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Filed Pursuant to Rule 424(b)(2)
Registration No. 333-53967
INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A
REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY
OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES
EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE
SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE SECURITIES
IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR
TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH STATE.
PROSPECTUS SUPPLEMENT (Subject to Completion, Issued June 30, 1998)
(To Prospectus dated June 17, 1998)
1,500,000 Shares
ARM Financial Group, Inc.
DEPOSITARY SHARES
EACH REPRESENTING 1/4 OF A SHARE OF
SERIES A FIXED/ADJUSTABLE RATE
CUMULATIVE PREFERRED STOCK
($200.00 Stated Value)
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All of the Depositary Shares being offered hereby are being offered by ARM
Financial Group, Inc. (the "Company"). Each Depositary Share (a "Depositary
Share") represents ownership of 1/4 of a share of Series A Fixed/Adjustable Rate
Cumulative Preferred Stock, par value $.01 per share, stated value $200.00 per
share (the "Series A Fixed/Adjustable Rate Preferred Stock"), of the Company to
be deposited with ChaseMellon Shareholder Services LLC, as Depositary, and,
through the Depositary, entitles the holder, proportionately, to all rights,
preferences and privileges of the Series A Fixed/Adjustable Rate Preferred Stock
represented thereby. The proportionate stated value of each Depositary Share is
$50.00. See "Description of Depositary Shares."
The Series A Fixed/Adjustable Rate Preferred Stock will not be redeemable
prior to July , 2003 except as stated below. On or after such date the Series
A Fixed/Adjustable Rate Preferred Stock will be redeemable at the option of the
Company, in whole or in part, upon not less than 30 days' notice, at a
redemption price equal to $200.00 per share of Series A Fixed/ Adjustable Rate
Preferred Stock (equivalent to $50.00 per Depositary Share) plus dividends
accrued and accumulated but unpaid to the redemption date. The Series A
Fixed/Adjustable Rate Preferred Stock may also be redeemed prior to July ,
2003, in whole but not in part, at the option of the Company, in the event of
certain amendments to the Internal Revenue Code of 1986, as amended (the
"Code"), in respect of the dividends received deduction. See "Description of
Series A Fixed/ Adjustable Rate Preferred Stock -- Optional Redemption."
Dividends on the Series A Fixed/Adjustable Rate Preferred Stock will be
cumulative from the date of issue and are payable quarterly, commencing
September 15, 1998. Dividends on the Series A Fixed/Adjustable Rate Preferred
Stock will be payable quarterly, when, as and if declared, on March 15, June 15,
September 15 and December 15 of each year, commencing September 15, 1998, at a
rate of % per annum through July , 2003. Thereafter, the dividend rate on
the Fixed/Adjustable Preferred Stock will be the Applicable Rate from time to
time in effect. Except as provided below, the Applicable Rate per annum for any
dividend period beginning on or after July , 2003 will be equal to % plus
the highest of the Treasury Bill Rate, the Ten-Year Constant Maturity Rate and
the Thirty-Year Constant Maturity Rate (each as defined herein), as determined
in advance of such dividend period. The Applicable Rate per annum for any
dividend period beginning on or after July , 2003 will not be less than %
nor greater than %. The amount of dividends payable in respect of the Series
A Fixed/Adjustable Rate Preferred Stock will be adjusted in the event of certain
amendments to the Code in respect of the dividends received deduction. See
"Description of Series A Fixed/Adjustable Rate Preferred Stock -- Dividends."
The Depositary Shares will be represented by one or more global securities
in fully registered form, deposited with a custodian for, and registered in the
name of a nominee of, The Depositary Trust Company ("DTC"). See "Book Entry
Procedures" in this Prospectus Supplement. Beneficial interests in the
Depositary Shares will be shown on, and transfers thereof will be effected only
through records maintained by, DTC and its participants.
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SEE "RISK FACTORS" BEGINNING ON PAGE S-6 FOR INFORMATION THAT SHOULD BE
CONSIDERED BY PROSPECTIVE INVESTORS
------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS SUPPLEMENT OR THE PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
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PRICE $50 A DEPOSITARY SHARE
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<TABLE>
<CAPTION>
UNDERWRITING
PRICE TO DISCOUNTS AND PROCEEDS TO
PUBLIC(1) COMMISSIONS(2) COMPANY(1)(3)
--------- -------------- -------------
<S> <C> <C> <C>
Per Depositary Share.............. $ $ $
Total............................. $ $ $
</TABLE>
- ---------------
(1) Plus accrued dividends, if any, from the date of issue.
(2) The Company has agreed to indemnify the Underwriters against certain
liabilities, including liabilities under the Securities Act of 1933, as
amended (the "Securities Act"). See "Underwriters."
(3) Before deducting expenses payable by the Company estimated to be $ .
------------------------
The Depositary Shares are offered, subject to prior sale, when, as and if
issued and accepted by the Underwriters, and subject to approval of certain
legal matters by LeBoeuf, Lamb, Greene & MacRae, L.L.P., counsel for the
Underwriters. It is expected that delivery of the Depositary Receipts evidencing
the Depositary Shares will be made on or about , 1998 through the
book-entry facilities of DTC against payment therefor in immediately available
funds.
------------------------
MORGAN STANLEY DEAN WITTER
DONALDSON, LUFKIN & JENRETTE
Securities Corporation
CIBC OPPENHEIMER
, 1998
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CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE DEPOSITARY SHARES.
SPECIFICALLY, THE UNDERWRITERS MAY OVER-ALLOT IN CONNECTION WITH THE OFFERING,
AND MAY BID FOR, AND PURCHASE, THE DEPOSITARY SHARES IN THE OPEN MARKET.
---------------------------------
"S&P 500(R) Composite Stock Price Index" is a trademark of The McGraw-Hill
Companies, Inc. and has been licensed for use by the Company. OMNI, the
Company's equity-indexed annuity product, is not sponsored, endorsed, sold or
promoted by Standard & Poor's Corporation ("S&P"), and S&P makes no
representation regarding the advisability of investing in OMNI.
FORWARD-LOOKING STATEMENTS
This Prospectus and the documents incorporated by reference herein contain
forward-looking statements within the meaning of Section 27A of the Securities
Act and Section 21E of the Securities Exchange Act of 1934, as amended (the
"Exchange Act"). These statements are based on management's beliefs and
assumptions, relying on information currently available to management, and are
subject to risks and uncertainties. Forward-looking statements include the
information concerning possible or assumed future results of operations of the
Company set forth (i) under "The Company," "Summary Historical Financial
Information" and "Management's Discussion and Analysis of Results of Operations
and Financial Condition" herein; (ii) under "Business" and "Management's
Discussion and Analysis" in the Company's Annual Report on Form 10-K, under
"Management's Discussion and Analysis" in the Company's Quarterly Report on Form
10-Q and in the Current Reports on Form 8-K incorporated by reference herein;
and (iii) in this Prospectus and the documents incorporated by reference herein
preceded by, followed by or that include the words "believes," "expects,"
"anticipates," "intends," "plans," "estimates" or similar expressions. Such
forward-looking statements are based on the Company's beliefs as to its
competitive position in its industry and the factors affecting its business. In
particular, the statements of the Company's belief as to (i) the stimulation of
future demand for long-term savings and retirement products, including fixed,
indexed and variable annuity products; and (ii) information relating to
insurance regulatory matters are forward-looking statements. Factors that could
cause actual results to differ materially from the forward-looking statements
related to the demand for fixed, indexed and variable annuity products include,
but are not limited to, a change in population demographics, development of
alternative investment products, a change in economic or market conditions, and
changes in current federal income tax laws. In addition, there can be no
assurance that (i) the Company has correctly identified and assessed all of the
factors affecting its business; (ii) the publicly available and other
information on which the Company has based its analyses is complete or correct;
(iii) the Company's analyses are correct; or (iv) the Company's strategy, which
is based in part on these analyses, will be successful.
Forward-looking statements are not guarantees of performance as they
involve risks, uncertainties and assumptions. The future results of the Company
may differ materially from those expressed in these forward-looking statements.
Many of the factors that will determine these results are beyond the Company's
ability to control or predict. Purchasers of the Depositary Shares are cautioned
not to put undue reliance on any forward-looking statements. The Company claims
the protection of the safe harbor for forward-looking statements contained in
the Private Securities Litigation Reform Act of 1995.
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THE COMPANY
Unless otherwise indicated, financial information and operating statistics
applicable to the Company set forth in this Prospectus are based on United
States generally accepted accounting principles ("GAAP") and not statutory
accounting principles. See "Glossary of Selected Insurance Terms" for the
definitions of certain terms used herein.
The Company specializes in the growing asset accumulation business with
particular emphasis on retirement savings and investment products. The Company's
earnings are derived from investment spread (the difference between income
earned on investments and interest credited on customer deposits) and fee
income. The Company's retail products include a variety of fixed, indexed and
variable annuities and face-amount certificates ("FACs") sold through a broad
spectrum of distribution channels including independent broker-dealers,
independent agents, stockbrokers, and financial institutions. The Company offers
institutional products, such as funding agreements, guaranteed investment
contracts ("GICs") and installment face-amount certificates, directly to bank
trust departments, plan sponsors, cash management funds, corporate treasurers,
and other institutional investors.
The Company commenced its business operations in November 1993 with the
acquisition of Integrity Holdings, Inc. ("Integrity Holdings"). The Company's
assets under management have grown from $2.3 billion as of November 26, 1993 to
$7.5 billion as of March 31, 1998. The Company attributes this growth to
internally generated sales, new product offerings and an opportunistic
acquisition. Operating earnings (net income applicable to common shareholders,
excluding, net of tax, realized investment gains and losses, non-recurring
charges and, for 1997 and 1996, income from defined benefit pension plan asset
management operations which were sold during November 1997) have grown to $34.1
million in 1997 from $22.2 million in 1996 and $4.5 million in 1995. Operating
earnings for the three months ended March 31, 1998 were $10.0 million. In June
1997, the Company raised $78.8 million through an initial public offering of its
Class A Convertible Common Stock, par value $.01 per share (the "Class A Common
Stock").
The Company expects to benefit from demographic trends and a growing demand
for retirement savings. As the U.S. population has aged, demand for retirement
savings has accelerated. According to U.S. Census Bureau information,
approximately 30% of today's population was born during the Baby Boom (1946 to
1964). By the time the Baby Boom generation begins to reach age 65 in 2011, the
population between the ages of 45 and 64 -- the peak period for asset
accumulation -- is projected to increase by approximately 45% to 79 million
people.
The Company also expects to benefit from anticipated higher consumer
savings due to an overburdened social security system, extended life spans,
concerns about corporate restructurings and downsizing, and volatile financial
markets. Among the products expected to benefit are tax-advantaged annuities.
Annual industry sales of individual annuity products increased dramatically from
$65 billion in 1990 to a preliminary estimate of $124 billion in 1997, with
projected growth of 8% to 12% per year for the next few years, according to an
industry study conducted by LIMRA.
The Company also expects to benefit from growth in the institutional
marketplace, which is partially fueled by retirement and consumer savings. The
Company intends to expand its institutional deposit base by increasing
penetration in the stable value and fixed income markets and the development of
new products and applications.
STRATEGY
The Company's strategy is focused on the following:
Developing and Marketing a Broad Array of Customized Products. The Company
believes that long-term success in the asset accumulation industry will depend
upon the Company's ability to adapt to rapidly changing consumer preferences in
fluctuating interest rate and equity market environments. The Company
continually redesigns existing products with enhanced features and continues to
develop and sell new and innovative products with a particular focus on
minimizing its dependence on any one product and meeting a variety of needs for
consumers and distribution channels. The Company works closely with the people
involved
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with its retail and institutional distribution to develop products that are
customized to suit their customers' particular needs. The Company was one of the
first to recognize the market opportunity for equity-indexed annuities and in
1996 introduced OMNI, the Company's equity-indexed annuity product. In 1997, the
Company enhanced its multi-manager variable annuity product, Pinnacle, making it
one of the first in the industry to offer Bankers Trust indexed funds, along
with a diverse selection of asset classes from well-known fund managers,
guaranteed rate options and the ability for systematic transfer of deposits over
time -- all in one product. In the institutional market, the Company offers a
short-term floating rate institutional spread-based product designed to meet the
market demand for products with attractive current yields and access to
liquidity. In 1997, the Company developed and funded a unique asset-backed
funding agreement, in alliance with Bayerische Landesbank Girozentrale, New York
Branch ("BLB"), a triple-A rated international banking institution. In
connection with another highly rated international bank, the Company is
developing a synthetic GIC product for the institutional spread marketplace that
will provide institutional clients with either absolute or relative investment
performance guarantees. On April 24, 1998, 312 Certificate Company, a
bankruptcy-remote, restricted special purpose corporation, and an indirect
wholly-owned subsidiary of the Company, issued a $500 million installment FAC to
a large institutional purchaser.
Capturing a Growing Share of Sales in Retail Distribution Channels. Over
the past few years, the Company has built the infrastructure necessary to
support increased growth in the retail market. The Company believes that it can
distinguish itself by strengthening its relationships with individual
distributors, often referred to as producers. To accomplish this objective, the
Company seeks to (i) provide superior service to producers through an expanded
and dedicated producer services unit; (ii) enhance the Company's technological
platform to permit superior and immediate access for producers to the Company's
administrative systems for transacting business; (iii) heighten producers'
awareness of the Company's products and insurance affiliates through focused
advertisements in industry publications and selective promotional programs; and
(iv) quickly develop innovative products with new features and services which
are responsive to market needs. For example, in 1997, as a means to strengthen
its relationships with distributors, the Company implemented a program, called
AnnuiTRAC(SM), whereby certain distributors have the capability to remotely
access the Company's systems and transact business with the Company on-line. The
Company also seeks to increase its retail market share by expanding and
diversifying its retail distribution channels. In 1996, the Company began
offering variable annuities through banks and thrifts, and in late 1997
introduced a new variable annuity product customized for that distribution
channel. Additionally, the Company recognizes the importance of building and
maintaining a strong capital base.
Expanding and Diversifying the Deposit Base in the Institutional
Marketplace. Since the Company's inception, its institutional business has
grown to $3.0 billion of funding agreement deposits and GIC deposits on the
Company's March 31, 1998 balance sheet. The Company believes that its integrated
asset/liability management approach to the business, along with its underwriting
philosophy, has allowed it to build competitive advantages. The Company has
found it beneficial to form strategic partnerships with organizations possessing
strong financial ratings and market presence. Since 1995, the Company has
written funding agreements and GICs primarily through a relationship with
General American Life Insurance Company ("General American") under which the
Company reinsures one-half of the business written. In late 1997, the Company
sold its first funding agreement structure outside the General American
relationship with a $500 million, five-year term offering, in alliance with BLB.
In April 1998, 312 Certificate Company issued a $500 million installment FAC to
a large institutional purchaser. In addition to offering its current products,
the Company intends to continue its growth in the institutional market by (i)
diversifying its product line with (a) customized product features for
alternative distribution channels, (b) fixed terms extending beyond current
product offerings and (c) on- and off-balance sheet synthetic products or new
funding agreement products in which the Company offers certain performance
guarantees; (ii) attracting new partners with larger and stronger balance sheets
to provide credit enhancement to help support and market the new product
structures and marketing initiatives; and (iii) expanding market penetration
within its existing clients while maintaining the persistency and profitability
of the current client base.
Enhancing Effective Use of Technology. The Company continues to invest in
technology designed to enhance the services provided to producers and customers,
increase the efficiency of operations and allow for
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administration of innovative and complex products. The Company's technology also
allows it to respond quickly to customer needs for new products by reducing
product development time. In addition, to supplement traditional inquiry and
transaction processing methods, the Company's client/server network can provide
producers, customers and employees with services and information easily
accessible through Internet, voice response and wide-area network technology.
One such example is the Company's 1997 introduction of AnnuiTRAC(SM), its
Internet based producer service program.
Minimizing Fixed Cost Structure. The Company attempts to minimize fixed
distribution costs by marketing its products through fiduciaries and other third
parties. Unlike many of its competitors, the Company does not maintain its own
field sales force, and distributors are primarily paid based on production. As a
consequence of its low fixed distribution costs, the Company has flexibility to
shift the mix of its sales and distribution channels in order to respond to
changes in market demand. In addition, the Company believes that its
administrative cost structure has benefitted from economies of scale achieved as
a result of its strategic acquisitions. The Company believes that the relocation
of the Company's main processing center from Ohio to the Company's headquarters
in Louisville, Kentucky, which was substantially completed during 1997, has
provided benefits of consolidation and supplemented the effective delivery of
service.
Implementing an Advanced and Integrated Risk Management Process. Using its
experience in offering investment guarantees in the insurance market sector, the
Company employs a highly analytical and disciplined asset/liability risk
management approach to develop new products and monitor investment portfolios
and liabilities. The Company does not view asset/liability management as a
discrete function to be performed by a separate committee. Instead,
asset/liability management permeates every aspect of the Company's operations.
Beginning with product design and continuing through the product sale and
eventual payout, professionals in each functional area (such as marketing,
actuarial, investments, legal, finance, and administration) work jointly with a
common set of risk/return characteristics to achieve the Company's overall
liquidity and profit objectives (rather than the specific objectives of any
particular functional area). The Company implements this process with the
analytical risk and capital management skills and the experience of its
management team. This foundation is supported with sophisticated computer
software and an emphasis on securities whose cash flows can be modeled
extensively against liability cash flows under different interest rate
scenarios. Risk components that cannot be appropriately modeled are typically
hedged or reinsured.
Maintaining Focus on Company Profitability. The Company designs products
and manages capital with a goal of achieving a superior return on common equity.
The Company's return on average common equity (based on operating earnings and
equity before unrealized gains and losses and giving pro forma effect to the
Company's initial public offering of Common Stock (as defined below)) was 16.4%
in 1997 and 13.5% in 1996. The Company's focus on profitability is supported by
an integrated team approach to developing products and operating the Company's
business. The Company's compensation system further reinforces the Company's
focus on the objective of profitability. Employees at all levels of the Company
are eligible to receive bonuses based on profitability. As of June 15, 1998,
current executive officers held shares and vested and unvested options to
purchase shares representing 8% of the Company's outstanding Common Stock.
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RISK FACTORS
An investment in the Series A Fixed/Adjustable Rate Preferred Stock
involves a significant degree of risk. In determining whether to make an
investment in the Series A Fixed/Adjustable Rate Preferred Stock, prospective
investors should consider carefully all of the information set forth in this
Prospectus or incorporated herein by reference and, in particular, the following
factors.
INTEREST RATE RISK
The Company's spread-based business is subject to several inherent risks
arising from movements in interest rates, especially if the Company fails to
anticipate or respond to such movements. First, interest rate changes can cause
compression of the Company's net spread between interest earned on investments
and interest credited on customer deposits, thereby adversely affecting the
Company's results. Second, if interest rate changes produce an unanticipated
increase in surrenders of the Company's spread-based products, the Company may
be forced to sell investment assets at a loss in order to fund such surrenders.
Finally, changes in interest rates can have significant effects on the
performance of the Company's portfolio of mortgage-backed securities ("MBSs"),
including its collateralized mortgage obligations ("CMOs"), as a result of
changes in the prepayment rate of the loans underlying such securities.
Spread Compression. The Company will experience spread compression when it
is unable to maintain the margin between its investment earnings and its
crediting rates. When interest rates rise, the Company may not be able to
replace the assets in its investment portfolio with sufficient higher-yielding
assets to fund higher crediting rates or to maintain full profit margins without
assuming excessive asset side risk. As a result, the Company may experience
either a decrease in sales and an increase in surrenders (as described below)
where it is able to maintain its spread by not raising its crediting rates, or
spread compression if it is willing or contractually required to increase its
crediting rates. Conversely, when interest rates fall, the Company would have to
reinvest the cash received from its investments (i.e., interest and payments of
principal upon maturity or redemption) in the lower-yielding instruments then
available. If the Company chose not to or was unable (i.e., due to guaranteed
minimum or fixed crediting rates or limitations on the frequency of
crediting-rate resets) to reduce the crediting rate on its spread-based products
or acquire relatively higher-risk securities yielding higher rates of return,
spread compression would occur.
Increase in Surrenders. If, as a result of interest rate increases, the
Company were unable or chose not to raise its crediting rates to keep them
competitive, the Company might experience an increase in surrenders. If the
Company lacked sufficient liquidity, the Company might have to sell investment
securities to fund associated surrender payments. Because the value of such
securities would likely have decreased in response to the increase in interest
rates, the Company would realize a loss on such sales. Although certain of the
Company's products contain market value adjustment features which approximate
and transfer such loss to the customer if the selected time horizon for the
fixed return investment is terminated prior to maturity, there can be no
assurance that the Company would be fully insulated from realizing any losses on
sales of its securities. In addition, regardless of whether the Company realizes
an investment loss, the surrenders would produce a decrease in invested assets,
with an adverse effect on future earnings therefrom. Finally, premature
surrenders also cause the Company to accelerate amortization of deferred policy
acquisition costs and value of insurance in force which would otherwise be
amortized over a longer period, but the impact of such acceleration generally
would be offset to some extent by surrender charge fees. Policies issued by the
Company's insurance subsidiaries include lapse protection provisions that help
to deter surrenders when interest rates rise. Surrender charges are generally
assessable within the first five to seven years after a policy is issued. The
Company realized surrender charge income of $4.5 million on net surrenders of
retail fixed and variable annuity products of $344.5 million in 1997. At
December 31, 1997, approximately 57% of the Company's insurance subsidiaries'
customer deposits had surrender penalties or other such restrictions or were not
subject to withdrawal.
MBS Prepayment and Extension. MBSs, including CMOs, are subject to
prepayment risks that vary with, among other things, interest rates. Such
securities accounted for approximately 41% of the Company's investment portfolio
as of December 31, 1997. During periods of declining interest rates, MBSs
generally
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prepay faster as the underlying mortgages are prepaid and refinanced by the
borrowers in order to take advantage of the lower rates. MBSs that have an
amortized cost that is greater than par (i.e., purchased at a premium) will
incur a reduction in yield or a loss as a result of such prepayments. In
addition, during such periods, the Company will generally be unable to reinvest
the proceeds of any such prepayment at comparable yields. Conversely, during
periods of rising interest rates, prepayments generally slow. MBSs that have an
amortized value that is less than par (i.e., purchased at a discount) will incur
a decrease in yield or a loss as a result of slower prepayments. The gross
unamortized premiums and unaccreted discounts of the Company's MBSs were $44.5
million and $82.7 million, respectively, at December 31, 1997.
The Company follows asset/liability strategies that are designed to
mitigate the effect of interest rate changes on the Company's profitability.
However, there can be no assurance that management will be successful in
implementing such strategies and achieving adequate investment spreads.
LIMITED OPERATING HISTORY; VARIABILITY OF OPERATING RESULTS
The Company has a limited operating history and sustained net losses for
the years ended December 31, 1994 and 1993 of $16.8 million and $40.8 million,
respectively. In 1994, these losses principally related to realized investment
losses due to the sale of fixed-maturity securities during a period of rising
interest rates, and in 1993, these losses related primarily to writedowns due to
other-than-temporary impairments in the value of certain investments in real
estate and joint ventures that occurred prior to the acquisition of the
Integrity Companies (as defined herein). Although the Company reported net
income of $27.6 million, $23.4 million and $11.9 million for the years ended
December 31, 1997, 1996 and 1995, respectively, there can be no assurance that
the Company will be able to sustain profitable operations in the future. In
addition, the Company may experience substantial variability in its earnings
from period to period, especially in view of the Company's active management of
its investment portfolio which may produce significant realized investment gains
or losses in a particular period as a result of changes in prevailing interest
rates.
