefits................ $ 64,457 $ 64,622 $ 63,642
========= ========= =========
Policyholder benefits totaled $64.5 million in 1998, which was little
changed compared to 1997 or 1996.
Insurance Related Expenses. Insurance related expenses (including
commissions, amortization of deferred policy acquisition costs and amortization
of present value of insurance in force) increased $12.8 million in 1998 compared
to 1997. During 1998, OLIC accelerated amortization of deferred acquisition
costs by $10.7 million primarily as a result of refinements in persistency
assumptions and unlocking of the estimates of future profits. 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. These increases were partially
offset by lower commissions in 1998 compared to 1997 primarily resulting from
OLIC's decision to cease writing certain products in 1997. Insurance related
expenses increased $10.5 million to $29.4 million in 1997 compared to 1996.
Amortization of deferred policy acquisition costs increased $8.5 million
primarily as a result of refinements to amortization schedules for AA Life to
reflect the unlocking of assumptions of future interest rates, lapses, expenses
and mortality which effect the estimated future profitability and as a result of
the growing block of policies in force, which had been sold subsequent to the
Company acquisition of AA Life. In addition, amortization of present value of
insurance in force for OLIC also increased from 1996 to 1997 primarily as a
result of unlocking of assumptions of future interest rates, lapses, expenses
and mortality which effects the estimated future profitability.
Other Operating Expenses. Other operating expenses (including general
operating, overhead and policy maintenance) increased $8.9 million from 1997
after remaining flat from 1996 to 1997. The increase is attributable to several
factors, including: (i) approximately $3.6 million of remediation costs
associated with Year 2000 systems conversions and upgrades, (ii) approximately
$2.0 million of acquisition costs at OLIC which were expensed in 1998 as
unrecoverable from future profits and (iii) additional non-deferrable expenses
such as consulting fees, appraisals and other costs associated with divisional
realignment which are not considered restructuring costs.
BUSINESSES HELD FOR SALE
Businesses Held for Sale include the operations of the Career Sales
Division, KIVEX, Professional, the United Life Assets and Marketing One. The
Career Sales Division, which includes the operations of Penn Life, markets and
underwrites fixed benefit accident and sickness products and, to a lesser
extent, life products through a sales force exclusive to the Company throughout
the United States and Canada. With the January 2, 1998, consummation of the
acquisition of the SW Financial Controlling Interest, the Company has integrated
Union Bankers, Marquette and Constitution with the Career Sales Division. KIVEX
is an internet service provider. Professional provides individual fixed benefit
and life products utilizing a network of independent agents primarily in the
southeastern United States through employer-sponsored payroll deduction
<PAGE>
programs. United Life principally markets fixed and variable annuities through
financial institutions and independent general agents, primarily in the southern
and western United States.
SELECTED PRO FORMA FINANCIAL INFORMATION
Year ended December 31,
------------------------------
1998 1997 1996
--------- -------- ---------
($ in thousands)
Revenues:
Policy revenues............................ $ 239,925 $263,680 $ 327,455
Net investment income...................... 147,201 154,087 160,767
Other income............................... 33,931 38,181 34,460
--------- -------- ---------
421,057 455,948 522,682
--------- -------- ---------
Benefits and expenses:
Total policyholder benefits................ 261,639 230,818 235,846
Insurance related expenses................. 86,718 93,359 103,288
Other operating expenses................... 91,023 86,400 93,669
--------- -------- ---------
439,380 410,577 432,803
--------- -------- ---------
Pre-tax operating income (loss)........... $ (18,323) $ 45,371 $ 89,879
========= ======== =========
Policy Revenues. Policy revenues declined 9.0% or $23.8 million to $239.9
million in 1998 compared to 1997. This followed a 19.5% or $63.8 million decline
in 1997 compared to 1996. 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. Union Bankers also accounts for nearly all of the $52.0 million of
the decrease in policy revenues in 1997 compared to 1996. 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 and a decrease of $6.4
million (4.3%) in 1997 compared to 1996 principally as a result of lower first
year sales.
Net Investment Income. Net investment income decreased $6.9 million (4.5%)
in 1998 compared to 1997 and decreased $6.7 million (4.2%) in 1997 compared to
1996. The decrease is primarily attributable to United Life, where net
investment income decreased $11.4 million in 1998 compared to 1997 and decreased
$5.3 million in 1997 compared to 1996. 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 $4.3 million (11.1%) to $33.9 million
in 1998 compared to 1997. Other income increased $3.7 million in 1997 compared
to 1996. The substantial decrease in other income in 1998 compared to 1997 is
attributable to 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. Also contributing to the decline in other income was
reduced revenues for Marketing One resulting from the cancellation of a number
of marketing relationships. These decreases are partially offset by increases in
revenue from KIVEX and increased fee income for United Life. The increase in
other income from 1997 compared to 1996 is principally attributable to Union
Bankers' amortization of deferred gain. The amortization was higher in 1997 due
to a full year amortization of the gain and higher than expected lapses of its
Medicare policies. The deferred gain was primarily generated as a result of a
June 1996 agreement.
Total Policyholder Benefits. Policyholder benefits increased $30.8 million
(13.4%) in 1998 compared to 1997. 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 has 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
<PAGE>
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 recently. With recent 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 $6.6 million to $86.7 million
in 1998 compared to 1997. This followed an $9.9 million (9.6%) decrease in 1997
compared to 1996. Amortization of present value of insurance in force decreased
$11.6 million 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 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. Most of the decrease in 1997 compared to 1996 relates
to a $14.5 million decrease in non-deferrable commissions at Union Bankers,
reflecting the Medicare reinsurance contract which ceded 80% of its Medicare
business including new sales, higher lapses, and the decision to stop selling
major medical and life policies. The Medicare reinsurance contract also resulted
in lower amortization of deferred policy acquisition costs and present value of
insurance in force at Union Bankers. However, this was more than offset by
increases in amortization of deferred policy acquisition costs and present value
of insurance in force at United Life and Professional primarily as a result of
higher than expected lapses.
Other Operating Expenses. Other operating expenses (including general
operating, overhead and policy maintenance) increased $4.6 million (5.4%) in
1998 compared to 1997. 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. Other operating expenses decreased $7.3 million (7.8%)
in 1997 compared to 1996. Union Bankers' expenses decreased $6.6 million
principally as a result of receiving an expense allowance on the Medicare
reinsurance contract for a full year in 1997 and only a partial year in 1996.
<PAGE>
GENERAL CORPORATE
Interest and Amortization of Deferred Debt Issuance Costs. Interest and
amortization of deferred debt issuance costs increased $4.3 million in 1998
compared to 1997. This 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. These are a direct result of the Company's current
financial position.
Corporate Expenses. Corporate expenses, eliminations and other costs were
$40.1 million, $23.9 million, and $0.3 million for the years ended December 31,
1998, 1997 and 1996, respectively. The increase 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 and 1996, 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
net loss derived by KB Management for the year ended December 31, 1998, was
effectively recognized as a 100% economic interest by the Company.
The strategic business evaluation and associated restructuring of the
Company begun 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 pre-tax
incremental costs ("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 and a $3.0 million write-off
associated with a small marketing entity which was shut down in anticipation of
the sale of Professional and not considered restructuring.
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. The effective tax rates (benefit) for the years ended
December 31, 1998, 1997 and 1996, were (0.8)%, 39.5% and 37.0%, respectively.
The significant change in the effective tax rate between 1998 and 1997 is
substantially due to the non-deductibility of the reduction in carrying value of
the assets associated with Businesses Held for Sale and an increase in the tax
valuation allowance, primarily representing unrecoverable net operating loss
carryforwards at certain non- life companies. The 1997 and 1996 effective rates
are higher than the statutory rate of 35% primarily due to non-deductible
amortization of costs in excess of net assets acquired and foreign taxes in
excess of foreign taxes utilized.
The 1996 consolidated life return of Constitution and its subsidiaries is
currently under examination by the Internal Revenue Service. Tax years prior to
1996 are closed by statute to examination for the Constitution consolidated life
insurance company tax group. The ultimate effect of the current examination is
not known at this time.
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, on a pro forma basis, of
$14.1 million, $19.3 million and $0.2 million, during 1998, 1997 and 1996,
respectively. During 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 $354.1
million and $275.7 million, respectively. During 1997, the Company liquidated
most of its equity holdings and private placement bond holdings.
<PAGE>
Item 7A Quantitative and Qualitative Disclosures about Market Risk Exposures of
Financial Instruments for the Retained Businesses
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, 1998,
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 Businesses Held for
Sale unless noted otherwise and include Southwestern Life for 1997.
INTEREST RATE RISK
Accumulation and Investment Oriented Insurance Products. General account
assets supporting accumulation and investment oriented insurance products total
$2,076.3 million or 70.2% and $2,253.7 million or 69.6% of total invested assets
at December 31, 1998 and 1997, 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, 1998, the weighted average
interest spread on interest sensitive insurance liabilities was 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 $634.4 million and $822.5 million as
of December 31, 1998 and 1997, 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 $1,441.9 million and $1,431.2 million at
December 31, 1998 and 1997, 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.
<PAGE>
Other Annuities. Assets aggregating $185.5 million and $191.6 million as
of December 31, 1998 and 1997, 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 $566.9 million
and $597.5 million of assets as of December 31, 1998 and 1997, 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. With the exception of 1996, interest rates have
generally been declining since 1994. Under scenarios in which interest rates
fall and remain at levels significantly lower than rates prevailing at December
31, 1998, 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 7.3% for the year ended December 31, 1998,
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.
The Company held $1,188.7 million and $1,152.5 million of mortgage-backed
bonds which represented 40.2% and 35.6% of total invested assets as of December
31, 1998 and 1997, 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 set 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 73.3% of the
<PAGE>
total insurance liabilities at December 31, 1998, had surrender penalties or
other restrictions and approximately 7.1% are not subject to surrender.
The Company seeks to maximize the total return on its investment 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, 1998 levels, the fair value of these insurance businesses, as
defined above, would be $54.4 million less than the fair value assuming no
change from the December 31, 1998 levels.
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, 1998 includes outstanding principal of
$114.6 million of unsecured 9 1/4% Senior Subordinated Notes due 2003 and $434.0
million of a revolving Bank Credit Facility maturing in 2000. The senior
subordinated notes carry fixed rates. Based on the interest rate exposure and
prevalent rules at December 31, 1998, a relative 300 basis point decrease in
interest rates would increase the fair value of fixed rate borrowed capital by
approximately $5.1 million. Interest expense on the revolving Bank Credit
Facility, which contains floating rate debt, will fluctuate as prevailing
interest rates change. At December 31, 1998, a relative 100 basis point increase
in interest rates would increase interest expense on a pre-tax basis by
approximately $4.3 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 $2,589.7
million and $2,719.0 million at December 31, 1998 and 1997, respectively. Of
those securities available for sale, 93.0% and 92.5% were rated BBB or above by
Standard & Poor's at December 31, 1998 and 1997, respectively.
<PAGE>
During the years ended December 31, 1998, 1997 and 1996, the Company,
inclusive of Businesses Held for Sale, sold $1,019.9 million, $801.1 million and
$373.7 million of fixed maturity and equity securities, and purchased $1,054.7
million, $1,021.5 million and $955.8 million of fixed maturity and equity
securities, respectively. Such sales and purchases were often effected to
improve the quality of the investment portfolio or to avoid prepayment risks. As
a result of the Company's decision to exit the private placement bond sector,
the Company transferred all of its remaining assets in the fixed maturities held
for investment portfolio to its fixed maturities available for sale portfolio as
of April 1, 1997. In accordance with Statement of Financial Accounting Standards
("SFAS") No. 115, the Company marked all assets subject to the transfer to fair
value resulting in an increase in shareholders' equity, net of applicable income
taxes, of approximately $1.8 million. During 1996, the Company sold one security
in its held for investment portfolio aggregating $4.9 million as a result of a
dramatic deterioration in its credit rating.
During 1997 and 1996, the Company had a portfolio of "trading securities"
to provide the Company with the opportunity to undertake interest rate hedging
strategies, to participate in short-term relative value trades and to invest in
special situations with the goal of generating short-term trading profits. As a
result of trading activities, the Company, inclusive of Businesses Held for
Sale, recognized $1.1 million and $1.3 million of profits during 1997 and 1996,
respectively. As of December 31, 1998 and 1997, the Company held no investments
in its trading portfolio.
Mortgage loans on real estate amounted to 1.3% and 1.8% of total invested
assets as of December 31, 1998 and 1997, respectively. The Company has
established a reserve for loan loss, which aggregated $4.3 million as of
December 31, 1998. As of December 31, 1998 and 1997, the Company had
non-performing loans amounting to $5.0 million and $0.7 million, respectively.
The Company is in various stages of foreclosure or sales of such loans. The
Company believes its current loan loss provision is adequate to cover any future
losses related to currently performing and non-performing loans.
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.
<PAGE>
Item 8.Financial Statements and Supplementary Data
Page
Management's Responsibility for Financial Statements. 52
PennCorp Financial Group, Inc. and Subsidiaries...... 54
Southwestern Financial Corporation and Subsidiaries.. 97
<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 and Chief Executive Officer Executive Vice President and Chief
Financial Officer
<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, 1998 and 1997, 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, 1998. 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, 1998 and 1997, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 1998, in conformity with generally accepted
accounting principles.
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
March 31, 1999
<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,
--------------------------------
1998 1997 1996
---------- -------- --------
<S> <C> <C> <C>
REVENUES:
Premiums, principally accident and sickness... $ 337,685 $254,020 $256,859
Interest sensitive policy product charges..... 121,473 91,546 91,231
Net investment income......................... 369,052 273,237 210,734
Other income.................................. 37,717 27,504 22,666
Net gains from the sale of investments........ 14,068 17,487 1,257
---------- -------- --------
Total revenues............................... 879,995 663,794 582,747
---------- -------- --------
BENEFITS AND EXPENSES:
Claims incurred............................... 308,432 202,472 188,727
Change in liability for future policy benefits
and other policy benefits................... 233,330 121,817 83,184
Amortization of present value of insurance in
force and deferred policy acquisition costs. 117,446 92,046 56,470
Amortization of costs in excess of net assets
acquired and other intangibles.............. 15,121 9,545 8,648
Underwriting and other administrative expenses 229,497 146,245 116,560
Interest and amortization of deferred debt
issuance costs.............................. 42,960 23,355 18,579
Restructuring charge.......................... 14,877 16,771 --
Impairment provision associated with assets of
Businesses Held for Sale.................... 342,960 -- --
---------- -------- --------
Total benefits and expenses.................. 1,304,623 612,251 472,168
---------- -------- --------
Income (loss) before income taxes, equity in
earnings of unconsolidated
affiliates and extraordinary charge........... (424,628) 51,543 110,579
Income taxes (benefits)...................... (3,369) 20,375 40,957
---------- -------- --------
Income (loss) before equity in earnings of
unconsolidated affiliates and
extraordinary charge.......................... (421,259) 31,168 69,622
Equity in earnings of unconsolidated affiliates -- 18,972 21,037
---------- -------- --------
Income (loss) before extraordinary charge....... (421,259) 50,140 90,659
Extraordinary charge (net of income taxes
of $900, $--and $1,277).................... (1,671) -- (2,372)
---------- -------- --------
Net income (loss)............................... (422,930) 50,140 88,287
Preferred stock dividend requirements........ 18,273 19,533 14,646
---------- -------- --------
Net income (loss) applicable to common stock.... $ (441,203) $ 30,607 $ 73,641
========== ======== ========
PER SHARE INFORMATION:
Basic:
Net income (loss) applicable to common stock
before extraordinary charge................. (15.17) 1.09 2.79
Extraordinary charge, net of income taxes.... (0.06) -- (0.09)
---------- -------- --------
Net income (loss) applicable to common stock.. $ (15.23) $ 1.09 $ 2.70
========== ======== ========
Common shares used in computing basic earnings
(loss) per share.............................. 29,091 28,016 27,208
========== ======== ========
Diluted:
Net income (loss) applicable to common stock
before extraordinary charge................. (15.17) 1.07 2.49
Extraordinary charge, net of income taxes.... (0.06) -- (0.07)
---------- -------- --------
Net income (loss) applicable to common stock.. $ (15.23) $ 1.07 $ 2.42
========== ======== ========
Common shares used in computing diluted
earnings (loss) per share..................... 29,091 28,645 35,273
========== ======== ========
COMPREHENSIVE INCOME (LOSS) INFORMATION:
Net income (loss)............................. $ (422,930) $ 50,140 $ 88,287
Change in unrealized foreign currency
translation gains (losses), net of income
taxes....................................... (6,089) (5,641) 568
Change in unrealized gains (losses) on
securities available for sale of
unconsolidated affiliate during the year..... -- 24,277 (6,045)
Change in unrealized holding gains (losses)
arising during the year on securities
available for sale, net of income taxes
(benefits) of ($4,818), $6,490 and ($1,828).. 5,602 27,185 (3,648)
Reclassification adjustments for gains included
in net income (loss)......................... (14,552) (15,890) (596)
---------- -------- --------
Total comprehensive income (loss) applicable to
common stock............................... $(437,969) $ 80,071 $ 78,566
========== ======== ========
</TABLE>
See accompanying Notes to Consolidated Financial Statements
<PAGE>
<TABLE>
PENNCORP FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share amounts)
<CAPTION>
As of December 31,
------------------------
1998 1997
---------- ----------
<S> <C> <C>
ASSETS:
Investments:
Fixed maturities available for sale, at fair value
(amortized cost $2,524,990 in 1998 and $2,618,515 in 1997) $2,589,714 $2,718,982
Equity securities available for sale, at fair value
(cost $2,008 in 1998 and $30,084 in 1997)............... 2,035 30,257
Mortgage loans on real estate, net of allowance of $4,295
in 1998 and $6,041 in 1997.............................. 36,882 240,879
Policy loans............................................. 207,490 145,108
Other investments........................................ 27,406 95,875
---------- ----------
Total investments ...................................... 2,863,527 3,231,101
Cash and cash equivalents.................................. 92,727 109,013
Accrued investment income.................................. 37,291 43,312
Accounts and notes receivable, net of allowance of $6,201
in 1998 and $9,025 in 1997............................... 14,319 46,655
Investment in unconsolidated affiliate..................... -- 183,158
Present value of insurance in force........................ 170,729 263,889
Deferred policy acquisition costs.......................... 139,708 310,117
Costs in excess of net assets acquired..................... 108,070 116,544
Income taxes, primarily deferred........................... 46,944 --
Other assets............................................... 136, 282 420,346
Assets of Businesses Held for Sale (including cash and
cash equivalents of $131,531)............................ 2,421,804 --
---------- ----------
Total assets ........................................... $6,031,401 $4,724,135
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY:
Liabilities:
Policy liabilities and accruals............................ $2,867,038 $3,289,925
Notes payable.............................................. 550,923 359,755
Income taxes, primarily deferred........................... -- 59,125
Accrued expenses and other liabilities..................... 110,945 135,227
Liabilities of Businesses Held for Sale.................... 2,066,554 --
---------- ----------
Total liabilities....................................... 5,595,460 3,844,032
---------- ----------
Mandatory redeemable preferred stock:
Series C, $.01 par value, $100 initial redemption value;
authorized, issued and outstanding-- in 1998 and
178,500 in 1997......................................... -- 19,867
Shareholders' equity:
$3.375 Convertible Preferred Stock, $.01 par value, $50
redemption value; authorized issued and outstanding
2,300,000 in 1998 and 1997............................... 112,454 110,513
$3.50 Series II Convertible Preferred Stock, $.01 par
value, $50 redemption value; authorized issued and
outstanding 2,875,000 in 1998 and 1997................... 141,673 139,157
Common stock, $.01 par value; authorized 100,000,000; issued
and outstanding 30,072,344 in 1998 and 28,860,206 in
1997..................................................... 301 289
Additional paid-in capital................................. 430,321 397,590
Accumulated other comprehensive income, net of income taxes 19,995 35,034
Retained earnings (deficit)................................ (234,921) 211,055
Treasury shares (1,105,369 in 1998 and 1,009,589 in 1997).. (32,391) (32,130)
Notes receivable and other assets secured by common stock.. (1,491) (1,272)
---------- ----------
Total shareholders' equity.............................. 435,941 860,236
---------- ----------
Total liabilities and shareholders' equity ............. $6,031,401 $4,724,135
========== ==========
</TABLE>
See accompanying Notes to Consolidated Financial Statements
<PAGE>
<TABLE>
PENNCORP FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(In thousands)
<CAPTION>
For the years ended December 31,
--------------------------------
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Convertible preferred stock:
Balance at beginning of year.................. $249,670 $249,670 $110,513
Issuance of convertible preferred stock....... -- -- 139,157
Accrual of dividends in arrears............... 4,457 -- --
--------- -------- --------
Balance at end of year....................... 254,127 249,670 249,670
--------- -------- --------
Common stock:
Balance at beginning of year.................. 289 286 229
Issuance of common stock...................... 10 1 56
Exercise of stock options..................... 2 2 1
--------- -------- --------
Balance at end of year....................... 301 289 286
--------- -------- --------
Additional paid-in capital:
Balance at beginning of year.................. 397,590 393,156 220,482
Issuance of common stock...................... 30,717 1,697 170,393
Exercise of stock options..................... 2,014 2,737 2,281
--------- -------- --------
Balance at end of year..................... 430,321 397,590 393,156
--------- -------- --------
Accumulated other comprehensive income:
Unrealized foreign currency translation
losses:
Balance at beginning of year................. (20,602) (14,961) (15,529)
Change in unrealized foreign currency
translation gains (losses)
during the year, net of income taxes....... (6,089) (5,641) 568
--------- -------- --------
Balance at end of year.................... (26,691) (20,602) (14,961)
--------- -------- --------
Unrealized gains on securities available for sale:
Balance at beginning of year................. 55,636 20,064 30,353
Change in equity in unrealized gains (losses)
on securities available for sale of
unconsolidated affiliate during the year... -- 24,277 (6,045)
Change in unrealized holding gains (losses) on
securities available for sale during the
year, net of income taxes.................. 5,602 27,185 (3,648)
Reclassification adjustments for gains included
in net income (loss)...................... (14,552) (15,890) (596)
--------- -------- --------
Balance at end of year.................... 46,686 55,636 20,064
--------- -------- --------
Total other comprehensive income.......... 19,995 35,034 5,103
--------- -------- --------
Retained earnings (deficit):
Balance at beginning of year.................. 211,055 186,032 117,987
Net income (loss)............................. (422,930) 50,140 88,287
Dividends on common stock..................... (2,860) (5,618) (5,630)
Accretion of dividends on preferred stock..... (18,273) (19,533) (14,646)
Redemption of Series C preferred stock........ (1,913) -- --
Earned portion of treasury stock awarded to
employees.................................. -- 34 34
--------- -------- --------
Balance at end of year..................... (234,921) 211,055 186,032
--------- -------- --------
Treasury shares:
Balance at beginning of year.................. (32,130) (3,370) (3,370)
Purchases of treasury stock................... (261) (28,760) --
--------- -------- --------
Balance at end of year..................... (32,391) (32,130) (3,370)
--------- -------- --------
Notes receivable and other assets secured by
common stock:................................. (1,491) (1,272) (1,500)
--------- -------- --------
Total shareholders' equity................. $ 435,941 $860,236 $829,377
========= ======== ========
</TABLE>
See accompanying Notes to Consolidated Financial Statements
<PAGE>
<TABLE>
PENNCORP FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
<CAPTION>
For the years ended December 31,
-----------------------------------
1998 1997 1996
----------- --------- ---------
<S> <C> <C> <C>
Cash flows from operating activities:
Income (loss) before equity in earnings of unconsolidated
affiliates and extraordinary charge......................... $ (421,259) $ 31,168 $ 69,622
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............................................ 342,960 -- --
Capitalization of deferred policy acquisition costs......... (128,592) (109,482) (98,140)
Amortization of present value of insurance in force,
deferred policy acquisition costs, intangibles,
depreciation and accretion, net.......................... 123,310 91,902 63,588
Increase (decrease) in policy liabilities and accruals and
other policyholder funds................................. 72,083 (1,644) 77,549
Sales of trading securities................................. -- 29,914 56,004
Other, net.................................................. 4,288 11,425 (16,476)
----------- --------- ---------
Net cash provided (used) by operating activities........... (7,210) 53,283 152,147
----------- --------- ---------
Cash flows from investing activities:
Cash and short-term investments acquired in acquisition of
businesses, net of cash expended of $82,771, $-- and $-- in
1998, 1997 and 1996......................................... 91,492 -- (99,596)
Purchases of fixed maturity securities held for investment..... -- -- (27,000)
Purchases of fixed maturity securities available for sale...... (1,049,341) (993,768) (920,430)
Purchases of equity securities available for sale.............. (5,391) (27,776) (8,398)
Maturities of fixed maturity securities held for investment.... -- -- 42,351
Maturities of fixed maturity securities available for sale..... 304,122 439,938 81,538
Sales of fixed maturity securities held for investment......... -- -- 4,910
Sales of fixed maturity securities available for sale.......... 987,788 777,960 368,331
Sales of equity securities available for sale.................. 32,062 23,121 5,328
Acquisitions and originations of mortgage loans................ (36,965) (44,375) (112,473)
Sales of mortgage loans........................................ 20,867 13,643 151,972
Principal collected on mortgage loans.......................... 50,794 54,145 21,657
Other, net..................................................... 21,203 (49,712) 75,915
----------- --------- ---------
Net cash provided (used) by investing activities........... 416,631 193,176 (415,895)
----------- --------- ---------
Cash flows from financing activities:
Additional borrowings.......................................... 203,000 250,000 177,161
Issuance of common stock....................................... 3 -- 155,450
Issuance of preferred stock.................................... -- -- 139,157
Purchases of treasury stock.................................... -- (28,760) --
Reduction of notes payable..................................... (126,839) (100,570) (330,624)
Redemption of preferred stock.................................. -- (14,705) --
Receipts from interest sensitive products credited to
policyholders' account balances.............................. 251,627 186,166 160,403
Return of policyholders' account balances on interest sensitive
products..................................................... (605,757) (461,888) (365,554)
Cash transferred on reinsurance ceded to an affiliate.......... -- (50,000) --
Other, primarily dividends, net................................ (16,210) (20,266) (14,399)
----------- --------- ---------
Net cash used by financing activities...................... (294,176) (240,023) (78,406)
----------- --------- ---------
Net increase (decrease) in cash............................ 115,245 6,436 (342,154)
Cash and cash equivalents at beginning of year................... 109,013 102,577 444,731
----------- --------- ---------
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).............................. $ 224,258 $ 109,013 $ 102,577
=========== ========= =========
Supplemental disclosures:
Income taxes paid (refunded)................................... $ 5,814 $ (1,554) $ (4,992)
Interest paid.................................................. 38,017 20,946 18,185
Non-cash financing activities:
Redemption of Series C Preferred Stock......................... $ 22,227 $ -- $ --
Securities issued in conjunction with acquisition.............. -- -- 14,999
Debt assumed with acquisition.................................. 115,015 -- --
Issuance of common stock associated with the acquisition of the
Fickes and Stone Knightsbridge Interests..................... 8,500 -- --
Other.......................................................... 261 1,281 948
</TABLE>
See accompanying Notes to Consolidated Financial Statements
<PAGE>
PENNCORP FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) BASIS OF PRESENTATION
PennCorp Financial Group, Inc. ("PennCorp," or the "Company") is an
insurance holding company. Through its wholly-owned life insurance subsidiaries;
Pennsylvania Life Insurance Company ("PLIC") and its wholly-owned subsidiary,
PennCorp Life Insurance Company (collectively referred to as "Penn Life");
Peninsular Life Insurance Company ("Peninsular"); Professional Insurance
Corporation ("Professional"); Pioneer Security Life Insurance Company ("Pioneer
Security") and its wholly-owned subsidiaries American-Amicable Life Insurance
Company of Texas and Pioneer American Insurance Company (Pioneer Security and
its subsidiaries collectively referred to as "AA Life"); Southwestern Financial
Corporation ("SW Financial") and its wholly-owned subsidiaries Southwestern Life
Insurance Company ("Southwestern Life"), Constitution Life Insurance Company
("Constitution"), Union Bankers Insurance Company ("Union Bankers"), and
Marquette National Life Insurance Company ("Marquette"); Security Life and Trust
Insurance Company, formerly Integon Life Insurance Corporation ("Security
Life"); Occidental Life Insurance Company of North Carolina ("OLIC"); United
Life & Annuity Insurance Company ("United Life"); 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"), an internet service provider, UC
Mortgage Corp. ("UC") and Cyberlink Development, Inc. ("Cyberlink").