COMPETITION; RATINGS
The Company operates in a highly competitive industry. The Company's
insurance subsidiaries compete in their markets with numerous major national
life insurance companies and insurance holding companies, many of which have
substantially greater capital and surplus, larger and more diversified
portfolios of life insurance policies and annuities, higher credit ratings,
greater economies of scale and greater access to distribution channels than the
Company's subsidiaries. Due to certain Supreme Court decisions, a ruling by the
office of the Comptroller of the Currency and other legislative and industry
developments, the Company's insurance subsidiaries also encounter increasing
competition from banks, securities brokerage firms and other financial
intermediaries marketing insurance products, annuities and other forms of
savings and pension products. Competition in the insurance industry is based on
many factors, including the overall financial strength and reputation of the
insurer, pricing and other terms and conditions of the offered product, levels
of customer service, access to distributor channels and experience in the
business, ratings assigned by A.M. Best Company, Inc. ("A.M. Best"), and the
claims-paying ability ratings assigned by nationally recognized statistical
rating organizations. Many financial institutions and broker-dealers focus on
the A.M. Best and claims-paying ability ratings of an insurer in determining
whether to market the insurer's annuities. As a result, if any of the Company's
insurance subsidiaries' ratings were downgraded from their current levels or if
the ratings of the Company's competitors improved and those of the Company's
insurance subsidiaries did not, the ability of the Company to distribute its
products and the persistency of its existing business could be adversely
affected. Each of the rating agencies reviews its ratings periodically, and
there can be no assurance that the Company's insurance subsidiaries' current
ratings will be maintained in the future.
HOLDING COMPANY STRUCTURE; DIVIDEND RESTRICTIONS
The Company is a holding company with no direct operations, and its
principal assets consist of the capital stock of Integrity Holdings, which owns
Integrity Life Insurance Company ("Integrity") and National Integrity Life
Insurance Company ("National Integrity" and, together with Integrity, the
"Integrity Companies") (domiciled in the States of Ohio and New York,
respectively), SBM Certificate Company and
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ARM Securities Corporation ("ARM Securities"). The Company relies primarily on
management fees, dividends and other distributions from its insurance and
non-insurance subsidiaries to meet ongoing cash requirements, including amounts
required for payment of interest and principal on outstanding debt obligations,
preferred stock dividends and corporate expenses. The ability of the Integrity
Companies to pay dividends to the Company in the future is subject, among other
things, to regulatory restrictions of their respective states of domicile and
will depend on their statutory surplus and earnings. Because National Integrity
is a subsidiary of Integrity, dividend payments by National Integrity to
Integrity must be made in compliance with New York standards, and the ability of
Integrity to pass those dividends on to the Company is subject to compliance
with Ohio standards. From time to time, the National Association of Insurance
Commissioners (the "NAIC") and various state insurance regulators have
considered, and may in the future consider, proposals to further restrict
dividend payments that may be made by an insurance company without regulatory
approval. No assurance can be given that there will not be any further
regulatory action restricting the ability of the Company's insurance
subsidiaries to pay dividends. Inability on the part of Integrity or National
Integrity to pay dividends to the Company in an amount sufficient to enable the
Company to meet its debt service and other cash requirements (including dividend
payments on the Series A Fixed/Adjustable Rate Preferred Stock) could have a
material adverse effect on the Company. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Liquidity and
Financial Resources."
DEPENDENCE ON CERTAIN THIRD-PARTY RELATIONSHIPS
The Company uses third-party marketing organizations with sales networks to
distribute certain of its retail annuity products. One such organization,
Financial Marketing Group, Inc. ("FMG"), supplements the Company's in-house
wholesaling unit by performing this function for certain independent
broker-dealers. Under this arrangement, the Company signs sales agreements with
each individual broker-dealer recruited by FMG and pays an override commission
to FMG based on the sales of those broker-dealers. Broker-dealers affiliated
with FMG accounted for 45% of total retail sales, and 11% of total retail and
institutional sales for the year ended December 31, 1997. No individual
broker-dealer affiliated with FMG accounted for more than 9% of total retail
sales for the year ended December 31, 1997. In addition to FMG, the Company
utilizes PaineWebber Incorporated ("PaineWebber") in the stockbroker channel for
the distribution of certain products. For the year ended December 31, 1997,
approximately 13% of the Company's total retail sales and approximately 3% of
total retail and institutional sales were made through PaineWebber. The Company
also relies on its joint venture with General American for the issuance of
funding agreements and GIC policies to institutional customers. In recent
periods, internal growth of the Company's spread-based business has been largely
dependent on the sales of funding agreements and GICs marketed by the Company
and issued by General American under the joint venture with the Company. Sales
of funding agreements and GICs accounted for 82% of the Company's sales of
spread products for the year ended December 31, 1997. For the same period, 65%
of all institutional spread product sales were made through General American, or
48% of total retail and institutional sales. If demand for funding agreements
and GIC products, or the Company's ability to market such products, were to
decrease, the Company's results of operations could be adversely affected. The
loss of the wholesaler FMG, of PaineWebber or of General American as a marketing
partner, or the impairment of the reputation or creditworthiness of any of them,
could materially adversely affect the Company's ability to market its retail
products or funding agreements and GICs until another distribution source or
marketing partner could be found. There can be no assurance that the Company
would be able to find an alternate source of distribution in a timely manner.
REGULATION
The Company's businesses and operations are subject to various federal and
state laws and regulations which, among other things, grant supervisory agencies
broad administrative powers over such businesses and operations, including the
power to limit or restrict such businesses if they fail to comply with
applicable laws and regulations.
The Company's insurance subsidiaries are regulated by insurance regulators
in Ohio and New York as well as in other jurisdictions in which they are
licensed or authorized to do business. Insurance laws and
S-8
<PAGE> 9
regulations, among other things, establish minimum capital requirements and
limit the amount of dividends and other payments insurance companies can make
without prior regulatory approval and impose restrictions on the amount and type
of investments such companies may hold. In addition, variable annuities and
related separate accounts of the Company's insurance subsidiaries are subject to
regulation by the Securities and Exchange Commission (the "Commission") under
the Securities Act and the Investment Company Act of 1940, as amended (the
"Investment Company Act"). The Company's non-insurance operations are also
subject to extensive regulation, including regulation under the Exchange Act,
the Employee Retirement Income Security Act of 1974, as amended, the Investment
Advisers Act of 1940, as amended (the "Advisers Act"), the Investment Company
Act, various other federal and state securities laws and regulations and by the
National Association of Securities Dealers, Inc. (the "NASD"). The Company
cannot predict, and no assurance can be given as to, the effect that any future
regulation or changes in interpretation of existing regulation may have on the
financial condition or operations of the Company.
As required by the Investment Company Act and the Advisers Act, the
Company's standard investment management and investment advisory agreements
provide that such agreements with registered investment companies terminate
automatically upon their assignment and agreements with other persons may not be
assigned by a party without the prior written consent of the other party. The
Investment Company Act and the Advisers Act define the term "assignment" to
include any "direct or indirect transfer" of a "controlling block of the voting
securities" of the Company. The Investment Company Act presumes that any person
holding more than 25% of the voting stock of any person "controls" such person.
Significant purchases or sales of Common Stock by the Company or any
stockholder, among other things, may raise issues relating to assignments of the
Company's investment management and investment advisory agreements.
Under the insurance guaranty fund laws existing in each state, insurers
licensed to do business in such state can be assessed for certain obligations of
insolvent insurance companies to policyholders and claimants. Because such
assessments are typically not made for several years after an insurer fails and
depend upon the final outcome of liquidation or rehabilitation proceedings, the
Company cannot accurately determine the precise amount or timing of its exposure
to known insurance company insolvencies at this time. In connection with the
acquisition by the Company of the Integrity Companies from The National Mutual
Life Association of Australasia Limited ("National Mutual"), National Mutual
agreed to indemnify the Company with regard to guaranty fund assessments levied
in respect of companies declared insolvent or subject to conservatorship prior
to November 26, 1993. No assurance can be given that the Company's reserve for
assessments or such indemnity will be adequate in the event of any loss suffered
by the Company in respect of any assessment made under state insurance guaranty
fund laws. The Company estimates its reserve for assessments using information
provided by the National Organization of Life and Health Guaranty Associations.
The reserve does not include any provision for future assessments related to
unknown failures or to known failures for which no estimate of the Company's
exposure can currently be made. The insolvency of large life insurance companies
in future years could result in additional material assessments to the Company
by state guaranty funds that could have a material adverse impact on the
Company's future earnings and liquidity.
FEDERAL INCOME TAX TREATMENT OF ANNUITY PRODUCTS
Current United States federal income tax laws generally permit the
tax-deferred accumulation of earnings on the premiums paid by the holder of an
annuity. Taxes, if any, are payable on the accumulated tax-deferred earnings
when these earnings are paid to such holder. In the event that the United States
federal income tax laws are changed such that accumulated earnings on annuity
products do not enjoy the tax deferral described above or that another product
acquires similar or preferred tax-advantaged status, consumer demand for annuity
products may decline substantially.
In recent years, several proposals have been made to change the federal
income tax system. These proposals have included various flat tax rate and
consumption taxes. Under a proposal currently included in the Clinton
Administration's Fiscal Year 1999 Budget, all exchanges involving a variable
annuity contract and all reallocations within variable annuity contracts would
be taxed. Such transfers are currently tax-free. An additional proposal would
reduce the policyholder's tax basis in an annuity contract by an amount equal to
specified expense charges. There can be no assurance that, if enacted, such
changes to existing federal income
S-9
<PAGE> 10
tax laws will not result in a material decrease in the demand for the Company's
annuity products. Such a decrease could adversely affect the operations and
business prospects of the Company.
DEPENDENCE ON KEY PERSONNEL
The success of the Company will depend, to a significant extent, upon the
continued services of the key executive officers of the Company. The loss or
unavailability of such key executive officers or the inability to attract or
retain key employees in the future could have an adverse effect upon the
Company's operations.
YEAR 2000
The Company is currently evaluating, on an ongoing basis, its computer
systems and the systems of other companies on which the Company's operations
rely to determine if they will function properly with respect to dates in the
year 2000 and beyond. These activities are designed to ensure that there is no
adverse effect on the Company's core business operations. While the Company
believes its planning efforts are adequate to address its Year 2000 concerns,
there can be no guarantee that the systems of other companies on which the
Company's operations rely will be converted on a timely basis and will not have
a material effect on the Company. The cost of the Company's Year 2000
initiatives is not expected to be material to the Company's results of
operations or financial condition.
USE OF PROCEEDS
The net proceeds from the sale of the Series A Fixed/Adjustable Rate
Preferred Stock will be used to redeem the Company's 9 1/2% Cumulative Perpetual
Preferred Stock (the "Existing Preferred Stock") on or after December 15, 1998
and for other general corporate purposes. Pending such uses, the net proceeds
will be invested in intermediate and short-term securities.
S-10
<PAGE> 11
RATIO OF EARNINGS TO COMBINED
FIXED CHARGES AND PREFERRED STOCK DIVIDENDS
The following table sets forth the consolidated ratios of earnings to
combined fixed charges and preferred stock dividends for the Company for the
periods indicated. No pro forma ratios of earnings to combined fixed charges and
preferred stock dividends are presented with respect to the issuance of the
Series A Fixed/ Adjustable Rate Preferred Stock and the redemption on or after
December 15, 1998 of the Company's outstanding Preferred Stock with a portion of
the proceeds of such issuance because such pro forma ratios (determined as if
both the issuance and redemption had occurred at January 1, 1997 or January 1,
1998) would differ from the actual historic ratios by less than 10%.
<TABLE>
<CAPTION>
THREE MONTHS
ENDED YEAR ENDED DECEMBER 31,
MARCH 31, ------------------------------------------
1998 1997 1996 1995 1994(3) 1993(3)
------------ ---- ---- ---- ------- -------
<S> <C> <C> <C> <C> <C> <C>
Excluding interest credited on
customer deposits(1)................ 6.4x 4.3x 3.4x 2.0x -- --
Including interest credited on
customer deposits(2)................ 1.2x 1.1x 1.1x 1.1x -- --
</TABLE>
- ------------
(1) In computing the ratio of earnings to combined fixed charges and preferred
stock dividends (excluding interest credited on customer deposits), combined
fixed charges and preferred stock dividends consist of interest expense on
debt, the portion of operating lease rentals representative of the interest
factor and dividends on the preferred stock of the Company on a tax
equivalent basis. Earnings are computed by adding fixed charges to pretax
income.
(2) In computing the ratio of earnings to combined fixed charges and preferred
stock dividends (including interest credited on customer deposits), combined
fixed charges and preferred stock dividends consist of interest expense on
debt, the portion of operating lease rentals representative of the interest
factor, interest credited on customer deposits, and dividends on the
preferred stock of the Company on a tax equivalent basis. Earnings are
computed by adding fixed charges to pretax income.
(3) Earnings were inadequate to cover combined fixed charges and preferred stock
dividends by $29.2 million and $41.0 million for the years ended December
31, 1994 and 1993, respectively.
S-11
<PAGE> 12
CAPITALIZATION
The following table sets forth the consolidated capitalization, based on
carrying amount, of the Company at March 31, 1998 and as adjusted to give effect
to (i) the sale in a secondary offering on May 13, 1998 by The Morgan Stanley
Leveraged Equity Fund II, L.P., Morgan Stanley Capital Partners III, L.P.,
Morgan Stanley Capital Investors, L.P. and MSCP III 892 Investors, L.P.
(collectively, the "Morgan Stanley Stockholders") of their shares of Class A
Common Stock and Class B Convertible Common Stock, par value $.01 per share (the
"Class B Common Stock" and, together with the Class A Common Stock, the "Common
Stock"), which was converted automatically into shares of Class A Common Stock
upon such sale, and (ii) the issuance and sale by the Company of the Series A
Fixed/Adjustable Rate Preferred Stock represented by the Depositary Shares
offered hereby and the application of approximately $50.0 million of the
proceeds therefrom to redeem the Existing Preferred Stock no earlier than
December 15, 1998. This table should be read in conjunction with the Company's
consolidated financial statements and the notes thereto and other financial and
operating information incorporated by reference in this Prospectus.
<TABLE>
<CAPTION>
MARCH 31, 1998
-----------------------
ACTUAL AS ADJUSTED
------ -----------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Long-term debt.............................................. $ 38,000 $ 38,000
Shareholders' equity:
9 1/2% Cumulative Perpetual Preferred Stock, $.01 par
value, $25.00 stated value; 2,000,000 shares issued and
outstanding and no shares issued and outstanding as
adjusted(1)............................................ 50,000 --
Series A Fixed/Adjustable Rate Cumulative Preferred Stock,
$.01 par value, $200.00 stated value; no shares issued
and outstanding and 375,000 shares issued and
outstanding as adjusted................................ -- 75,000
Class A Common Stock, $.01 par value; 150,000,000 shares
authorized; 21,441,641 shares issued and outstanding
and 23,389,287 shares issued and outstanding as
adjusted(2)............................................ 214 233
Class B Common Stock, $.01 par value, 50,000,000 shares
authorized; 1,947,646 shares issued and outstanding and
no shares issued and outstanding as adjusted........... 19 --
Additional paid-in capital................................ 216,024 216,024
Retained earnings......................................... 30,474 30,474
Accumulated other comprehensive income from net unrealized
gains on available-for-sale securities................. 826 826
-------- --------
Total shareholders' equity........................ 297,557 322,557
-------- --------
Total capitalization.............................. $335,557 $360,557
======== ========
</TABLE>
- ------------
(1) The 9 1/2% Cumulative Perpetual Preferred Stock will remain outstanding
until redeemed on or after December 15, 1998.
(2) Excludes 2,428,629 shares of Common Stock issuable upon exercise of vested
and unvested options outstanding at June 1, 1998.
S-12
<PAGE> 13
SUMMARY HISTORICAL FINANCIAL INFORMATION
<TABLE>
<CAPTION>
THREE MONTHS
ENDED MARCH 31, YEAR ENDED DECEMBER 31,
------------------------- ----------------------------------------
1998 1997 1997 1996 1995
---- ---- ---- ---- ----
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Investment income.................................... $ 104,406 $ 69,700 $ 329,979 $ 250,031 $ 196,024
Interest credited on customer deposits............... (81,680) (51,325) (247,418) (182,161) (146,867)
---------- ---------- ---------- ---------- ----------
Net investment spread.............................. 22,726 18,375 82,561 67,870 49,157
Fee income:
Variable annuity fees.............................. 4,426 3,239 14,630 10,786 7,238
Asset management fees.............................. --(1) 1,884 8,595 5,780 3,161
Other fee income................................... 232 397 1,386 1,267 949
---------- ---------- ---------- ---------- ----------
Total fee income............................ 4,658 5,520 24,611 17,833 11,348
Other income and expenses:
Surrender charges.................................. 1,334 882 4,482 5,024 3,339
Operating expenses................................. (7,550) (8,156) (32,528) (31,055) (22,957)
Commissions, net of deferrals...................... (598) (638) (2,218) (2,372) (1,557)
Interest expense on debt........................... (617) (686) (2,517) (3,146) (3,461)
Amortization:
Deferred policy acquisition costs................ (2,724) (2,175) (10,416) (6,835) (2,932)
Value of insurance in force...................... (1,531) (2,241) (9,293) (7,320) (7,104)
Acquisition-related deferred charges............. (126) (126) (503) (1,503) (9,920)
Goodwill......................................... (94) (122) (424) (488) (358)
Non-recurring charges(2):
Stock-based compensation......................... (3,570) -- (8,145) -- --
Other............................................ -- (1,445) (6,678) (5,004) --
Other, net......................................... (593) (995) (386) (5,366) (687)
---------- ---------- ---------- ---------- ----------
Total other income and expenses............. (16,069) (15,702) (68,626) (58,065) (45,637)
Realized investment gains............................ 5,165 2,231 3,192 907 4,048
---------- ---------- ---------- ---------- ----------
Income before income taxes........................... 16,480 10,424 41,738 28,545 18,916
Income tax expense................................... (5,499) (2,814) (14,139) (5,167) (7,026)
---------- ---------- ---------- ---------- ----------
Net income........................................... 10,981 7,610 27,599 23,378 11,890
Dividends on preferred stock......................... (1,188) (1,188) (4,750) (4,750) (4,750)
---------- ---------- ---------- ---------- ----------
Net income applicable to common shareholders......... $ 9,793 $ 6,422 $ 22,849 $ 18,628 $ 7,140
========== ========== ========== ========== ==========
Dividends to common shareholders..................... $ (468) $ -- $ (930) $ -- $ --
========== ========== ========== ========== ==========
OTHER OPERATING DATA:
Operating earnings(3)................................ $ 10,006 $ 5,836 $ 34,149 $ 22,227 $ 4,509
========== ========== ========== ========== ==========
Pro forma operating earnings(4)...................... $ 10,006 $ 6,976 $ 36,343 $ 26,789
========== ========== ========== ==========
BALANCE SHEET DATA (AT END OF PERIOD):
Total cash and investments........................... $4,935,049 $3,499,000 $4,467,477 $3,347,477 $2,798,027
Assets held in separate accounts..................... 2,637,707 1,201,621 2,439,884 1,135,048 809,927
Total assets......................................... 7,858,736 4,943,221 7,138,424 4,701,664 3,793,580
Long-term debt....................................... 38,000 38,000 38,000 40,000 40,000
Total liabilities.................................... 7,561,179 4,785,247 6,830,879 4,519,722 3,605,589
Shareholders' equity:
Carrying amount.................................... 297,557 157,974 307,545 181,942 187,991
Excluding the effects of SFAS No. 115(5)........... 296,731 184,695 287,245 178,273 159,461
</TABLE>
- ---------------
(1) Reflects the sale of 80% of the Company's defined benefit pension plan asset
management operations in November 1997.
(2) The Company recorded non-recurring charges of $3.6 million in the first
quarter of 1998 as part of a retirement arrangement for John Franco, the
Company's former co-chairman and co-chief executive officer. The Company
recorded non-recurring charges of $1.4 million in the first quarter of 1997
primarily related to the relocation and consolidation of the Company's
operation facilities from Ohio to Louisville, Kentucky. The Company recorded
non-recurring charges of $14.8 million for the year ended December 31, 1997
including (i) a one-time non-cash stock-based compensation charge of $8.1
million related to the aggregate difference between the initial public
offering price of $15.00 per share of Class A Common Stock and the exercise
price of all of the then-outstanding options; and (ii) costs primarily
attributable to the relocation and consolidation of the Company's operation
facilities from Ohio to Louisville, Kentucky. The Company recorded a
non-recurring charge of $5.0 million in the year ended December 31, 1996
that also included $3.2 million for facilities consolidation and costs of
$1.8 million primarily related to merger and acquisition activity that did
not result in a transaction.
(3) "Operating earnings" is defined as net income applicable to common
shareholders excluding, net of tax, realized investment gains and losses,
non-recurring charges and income from defined benefit pension plan asset
management operations which were sold during November 1997.
(4) Operating earnings including a pro forma adjustment to reflect investment
income at an assumed rate of 7.5% on the net proceeds of the Company's
initial public offering of Class A Common Stock assuming it occurred at the
beginning of the period.
(5) Excludes from the carrying amount of shareholders' equity the net unrealized
gains and losses on securities classified as available-for-sale, net of
related amortization and taxes.
S-13
<PAGE> 14
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
The Company specializes in the growing asset accumulation business with
particular emphasis on retirement savings and investment products. The Company's
products and services are sold in two principal markets, the retail and
institutional markets, through a broad spectrum of distribution channels.
The Company derives its earnings from the investment spread and fee income
generated by the assets it manages. The Company earns a spread between what is
earned on invested assets and what is credited to customer accounts with its
retail spread products (primarily fixed and indexed annuities) and institutional
spread products (funding agreements, GICs and face-amount certificates). The
Company receives a fee in exchange for managing customers' deposits, and the
customer accepts the investment risk with its retail variable products (variable
annuity mutual fund options). The Company believes that market forces and
population demographics are producing and will continue to generate strong
consumer demand for long-term savings and retirement products, including fixed,
indexed and variable annuity products. In addition, the Company expects to
benefit from the growing institutional marketplace by increasing penetration in
the stable value and fixed income markets and developing new products and
applications. Although the Company's core business is developing and managing
spread-based investment products, it has also focused on the development of its
fee-based variable annuity business. Fee-based business is less capital
intensive than spread-based business and provides the Company with diversified
sources of income.
On November 7, 1997 the Company transferred substantially all of the assets
and operations of ARM Capital Advisors, Inc. ("ARM Capital Advisors") to ARM
Capital Advisors, LLC ("New ARMCA") and sold an 80% interest in New ARMCA.
Although third-party assets managed by ARM Capital Advisors grew since 1995 when
ARM Capital Advisors began its operations, the Company believes that market
attitudes towards developing an asset management service for defined benefit
pension plans within a holding company structure consisting predominantly of
insurance companies constrained ARM Capital Advisors' growth. ARM Capital
Advisors' management of defined benefit pension plan accounts generated asset
management fees of $1.9 million during the first quarter of 1997.
On December 13, 1996, the Company transferred its contracts to perform
management and advisory services for the State Bond Mutual Funds to Federated
Investors for $4.5 million. Had the sale of ARM Capital Advisors' operations and
the sale of the management contracts for the State Bond Mutual Funds occurred on
January 1, 1995, they would not have had a material effect on the Company's net
income for the years ended December 31, 1997, 1996 and 1995.
The following discussion compares the results of operations for the Company
for the three months ended March 31, 1998 and 1997 and the years ended December
31, 1997, 1996 and 1995. As the Company acquired substantially all of the assets
and business operations of SBM Company ("SBM") effective May 31, 1995, results
for 1996 and 1997 each include a full year of acquired SBM business operations
compared to seven months in 1995. Therefore, results of operations for 1995 are
not completely comparable with 1996 and 1997.
RESULTS OF OPERATIONS
Three Months Ended March 31, 1998 Compared with Three Months Ended March 31,
1997
Net income during the first quarter of 1998 was $11.0 million compared to
$7.6 million for the first quarter of 1997. Operating earnings (net income
applicable to common shareholders, excluding, net of tax, realized investment
gains and losses, non-recurring charges and, for 1997, income from defined
benefit pension plan asset management operations which were sold) were $10.0
million and $5.8 million for the first quarter of 1998 and 1997, respectively.