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, United Life, UC, Cyberlink and Marketing One within a period not
likely to exceed one year (see Note 3 and 16 of Notes to Consolidated Financial
Statements), the assets and liabilities of the Career Sales Division, KIVEX,
Professional, United Life, UC, Cyberlink and Marketing One (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.
The Retained Businesses 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.
(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. 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
<PAGE>
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 and 1996, the Company carried a certain equity investment in
an affiliate on the equity basis of accounting as a result of its percentage
ownership and lack of voting control. Mortgage-backed fixed maturity securities
held for investment or available for sale are amortized using the interest
method including anticipated prepayments at the date of purchase. Significant
changes in estimated cash flows from original assumptions are reflected in the
period of such change. Mortgage loans on real estate are recorded at cost,
adjusted for amortization of premium or discount and provision for loan loss, if
necessary. Policy loans, short-term investments, and other investments are
recorded at cost.
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
1998 and 1997, the Company wrote off receivables totaling $1,960 and $6,605,
respectively.
Intangible Assets
During 1996, the Company implemented Statement of Financial Accounting
Standards ("SFAS") No. 121, "Accounting for the Impairment of Long-Lived Assets
and Assets to be Disposed of." This accounting standard modified the methodology
companies utilize to evaluate the carrying value of certain assets by requiring,
among other things, companies evaluate assets at the lowest level at which
identifiable cash flows can be determined.
The Company continually monitors the recoverability of the carrying value
of intangible assets using the methodology prescribed in SFAS No. 121. The
Company also reviews 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 the forecast undiscounted net cash flows of the
operation to which the assets relate, to the carrying amount, including
associated intangible assets, of such operation. If the operation 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 1998, the Company recognized an aggregate $342,960 non-cash charge
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."
<PAGE>
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.
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 $96,273
and $192,049 as of December 31, 1998 and 1997, 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 $31,024 and $44,606 as of December 31, 1998 and 1997,
respectively. Unamortized costs in excess of net assets acquired in the amount
of $22,792 were transferred to assets of Businesses Held for Sale in 1998 and
$114,514 was written off in connection with the impairment provision.
For each of the periods presented, the Company has made certain valuation
determinations with respect to pre- acquisition contingencies or allocations.
For the year ended December 31, 1998, the Company made a valuation determination
with respect to 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.
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.
For the year ended December 31, 1996, the Company determined the following
with respect to certain material acquisition contingencies or allocations: (i)
the Company incurred additional costs associated with the acquisition of United
Life of $2,500, which resulted in a corresponding increase to costs in excess of
net assets acquired, (ii) the Company decreased real estate and mortgage loan
loss valuations of Security Life by $6,800, which resulted in a decrease in
costs in excess of net assets acquired of $4,400 and deferred tax assets of
$2,400, and (iii) the Company increased certain policy reserves of Security Life
aggregating $10,000, which resulted in a corresponding increase to costs in
excess of net assets acquired of $10,000.
<PAGE>
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. The Company has been
closely monitoring the development of claims reserve experience for Penn Life.
The methodology previously utilized has experienced, what appears to be, a
deterioration of the adequacy of its 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.
Insurance Revenue Recognition
Accident and sickness insurance premiums are recognized as revenue ratably
over the time period to which premiums relate. Revenues from traditional life
insurance policies represent premiums which are recognized as earned when due.
Benefits and expenses are associated with earned premiums so as to result in
recognition of profits over the lives of the policies. This association is
accomplished by means of the provision for liabilities for future policy
benefits and the deferral and amortization of policy acquisition costs.
Revenues for interest sensitive products such as universal life and
annuity contracts represent charges assessed against the policyholders' account
balance for the cost of insurance, surrenders and policy administration.
Benefits charged to expenses include benefit claims incurred during the period
in excess of policy account balances and interest credited to policy account
balances.
Net Income (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.
<PAGE>
The Company adopted the disclosure requirements of SFAS No. 123,
"Accounting for Stock-Based Compensation," in 1996. This statement provides a
choice for the accounting of employee stock compensation plans. A company may
elect to use a new fair-value methodology, under which compensation cost is
measured and recognized in results of operations, or continue to account for
these plans under Accounting Principles Board ("APB") No. 25, "Accounting for
Stock Issued to Employees," and related Interpretations. Note 13 of the Notes to
Consolidated Financial Statements contains a summary of the pro forma effects to
reported net income applicable to common stock and earnings per share for 1998,
1997 and 1996, as if the Company had elected to account for employee stock
compensation plans utilizing the fair value methodology prescribed by SFAS No.
123.
Business Combinations
Business combinations accounted for as a purchase result in the allocation
of the purchase consideration to the fair values of the assets and liabilities
acquired establishing such fair values as the new accounting bases. Purchase
consideration in excess of the fair value of net assets acquired is allocated to
"costs in excess of net assets acquired." Should the fair value of the net
assets acquired exceed the purchase consideration, such excess is utilized to
reduce certain intangible assets, primarily "present value of insurance in
force." Allocation of purchase price is performed in the period in which the
purchase is consummated and may be preliminary. Adjustments resulting from
completion of the purchase allocation process affect the value of the assets and
liabilities acquired.
Foreign Currency Translation
The financial statement accounts of the Company's Canadian operations,
which are denominated in Canadian dollars, are translated into U.S. dollars as
follows: (i) Canadian currency assets and liabilities are translated at the
rates of exchange as of the balance sheet dates and the related unrealized
translation adjustments are included as 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.
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 is effective for all fiscal quarters of all years beginning after June
15, 1999. The Company is currently evaluating SFAS No.133 and has not determined
its effect on the consolidated financial statements.
In December 1997, the AICPA issued Statement of Position ("SOP") 97-3. SOP
97-3 provides: (1) guidance for determining when an entity should recognize a
liability for guaranty-fund and other insurance-related assessments, (2)
guidance on how to measure the liability, (3) guidance on when an asset may be
recognized for a portion or all of the assessment liability or paid assessment
that can be recovered through premium tax offsets or policy surcharges, and (4)
requirements for disclosure of certain information. This SOP is effective for
financial statements for fiscal years beginning after December 15, 1998. The
Company's present accounting methodology for guaranty fund and other reinsurance
assessments substantially conforms to the requirements of this SOP.
In March 1998, the AICPA issued SOP 98-1, "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use." This SOP provides
guidance for determining whether costs of software developed or obtained for
internal use should be capitalized or expensed as incurred. In the past, the
Company has expensed such costs as they were
<PAGE>
incurred. This SOP is also effective for fiscal years beginning after December
15, 1998. The Company is currently completing its evaluation of the financial
impact as well as the changes to its related disclosures.
Reclassifications
Certain prior year amounts have been reclassified to conform to the
current year presentation.
(3) ACQUISITIONS AND DISPOSITIONS
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, a former director and David J. Stone, a
director 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). Mr. Fickes will
receive consideration in the form of estimated annual interest payments, ranging
from $301 to $330, on April 15 each year through 2001 and will 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.
The Company acquired United Life in 1996 for a total purchase price of
$110,056 including expenses incurred of $9,706 and earnings through the date of
consummation of the acquisition of $3,608. The United Life acquisition has been
accounted for as a purchase transaction in accordance with generally accepted
accounting principles, the fair value of net assets acquired amounted to $82,580
(as adjusted) resulting in $27,476 (as adjusted) of costs in excess of net
assets acquired which will be amortized over 20 years.
Businesses Held for Sale
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.
The Career Sales Division is comprised in part of the operations of Penn
Life. With the acquisition in January 1998 of SW Financial, the Company has
integrated Union Bankers, Constitution and Marquette into the Career Sales
Division.
On December 31, 1998, the Company entered into a definitive agreement to
sell the Career Sales Division and related assets to Universal American
Financial Corp. ("Universal American"). The purchase price of $175,000 is
subject to adjustment based on the capital and surplus of the Career Sales
Division at the closing date. The purchase price consists of $136,000 in cash
and $39,000 initial principal amount, subject to adjustment, of subordinated
notes of Universal American. The subordinated notes will bear interest at a rate
of 8.0% per annum and will mature ten years from date of issuance. The accreted
value of the notes will be subject to offset in the event of adverse development
(or subject to increase in the event of positive development) in the disability
income reserves of PLIC and may be offset for other indemnification claims under
<PAGE>
the purchase and sale agreement. In addition, the Company is required under
terms of the purchase and sale agreement to deliver the Career Sales Division
and related assets with certain minimum levels of statutory capital and surplus,
pay certain ongoing costs and other expenses which will result in the Company
receiving net cash proceeds of approximately $70,000 to $78,000. For additional
information concerning the disability insurance reserves of PLIC, see Note 8 of
Notes to Consolidated Financial Statements.
Also on December 31, 1998, the Company signed a definitive agreement to
sell Professional. Professional, which previously was included in the Payroll
Sales Division, 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. Pursuant to the purchase
and sale agreement, Professional will be sold to GE Financial Assurance
Holdings, Inc. ("GEFAH") for $47,500 in cash. The purchase price is subject to
adjustment based on Professional's capital and surplus at the closing date. In
addition, GEFAH will pay interest on the purchase price from December 31, 1998
to the date of settlement. The Company currently estimates receiving net cash
proceeds for the Professional sale of approximately $40,000 to $41,500.
On February 21, 1999, the Company signed a definitive agreement to sell
United Life and its wholly-owned subsidiary, United Variable Services, Inc., to
ING America Insurance Holdings, Inc. ("ING"). United Life, which previously was
included in the Financial Services Division, principally markets fixed and
variable annuities through financial institutions and independent general
agents, primarily in the southern and western United States. The sale of United
Life to ING also includes the sale of UC, Cyberlink and certain assets of
Marketing One. The aggregate purchase price consists of $152,000 and a dividend
payable by United Life at closing, which the Company estimates will be
approximately $2,100. The purchase consideration may be reduced as a result of
the Company's obligation to purchase certain mortgages from United Life at
closing. Additionally, a portion of the purchase price may be escrowed at
closing to fund the Company's obligation to purchase additional mortgages from
United Life after closing. United Life, including its subsidiary United Variable
Services, Inc., UC, Cyberlink and certain assets of Marketing One are referred
to herein collectively as the "United Life Assets." The Company anticipates
receiving net cash proceeds from the sale of the United Life Assets of
approximately $140,000.
In the third quarter of 1998, the Company made the decision to sell KIVEX,
an internet service provider. The Company has engaged the investment banking
firm of ING Barings Furman Selz in this regard and is currently soliciting
interest from prospective purchasers. To date, the Company has not entered into
a definitive agreement to sell KIVEX. In addition, the Company has made the
decision to sell Marketing One, excluding those assets included with the sale of
United Life.
Separate selected pro forma financial information is presented in Note 17
to illustrate the effects of the purchase of the SW Financial Controlling
Interests and the Fickes and Stone Knightsbridge Interest as well as the sale of
Businesses Held for Sale for the years ended December 31, 1998 and 1997.
(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) impairment valuation associated with Businesses Held for
Sale, (iv) interest expense, (v) income taxes and (vi) 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 of
Notes to Consolidated Financial Statements). Segment data for 1997 and 1996 have
been restated to conform to the 1998 presentation.
<PAGE>
<TABLE>
<CAPTION>
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
Premiums and policy product charges:
Financial Services Division............ $ 129,242 $ 69,830 $ 71,758
Payroll Sales Division................. 89,991 89,699 83,747
Businesses Held for Sale (United States) 194,995 141,834 149,808
Businesses Held for Sale (Canada)...... 44,930 44,203 42,777
---------- ---------- ----------
$ 459,158 $ 345,566 $ 348,090
========== ========== ==========
Net investment income:
Financial Services Division............ $ 183,618 $ 90,787 $ 94,185
Payroll Sales Division................. 39,046 38,161 36,023
Businesses Held for Sale............... 147,201 138,355 75,860
Corporate.............................. (813) 5,934 4,666
---------- ---------- ----------
$ 369,052 $ 273,237 $ 210,734
========== ========== ==========
Operating profit (loss):
Financial Services Division............ $ 23,206 $ 27,756 $ 39,156
Payroll Sales Division................. (2,728) 23,960 22,796
Businesses Held for Sale............... (18,323) 37,479 63,840
---------- ---------- ----------
$ 2,155 $ 89,195 $ 125,792
========== ========== ==========
Amortization of present value of insurance
in force and deferred policy
acquisition costs:
Financial Services Division............ $ 26,122 $ 19,468 $ 9,996
Payroll Sales Division................. 37,977 24,271 13,078
Businesses Held for Sale............... 53,347 48,307 33,396
---------- ---------- ----------
$ 117,446 $ 92,046 $ 56,470
========== ========== ==========
Total assets:
Financial Services Division............ $2,823,007 $1,386,751 $1,529,821
Payroll Sales Division................. 695,777 751,261 732,871
Businesses Held for Sale (United States) 2,294,945 2,129,751 2,219,771
Businesses Held for Sale (Canada)...... 126,859 181,768 183,500
---------- ---------- ----------
$5,940,588 $4,449,531 $4,665,963
========== ========== ==========
</TABLE>
(Remainder of Page Intentionally Left Blank)
<PAGE>
Reconciliations of segment data to the Company's consolidated data are as
follows:
1998 1997 1996
-------- -------- --------
Total revenues:
Segments--premiums and policy product
charges.............................. $459,158 $345,566 $348,090
Segments--net investment income........ 369,052 273,237 210,734
Other income........................... 37,717 27,504 22,666
Net gain from sale of investments...... 14,068 17,487 1,257
-------- -------- --------
$879,995 $663,794 $582,747
======== ======== ========
Income (loss) before taxes, equity in earnings of unconsolidated affiliates
and extraordinary charge:
Segments............................... $ 2,155 $ 89,195 $125,792
Corporate expenses and eliminations.... (40,054) (15,013) 2,109
Impairment provision associated with
assets of Businesses Held for Sale... (342,960) -- --
Interest and amortization of deferred
debt issuance costs.................. (42,960) (23,355) (18,579)
Net gains on the sale of investments... 14,068 17,487 1,257
Restructuring costs.................... (14,877) (16,771) --
--------- -------- --------
$(424,628) $ 51,543 $110,579
========= ======== ========
Total assets:
Segments............................... $5,940,588 $4,449,531 $4,665,963
Corporate and other.................... 90,813 274,604 143,360
---------- ---------- ----------
$6,031,401 $4,724,135 $4,809,323
========== ========== ==========
(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>
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
========== ========== ========== ==========
<CAPTION>
1997
-------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Mortgage-backed securities, principally
obligations of U.S. Government agencies.... $1,242,805 % 46,157 $ 1,313 $1,287,649
U.S. Treasury securities and obligations of
U.S. Government corporations and agencies.. 135,255 7,551 120 142,686
Debt securities issued by foreign governments 66,635 7,188 12 73,811
Corporate securities........................ 1,173,820 49,164 8,148 1,214,836
---------- ---------- ---------- ----------
$2,618,515 $ 110,060 $ 9,593 $2,718,982
========== ========== ========== ==========
</TABLE>
<PAGE>
The amortized cost and fair value of fixed maturities available for sale
as of December 31, 1998, by contractual maturity, are shown below:
Amortized Fair
Cost Value
---------- ----------
Due in one year or less ............. $ 57,449 $ 57,946
Due after 1 through 5 years ......... 404,727 413,521
Due after 5 through 10 years ........ 439,041 453,840
Due after 10 years .................. 459,034 475,721
Mortgage-backed securities, principally
obligations of U.S. Government
agencies............................ 1,164,739 1,188,686
---------- ----------
$2,524,990 $2,589,714
========== ==========
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, 1998
and 1997, are below investment-grade securities with an amortized cost of
$177,263 and $165,511 and a fair value of $163,252 and $167,518, respectively.
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. Included in fixed maturities available for sale as of December 31, 1997
are unrated securities with an amortized cost and a fair value of $26,563.