The increase in operating earnings is primarily attributable to an increase in
net investment spread due to deposit growth from sales of retail and
institutional spread products.
S-14
<PAGE> 15
Pro forma operating earnings for the first quarter of 1997 (operating
earnings including a pro forma adjustment to reflect investment income at an
assumed rate of 7.5% on the net proceeds of the Company's June 1997 initial
public offering of Class A Common Stock assuming it occurred on January 1, 1997)
were $7.0 million. Operating earnings per share (pro forma for 1997) were $.41
and $.29 for the first quarter of 1998 and 1997, respectively. The pro forma
information for 1997 is not necessarily indicative of what would have occurred
had the initial public offering occurred on the date indicated.
Annualized pretax operating earnings for retail spread products were 1.49%
and 1.33% of average assets under management of $2.82 billion and $2.63 billion
for that segment during the first quarter of 1998 and 1997, respectively.
Annualized pretax operating earnings for institutional spread products were
0.60% and 0.54% of average assets under management of $2.80 billion and $1.00
billion for that segment during the first quarter of 1998 and 1997,
respectively. Annualized pretax operating earnings for retail variable products
(fee business) were 0.53% and 0.41% of average assets under management of $1.20
billion and $847.9 million for that segment during the first quarter of 1998 and
1997, respectively. The Company's corporate and other segment includes earnings
on surplus of insurance subsidiaries and holding company cash and investments,
fee income from marketing partnerships and broker-dealer fee operations,
unallocated amortization expenses, and other various corporate expenditures that
are not allocated to specific products. Income tax expense and preferred stock
dividends are not allocated to any segment.
Net investment spread for the three months ended March 31, 1998 and 1997
was as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
----------------------
1998 1997
--------- ---------
(DOLLARS IN THOUSANDS,
EXCEPT AS NOTED)
<S> <C> <C>
Investment income...................................... $104,406 $ 69,700
Interest credited on customer deposits................. (81,680) (51,325)
-------- --------
Net investment spread................................ $ 22,726 $ 18,375
======== ========
Annualized investment yield............................ 7.24% 7.45%
Annualized average credited rate....................... (5.94)% (5.67)%
-------- --------
Investment spread rate............................... 1.30% 1.78%
======== ========
Average cash and investments (in billions)............. $ 5.77 $ 3.74
Average spread-based customer deposits (in billions)... $ 5.58 $ 3.67
</TABLE>
The decrease in the overall investment spread rate from 1.78% in 1997 to
1.30% in 1998 is primarily attributable to a greater proportion of institutional
spread product deposits in 1998, which generate lower spreads. Changes in
investment yield and average credited rates must be analyzed in relation to the
liability portfolios to which they relate. The annualized investment yield on
cash and investments, excluding assets supporting institutional spread product
deposits, was 7.74% for the first quarter of 1998, down slightly from 7.83% for
the comparable 1997 period. In comparison, the annualized investment yield on
cash and investments supporting institutional spread product deposits was 6.70%
and 6.42% for the first quarter of 1998 and 1997, respectively. Average cash and
investments related to institutional spread product deposits grew from $1.00
billion during the first quarter of 1997 to $2.80 billion during the first
quarter of 1998, contributing to the aggregate decrease in investment yields.
The proceeds from institutional spread product sales are invested in securities
of shorter duration (which generally have lower investment yields) than the
Company's other investment portfolios. The average credited rate pattern is
dependent upon the general trend of market interest rates, frequency of credited
rate resets and business mix. Crediting rates are reset monthly or quarterly
based on London Interbank Offered Rates ("LIBOR") for institutional spread
products and semi-annually or annually for certain fixed annuities. The increase
in the average rate of interest credited on customer deposits during the first
quarter of 1998 was primarily attributable to higher LIBOR compared to the first
quarter of 1997 and to a greater proportion of institutional spread product
deposits in 1998. To date, the Company has been able to react to changes in
market interest rates and maintain an adequate investment spread without a
S-15
<PAGE> 16
significant effect on retail surrender and withdrawal activity, although there
can be no assurance that the Company will be able to continue to do so.
Variable annuity fees, which are based on the market value of the mutual
fund assets supporting variable annuity customer deposits in nonguaranteed
separate accounts, increased to $4.4 million in the first quarter of 1998 from
$3.2 million in the first quarter of 1997. This increase is principally due to
asset growth from the receipt of variable annuity deposits and from a
market-driven increase in the value of existing variable annuity deposits
invested in mutual funds.
Assets under management as of March 31, 1998 and 1997 were as follows:
<TABLE>
<CAPTION>
MARCH 31,
----------------------------------------------
1998 1997
--------------------- ---------------------
PERCENT PERCENT
AMOUNT OF TOTAL AMOUNT OF TOTAL
------ -------- ------ --------
(DOLLARS IN MILLIONS)
<S> <C> <C> <C> <C>
Retail spread products (primarily fixed and
indexed annuity and face-amount
certificate deposits)..................... $2,815.4 37% $2,653.5 52%
Institutional spread products (funding
agreement and GIC deposits)............... 2,989.6 40 1,141.3 22
Retail variable products (variable annuity
deposits invested in mutual funds)........ 1,302.1 17 859.5 17
Corporate and other:
Off-balance sheet deposits under marketing
partnership arrangements............... 233.7 3 368.7 7
Cash and investments in excess of customer
deposits............................... 190.6 3 75.1 2
-------- --- -------- ---
Total assets under management..... $7,531.4 100% $5,098.1 100%
======== === ======== ===
</TABLE>
The increase in total assets under management was primarily attributable to
sales of floating rate funding agreements and GICs to institutional customers
and an increase in retail variable product deposits attributable to variable
annuity sales and the investment performance of variable annuity mutual funds
due to strong stock market returns.
Sales of retail and institutional spread products include premiums and
deposits received for products issued by the Company's insurance and face-amount
certificate subsidiaries. Sales of retail variable products include premiums for
the investment portfolio options of variable annuity products issued by the
Company's insurance subsidiaries.
Sales by market and type of product for the three months ended March 31,
1998 and 1997 were as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
------------------
1998 1997
------- -------
(IN MILLIONS)
<S> <C> <C>
Retail:
Spread products.......................................... $ 38.0 $ 68.8
Variable products........................................ 83.5 36.3
------ ------
Total retail.......................................... 121.5 105.1
Institutional:
Institutional spread products............................ 447.2 248.6
------ ------
Total sales...................................... $568.7 $353.7
====== ======
</TABLE>
Sales of retail variable products increased $47.2 million over the first
quarter of 1997. This increase is primarily attributable to the reintroduction
and enhancement of the Pinnacle variable annuity product in late
S-16
<PAGE> 17
1997. Sales of retail spread products decreased to $38.0 million for the first
quarter of 1998. This decrease is related to the decline in the yield on
intermediate-term U.S. Treasury securities which is one of the factors
considered in setting credited rates on retail spread products. The Company's
sales strategy is to broaden its mix of products, services and distribution
channels to enable it to achieve its target sales within different interest rate
environments. The increase in institutional sales was attributable to increased
sales of institutional funding agreements.
Net surrenders of retail spread and variable annuity products issued by the
Company's insurance subsidiaries were $79.7 million in the first quarter of 1998
compared to $76.1 million in the first quarter of 1997. Surrender charge income
increased to $1.3 million in the first quarter of 1998 from $.9 million in the
first quarter of 1997. The increase in surrender charge income is attributable
to a larger mix of surrenders of customer deposits acquired in connection with
the 1995 acquisition of SBM's insurance subsidiary which have higher surrender
charge penalties. Retail products issued by the Company's insurance subsidiaries
generally include lapse protection provisions that provide a deterrent to
surrenders when interest rates rise. These provisions can include surrender
charges and market value adjustments on annuity withdrawals. During the period
that surrender charges are assessable (generally the first five to seven years
after a policy is issued) surrenders are relatively low. The surrender and
withdrawal activity during the first quarters of 1997 and 1998 was generally
expected by the Company due to the level of customer deposits written several
years ago that were subject to declining or expiring surrender charges, and the
Company's strategy of maintaining investment spreads. The Company attempts to
reduce retail surrender activity and improve persistency through various
programs. The Company has experienced minimal withdrawals (excluding scheduled
interest payments) by institutional spread product customers during the first
quarter of 1997 and 1998.
Amortization of deferred policy acquisition costs related to operations was
$2.7 million and $2.2 million during the three months ended March 31, 1998 and
1997, respectively. This increase was primarily the result of growth in the
deferred policy acquisition cost asset due to additional sales of fixed, indexed
and variable annuity products. Variable costs of selling and issuing the
Company's insurance subsidiaries' products (primarily commissions and certain
policy issuance and marketing costs) are deferred and then amortized over the
expected life of the contract.
Amortization of value of insurance in force related to operations of $1.5
million and $2.2 million for the three months ended March 31, 1998 and 1997,
respectively, primarily reflects the amortization of the value of insurance in
force established as an asset by the Company in connection with the 1995
acquisition of SBM's insurance subsidiary. The decrease in amortization of value
of insurance in force related to operations is a result of the decrease in the
value of insurance in force asset from $50.8 million at March 31, 1997 to $31.0
million at March 31, 1998.
The Company recorded non-recurring charges of $3.6 million in the first
quarter of 1998 as part of a retirement package for John Franco, the Company's
former Co-Chairman and Co-Chief Executive Officer. Mr. Franco retired effective
February 10, 1998. These charges consisted of (i) a $2.1 million non-cash charge
in connection with the vesting of the unvested portion of the options held by
Mr. Franco to purchase 232,647 shares of the Company's Common Stock and (ii) a
$1.5 million charge for fulfilling remaining compensation related to his
employment agreement. The Company recorded non-recurring charges of $1.4 million
in the first quarter of 1997 primarily related to the relocation and
consolidation of the Company's operations facilities from Ohio to Louisville,
Kentucky.
Other expenses, net primarily includes premiums paid on agreements to
reinsure the majority of the mortality risks associated with single premium
endowment and variable annuity deposits.
Realized investment gains, which are reported net of related amortization
of deferred policy acquisition costs and value of insurance in force, were $5.2
million in the first quarter of 1998 compared to $2.2 million in the first
quarter of 1997. Such realized investment gains were primarily interest-rate
related and attributable to the ongoing management of the Company's fixed
maturity securities classified as available-for-sale which can result in
period-to-period swings in realized investment gains and losses since securities
are sold during both rising and falling interest rate environments. The ongoing
management of securities is a significant component of the Company's
asset/liability management strategy. The ongoing portfolio management process
involves
S-17
<PAGE> 18
evaluating the various asset sectors (i.e., security types and industry classes)
and individual securities comprising the Company's investment portfolios and,
based on market yield rates, repositioning holdings from sectors perceived to be
relatively overvalued to sectors perceived to be undervalued with the aim of
improving cash flows. The Company endeavors to accomplish this repositioning
without materially changing the overall credit, asset duration, convexity, and
liquidity characteristics of its investment portfolios.
Income tax expense was $5.5 million and $2.8 million during the three
months ended March 31, 1998 and 1997, respectively, reflecting effective tax
rates of 33.4% and 27.0%.
Year Ended December 31, 1997 Compared with Year Ended December 31, 1996
Net income during 1997 was $27.6 million compared to $23.4 million for
1996. Operating earnings (net income applicable to common shareholders,
excluding, net of tax, realized investment gains and losses, non-recurring
charges and income from defined benefit pension plan asset management operations
which were sold) were $34.1 million and $22.2 million for 1997 and 1996,
respectively. The increase in operating earnings is primarily attributable to an
increase in net investment spread due to both deposit growth from sales of
retail and institutional spread products and ongoing asset/liability management
and, to a lesser extent, an increase in fee income as a result of a larger base
of variable annuity deposits.
Pro forma operating earnings (operating earnings including a pro forma
adjustment to reflect investment income at an assumed rate of 7.5% on the net
proceeds of the Company's initial public offering of Class A Common Stock
assuming it occurred on January 1, 1996) were $36.3 million and $26.8 million
for 1997 and 1996, respectively. Pro forma operating earnings per share were
$1.51 and $1.13 for the same respective years. This pro forma information is not
necessarily indicative of what would have occurred had the offering occurred on
the date indicated.
Operating earnings for retail spread products were 1.36% and 1.30% of
average assets under management of $2.76 billion and $2.66 billion for that
segment during 1997 and 1996, respectively. This increase in retail spread
margins is primarily attributable to ongoing asset/liability management, which
generated higher net investment spreads. Operating earnings for institutional
spread products were .62% and .57% of average assets under management of $1.48
billion and $567.7 million for that segment during 1997 and 1996, respectively.
The increase in institutional spread margins is also primarily attributable to
ongoing asset/liability management. Operating earnings for retail variable
products (fee business) were .52% and .66% of average assets under management of
$970.3 million and $728.2 million for that segment during 1997 and 1996,
respectively. The decline in retail variable margins is primarily attributable
to lower amortization expense of deferred policy acquisition costs during 1996.
The Company's corporate and other segment primarily includes earnings on
insurance subsidiaries surplus and holding company cash and investments,
marketing partnership and broker-dealer fee income, and unallocated corporate
overhead. Income tax expense and preferred stock dividends are not allocated to
any segment.
Net investment spread for the years ended December 31, 1997 and 1996 was as
follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------
1997 1996
---------- ----------
(DOLLARS IN THOUSANDS,
EXCEPT AS NOTED)
<S> <C> <C>
Investment income.................................... $ 329,979 $ 250,031
Interest credited on customer deposits............... (247,418) (182,161)
--------- ---------
Net investment spread.............................. $ 82,561 $ 67,870
========= =========
Investment yield..................................... 7.60% 7.75%
Average credited rate................................ (5.83)% (5.67)%
--------- ---------
Investment spread rate............................. 1.77% 2.08%
========= =========
Average cash and investments (in billions)........... $ 4.34 $ 3.23
Average spread-based customer deposits (in
billions).......................................... $ 4.24 $ 3.21
</TABLE>
S-18
<PAGE> 19
The decrease in the overall investment spread rate from 2.08% in 1996 to
1.77% in 1997 is attributable to a greater proportion of institutional spread
product deposits in 1997, which generate lower spreads. Changes in investment
yield and interest credited rates must be analyzed in relation to the liability
portfolios to which they relate. When analyzed individually, investment spread
rates increased in 1997 for both retail and institutional spread products. The
investment yield on cash and investments, excluding assets supporting
institutional spread product deposits, was 8.04% for 1997, up from 8.01% in
1996. In comparison, the investment yield on cash and investments supporting
institutional spread product deposits was 6.74% and 6.53% for 1997 and 1996,
respectively. These increases reflect the benefits of ongoing investment
portfolio management. Average cash and investments related to institutional
spread product deposits grew from $567.7 million during 1996 to $1.48 billion
during 1997, causing the aggregate decrease in investment yields. The proceeds
from institutional spread product sales are invested in securities of shorter
duration (which generally have lower investment yields) than the Company's other
investment portfolios. The average credited rate pattern is dependent upon the
general trend of market interest rates (which were somewhat higher on the
average in 1997), frequency of credited rate resets and business mix. Crediting
rates are reset monthly based on the LIBOR for institutional spread products and
semi-annually or annually for certain fixed annuities. To date, the Company has
been able to react to changes in market interest rates and maintain an adequate
investment spread without a significant effect on surrender and withdrawal
activity, although there can be no assurance that the Company will be able to
continue to do so.
Fee income increased to $24.6 million in 1997 from $17.8 million in 1996.
This increase is attributable to variable annuity fees, which are based on the
market value of the mutual fund assets supporting variable annuity customer
deposits in nonguaranteed separate accounts. Variable annuity fees increased to
$14.6 million in 1997 from $10.8 million in 1996 principally due to asset growth
from the receipt of variable annuity deposits and from a market-driven increase
in the value of existing variable annuity deposits invested in mutual funds.
Variable annuity deposits averaged $970.3 million in 1997, an increase from
$728.2 million in 1996. In addition, asset management fees earned by ARM Capital
Advisors on off-balance sheet assets, primarily related to defined benefit
pension plans, increased to $8.6 million in 1997 from $5.8 million in 1996
(which included fees from the State Bond Mutual Funds which were sold by the
Company in December 1996), reflecting a significant increase in the average fair
value of off-balance sheet assets managed due to sales. As a result of the sale
of ARM Capital Advisors' operations and the State Bond Mutual Funds management
contracts, asset management fee income will decrease in the future.
Assets under management as of December 31, 1997 and 1996 were as follows:
<TABLE>
<CAPTION>
1997 1996
--------------------- ---------------------
PERCENT PERCENT
AMOUNT OF TOTAL AMOUNT OF TOTAL
------ -------- ------ --------
(DOLLARS IN MILLIONS)
<S> <C> <C> <C> <C>
Retail spread products (primarily fixed and
indexed annuity and face-amount
certificate deposits)..................... $2,820.6 41% $2,646.2 55%
Institutional spread products (funding
agreement and GIC deposits)............... 2,542.3 37 891.9 18
Retail variable products (variable annuity
deposits invested in mutual funds)........ 1,129.1 16 844.3 17
Corporate and other:
Off-balance sheet deposits under marketing
partnership arrangements............... 232.9 3 366.2 8
Cash and investments in excess of customer
deposits............................... 180.8 3 77.0 2
-------- --- -------- ---
Total corporate and other.............. 413.7 6 443.2 10
-------- --- -------- ---
Total assets under management..... $6,905.7 100% $4,825.6 100%
======== === ======== ===
</TABLE>
The increase in total assets under management was primarily attributable to
sales of floating rate funding agreements and GICs to institutional customers
and, to a lesser extent, an increase in retail variable product
S-19
<PAGE> 20
deposits attributable to variable annuity sales and the investment performance
of variable annuity mutual funds due to strong stock market returns.
Sales of retail and institutional spread products include premiums and
deposits received for products issued by the Company's insurance and face-amount
certificate subsidiaries. Sales of retail variable products include premiums for
the investment portfolio options of variable annuity products issued by the
Company's insurance subsidiaries.
Sales by market and type of product for 1997 and 1996 were as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------
1997 1996
---------- ----------
(IN MILLIONS)
<S> <C> <C>
Retail:
Spread products....................................... $ 382.5 $ 130.6
Variable products..................................... 206.3 200.1
-------- --------
Total retail....................................... 588.8 330.7
Institutional:
Institutional spread products......................... 1,708.7 747.5
-------- --------
Total sales................................... $2,297.5 $1,078.2
======== ========
</TABLE>
Total sales during 1997 rose to $2,297.5 million, an increase of
approximately 113% over 1996. The growth is primarily attributable to continued
diversification and expansion in the retail and institutional markets. The
growth in retail spread product sales is largely due to an increase in marketing
efforts for the Company's guaranteed rate option annuity products. Institutional
spread product sales increased as a result of (i) the addition of sales staff
and further penetration into institutional channels; and (ii) the launching of a
new funding agreement product. In November 1997, the Company received a deposit
of $500 million for the new product, which was sold in partnership with BLB and
initially matures in five years and is renewable annually thereafter.
Net surrenders of retail fixed and variable annuity products issued by the
Company's insurance subsidiaries were $344.5 million for 1997 compared to $326.2
million for 1996. Surrender charge income decreased to $4.5 million in 1997 from
$5.0 million in 1996. The decrease in surrender charge income is attributable to
a larger portion of the surrenders being partial surrenders which do not result
in a surrender charge penalty. Retail products issued by the Company's insurance
subsidiaries generally include lapse protection provisions that provide a
deterrent to surrenders when interest rates rise. These provisions can include
surrender charges and market value adjustments on annuity withdrawals. During
the period that surrender charges are assessable (generally the first five to
seven years after a policy is issued) surrenders are relatively low. The
surrender and withdrawal activity in 1996 and 1997 was generally expected by the
Company due to the level of customer deposits written several years ago that
were subject to declining or expiring surrender charges, and the Company's
strategy of maintaining investment spreads. The Company attempts to reduce
surrender activity and improve persistency through various programs.
Operating expenses increased to $32.5 million in 1997 from $31.1 million in
1996. The increase is primarily attributable to increased marketing efforts
(including an increase in marketing staff and additional investments in
technology) to expand and enhance the support of distribution channels in the
retail and institutional markets, partially offset by a reduction in
state-mandated guaranty fund assessment accruals. The Company continues to
actively pursue and retain producers within its distribution channels to market
its products.
Amortization of deferred policy acquisition costs related to operations was
$10.4 million and $6.8 million in 1997 and 1996, respectively. This increase was
primarily the result of growth in the deferred policy acquisition cost asset due
to additional sales of retail fixed and variable annuity products. Amortization
specifically attributable to variable annuity products increased $1.9 million
during 1997. Variable costs of
S-20
<PAGE> 21
selling and issuing the Company's insurance subsidiaries' products (primarily
commissions and certain policy issuance and marketing costs) are deferred and
then amortized over the expected life of the contract.
Amortization of value of insurance in force related to operations of $9.3
million and $7.3 million for 1997 and 1996, respectively, primarily reflects the
amortization of the value of insurance in force established as an asset by the
Company in connection with the acquisition of SBM's insurance subsidiary. The
increase in amortization expense corresponds with lower than expected gross
margins for that block of annuity business.
The Company recorded non-recurring charges of $14.8 million for 1997
including (i) a one-time non-cash stock-based compensation charge of $8.1
million related to the aggregate difference between the initial public offering
price of $15.00 per share of Class A Common Stock and the exercise price of all
of the then-outstanding options; and (ii) other non-recurring costs primarily
attributable to the relocation and consolidation of the Company's operations
facilities from Ohio to Louisville, Kentucky. The Company recorded a non-
recurring charge of $5.0 million in 1996 that also included $3.2 million for
facilities consolidation and costs of $1.8 million primarily related to merger
and acquisition activity that did not result in a transaction.
Other expenses, net decreased to $.4 million in 1997 from $5.4 million in
1996. This decrease is attributable to higher mortality costs in 1996 related to
immediate annuity deposits. In addition, 1997 benefitted from mortgage loan
prepayment penalty income of $2.1 million and the favorable resolution of a
reinsurance claim of $2.4 million.
Realized investment gains, which are reported net of related amortization
of deferred policy acquisition costs and value of insurance in force, were $3.2
million in 1997 compared to $.9 million in 1996. Realized investment gains in
1997 include an estimated loss of $4.0 million related to the write-down to fair
value of an investment in a fixed income security. Realized investment gains in
1996 include an estimated loss of $15.2 million related to the write-down to
fair value of an investment in a fixed income security and a gain of $4.5
million, before selling expenses, related to the transfer of the State Bond
Mutual Funds management contracts. Other realized investment gains and losses
were primarily interest-rate related and attributable to the ongoing management
of the Company's fixed maturity securities classified as available-for-sale
which can result in period-to-period swings in realized investment gains and
losses since securities are sold during both rising and falling interest rate
environments. The ongoing management of securities is a significant component of
the Company's asset/liability management strategy. The ongoing portfolio
management process involves evaluating the various asset sectors (i.e., security
types and industry classes) and individual securities comprising the Company's
investment portfolios and, based on market yield rates, repositioning holdings
from sectors perceived to be relatively overvalued to sectors perceived to be
undervalued with the aim of improving cash flows. The Company endeavors to
accomplish this repositioning without materially changing the overall credit,
asset duration, convexity, and liquidity characteristics of its investment
portfolios.
Income tax expense was $14.1 million and $5.2 million in 1997 and 1996,
respectively, reflecting effective tax rates of 33.9% and 18.1% as a percentage
of pretax income. If the nonrecurring stock-based compensation charge was added
back to pretax income, the effective tax rate for 1997 would be 28.3%. A tax
benefit was not recognized for the charge because a full valuation allowance was
provided on the Company's non-life deferred tax assets.