As of December 31, 1998, net unrealized appreciation in equity securities
available for sale of $27 consisted of gross unrealized gains of $27. As of
December 31, 1997, net unrealized appreciation in equity securities available
for sale of $173 consisted of gross unrealized gains of $242, less gross
unrealized losses of $69.
The Company's commercial and residential mortgage portfolios had net
carrying values $36,882 and $240,879, respectively, and, fair values of
approximately $38,865 and $248,052, respectively, as of December 31, 1998 and
1997.
As of December 31, 1998, commercial and residential mortgage loan
investments were concentrated in the following states:
Percent of Total
Carrying Value Carrying Value
-------------- ----------------
Texas............................... $17,885 48.5%
North Carolina...................... 7,730 21.0
Kansas.............................. 2,250 6.1
Illinois............................ 1,926 5.2
Nevada.............................. 1,805 4.9
Alabama............................. 1,604 4.3
All other (less than 4% individually) 3,682 10.0
------- -----
$36,882 100.0%
======= =====
Investments with a carrying value of $146,385 and $68,219 were on deposit
with certain regulatory authorities as of December 31, 1998 and 1997,
respectively.
<PAGE>
Realized, and changes in unrealized gains and losses on investments were
as follows for the years ended December 31:
1998 1997 1996
------- -------- --------
Realized gains (losses) on dispositions of
investments:
Securities held for investment:
Gross gains from sales.................... $ -- $ -- $ --
Gross losses from sales................... -- -- (28)
Net gains (losses) from redemptions....... -- -- (105)
------- -------- --------
-- -- (133)
------- -------- --------
Securities available for sale:
Gross gains from sales.................... 20,509 22,076 2,562
Gross losses from sales................... (5,960) (6,186) (1,800)
Net gains (losses) from redemptions....... 3 -- (166)
------- -------- --------
14,552 15,890 596
------- -------- --------
Mortgage loans............................. (6,545) (284) 794
Other investments.......................... 6,061 1,881 --
------- -------- --------
Net realized gains...................... $14,068 $ 17,487 $ 1,257
======= ======== ========
Change in unrealized gains (losses):
Securities held for investment............. $ -- $ (2,429) $ 2,441
------- -------- --------
Securities available for sale.............. $(27,038) $ 44,627 $(18,250)
Securities available for sale of
unconsolidated affiliate................ -- 24,277 (6,045)
Less effect on other balance sheet accounts:
Value of business acquired, deferred
acquisition costs and other, principally
unearned revenue on interest sensitive
products............................... 13,270 (26,842) 12,178
Deferred income taxes (benefits).......... 4,818 (6,490) 1,828
------- -------- --------
Net change in unrealized gains.......... $(8,950) $ 35,572 $(10,289)
======= ======== ========
Trading portfolio:
Net gains (losses) from sales.............. $ -- $ (142) $ 4,930
Net change in unrealized gains (losses).... -- 1,258 (3,626)
------- -------- --------
Total net trading gains ................ -- $ 1,116 $ 1,304
======= ======== ========
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.
During 1996, the Company sold one security in its held for investment portfolio
aggregating $4,900 as a result of a dramatic deterioration in its credit rating
and realized a loss of $28.
Major categories of net investment income consisted of the following for
the years ended December 31:
1998 1997 1996
-------- -------- --------
Fixed maturity securities.................... $310,798 $231,867 $169,847
Mortgage loans on real estate ............... 27,773 26,498 11,888
Policy loans ................................ 16,235 9,037 8,409
Cash and cash equivalents.................... 9,016 6,366 12,966
Other investments............................ 13,553 9,177 13,100
-------- -------- --------
Gross investment income ................... 377,375 282,945 216,210
Less: investment expenses.................... 8,323 9,708 5,476
-------- -------- --------
Net investment income ..................... $369,052 $273,237 $210,734
======== ======== ========
<PAGE>
The Retained Businesses had non-income producing investments at December
31, 1998 with an amortized cost and fair value as follows:
Amortized Fair
Cost Value
--------- -------
Fixed maturities............................. $ 6,762 $ 605
Mortgage loans............................... 5,018 5,018
Other investments............................ 6,630 6,630
--------- -------
$ 18,410 $12,253
========= =======
(6) SOUTHWESTERN LIFE INVESTMENT
On December 14, 1995, SW Financial (see Notes 18 and 19 of the Notes to
Consolidated Financial Statements) 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 and 1996, 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 and $21,947 as of
December 31, 1997 and 1996, respectively.
On August 5, 1997, the Company purchased $40,000 of SW Financial Notes
from the liquidating trust for the creditors of ICH Corporation, SW Financial's
former parent. SW Financial had issued the SW Financial Notes as part of the
acquisition consideration paid to the liquidating trust. The SW Financial Notes
were purchased by the Company at par and were included in other investments as
of December 31, 1997. Interest due under the SW Financial Notes is currently set
at 7.0%, per annum.
On January 2, 1998, the Company acquired the SW Financial Controlling
Interest (see Note 3 of the Notes to Consolidated Financial Statements).
(Remainder of Page Intentionally Left Blank)
<PAGE>
The Company accounted for its investment in SW Financial utilizing the
equity method for the years ended December 31, 1997 and 1996. The consolidated
condensed results of operations for the years ended December 31, 1997 and 1996
and financial position of SW Financial at December 31, 1997, are provided below:
For the years ended
December 31,
1997 1996
---------- ----------
Revenues:
Policy revenues................................ $ 145,818 $ 196,912
Net investment income.......................... 126,427 128,692
Other income (including limited partnership
distributions of $15,811 in 1996)............ 16,039 27,439
Net gains from the sale of investments......... 1,841 516
---------- ----------
Total revenues............................ 290,125 353,559
---------- ----------
Benefits and expenses:
Claims incurred................................ 201,385 211,460
Change in liability for future policy benefits
and other policy benefits.................... (35,103) (13,616)
Insurance and other operating expenses......... 66,319 92,632
Interest and amortization of deferred debt
issuance costs.............................. 13,773 14,052
---------- ----------
Total benefits and expenses................. 246,374 304,528
---------- ----------
Income before income taxes..................... 43,751 49,031
Income taxes................................. 16,416 18,149
---------- ----------
Net income .................................... 27,335 30,882
Preferred stock dividend requirements........ 3,012 2,754
---------- ----------
Net income applicable to common stock.......... $ 24,323 $ 28,128
========== ==========
December 31,
1997
----------
Assets:
Invested assets.......................................... $2,026,768
Insurance assets......................................... 114,395
Other assets............................................. 283,717
----------
Total assets............................................. $2,424,880
==========
Liabilities and Shareholders' Equity:
Insurance liabilities.................................... $1,942,214
Long-term debt........................................... 154,750
Other liabilities........................................ 98,509
Redeemable preferred stock............................... 36,891
Shareholders' equity..................................... 192,516
----------
Total liabilities and shareholders' equity ............ $2,424,880
==========
<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:
1998 1997 1996
--------- -------- --------
Balance as of January 1.................... $ 310,117 $252,428 $185,570
Policy acquisition costs deferred:
Commissions............................... 86,441 59,238 49,775
Underwriting and issue costs ............. 42,151 50,244 48,365
Addition due to acquisition, including $171
of unrealized loss...................... 30,606 -- --
--------- -------- --------
469,315 361,910 283,710
Policy acquisition costs amortized ........ (79,291) (44,323) (30,744)
Unrealized investment loss adjustment ..... (1,213) (2,344) (461)
Foreign currency translation adjustment ... (1,038) (1,482) (77)
Reduction due to sale of blocks of business (4,129) (3,644) --
SFAS No. 121 impairment for Businesses Held
for Sale................................. (191,595) -- --
Amounts transferred to assets of Businesses
Held for Sale........................... (52,341) -- --
--------- -------- --------
Balance as of December 31................. $ 139,708 $310,117 $252,428
========= ======== ========
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.
<PAGE>
Information related to the present value of insurance in force is as
follows:
1998 1997 1996
-------- -------- --------
Balance as of January 1 ..................... $263,889 $339,010 $283,106
Addition due to acquisition, including $1,235
of unrealized loss......................... 58,564 -- 69,077
Accretion of interest ....................... 4,693 20,371 27,205
Amortization ................................ (42,848) (68,094) (52,931)
Transfer to unconsolidated affiliate pursuant
to reinsurance transaction................. -- (2,291) --
SFAS No. 121 impairment for Business Held for
Sale....................................... (98,164) -- --
Unrealized investment gain (loss) adjustment. 14,025 (24,444) 12,582
Foreign currency translation adjustment ..... (333) (663) (29)
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 ................. $170,729 $263,889 $339,010
======== ======== ========
Expected gross amortization of the present value of insurance in force,
based upon current assumptions and accretion of interest at a policy liability
or contract rate ranging from 3.5 to 14.5 percent, for the next five years is as
follows:
<TABLE>
<CAPTION>
Beginning Gross Accretion Net
Balance Amortization of Interest Amortization
--------- ------------ ----------- ------------
<S> <C> <C> <C> <C>
1999............................ $170,729 $27,757 $8,827 $18,930
2000............................ 151,799 25,078 7,951 17,127
2001............................ 134,672 22,372 7,187 15,185
2002............................ 119,487 20,347 6,477 13,870
2003............................ 105,617 18,653 5,821 12,832
</TABLE>
(8) FUTURE POLICY BENEFITS
The liability for future policy benefits consists of reserves for fixed
benefit, life and accumulation products. For interest sensitive life and annuity
products, the liability for future policy benefits is equal to the accumulated
fund value. Fund values are equal to the premium received and interest credited
to the fund value less deductions for mortality costs and expense charges.
Current declared interest rates credited range from 4.0 to 6.75 percent.
Mortality costs and expense charges are established by the Company based upon
its experience and cost structure and in accordance with policy terms.
For traditional life products, the liability for future policy benefits is
based primarily upon Commissioners' Standard Ordinary Tables with interest rates
ranging from 2.5 to 6.0 percent. Fixed benefit products establish a liability
for future policy benefits equal to the excess of the present value of future
benefits to or on behalf of the policyholder over the future net premium
discounted at interest rates ranging primarily from 4.5 to 8.0 percent.
Traditional life products and fixed benefit products future policy benefits may
also be determined using Company experience as to mortality, morbidity and
lapses with a provision for adverse deviation. The Company may vary assumptions
by year of policy issue.
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 $525,445
and $504,562 as of December 31, 1998 and 1997, respectively. If developing
trends were to continue, principally the less than expected level of the lapses
currently associated with such interest sensitive blocks, 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 approximately $9,000. Management is
also assessing the potential impact of future management actions, which might
mitigate the financial impact of these trends. Type of management actions would
likely include, but 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. The Company is
continuing to refine its actuarial estimates, likely management action plans and
associated sensitivity testing of such
<PAGE>
interdependencies on policy reserves associated with these contracts which could
result in changes in such estimates in the future.
Total future policy benefits consist of the following as of December 31,
1998 and 1997:
1998 1997
---------- ----------
Future policy benefits on traditional products:
Traditional life insurance contracts......... $ 671,637 $ 527,078
Health....................................... 10,824 40,628
Unearned premiums............................ 730 13,359
---------- ----------
683,191 581,065
---------- ----------
Interest sensitive products:
Universal life............................... 1,441,912 1,968,548
Annuities.................................... 634,370 527,507
---------- ----------
2,076,282 2,496,055
---------- ----------
Policy and contract claims:
Health....................................... 13,073 119,157
Life and other............................... 25,245 24,177
Other policyholder funds.................... 69,247 69,471
---------- ----------
Total future policy benefits................ $2,867,038 $3,289,925
========== ==========
The following table presents information on changes in the liability for
health claims for the years ended December 31:
1998 1997 1996
-------- -------- --------
Claim liability as of January 1........ $125,005 $130,392 $127,078
Less reinsurance recoverables........ 5,848 2,242 1,372
-------- -------- --------
Net balance as of January 1......... 119,157 128,150 125,706
-------- -------- --------
Addition due to acquisition............ 26,229 -- 1,079
-------- -------- --------
Add claims incurred during the year related to:
Current year......................... 116,170 60,727 63,673
Prior years.......................... 31,545 6,344 (6,816)
-------- -------- --------
Total claims incurred............... 147,715 67,071 56,857
-------- -------- --------
Less claims paid during the year related to:
Current year......................... 57,370 28,268 19,057
Prior years.......................... 65,736 47,796 36,435
-------- -------- --------
Total claims paid................... 123,106 76,064 55,492
-------- -------- --------
Less reduction for liabilities of Business
Held for Sale....................... 156,922 -- --
Net balance as of December 31.......... 13,073 119,157 128,150
Plus reinsurance recoverables........ 1,390 5,848 2,242
-------- -------- --------
Claim liability as of December 31... $ 14,463 $125,005 $130,392
======== ======== ========
As a result of changes in methodology (described below) and estimates of
insured events in prior years, the liability for health policy and contract
claims increased net of reinsurance by $31,545 in 1998 and $6,344 in 1997 and
decreased, net of reinsurance by $6,816 in 1996.
The Company has 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
<PAGE>
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 recently. With recent 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
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:
1998 1997
-------- --------
Unsecured 9 1/4% Senior Subordinated Notes
due 2003(a)................................... $114,646 $114,646
Revolving Bank Credit Facility maturing 2002(b). 434,000 242,000
Other........................................... 2,277 3,109
-------- --------
$550,923 $359,755
======== ========
--------------
(a)Interest costs under the Unsecured 9 1/4% Senior Subordinated Notes due
2003 (the "Notes") totaled $10,622, $11,461 and $13,545 during 1998,
1997 and 1996, respectively. As of December 31, 1998, the effective rate
for the Notes was approximately 9 1/4%.
(b)Interest costs under the $450,000 revolving credit facility totaled
$30,680 and $9,188 during 1998 and 1997. The effective rate of interest
as of December 31, 1998 was approximately 8.4%, including facility fees
of 0.75% as of December 31, 1998. During 1997 and 1996, the Company had
a $175,000 revolving credit facility for which it incurred interest
costs of $1,855 and $1,558, respectively.
The aggregate maturities of notes payable during each of the five years
after December 31, 1998, are as follows: 1999, $726; 2000, $728; 2001, $434,666;
2002, $157; and 2003, $114,646.
Covenants and Liquidity. The Notes and the revolving 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 of Notes to Consolidated Financial Statements), and requires
the Company to maintain specified financial ratios and meet specified financial
tests.
On March 30, 1999, the Company entered into an amendment (the "amendment")
to its existing Bank Credit Facility. The amendment provides for additional
covenants and revises certain financial covenants to the Bank Credit Agreement.
With the consummation of the amendment, the Company and its subsidiaries were in
compliance with all applicable covenants, as amended at December 31, 1998. In
addition, the amendment changes the maturity date of the Bank Credit Facility to
May 2000. Significant additional covenants include the requirement for the
Company to repay indebtedness at specified dates and amounts throughout 1999,
based upon anticipated dates and cash proceeds to be received from the
<PAGE>
consummation of the Career Sales Division, Professional and the United Life
Asset sales. The timing and required debt reduction follows:
Date Amount
---- ---------
April 30, 1999 $ 40,000
May 31, 1999 127,000
June 30, 1999 70,000
The Company's ability to meet the debt reduction covenants of the Bank
Credit Facility is dependent on being able to consummate the sales of Career
Sales Division, Professional and the United Life Assets (see Note 3 to Notes to
Consolidated Financial Statements) to generate sufficient cash proceeds. Failure
to consummate such transactions could result in action from ratings agencies,
state regulatory agencies, and/or creditors. Based upon current conditions and
circumstances, management intends and believes the Company has the ability to
consummate such sales to generate sufficient cash proceeds to meet the
covenants.
The amendment requires the Company to work with the bank group on
aggregating cash at the parent company level, provide information on asset sale
transactions, obtain the bank's consent to the potential sale of KIVEX and meet
certain cash flow payment requirements from the Surplus Note Companies on
specified dates. In addition, the amendment eliminates the Company's ability to
pay dividends on its common and preferred stock and severely limits ability of
the Company to effectuate the sale of capital securities or to borrow funds
available under the Bank Credit Facility. With respect to borrowings, the
Company may only borrow funds, up to $7,000, for the payment of interest under
the Bank Credit Facility and the Notes subject to certain restrictions. Upon
consummation of the Career Sales Division divestiture, the commitment will be
reduced to $5,000. Finally, the amendment modifies pricing spreads, fees and
other costs associated with the Bank Credit Facility. Total annualized interest
and associated costs with the Bank Credit Facility are expected to exceed LIBOR
based borrowing rates by approximately 400 basis points.
Projected Cash Sources and Uses in 1999. During 1999, the Company
anticipates receiving approximately $25,200 in the form of principal and
interest payments or dividends and tax sharing payments for the Surplus Note
Companies as a result of the ordinary dividend flow from the Surplus Notes
Companies insurance subsidiaries. In addition, the Company anticipates receiving
principal payments under the surplus debentures as a result of the sales of the
Career Sales Division, Professional and the United Life Assets by the Surplus
Note Companies. Total cash proceeds anticipated by the Company from such sales
aggregates approximately $258,500. The Company anticipates utilizing $237,000 to
repay indebtedness and the remainder of such proceeds to fund interest costs and
operating expenses of the parent company.
The Company's ability to receive principal and interest payments above
$25,200 under the surplus notes is contingent upon the Company's ability to
consummate each of the sales transactions of the Businesses Held for Sale
currently under contract. The Company has currently estimated net cash proceeds
after required debt reduction under the Company's Bank Credit Facility of
$21,100. Such liquidity is necessary for the Company to fund interest payments
under the Bank Credit Facility and the notes and to fund operating expenses of
the Company. Though the Company has the obligation to consummate the sales of
the Businesses Held for Sale and to prepay the loans to certain covenanted
levels, the Company may not have the requisite ability to effectuate the sale as
a result of the restrictive covenants contained in the Amended Bank Credit
Facility. The accessibility of the cash proceeds of the Businesses Held for Sale
are the subject of regulatory approval. While certain regulatory filings with
respect to the sale of the Businesses Held for Sale have been made, not all
filings have been so made and the final structure by which such proceeds will be
upstreamed to the Company have not yet been finalized. The Amended Credit
Agreement provides that the Company and its subsidiaries are limited from
entering into certain mergers, consolidations, amalgamations, liquidations,
winding up or dissolutions, incurring certain indebtedness and liabilities,
making disposition, prepaying certain indebtedness, declaring dividends, or
issuing, redeeming, purchasing, retiring, exchanging or converting capital
securities, in each case with very limited or scheduled exceptions. While the
Company believes it has scheduled or otherwise provided for a great majority of
the possible combinations it will take to effectively upstream the cash proceeds
of the sales of the Businesses Held for Sale, it is not possible to foresee all
combinations. Accordingly, the mechanism to upstream to the Company the
necessary cash to pay the covenanted prepayment under the Amended Credit
Agreement may be subject to the approval of the majority banks which, if not
given, would result in an event of default under the Amended Bank Credit
Agreement. Should the sale transactions not close within specified time periods,
the Company may face difficulty in meeting its existing and estimated cash
obligations and would be in default of certain covenants under the Bank Credit
Facility.
<PAGE>
The net proceeds available to the Company from the asset sales may vary
significantly from current estimates as a result of (i) minimum levels of
statutory capital and surplus required to be delivered at closing for certain
insurance subsidiaries, (ii) amounts to be held in escrow, (iii) valuation of
certain consideration to be received by the Company, (iv) the timing of the
closing and (v) various indemnification obligations included in each purchase
and sale agreement. Specifically, the purchase and sale agreement for the Career
Sales Division requires the purchaser to be satisfied with disability claims
reserve liabilities and other active life reserves. The Company has engaged an
actuarial consulting firm to provide analysis to the purchaser regarding such
reserves. The Company is aware of potential deficiencies aggregating
approximately $16,200 in the statutory determination of disability claims
reserves that will likely impact the total consideration the Company is to
receive. The Company and the purchaser have not engaged in discussions to
resolve the disability claims reserve issue. In addition, the purchase and sale
agreement for the United Life Assets requires the Company to purchase certain
residential mortgage loans from United Life, should the loans not meet specified
criteria under the purchase and sale agreement or should United Life not be able
to provide clear title to the loans. The residential loans are part of a
servicing agreement with United Companies Financial Corporation, the "servicer,"
which has recently filed for bankruptcy. The servicer currently maintains within
its control all applicable loan documents. Should the Company be unable to
obtain satisfactory control of all of the applicable documents, the Company's
anticipated net proceeds from the United Life Asset sale could be reduced by
approximately $12,600. Such reduction would have a material impact on the
liquidity of the Company.
As a result of these anticipated actions, management believes the Company
will likely have sufficient financial flexibility and projected liquidity
sources to meet all cash requirements for 1999. However, there can be no
assurances actual liquidity sources will develop as currently projected. In the
event of a shortfall of actual liquidity sources, the Company will explore
options to generate any necessary liquidity such as: (i) the sale of
non-strategic subsidiaries, (ii) obtain regulatory approval for extraordinary
dividends from its insurance subsidiaries (which is unlikely at the present
time) and (iii) borrowing on a secured basis. 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.
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.
For the year ended December 31, 1996, the Company realized an after-tax
extraordinary charge of $2,372. The charge represents (i) the write-off of $816
of deferred financing costs related to the retirement of certain indebtedness of
the Company and its subsidiaries, and (ii) the write-off of $1,556 of deferred
financing, swap cancellation and other costs related to the repurchase of
approximately $35,354 in principal amount of the Notes.
(10) INCOME TAXES (BENEFITS)
The Company and a number of its non-insurance subsidiaries file a
consolidated federal income tax return. Marketing One and its 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 as the parent of the particular consolidated life insurance company
tax group.