Year Ended December 31, 1996 Compared with Year Ended December 31, 1995
During 1996, net income for the Company was $23.4 million compared to $11.9
million for 1995. Operating earnings (net income applicable to common
shareholders, excluding, net of tax, realized investment gains and losses,
non-recurring charges and income from defined benefit pension plan asset
management operations which were sold during November 1997) were $22.2 million
and $4.5 million for 1996 and 1995, respectively. The increase in operating
earnings is primarily attributable to (i) an increase in net investment spread
due to ongoing asset/liability management and deposit growth from the full
year's effects of the May 31, 1995 acquisition of the SBM assets and business
operations and additional sales of retail and institutional spread products; and
(ii) an increase in fee income as a result of a growing base of variable annuity
deposits. Such increases in revenues were partially offset by an increase in
operating expenses as a result of business growth.
S-21
<PAGE> 22
Operating earnings for retail spread products were 1.30% and .91% of
average assets under management of $2.66 billion and $2.43 billion for that
segment during 1996 and 1995, respectively. This increase in retail spread
margins is primarily attributable to ongoing asset/liability management, which
generated higher net investment spreads. Operating earnings for institutional
spread products were .57% and .60% of average assets under management of $567.7
million and $38.5 million for that segment during 1996 and 1995, respectively.
Operating earnings for retail variable products for 1996 were slightly higher
than the corresponding prior period as evidenced by the increase to .66% from
.64% of average retail variable assets under management of $728.2 million and
$491.5 million during 1996 and 1995, respectively.
Net investment spread for the years ended December 31, 1996 and 1995 was as
follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------
1996 1995
------------- -------------
(DOLLARS IN THOUSANDS, EXCEPT
AS NOTED)
<S> <C> <C>
Investment income.................................... $ 250,031 $ 196,024
Interest credited on customer deposits............... (182,161) (146,867)
--------- ---------
Net investment spread.............................. $ 67,870 $ 49,157
========= =========
Investment yield..................................... 7.75% 7.84%
Average credited rate................................ (5.67)% (5.90)%
--------- ---------
Investment spread rate............................. 2.08% 1.94%
========= =========
Average cash and investments (in billions)........... $ 3.23 $ 2.50
Average customer deposits (in billions).............. $ 3.21 $ 2.49
</TABLE>
The decrease in investment yields on cash and investments primarily relates
to a significant increase in institutional spread product deposits which grew
from zero to $143.2 million during 1995 and to $891.9 million at December 31,
1996. The proceeds from institutional spread product sales are invested in
securities of shorter duration (which generally have lower investment yields)
than the Company's other investment portfolios. The investment yield on cash and
investments supporting institutional spread product deposits was 6.53% for 1996.
In comparison, the investment yield on cash and investments, excluding assets
supporting institutional spread product deposits, was 8.01% for 1996, up from
7.85% for 1995, which reflects the benefits of the ongoing management of the
Company's investment portfolios. The decrease in the average rate of interest
credited on customer deposits during 1996 was due primarily to annual or
semi-annual crediting rate resets occurring at a time when the overall interest
rate environment was generally lower (the last half of 1995 and the first half
of 1996 compared to the last half of 1994 and the first half of 1995).
Fee income increased to $17.8 million in 1996 from $11.3 million in 1995.
This increase is in part attributable to variable annuity fees which are based
on the market value of assets supporting the investment portfolio options of
variable annuity customer deposits in separate accounts. Variable annuity fees
increased to $10.8 million in 1996 from $7.2 million in 1995 principally due to
asset growth from the receipt of variable annuity deposits and from a
market-driven increase in the value of existing variable annuity deposits
invested in mutual funds. Variable annuity deposits increased to $844.3 million
in 1996 from $617.3 million in 1995. In addition, asset management fees earned
by ARM Capital Advisors on off-balance sheet assets, related to defined benefit
pension plans and the State Bond Mutual Funds, increased to $5.8 million in 1996
from $3.2 million in 1995. This increase in asset management fees reflects a
significant increase in the average amount of corresponding off-balance sheet
assets managed due to new defined benefit pension plan accounts. The average
amount of off-balance sheet assets managed by ARM Capital Advisors was $2.16
billion in 1996 compared to $1.10 billion in 1995.
S-22
<PAGE> 23
Assets under management as of December 31, 1996 and 1995 were as follows:
<TABLE>
<CAPTION>
1996 1995
--------------------- ---------------------
PERCENT PERCENT
AMOUNT OF TOTAL AMOUNT OF TOTAL
-------- --------- --------- --------
(DOLLARS IN MILLIONS)
<S> <C> <C> <C> <C>
Retail spread products (primarily fixed and
indexed annuity and face-amount
certificate deposits)..................... $2,646.2 55% $2,716.2 69%
Institutional spread products (funding
agreement and GIC deposits)............... 891.9 18 143.2 4
Retail variable products (variable annuity
deposits invested in mutual funds)........ 844.3 17 617.3 16
Corporate and other:
Off-balance sheet deposits under marketing
partnership arrangements............... 366.2 8 387.3 10
Cash and investments in excess of customer
deposits............................... 77.0 2 61.1 1
-------- --- -------- ---
Total corporate and other.............. 443.2 10 448.4 11
-------- --- -------- ---
Total assets under management*.... $4,825.6 100% $3,925.1 100%
======== === ======== ===
</TABLE>
- ------------
* Does not include off-balance sheet assets managed by ARM Capital Advisors for
institutional clients and off-balance sheet assets in the State Bond Mutual
Funds. Including such assets, total assets under management at December 31,
1996 and 1995 were $7,553.0 million and $5,364.2 million, respectively.
The increase in total assets under management was primarily attributable to
an increase in sales of funding agreements and GICs to institutional customers
and, to a lesser extent, increased sales of retail variable products.
Sales by market and type of product for 1996 and 1995 were as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------
1996 1995
---------- --------
(IN MILLIONS)
<S> <C> <C>
Retail:
Spread products...................................... $ 130.6 $115.4
Variable products.................................... 200.1 177.7
-------- ------
Total retail...................................... 330.7 293.1
Institutional:
Institutional spread products........................ 747.5 142.2
Fee-based marketing partnerships..................... -- 272.9
-------- ------
Total institutional............................... 747.5 415.1
-------- ------
Total sales*................................. $1,078.2 $708.2
======== ======
</TABLE>
- ------------
* Does not include new deposits related to off-balance sheet assets managed by
ARM Capital Advisors for institutional clients and the State Bond Mutual
Funds. Total retail sales for the years ended December 31, 1996 and 1995 were
$342.8 million and $300.9 million, respectively, and total institutional sales
for the years ended December 31, 1996 and 1995 were $2,401.5 million and
$886.9 million, respectively, including such deposits.
The increase in retail sales was primarily attributable to an increase in
sales of investment portfolio options of variable annuity contracts due, in
part, to the strong stock market returns during 1996 and an increased emphasis
on marketing efforts of retail products during the fourth quarter, principally
through stockbrokers and independent agents. The Company's institutional spread
products were issued primarily
S-23
<PAGE> 24
through the marketing partnership arrangement with General American. Expanded
distribution of funding agreement products and GIC products through bank trust
departments, mutual fund companies, investment managers, insurance companies and
investment consultants contributed to the increase in sales of such products.
The decrease in institutional fee-based sales was attributable to the Company's
marketing partnership arrangement with General American which was converted from
a fee-based to primarily a spread-based arrangement in late 1995.
Net surrenders of annuity products issued by the Company's insurance
subsidiaries were $326.2 million and $319.8 million in 1996 and 1995,
respectively. Of these amounts, $106.9 million and $62.8 million, respectively,
can be attributed to fixed annuity business acquired from SBM. Surrender charge
income increased to $5.0 million in 1996 from $3.3 million in 1995, due to
higher average surrender charges associated with SBM products compared to other
products of the Company's insurance subsidiaries and to the overall increase in
the volume of surrenders. The surrender and withdrawal activity during 1995 and
1996 was generally expected by the Company due to the level of customer deposits
written several years ago that were subject to declining or expiring surrender
charges and the Company's strategy of maintaining investment spreads.
Operating expenses increased to $31.1 million in 1996 from $23.0 million in
1995. The increase was primarily attributable to (i) the inclusion of twelve
months of incremental operating expenses related to the acquired SBM operations
in the 1996 results versus seven months for the comparable 1995 period; (ii) the
expansion of product distribution channels; and (iii) a charge of $1.6 million
to increase the reserve for anticipated future guaranty fund assessments.
Commissions, net of deferrals, were $2.4 million and $1.6 million in 1996
and 1995, respectively. The increase was primarily attributable to the inclusion
in 1996 results of twelve months' renewal and trailer commissions under certain
deferred annuity contracts acquired through the SBM acquisition versus seven
months for the comparable 1995 period.
Amortization of deferred policy acquisition costs related to operations was
$6.8 million and $2.9 million during 1996 and 1995, respectively. This increase
was the result of growth in the deferred policy acquisition cost asset due to
additional sales of fixed and variable annuity products.
Amortization of value of insurance in force related to operations increased
to $7.3 million in 1996 from $7.1 million in 1995. The increase is attributable
to amortization of the value of insurance in force established as an asset by
the Company on May 31, 1995 in connection with the acquisition of SBM's
insurance subsidiary.
Amortization of acquisition-related deferred charges was $1.5 million and
$9.9 million in 1996 and 1995, respectively. The decrease was primarily
attributable to the accelerated amortization during the third quarter of 1995 of
certain costs and charges deferred during 1993 and 1994. During the third
quarter of 1995, Company management determined that changes in facts and
circumstances had resulted in a change in their original estimate of the periods
benefitted by these costs and charges. As a result of this change in estimate,
the remaining unamortized balances of these deferred costs and charges were
fully amortized as of September 30, 1995, resulting in lower amortization in
future periods.
Other expenses, net were $5.4 million in 1996 compared to $.7 million in
1995. The increase is primarily attributable to an increase in premiums and fees
paid or accrued in 1996, net of a reduction in net benefits paid, under
reinsurance agreements. Through the reinsurance agreements, one of which
commenced December 31, 1995, substantially all mortality risks associated with
single premium endowment deposits have been reinsured.
The Company recorded a $5.0 million non-recurring charge in 1996 including
$3.2 million related to the move of operations facilities from Ohio to
Louisville, Kentucky and costs of $1.8 million primarily related to mergers and
acquisitions activities that did not result in a transaction.
Realized investment gains, which are reported net of related amortization
of deferred policy acquisition costs and value of insurance in force, were $.9
million in 1996 compared to $4.0 million in 1995. Realized
S-24
<PAGE> 25
investment gains in 1996 include an estimated loss of $15.2 million related to
the write-down to fair value of an investment in a fixed income security and a
gain of $4.5 million, before selling expenses, related to the transfer of the
State Bond Mutual Funds management contracts. Other 1996 and all 1995 realized
investment gains and losses were interest-rate related and attributable to the
ongoing management of the Company's fixed maturity securities classified as
available-for-sale which can result in period-to-period swings in realized
investment gains and losses since securities are sold during both rising and
falling interest rate environments.
Income tax expense was $5.2 million and $7.0 million in 1996 and 1995,
respectively, reflecting effective tax rates of 18.1% and 37.1%. The lower
effective tax rate in 1996 resulted primarily from the recognition of benefits
associated with certain deferred tax assets established in connection with the
Company's acquisition of Integrity and National Integrity on November 26, 1993
for which a full valuation allowance was originally provided. These deferred tax
benefits are being recognized based on the taxable income generated by the
Integrity Companies in the post-acquisition period and projections of future
taxable income.
ACQUISITION ACTIVITY
ARM Capital Advisors
Through its acquisition of the U.S. fixed income unit of Kleinwort Benson
Investment Management Americas, Inc. in January 1995, the Company obtained a
recognized fixed income management service which became part of the then newly
formed ARM Capital Advisors. In addition to providing asset management services
to institutional clients, ARM Capital Advisors managed the investment portfolios
of the Company's subsidiaries. Although third-party assets managed by ARM
Capital Advisors grew since the acquisition, the Company believes that market
attitudes towards developing an asset management service for defined benefit
pension plans within a holding company structure consisting predominantly of
insurance companies constrained ARM Capital Advisors' growth. Accordingly, on
November 7, 1997, the Company transferred substantially all of the assets and
operations of ARM Capital Advisors to New ARMCA and sold an 80% interest in New
ARMCA.
SBM Company
Effective May 31, 1995, the Company completed the acquisition of
substantially all of the assets and business operations of SBM, including all of
the issued and outstanding capital stock of SBM's subsidiaries, State Bond and
Mortgage Life Insurance Company ("SBM Life") and ARM Securities (formerly known
as SBM Financial Services, Inc.), as well as the management contracts for the
State Bond Mutual Funds. The aggregate purchase price for the SBM acquisition
was $38.8 million. The Company financed the acquisition by issuing approximately
6.9 million shares of Common Stock, primarily to the MSCP Funds, for an
aggregate sale price of $63.5 million. The Company used proceeds from the
issuance of the new common equity in excess of the adjusted purchase price for
the acquisition to make a $19.9 million capital contribution to SBM Life and
acquire SBM Certificate Company from SBM Life for $3.3 million. The capital
contribution to SBM Life of $19.9 million was used to strengthen SBM Life's
financial position and allowed for a significant investment portfolio
restructuring immediately following the acquisition with no net adverse effect
on statutory adjusted capital and surplus. On December 31, 1995, SBM Life was
merged with and into Integrity to create certain operating efficiencies. The SBM
acquisition provided the Company with expanded distribution channels, as well as
a deposit base in the 403(b) tax-deferred annuity marketplace. On December 13,
1996, the Company transferred its responsibility for performing management and
investment advisory services for the State Bond Mutual Funds to Federated
Investors for $4.5 million. The State Bond Mutual Funds had aggregate assets of
$236.9 million on December 13, 1996.
ASSET PORTFOLIO REVIEW
The Company primarily invests in securities with fixed maturities with the
objective of earning reasonable returns while limiting credit and liquidity
risks. At amortized cost, fixed maturities at March 31, 1998 totaled $4.4
billion, compared with $4.0 billion at December 31, 1997, representing
approximately 90% and 91% of
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<PAGE> 26
total cash and investments, respectively. This increase in investments in fixed
maturities primarily resulted from the investment of the proceeds from the sales
of institutional spread products.
The Company's cash and investments as of March 31, 1998 are detailed as
follows:
<TABLE>
<CAPTION>
AMORTIZED COST
--------------------
PERCENT ESTIMATED
AMOUNT OF TOTAL FAIR VALUE
-------- -------- ----------
(DOLLARS IN MILLIONS)
<S> <C> <C> <C>
Fixed maturities:
Corporate securities................................ $1,595.6 32% $1,599.1
U.S. Treasury securities and obligations of U.S
government agencies.............................. 333.5 7 334.3
Other government securities......................... 84.9 2 85.9
Asset-backed securities............................. 416.5 9 415.1
Mortgage-backed securities ("MBSs"):
Agency pass-throughs............................. 37.5 1 37.6
Collateralized mortgage obligations ("CMOs"):
Agency......................................... 258.3 5 260.4
Non-agency..................................... 1,687.0 34 1,688.1
-------- --- --------
Total fixed maturities...................... 4,413.3 90 4,420.5
Equity securities (i.e., non-redeemable preferred
stock)........................................... 28.2 1 27.9
Mortgage loans on real estate....................... 16.2 * 16.2
Policy loans........................................ 126.3 2 126.3
Cash and cash equivalents........................... 344.1 7 344.1
-------- --- --------
Total cash and investments.................. $4,928.1 100% $4,935.0
======== === ========
</TABLE>
- ---------------
* Less than 1%.
Agency pass-through certificates are MBSs which represent an undivided
interest in a specific pool of residential mortgages. The payment of principal
and interest is guaranteed by the U.S. government or U.S. government agencies.
CMOs are pools of mortgages that are segregated into sections, or tranches,
which provide prioritized retirement of bonds rather than a pro rata share of
principal return as in the pass-through structure. The underlying mortgages of
agency CMOs are guaranteed by the U.S. government or U.S. government agencies.
Of the Company's non-agency CMO investments at March 31, 1998 (on an amortized
cost basis), 87% used mortgage loans or mortgage loan pools, letters of credit,
agency mortgage pass-through securities and other types of credit enhancement as
collateral. The remaining 13% of the non-agency CMOs used commercial mortgage
loans as collateral.
The Company manages prepayment exposure on CMO holdings by diversifying not
only within the more stable CMO tranches, but across alternative collateral
classes such as commercial mortgages and Federal Housing Administration project
loans, which are generally less volatile than agency-backed, residential
mortgages. Additionally, prepayment sensitivity is evaluated and monitored,
giving full consideration to the collateral characteristics such as weighted
average coupon rate, weighted average maturity and the prepayment history of the
specific collateral. MBSs are subject to risks associated with prepayments of
the underlying collateral pools. Prepayments cause these securities to have
actual maturities different from those projected at the time of purchase.
Securities that have an amortized cost that is greater than par (i.e., purchased
at a premium) that are backed by mortgages that prepay faster than expected will
incur a reduction in yield or a loss, versus an increase in yield or a gain if
the mortgages prepay slower than expected. Those securities that have an
amortized cost that is less than par (i.e., purchased at a discount) that are
backed by mortgages that prepay faster than expected will generate an increase
in yield or a gain, versus a decrease in yield or a loss if the mortgages prepay
slower than expected. The reduction or increase in yields may be partially
offset as funds from prepayments are reinvested at current interest rates. The
degree to which
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<PAGE> 27
a security is susceptible to either gains or losses is influenced by the
difference between its amortized cost and par, the relative sensitivity of the
underlying mortgages backing the assets to prepayments in a changing interest
rate environment and the repayment priority of the securities in the overall
securitization structure. The Company had gross unamortized premiums and
unaccreted discounts of MBSs of $19.9 million and $15.3 million, respectively,
at March 31, 1998. Although the interest rate environment has experienced
volatility during 1997 and the first quarter of 1998, prepayments and extensions
of cash flows from MBSs have not materially affected investment income of the
Company.
Asset-backed securities ("ABSs") are securitized bonds which can be backed
by, but not limited to, collateral such as home equity loans, second mortgages,
automobile loans and credit card receivables. At March 31, 1998, home equity
loan collateral represented 42% of the Company's investments in the ABS market.
The typical structure of an ABS provides for favorable yields, high credit
rating and stable prepayments.
Total cash and investments (on an amortized cost basis) were 93% and 95%
investment grade or equivalent as of March 31, 1998 and December 31, 1997,
respectively. Investment grade securities are those classified as 1 or 2 by the
NAIC or, where such classifications are not available, having a rating on the
scale used by S&P of BBB- or above. Yields available on non-investment grade
securities are generally higher than are available on investment grade
securities. However, credit risk is greater with respect to such non-investment
grade securities. The Company has a diversified foreign portfolio of Yankee
Bonds, including a limited exposure to the Asian market. The Company reduces the
risks associated with buying foreign securities by limiting the exposure to both
issuer and country. The Company closely monitors the creditworthiness of such
issuers and the stability of each country. Additionally, the Company's
investment portfolio has minimal exposure to real estate, mortgage loans and
common equity securities, which represented less than 1% of cash and investments
as of March 31, 1998.
The Company analyzes its investment portfolio, including below investment
grade securities, at least quarterly in order to determine if its ability to
realize its carrying value on any investment has been impaired. For fixed
maturity and equity securities, if impairment in value is determined to be other
than temporary (i.e., if it is probable that the Company will be unable to
collect all amounts due according to the contractual terms of the security), the
cost basis of the impaired security is written down to fair value, which becomes
the security's new cost basis. The amount of the write-down is included in
earnings as a realized loss. Future events may occur, or additional or updated
information may be received, which may necessitate future write-downs of
securities in the Company's portfolio. Significant write-downs in the carrying
value of investments could materially adversely affect the Company's net income
in future periods.
At March 31, 1998 the ratings assigned by the NAIC and comparable S&P
ratings on the Company's fixed maturity portfolio were as follows:
<TABLE>
<CAPTION>
AMORTIZED COST
--------------------
PERCENT ESTIMATED
NAIC DESIGNATION (COMPARABLE S&P RATING) AMOUNT OF TOTAL FAIR VALUE
---------------------------------------- -------- -------- ----------
(DOLLARS IN MILLIONS)
<C> <S> <C> <C> <C>
1 (AAA, AA, A)............................... $2,804.4 64% $2,803.4
2 (BBB)...................................... 1,241.5 28 1,250.6
3 (BB)....................................... 204.8 4 206.3
4 (B)........................................ 162.6 4 160.2
5 (CCC, CC, C)............................... -- -- --
6 (CI, D).................................... -- -- --
-------- --- --------
Total fixed maturities..................... $4,413.3 100% $4,420.5
======== === ========
</TABLE>
Pursuant to SFAS No. 115, "Accounting for Certain Investments in Debt and
Equity Securities," the Company classifies its entire fixed maturities portfolio
as available-for-sale. Fixed maturities classified as available-for-sale are
carried at fair value and changes in fair value, net of related deferred policy
acquisition cost and value of insurance in force amortization and deferred
income taxes, are charged or credited directly to
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<PAGE> 28
shareholders' equity and classified as accumulated other comprehensive income
from net unrealized gains on available-for-sale securities.
The fluctuations in interest rates during the first quarter of 1998
resulted in net unrealized gains on available-for-sale securities which totaled
$.8 million (net of $5.7 million of related amortization of deferred policy
acquisition costs and value of insurance in force and $.4 million of deferred
income taxes) at March 31, 1998, compared to net unrealized gains of $20.3
million (net of $15.8 million of related amortization of deferred policy
acquisition costs and value of insurance in force and $10.9 million of deferred
income taxes) at December 31, 1997. This change in net unrealized gains on
available-for-sale securities for the first quarter of 1998 decreased reported
shareholders' equity by $19.5 million as compared to an increase of $16.6
million for the year ended December 31, 1997. This volatility in reported
shareholders' equity occurs as a result of SFAS No. 115, which requires that
available-for-sale securities be carried at fair value while other assets and
all liabilities are carried at historical values. At March 31, 1998 and December
31, 1997, shareholders' equity excluding the effects of SFAS No. 115 was $296.7
million and $287.2 million, respectively.
The Company manages assets and liabilities in a closely integrated manner,
with the aim of reducing the volatility of investment spreads during a changing
interest rate environment. As a result, adjusting shareholders' equity for
changes in the fair value of the Company's fixed maturities and equity
securities without reflecting offsetting changes in the value of the Company's
liabilities or other assets creates volatility in reported shareholders' equity
but does not reflect the underlying economics of the Company's business. The
Company's accompanying consolidated financial statements include fair value
balance sheets which demonstrate that the general rise in interest rates during
1996 and subsequent decrease during 1997 did not have a material effect on the
financial position of the Company when all assets and liabilities are adjusted
to estimated fair values.
Assets held in the Company's guaranteed separate accounts include $1.20
billion and $1.26 billion of cash and investments at March 31, 1998 and December
31, 1997, of which approximately 93% and 87% were fixed maturities,
respectively. Total guaranteed separate account cash and investments were 98%
and 99% investment grade at March 31, 1998 and December 31, 1997, respectively.
Separate accounts are investment accounts maintained by an insurer to which
funds have been allocated for certain policies under provisions of relevant
state law. The investments in each separate account are maintained separately
from those in other separate accounts and from an insurance company's general
account.
LIQUIDITY AND FINANCIAL RESOURCES
Holding Company Operations
The Company's principal need for liquidity has historically consisted of
debt service obligations under its bank financing agreements, dividend payments
on its common and preferred stock, operating expenses not absorbed by management
fees charged to its subsidiaries, and corporate development expenditures. The
Company is dependent on dividends from Integrity and management and service fee
income from the Company's subsidiaries to meet ongoing cash needs, including
amounts required to pay dividends on its common and preferred stock.