Total income taxes (benefits) were allocated as follows for the years
ended December 31:
1998 1997 1996
------- ------- -------
Income (loss) before income taxes, equity
in earnings of unconsolidated affiliates
and extraordinary charge................. (3,369) $20,375 $40,957
Extraordinary charge....................... (900) -- (1,277)
------- ------- -------
$(4,269) $20,375 $39,680
======= ======= =======
<PAGE>
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:
1998 1997 1996
-------- ------- -------
Current U.S.................................. $(12,031) $ 3,775 $(1,285)
Current foreign.............................. 778 3,598 2,319
Deferred U.S................................. 10,108 10,984 35,482
Deferred foreign............................. (2,224) 2,018 4,441
-------- ------- -------
Income tax expense (benefit)............... $ (3,369) $20,375 $40,957
======== ======= =======
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:
1998 1997 1996
--------- ------- -------
Tax expense (benefit) computed at statutory
rate....................................... $(148,620) $18,040 $38,702
Dividends received deduction................. (268) (1,450) (977)
Amortization of costs in excess of net assets
acquired................................... 3,678 3,341 3,040
Impairment on assets held for sale........... 116,886 -- --
Change in valuation allowance................ 23,492 (525) (1,265)
Foreign taxes net of U.S. tax benefit........ (181) 263 1,507
Other........................................ 1,644 706 (50)
--------- ------- -------
Income tax expense (benefit)............... $ (3,369) $20,375 $40,957
========= ======= =======
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>
1998 1997
------------------------ -----------------------
Deferred Deferred Deferred Deferred
Tax Tax Tax Tax
Assets Liabilities Assets Liabilities
-------- ----------- -------- -----------
<S> <C> <C> <C> <C>
Deferred policy acquisition costs.. $ -- $ 21,536 $ -- $ 90,151
Present value of insurance in force -- 55,248 -- 74,192
Future policy benefits............. 106,212 -- 62,131 --
Net operating losses............... 41,081 -- 38,584 --
Foreign and alternative minimum tax
credits......................... -- -- 22,851 --
Unrealized gain on investment
securities...................... -- 16,890 -- 20,140
Other.............................. 35,762 -- 19,133 1,593
-------- -------- -------- --------
183,055 93,674 142,699 186,076
Valuation allowance................ (44,784) -- (10,367) --
-------- -------- -------- --------
$138,271 $ 93,674 $132,332 $186,076
======== ======== ======== ========
</TABLE>
The valuation allowance for deferred tax assets as of December 31, 1998
and 1997, was $44,784 and $10,367, respectively. The net change in the total
valuation allowance for the years ended December 31, 1998 and 1997, was an
increase (decrease) of $23,492 and ($5,525) (including $5,000 that was used in
1997 to reduce costs in excess of net assets acquired), respectively. The 1998
increase in valuation allowance is largely attributable to deferred tax assets
resulting from net operating losses generated by the Company's non-life members.
During 1997, an additional $14,635 increase to the deferred tax asset was used
to reduce costs in excess of net assets acquired related to the Security Life
acquisition as acquisition date tax contingencies were resolved.
In assessing the realization of deferred taxes, management considers
whether it is more likely than not that some portion or all of the deferred tax
assets will be realized. The ultimate realization of deferred tax assets is
dependent on the generation of future taxable income during the periods in which
those temporary differences become deductible. Management considers the
scheduled reversal of deferred tax liabilities, projected future taxable income
and tax planning strategies in making this assessment. Based upon those
considerations, management has established a valuation allowance for all net
deferred tax assets associated with the non-life insurance members of its group.
Management believes it is more
<PAGE>
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, 1998.
The Company's recording of an impairment provision associated with the
Businesses Held for Sale results in a reduction in deferred tax liabilities of
$95,137 related to such assets.
As of December 31, 1998, the Company has life consolidated net operating
loss carryforwards of approximately $97,362 for tax return purposes, of which
$47,813 relates to Retained Businesses, which, if not utilized will begin to
expire in 2005. The Company has life consolidated capital loss carryforwards of
approximately $7,516 of which, $5,792 relates to Retained Businesses, which, if
not utilized, will expire in 2001. In addition, OLIC and Peninsular have
available, on a separate return basis, acquired net operating loss carryforwards
of approximately $10,417. The utilization of acquired net operating loss
carryforwards is limited in any one year to the lesser of (i) the life insurance
group's consolidated taxable income or (ii) the subsidiary's taxable income
computed on a separate return basis. The acquired net operating loss
carryforwards will expire in 2004 and 2005.
As of December 31, 1998, the Company has non-life consolidated net
operating loss carryforwards of approximately $60,860 for tax purposes which, if
not utilized, will begin to expire in 2012.
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 1, 1999, the
Clinton administration released its Fiscal Year 2000 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 ten 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
$14,805.
The 1996 consolidated life return of Constitution and its subsidiaries is
currently under examination by the Internal Revenue Service. Tax years prior to
1996 are closed by statute to examination for the Constitution consolidated life
insurance company tax group. The ultimate effect of the current examination is
not known at this time.
<PAGE>
(11) COMPUTATION OF EARNINGS (LOSS) PER SHARE
The following is a reconciliation of net income (loss) applicable to
common stock as well as common stock used to compute basic and diluted earnings
(loss) per share for the years ended December 31:
1998 1997 1996
--------- ------- -------
Reconciliation of net income (loss) applicable
to common stock:
Basic net income (loss) applicable to common
stock:
Net income (loss) applicable to common
stock before extraordinary charge..........$(439,532) $30,607 $76,013
Redemption of Series C Preferred Stock.... (1,913) -- --
--------- ------- -------
(441,445) 30,607 76,013
Extraordinary charge...................... (1,671) -- (2,372)
--------- ------- -------
$(443,116) $30,607 $73,641
========= ======= =======
Diluted net income (loss) applicable to common
stock:
Net income (loss) applicable to common stock
before extraordinary charge................$(439,532) $30,607 $76,013
Redemption of Series C Preferred Stock.... (1,913) -- --
--------- ------- -------
(441,445) 30,607 76,013
Common stock equivalents:
Convertible preferred stock dividend
requirements.......................... -- -- 11,788
--------- ------- -------
(441,445) 30,607 87,801
Extraordinary charge...................... (1,671) -- (2,372)
--------- ------- -------
$(443,116) $30,607 $85,429
========= ======= =======
1998 1997 1996
--------- ------- -------
Common stock used to compute basic and diluted
earnings (loss) per share:
Basic:
Shares outstanding beginning of period....... 28,860 28,648 22,880
Common stock issuance:
Issuance of 5,131 common shares on March 5,
1996..................................... -- -- 4,232
Acquisition of United Life (483,839 common
shares).................................. -- -- 212
Incremental shares applicable to Stock
Warrants/Stock Options..................... 374 143 74
Acquisition of the Fickes and Stone
Knightsbridge Interests.................... 346 -- --
Redemption of Series C Preferred Stock....... 521 -- --
Treasury shares.............................. (1,010) (775) (190)
--------- ------- -------
29,091 28,016 27,208
--------- ------- -------
Diluted:
Shares outstanding beginning of period....... 28,860 28,648 22,880
Common stock issuance:
Issuance of 5,131 common shares on March 5,
1996..................................... -- -- 4,232
Acquisition of United Life (483,839 common
shares).................................. -- -- 212
Incremental shares applicable to Stock
Warrants/Stock Options.................... 374 772 1,347
Acquisition of the Fickes and Stone
Knightsbridge Interests................... 346 -- --
Redemption of Series C Preferred Stock....... 521 -- --
Treasury shares.............................. (1,010) (775) (190)
Conversion of $3.375 Convertible Preferred
Stock at a rate of 2.2123 common shares
to 1 preferred share....................... -- -- 5,088
Conversion of $3.50 Series II Convertible
Preferred Stock at a rate of 1.4327 common
shares to 1 preferred share................ -- -- 1,704
--------- ------- -------
29,091 28,645 35,273
========= ======= =======
(12) COMMON AND PREFERRED STOCK
At December 31, 1998 the Company had 100,000,000 shares of $.01 par value
common stock authorized and 30,072,344 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.
<PAGE>
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 as of December 31, 1998.
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 and $2,267 of compensation
expense. As of December 31, 1998, the balance of deferred compensation was $484
and was recorded as an offset 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, two notes receivable secured by 7,500
shares of common stock were discharged and 88,280 shares of common stock were
abandoned as a result of the severance. The result was to increase treasury
stock, and decrease notes receivable secured by common stock, by $261.
The Company 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") on August 2, 1996.
The Series II Convertible Preferred Stock is convertible at the option of the
holder, unless previously redeemed, into 1.4327 shares of common stock for each
share, subject to adjustment in certain events. As of December 31, 1998, the
estimated fair value of the Series II Convertible Preferred Stock, based upon
market-maker quotes, was $23,431 or $8.15 per share.
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.
The Company 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") on July 14, 1995. The Convertible
Preferred Stock is convertible at the option of the holder, unless previously
redeemed, into 2.2124 shares of common stock for each share, subject to
adjustment in certain events. As of December 31, 1998, the estimated fair value
of the Convertible Preferred Stock, based upon active market quotes, was $20,125
or $8.75 per share.
As of December 31, 1998 and 1997, accrued and unpaid dividends on the
$3.375 Convertible Preferred Stock amounted to $3,558 and $1,617, respectively.
As of December 31, 1998 and 1997, accrued and unpaid dividends on the $3.50
Convertible Preferred Stock amounted to $4,193 and $1,677, respectively.
The Company has suspended the payment of cash dividends 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.
<PAGE>
(13) STOCK OPTIONS AND WARRANTS
The Company has established two management stock option plans, the 1992
Stock Option Plan which set aside up to 475,635 shares for grant and the 1996
Stock Option Plan which set aside up to 2,800,000 shares for grant. Options
granted under the 1992 Stock Option Plan are deemed to be in four equal units
which are earned over four years from the date of grant and are exercisable
during a one-year period immediately following the fourth anniversary of the
date of grant. The 1996 Stock Option Plan allows for awards of stock or options
subject to such terms, conditions, and restrictions, and/or limitations, if any,
as the Stock Option Committee of the Board of Directors deems appropriate.
The Company has also established a senior management 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, 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, 1998, 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 has established a U.S. Sales Manager incentive stock option
plan in which the senior sales manager of one of the Company's insurance
subsidiaries may earn stock options in the amount of 275,000 shares over a
five-year period, subject to achieving certain performance goals, in addition to
an initial grant of 100,000 options. Such options are vested immediately as
earned, except for the initial 100,000 which vest in September 1999, and option
prices range from $15 per share, for the initial 100,000 options, to the fair
value of the common stock of the Company on the date of grant for those shares
subject to performance goals 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>
1998 1997 1996
------------------ ----------------- ------------------
<S> <C> <C> <C> <C> <C> <C>
Number of shares subject to
option/warrant:
Outstanding at beginning
of year............... 3,344,477 $21.73 1,984,049 $11.56 2,148,599 $10.86
Granted.................. 1,244,072 $29.93 1,565,500 $32.34 44,000 $31.09
Expired/cancelled........ (542,500) $30.11 (46,303) $11.41 (59,000) $13.82
Exercised................ (616,572) $14.36 (158,769) $ 7.97 (149,550) $5.40
--------- --------- ---------
Outstanding at end of year 3,429,477 $24.70 3,344,477 $21.73 1,984,049 $11.56
========= ========= =========
Exercisable at end of year. 2,649,446 $22.47 2,037,067 $15.38 1,808,207 $11.40
========= ========= =========
Available for future grant
at end of year.......... 726,292 1,488,460 2,792,000
========= ========= =========
</TABLE>
<PAGE>
The following table summarizes information concerning outstanding and
exercisable options and warrants as of December 31, 1998:
<TABLE>
<CAPTION>
Options/Warrants Outstanding Options/Warrants Exercisable
----------------------------------------------- ----------------------------
Weighted Weighted Weighted
Range of Number Average Remaining Average Number Average
Exercise Prices Outstanding Contractual Life Exercise Price Exercisable Exercise Price
--------------- ----------- ----------------- -------------- ----------- --------------
<S> <C> <C> <C> <C> <C> <C>
$ 4.00 - $ 4.00 570,760 1.64 $ 4.00 570,760 $ 4.00
$15.00 - $23.50 647,500 3.80 $16.59 587,500 $15.96
$27.25 - $38.40 2,211,217 1.67 $31.45 1,490,561 $32.11
--------- ---------
3,429,477 2,648,821
========= =========
</TABLE>
(Remainder of Page Intentionally Left Blank)
<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>
1998 1997 1996
--------- --------- --------
<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)................................ $(439,532) $ 30,607 $ 76,013
Redemption of Series C Preferred Stock... (1,913) -- --
--------- --------- --------
(441,445) -- 76,013
Extraordinary charge..................... (1,671) -- (2,372)
--------- --------- --------
Net income (loss) applicable to common
stock (as reported)................... (443,116) 30,607 73,641
Pro forma compensation expense, net of
tax benefits.......................... (3,316) (10,229) (287)
--------- --------- --------
Net income (loss) applicable to common
stock (pro forma)..................... $(446,432) $ 20,378 $ 73,354
========= ========= ========
Diluted net income (loss) applicable to common
stock:
Net income (loss) applicable to common stock
before extraordinary charge (as reported). $(439,532) $30,607 $76,013
Redemption of Series C Preferred Stock... (1,913) -- --
--------- --------- --------
(441,445) 30,607 76,013
Common stock equivalents:
Convertible preferred stock dividend
requirements.......................... -- -- 11,788
--------- --------- --------
(441,445) 30,607 87,801
Extraordinary charge..................... (1,671) -- (2,372)
--------- --------- --------
Net income (loss) applicable to common
stock (as reported)................... (443,116) 30,607 85,429
Pro forma compensation expense, net of
tax benefits.......................... (3,316) (10,229) (287)
--------- --------- --------
Net income (loss) applicable to common
stock (pro forma)...................... $(446,432) $ 20,378 $ 85,142
========= ========= ========
Per share information:
Basic net income (loss) applicable to common
stock:
Net income (loss) applicable to common
stock before extraordinary charge (as
reported)................................ $ (15.17) $ 1.09 $ 2.79
Extraordinary charge..................... (0.06) -- (0.09)
--------- --------- --------
Net income (loss) applicable to common
stock (as reported)................... (15.23) 1.09 2.70
Pro forma compensation expense........... (0.11) (0.37) (0.01)
--------- --------- --------
Net income (loss) applicable to common
stock (pro forma)..................... $ (15.34) $ 0.72 $ 2.69
========= ========= ========
Common shares used in computing basic
earnings (loss) per share................... 29,091 28,016 27,208
========= ========= ========
Diluted net income (loss) applicable to
common stock:
Net income (loss) applicable to common
stock before extraordinary charge (as
reported).................................. $ (15.17) $ 1.07 $ 2.16
Common stock equivalents:
Convertible preferred stock dividend
requirements.......................... -- -- 0.33
Extraordinary charge..................... (0.06) -- (0.07)
--------- --------- --------
Net income (loss) applicable to common
stock (as reported)................... (15.23) 1.07 2.42
Pro forma compensation expense........... (0.11) (0.36) (0.01)
--------- --------- --------
Net income (loss) applicable to common
stock (pro forma)..................... $ (15.34) $ 0.71 $ 2.41
========= ========= ========
Common shares used in computing diluted
earnings (loss) per share................... 29,091 28,645 35,273
========= ========= ========
</TABLE>
<PAGE>
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 1998, 1997 and 1996:
1998 1997 1996
------- ------- -------
Weighted average risk-free interest rate..... 6.06% 6.34% 6.62%
Weighted average dividend yields............. --% --% --%
Volatility factors........................... 0.83 .61 .61
Weighted average expected life (years)....... 1.90 4.50 5.00
Weighted average fair value per share........ $15.02 $15.67 $18.57
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 and Pioneer Security
(collectively, the "Surplus Note Companies"). The amounts outstanding under the
surplus debentures totaled $453,118 and $358,346 as of December 31, 1998 and
1997, 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.
Dividend payments by the Company's insurance subsidiaries are limited by,
or subject to the approval of the insurance regulatory authority of each
subsidiary's state of domicile. Such dividend requirements and approval
processes vary significantly from state to state. In 1999, the Company's
retained insurance subsidiaries, subject to availability of cash, statutory
capital and surplus and regulatory approval, will be able to pay a maximum of
$25,848 in dividends to the Surplus Note Companies (including SW Financial).
Statutory capital and surplus of the Company's life insurance subsidiaries
as reported to regulatory authorities at December 31, 1998 and 1997, totaled
$399,766 and $299,062, respectively. Statutory net income (loss) of the
Company's life insurance subsidiaries as reported to regulatory authorities
totaled ($44,563), $18,776 and ($28,600) for the years ended December 31, 1998,
1997 and 1996, respectively. Surplus note interest expense of $40,531, $34,758
and $51,254 for the years ended December 31, 1998, 1997 and 1996, respectively,
is included in statutory net income (loss).
For the years ended December 31, 1998 and 1999 PLIC has received a
permitted statutory accounting practice allowing PLIC to utilize its own
experience and other modification factors in the determination of statutory
disability income claims reserves. If PLIC were to utilize the model regulation
for the determination of disability income claims reserves, management estimates
that the amount of additional statutory claims reserves necessary to be recorded
would be approximately $16,200. If PLIC were to record such additional reserves
on a statutory basis, its risk based capital would be reduced significantly
which in turn could lead to regulatory action. For the year ended December 31,
1999, PLIC will be required, in the event of the non-completion of the Career
Sales Division divestiture, to increase its disability claims reserves by
approximately $5,300 and receive capital contributions of at least $5,300 to
offset such reserve increases.
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, either the Model Act or similar
legislation or regulation has been adopted in all the domiciliary states of the
Company's insurance subsidiaries.
Calculations using the NAIC formula and the life insurance subsidiaries'
statutory financial statements as of December 31, 1998, indicate that each of
the insurance subsidiaries' capital exceeded RBC requirements, except for PLIC
(see Note 20 of Notes to Consolidated Financial Statements).
<PAGE>
(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 employer 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 employer 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, 1998, 1997 and 1996
amounted to $3,341, $1,483 and $1,520.
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 accrued or paid $3,390, $1,417 and $1,144 under this plan during the
years ended December 31, 1998, 1997 and 1996, respectively.
The Company and, through its wholly-owned subsidiary, SW Financial (as a
result of the acquisition of the SW Financial Controlling Interest, see Note 3
of Notes to Consolidated Financial Statements), 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
analysis of the accumulated benefit obligation and the liability for accrued
postretirement benefits for the year ended December 31, 1998 and 1997:
1998 1997
-------- -------
Benefit obligation at beginning of year...... $ 10,380 $11,059
Service cost................................. 184 --
Interest cost................................ 1,533 789
Plan participants' contributions............. 364 65
Actuarial (gain) loss........................ 1,975 (478)
Acquisition.................................. 14,827 --
Benefit paid................................. (2,661) (1,055)
-------- -------
Benefit obligation at end of year........... $ 26,602 $10,380
======== =======
The liability for accrued benefit obligation includes the following at
December 31, 1998 and 1997:
1998 1997
-------- -------
Accumulated benefit obligation............... $ 26,602 $10,380
Unrecognized prior service cost.............. 162 216
Unrecognized transition obligation........... (5,185) (4,202)
Unrecognized actuarial loss.................. 827 3,502
-------- -------
Benefit obligation at end of year........... $ 22,406 $ 9,896
======== =======
<PAGE>
Components of net periodic benefit cost include the following for the year
ended December 31, 1998 and 1997:
1998 1997
-------- -------
Service cost................................. $ 130 $ --
Interest cost................................ 1,533 789
Amortization of transition obligation........ 657 288
Recognized net actuarial loss................ (108) (147)
-------- -------
Net periodic benefit cost................... $ 2,212 $ 930
======== =======
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.
For measurement purposes, an annual rate increase ranging from 5.5% to 7%
in the health care cost trend rate was assumed for 1998; 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................................... $ 121 $ (104)
Effect on postretirement benefit obligation.... 1,544 (1,331)
(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, United Life, UC, Cyberlink and
Marketing One within a period not likely to exceed one year, the assets and
liabilities of the Career Sales Division, KIVEX, Professional, United Life, UC,
Cyberlink and Marketing One were reported as "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 of Notes to Consolidated
Financial Statements). 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................................. 249,105
----------
Total assets............................... $2,421,804
==========
Insurance liabilities........................ $1,853,163
Other liabilities............................ 213,391
----------
Total liabilities.......................... $2,066,554
==========
For the year ended December 31, 1998 the Company recorded the impairment
provision aggregating $342,960. In accordance with SFAS No. 121, the Company
recorded an impairment provision to reduce costs in excess of net assets
acquired 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 is based primarily upon the terms of
definitive sales agreements. The impairment provisions for costs in excess of
net assets acquired for the Career Sales Division, Professional and the United
Life Assets were $100,138, $3,263 and $11,113, respectively. To the extent that
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. The Company will continue to evaluate the terms and
conditions of the definitive agreements relative
<PAGE>
to its accounting basis in the Businesses Held for Sale and, as a result, may
need to reflect additional impairment provisions prior to ultimate disposition
of the 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 purchase of the SW Financial
Controlling Interest as well as the Fickes and Stone Knightsbridge Interests and
the sales of Career Sales Division, KIVEX, Professional, United Life, UC,
Cyberlink and Marketing One. The pro forma statements of operations for the
years ended December 31, 1998 and 1997 give effect to such purchases and sales
as if they had occurred on January 1, 1997. 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, 1997, or results which may occur in the future.
(Unaudited)
As Reported Pro Forma
1998 1998
----------- -----------
(In thousands, except
per share amounts)
Total revenues................................. $ 879,995 $449,868
Income (loss) before extraordinary charge...... (421,259) (66,328)
Income (loss) before extraordinary charge
applicable to common stock.................. (439,532) (84,601)
Per share information:
Net income (loss) before extraordinary
charge applicable to common stock-basic.... $ (15.17) $ (2.97)
Net income (loss) before extraordinary
charge applicable to common stock-diluted.. (15.17) (2.97)
(Unaudited)
As Reported Pro Forma
1997 1997
----------- -----------
(In thousands, except
per share amounts)
Total revenues................................. $663,794 $490,564
Income (loss) before extraordinary charge...... 50,140 (16,863)
Income (loss) before extraordinary charge
applicable to common stock.................. 30,607 (36,396)
Per share information:
Net income (loss) before extraordinary charge
applicable to common stock-basic........... $ 1.09 $ (1.30)
Net income (loss) before extraordinary charge
applicable to common stock-diluted......... 1.07 (1.27)
(18) RELATED PARTY TRANSACTIONS
Related party transactions described herein include those transactions not
included elsewhere in the Notes to Consolidated Financial Statements.
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.