The ability of the Company's insurance subsidiaries to pay dividends and
enter into agreements with affiliates for the payment of service or other fees
is limited by state insurance laws. In March 1998, the Company received a cash
dividend of $6.0 million from Integrity. The maximum dividend payments that may
be made by Integrity to the Company during 1998 without the prior approval of
the Ohio Insurance Director are $38.2 million. The Company had cash and
investments at the holding company level of $44.6 million at March 31, 1998. In
addition, the Company has a $75.0 million syndicated bank credit facility, of
which $37.0 million is available to the Company at March 31, 1998.
In June 1997, the Company completed an initial public offering of 9.2
million shares of Class A Common Stock of which 5.75 million shares were sold by
the Company for net proceeds of $78.8 million. The remaining 3.45 million shares
were sold by the Morgan Stanley Stockholders. On June 30, 1997, the Company used
a portion of such net proceeds to make a $40 million capital contribution to its
primary insurance subsidiary,
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<PAGE> 29
Integrity, thereby strengthening Integrity's capital base to provide for future
growth. The Company plans to also use the net proceeds to enhance the Company's
retail market presence, to consolidate operating locations and for other
corporate purposes, which may include acquisitions.
In May 1998, the Company completed a public offering of approximately 12.4
million shares of Common Stock held by the Morgan Stanley Stockholders. The
Company did not receive any of the proceeds from the public offering. As a
result of the public offering, the Morgan Stanley Stockholders no longer own any
shares of the Company's outstanding Common Stock and all Class B Common Stock
was converted into Class A Common Stock.
Insurance Subsidiaries Operations
The primary sources of liquidity of the Company's insurance subsidiaries
are investment income and proceeds from maturities and redemptions of
investments. The principal uses of such funds are benefits, withdrawals and
loans associated with customer deposits, commissions, operating expenses, and
the purchase of new investments.
The Company develops cash flow projections under a variety of interest rate
scenarios generated by the Company. The Company attempts to structure asset
portfolios so that the interest and principal payments, along with other fee
income, are more than sufficient to cover the cash outflows for benefits,
withdrawals and expenses under the expected scenarios developed by the Company.
In addition, the Company maintains other liquid assets and aims to meet
unexpected cash requirements without exposure to material realized losses during
a higher interest rate environment. These other liquid assets include cash and
cash equivalents and high-grade floating-rate securities held by both the
Company and its insurance subsidiaries.
During the three months ended March 31, 1998 and 1997, the Company met its
liquidity needs entirely by cash flows from operating activities and principal
payments and redemptions of investments. At March 31, 1998, cash and cash
equivalents totaled $344.1 million compared to $228.2 million at December 31,
1997. This increase in cash and cash equivalents is temporary and is a result of
deposits for institutional spread products received prior to March 31, 1998,
which were not fully invested until after March 31, 1998. During the years ended
December 31, 1997, 1996 and 1995, the Company met its liquidity needs entirely
by cash flows from operating activities and principal payments and redemptions
of investments. At December 31, 1997, cash and cash equivalents totaled $228.2
million compared to $110.1 million at December 31, 1996. The Company's aim is to
manage its cash and cash equivalents position in order to satisfy short-term
liquidity needs. In connection with this management of cash and cash
equivalents, the Company may invest idle cash in short-duration fixed maturities
to capture additional yield when short-term liquidity requirements permit.
The Company generated cash flows of $60.2 million and $46.7 million from
operating activities during the quarters ended March 31, 1998 and 1997,
respectively. These cash flows resulted principally from investment income, less
commissions and operating expenses. Proceeds from sales, maturities and
redemptions of investments generated $1,821.0 million and $1,026.2 million in
cash flows during the quarters ended March 31, 1998 and 1997, respectively,
which were offset by purchases of investments of $2,105.3 million and $1,209.7
million, respectively. An increase in investment purchases and sales activity
during the first quarter of 1998 reflects the Company's ongoing management of
its fixed maturity portfolio which has increased in size due primarily to sales
of retail and institutional spread products.
The Company generated cash flows of $216.1 million, $192.9 million and
$138.4 million from operating activities during the years ended December 31,
1997, 1996 and 1995, respectively. These cash flows resulted principally from
investment income, less commissions and operating expenses. Proceeds from sales,
maturities and redemptions of investments generated $3,884.2 million, $2,214.4
million and $1,463.3 million in cash flows during 1997, 1996 and 1995,
respectively, which were offset by purchases of investments of $4,782.6 million,
$2,772.0 million and $1,506.5 million, respectively. An increase in investment
purchases and sales activity during 1997 compared to 1996 reflects the Company's
ongoing management of its fixed maturity portfolio which has increased in size
due primarily to sales of retail and institutional spread products.
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<PAGE> 30
INCOME TAXES
At March 31, 1998, the Company reported an asset for deferred income taxes
of $43.8 million on the carrying amount balance sheet. Such amount is net of a
valuation allowance of $35.3 million. The net deferred tax asset represents
deductible temporary differences and net operating loss carryforwards. Based on
historical operating results and projections of future taxable ordinary income,
management believes that the net tax benefit recorded will be fully utilized.
DERIVATIVES
The Company has only limited involvement with derivative financial
instruments and does not use them for trading purposes. They are used to manage
specific interest rate risks and, with respect to the Company's equity-indexed
annuity deposits, equity market risks.
EFFECTS OF INFLATION AND INTEREST RATE CHANGES
The Company believes that inflation will not have a material adverse effect
on results of operations. The Company manages its investment portfolios in part
to reduce its exposure to interest rate fluctuations. In general, the fair value
of the Company's fixed maturities portfolio increases or decreases inversely
with fluctuations in interest rates, and the Company's investment income
increases or decreases directly with interest rate changes. For example, if
interest rates decline, the Company's fixed maturity investments generally will
increase in fair value, while investment income will decrease as fixed income
investments are sold or mature and proceeds are reinvested at declining rates.
The converse will generally be true if interest rates rise.
YEAR 2000
The Company is currently evaluating, on an ongoing basis, its computer
systems and the systems of other companies on which the Company's operations
rely to determine if they will function properly with respect to dates in the
year 2000 and beyond. These activities are designed to ensure that there is no
adverse effect on the Company's core business operations. While the Company
believes its planning efforts are adequate to address its Year 2000 concerns,
there can be no guarantee that the systems of other companies on which the
Company's operations rely will be converted on a timely basis and will not have
a material effect on the Company. The cost of the Company's Year 2000
initiatives is not expected to be material to the Company's results of
operations or financial condition.
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<PAGE> 31
DESCRIPTION OF SERIES A FIXED/ADJUSTABLE RATE PREFERRED STOCK
The following description of the Series A Fixed/Adjustable Rate Preferred
Stock offered hereby supplements the description of the general terms and
provisions of the Offered Preferred Stock set forth in the Prospectus. The
following summary of the particular terms and provisions of the Series A
Fixed/Adjustable Rate Preferred Stock does not purport to be complete and is
qualified in its entirety by reference to the Company's Restated Certificate of
Incorporation and the Certificate of Designation of Preferences and Rights of
the Fixed/Adjustable Rate Preferred Stock (the "Certificate of Designation").
Pursuant to action of the Board of Directors of the Company (the "Board")
or a committee thereof (the "Committee"), the shares of Series A
Fixed/Adjustable Rate Preferred Stock represented by the Depositary Shares
(including the shares of Series A Fixed/Adjustable Rate Preferred Stock
represented by the Depositary Shares that are subject to the Underwriters'
overallotment option) constitute a single series of Preferred Stock. The Series
A Fixed/Adjustable Rate Preferred Stock is not convertible into shares of any
other class or series of stock of the Company. Shares of Series A
Fixed/Adjustable Rate Preferred Stock have no preemptive rights. Any shares of
Series A Fixed/Adjustable Rate Preferred Stock that are surrendered for
redemption will be returned to the status of authorized and unissued Preferred
Stock.
ChaseMellon Shareholder Services LLC is the registrar, transfer agent and
dividend disbursing agent for the shares of Series A Fixed/Adjustable Rate
Preferred Stock, and Depositary for the Depositary Shares. See "Description of
Depositary Shares."
Rank. As of the date hereof, the Series A Fixed/Adjustable Rate Preferred
Stock ranks as to payment of dividends and amounts payable on liquidation prior
to the Company's Class A Common Stock and on a parity with the Company's
Existing Preferred Stock.
Dividends. Holders of shares of Series A Fixed/Adjustable Rate Preferred
Stock are entitled to receive cash dividends when, as and if declared by the
Board or the Committee out of assets legally available therefor. Dividends on
the Series A Fixed/Adjustable Rate Preferred Stock, calculated as a percentage
of the stated value, will be payable quarterly on March 15, June 15, September
15 and December 15 of each year (each a "dividend payment date"), commencing
September 15, 1998. From the date of issuance of the Series A Fixed/Adjustable
Rate Preferred Stock and continuing through July , 2003, the rate of such
dividend will be % per annum.
After July , 2003, dividends on the Series A Fixed/Adjustable Rate
Preferred Stock will be payable quarterly on each dividend payment date at the
Applicable Rate (as defined below) from time to time in effect. Except as
provided below, the Applicable Rate per annum for any dividend period beginning
on or after July , 2003 will be equal to % plus the highest of the Treasury
Bill Rate, the Ten-Year Constant Maturity Rate and the Thirty-Year Constant
Maturity Rate (each as defined below under "Adjustable Rate Dividends"), as
determined in advance of such dividend period. The Applicable Rate per annum for
any dividend period beginning on or after July , 2003, will not be less than
% nor greater than % (without taking into account any adjustments as
described below under "Changes in the Dividends Received Percentage").
Dividends (including Additional Dividends as defined below) on the Series A
Fixed/Adjustable Rate Preferred Stock will be cumulative from the date of
initial issuance of such Series A Fixed/Adjustable Rate Preferred Stock.
Dividends will be payable to holders of record as they appear on the stock books
of the Company on such record dates, not more than 60 days nor less than 10 days
preceding the payment dates, as shall be fixed by the Board or the Committee.
Adjustable Rate Dividends. Except as provided below, the "Applicable Rate"
per annum for any dividend period beginning on or after July , 2003 will be
equal to % plus the Effective Rate (as defined below), but not less than
% nor greater than % (without taking into account any adjustments as
described below under "Changes in the Dividends Received Percentage"). The
"Effective Rate" for any dividend period beginning on or after July , 2003
will be equal to the highest of the Treasury Bill Rate, the Ten-Year Constant
Maturity Rate and the Thirty-Year Constant Maturity Rate (each as defined below)
for such dividend period. If the Company determines in good faith that for any
reason: (i) any one of the Treasury
S-31
<PAGE> 32
Bill Rate, the Ten-Year Constant Maturity Rate or the Thirty-Year Constant
Maturity Rate cannot be determined for any dividend period beginning on or after
July , 2003, then the Effective Rate for such dividend period will be equal to
the higher of whichever two of such rates can be so determined; (ii) only one of
the Treasury Bill Rate, the Ten-Year Constant Maturity Rate or the Thirty-Year
Constant Maturity Rate can be determined for any dividend period beginning on or
after July , 2003, then the Effective Rate for such dividend period will be
equal to whichever such rate can be so determined; or (iii) none of the Treasury
Bill Rate, the Ten-Year Constant Maturity Rate or the Thirty-Year Constant
Maturity Rate can be determined for any dividend period beginning on or after
July , 2003, then the Effective Rate for the preceding dividend period will be
continued for such dividend period.
The "Treasury Bill Rate" for each dividend period will be the arithmetic
average of the two most recent weekly per annum market discount rates (or the
one weekly per annum market discount rate, if only one such rate is published
during the relevant Calendar Period (as defined below)) for three-month U.S.
Treasury bills, as published weekly by the Federal Reserve Board (as defined
below) during the Calendar Period immediately preceding the tenth calendar day
preceding the dividend period for which the dividend rate on the Series A
Fixed/Adjustable Rate Preferred Stock is being determined.
The "Ten-Year Constant Maturity Rate" for each dividend period will be the
arithmetic average of the two most recent weekly per annum Ten-Year Average
Yields (as defined below) (or the one weekly per annum Ten-Year Average Yield,
if only one such yield is published during the relevant Calendar Period), as
published weekly by the Federal Reserve Board during the Calendar Period
immediately preceding the tenth calendar day preceding the dividend period for
which the dividend rate on the Series A Fixed/Adjustable Rate Preferred Stock is
being determined.
The "Thirty-Year Constant Maturity Rate" for each dividend period will be
the arithmetic average of the two most recent weekly per annum Thirty-Year
Average Yields (as defined below) (or the one weekly per annum Thirty-Year
Average Yield, if only one such yield is published during the relevant Calendar
Period), as published weekly by the Federal Reserve Board during the Calendar
Period immediately preceding the tenth calendar day preceding the dividend
period for which the dividend rate on the Series A Fixed/Adjustable Rate
Preferred Stock is being determined.
If the Federal Reserve Board does not publish a weekly per annum market
discount rate, Ten-Year Average Yield or Thirty-Year Average Yield during any
applicable Calendar Period, then the Treasury Bill Rate, Ten-Year Constant
Maturity Rate or Thirty-Year Constant Maturity Rate, as the case may be, for
such dividend period will be the arithmetic average of the two most recent
weekly per annum market discount rates for three-month U.S. Treasury bills,
Ten-Year Average Yields or Thirty-Year Average Yields, as the case may be (or
the one weekly per annum rate, if only one such rate is published during the
relevant Calendar Period), as published weekly during such Calendar Period by
any Federal Reserve Bank or by any U.S. Government department or agency selected
by the Company. If any such rate is not published by the Federal Reserve Board
or by any Federal Reserve Bank or by any U.S. Government department or agency
during such Calendar Period, then the Treasury Bill Rate, Ten-Year Constant
Maturity Rate or Thirty-Year Constant Maturity Rate for such dividend period
will be the arithmetic average of the two most recent weekly per annum (i) in
the case of the Treasury Bill Rate, market discount rates (or the one weekly per
annum market discount rate, if only one such rate is published during the
relevant Calendar Period) for all of the U.S. Treasury bills then having
remaining maturities of not less than 80 nor more than 100 days, and (ii) in the
case of the Ten-Year Constant Maturity Rate, average yields to maturity (or the
one weekly per annum average yield to maturity, if only one such yield is
published during the relevant Calendar Period) for all of the actively traded
marketable U.S. Treasury fixed interest rate securities (other than Special
Securities (as defined below)) then having remaining maturities of not less than
eight nor more than twelve years, and (iii) in the case of the Thirty-Year
Constant Maturity Rate, average yields to maturity (or the one weekly per annum
average yield to maturity, if only one such yield is published during the
relevant Calendar Period) for all of the actively traded marketable U.S.
Treasury fixed interest rate securities (other than Special Securities) then
having remaining maturities of not less than twenty-eight nor more than thirty
years, in each case as published during such Calendar Period by the Federal
Reserve Board or, if the Federal Reserve Board does not publish such rates, by
any Federal Reserve Bank or by any U.S. Government department or agency
S-32
<PAGE> 33
selected by the Company. If the Company determines in good faith that for any
reason (i) no such U.S. Treasury bill rates are published as provided above
during such Calendar Period or (ii) the Company cannot determine the Treasury
Bill Rate for any dividend period; then the Treasury Bill Rate for such dividend
period will be the arithmetic average of the per annum market discount rates
based upon the closing bids during such Calendar Period for each of the issues
of marketable non-interest-bearing U.S. Treasury securities with a remaining
maturity of not less than 80 nor more than 100 days from the date of each such
quotation, as chosen and quoted daily for each business day in New York City (or
less frequently if daily quotations are not generally available) to the Company
by at least three recognized dealers in U.S. Government securities selected by
the Company. If the Company determines in good faith that for any reason the
Company cannot determine the Ten-Year Constant Maturity Rate or Thirty-Year
Constant Maturity Rate for any dividend period as provided above, then the
applicable rate for such dividend period will be the arithmetic average of the
per annum average yields to maturity based upon the closing bids during such
Calendar Period for each of the issues of actively traded marketable U.S.
Treasury fixed interest rate securities (other than Special Securities) with a
final maturity date (i) in the case of the Ten-Year Constant Maturity Rate, not
less than eight nor more than twelve years from the date of each such quotation,
and (ii) in the case of the Thirty-Year Constant Maturity Rate, not less than
twenty-eight nor more than thirty years from the date of each such quotation, in
each case as chosen and quoted daily for each business day in New York City (or
less frequently if daily quotations are not generally available) to the Company
by at least three recognized dealers in the United States.
The Treasury Bill Rate, the Ten-Year Constant Maturity Rate and the
Thirty-Year Constant Maturity Rate will each be rounded to the nearest five
hundredths of a percent, with .025% being rounded upward.
The Applicable Rate with respect to each dividend period beginning on or
after July , 2003 will be calculated as promptly as practicable by the Company
according to the appropriate method described above. The Company will cause
notice of each Applicable Rate to be given to the holders of Series A Fixed/
Adjustable Rate Preferred Stock when payment is made of the dividend for the
immediately preceding dividend period.
As used above, the term "Calendar Period" means a period of fourteen
calendar days; the term "Federal Reserve Board" means the Board of Governors of
the Federal Reserve System; the term "Special Securities" means securities which
can, at the option of the holder, be surrendered at face value in payment of any
Federal estate tax or which provide tax benefits to the holder and are priced to
reflect such tax benefits or which were originally issued at a deep or
substantial discount; the term "Ten-Year Average Yield" means the average yield
to maturity for actively traded marketable U.S. Treasury fixed interest rate
securities (adjusted to constant maturities of ten years); and the term
"Thirty-Year Average Yield" means the average yield to maturity for actively
traded marketable U.S. Treasury fixed interest rate securities (adjusted to
constant maturities of thirty years).
Changes in the Dividends Received Percentage. In the past, certain
amendments to the Code have been proposed that, if adopted, would have reduced
the dividends received deduction applicable to corporate holders of the Series A
Fixed/Adjustable Rate Preferred Stock. No such amendments are currently pending
before the United States Congress, but there can be no assurance that similar
amendments will not be enacted in the future or that other legislation will not
be enacted that would reduce the dividends received deduction available to
corporate holders of the Series A Fixed/Adjustable Rate Preferred Stock.
If, at any time prior to January , 2000, one or more amendments to the
Code are enacted which reduce the percentage of the dividends received deduction
(currently 70%) as specified in Section 243(a)(1) of the Code or any successor
provision (the "Dividends Received Percentage"), the amount of each dividend (if
declared) on each share of the Series A Fixed/Adjustable Rate Preferred Stock
for dividend payments made on or after the effective date of such change in the
Code will be adjusted by multiplying the amount of the dividend payable
determined as described above under "Dividends" (before adjustment) by a factor,
which
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<PAGE> 34
will be the number determined in accordance with the following formula (the "DRD
Formula"), and rounding the result to the nearest cent (with one-half cent
rounded up):
1 - [.35(1 - .70)]
---------------------
1 - [.35(1 - DRP)]
For the purposes of the DRD Formula, "DRP" means the Dividends Received
Percentage (expressed as a decimal) applicable to the dividend in question;
provided, however, that if the Dividends Received Percentage applicable to the
dividend in question shall be less than 50%, then the DRP shall equal .50. No
amendment to the Code, other than a change in the percentage of the dividends
received deduction set forth in Section 243(a)(1) of the Code, or any successor
provision thereto, will give rise to an adjustment. Notwithstanding the
foregoing provisions, in the event that, with respect to any such amendment, the
Company receives either an unqualified opinion of nationally recognized
independent tax counsel selected by the Company or a private letter ruling or
similar form of authorization from the Internal Revenue Service ("IRS") to the
effect that such an amendment does not apply to dividends payable on the Series
A Fixed/ Adjustable Rate Preferred Stock, then any such amendment will not
result in the adjustment provided for pursuant to the DRD Formula. The opinion
referenced in the previous sentence will be based upon the legislation amending
or establishing the DRP or upon a published pronouncement of the IRS addressing
such legislation.
If any such amendment to the Code is enacted after the dividend payable on
a Dividend Payment Date has been declared, the amount of the dividend payable on
such Dividend Payment Date will not be increased; instead, additional dividends
(the "Post Declaration Date Dividends") equal to the excess, if any, of (x) the
product of the dividend paid by the Company on such Dividend Payment Date and
the DRD Formula (where the DRP used in the DRD Formula would be equal to the
greater of the Dividend Received Percentage and .50) applicable to the dividend
in question over (y) the dividend paid by the Company on such Dividend Payment
Date, will be payable (if declared) to holders of Series A Fixed/Adjustable Rate
Preferred Stock on the record date applicable to the next succeeding Dividend
Payment Date or, if the Series A Fixed/Adjustable Rate Preferred Stock is called
for redemption prior to such record date, to holders of Series A Fixed/
Adjustable Rate Preferred Stock on the redemption date, as the case may be, in
addition to any other amounts payable on such date. Notwithstanding the
foregoing provisions, if, with respect to any such amendment, the Company
receives either an unqualified opinion of nationally recognized independent tax
counsel selected by the Company or a private letter ruling or similar form of
authorization from the IRS to the effect that such amendment does not apply to a
dividend so payable on the Series A Fixed/Adjustable Rate Preferred Stock, then
such amendment will not result in the payment of Post Declaration Date
Dividends. The opinion referenced in the previous sentence will be based upon
the legislation amending or establishing the DRP or upon a published
pronouncement of the IRS addressing such legislation.
If any such amendment to the Code is enacted and the reduction in the
Dividends Received Percentage retroactively applies to a Dividend Payment Date
as to which the Company previously paid dividends on the Series A
Fixed/Adjustable Rate Preferred Stock (each, an "Affected Dividend Payment
Date"), the Company will pay (if declared) additional dividends (the
"Retroactive Dividends") to holders of Series A Fixed/Adjustable Rate Preferred
Stock on the Record Date applicable to the next succeeding Dividend Payment Date
(or, if such amendment is enacted after the dividend payable on such Dividend
Payment Date has been declared, to holders of Series A Fixed/Adjustable Rate
Preferred Stock on the record date following the date of enactment) or, if the
Series A Fixed/Adjustable Rate Preferred Stock is called for redemption prior to
such record date, to holders of Series A Fixed/Adjustable Rate Preferred Stock
on the redemption date, as the case may be, in an amount equal to the excess of
(x) the product of the sum of the dividends paid by the Company on each Affected
Dividend Payment Date and the DRD Formula (where the DRP used in the DRD Formula
would be equal to the greater of the Dividends Received Percentage and .50)
applied to each Affected Dividend Payment Date over (y) the sum of the dividends
paid by the Company on each Affected Dividend Payment Date. The Company will
only make one payment of Retroactive Dividends for any such amendment.
Notwithstanding the foregoing provisions, if, with respect to any such
amendment, the Company receives either an unqualified opinion of nationally
recognized independent tax counsel selected by
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<PAGE> 35
the Company or a private letter ruling or similar form of authorization from the
IRS to the effect that such amendment does not apply to a dividend payable on an
Affected Dividend Payment Date for the Series A Fixed/Adjustable Rate Preferred
Stock, then such amendment will not result in the payment of Retroactive
Dividends with respect to such Affected Dividend Payment Date. The opinion
referenced in the previous sentence will be based upon the legislation amending
or establishing the DRP or upon a published pronouncement of the IRS addressing
such legislation.
Notwithstanding the foregoing, no adjustment in the dividends payable by
the Company will be made, and no Post Declaration Date Dividends or Retroactive
Dividends will be payable by the Company, in respect of the enactment of any
amendment to the Code at any time on or after January , 2000 that reduces the
Dividends Received Percentage.
In the event that the amount of dividends payable per share of the Series A
Fixed/Adjustable Rate Preferred Stock is adjusted pursuant to the DRD Formula
and/or Post Declaration Date Dividends or Retroactive Dividends are to be paid,
the Company will give notice of each such adjustment and, if applicable, any
Post Declaration Date Dividends and Retroactive Dividends to the holders of
Series A Fixed/Adjustable Rate Preferred Stock.