<PAGE>
During 1998 the Company liquidated its common and preferred stock holdings
in ACO. Total proceeds received from the sale of the 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 Capital Fund I
investment in ACO.
The Company owns 66,555 shares of redeemable preferred stock of Portsmouth
Financial Group, Inc.
("Portsmouth") with a carrying value of $6,656. Southwestern Life may, subject
to regulatory approvals, make up to a $10,000 preferred equity investment in
Portsmouth. The preferred stock pays dividends of 18.0% of which 12% is in cash
with the remainder in the form of additional preferred stock. The shares are
mandatorily redeemable in June 30, 2002. Portsmouth underwrites, acquires and
holds to receipts of benefits, life insurance contacts covering individuals
facing terminal illnesses. Portsmouth is owned by KB Fund and its affiliates.
As of December 31, 1998, the Company invested a total of $12,641 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 $11,393 in future transactions sponsored by Wand
Partners.
For the years ended December 31, 1997 and 1996, PennCorp paid or accrued
$2,385 and $2,548 in transaction fees and expenses to KM related to the
Washington National, United Life and SW Financial transactions, respectively.
During 1997 and 1996, certain of the Company's affiliates and subsidiaries paid
management fees to KM amounting to $5,325 and $3,333, respectively. SW Financial
and United Life incurred KM investment advisory fees totaling $4,358 and $2,426
during 1997 and 1996, respectively. In addition during 1996, PennCorp received a
$1,000 stand-by commitment fee from SW Financial for contingent financing on a
real estate transaction. SW Financial did not draw upon the commitment which has
expired.
During 1998 and 1997, the Company's insurance subsidiaries paid management
and commitment fees aggregating $718 and $444, respectively, to investment funds
managed by a member of the Board of Directors.
Certain individuals, who are shareholders and directors of PennCorp, and
affiliates of these individuals, provide services to the Company. During 1997
and 1996, payments aggregating $250 and $250, respectively, were made to these
individuals and their affiliates for services provided in connection with the
Company's acquisition activity.
(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 $5,299,
$5,178 and $8,416 in 1998, 1997 and 1996, respectively.
Minimum lease commitments for the Retained Businesses are:
1999......................................... $ 3,821
2000......................................... 2,690
2001......................................... 2,676
2002......................................... 2,521
2003......................................... 2,375
2004 and thereafter.......................... 2,242
-------
Total minimum payments required........... $16,325
=======
In January 1996, stockholder derivative lawsuits styled Tozour Energy
Systems Retirement Plan v. David J. Stone et al and the PennCorp Financial
Group, Inc., C.A. No. 14775 (the "Tozour Case") and Lois Miller v. David J.
Stone et al, and the PennCorp Financial Group, Inc., C. A. No. 14795 (the
"Miller Complaint") were filed against the Company and each of its directors,
individually, in the Delaware Court of Chancery. The complaint in the Miller
suit was never served on the Company or the other defendants. Both suits allege
that the SW Financial Investment involved the usurpation of a corporate
opportunity and a waste of the Company's assets by Messrs. Stone and Fickes, and
that the directors of the Company in approving that transaction, failed to act
in good faith and breached their fiduciary duties, including the duty of loyalty
to the Company and its stockholders, having favored the interests of Messrs.
Stone and Fickes over the Company and its stockholders. These lawsuits sought
judgments against each of the defendants for the amount of damages sustained, or
to be sustained, by the Company as a result of the breaches of fiduciary duty
alleged in the complaint, the imposition of a constructive trust for the benefit
of the Company on profits or benefits obtained by any defendant through the
alleged breaches of fiduciary duty, attorney's fees and costs, and such other
relief as the court determines to be just, proper or equitable.
<PAGE>
The defendants and the plaintiffs' counsel entered into a stipulation of
settlement on March 28, 1997 (the "Original Proposed Settlement"). The Original
Proposed Settlement consisted of the following principal elements: (i) Messrs.
Stone and Fickes will cancel the 335,564 SW Financial common stock warrants they
hold for no consideration enabling PennCorp to purchase the SW Financial
Controlling Interest for $67,500, reducing the price to be paid by PennCorp for
the SW Financial Controlling Interest by approximately $2,000, (ii) the PennCorp
Board will proceed with the purchase of The Fickes and Stone Knightsbridge
Interests, having received a fairness opinion of a nationally recognized
investment banking firm with respect to the price to be paid for The Fickes and
Stone Knightsbridge Interests, (iii) the PennCorp Board will proceed with the
acquisition of the SW Financial Controlling Interest, having received a fairness
opinion of a nationally recognized investment banking firm with respect to the
price to be paid for the SW Financial Controlling Interest, (iv) the PennCorp
Board will submit the purchases of The Fickes and Stone Knightsbridge Interests
and the SW Financial Controlling Interest to a shareholder vote of a majority of
the PennCorp stockholders present at a meeting and entitled to vote, and
stockholders must approve both transactions, (v) Messrs. Stone and Fickes will
abstain from voting on the proposals to approve the purchase of The Fickes and
Stone Knightsbridge Interests and the SW Financial Controlling Interest, and
(vi) the plaintiffs' counsel will be entitled to conduct confirmatory discovery.
On December 1, 1997, the defendants and the plaintiffs' counsel agreed in
principle to amend the Original Proposed Settlement (as so amended, the "Amended
Proposed Settlement") following the PennCorp Board's conclusion that it would be
appropriate to increase the amount paid to the KB Fund for the SW Financial
Controlling Interest to compensate the limited partners for, among other things,
the unexpected and substantial delay in the consummation of the purchase of the
SW Financial Controlling Interest. The terms of the Amended Proposed Settlement
are identical to the terms of the Original Proposed Settlement, except that the
Amended Proposed Settlement provides that the Company will acquire the SW
Financial Controlling Interest for $73,658, and will provide a one-time "price
protection" payment associated with a disposition of the SW Financial
Controlling Interest by PennCorp during the 12-month period ending November 25,
1998. The Amended Proposed Settlement also requires Messrs. Stone and Fickes to
grant PennCorp a price protection right in the event of a sale of their
Portsmouth investment.
The Amended Proposed Settlement was subject to approval by the Chancery
Court after notice to PennCorp stockholders. As discussed above, Messrs. Stone
and Fickes agreed that, if the Amended Proposed Settlement was approved by the
Chancery Court, they would cancel their SW Financial common stock warrants and
they would not participate in the increased consideration (other than the
possible price protection right) for the SW Financial Controlling Interest to
the extent it relates to their $7,000 personal investment in SW Financial, which
together would reduce the price to be paid by PennCorp for the SW Financial
Controlling Interest by approximately $3,667. Because the Knightsbridge
restructuring would have the effect of substantially eliminating potential
future conflicts of interest between Messrs. Stone and Fickes and PennCorp, and
because the Amended Proposed Settlement would have the effect of reducing the
price paid for the SW Financial Controlling Interest and would obviate the need
to expend considerable management and director time to litigate the actions, the
PennCorp Board determined that the Amended Proposed Settlement was in the best
interests of PennCorp and its shareholders and conferred a substantial economic
benefit on PennCorp. Accordingly, the PennCorp Board authorized the payment to
plaintiffs' counsel of legal fees of $785 and documented expenses not to exceed
$50 in connection with the lawsuits and the related settlement negotiations.
The Amended Proposed Settlement was approved by the Chancery Court on May
12, 1998. The time period for filing an appeal had expired and the Company paid
$835 to plaintiffs counsel representing fees of $785 and documented expenses of
$50.
On August 25, 1998, the first of ten class-action complaints were filed in
the United States District Court for the Southern District of New York 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. Pursuant
to a schedule agreed to at the conference, 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 Chairman
and Chief Executive Officer, and Steven W. Fickes, formerly 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").
<PAGE>
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 a motion to dismiss the Complaint. Although there are not
assurances that the motion to dismiss will be granted, management believes that
there are meritorious defenses to the action that will be 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 all expenses and any
losses in excess of the $1,000 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.
The Company expects that this litigation will not affect its ability to
operate through December 31, 1999. 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 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.
On July 30, 1998, the SEC notified the Company that it has 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 nine 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.
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 changing 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 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 recently 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 change 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. No further
communications from the NCAG have been received to date. The Company has
initiated an exchange program which enables policyholders of such life insurance
products to terminate their policies and obtain either (i) the refund of all
premiums paid and other consideration or (ii) another Security Life product. See
Item 1. Business -- Regulatory Matters. There can be no assurances that the
exchange program will be successful or that the Company will resolve these
matters on such life insurance product 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.
In connection with a potential leveraged buyout of the Career Sales
Division, the sales force of Penn Life agreed to a reduction in the commission
rates over the life of the policy contract on new sales on and after January 1,
1998, in exchange for the opportunity to participate in the equity in a
newly-formed leveraged entity. Discussions have also been held relating to
equity incentive programs based on sales production and persistency measures.
Additionally, the Company has held discussions with a marketing organization,
which it has contracted with for the development and marketing of products
focused on the senior marketplace, concerning the issuance of equity in the
newly-formed leveraged entity based on a percentage of profits contributed by
such marketing organization. In connection with the Company's definitive
agreement to sell the Career Sales Division and related assets to Universal
American, the sales force of Penn Life and the marketing organization will
receive equity in Universal American and will participate in certain equity
incentive programs of Universal
<PAGE>
American. A portion of the proceeds to be received by the Company from Universal
American for the sale of the Career Sales Division will be used to fund the
equity of Universal American to be issued to the sales force of Penn Life and to
make certain other payments to the sales force in exchange for a release
relating to the potential leveraged buyout. If the Company does not consummate
its transaction with Universal American, then it will pursue alternatives with
the Penn Life sales force in light of the modifications to commissions
associated with new business production after January 1, 1998 and with the
marketing organization in light of the marketing contract.
The life insurance companies are required to be members of various state
insurance guaranty associations in order to conduct business in those states.
These associations have the authority to assess member companies in the event
that an insurance company conducting business in that state is unable to meet
its policyholder obligations. Assessments from guaranty associations, which have
not been material, are recorded as assessments when received.
In May 1998, the three senior executive of the Company entered into two
year employment agreements with the Company which have various annual bonus and
termination provisions. For the year ended December 31, 1998, the Company has
accrued compensation expense of $1,800 and $3,036 for the annual bonus and
termination provisions, respectively, of these employment agreements.
Termination provisions are payable upon the expiration of the employment
agreement or termination by the officer for "good reason" as defined in the
employment agreement.
Many computer and software programs were designed to accommodate only two
digit fields to represent a given year (e.g. "98" represents 1998). It is highly
likely that such systems will not be able to accurately process data containing
date information for the year 2000 and beyond. The 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 lead to a significant business interruption. Such
an interruption could result in a decline in current and long-term profitability
and business franchise value.
Although the Company believes that its operating divisions, outside
vendors and most critical business partners will be sufficiently compliant that
the year 2000 issue should not cause a material disruption in the Company's
business, there can be no assurance that there will not be material disruptions
to the Company's business or an increase in the cost of the Company doing
business. Although the Company believes that the year 2000 issues should not
cause a material disruption in the Company's business, the Company has developed
various contingency plans associated with remediation tasks which the Company
believes are at a higher risk for potential failure.
The Company has provided certain assurances to each respective purchaser
of the Businesses Held for Sale with respect to each entity's ability to process
date-sensitive information for the year 2000 and beyond. Although the Company
believes that it will be able to meet the year 2000 representations and
warranties provided to the respective purchasers, there can be no assurances.
Failure of the Company to meet such representations and warranties could result
in a decision by the purchaser not to consummate the transaction and/or
indemnification claims for breach of contract.
The Company has outstanding commitments to invest up to $7,600 in various
unaffiliated limited partnership funds and other investments.
The Company has a contingent obligation for mortgage loans previously sold
aggregating $5,905 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.
On September 30, 1998, PLIC entered into a financial reinsurance agreement
with an unaffiliated reinsurer to coinsure certain in force individual life and
health business written or acquired by PLIC prior to January 1, 1998. Such
<PAGE>
reinsurance provided PLIC with approximately $20,000 of additional statutory
capital and surplus allowing it to maintain its RBC at the "Company Action
Level" for the year ended December 31, 1998.
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:
1998 1997 1996
--------- --------- ---------
Direct policy revenues and amounts assessed
against policyholders...................... $ 586,317 $ 375,538 $ 358,825
Reinsurance assumed.......................... 6,018 2,527 1,320
Reinsurance ceded............................ (133,177) (32,499) (12,055)
--------- --------- ---------
Net premiums and amounts earned............ $ 459,158 $ 345,566 $ 348,090
========= ========= =========
Policyholder benefits ceded.................. $ 109,079 $ 33,612 $ 35,868
========= ========= =========
Fees incurred for financial reinsurance were approximately, $675 in 1998,
$145 in 1997, and $265 in 1996.
(21) RESTRUCTURING AND OTHER COSTS
The Company has developed restructuring plans to realign or consolidate
certain operations resulting in restructuring costs incurred during the fourth
quarter of 1998, the first quarter of 1998 and 1997. The restructuring was
necessary as a result of the tremendous growth of the Company and the resulting
diversification of the underlying businesses.
4th Quarter 1998 Plan
The Company recorded in the fourth quarter of 1998 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 year ended December
31, 1998 on the restructuring accrual balances under the 4th Quarter 1998 Plan:
<TABLE>
<CAPTION>
1998 Activities
-----------------------
Paid or
Charged 1998
1998 Against Ending
Provision Liability Adjustments Balance
--------- --------- ----------- -------
<S> <C> <C> <C> <C>
Severance and related benefits... $ 6,259 $ (3,985) $ -- $ 2,274
Estimated holding costs of
vacated facilities............ 2,954 (2,954) -- --
Estimated contract terminations
costs......................... 61 (29) -- 32
--------- --------- --------- -------
$ 9,274 $ (6,968) $ -- $ 2,306
========= ========= ========= =======
</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. It is anticipated that
all severance will be paid by September 30, 1999 with the exception of one
former executive officer whose severance will be paid monthly through December
2003. The Company had incurred costs of $3,985 which were charged against the
accrual during 1998 for terminated employees.
The fourth quarter 1998 plan recognized abandoned leasehold improvement
costs in connection with the Company's plan to shut down the New York offices.
The Company expensed $2,954 principally as a result of abandoning the New York
leased property.
<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 year ended December
31, 1998 on the restructuring accrual balances under the 1st Quarter 1998 Plan:
<TABLE>
<CAPTION>
1998 Activities
-----------------------
Paid or
Charged 1998
1998 Against Ending
Provision Liability Adjustments Balance
--------- --------- ----------- -------
<S> <C> <C> <C> <C>
Severance and related benefits... $ 3,831 $ (4,417) $ 1,205 $ 619
Estimated holding costs of
vacated facilities............. 2,205 -- -- 2,205
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
========= ========= ========= ========
</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 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 $4,417 against the severance accrual during 1998 as the result
of termination payments. In addition, during 1998 the Company increased the
severance accrual by $1,610 as a result of the decision to terminate all 54 of
Security Life's remaining Raleigh employees. This increase was partially offset
in the amount of $405, due to the Company paying less severance costs as a
result of natural attrition and other factors such as inter-company transfers of
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.
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
As a result of the tremendous growth of the Company and the
diversification of the underlying business units resulting from acquisition over
time, 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.
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.
<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 1997 Charged 1998
1997 Against Ending Against Ending
Provision Liability Adjustments Balance Liability Adjustments Balance
--------- --------- ----------- ------- --------- ----------- -------
<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 incurred approximately $6,296 and $4,652 of pre-tax
incremental 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.
<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, 1998 and 1997:
<TABLE>
<CAPTION>
1998 1997
----------------------- ----------------------
Carrying Fair Carrying Fair
Value Value Value Value
----------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Assets:
Cash and cash equivalents ........................ $ 92,727 $ 92,727 $ 109,013 $ 109,013
Fixed maturities ................................. 2,589,714 2,589,714 2,718,982 2,718,982
Equity securities ................................ 2,035 2,035 30,257 30,257
Mortgage loans ................................... 36,882 38,865 240,879 248,052
Policy loans ..................................... 207,490 207,490 145,108 145,108
Other investments ................................ 27,406 27,406 95,875 95,875
Accounts and notes receivable .................... 14,319 14,319 46,655 46,655
Liabilities:
Notes payable .................................... 550,923 497,039 359,755 364,914
Universal life and investment contract liabilities 2,063,823 1,756,762 2,496,055 2,092,348
</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 receivable 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 March 22, 1999, the Company received regulatory approval for the sale
of Professional. The Company anticipates the transaction, subject to certain
closing conditions, will be finalized on or about March 31, 1999.
<PAGE>
(24) UNAUDITED QUARTERLY FINANCIAL DATA
The following is a summary of the quarterly results of operations for the
years ended December 31, 1998 and 1997:
(In thousands, except per share amounts)
<TABLE>
<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)
<CAPTION>
1997 Quarter-ended March 31 June 30 September 30 December 31
- ------------------ -------- ------- ------------ -----------
<S> <C> <C> <C> <C>
Total revenues ........................................ $168,116 $ 163,608 $ 172,968 $ 159,102
Net income (loss) applicable to common stock........... $ 7,436 $ 13,209 $ 26,070 $ (16,108)
Net income (loss) per share of common
stock - basic ....................................... $ 0.26 $ 0.47 $ 0.93 $ (0.58)
Net income (loss) per share of common
stock - diluted ..................................... $ 0.25 $ 0.45 $ 0.80 $ (0.58)
</TABLE>
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.
The Company's fourth quarter 1997 reported loss was primarily a result of
reserve strengthening aggregating $12,373 associated with the Businesses Held
for Sale and certain non-recurring charges including transaction costs, period
restructuring costs and other costs aggregating $5,222, associated with the
Retained Businesses. In addition, the Company unlocked certain actuarial
assumptions on interest sensitive blocks of business resulting in additional
amortization of deferred policy acquisition costs and present value of insurance
in force amounting to $6,944.
<PAGE>
INDEPENDENT AUDITORS' REPORT
Board of Directors
Southwestern Financial Corporation:
We have audited the accompanying consolidated balance sheets of Southwestern
Financial Corporation and subsidiaries as of December 31, 1997 and 1996 and the
related consolidated statements of income, shareholders' equity, and cash flows
for the years then ended. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Southwestern
Financial Corporation and subsidiaries as of December 31, 1997 and 1996 and the
results of their operations and their cash flows for the years then ended in
conformity with generally accepted accounting principles.
KPMG Peat Marwick LLP
Dallas, Texas
March 19, 1998
<PAGE>
<TABLE>
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
as of December 31, 1997 and 1996
(In thousands, except share information)
<CAPTION>
1997 1996
---------- ----------
<S> <C> <C> <C> <C>
ASSETS
Investments:
Fixed maturities available for sale at fair value (cost$$1,643,769 $nd $1,270,507).................. $1,677,508 $1,255,270
Equity securities available for sale at fair value (cost $688 and $959)............................. 1,079 1,129
Mortgage loans on real estate, net of allowance of $680 in 1997 and $1,000 in 1996.................. 51,070 59,993
Policy loans ....................................................................................... 123,041 128,551
Short-term investments ............................................................................. 157,140 135,203
Collateral loans ................................................................................... -- 21,308
Real estate ........................................................................................ 1,893 7,649
Other investments .................................................................................. 8,461 5,553
---------- ----------
Total investments ................................................................................. 2,020,192 1,614,656
Cash ................................................................................................. 6,576 26,692
Due from reinsurers .................................................................................. 109,051 259,288
Accrued investment income ............................................................................ 25,224 20,802
Accounts and notes receivable, net of allowance of $181 and $5615,507 ................................ 13,773
Present value of insurance in force .................................................................. 58,565 71,333
Deferred policy acquisition costs .................................................................... 30,606 15,095
Deferred income taxes, net ........................................................................... 34,746 47,954
Other assets ......................................................................................... 19,025 18,549
Costs in excess of net assets acquired ............................................................... 115,388 119,760
---------- ----------
Total assets ...................................................................................... $2,424,880 $2,207,902
========== ==========
LIABILITIES
Policy liabilities and accruals:
Future policy benefits on traditional products ..................................................... $ 554,998 $ 584,179
Universal life and investment contract liabilities ................................................. 1,315,496 1,088,335
Policy and contract claims ......................................................................... 57,517 55,011
Other policyholder funds ........................................................................... 14,203 17,635
---------- ----------
Total policy liabilities and accruals ............................................................. 1,942,214 1,745,160
Federal income taxes payable ......................................................................... 1,298 9,118
Notes payable ........................................................................................ 154,750 159,750
Accrued expenses and other liabilities ............................................................... 97,211 118,119
---------- ----------
Total liabilities ................................................................................. 2,195,473 2,032,147
---------- ----------
Mandatorily redeemable preferred stock:
Series A 10%, $.01 par value, $100 redemption value; 500,000 shares authorized, 257,070 and 232,890
issued and outstanding at December 31, 1997 and 1996, respectively.............................. 25,707 23,289
5.5% preferred stock $.01 par value, $10,000 redemption value; 2,000 shares authorized, 1,118 and
1,059 shares issued and outstanding at December 31, 1997 and 1996, respectively.................. 11,184 10,590
SHAREHOLDERS' EQUITY
Common Stock, Class A, $.01 par value; 18,000,000 shares authorized; 3,500,000 shares issued and
outstanding......................................................................................... 35 35
Common Stock, Class B, non-voting $.01 par value; 10,000,000 shares authorized; 8,400,000 shares
issued and outstanding.............................................................................. 84 84
Additional paid in capital ........................................................................... 116,992 120,626
Unrealized gains (losses) on securities available for sale, net of tax (benefit) of $11,776 and
($4,224) ........................................................................................... 21,870 (8,081)
Retained earnings .................................................................................... 53,535 29,212
---------- ----------
Total shareholders' equity ........................................................................ 192,516 141,876
---------- ----------
Total liabilities and shareholders' equity ........................................................ $2,424,880 $2,207,902
========== ==========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
<PAGE>
<TABLE>
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
for the Years Ended December 31, 1997 and 1996
(In thousands)
<CAPTION>
1997 1996
-------- --------
<S> <C> <C>
Revenues:
Premiums ....................................... $103,138 $152,803
Interest sensitive policy product charges ...... 42,680 44,109
Net investment income .......................... 126,427 128,692
Net gains from sale of investments ............. 1,841 516
Other income, including $15,811 in earnings of
limited partnership in 1996.................. 16,039 27,439
-------- --------
Total revenues ................................ 290,125 353,559
-------- --------
Benefits and expenses:
Policyholder benefits incurred ................. 201,385 234,773
Change in liability for future policy benefits
and other policy benefits..................... (35,103) (36,929)
Amortization of present value of insurance
in force and deferred policy acquisition costs 21,589 23,392
Amortization of costs in excess of net assets
acquired....................................... 4,130 4,130
Underwriting and other administrative expenses.. 40,600 65,110
Interest and amortization of deferred debt
issuance costs 13,773 14,052
-------- --------
Total benefits and expenses ................... 246,374 304,528
-------- --------
Income before income taxes ....................... 43,751 49,031
Income taxes .................................. 16,416 18,149
-------- --------
Net income ....................................... 27,335 30,882
Preferred stock dividend requirements ......... 3,012 2,754
-------- --------
Net income available to common shareholders ...... $ 24,323 $ 28,128
======== ========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
<PAGE>
<TABLE>
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
for the Years Ended December 31, 1997 and 1996
(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, 1995...... $ 35 $ 84 $120,626 $ 2,413 $ 1,084 $124,242
Net income ....................... -- -- -- -- 30,882 30,882
Preferred dividends .............. -- -- -- -- (2,754) (2,754)
Unrealized loss on securities
available for sale, net ........ -- -- -- (10,494) -- (10,494)
------- ------- -------- ------- -------- --------
Balance at December 31, 1996 ..... 35 84 120,626 (8,081) 29,212 141,876
Net income ....................... -- -- -- 27,335 27,335
Preferred dividends .............. -- -- -- (3,012) (3,012)
Deemed dividend to eliminate
effects of reinsurance contract
with affiliate ................. -- -- (3,634) 4,161 -- 527
Unrealized gain on securities
available for sale, net ........ -- -- -- 25,790 -- 25,790
------- ------- -------- ------- -------- --------
Balance at December 31, $997...... $ 35 $ 84 $116,992 $21,870 $ 53,535 $192,516
======= ======= ======== ======= ======== ========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
<PAGE>
<TABLE>
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
for the Years Ended December 31, 1997 and 1996
(In thousands)
1997 1996
--------- --------
Cash flows from operating activities:
<S> <C> <C>
Net income ............................................... $ 27,335 $ 30,882
Adjustments to reconcile net income to net cash used by
operating activities:
Adjustments relating to universal life and investment
products:
Interest credited to account balances ................. 55,135 56,203
Charges for mortality and administration .............. (50,687) (50,689)
Capitalization of deferred policy acquisition costs ..... (24,808) (16,806)
Amortization of intangibles, depreciation and accretion,
net.................................................... 26,545 29,427
Decrease in policy liabilities, accruals and other
policyholder funds..................................... (24,319) (54,427)
Decrease in accrued expenses and other liabilities ...... (19,673) (7,477)
Decrease (increase) in notes and accounts receivable and
accrued investment income ............................. 3,844 (3,000)
(Decrease) increase in taxes payable .................... (7,820) 5,218
Deferred income taxes ................................... (836) 12,847
Equity in undistributed earnings of limited partnership . -- (15,811)
Net gains from sales of investments ..................... (1,841) (516)
Other, net .............................................. 5,330 7,916
--------- --------
Net cash used by operating activities ................. (11,795) (6,233)
--------- --------
Cash flows from investing activities:
Sales of fixed maturities available for sale ............. 201,402 52,085
Maturities and other redemptions of fixed maturities
available for sale .................................... 129,600 147,114
Sales of mortgages, real estate and other investments .... 7,512 57,278
Principal collected on mortgage loans and collateral
loans ................................................. 28,030 4,687
Change in short-term investments, net .................... (21,929) 19,369
Distributions from limited partnership ................... -- 53,520
Purchases of fixed maturities available for sale ......... (419,525)
Purchases of other investments ........................... (764) (694)
--------- --------
Net cash (used) provided by investing activities ...... (75,674) 9,774
--------- --------
Cash flows from financing activities:
Receipts from interest sensitive products credited to
policyholders' account balances ........................ 103,243 99,409
Return of policyholders' account balances on interest
sensitive products ..................................... (102,112) (117,806)
Cash provided by reinsurance recapture ................... 21,222 --
Cash provided by assumed reinsurance with affiliate ...... 50,000 --
Reduction of notes payable ............................... (5,000) (250)
--------- --------
Net cash provided (used) by financing activities ...... 67,353 (18,647)
--------- --------
Decrease in cash ........................................... (20,116) (15,106)
Cash at beginning of year .................................. 26,692 41,798
--------- --------
Cash at end of year ........................................ $ 6,576 $ 26,692
========= ========
Supplemental disclosures:
Income taxes paid ........................................ $ 25,072 $ 84
Interest paid ............................................ 12,305 12,714
Non-cash financing activities:
Preferred stock issued as dividends ...................... 3,012 2,754
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
<PAGE>
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997 and 1996
(In thousands)
1. Basis of Presentation
On December 14, 1995 (the acquisition date), Southwestern Financial Corporation
(SWF or the Company), a newly organized corporation, was formed by PennCorp
Financial Group, Inc. (PennCorp) and Knightsbridge Capital Fund I, L.P.
(Knightsbridge). A wholly-owned subsidiary of SWF acquired from I.C.H.
Corporation (ICH), Southwestern Life Insurance Company (Southwestern Life) and
its wholly-owned subsidiary, Constitution Life Insurance Company (Constitution)
and its 83% owned subsidiary, ICH Funding Corp. (ICH Funding), and Union Bankers
Insurance Company (Union Bankers) and its wholly-owned subsidiary, Marquette
National Life Insurance Company (Marquette). In addition, a wholly-owned
subsidiary of SWF acquired from ICH substantially all of the assets and
liabilities of Facilities Management Installation, Inc. (FMI), which had
provided management services to ICH's insurance companies. The acquisition was
accounted for as a purchase in accordance with generally accepted accounting
principles (GAAP) and, accordingly, the purchase price was allocated to assets
and liabilities acquired based on estimates of their fair value as of the
acquisition date, which became the new cost basis. Subsequently, the insurance
companies were reorganized such that Constitution became the parent of
Southwestern Life and Union Bankers. Effective January 2, 1998, PennCorp
acquired Knightsbridge's interest in SWF and SWF became a wholly-owned
subsidiary of PennCorp. (See Note 16).
In August 1997, the Company acquired from ICH the remaining 17% interest in ICH
Funding and certain other assets and released ICH from indemnification
obligations relative to certain tax, litigation and other matters. Minority
interest in ICH Funding, totaling $1,486 at December 31, 1996 is included in
accrued expenses and other liabilities as of December 31, 1996.
SWF and its subsidiaries market and underwrite a broad range of life insurance,
annuities and accident and health products to individuals through a sales force
of independent agents. The insurance subsidiaries are licensed to write business
in 48 states, the District of Columbia and Guam. Approximately 27.4% of the
total direct premium of the Company's insurance subsidiaries was generated from
business written in Texas. No other states accounted for more than 10% of the
direct premium of the Company in 1997.
The accompanying consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiaries. All significant intercompany accounts
and transactions have been eliminated.
The preparation of financial statements in conformity with GAAP requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and the reported amounts of revenues and expenses during
the reporting period. Accounts that the Company deems to be acutely sensitive to
changes in estimates include deferred policy acquisition costs, future policy
benefits, policy and contract claims and present value of insurance in force. In
addition, the Company must determine requirements for disclosure of contingent
assets and liabilities as of the date of the financial statements based upon
estimates. In all instances, actual results could differ from estimates.
2. Summary of Significant Accounting Policies
(a) Investments
Fixed maturity and equity securities classified as available for sale are
recorded at fair value, as they may be sold in response to changes in
interest rates, prepayment risk, liquidity needs, the need or desire to
increase income or capital and other economic factors. Changes in
unrealized gains and losses related to securities available for sale are
recorded as a separate component of shareholders' equity, net of
applicable taxes and amount attributable to deferred policy acquisition
costs and present value of insurance in force related to universal life
and investment-type products. Mortgage-backed securities are amortized
using the interest method including 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.
<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
<PAGE>
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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 and
$22,889 as of December 31, 1997 and 1996, respectively.
(g) Deferred Debt Issuance Costs
Deferred debt issuance costs, which are included in other assets,
represent costs incurred in connection with obtaining long-term debt
financing which have been capitalized and are being amortized on an
interest yield method over the terms of the respective debt. Deferred
costs totaled $2,530 and $3,309 which are net of accumulated amortization
of $1,580 and $801 at December 31, 1997 and 1996, respectively.
(h) Costs in Excess of Net Assets Acquired
Costs in excess of the fair value of net assets acquired are amortized on
a straight-line basis over 30 years. Accumulated amortization totaled
$8,260 and $4,130 at December 31, 1997 and 1996, respectively.
(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
<PAGE>
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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 and 1996 are listed below:
<TABLE>
<CAPTION>
1997 1996
------------------------ ------------------------
Percent of Percent of
Carrying Shareholders' Carrying Shareholders'
Value Equity Value Equity
-------- ------------- -------- -------------
<S> <C> <C> <C> <C>
Fund America Investors Corp., Ser. 93-C,
Class B Certificates ................. $19,271 10.0% $16,250 11.2%
James M. Fail and Stone Capital, Inc.
Collateral loans ..................... -- -- 21,308 14.7
</TABLE>
The amortized cost and fair value of investments in fixed maturities available
for sale at December 31, 1997 and 1996 by categories of securities are as
follows:
<TABLE>
<CAPTION>
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- -----
<S> <C> <C> <C> <C>
December 31, 1997:
Mortgage-backed securities ............................................ $ 820,837 $22,791 $(1,434) $ 842,194
U.S. Treasury securities and obligations of
U.S. Government corporations and agencies .......................... 27,492 91 (12) 27,571
Debt securities issued by states of the United States
and political subdivisions of the states ........................... 22,469 365 (130) 22,704
Debt securities issued by foreign governments ......................... 20,525 821 -- 21,346
Corporate debt securities ............................................. 752,446 14,664 (3,417) 763,693
---------- ------- ------- ----------
Total fixed maturities available for sale ........................... $1,643,769 $38,732 $(4,993) $1,677,508
========== ======= ======= ==========
</TABLE>
<PAGE>
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. Investments (Continued)
<TABLE>
<CAPTION>
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---------- ---------- ---------- -----
<S> <C> <C> <C> <C>
December 31, 1996:
Mortgage-backed securities .......................................... $ 609,593 $ 8,153 $ (7,304) $ 610,442
U.S. Treasury securities and obligations of
U.S. Government corporations and agencies ......................... 49,598 224 (343) 49,479
Debt securities issued by states of the United States
and political subdivisions of the states ......................... 15,226 -- (388) 14,838
Debt securities issued by foreign governments ....................... 22,698 176 (870) 22,004
Corporate debt securities ........................................... 573,392 1,429 (16,314) 558,507
---------- ------- -------- ----------
Total fixed maturities available for sale... ...................... $1,270,507 $ 9,982 $(25,219) $1,255,270
========== ======= ======== ==========
</TABLE>
The amortized cost and fair value of fixed maturities at December 31, 1997, by
contractual maturity, are shown below:
<TABLE>
<CAPTION>
Amortized Fair
Cost Value
--------- -----
<S> <C> <C>
Available for sale:
Due in one year or less ................................... $ 28,929 $ 28,921
Due after one year through five years ..................... 234,776 236,677
Due after five years through ten years .................... 272,127 275,248
Due after ten years ....................................... 287,100 294,468
---------- ----------
822,932 835,314
Mortgage-backed securities ................................ 820,837 842,194
---------- ----------
$1,643,769 $1,677,508
========== ==========
</TABLE>
Expected maturities will differ from contractual maturities because borrowers
may have the right to call or prepay obligations with or without prepayment
penalties.
Investments with a fair value of $119,695 and $121,617 were on deposit with
certain regulatory authorities at December 31, 1997 and 1996, respectively.
Included in fixed maturities available for sale at December 31, 1997 and 1996,
are below investment-grade securities with amortized costs of $71,467 and
$40,177, respectively, and fair values of $74,227 and $39,955, respectively.
Included in fixed maturities available for sale as of December 31, 1997, are
unrated securities with an amortized cost and fair value of $11,811.
During 1997, the Company purchased $7,650 of subordinated indebtedness of ACO
Acquisition Corp., which was subsequently re-named Acordia, Inc. (Acordia). The
Acordia subordinated notes pay interest on a current basis at 12.5% per annum,
payable in semi-annual installment. Acordia is an insurance broker specializing
in the marketing of commercial property and casualty programs. Acordia is 28.6%
owned by Knightsbridge.
In addition, during 1997, the Company acquired 41,605 shares of redeemable
preferred stock of Portsmouth Financial Group, Inc. (Portsmouth) for $4,161. The
preferred stock pays dividends of 18.0% of which 12.5% is in cash with the
remainder in the form of additional preferred stock. The shares are mandatorily
redeemable on June 30, 2002. Portsmouth underwrites, acquires, and holds to
receipt of benefits, life insurance contracts covering individuals facing
terminal illnesses. Portsmouth is owned by Knightsbridge and its affiliates. The
Company has agreed, subject to required regulatory approvals to make up to a
$10,000 preferred equity investment in Portsmouth.
<PAGE>
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. Investments (Continued)
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. At
December 31, 1996 net unrealized appreciation of $170 consisted of gross
unrealized gains of $207, less unrealized losses of $37.
Following is an analysis of net gains (losses) from sale of investments for the
years ended December 31, 1997 and 1996:
1997 1996
--------- ---------
Fixed maturities................. $ 553 $ 1,385
Equity securities................ -- (43)
Other investments................ 1,146 1,736
Real estate...................... 134 (125)
Mortgage loans................... -- (2,437)
Short-term investments........... 8 --
--------- ---------
$ 1,841 $ 516
========= =========
For the year ended December 31, 1997, net realized gains on sale of fixed
maturities consisted of gross gains of $2,779 and gross losses of $2,226. For
the year ended December 31, 1996, net realized gains on sale of fixed maturities
consisted of gross gains of $2,923 and gross losses of $1,538.
Following are changes in unrealized appreciation (depreciation) on investments
for the years ended December 31, 1997 and 1996:
1997 1996
--------- ---------
Investments carried at fair value:
Fixed maturities...................................... $ 48,976 $ (18,991)
Equity securities..................................... 221 194
Other investments..................................... (713) 1,652
--------- ---------
48,484 (17,145)
Eliminate effects from reinsurance contract with
affiliate ............................................ (4,161) --
Less effect on other balance sheet accounts:
Value of business acquired and deferred acquisition
costs .............................................. (2,768) 1,362
Deferred income taxes................................. (16,000) 5,524
Minority interest in unrealized losses................ 235 (235)
--------- ---------
Change in unrealized investment gains and losses........ $ 25,790 $ (10,494)
========= =========
<PAGE>
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. Investments (Continued)
Major categories of net investment income for the years ended December 31, 1997
and 1996 consist of the following:
1997 1996
--------- ---------
Fixed maturities...................................... $ 98,906 $ 87,348
Equity securities..................................... -- 58
Mortgage loans........................................ 5,490 11,156
Policy loans.......................................... 7,621 8,011
Short-term investments................................ 4,442 7,738
Collateral loans...................................... 2,218 2,947
Real estate........................................... 441 3,956
Investments held in trust under reinsurance treaty(a). 9,617 12,130
Other investments..................................... 1,250 1,503
Investment expenses................................... (3,558) (6,155)
--------- ---------
$ 126,427 $ 128,692
========= =========
--------------------
(a)Investments held in trust by a reinsurer with carrying values of $121,016
as of December 31, 1996, are included in amounts due from reinsurers. This
contract was recaptured during 1997 (see Note 10).
At December 31, 1997 and 1996 the Company held mortgage loans principally
involving commercial real estate with carrying values of $51,070 and $59,993,
respectively, net of an allowance for losses of $680 and $1,000 at December 31,
1997 and 1996, respectively. Estimated fair values of mortgage loans totaled
$51,816 and $59,993 at December 31, 1997 and 1996, respectively. The average
outstanding loan balances were approximately $1,027 and $955 at December 31,
1997 and 1996, respectively. At December 31, 1997 mortgage loan investments were
concentrated in the following states:
Percent of Total
Carrying Value Carrying Total
-------------- --------------
Texas .................................. $23,832 46.7%
Illinois ............................... 7,029 13.7
Oklahoma ............................... 4,915 9.6
Florida ................................ 3,180 6.3
Kansas ................................. 2,527 4.9
All other .............................. 9,587 18.8
------- -----
Balance, end of period ................. $51,070 100.0%
======= =====
During 1996, the Company had a limited partnership investment representing a 50%
interest in a partnership, GSSW, L.P. (GSSW) formed to acquire through auction
certain mortgage loans and real estate formerly held by failed savings and loan
associations. Effective December 31, 1996, GSSW liquidated the general partner
interests through distribution of certain assets at fair value, sold
substantially all remaining investments and utilized the proceeds to buy the
limited partnership interest not owned by the Company. As a result of these
transactions, the Company became the parent of GSSW, realized earnings on GSSW
of $13,171, received net cash distributions of $47,520 and paid PennCorp, a
shareholder, a fee of $1,000 as guarantor in GSSW's sale of assets.
<PAGE>
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. Investments (Continued)
Following is an analysis of the investment in the GSSW limited partnership for
the year ended December 31, 1996:
Balance, beginning of period............................... $ 39,600
Equity in operating earnings during year................... 3,640
Equity in earnings on transactions at December 31, 1996.... 13,171
Distributions during year.................................. (6,000)
Net distributions at December 31, 1996..................... (47,520)
--------
Balance, December 31, 1996................................. $ 2,891
========
At December 31, 1997 and 1996, the accounts of GSSW are consolidated into the
accompanying consolidated balance sheet.
4. Policy Liabilities and Accruals
For interest sensitive life products and annuity products, the liability for
future policy benefits is equal to the accumulated fund value. Fund values are
equal to the excess premium received and interest credited to the fund value
less deductions for mortality costs and expense charges. Current interest rates
credited range from 4% to 8%. Mortality costs and expense charges are
established by the Company based upon its experience and cost structure.
For traditional life products, the liability for future policy benefits has been
computed by the net level premium method based on estimated future investment
yield, mortality, and withdrawal experience. Reserve interest assumptions are
graded and range from 6.25% to 7.375%. For accident and health products,
liabilities for future policy benefits are established equal to the excess of
the present value of future benefits to or on behalf of policyholders over
future net premiums discounted at interest rates ranging primarily from 6.5% to
8.0%. The future policy benefits of traditional life products and accident and
health products are determined using mortality, morbidity and withdrawal
assumptions that reflect the experience of the Company modified as necessary to
reflect anticipated trends and to include provisions for possible unfavorable
deviations. The assumptions vary by plan, year of issue and duration.
The Company has carefully monitored a block of interest sensitive life policies
where overall financial performance was not satisfactory. During the third
quarter of 1997, management implemented certain corrective actions. These
actions included reduction in credited interest rates, increased monthly expense
charges and cost of insurance increases on selected policy forms. As a result,
reserves on this block were reduced approximately $17,000.
Policy and contract claims include provisions for reported claims in process of
settlement, valued in accordance with the terms of the related policies and
contracts, as well as provisions for claims incurred and unreported based on the
Company's prior experience.
While management believes the estimated amounts included in financial statements
for policy liabilities and accruals are adequate, such estimates may be more or
less than the amounts ultimately paid when the claims are settled. In addition,
the Company is involved in certain litigation regarding policyholder benefits.
The Company intends to vigorously defend its position relative to these claims;
however, if unsuccessful, the level of reserves currently provided could be
adversely effected.
<PAGE>
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. Policy Liabilities and Accruals (Continued)
Total policy liabilities and accruals consist of the following as of December
31, 1997 and 1996:
<TABLE>
<CAPTION>
1997 1996
---------- ----------
<S> <C> <C>
Future policy benefits on traditional products:
Traditional life insurance contracts ............... $ 335,283 $ 344,520
Traditional annuity products ....................... 105,663 105,246
Individual accident and health ..................... 87,152 104,071
Unearned premiums .................................. 26,900 30,342
---------- ----------
Total future policy benefits ...................... 554,998 584,179
---------- ----------
Universal life and investment contract liabilities:
Universal life and annuities ....................... 1,315,333 1,086,632
Guaranteed investment contracts .................... 163 1,703
---------- ----------
Total universal and investment contract liabilities 1,315,496 1,088,335
---------- ----------
Policy and contract claims ........................... 57,517 55,011
Other policyholder funds ............................. 14,203 17,635
---------- ----------
Total policy liabilities and accruals ............. $1,942,214 $1,745,160
========== ==========
</TABLE>
The following table presents information on changes in the liability for policy
and contract claims for the years ended December 31, 1997 and 1996:
1997 1996
-------- --------
Policy and contract claims at January 1 $ 55,011 $ 62,140
Less reinsurance recoverables .......... 153 118
-------- --------
Net balance at January 1 ............. 54,858 62,022
-------- --------
Add claims incurred, net of reinsurance
related to:
Current year ......................... 81,168 91,496
Prior years .......................... (6,012) (2,646)
-------- --------
75,156 88,850
-------- --------
Deduct claims paid, net of reinsurance
related to:
Current year ......................... 58,658 52,240
Prior years .......................... 13,839 43,774
-------- --------
72,497 96,014
-------- --------
Policy and contract claims, net of
related reinsurance recoverables at
December 31 ......... ............... 57,517 54,858
Plus reinsurance recoverables .......... -- 153
-------- --------
Policy and contract claims at December 31 $ 57,517 $ 55,011
======== ========
As a result of changes in estimates of insured events in prior years, the
liability for policy and contract claims decreased, net of reinsurance, by
$6,012 in 1997 and $2,646 in 1996.