Unless the context otherwise requires, references to dividends in this
Prospectus Supplement include dividends as adjusted by the DRD Formula, Post
Declaration Date Dividends and Retroactive Dividends. The Company's calculation
of the dividends payable, as so adjusted and as certified accurate as to
calculation and reasonable as to method by the independent certified public
accountants then regularly engaged by the Company, will be final and not subject
to review absent manifest error.
If the Dividends Received Percentage is reduced to 50% or less prior to
January , 2000, the Company may, at its option, redeem the Series A
Fixed/Adjustable Rate Preferred Stock as a whole but not in part as described
below. See "Optional Redemption."
Liquidation Rights. In the event of any liquidation, dissolution or
winding up of the Company, the holders of shares of Series A Fixed/Adjustable
Rate Preferred Stock will be entitled to receive out of the assets of the
Company available for distribution to stockholders, before any distribution is
made to holders of (i) any other shares of Preferred Stock ranking junior to the
Series A Fixed/Adjustable Rate Preferred Stock as to rights upon liquidation,
dissolution or winding up which may be issued in the future or (ii) Common
Stock, liquidating distributions in the amount of $200.00 per share (equivalent
to $50.00 per Depositary Share), plus accrued and accumulated but unpaid
dividends to the date of final distribution, but the holders of the shares of
Series A Fixed/Adjustable Rate Preferred Stock will not be entitled to receive
the liquidation price of such shares until the liquidation preference of any
other shares of the Company's capital stock ranking senior to the Series A
Fixed/Adjustable Rate Preferred Stock as to rights upon liquidation, dissolution
or winding up shall have been paid (or a sum set aside therefor sufficient to
provide for payment) in full.
Optional Redemption. Prior to July , 2003, the Series A Fixed/Adjustable
Rate Preferred Stock is not redeemable, except under certain limited
circumstances as described below. On or after such date, each share of the
Series A Fixed/Adjustable Rate Preferred Stock will be redeemable, in whole or
in part, at the Company's option, at any time and from time to time upon not
less than thirty nor more than sixty days' notice, at $200.00 per share, plus
accrued and unpaid dividends (whether or not declared and including any increase
in dividends payable due to changes in the Dividends Received Percentage) from
the immediately preceding Dividend Payment Date to the date fixed for redemption
(but without any accumulation for unpaid dividends for prior dividend periods on
the Series A Fixed/Adjustable Rate Preferred Stock).
If full cumulative dividends on the Series A Fixed/Adjustable Rate
Preferred Stock have not been paid, the Series A Fixed/Adjustable Rate Preferred
Stock may not be redeemed in part and the Corporation may not purchase or
acquire any shares of the Series A Fixed/Adjustable Rate Preferred Stock
otherwise than pursuant to a purchase or exchange offer made on the same terms
to all holders of the Series A Fixed/ Adjustable Rate Preferred Stock. If fewer
than all the outstanding shares of Series A Fixed/Adjustable Rate Preferred
Stock are to be redeemed, the Corporation will select those to be redeemed by
lot or a substantially equivalent method.
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<PAGE> 36
However, if at any time prior to January , 2000, one or more amendments
to the Code are enacted that reduce the Dividends Received Percentage to 50% or
less, and, as a result, the amount of dividends on the Series A Fixed/Adjustable
Rate Preferred Stock payable on any Dividend Payment Date may be adjusted
upwards as described above under "Changes in the Dividends Received Percentage,"
the Company, at its option, may redeem all, but not less than all, of the
outstanding shares of the Series A Fixed/Adjustable Rate Preferred Stock,
provided that, within sixty days of the date on which an amendment to the Code
is enacted that reduces the Dividends Received Percentage to 50% or less, the
Company sends notice to holders of the Series A Fixed/Adjustable Rate Preferred
Stock of such redemption. Any redemption of the Series A Fixed/ Adjustable Rate
Preferred Stock pursuant to this paragraph will take place on the date specified
in the notice, which will be not less than thirty nor more than sixty days from
the date such notice is sent to holders of the Series A Fixed/Adjustable Rate
Preferred Stock. Any such redemption of the Series A Fixed/Adjustable Rate
Preferred Stock will be at a redemption price of $204.00 per share (equivalent
to $51.00 per Depositary Share), plus accrued and unpaid dividends (whether or
not declared and including any increase in dividends payable due to changes in
the Dividends Received Percentage) from the immediately preceding Dividend
Payment Date or the date of original issuance of the Series A Fixed/Adjustable
Rate Preferred Stock, as the case may be, to the date fixed for redemption (but
without any accumulation for unpaid dividends for prior dividend periods on the
Series A Fixed/Adjustable Rate Preferred Stock).
Holders of the Series A Fixed/Adjustable Rate Preferred Stock will have no
right to require redemption of the Series A Fixed/Adjustable Rate Preferred
Stock.
Voting Rights. Holders of Series A Fixed/Adjustable Rate Preferred Stock
will not have any voting rights except as set forth below or as otherwise from
time to time required by law. Whenever dividends on Series A Fixed/Adjustable
Rate Preferred Stock or any other class or series of stock ranking on a parity
with the Series A Fixed/Adjustable Rate Preferred Stock with respect to the
payment of dividends shall be in arrears for dividend periods, whether or not
consecutive, containing in the aggregate a number of days equivalent to six
calendar quarters, the holders of shares of Series A Fixed/Adjustable Rate
Preferred Stock (voting separately as a class with all other series of Preferred
Stock upon which like voting rights have been conferred and are exercisable)
will be entitled to vote for the election of two of the authorized number of
directors of the Company at the next annual meeting of stockholders and at each
subsequent meeting until all dividends accumulated on Series A Fixed/Adjustable
Rate Preferred Stock have been fully paid or set apart for payment. The term of
office of all directors elected by the holders of Preferred Stock shall
terminate immediately upon the termination of the right of the holders of
Preferred Stock to vote for directors. Holders of shares of Series A
Fixed/Adjustable Rate Preferred Stock will have one vote for each share held.
DESCRIPTION OF DEPOSITARY SHARES
Each Depositary Share represents 1/4 of a share of Series A
Fixed/Adjustable Rate Preferred Stock deposited with the Depositary pursuant to
the Deposit Agreement, dated as of July , 1998 (the "Deposit Agreement"),
among the Company, ChaseMellon Shareholder Services LLC, as depositary (the
"Depositary"), and the holders from time to time of depositary receipts issued
thereunder. Subject to the terms of the Deposit Agreement, each holder of a
Depositary Share is entitled, through the Depositary, in proportion to the 1/4
of a share of Series A Fixed/Adjustable Rate Preferred Stock represented by such
Depositary Share, to all the rights, preferences and privileges of the Series A
Fixed/Adjustable Rate Preferred Stock represented thereby (including dividend,
voting and liquidation rights) contained in the Certificate of Designation
summarized under "Description of Series A Fixed/Adjustable Rate Preferred
Stock." The Company does not expect that there will be any public trading market
for the Series A Fixed/Adjustable Rate Preferred Stock except as represented by
the Depositary Shares. The Depositary Shares will be evidenced by depositary
receipts ("Depositary Receipts") issued pursuant to the Deposit Agreement.
The following description of the particular terms and provisions of the
Depositary Shares offered hereby supplements the description of the general
terms and provisions of the Depositary Shares set forth in the Prospectus, to
which description reference is hereby made. The following summary of the
Depositary Shares,
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<PAGE> 37
the Depositary Receipts and the Deposit Agreement does not purport to be
complete and is qualified in its entirety by reference to the Deposit Agreement
(which contains the form of Depositary Receipt).
Issuance of Depositary Receipts. Immediately following the issuance of the
Series A Fixed/Adjustable Rate Preferred Stock by the Company, the Company will
deposit the Series A Fixed/Adjustable Rate Preferred Stock with the Depositary,
which will then issue and deliver the Depositary Receipts to the Underwriters.
Depositary Receipts will be issued evidencing only whole Depositary Shares.
Dividends and Other Distributions. The Depositary will distribute all
dividends or other cash distributions received in respect of the Series A
Fixed/Adjustable Rate Preferred Stock to the record holders of Depositary Shares
in proportion to the number of the Depositary Shares owned by such holders. The
amount distributed will be reduced by any amounts required to be withheld by the
Company or the Depositary on account of taxes or other governmental charges.
Withdrawal of Stock. Upon surrender of the Depositary Receipts at the
corporate trust office of the Depositary and upon payment of the taxes, charges
and fees provided for in the Deposit Agreement and subject to the terms thereof,
the holder of the Depositary Shares evidenced thereby is entitled to delivery at
such office, to or upon his or her order, of the number of whole shares of
Series A Fixed/Adjustable Rate Preferred Stock and any money or other property,
if any, represented by such Depositary Shares. Holders of Depositary Shares will
be entitled to receive whole shares of Series A Fixed/Adjustable Rate Preferred
Stock on the basis set forth herein, but holders of such whole shares of Series
A Fixed/Adjustable Rate Preferred Stock will not thereafter be entitled to
deposit such shares of Series A Fixed/Adjustable Rate Preferred Stock with the
Depositary or to receive Depositary Shares therefor.
Voting Rights. Because each Depositary Share represents ownership of 1/4
of a share of Series A Fixed/ Adjustable Rate Preferred Stock, holders of
Depositary Shares will be entitled to 1/4 of a vote per Depositary Share under
the limited circumstances in which the holders of Series A Fixed/Adjustable Rate
Preferred Stock are entitled to vote.
Redemption. The Depositary Shares will be redeemed, upon not less than 30
days' notice, using the cash proceeds received by the Depositary resulting from
any redemption of shares of Series A Fixed/ Adjustable Rate Preferred Stock held
by the Depositary. Except in the case of certain optional redemptions, the
redemption price will be equal to $50.00 per Depositary Share plus accrued and
accumulated but unpaid dividends on the Series A Fixed/Adjustable Rate Preferred
Stock represented thereby. See "Description of Series A Fixed/Adjustable Rate
Preferred Stock -- Optional Redemption." If the Company redeems shares of Series
A Fixed/Adjustable Rate Preferred Stock held by the Depositary, the Depositary
will redeem as of the same redemption date the number of Depositary Shares
representing the shares of Series A Fixed/ Adjustable Rate Preferred Stock so
redeemed. If fewer than all the Depositary Shares are to be redeemed, the
Depositary Shares to be redeemed will be selected by lot or substantially
equivalent method determined by the Depositary.
Holders of Depositary Receipts will pay transfer and other taxes and
governmental charges and such other charges as are expressly provided in the
Deposit Agreement to be for their accounts.
BOOK-ENTRY PROCEDURES
Depositary Shares will be issued in book-entry form in the form of a single
global Depositary Receipt deposited with, or on behalf of, DTC and registered in
the name of DTC or its nominee. Except as set forth below, the global Depositary
Receipt may not be transferred except as a whole by DTC to a nominee of DTC or
by a nominee of DTC to DTC or another nominee of DTC or by DTC or any nominee to
a successor of DTC or a nominee of such successor.
DTC is a limited-purpose trust company organized under the New York Banking
Law, a "banking organization" within the meaning of the New York Banking Law, a
member of the Federal Reserve System, a "clearing corporation" within the
meaning of the New York Uniform Commercial Code and a "clearing agency"
registered pursuant to the provisions of Section 17A of the Exchange Act. DTC
holds securities that
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its participants ("Participants") deposit with DTC. DTC also facilitates the
settlement among Participants of securities transactions, such as transfers and
pledges, in deposited securities through electronic computerized book-entry
changes in Participants' accounts, thereby eliminating the need for physical
movement of securities certificates. Direct Participants include securities
brokers and dealers, banks, trust companies, clearing corporations and certain
other organizations ("Direct Participants"). DTC is owned by a number of its
Direct Participants and by the New York Stock Exchange, the American Stock
Exchange, Inc., and the NASD. Access to the DTC system is also available to
others, such as securities brokers and dealers, banks and trust companies that
clear transactions through or maintain a direct or indirect custodial
relationship with a Direct Participant. The rules applicable to DTC and its
Participants are on file with the Commission.
DTC's nominee for all purposes will be considered the sole owner or holder
of the Depositary Shares held in book-entry form. Owners of beneficial interests
in the global Depositary Receipt will not be entitled to have Depositary Shares
registered in their names, will not receive or be entitled to receive physical
delivery of Depositary Shares in definitive form, and will not be considered the
holders thereof under the Certificate of Incorporation or the Deposit Agreement.
Neither the Company nor the Depositary will have any responsibility or
liability for any aspect of the records relating to or payments made on account
of beneficial ownership interests in the global Depositary Receipt, or for
maintaining, supervising or reviewing any records relating to such beneficial
ownership interest.
A holder's ownership of Depositary Shares issued in book-entry form will be
recorded on or through the records of the brokerage firm or other entity that
maintains that holder's account. In turn, the total number of Depositary Shares
held by an individual brokerage firm or other entity for its clients will be
maintained on the records of DTC in the name of that brokerage firm or other
entity (or in the name of a Participant that acts as agent for the holder's
brokerage firm or other entity if it is not a Participant). Therefore, a holder
must rely upon the records of the holder's brokerage firm or other entity to
evidence the holder's ownership of Depositary Shares and transfer of ownership
of Depositary Shares may be effected only through the brokerage firm or other
entity that maintains the holder's account.
Dividends or other distributions payable in respect of Depositary Shares
will be paid by the Depositary to DTC. DTC will be responsible for crediting the
amount of payments that it receives to the accounts of the Participants in
accordance with their respective standard procedures, which currently provide
for payment in same-day funds. Each Participant will be responsible for
disbursing the payment for which it is so credited to the holders that it
represents and to each brokerage firm or other entity for which it acts as
agent. Each such brokerage firm or other entity will be responsible for
disbursing funds to the holders that it represents.
If DTC is at any time unwilling or unable to continue as depository in
respect of a global Depositary Receipt and a successor depository is not
appointed within 90 days, the Company will issue Depositary Receipts in
definitive form in exchange for the global Depositary Receipt. In addition, the
Company may determine at any time not to have Depositary Shares represented by a
global Depositary Receipt and, in such event, will issue Depositary Shares in
definitive form in exchange for such global Depositary Receipt. In such
instance, an owner of a beneficial interest in the global Depositary Receipt
will be entitled to have Depositary Shares equal in aggregate amount to that
beneficial interest registered in its name and will be entitled to physical
delivery of a definitive certificate evidencing such Depositary Shares. The
registered holder of Depositary Shares will be entitled to receive the dividends
or other distributions or, if applicable, the redemption price payable in
respect of such Depositary Shares, upon surrender of the Depositary Receipt
evidencing such Depositary Shares to the Depositary in accordance with the
procedures set forth in the Deposit Agreement.
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<PAGE> 39
UNDERWRITERS
Under the terms and subject to the conditions contained in the Underwriting
Agreement dated the date hereof, each underwriter named below (the
"Underwriters"), for whom Morgan Stanley & Co. Incorporated is acting as
representative, has severally agreed to purchase from the Company, and the
Company has agreed to sell to each such Underwriter, the respective number of
Depositary Shares set forth opposite their names below:
<TABLE>
<CAPTION>
NUMBER OF
NAME DEPOSITARY SHARES
- ---- -----------------
<S> <C>
Morgan Stanley & Co. Incorporated...........................
Donaldson, Lufkin & Jenrette Securities Corporation.........
CIBC Oppenheimer Corp.......................................
---------
Total............................................. 1,500,000
=========
</TABLE>
The Underwriting Agreement provides that the obligations of the several
Underwriters to pay for and accept delivery of the Depositary Shares are subject
to the approval of certain legal matters by their counsel and to certain other
conditions. The Underwriters are committed to take and pay for all of the
Depositary Shares if any such shares are taken.
The Underwriters initially propose to offer part of the Depositary Shares
directly to the public at the public offering price set forth on the cover page
hereof and part to certain dealers at a price that represents a concession not
in excess of $ per Depositary Share. Any Underwriter may allow, and such
dealers may reallow, a concession, not in excess of $ per Depositary Share,
to certain other dealers. After the initial offering of the Depositary Shares,
the offering price and other selling terms may from time to time be varied by
Morgan Stanley & Co. Incorporated, as representative of the Underwriters named
on the cover page of this Prospectus Supplement.
The Company has agreed to indemnify the Underwriters against certain
liabilities, including liabilities under the Securities Act.
The Company does not intend to apply for listing of any of the Depositary
Shares on a national securities exchange, but has been advised by the
Underwriters that they presently intend to make a market in the Depositary
Shares, as permitted by applicable laws and regulations. The Underwriters are
not obligated, however, to make a market in the Depositary Shares and any such
market-making may be discontinued at any time at the sole discretion of the
Underwriters. Accordingly, no assurance can be given as to the liquidity of, or
trading markets for, the Depositary Shares.
In order to facilitate the offering of the Depositary Shares, the
Underwriters may engage in transactions that stabilize, maintain or otherwise
affect the prices of the Depositary Shares. Specifically, the Underwriters may
overallot in connection with the offering, creating a short position in the
Depositary Shares for their own account. In addition, to cover overallotments or
to stabilize the price of the Depositary Shares, the Underwriters may bid for,
and purchase, the Depositary Shares in the open market. Finally, the
underwriting syndicate may reclaim selling concessions allowed to an underwriter
or a dealer for distributing the Depositary Shares in the offering, if the
syndicate repurchases previously distributed Depositary Shares in transactions
to cover syndicate short positions, in stabilization transactions or otherwise.
Any of these activities may stabilize or maintain the market prices of the
Depositary Shares above independent market levels. The Underwriters are not
required to engage in these activities, and may end any of these activities at
any time.
In the ordinary course of business, certain of the Underwriters have
engaged in transactions with and, from time to time, have performed services
for, the Company and its affiliates, for which they have received customary
compensation.
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LEGAL MATTERS
The validity of the Series A Fixed/Adjustable Rate Preferred Stock and
certain legal matters relating to the Depositary Shares and certain United
States federal income tax matters will be passed upon for the Company by
Shearman & Sterling, New York, New York. Shearman & Sterling regularly
represents Morgan Stanley Dean Witter & Co., Morgan Stanley & Co. Incorporated
and their affiliates on a variety of legal matters. Certain legal matters
relating to the Series A Fixed/Adjustable Rate Preferred Stock and the
Depositary Shares will be passed upon for the Underwriters by LeBoeuf, Lamb,
Greene & MacRae, L.L.P. a limited liability partnership including professional
corporations, New York, New York. LeBoeuf, Lamb, Greene & MacRae, L.L.P.
regularly represents the Company on insurance related matters. Donald B.
Henderson, Jr., a partner of LeBoeuf, Lamb, Greene & MacRae, L.L.P., is a
director of National Integrity Life Insurance Company, a subsidiary of the
Company.
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<PAGE> 41
GLOSSARY OF SELECTED INSURANCE TERMS
Adjusted capital and
surplus....................... The sum of statutory-basis capital and asset
valuation reserves, and asset valuation
reserves of wholly owned insurance
subsidiaries.
Annuity....................... A contract that provides for a fixed or
variable periodic payment for a specified
period of time.
Asset valuation reserve
("AVR")....................... A formula-driven liability on an insurer's
statutory-basis financial statements designed
to provide over time for potential losses
associated with investments. The AVR
establishes statutory reserves for mortgage
loans, equity real estate and joint ventures as
well as for fixed maturities and common and
preferred stock. The AVR generally captures all
realized and unrealized gains and losses on
such assets, other than those resulting from
changes in interest rates, and cushions surplus
from large swings related to capital gains or
losses. The AVR has no effect on financial
statements prepared in conformity with GAAP.
Assets under management....... Customer deposits, off-balance sheet fee-based
deposits under marketing partnership
arrangements and surplus assets.
Capital and surplus........... Consists of capital stock, paid-in or
contributed surplus, special surplus funds and
unassigned surplus determined in accordance
with statutory accounting practices.
Cede.......................... To transfer to a reinsurer all or part of the
insurance written by an insurance entity.
Crediting rates............... Interest rates applied to annuity contracts and
life insurance policies during the accumulation
period, whether a guaranteed fixed rate or
variable rate or some combination thereof.
Customer deposits............. Funds received from a customer under an
insurance contract which accumulate interest or
investment income performance, depending on the
contract.
Deferred annuity.............. An annuity purchased with a single premium or a
series of installment premiums that provides
for the income payments to begin at some future
date.
Deferred policy acquisition
costs......................... Policy acquisition costs (as defined elsewhere
in this Glossary) that are deferred and
amortized based on the present value of
estimated gross profits, for investment-type
products, related to the issued policy in
conformity with GAAP.
Disintermediation............. The risk to a financial institution of a loss
due to the movement of customers' funds at book
value (i.e., without a market value adjustment)
when interest rates are higher than at contract
inception.
Fixed annuity................. An annuity that guarantees the preservation of
the assets contributed to the contract and the
interest rate those contributions will earn.
The guaranteed rate can vary in duration
depending on whether the contract is in the
accumulation or pay-out phase. The guaranteed
rate may change periodically during the
accumulation phase depending on financial
market interest rates.
S-41
<PAGE> 42
Flexible premium deferred
annuities..................... Deferred annuities (as defined elsewhere in
this Glossary) that permit the contractholder
to vary the amounts and timing of premium
payments.
403(b) tax-deferred
annuities..................... Annuities issued by life insurance companies
that are available only to employees of
educational and charitable organizations.
Tax-deferred contributions are allowed for such
employees through voluntary salary reduction or
pursuant to an employer-funded plan.
General account............... All of the assets of an insurance company held
for the purposes of the insurance company's
general business, as distinguished from
separate account assets (as defined elsewhere
in this Glossary).
Guaranteed investment
contracts and funding
agreements.................... Contracts sold to the qualified and
non-qualified institutional markets for use in
public and private retirement plans, municipal
funds, endowment and foundation funds, mutual
funds, government funds and trust funds. These
contracts guarantee principal and a stated
interest rate for a specified period of time.
Guaranteed rate options
("GROs")...................... Fixed rate options within both fixed and
variable annuity contracts which allow
customers to lock in a fixed return for a
specified number of years. Deposits into GROs
are held in a separate account established by
the insurance company. Funds may be transferred
to or from any of the guarantee period options
(or to other investment options within the
annuity contract) subject to a market value
adjustment.
Guaranteed separate account... Assets held in an insurer's separate account,
where the insurer provides some form of
guarantee on the rate credited to the annuity
contract. This guarantee is backed by the
general account assets of the insurer. Assets
held in guaranteed separate accounts usually
contain a market value adjustment to protect
the insurer against disintermediation risk.
Immediate annuity............. An annuity that begins payments to the
contractholder after a single premium payment
is made.
Interest maintenance reserve
("IMR")....................... A liability on an insurer's statutory-basis
financial statements which is increased or
decreased with the portion of realized capital
gains or losses, respectively, that result from
the sale of fixed-income securities and that
are attributable to changes in interest rates.
The IMR is required to be amortized against
earnings on a basis reflecting the remaining
period to maturity of the fixed-income
securities sold. The IMR has no effect on
financial statements prepared in accordance
with GAAP.
Investment spread............. The difference between income earned on
investments and interest credited on customer
deposits.
Lapse or lapsation............ The termination or forfeiture of an insurance
policy prior to maturity.
Market value adjustment....... For GROs, an adjustment, either positive or
negative, made to the contractholder's account
value for any transfer, partial withdrawal in
excess of the free withdrawal amount or
surrender (as defined elsewhere in this
Glossary).
S-42
<PAGE> 43
Nonguaranteed separate
account....................... Assets held in an insurer's separate account as
to which the insurer does not guarantee any
minimum return to the contractholder. Rather,
any investment income and net realized capital
gains and losses with respect to these assets
accrue directly to the contractholder.
Non-qualified annuities....... Annuities which do not comply with the
requirements of tax qualified retirement plans.
Off-balance sheet assets...... Assets that are not recorded on the Company's
balance sheet and which the Company manages for
a fee.
Persistency................... The maintenance of insurance policies in full
force until completion of the term for which
the policy was written (with respect to life
insurance this includes death or maturity). The
term may also refer to continuance and renewal
of insurance and annuity contracts.
Policy acquisition costs...... Costs incurred in the marketing and issuance
(i.e., acquisition) of new and renewal
insurance and annuity contracts. Acquisition
costs include those costs that vary with and
are primarily related to the acquisition of
insurance and annuity contracts (for example,
agent and broker commissions and certain
underwriting and policy issue costs).
Premiums and deposits......... The amount of money that the contractholder
pays to the insurance company for an insurance
policy or annuity. Deposits under
investment-type products are not recognized as
premium income under GAAP.
Reinsurance................... The acceptance by one or more insurers, called
reinsurers, of a portion of the risk
underwritten by another insurer, called the
ceding company, who has directly written the
coverage. However, the legal rights of the
insured generally are not affected by the
reinsurance transaction and the ceding company
remains liable to the insured for payment of
policy benefits.
Separate account.............. Investment accounts maintained by an insurer to
which funds have been allocated for certain
policies under provisions of relevant state
law. The investments in each separate account
are maintained separately from those in other
separate accounts and from the general account.
Separate accounts may be of a guaranteed or
non-guaranteed nature.
Single premium deferred
annuities..................... Annuities that require a one-time lump sum
premium payment upon the issuance of the
contract and that begin payments to the holder
at a specified later date.
Single premium endowment
contracts..................... Contracts under which principal is guaranteed,
and the face amount of the policy is paid upon
the death of the insured. The contracts are
credited with a specified rate of interest that
is guaranteed for a period of time and reset
periodically thereafter.
Single premium immediate
annuities..................... Annuities that require a one-time lump sum
premium payment upon the issuance of the
contract and that begin payments to the holder
immediately after issuance.
S-43
<PAGE> 44
Statutory accounting
practices..................... Those accounting practices prescribed or
permitted by an insurer's domiciliary state
insurance regulatory authority for purposes of
recording transactions and preparing financial
statements. Statutory accounting practices
emphasize solvency rather than matching
revenues and expenses during an accounting
period.
Surplus....................... As determined in accordance with statutory
accounting practices, the amount remaining
after all statutory liabilities are subtracted
from all admitted assets. Statutory surplus
includes common stock, paid-in and contributed
surplus, special surplus funds and earned
(unassigned) surplus.
Surrender..................... The act of terminating an annuity contract
during the accumulation period where the
contractholder receives the contract's account
value less any applicable surrender charges
(cash surrender value).
Surrender charge.............. The fee charged to a contractholder when an
annuity is surrendered for its cash value
during a specified term. Such charge is
intended to recover unamortized deferred policy
acquisition costs and to discourage premature
termination. Surrender charges typically apply
over a specified period of time and decline
over that period as a percentage of the account
value in relation to the anticipated
amortization of the deferred policy acquisition
costs.
Synthetic guaranteed
investment contracts
("Synthetic GICs")............ An investment product for the institutional
defined contribution retirement plan market.
Synthetic GICs have two components: (i) an
investment portfolio owned directly by the
plan; and (ii) a book value "wrapper" which
promises to pay authorized plan benefits at par
value, regardless of the actual investment
experience of the fund. Under all synthetic
product structures, the contractholder
maintains direct ownership of their assets held
in a custodial trust.
Tax qualified annuities....... Annuities which are issued pursuant to a tax
qualified retirement plan.
Underwriting.................. An insurer's process of examining, accepting or
rejecting insurance risks, and classifying
those accepted, in order to charge the
appropriate premium for each accepted risk.
Value of insurance in force
("VIF")....................... An asset created on the GAAP-basis balance
sheet of an insurance company when it acquires
a block of insurance business, equal to the
actuarially determined present value of the
expected pretax future profits of the business
acquired. VIF is amortized based on the present
value of estimated future gross profits over
the term of the underlying policies.
Variable annuity.............. An annuity in which premium payments are used
to purchase accumulation units of separate
accounts. The value of a unit fluctuates in
accordance with the investment experience of
the related separate account. Variable annuity
contracts may include a general account
guaranteed interest investment option or a GRO.
At the time of benefit payments to the
annuitant, the annuitant can generally elect
from a number of payment options which provide
either fixed or variable benefit payments.
S-44
<PAGE> 45
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
ARM FINANCIAL GROUP, INC. AND SUBSIDIARIES:
Condensed Consolidated Balance Sheets at March 31, 1998 and
December 31, 1997......................................... F-2
Condensed Consolidated Statements of Income (Unaudited) for
the Three Months Ended March 31, 1998 and 1997............ F-3
Condensed Consolidated Statements of Cash Flows (Unaudited)
for the Three Months Ended March 31, 1998 and 1997........ F-4
Notes to Condensed Consolidated Financial Statements
(Unaudited)............................................... F-5
Report of Independent Auditors.............................. F-9
Consolidated Balance Sheets at December 31, 1997 and 1996... F-10
Consolidated Statements of Income for the Years Ended
December 31, 1997, 1996 and 1995.......................... F-11
Consolidated Statements of Shareholders' Equity for the
Years Ended December 31, 1997, 1996
and 1995.................................................. F-12
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1997, 1996 and 1995.......................... F-13
Notes to Consolidated Financial Statements.................. F-14
</TABLE>
F-1
<PAGE> 46
ARM FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1998 1997
----------- ------------
(UNAUDITED)
(IN THOUSANDS)
<S> <C> <C>
ASSETS
Cash and investments:
Fixed maturities, available-for-sale, at fair value
(amortized cost: March 31, 1998 -- $4,413,322; December
31, 1997 -- $4,021,495)................................ $4,420,538 $4,068,386
Equity securities, at fair value (cost: March 31,
1998 -- $28,165; December 31, 1997 -- $28,177)......... 27,897 28,342
Mortgage loans on real estate............................. 16,235 16,429
Policy loans.............................................. 126,300 126,114
Cash and cash equivalents................................. 344,079 228,206
---------- ----------
Total cash and investments............................. 4,935,049 4,467,477
Assets held in separate accounts:
Guaranteed................................................ 1,292,589 1,266,796
Nonguaranteed............................................. 1,345,118 1,173,088
Accrued investment income................................... 50,117 44,546
Value of insurance in force................................. 30,951 25,975
Deferred policy acquisition costs........................... 95,914 87,170
Goodwill.................................................... 6,229 6,523
Deferred federal income taxes............................... 43,763 31,049
Other assets................................................ 59,006 35,800
---------- ----------
Total assets...................................... $7,858,736 $7,138,424
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Customer deposits......................................... $4,647,540 $4,242,578
Customer deposits in separate accounts:
Guaranteed............................................. 1,281,509 1,254,801
Nonguaranteed.......................................... 1,336,469 1,160,595
Long-term debt............................................ 38,000 38,000
Accounts payable and accrued expenses..................... 23,004 18,741
Payable for investment securities purchased............... 195,026 69,286
Payable to reinsurer...................................... 8,330 8,800
Other liabilities......................................... 31,301 38,078
---------- ----------
Total liabilities...................................... 7,561,179 6,830,879
Contingencies
Shareholders' equity:
Preferred stock, $25.00 stated value...................... 50,000 50,000
Class A common stock, $.01 par value, 21,441,641 and
21,316,068 shares issued and outstanding,
respectively........................................... 214 213
Class B common stock, $.01 par value, 1,947,646 shares
issued and outstanding................................. 19 19
Additional paid-in capital................................ 216,024 211,430
Retained earnings......................................... 30,474 25,583
Accumulated other comprehensive income from net unrealized
gains on available-for-sale securities................. 826 20,300
---------- ----------
Total shareholders' equity............................. 297,557 307,545
---------- ----------
Total liabilities and shareholders' equity........ $7,858,736 $7,138,424
========== ==========
</TABLE>
See accompanying notes.
F-2
<PAGE> 47
ARM FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
FOR THE THREE MONTHS ENDED MARCH 31, 1998 AND 1997
<TABLE>
<CAPTION>
1998 1997
----------- -----------
(IN THOUSANDS, EXCEPT PER
SHARE AMOUNTS)
<S> <C> <C>
Investment income........................................... $104,406 $ 69,700
Interest credited on customer deposits...................... (81,680) (51,325)
-------- --------
Net investment spread..................................... 22,726 18,375
Fee income:
Variable annuity fees..................................... 4,426 3,239
Asset management fees..................................... -- 1,884
Other fee income.......................................... 232 397
-------- --------
Total fee income....................................... 4,658 5,520
Other income and expenses:
Surrender charges......................................... 1,334 882
Operating expenses........................................ (7,550) (8,156)
Commissions, net of deferrals............................. (598) (638)
Interest expense on debt.................................. (617) (686)
Amortization:
Deferred policy acquisition costs...................... (2,724) (2,175)
Value of insurance in force............................ (1,531) (2,241)
Acquisition-related deferred charges................... (126) (126)
Goodwill............................................... (94) (122)
Non-recurring charges..................................... (3,570) (1,445)
Other, net................................................ (593) (995)
-------- --------
Total other income and expenses................... (16,069) (15,702)
Realized investment gains................................... 5,165 2,231
-------- --------
Income before income taxes.................................. 16,480 10,424
Income tax expense.......................................... (5,499) (2,814)
-------- --------
Net income.................................................. 10,981 7,610
Dividends on preferred stock................................ (1,188) (1,188)
-------- --------
Net income applicable to common shareholders................ $ 9,793 $ 6,422
======== ========
Net income per common share (basic)......................... $ 0.42 $ 0.37
======== ========
Net income per common and common equivalent share
(diluted)................................................. $ 0.40 $ 0.37
======== ========
Cash dividends paid per common share........................ $ 0.02 --
======== ========
</TABLE>
See accompanying notes.
F-3
<PAGE> 48
ARM FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
FOR THE THREE MONTHS ENDED MARCH 31, 1998 AND 1997
<TABLE>
<CAPTION>
1998 1997
----------- -----------
(IN THOUSANDS)
<S> <C> <C>
CASH FLOWS PROVIDED BY OPERATING ACTIVITIES................. $ 60,234 $ 46,677
CASH FLOWS PROVIDED BY (USED IN) INVESTING ACTIVITIES:
Fixed maturity investments:
Purchases................................................. (2,105,306) (1,199,200)
Maturities and redemptions................................ 202,755 59,905
Sales..................................................... 1,617,874 947,397
Other investments:
Purchases................................................. -- (10,489)
Maturities and redemptions................................ 337 8,029
Sales..................................................... 75 10,892
Policy loans, net........................................... (186) 169
Transfers (to) from the separate accounts:
Purchase of assets held in separate accounts.............. (112,026) (102,059)
Proceeds from sale of assets held in separate accounts.... 37,657 20,383
----------- -----------
Cash flows used in investing activities..................... (358,820) (264,973)
CASH FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITIES:
Amounts received from customers from the sale of general and
separate account products................................. 565,728 357,581
Amounts paid to customers for benefits and withdrawals
related to general and separate account products.......... (149,143) (112,693)
Principal payment on long-term debt......................... -- (2,000)
Change in payable to reinsurer.............................. (470) --
Dividends on common stock................................... (468) --
Dividends on preferred stock................................ (1,188) (1,188)
----------- -----------
Cash flows provided by financing activities................. 414,459 241,700
----------- -----------
Net increase in cash and cash equivalents................... 115,873 23,404
Cash and cash equivalents at beginning of period............ 228,206 110,067
----------- -----------
Cash and cash equivalents at end of period.................. $ 344,079 $ 133,471
=========== ===========
</TABLE>
See accompanying notes.
F-4
<PAGE> 49
ARM FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
MARCH 31, 1998
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with generally accepted accounting principles
("GAAP") for interim financial information and with the instructions to Form
10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of
the information and footnotes required by GAAP for complete financial
statements. In the opinion of management, all adjustments (consisting of normal
recurring accruals) considered necessary for a fair presentation have been
included. Operating results for the three months ended March 31, 1998 are not
necessarily indicative of those to be expected for the year ending December 31,
1998. For further information, refer to the consolidated financial statements
and footnotes thereto included in the annual report on Form 10-K of ARM
Financial Group, Inc. (the "Company") for the year ended December 31, 1997.
Certain amounts from prior years have been reclassified to conform to the
current year's presentation. Such reclassifications have no effect on previously
reported net income or shareholders' equity.
2. INCOME TAXES
Income tax expense differs from that computed using the expected federal
income tax rate of 35%. The differences are primarily attributable to changes in
valuation allowances related to deferred federal income tax assets.
3. NON-RECURRING CHARGES
Effective February 10, 1998, John Franco, the Company's Co-Chairman and
Co-Chief Executive Officer, retired. Mr. Franco had shared that title with
Martin H. Ruby since the Company was founded in 1993. As part of the retirement
package for Mr. Franco, the Company recorded a non-recurring charge of $3.6
million in the first quarter of 1998. The charge consisted of (i) a $2.1 million
non-cash charge in connection with the vesting of the unvested portion of the
options held by Mr. Franco to purchase 232,647 shares of the Company's common
stock and (ii) a $1.5 million charge for fulfilling remaining compensation
related to his employment agreement. Concurrent with Mr. Franco's retirement,
Mr. Ruby assumed the role of Chairman and Chief Executive Officer of the
Company.
The Company recorded non-recurring charges of $1.4 million in the first
quarter of 1997 primarily related to the relocation and consolidation of the
Company's operations facilities from Ohio to Louisville, Kentucky.
4. EARNINGS PER SHARE
In 1997, the Company adopted the provisions of Statement of Financial
Accounting Standards ("SFAS") No. 128, "Earnings Per Share," which superseded
Accounting Principles Board Opinion No. 15 of the same name. Earnings per share
("EPS") for all periods presented reflect the adoption of SFAS No. 128. SFAS No.
128 requires companies to present basic and, if applicable, diluted EPS, instead
of primary and fully diluted EPS. Basic EPS excludes dilution and is computed by
dividing net income applicable to common shareholders by the weighted average
number of common shares outstanding for the period. Diluted EPS reflects the
potential dilution that could occur if options to issue common stock were
exercised into common stock.
F-5
<PAGE> 50
ARM FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) -- (CONTINUED)
The following is a reconciliation of the number of shares used in the basic
and diluted EPS computations:
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
----------------------------------------------
1998 1997
--------------------- ---------------------
WEIGHTED WEIGHTED
AVERAGE PER SHARE AVERAGE PER SHARE
SHARES AMOUNT SHARES AMOUNT
-------- --------- -------- ---------
(Shares in thousands)
<S> <C> <C> <C> <C>
Basic EPS.................................. 23,322 $ 0.42 17,506 $0.37
Effect of dilutive stock options........... 1,030 (0.02) -- --
------ ------ ------ -----
Diluted EPS................................ 24,352 $ 0.40 17,506 $0.37
====== ====== ====== =====
</TABLE>
5. SEGMENT INFORMATION
Effective December 31, 1997, the Company adopted SFAS No. 131, "Disclosures
about Segments of an Enterprise and Related Information." SFAS No. 131
superseded SFAS No. 14, "Financial Reporting for Segments of a Business
Enterprise." SFAS No. 131 establishes standards for the way that public business
enterprises report information about operating segments. The adoption of SFAS
No. 131 did not affect results of operations or financial position, but did
affect the disclosure of segment information.
The Company currently has four reportable segments: retail spread products
(fixed and indexed annuities and face-amount certificates), institutional spread
products (funding agreements, guaranteed investment contracts ("GICs") and
face-amount certificates), retail variable products (fee-based variable annuity
mutual fund options), and corporate and other. The Company's corporate and other
segment includes earnings on surplus of insurance subsidiaries and holding
company cash and investments, fee income from marketing partnerships and
broker-dealer operations, unallocated amortization expenses, and other various
corporate expenditures that are not allocated to specific products. Income tax
expense and preferred stock dividends are not allocated to any segment.
The Company's reportable segments are based on the characteristics of the
product or service and the markets through which the product or service is sold.
The reportable segments are each managed separately because the impact of
fluctuating interest rates and changes in the equity market environment affects
each segments' products and services differently. The Company evaluates
performance based on operating earnings. Operating earnings represents net
income applicable to common shareholders, excluding, net of tax, realized
investment gains and losses, non-recurring charges and for 1997, income from
defined benefit pension plan asset management operations which were sold.
F-6
<PAGE> 51
ARM FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) -- (CONTINUED)
<TABLE>
<CAPTION>
THREE MONTHS
ENDED MARCH 31,
-------------------
1998 1997
-------- -------
(IN THOUSANDS)
<S> <C> <C>
REVENUES
Retail spread products...................................... $ 55,508 $51,959
Institutional spread products............................... 46,966 16,036
Retail variable products.................................... 4,426 3,239
Corporate and other......................................... 2,164 3,986
-------- -------
Consolidated total revenues (investment income and fee
income)................................................ $109,064 $75,220
======== =======
EARNINGS SUMMARY
Retail spread products...................................... $ 10,517 $ 8,726
Institutional spread products............................... 4,182 1,345
Retail variable products.................................... 1,601 878
Corporate and other......................................... (1,415) (1,892)
-------- -------
Pretax operating earnings (before preferred stock
dividends)............................................. 14,885 9,057
Income taxes on operations.................................. (3,691) (2,033)
Preferred stock dividends................................... (1,188) (1,188)
-------- -------
Operating earnings........................................ 10,006 5,836
Realized investment gains, net of tax....................... 3,357 1,450
Non-recurring charges....................................... (3,570) (1,445)
Income from defined benefit pension plan asset management
operations................................................ -- 581
-------- -------
Net income applicable to common shareholders.............. $ 9,793 $ 6,422
======== =======
</TABLE>
6. COMPREHENSIVE INCOME
As of January 1, 1998, the Company adopted SFAS No. 130, "Reporting
Comprehensive Income." SFAS No. 130 establishes new rules for the reporting and
display of comprehensive income and its components; however, the adoption of
this Statement had no impact on the Company's net income or total shareholders'
equity. SFAS No. 130 requires unrealized gains or losses on the Company's
available-for-sale securities to be included in other comprehensive income.
The components of comprehensive income (loss), net of related tax, for the
three months ended March 31, 1998 and 1997 are as follows:
<TABLE>
<CAPTION>
THREE MONTHS
ENDED MARCH 31,
--------------------
1998 1997
-------- --------
(IN THOUSANDS)
<S> <C> <C>
Net income............................................. $ 10,981 $ 7,610
Net unrealized losses on available-for-sale
securities........................................... (19,474) (30,390)
-------- --------
Comprehensive income (loss)............................ $ (8,493) $(22,780)
======== ========
</TABLE>
F-7
<PAGE> 52
ARM FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) -- (CONTINUED)
7. SUBSEQUENT EVENTS
312 Certificate Company
The Company established a new subsidiary, 312 Certificate Company ("312"),
a bankruptcy-remote, restricted special purpose corporation, to sell face-amount
certificates in the institutional market. On April 24, 1998, 312 completed its
first sale of a $500 million face-amount certificate to a large institutional
purchaser. 312 is a wholly owned subsidiary of ARM Face-Amount Certificate
Group, which is a wholly owned subsidiary of the Company.
Public Offering
In May 1998, the Company completed a public offering of approximately 12.4
million shares of common stock held by certain private equity funds (the "Morgan
Stanley Stockholders") sponsored by Morgan Stanley Dean Witter & Co. The Company
did not receive any of the proceeds from the public offering. As a result of the
public offering, the Morgan Stanley Stockholders no longer own any shares of the
Company's outstanding common stock and all Class B common stock was converted
into Class A common stock.
F-8
<PAGE> 53
REPORT OF INDEPENDENT AUDITORS
Board of Directors and Shareholders
ARM Financial Group, Inc.
We have audited the accompanying consolidated carrying amount balance
sheets of ARM Financial Group, Inc. and subsidiaries as of December 31, 1997 and
1996, and the related consolidated statements of income, shareholders' equity,
and cash flows for each of the three years in the period ended December 31,
1997. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by the
Company's management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
We have also audited in accordance with generally accepted auditing
standards the consolidated supplemental fair value balance sheets of ARM
Financial Group, Inc. and subsidiaries as of December 31, 1997 and 1996. As
described in Note 4, the consolidated supplemental fair value balance sheets
have been prepared by management to present relevant financial information that
is not provided by the carrying amount balance sheets and is not intended to be
a presentation in conformity with generally accepted accounting principles. In
addition, the consolidated supplemental fair value balance sheets do not purport
to present the net realizable, liquidation or market value of ARM Financial
Group, Inc. as a whole. Furthermore, amounts ultimately realized by ARM
Financial Group, Inc. from the disposal of assets may vary significantly from
the fair values presented. In our opinion, the consolidated supplemental fair
value balance sheets referred to above present fairly, in all material respects,
the information set forth therein as described in Note 4.
In our opinion, the financial statements referred to in paragraph one above
present fairly, in all material respects, the consolidated financial position of
ARM Financial Group, Inc. and subsidiaries at December 31, 1997 and 1996, and
the consolidated results of their operations and their cash flows for each of
the three years in the period ended December 31, 1997, in conformity with
generally accepted accounting principles.
/s/ ERNST & YOUNG LLP
Louisville, Kentucky
February 10, 1998
F-9
<PAGE> 54
ARM FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
CARRYING AMOUNT FAIR VALUE
----------------------- ------------------------
DECEMBER 31, DECEMBER 31,
----------------------- ------------------------
1997 1996 1997 1996
---------- ---------- ---------- ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
ASSETS
Cash and investments:
Fixed maturities, available-for-sale, at fair value
(amortized cost: 1997 -- $4,021,495;
1996 -- $3,048,834)............................... $4,068,386 $3,054,513 $4,068,386 $3,054,513
Equity securities, at fair value (cost:
1997 -- $28,177; 1996 -- $21,268)................. 28,342 22,552 28,342 22,552
Mortgage loans on real estate....................... 16,429 36,879 16,429 36,879
Policy loans........................................ 126,114 123,466 126,114 123,466
Cash and cash equivalents........................... 228,206 110,067 228,206 110,067
---------- ---------- ---------- ----------
Total cash and investments........................ 4,467,477 3,347,477 4,467,477 3,347,477
Assets held in separate accounts:
Guaranteed.......................................... 1,266,796 261,823 1,266,796 261,823
Nonguaranteed....................................... 1,173,088 873,225 1,173,088 873,225
Accrued investment income............................. 44,546 36,233 44,546 36,233
Value of insurance in force........................... 25,975 52,024 -- --
Deferred policy acquisition costs..................... 87,170 59,001 -- --
Goodwill.............................................. 6,523 7,636 6,523 7,636
Deferred federal income taxes......................... 31,049 35,604 51,887 42,653
Other assets.......................................... 35,800 28,641 35,800 28,641
---------- ---------- ---------- ----------
Total assets................................. $7,138,424 $4,701,664 $7,046,117 $4,597,688
========== ========== ========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Customer deposits................................... $4,242,578 $3,294,174 $4,218,297 $3,199,638
Customer deposits in separate accounts:
Guaranteed........................................ 1,254,801 261,823 1,224,551 249,132
Nonguaranteed..................................... 1,160,595 868,336 1,109,277 829,253
Long-term debt...................................... 38,000 40,000 38,000 40,000
Accounts payable and accrued expenses............... 18,741 22,684 18,741 22,684
Payable for investment securities purchased......... 69,286 10,431 69,286 10,431
Payable to reinsurer................................ 8,800 10,000 8,800 10,000
Other liabilities................................... 38,078 12,274 38,078 12,274
---------- ---------- ---------- ----------
Total liabilities................................. 6,830,879 4,519,722 6,725,030 4,373,412
Contingencies.........................................