<PAGE>
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. Notes Payable
The outstanding principal amounts of notes payable at December 31, 1997 and 1996
consist of the following:
1997 1996
-------- --------
Revolving bank debt .............................. $ 90,250 $ 95,000
Bank debt with quarterly principal requirements .. 24,50 24,750
7.0% convertible subordinated note ............... 40,000 40,000
-------- --------
$154,750 $159,750
======== ========
Interest costs under the revolving bank debt totaled $7,860 and $8,128 for the
years ended December 31, 1997 and 1996, respectively. The interest rate of the
debt is based on, at the Company's option, either a floating rate (based on the
base rate of the First National Bank of Chicago) plus a margin of 1.75% or a
Eurodollar rate (based on the London Interbank Offered Rate or LIBOR) plus a
margin of 2.75%. At December 31, 1997, the effective rate of the revolving loan
was approximately 9.13%. The revolving bank debt was repaid on January 2, 1998.
Interest costs under the bank term debt totaled $2,229 and $2,250 for the years
ended December 31, 1997 and 1996, respectively. The interest rate of the term
debt is based on, at the Company's option, either a floating rate (based on the
base rate of the First National Bank of Chicago) plus a margin of 2.25% or a
Eurodollar rate (based on LIBOR) plus a margin of 3.25%. At December 31, 1997,
the effective rate of the term loans was approximately 9.63%. The bank term debt
was repaid on January 2, 1998.
As part of the consideration for the acquisition of Southwestern Life, Union
Bankers, Constitution and Marquette from ICH, the Company issued to ICH a
$40,000 aggregate principal amount of SWF's 7.0% Convertible Subordinated Notes
due 2005. The notes are convertible into an aggregate 3,200,000 shares of common
stock of SWF, of which 800,000 will be Class B non-voting common stock. In the
aggregate the shares upon conversion represent approximately 21.2% of SWF's
fully diluted shares at closing before giving effect to certain warrants
outstanding. During 1997, PennCorp acquired the notes from the liquidating trust
for the creditors of ICH for $40,000 plus accrued interest. The Convertible
Notes are unsecured obligations and are subordinate in right of payment to SWF's
bank debt and all of the indebtedness of SWF. Interest costs under the
Convertible Notes totaled $2,800 for the years ended December 31, 1997 and 1996.
The Company agreed to maintain sufficient cash and cash equivalents to fund the
interest payments on the Convertible Notes for the first three years. At
December 31, 1997 and December 31, 1996, restricted cash and short-term
investments totaled $3,339 and $5,959, respectively.
In conjunction with the bank debt, the Company entered into interest rate
protection agreements in the form of a series of interest rate caps in the
notional amount of $62,500 which expire May 1998. These entitle the Company to
revenue should three-month LIBOR exceed the cap rate of 7.5%. At December 31,
1997, three-month LIBOR was 5.81%.
6. Preferred and Common Stock
On December 14, 1995, the Company issued 210,000 shares of Series A preferred
stock with a liquidation value of $21,000 to PennCorp and one of its
subsidiaries. The Series A preferred stock accrues dividends at a rate of 10.0%
per annum, compounded quarterly and is mandatorily redeemable at December 31,
2005. Dividends on the Series A preferred stock are payable in cash, or at SWF's
option, are payable in kind. The Series A preferred stock is not redeemable at
the option of the Company but at maturity will be required to be redeemed for
approximately $56 million in cash assuming no cash dividend distributions. If
the Company fails to satisfy its mandatory redemption obligation, the holders of
the Series A preferred stock
<PAGE>
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. Preferred and Common Stock (Continued)
will be entitled to elect 49.0% of the members of the Board of SWF and, upon
receipt of regulatory approval, a majority of the directors of SWF. The Series A
preferred stock is senior preferred stock. The holders of the Series A preferred
stock are entitled to class voting rights under certain circumstances, including
in connection with a merger of SWF or a sale of all or substantially all its
assets or the authorization or issuance of senior or pari passu preferred stock,
and as otherwise provided by law. For the years ended December 31, 1997 and
1996, 24,180 and 21,900 additional shares were issued with a redemption value of
$2,418 and $2,190, respectively in lieu of cash to satisfy dividend
requirements.
In addition, certain of PennCorp's insurance subsidiaries purchased $10,000
liquidation value of 5.5% Mandatorily Redeemable Preferred Stock, par value
$0.01 per share (the 5.5% Preferred Stock) of Southwestern Life Acquisition
Corporation, a wholly-owned subsidiary of SWF. During 1996 SLAC was dissolved
and the 5.5% Preferred Stock was exchanged for 5.5% Preferred Stock of
Southwestern Life Companies, Inc. (SLC), also a wholly-owned subsidiary of SWF.
The 5.5% Preferred Stock accrues dividends payable in cash or, subject to
certain conditions, through the issuance of additional shares of 5.5% Preferred
Stock. The 5.5% Preferred Stock is not subject to optional redemption and
matures on December 31, 2005. If SLC fails to satisfy its mandatory redemption
obligation or if dividends payable on the 5.5% Preferred Stock are in arrears
for four or more quarterly dividend periods, the holders of the 5.5% Preferred
Stock will be entitled to elect 49.0% of the members of the Board of Directors
of SLC and, upon receipt of regulatory approval, a majority of the Board of
Directors of SLC. The 5.5% Preferred Stock is the only preferred stock of SLC
authorized for issuance. The holders of the 5.5% Preferred Stock are entitled to
class voting rights under certain circumstances, including in connection with a
merger of SLC or a sale of all or substantially all its assets or the
authorization or issuance of senior pari passu preferred stock, and as otherwise
provided by law. For the years ended December 31, 1997 and 1996, 59 and 59
additional shares were issued with a redemption value of $594 and $590,
respectively in lieu of cash to satisfy dividend requirements.
7. Income Taxes
The Company and its non-insurance subsidiaries file a consolidated federal
income tax return. The Company's life insurance subsidiaries also file a
consolidated federal income tax return.
Total income taxes for the years ended December 31, 1997 and 1996 are as
follows:
1997 1996
--------- ---------
Current......................................... $ 17,252 $ 5,302
Deferred........................................ (836) 12,847
--------- ---------
$ 16,416 $ 18,149
========= =========
Income taxes computed using the prevailing corporate tax rate of 35% are
reconciled to the Company's actual income tax expense attributable to income for
the years ended December 31, 1997 and 1996, as follows:
1997 1996
-------- --------
Tax expense computed at statutory rate ........... $ 15,313 $ 17,161
Amortization of costs in excess of net assets
acquired ........................................ 1,445 1.445
Change in deferred tax asset valuation allowance . 364 (183)
Other ............................................ (706) (274)
-------- --------
$ 16,416 $ 18,149
======== ========
<PAGE>
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. Income Taxes (Continued)
Temporary differences, including $1,956 in 1997 of deferred tax assets
transferred in association with a reinsurance contract with an affiliate,
between the financial statement carrying amounts and tax bases of assets and
liabilities that give rise to the deferred tax assets (liabilities) at December
31, 1997 and 1996 relate to the following:
1997 1996
-------- ---------
Deferred tax assets:
Deferred policy acquisition costs .............. $ 9,548 $ 10,407
Future policy benefits ......................... 73,660 112,408
Invested assets, subject to capital gains
treatment ..................................... 24,907 16,770
Net unrealized loss ............................ -- 4,224
-------- ---------
108,115 143,809
-------- ---------
Deferred tax liabilities:
Present value of insurance in force ............ (20,498) (24,967)
Other assets and liabilities ................... (20,123) (50,280)
Net unrealized gain ............................ (11,776) --
-------- ---------
(52,397) (75,247)
-------- ---------
Net deferred tax asset ......................... 55,718 68,562
Valuation allowance ............................ (20,972) (20,608)
-------- ---------
$ 34,746 $ 47,954
======== =========
The valuation allowances at December 31, 1997 and 1996, are attributable to
deferred tax assets principally arising from differences in the book and tax
bases of invested assets subject to capital gains treatment that existed as of
the date of acquisition of the company's insurance subsidiaries. To the extent
that income tax benefits relative to such tax assets are ultimately realized,
the reduction in the related valuation allowance would be allocated to reduce
costs in excess of net assets acquired.
In assessing the realizability of deferred tax assets, management considers
whether it is more likely than not that some portion or all of the deferred tax
assets will be realized. The ultimate realization of deferred tax assets is
dependent on the generation of future taxable income during the periods in which
those temporary differences become deductible. Management considers the
scheduled reversal of deferred tax liabilities, projected future taxable income
and tax planning strategies in making this assessment. Based upon those
considerations, management believes it is more likely than not that the Company
will realize the benefits of these deductible differences, net of the existing
valuation allowance at December 31, 1997.
8. Deferred Policy Acquisition Costs and Present Value of Insurance in Force
Deferred policy acquisition costs represent commissions and certain costs of
policy issuance and underwriting. Information relating to these costs for the
years ended December 31, 1997 and 1996, is as follows:
<TABLE>
<CAPTION>
1997 1996
-------- -------
<S> <C> <C>
Balance at beginning of period ........................................ $ 15,095 $ --
Policy acquisition costs deferred:
Commissions ......................................................... 17,443 11,810
Underwriting and issue costs ........................................ 7,366 4,996
Released by 80% coinsurance of Medicare business (see Note 10) ........ -- (1,243)
Policy acquisition costs amortized .................................... (9,092) (503)
Unrealized investment (gain) loss adjustment .......................... (206) 35
-------- -------
Unamortized deferred policy acquisition costs$at period end ........... $ 30,606 $15,095
======== =======
</TABLE>
<PAGE>
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. Deferred Policy Acquisition Costs and Present Value of Insurance in Force
(Continued)
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 years
ended December 31, 1997 and 1996 is as follows:
<TABLE>
<CAPTION>
1997 1996
-------- ---------
<S> <C> <C>
Balance at beginning of year ..................................... $ 71,333 $ 115,831
Released by 80% coinsurance of Medicare business (see Note 10) ... -- (22,936)
Accretion of interest ............................................ 3,806 4,415
Amortization ..................................................... (16,303) (27,304)
Transferred on assumed reinsurance contract with affiliate ....... 2,291 --
Unrealized investment (gain) loss adjustment ..................... (2,562) 1,327
-------- ---------
Balance at end of year ......................................... $ 58,565 $ 71,333
======== =========
</TABLE>
Expected amortization, based upon current assumptions and accretion of interest
at a policy liability or contract rate ranging from 5.5% to 6.6% for the next
five years of the present value of insurance in force is as follows:
<TABLE>
<CAPTION>
Beginning Gross Accretion Net
Balance Amortization of Interest Amortization
------- ------------ ----------- ------------
<S> <C> <C> <C> <C>
1998 ................................... $58,565 $12,805 $3,226 $9,579
1999 ................................... 48,986 7,806 2,719 5,087
2000 ................................... 43,899 8,374 2,315 6,059
2001 ................................... 37,840 6,957 1,989 4,968
2002 ................................... 32,872 5,673 1,724 3,949
</TABLE>
<PAGE>
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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 and 1996 totaled
approximately $174,715 and $177,510, respectively. Statutory net income (loss)
of the Company's life insurance subsidiaries as reported to regulatory
authorities totaled ($2,521) and $24,919 for the years ended December 31, 1997
and 1996.
10. Reinsurance
In the normal course of business, the Company reinsures portions of certain
policies that it underwrites to limit disproportionate risks. The Company
retains varying amounts of individual insurance up to a maximum retention of
$500 on any life. Amounts not retained are ceded to other insurance enterprises
or reinsurers on an automatic or facultative basis.
Reinsurance contracts do not relieve the Company from its obligations to
policyholders. Therefore, the Company is contingently liable for recoverable
unpaid claims and policyholder liabilities ceded to reinsurers in the unlikely
event that assuming reinsurers are unable to meet their obligations. The Company
evaluates the financial condition of its reinsurers to minimize its exposure to
significant losses from reinsurer insolvencies. The effect of reinsurance on
policy revenues earned and the related benefits incurred by such reinsurers for
the years ended December 31, 1997 and 1996 is as follows:
<TABLE>
<CAPTION>
1997 1996
--------- ---------
<S> <C> <C>
Direct policy revenues and amounts assessed
against policyholders .......................... $ 252,656 $ 255,352
Reinsurance assumed .............................. 1,182 3,483
Reinsurance ceded ................................ (108,020) (61,923)
--------- ---------
Net premiums and amounts earned .................. $ 145,818 $ 196,912
========= =========
Policyholder benefits ceded ...................... $ 78,767 $ 25,513
========= =========
</TABLE>
<PAGE>
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. Reinsurance (Continued)
Effective July 1, 1996, Union Bankers entered into reinsurance agreements with
Cologne Life Reinsurance Company ("Cologne") to coinsure 80% of its Medicare
supplement business in force on July 1, 1996 and to coinsure 80% of its Medicare
policies issued on or after July 1, 1996. The Company recorded a deferred gain
on the transaction of $53,893 as of July 1, 1996, which is being amortized into
income over the life of the business. For the year ended December 31, 1997 and
for the period from July 1, 1996 to December 31, 1996 $14,222 and $6,445,
respectively of the deferred gain has been recognized and is included in other
income. The Company is not subject to any negative experience adjustments if the
ceded business is unprofitable; however, the Company may participate in a
portion of future earnings from the ceded business after Cologne recovers its
initial ceding commission plus interest at a specified rate. Union Bankers
retained administration for the ceded block of business and is reimbursed by
Cologne for administrative costs at the rate of 8.5% of ceded renewal premiums
and 11.5% of ceded first year premiums.
Southwestern Life previously ceded a block of annuities under a reinsurance
agreement with Employees Reassurance Corporation (ERC). Such reinsurance,
accounted for as a financing arrangement, is not reflected in the accompanying
financial statements except for the risk fees paid to ERC. The reinsurance
agreement was terminated as of November 30, 1997. Statutory surplus provided by
this treaty totaled $8,714 at December 31, 1996. Risk fees paid to the reinsurer
were 2% of the net amount of surplus provided, but not less than a minimum fee
of $40 per quarter, and totaled $110 and $222 for the years ended December 31,
1997 and 1996, respectively. Amounts due from reinsurers included amounts due
from ERC of $121,016 at December 31, 1996. The underlying assets held by ERC had
carrying values of $121,016 and fair values of $122,639 at December 31, 1996.
At December 31, 1997, Southwestern Life entered into a reinsurance agreement
with Integon Life Insurance Corporation (Integon), an indirect wholly-owned
subsidiary of PennCorp, to coinsure certain annuities which had GAAP policy
liabilities of $256,673. Cash of $50,000 and securities were transferred at a
cost basis of $198,793 which had fair values equal to statutory policy
liabilities of $255,195. The present value of insurance in force which Integon
had recorded on these policies was estimated to be $2,291. Because Southwestern
Life and Integon are affiliates, the historical GAAP book value of the
securities and the present value of insurance in force at Integon was retained
by Southwestern Life. Rather than record a loss of $3,634, which is net of taxes
of $1,956, on a GAAP basis, Southwestern Life recorded a "deemed dividend" of
this amount as a direct charge to its paid in capital. In addition, the change
in unrealized investment gain (loss) associated with the transferred securities
is recorded as an adjustment to prior unrealized gains.
11. Retirement and Profit Sharing Plans
The Company has a defined contribution retirement plan (Defined Contribution
Plan) for all employees who have attained age 21 and completed a year of
service. Contributions to the Plan are made pursuant to salary deferral
elections by participants in an amount equal to 1% to 15% of their annual
compensation. In addition, the Company makes matching contributions in an amount
equal to 50% of each participant's salary deferral to a maximum of 3% of annual
compensation. The Defined Contribution Plan also provides for a discretionary
employer profit sharing contribution, which is determined annually by the Board
of Directors for the succeeding plan year. Profit sharing contributions are
credited to participant's accounts on the basis of their respective
compensation. Salary deferral contribution accounts are at all times fully
vested, while matching contribution and profit sharing contribution accounts
vest ratably from one to five years of service. All participant accounts are
fully vested at death, disability or attainment of age 65. Payment of vested
benefits under the Defined Contribution Plan may be elected by a participant in
a variety of forms of payment. Expenses related to this plan for the years ended
December 31, 1997 and 1996 amounted to $936 and $696, respectively.
In addition, the Company has a bonus plan for certain key officers. The amount
available to pay awards for any year is determined by a committee of senior
executives of the Company and is subject to approval of the Board of Directors
of the Company. Awards are based on the performance of the Company and the
performance of eligible participants. The Company accrued or paid $1,350 and
$1,700 under this plan during the years ended December 31, 1997 and 1996,
respectively.
The Company provides certain health care and life insurance benefits for retired
employees. Employees meeting certain age and length of service requirements
become eligible for these benefits. The Company's obligation for accrued
postretirement
<PAGE>
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. Retirement and Profit Sharing Plans (Continued)
health and welfare benefits is unfunded. Following is an analysis of the change
in the liability for accrued postretirement benefits for the years ended
December 31, 1997 and 1996:
1997 1996
--------- ---------
Accrued postretirement benefits, beginning of
year ...................................... $ 12,686 $ 12,821
--------- ---------
Recognition of components of net periodic
postretirement benefit cost:
Service cost ................................ 269 244
Interest cost................................ 930 834
--------- ---------
Net periodic postretirement benefit cost..... 1,199 1,078
Benefit payments.............................. (1,290) (1,213)
--------- ---------
Net change.................................... (91) (135)
--------- ---------
Accrued postretirement benefits, end of year.. $ 12,595 $ 12,686
========= =========
The liability for accrued postretirement benefits includes the following at
December 31, 1997 and 1996:
Accumulated postretirement benefit obligation:
Retirees..................................... $ 11,167 $ 10,884
Active eligible.............................. 1,076 1,194
Active ineligible............................ 944 831
--------- ---------
13,187 12,909
Unrecognized actuarial loss................... (592) (223)
--------- ---------
Accrued postretirement benefits............... $ 12,595 $ 12,686
========= =========
For measurement purposes, an 5.5% annual rate increase in the health care cost
trend rate was assumed for 1998; the rate was assumed to decrease gradually to
4.0% by the year 2015 and remain at that level thereafter. The health care cost
trend rate assumption has a significant effect on the amounts reported. To
illustrate, increasing the assumed health care cost trend rates by one
percentage point in each year would increase the accumulated postretirement
health care benefit obligation as of December 31, 1997 by $767 and the aggregate
of the service and interest components of net periodic postretirement health
care benefit cost for 1997 by $127. The weighted average discount rate used in
determining the accumulated postretirement benefit obligation was 7.0%.
12. Related Party Transactions
Related party transactions described herein include those transactions not
included elsewhere in the Notes to Consolidated Financial Statements.
The Company and its subsidiaries have management and services agreements with
entities affiliated with Knightsbridge, a shareholder. In connection with an
Advisory and Management Services Agreement with Knightsbridge Management,
L.L.C., the Company pays an annual fee of $1,500 plus expenses. Each insurance
subsidiary has an Investment Management Agreement with Knightsbridge
Consultants, L.L.C. For the years ended December 31, 1997 and 1996, fees
incurred totaled $1,871 and $1,658, respectively.
The Company agreed to pay PennCorp, a shareholder, $1,000 in conjunction with
the GSSW transaction in 1996 (see Note 3). The Company paid interest of $1,400
in 1997 in conjunction with PennCorp's acquisition of the Company's 7.0%
convertible subordinated note.
The Company provides services for a wholly-owned subsidiary of PennCorp. The
Company charges the subsidiary for its direct costs and a share of overhead
costs based upon time and utilization studies. These costs totaled approximately
$5,178 during 1997.
<PAGE>
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
13. Other Commitments and Contingencies
The Company and its subsidiaries are obligated under operating leases, primarily
for office space. Rent expense was $2,169 in 1997 and $2,058 in 1996. There was
no significant sublease income in 1997 or 1996.
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 and $1,357 in 1996. Based on
information currently available, the insurance subsidiaries have accrued $3,194
at December 31, 1997 for future assessments, net of future premium tax
reductions.
14. Other Operating Information
Underwriting and other administrative expenses for the years ended December 31,
1997 and 1996 are as follows:
1997 1996
--------- ---------
Non-deferrable commission expense............. $ 19,746 $ 30,768
Commission allowances on reinsurance ceded.... (12,696) (8,331)
Taxes, licenses and fees...................... 7,492 9,214
General and administrative expenses........... 34,467 39,241
Expense allowance on reinsurance ceded........ (8,409) (5,782)
--------- ---------
Underwriting and other administrative expenses $ 40,600 $ 65,110
========= =========
<PAGE>
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
15. Financial Instruments
The following is a summary of the carrying value and fair value of the Company's
financial instruments at December 31, 1997 and 1996:
<TABLE>
<CAPTION>
1997 1996
---------------------- ------------------------
Carrying Fair Carrying Fair
Value Value Value Value
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Assets:
Cash and short-term investments ................ $ 163,716 $ 163,716 $ 161,895 $ 161,895
Fixed maturities ............................... 1,677,508 1,677,508 1,255,270 1,255,270
Equity securities .............................. 1,079 1,079 1,129 1,129
Mortgage loans ................................. 51,070 51,816 59,993 59,993
Policy loans ................................... 123,041 123,041 128,551 128,551
Collateral loans ............................... -- -- 21,308 21,308
Other investments .............................. 8,461 8,461 5,553 5,553
Interest rate cap .............................. 41 -- 145 --
Agent and premium receivables .................. 5,508 5,508 13,773 13,773
Liabilities:
Notes payable .................................. 154,750 154,750 159,750 159,750
Universal life and investment contract
liabilities .................................. 1,315,496 1,315,496 1,088,335 1,088,335
</TABLE>
The following methods and assumptions were used by the Company in estimating its
fair value disclosures for financial instruments:
Cash and Short-term Investments, Agent and Premium Receivables: The
carrying value of short-term investments and amounts receivable
approximate their fair value due to the short-term maturity of these
instruments.
Fixed Maturities and Equities Available for Sale: Fair values for fixed
maturities available for sale are based on quoted market prices, where
available. For fixed maturities not actively traded, fair values are
estimated using values obtained from independent pricing services or are
estimated based on expected future cash flows using a current market rate
applicable to the yield, credit quality, and maturity of the investments.
The fair values for equity securities are based on quoted market prices.
Mortgage and Collateral Loans: The fair values for mortgage and collateral
loans are estimated using discounted cash flow analyses, based on interest
rates currently being offered for similar loans to borrowers with similar
credit ratings. Loans with similar characteristics are aggregated for
purposes of the calculations.
Other Investments: The fair value of Company's investment in residual
interests in mortgage-backed securities was obtained from an independent
broker-dealer. The fair values of other miscellaneous invested assets have
not been estimated due to their relative immateriality.
Interest rate cap: The fair value of the interest rate cap is $-- 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.
<PAGE>
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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.
<PAGE>
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
PART III
Item 10. Directors and Executive Officers of the Registrant
Information required by this Item is incorporated by reference to
"Election of Directors" and "Executive Officers" in the Company's Proxy
Statement for its 1998 Annual Meeting of the Shareholders.
Item 11. Executive Compensation
Information required by this Item is incorporated by reference to
"Director-Fees," "Executive Compensation and Other Information" and
"Compensation Committee Interlocks and Insider Participation" in the Company's
Proxy Statement for its 1998 Annual Meeting of Shareholder, except that the
information required by paragraphs (k) and (l) of Item 402 of Regulation S-K and
set forth in such Proxy Statement is specifically not incorporated by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management
Information required by this Item is incorporated by reference to
"Security Ownership of Certain Beneficial Owners and Management" in the
Company's Proxy Statement for its 1998 Annual Meeting of Shareholders.
Item 13. Certain Relationships and Related Transactions
Information required by this Item is incorporated by reference to
"Compensation Committee Interlocks and Insider Participation" and "Certain
Transactions" in the Company's Proxy Statement for its 1998 Annual Meeting of
Shareholders.
(Remainder of Page Intentionally Left Blank)
<PAGE>
PART IV
Item 14Exhibits, 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 50 through 89, and the Independent
Auditors' Report set forth on page 49 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 122 of
this filing.
3. Exhibits
2.1 Purchase Agreement dated as of December 31, 1998 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. (23)
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)
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 Certificate of Designation of Series C Preferred Stock. (4)
4.2 Corrected Certificate of Designation of $3.375 Convertible
Preferred Stock. (4)
4.3 Certificate of Designation of $3.50 Series II Convertible
Preferred Stock. (3)
4.4 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)
10.1 Surplus Debenture Number Four in the original principal
amount of $162,539,890, issued by Pacific Life and Accident
Insurance Company to PennCorp Financial Group, Inc., dated
January 1, 1994. (7)
10.2 Surplus Debenture Number Five in the original principal
amount of $17,606,203, issued by Pacific Life and Accident
Insurance Company to PennCorp Financial Group, Inc., dated
September 29, 1994. (12)
10.3 Surplus Debenture Number Six in the original principal
amount of $55,000,000, issued by Pacific Life and Accident
Insurance Company to PennCorp Financial Group, Inc., dated
July 24, 1996. (11)
10.4 10% Promissory Note in the original principal amount of
$30,661,996, issued by American- Amicable Holdings
Corporation to Pennsylvania Life Insurance Company, dated
July 1, 1996. (11)
MANAGEMENT COMPENSATION
RELATED AGREEMENTS
10.5 PennCorp Financial, Inc. Retirement and Savings
Plan. (10)
<PAGE>
10.6 PennCorp Financial Group, Inc. Retirement and
Savings Plan. (1)
10.7 PennCorp Financial Group, Inc. 1992 Stock Option
Plan. (10)
10.8 PennCorp Financial Group, Inc. Senior Management
Warrant Award Program. (10)
10.9 Form of Restricted Stock Agreement by and between
PennCorp Financial Group, Inc. and certain
participants, effective as of April 1, 1994. (6)
10.10 Employment Agreement between PennCorp Financial
Group, Inc. and David J. Stone entered into June 7,
1996. (11)
10.11 Employment Agreement between PennCorp Financial
Group, Inc. and Steven W. Fickes entered into June
7, 1996. (11)
10.12 Amendment Number One to Employment Agreement between
PennCorp Financial Group, Inc. and David J. Stone
dated April 28, 1997. (12)
10.13 Amendment Number One to Employment Agreement between
PennCorp Financial Group, Inc. and Steven W. Fickes
dated April 28, 1997. (12)
10.14 Amendment No. 2 to Employment Agreement between
PennCorp Financial Group, Inc. and David J. Stone
entered into January 5, 1998. (18)
10.15 Amendment No. 2 to Employment Agreement between
PennCorp Financial Group, Inc. and Steven W. Fickes
entered into January 5, 1998. (18)
10.16 Amendment No. 3 to Employment Agreement dated the
10th day of November, 1998 and effective as of the
21st day of August, 1998 by and between PennCorp
Financial Group, Inc. and David J. Stone. (21)
10.17 Executive Retention Agreement between Charles
Lubochinski and PennCorp Financial Group, Inc. (18)
10.18 Schedule of similar Executive Retention Agreements.
(18)
10.19 PennCorp Financial Group, Inc. 1996 Stock Award and
Stock Option Plan. (11)
10.20 Amendment Number One to PennCorp Financial Group,
Inc. 1996 Stock Award and Stock Option Plan. (17)
10.21 Amendment Number Two to PennCorp Financial Group,
Inc. 1996 Stock Award and Stock Option Plan. (1)
10.22 PennCorp Financial Group, Inc. 1996 Senior Executive
Annual Incentive Award Plan. (11)
10.23 Amendment Agreement dated July 29, 1998 to Executive
Retention Agreement by and between Michael Prager
and PennCorp Financial Group, Inc. (21)
10.24 Accommodation Agreement entered into as of July 6,
1998 by and between PennCorp Financial Group, Inc.
and David J. Stone. (21)
10.25 Executive Employment Agreement dated May 22, 1998 by
and between PennCorp Financial Group, Inc. and James
P. McDermott. (19)
10.26 Executive Retention Agreement dated May 22, 1998 by
and between PennCorp Financial Group, Inc. and James
P. McDermott. (19)
<PAGE>
10.27 Executive Employment Agreement dated May 22, 1998 by
and between PennCorp Financial Group, Inc. and Scott
D. Silverman. (19)
10.28 Executive Retention Agreement dated May 22, 1998 by
and between PennCorp Financial Group, Inc. and Scott
D. Silverman. (19)
10.29 Executive Employment Agreement dated July 1, 1998 by
and between PennCorp Financial Group, Inc. and Keith
A. Maib. (19)
10.30 Executive Retention Agreement dated July 1, 1998 by
and between PennCorp Financial Group, Inc. and Keith
A. Maib. (19)
10.31 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. (1)
10.32 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 (1)
10.33 Letter Agreement dated May 21, 1998 for Option to
Purchase Shares of ACO Brokerage Holdings
Corporation by and between PennCorp Financial Group,
Inc. and Charles Lubochinski (1)
10.34 Letter Agreement dated May 21, 1998 for Option to
Purchase Shares of ACO Brokerage Holdings
Corporation by and between PennCorp Financial Group,
Inc. and Michael Prager (1)
10.35 Conversion, Standstill and Registration Rights Agreement
between United Companies Financial Corporation and PennCorp
Financial Group, Inc. dated as of July 24, 1996. (11)
10.36 Registration Rights Agreement dated as of August 2, 1996,
by and among PennCorp Financial Group, Inc., Smith Barney
Inc., Donaldson, Lufkin & Jenrette Securities Corporation
and Merrill Lynch, Pierce, Fenner & Smith Incorporated.
(11)
10.37 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)
10.38 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)
10.39 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)
10.40 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. (1)
10.41 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)
<PAGE>
10.42 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)
10.43 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)
10.44 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)
10.45 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)
10.46 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)
10.47 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)
10.48 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)
10.49 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 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)
10.52 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)
10.53 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)
10.54 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)
10.55 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)
<PAGE>
10.56 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)
10.57 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)
10.58 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)
10.59 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)
10.60 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 Form 8-K dated November
25, 1996, which was filed with the Securities and Exchange Commission by
PennCorp Financial Group, Inc. on December 4, 1996, providing a copy of
the Amended and Restated Agreement and Plan of Merger with Washington
National Corporation.
(3) Suchexhibit 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-A dated July 11,
1995 which was filed by PennCorp Financial Group, Inc. with the
Securities and Exchange Commission on July 12, 1995.
(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.
<PAGE>
(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.
(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 Annual Report on Form
10-K for the fiscal year ended December 31, 1997 of PennCorp Financial
Group, Inc.
(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.
(b) Reports on Form 8-K.
A report on Form 8-K, dated November 17, 1998, was filed with the
Securities and Exchange Commission by PennCorp Financial Group, Inc. on
November 17, 1998, providing Amendment No. 4 and Waiver to Credit
Agreement dated as of March 12, 1997 by and among PennCorp Financial
Group, Inc., the lenders signatory to the Credit Agreement and The Bank of
New York.
<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: March 31, 1999
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
- ----------------------------------
Keith A. Maib
Director
Date: March 31, 1999
/s/ Kenneth Roman
- ----------------------------------
Kenneth Roman
Director
Date: March 31, 1999
/s/ David J. Stone
- ----------------------------------
David J. Stone
Director
Date: March 31, 1999
/s/ Allan D. Greenberg
- ----------------------------------
Allan D. Greenberg
Director
Date: March 31, 1999
/s/ Thomas A. Player
- ----------------------------------
Thomas A. Player
Director
Date: March 31, 1999
/s/ Bruce W. Schnitzer
- ----------------------------------
Bruce W. Schnitzer
Director
Date: March 31, 1999
/s/ David C. Smith
- ----------------------------------
David C. Smith
Chairman of the Board and Director
Date: March 31, 1999
<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.... 129
Schedule II Condensed Financial Information of Registrant ..... 130
Schedule III Supplementary Insurance Information ............... 133
Schedule IV Reinsurance ....................................... 134
Schedule V Valuation and Qualifying Accounts ................. 135
* All other schedules have been omitted as they are not applicable or not
required, or the information is given in the financial statements, notes
hereto or in other schedules.
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Shareholders and Board of Directors of PennCorp Financial Group, Inc.
Under date of March 31, 1999, we reported on the consolidated balance
sheets of PennCorp Financial Group, Inc. and subsidiaries as of December 31,
1998 and 1997, 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, 1998, as contained
in the annual report on Form 10-K for the year 1998. 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.
KPMG LLP
Dallas, Texas
March 31, 1999
<PAGE>
<TABLE>
SCHEDULE II
PENNCORP FINANCIAL GROUP, INC.
(PARENT COMPANY ONLY)
CONDENSED STATEMENTS OF INCOME (LOSS) For the years ended
December 31, 1998, 1997 and 1996
(In thousands)
<CAPTION>
1998 1997 1996
--------- -------- -------
Revenue:
<S> <C> <C> <C>
Interest income from subsidiaries ........................ $ 19,663 $ 21,173 $35,525
Other interest income .................................... 2,865 3,547 2,428
Net gains from sale of investments ....................... 577 -- --
Other income ............................................. 589 249 423
--------- -------- -------
Total revenue ......................................... 23,694 24,969 38,376
--------- -------- -------
Operating expenses:
General and administrative expenses ...................... 19,429 36,939 2,493
Interest and amortization of deferred debt issuance costs. 42,730 23,103 17,920
Restructuring charges .................................... 4,529 -- --
Impairment provision associated with assets of
Businesses Held for Sale ................................ 9,000 -- --
--------- -------- -------
Total operating expenses .............................. 75,688 60,042 20,413
--------- -------- -------
Income (loss) before income taxes (benefits), equity in
earnings of subsidiaries and extraordinary charge ........ (51,994) (35,073) 17,963
Income tax expense (benefit) ............................ (3,132) (8,689) 251
--------- -------- -------
Income (loss) before equity in earnings of subsidiaries
and extraordinary charge ................................. (48,862) (26,384) 17,712
Equity in earnings (losses) of subsidiaries ............. (374,068) 76,524 72,305
--------- -------- -------
Income (loss) before extraordinary charge .................. (422,930) 50,140 90,017
Extraordinary charge, net of income taxes of $--, $--and
$932 .................................................. -- -- (1,730)
--------- -------- -------
Net income (loss) .......................................... $(422,930) $ 50,140 $88,287
========= ======== =======
</TABLE>
See accompanying independent auditors' report.
<PAGE>
SCHEDULE II
PENNCORP FINANCIAL GROUP, INC.
(PARENT COMPANY ONLY)
CONDENSED BALANCE SHEETS
As of December 31, 1998 and 1997
(In thousands)
1998 1997
---------- ----------
ASSETS
Investments:
Investment in subsidiaries .................... $ 730,436 $ 932,931
Notes receivable from subsidiaries ............ 257,442 275,146
Equity securities available for sale .......... -- 22,948
Other ......................................... -- 1,075
---------- ----------
Total investments ........................... 987,878 1,232,100
Cash and cash equivalents ...................... 12,654 4,464
Accrued investment income due from subsidiaries -- 8,697
Deferred debt issuance costs ................... 4,896 2,219
Other assets ................................... 1,145 6,849
---------- ----------
Total assets ................................ $1,006,573 $1,254,329
========== ==========
LIABILITIES
Notes payable .................................. $ 548,646 $ 356,646
Due to subsidiaries ............................ -- 8,404
Accrued expenses and other liabilities ......... 21,986 9,176
---------- ----------
Total liabilities ........................... 570,632 374,226
---------- ----------
Mandatory redeemable preferred stock, Series C . -- 19,867
SHAREHOLDERS' EQUITY
$3.375 Convertible preferred stock ............. 112,454 110,513
$3.50 Series II convertible preferred stock .... 141,673 139,157
Common stock ................................... 301 289
Additional paid in capital ..................... 430,321 397,590
Accumulated other comprehensive income ......... 19,995 35,034
Retained earnings (deficit) .................... (234,921) 211,055
Treasury shares ................................ (32,391) (32,130)
Notes receivable and other assets secured by
common stock................................. (1,491) (1,272)
---------- ----------
Total shareholders' equity .................. 435,941 860,236
---------- ----------
Total liabilities and shareholders' equity .. $1,006,573 $1,254,329
========== ==========
See accompanying independent auditors' report.
<PAGE>
<TABLE>
SCHEDULE II
PENNCORP FINANCIAL GROUP, INC.
(PARENT COMPANY ONLY)
CONDENSED STATEMENTS OF CASH FLOWS For the years ended
December 31, 1998, 1997 and 1996
(In thousands)
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss) .................................... $(422,930) $ 50,140 $ 88,287
Adjustments to reconcile net income (loss) to
net cash provided (used) in operating activities:
Amortization of intangibles and depreciation ...... 1,966 1,389 1,238
Impairment provision associated with assets of
Businesses Held for Sale ......................... 9,000 -- --
Equity in earnings (loss) of subsidiaries ......... 374,068 (76,524) (72,305)
Increase (decrease) in liabilities and due to
subsidiaries .................................... (6,164) 12,870 (544)
Other, net ........................................ 2,644 (9,227) 79
--------- --------- ---------
Net cash provided (used) by operations ........... (41,416) (21,352) 16,755
--------- --------- ---------
Cash flows from investing activities:
Acquisition of businesses ............................ (73,858) -- --
Purchase of equity security .......................... (5,000) (20,000) --
Sale of equity security .............................. 30,500 -- --
Issuance of surplus note to subsidiary ............... -- -- (155,000)
Principal payment on surplus note .................... -- -- 100,000
Dividend received from subsidiary .................... 44,327 14,677 11,283
Capital contribution to subsidiary ................... (7,853) (14,889) (208,708)
Other, net ........................................... 712 (42,142) --
--------- --------- ---------
Net cash used by investing activities ............. (11,172) (62,354) (252,425)
--------- --------- ---------
Cash flows from financing activities:
Issuance of notes payable ............................ 203,000 250,000 230,000
Issuance of common stock ............................. 3 -- 155,450
Issuance of preferred stock .......................... -- -- 139,157
Purchase of treasury stock ........................... -- (28,760) --
Reduction of notes payable ........................... (126,015) (100,000)
Redemption of preferred stock ........................ -- (14,705) --
Other, primarily dividends, net ...................... (16,210) (20,464) (15,198)
--------- --------- ---------
Net cash provided by financing activities ......... 60,778 86,071 236,056
--------- --------- ---------
Net increase in cash ................................... 8,190 2,365 386
Cash and cash equivalents at beginning of year ......... 4,464 2,099 1,713
--------- --------- ---------
Cash and cash equivalents at end of year ............... $ 12,654 $ 4,464 $ 2,099
========= ========= =========
Supplemental Disclosure:
Interest paid ........................................ $ 37,849 $ 20,946 $ 16,921
Taxes paid (refunded) ................................ (213) -- 200
Non-cash financing activities:
Redemption of Series C Preferred Stock ............... 22,227 -- --
Debt assumed with acquisition ........................ 115,015 -- --
Securities issued in conjunction with acquisition .... -- -- 14,999
Issuance of common stock associated with the
acquisition of the Fickes and Stone Knightsbridge
Interests ............ .............................. 8,500 -- --
Other ................................................ 261 1,281 948
</TABLE>
See accompanying independent auditors' report.
<PAGE>
<TABLE>
SCHEDULE III
PENNCORP FINANCIAL GROUP, INC.
SUPPLEMENTARY INSURANCE INFORMATION
For the years ended December 31, 1998, 1997 and 1996
(In thousands)
<CAPTION>
Future
Policy Amorti-
Benefits Benefits, zation of
Deferred Losses, Claims, Deferred
Policy Claims Net Losses & Policy Other
Acquisition & Loss Premium Investment Settlement Acquisition Operating
Costs Expenses Revenue Income Expenses Costs Expenses
----------- ---------- -------- ---------- ---------- ----------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
1998
- --------------------
Fixed benefit. ..... $ -- $ 24,190 $216,219 $ 25,826 $160,135 $27,251 $107,772
Life ............... 136,420 2,086,957 234,540 174,249 267,074 49,265 98,906
Accumulation ....... 3,288 755,891 8,399 168,977 114,553 2,775 22,819
-------- ---------- -------- -------- -------- ------- --------
Total ............ $139,708 $2,867,038 $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
======== ========== ======== ======== ======== ======= ========
1996
- --------------------
Fixed benefit. ..... $127,091 $ 294,068 $169,311 $ 22,730 $ 63,663 $ 16,446 $ 55,161
Life ............... 105,063 1,212,374 169,974 88,220 137,867 12,010 48,706
Accumulation ....... 20,274 2,060,013 8,805 99,784 70,381 2,288 12,693
-------- ---------- -------- -------- -------- ------- --------
Total ............ $252,428 $3,566,455 $348,090 $210,734 $271,911 $ 30,744 $116,560
======== ========== ======== ======== ======== ======== ========
</TABLE>
See accompanying independent auditors' report
<PAGE>
<TABLE>
SCHEDULE IV
PENNCORP FINANCIAL GROUP, INC.
REINSURANCE
For the years ended December 31, 1998, 1997, and 1996
(In thousands)
<CAPTION>
Percentage
Ceded to Assumed Of Amount
Gross Other from Other Net Assumed
Amount Companies Companies Amount to Net
----------- ---------- ---------- ----------- ----------
<S> <C> <C> <C> <C> <C>
Year ended December 31, 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
=========== ========== ========== ===========
Year ended December 31, 1996:
Life insurance in force ....................... $31,498,035 $5,884,609 $1,779,439 $27,392,865
=========== ========== ========== ===========
Premiums:
Accident and health insurance ................. $ 169,727 $ 416 $ -- $ 169,311 --%
Life insurance/accumulation ................... 189,098 11,639 1,320 178,779 0.7%
----------- ---------- ---------- -----------
$ 358,825 $ 12,055 $ 1,320 $ 348,090
=========== ========== ========== ===========
</TABLE>
See accompanying independent auditors' report.
<PAGE>
<TABLE>
SCHEDULE V
PENNCORP FINANCIAL GROUP, INC.
VALUATION AND QUALIFYING ACCOUNTS For the years ended
December 31, 1998, 1997 and 1996
(In thousands)
<CAPTION>
Balance at Charge to Charge to Balance at
Beginning Cost and to Other End of
Of Period Expenses Accounts Deductions Period
---------- --------- --------- ---------- ----------
<S> <C> <C> <C> <C> <C>
1998:
Mortgage loans on real estate ..... $ 6,721(b) $11,425 $ -- $13,851(c) $4,295
Allowance for bond losses ......... -- -- -- -- --
Unearned loan charges ............. 1,569 -- -- 1,569(c) --
Accounts and notes receivable ..... 9,205(b) 4,449 -- 7,453(c) 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
1996:
Mortgage loans on real estate ..... $ 4,211(a) $ -- $ -- $ -- $4,211
Allowance for bond losses ......... 189(a) -- -- -- 189
Unearned loan charges ............. 266(a) -- -- -- 266
Accounts and notes receivable ..... 8,388 4,082 -- 5,942 6,528
</TABLE>
- ----------
(a) Amount recorded as a purchase GAAP adjustment in conjunction with the
acquisition of United Life.
(b) Includes amounts recorded as a purchase GAAP adjustment in conjunction
with the acquisition of SW Financial.
(c) Includes amounts transferred to assets of Businesses Held for Sale.
See accompanying independent auditors' report.
<TABLE> <S> <C>
<ARTICLE> 7
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> DEC-31-1998
<DEBT-HELD-FOR-SALE> 2,589,714
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 2,035
<MORTGAGE> 36,882
<REAL-ESTATE> 8,644
<TOTAL-INVEST> 2,863,527
<CASH> 92,727
<RECOVER-REINSURE> 0
<DEFERRED-ACQUISITION> 139,708
<TOTAL-ASSETS> 6,031,401
<POLICY-LOSSES> 2,757,500
<UNEARNED-PREMIUMS> 1,972
<POLICY-OTHER> 38,319
<POLICY-HOLDER-FUNDS> 69,247
<NOTES-PAYABLE> 550,923
0
254,127
<COMMON> 301
<OTHER-SE> 181,513
<TOTAL-LIABILITY-AND-EQUITY> 6,031,401
459,158
<INVESTMENT-INCOME> 369,052
<INVESTMENT-GAINS> 14,068
<OTHER-INCOME> 37,717
<BENEFITS> 541,762
<UNDERWRITING-AMORTIZATION> 79,291
<UNDERWRITING-OTHER> 625,733
<INCOME-PRETAX> (424,628)
<INCOME-TAX> (3,369)
<INCOME-CONTINUING> (421,259)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (441,203)
<EPS-BASIC> (15.23)
<EPS-DILUTED> (15.23)
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 0
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