Shareholders' equity:
Preferred stock, $.01 par value, $25.00 stated
value; 2,300,000 shares authorized; 2,000,000
shares issued and outstanding..................... 50,000 50,000
Class A Common Stock, $.01 par value; 150,000,000
and 19,259,680 shares authorized, respectively;
21,316,068 and 16,799,976 shares issued and
outstanding, respectively......................... 213 *
Class B Common Stock, $.01 par value; 50,000,000 and
762,480 shares authorized, respectively; 1,947,646
and 706,000 shares issued and outstanding,
respectively...................................... 19 *
Additional paid-in capital.......................... 211,430 124,609
Net unrealized gains on available-for-sale
securities........................................ 20,300 3,669
Retained earnings................................... 25,583 3,664
---------- ----------
Total shareholders' equity........................ 307,545 181,942 321,087 224,276
---------- ---------- ---------- ----------
Total liabilities and shareholders' equity... $7,138,424 $4,701,664 $7,046,117 $4,597,688
========== ========== ========== ==========
</TABLE>
- ---------------
* Less than $1,000.
See accompanying notes.
F-10
<PAGE> 55
ARM FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------
1997 1996 1995
----------- ----------- -----------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C>
Investment income....................................... $ 329,979 $ 250,031 $ 196,024
Interest credited on customer deposits.................. (247,418) (182,161) (146,867)
--------- --------- ---------
Net investment spread.............................. 82,561 67,870 49,157
Fee income:
Variable annuity fees................................. 14,630 10,786 7,238
Asset management fees................................. 8,595 5,780 3,161
Other fee income...................................... 1,386 1,267 949
--------- --------- ---------
Total fee income................................... 24,611 17,833 11,348
Other income and expenses:
Surrender charges..................................... 4,482 5,024 3,339
Operating expenses.................................... (32,528) (31,055) (22,957)
Commissions, net of deferrals......................... (2,218) (2,372) (1,557)
Interest expense on debt.............................. (2,517) (3,146) (3,461)
Amortization:
Deferred policy acquisition costs.................. (10,416) (6,835) (2,932)
Value of insurance in force........................ (9,293) (7,320) (7,104)
Acquisition-related deferred charges............... (503) (1,503) (9,920)
Goodwill........................................... (424) (488) (358)
Non-recurring charges:
Stock-based compensation........................... (8,145) -- --
Other.............................................. (6,678) (5,004) --
Other, net............................................ (386) (5,366) (687)
--------- --------- ---------
Total other income and expenses.................... (68,626) (58,065) (45,637)
Realized investment gains............................... 3,192 907 4,048
--------- --------- ---------
Income before income taxes.............................. 41,738 28,545 18,916
Income tax expense...................................... (14,139) (5,167) (7,026)
--------- --------- ---------
Net income.............................................. 27,599 23,378 11,890
Dividends on preferred stock............................ (4,750) (4,750) (4,750)
--------- --------- ---------
Net income applicable to common shareholders............ $ 22,849 $ 18,628 $ 7,140
========= ========= =========
Net income per common share (basic)..................... $ 1.11 $ 1.06 $ 0.49
========= ========= =========
Net income per common and common equivalent share
(diluted)............................................. $ 1.07 $ 1.06 $ 0.49
========= ========= =========
Cash dividends paid per common share.................... $ 0.04 $ -- $ --
========= ========= =========
</TABLE>
See accompanying notes.
F-11
<PAGE> 56
ARM FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
NET
UNREALIZED
GAINS
(LOSSES) ON
CLASS A CLASS B ADDITIONAL AVAILABLE- TOTAL
PREFERRED COMMON COMMON PAID-IN FOR-SALE RETAINED SHAREHOLDERS'
STOCK STOCK STOCK CAPITAL SECURITIES EARNINGS EQUITY
--------- ------- ------- ---------- ----------- -------- -------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, January 1, 1995........ $50,000 $ * $ * $ 62,920 $(104,949) $(22,104) $(14,133)
Issuance of 6,897,620 shares
of Class A common stock..... * 61,505 61,505
Net income.................... 11,890 11,890
Dividends on preferred
stock....................... (4,750) (4,750)
Change in net unrealized
losses on available-for-sale
securities.................. 133,479 133,479
------- ---- --- -------- --------- -------- --------
Balance, December 31, 1995...... 50,000 * * 124,425 28,530 (14,964) 187,991
Issuance of 18,356 shares of
Class A common stock........ * 184 184
Net income.................... 23,378 23,378
Dividends on preferred
stock....................... (4,750) (4,750)
Change in net unrealized gains
on available-for-sale
securities.................. (24,861) (24,861)
------- ---- --- -------- --------- -------- --------
Balance, December 31, 1996...... 50,000 * * 124,609 3,669 3,664 181,942
Recapitalization of Class A
and Class B common stock.... 156 19 (175) --
Issuance of 5,750,000 shares
of Class A Common Stock from
initial public offering..... 57 78,755 78,812
Issuance of 7,743 shares of
Class A Common Stock from
exercise of stock options... * 96 96
Net income.................... 27,599 27,599
Dividends on preferred
stock....................... (4,750) (4,750)
Dividends on common stock..... (930) (930)
Stock-based compensation
charge...................... 8,145 8,145
Change in net unrealized gains
on available-for-sale
securities.................. 16,631 16,631
------- ---- --- -------- --------- -------- --------
Balance, December 31, 1997...... $50,000 $213 $19 $211,430 $ 20,300 $ 25,583 $307,545
======= ==== === ======== ========= ======== ========
</TABLE>
- ---------------
* Less than $1,000.
See accompanying notes.
F-12
<PAGE> 57
ARM FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------------
1997 1996 1995
----------- ----------- -----------
(IN THOUSANDS)
<S> <C> <C> <C>
CASH FLOWS PROVIDED BY (USED IN) OPERATING ACTIVITIES:
Net income.................................................. $ 27,599 $ 23,378 $ 11,890
Adjustments to reconcile net income to cash flows provided
by operating activities:
Interest credited on general account customer deposits.... 212,964 172,202 136,824
Stock-based compensation charge........................... 8,145 -- --
Realized investment gains................................. (3,192) (907) (4,048)
Amortization of value of insurance in force and deferred
policy acquisition costs................................ 19,709 14,155 10,036
Other amortization........................................ 1,426 1,374 12,406
Deferral of policy acquisition and other costs............ (40,033) (24,202) (24,505)
Deferred tax expense...................................... 1,003 2,554 6,385
(Increase) decrease in accrued investment income.......... (8,313) 149 (1,609)
Changes in other assets and liabilities................... (3,243) 4,171 (9,020)
----------- ----------- -----------
Cash flows provided by operating activities............. 216,065 192,874 138,359
CASH FLOWS PROVIDED BY (USED IN) INVESTING ACTIVITIES:
Fixed maturity investments:
Purchases................................................. (4,710,312) (2,716,010) (1,498,623)
Maturities and redemptions................................ 445,772 241,391 205,319
Sales..................................................... 3,355,461 1,922,689 1,197,468
Other investments:
Purchases................................................. (72,283) (55,995) (7,891)
Maturities and redemptions................................ 20,806 7,310 24,377
Sales..................................................... 62,196 42,961 36,119
Policy loans, net........................................... (2,648) (5,938) (6,428)
Transfers (to) from the separate accounts:
Purchase of assets held in separate accounts.............. (1,066,348) (302,993) (226,812)
Proceeds from sale of assets held in separate accounts.... 110,524 83,077 45,249
Cash and cash equivalents acquired in excess of purchase
price paid for substantially all assets of SBM Company.... -- -- 36,490
----------- ----------- -----------
Cash flows used in investing activities..................... (1,856,832) (783,508) (194,732)
CASH FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITIES:
Amounts received from customers from the sale of general and
separate account products................................. 2,268,496 1,072,323 425,628
Amounts paid to customers for benefits and withdrawals
related to general and separate account products.......... (579,618) (441,944) (406,977)
Net proceeds from issuance of common stock.................. 80,308 184 63,505
Organizational, debt and stock issuance costs............... (1,400) -- (2,000)
Principal payment on long-term debt......................... (2,000) -- --
Change in payable to reinsurer.............................. (1,200) 10,000 --
Dividends on common stock................................... (930) -- --
Dividends on preferred stock................................ (4,750) (4,750) (4,750)
Change in repurchase agreement liability.................... -- (12,008) 12,008
----------- ----------- -----------
Cash flows provided by financing activities................. 1,758,906 623,805 87,414
----------- ----------- -----------
Increase in cash and cash equivalents....................... 118,139 33,171 31,041
Cash and cash equivalents at beginning of year.............. 110,067 76,896 45,855
----------- ----------- -----------
Cash and cash equivalents at end of year.................... $ 228,206 $ 110,067 $ 76,896
=========== =========== ===========
Supplemental cash flow information:
Interest paid on debt..................................... $ 1,837 $ 2,613 $ 2,736
=========== =========== ===========
Income taxes paid......................................... $ 2,943 $ 7,230 $ --
=========== =========== ===========
</TABLE>
See accompanying notes.
F-13
<PAGE> 58
ARM FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
Organization
ARM Financial Group, Inc. (the "Company") specializes in the growing asset
accumulation business with particular emphasis on retirement savings and
investment products. The Company's retail products include a variety of fixed,
indexed and variable annuities and face-amount certificates sold through a broad
spectrum of distribution channels including independent broker-dealers,
independent agents, stockbrokers, and financial institutions. The Company offers
institutional products, such as funding agreements and guaranteed investment
contracts ("GICs") directly to bank trust departments, plan sponsors, cash
management funds, corporate treasurers, and other institutional investors.
The Company derives its earnings from the net investment spread and fee
income generated by the assets it manages. With retail and institutional spread
products offered by the Company, the Company's insurance and face-amount
certificate subsidiaries agree to return customer deposits with interest at a
specified rate or based on a specified index (e.g., LIBOR, S&P 500 -- both
defined below). As a result, the Company's insurance and face-amount certificate
subsidiaries accept investment risk in exchange for the opportunity to achieve a
spread between what the Company earns on invested assets and what it pays or
credits on customer deposits. With retail variable products offered by the
Company, the Company's subsidiaries receive a fee in exchange for managing
deposits, and the customer accepts investment risk associated with their chosen
mutual fund options. Because the investment risk is borne by the customer, this
business requires significantly less capital support than spread-based business.
The Company conducts its different businesses through a variety of
subsidiaries. Retail fixed, indexed and variable annuities and institutional
funding agreements and GICs are issued by the Company's insurance subsidiaries,
Integrity Life Insurance Company ("Integrity") and National Integrity Life
Insurance Company ("National Integrity")(collectively, the "Integrity
Companies"). ARM Securities Corporation ("ARM Securities"), a registered
broker-dealer, provides a distribution channel for selling affiliated and
nonaffiliated retail products. SBM Certificate Company is an issuer of
face-amount certificates, a retail product similar to certificates of deposit
issued by banks.
The Company received initial start-up capital as partial funding for the
acquisition of the Integrity Companies through the private issuance of common
stock in November 1993. In June 1995, the Company received additional capital to
fund the acquisition of substantially all of the assets and business operations
of SBM Company ("SBM") also through the private issuance of common stock. Such
capital was primarily provided by certain private equity funds sponsored by
Morgan Stanley Dean Witter & Co. (the "Morgan Stanley Stockholders"). In June
1997, the Company completed an initial public offering (the "Offering") of
common stock. The Morgan Stanley Stockholders owned approximately 91% of the
outstanding shares of the Company's common stock prior to the Offering and, as a
result of the Offering, owned approximately 53% at December 31, 1997. At
December 31, 1997, approximately 40% of the outstanding shares of the Company's
common stock was publicly held, with the remainder being nonregistered common
stock issued to certain original private investors of the Company (excluding the
Morgan Stanley Stockholders).
The Company had no significant business activity until November 26, 1993,
when it acquired the Integrity Companies resulting in $2.3 billion of assets
under management. Assets under management have grown to $6.9 billion as of
December 31, 1997.
Basis of Presentation
The consolidated financial statements have been prepared in accordance with
generally accepted accounting principles ("GAAP") and include the accounts of
the Company and its subsidiaries. All significant intercompany accounts and
transactions have been eliminated in consolidation. Certain amounts from prior
years have been reclassified to conform to the current year's presentation.
F-14
<PAGE> 59
ARM FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The preparation of financial statements in conformity with GAAP requires
management of the Company to make estimates and assumptions that affect the
amounts reported in the consolidated financial statements and accompanying
notes. Actual results could differ from those estimates.
The consolidated balance sheets include a dual presentation of carrying
amount and fair value balances. In accordance with Statement of Financial
Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in
Debt and Equity Securities," fixed maturities classified as available-for-sale
are reported at fair value in the carrying amount balance sheets; however,
corresponding customer deposits are reported at historical values. In contrast,
in the fair value balance sheets, both assets and liabilities are reported at
fair value. As permitted by SFAS No. 107, "Disclosures About Fair Value of
Financial Instruments," the fair value balance sheets are presented as a
supplemental disclosure to provide a more meaningful picture of the Company's
financial position. Note 4 describes the methods and assumptions used by the
Company in estimating fair value.
Investments
All of the Company's fixed maturities and equity securities are classified
as available-for-sale and stated at fair value. Unrealized gains and losses on
available-for-sale securities are reported as a separate component of
shareholders' equity, net of adjustments to value of insurance in force and
deferred policy acquisition costs equal to the change in amortization that would
have been recorded if these securities had been sold as of the balance sheet
date, and net of deferred income taxes. The amortized cost of fixed maturities
is adjusted for amortization of premiums and accretion of discounts to maturity,
or in the case of mortgage-backed and asset-backed securities, over the
estimated life of the security. Such amortization and accretion is computed
using the interest method and is included in investment income. Anticipated
prepayments on mortgage-backed and asset-backed securities are considered in
determining the effective yield on such securities. If a difference arises
between anticipated and actual prepayments, the carrying value of the investment
is adjusted with a corresponding charge or credit to investment income. Interest
and dividends are included in investment income. Mortgage loans on real estate
and policy loans are carried at their unpaid principal balances. Cash and cash
equivalents consist of highly liquid investments with maturities of three months
or less at their time of purchase.
Realized gains and losses on the sale of investments are determined based
upon the average cost method and include provisions for other-than-temporary
impairments where appropriate. In addition, the amortization of value of
insurance in force and deferred policy acquisition costs is adjusted for gains
and losses realized on sales of investments which support customer deposits. The
adjustment to amortization associated with such realized gains and losses is
included in Realized Investment Gains in the consolidated statements of income.
Value of Insurance in Force, Deferred Policy Acquisition Costs and Goodwill
A portion of the purchase price paid for the insurance subsidiaries was
allocated to the value of insurance in force based on the actuarially-determined
present value of the expected pretax future profits from the business assuming a
discount rate of 13%. This present value amount was reduced to the extent that
the fair value of the net assets acquired including the value of insurance in
force exceeded the purchase price allocated to the insurance subsidiaries.
Interest is accrued on the balance annually at a rate consistent with the rate
credited on the acquired policies on the acquisition date. Recoverability of the
value of insurance in force is evaluated quarterly by comparing the current
estimate of the present value of expected pretax future profits to the
unamortized asset balance. If such current estimate is less than the existing
asset balance, the difference would be charged to expense. To the extent
recoverable from future gross profits, costs of producing new business
(primarily commissions and certain policy issuance and marketing costs) which
vary with and are primarily related to the production of new business are
deferred. Value of insurance in force and deferred policy acquisition costs are
amortized in proportion to the emergence of future gross profits, including
related
F-15
<PAGE> 60
ARM FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
realized investment gains and losses, over the estimated term of the underlying
policies. In addition, an adjustment is made to value of insurance in force and
deferred policy acquisition costs equal to the change in amortization that would
have been recorded if unrealized gains and losses on available-for-sale
securities had been realized as of the balance sheet date.
A portion of the purchase price paid for subsidiaries was allocated to
goodwill representing the excess of the purchase price paid over the fair value
of net assets acquired. Goodwill currently recorded is amortized over a period
not exceeding twenty years using the straight-line method.
Incremental costs directly related to the integration of acquired companies
are deferred, to the extent recoverable from future gross profits of the
acquired companies. Such deferred transition costs are amortized using the
straight-line method over the estimated term of the policies underlying the
acquired companies.
Assets Held in Separate Accounts and Customer Deposits in Separate Accounts
Assets held in separate accounts of the Company's insurance subsidiaries
are segregated from other investments and are not subject to claims that arise
out of any other business of the Company. The separate accounts include customer
deposits and related invested assets, for retail and institutional spread
products (guaranteed) and retail variable products (nonguaranteed). Separate
account assets and liabilities are carried at estimated fair values. Investment
income and interest credited on customer deposits related to spread product
deposits are included as such in the statements of income. The Company receives
administrative fees for managing retail variable product deposits and other fees
for assuming mortality and certain expense risks. Such fees are included in
Variable Annuity Fees in the statements of income.
During 1996, the Company began offering an equity-indexed annuity product
through its separate accounts which aims to meet consumer demand for equity
investments with downside protection. In connection with this product, the
Company's separate accounts purchased call options based on the S&P 500
Composite Stock Price Index ("S&P 500"). The options perform as a hedge against
the Company's obligation to pay equity-indexed annuity policyholders returns
tied to the S&P 500. As of December 31, 1997 and 1996, these options are carried
at fair value and unrealized gains and losses increase or decrease obligations
to policyholders.
Customer Deposits
For single and flexible premium deferred annuities, single premium
endowments, face-amount certificates, funding agreements, and guaranteed
investment contracts, customer deposits represent account values before
applicable surrender charges. Such account values represent premiums and
deposits received, plus interest credited, less withdrawals and assessed fees.
For structured settlements and other single premium immediate annuities,
customer deposits represent the present value of future benefit payments and
maintenance expenses. The interest rate used in determining such present value
was approximately 7.35% as of December 31, 1997.
Recognition of Fee Income
Variable annuity fees and asset management fees are recorded in income as
earned. Other fee income includes marketing partnership fees earned related to
ventures with other insurance companies and certain fees earned by ARM
Securities (primarily net retained commissions). Premiums and deposits received
from customers are not included in the statements of income.
Federal Income Taxes
Deferred income tax reflects the net tax effects of (i) temporary
differences between the carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes and (ii)
operating and capital losses.
F-16
<PAGE> 61
ARM FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Net Income Per Share of Common Stock
In 1997, the Company adopted the provisions of SFAS No. 128, "Earnings Per
Share," which superseded Accounting Principles Board Opinion No. 15 of the same
name. Earnings per share for all periods presented reflect the adoption of SFAS
No. 128. SFAS No. 128 requires companies to present basic earnings per share,
and, if applicable, diluted earnings per share, instead of primary and fully
diluted earnings per share. Basic earnings per share excludes dilution and is
computed by dividing net income applicable to common shareholders by the
weighted average number of common shares outstanding for the period. Diluted
earnings per share reflects the potential dilution that could occur if options
to issue common stock were exercised into common stock.
2. ACQUISITIONS
SBM Company
Effective May 31, 1995, the Company completed the acquisition of
substantially all of the assets and business operations of SBM, including all of
the issued and outstanding capital stock of SBM's subsidiaries, State Bond and
Mortgage Life Insurance Company ("SBM Life"), SBM Financial Services, Inc.
(which subsequently changed its name to ARM Securities), SBM Certificate
Company, and SBM's management contracts with six mutual funds (the "State Bond
Mutual Funds").
The aggregate purchase price for the acquisition was $38.8 million. The
Company financed the acquisition by issuing approximately 6.9 million shares of
the Company's Class A common stock, primarily to the Morgan Stanley
Stockholders, for an aggregate sale price of $63.5 million. The Company used the
proceeds from the issuance of new common equity in excess of the aggregate
purchase price for the acquisition to make a $19.9 million capital contribution
to SBM Life and acquire all of the issued and outstanding capital stock of SBM
Certificate Company from SBM Life for a purchase price of $3.3 million.
The capital contribution to SBM Life was used to strengthen SBM Life's
financial position and allowed for a significant investment portfolio
restructuring immediately following the acquisition with no net adverse effect
on statutory adjusted capital and surplus. On December 31, 1995, SBM Life was
merged with and into Integrity to create certain operating efficiencies intended
to benefit the Company and its customers. On December 13, 1996, the Company
transferred its contracts to perform management and advisory services for the
State Bond Mutual Funds to Federated Investors for $4.5 million. Asset
management fee income of $1.6 million and $1.0 million was recorded by the
Company during 1996 and 1995, respectively, with respect to the management of
such funds. The State Bond Mutual Funds had aggregate assets of $236.9 million
on December 13, 1996.
ARM Capital Advisors
On January 5, 1995, the Company completed the acquisition of substantially
all the assets and business of the U.S. fixed income unit of Kleinwort Benson
Investment Management Americas Inc. ("KBIMA"), including its third-party account
asset management operations. KBIMA provided investment advisory services to the
Company during 1994. The business acquired became part of the then newly-formed
ARM Capital Advisors, Inc. ("ARM Capital Advisors"). ARM Capital Advisors is a
registered investment advisor and wholly owned subsidiary of the Company. ARM
Capital Advisors' management of third-party accounts generated asset management
fees of $8.6 million, $4.2 million and $2.2 million during 1997, 1996 and 1995,
respectively. Although third-party assets managed by ARM Capital Advisors grew
since the acquisition, the Company believes that market attitudes towards
developing an asset management business for defined benefit pension plans within
a holding company structure consisting predominantly of insurance companies
constrained ARM Capital Advisors' growth. Accordingly, on November 7, 1997, the
Company transferred substantially all of the assets and operations of ARM
Capital Advisors to a newly formed subsidiary, ARM
F-17
<PAGE> 62
ARM FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Capital Advisors, LLC ("New ARMCA"), and sold an 80% interest therein to ARM
Capital Advisors Holdings, LLC, an entity controlled by Emad A. Zikry, the
President of ARM Capital Advisors prior to the sale. The Company recognized an
immaterial gain on the sale. The Company has continued to engage New ARMCA as
its investment adviser but will consider retaining other investment management
firms as it deems appropriate. The terms of the sale provided for a transition
period following the sale through December 31, 1997 whereby the Company (i)
provided all accounting and administrative services required by New ARMCA and
paid all of its costs and expenses and (ii) received all of the gross revenues
of New ARMCA. After the sale, ARM Capital Advisors was renamed Integrity Capital
Advisors, Inc.
Integrity Companies
On November 26, 1993, the Company completed the acquisition of the
Integrity Companies from the National Mutual Life Association of Austalasia
Limited ("National Mutual"). In connection with the acquisition, National Mutual
provided the Integrity Companies with indemnification as to future claims for
taxes, assessments from guaranty funds, and claims from litigation, which arise
from preclosing events.
3. INVESTMENTS
The amortized cost and estimated fair values of available-for-sale
securities were as follows:
<TABLE>
<CAPTION>
GROSS GROSS
UNREALIZED UNREALIZED ESTIMATED
COST GAINS LOSSES FAIR VALUE
---------- ---------- ---------- ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
DECEMBER 31, 1997:
Fixed Maturities:
Mortgage-backed securities.............. $1,828,062 $29,881 $ 3,456 $1,854,487
Corporate securities.................... 1,390,274 35,875 16,134 1,410,015
Asset-backed securities................. 400,276 1,981 1,832 400,425
U.S. Treasury securities and obligations
of U.S. government agencies........... 318,583 1,464 371 319,676
Foreign governments..................... 79,466 1,633 1,867 79,232
Obligations of state and political
subdivisions.......................... 4,834 12 295 4,551
---------- ------- ------- ----------
Total fixed maturities................ 4,021,495 70,846 23,955 4,068,386
Equity securities..................... 28,177 309 144 28,342
---------- ------- ------- ----------
Total available-for-sale
securities....................... $4,049,672 $71,155 $24,099 $4,096,728
========== ======= ======= ==========
DECEMBER 31, 1996:
Fixed Maturities:
Mortgage-backed securities.............. $1,459,851 $19,393 $11,644 $1,467,600
Corporate securities.................... 992,003 13,260 13,693 991,570
Asset-backed securities................. 299,365 686 1,951 298,100
U.S. Treasury securities and obligations
of U.S. government agencies........... 247,041 1,363 1,481 246,923
Foreign governments..................... 45,611 611 462 45,760
Obligations of state and political
subdivisions.......................... 4,963 3 406 4,560
---------- ------- ------- ----------
Total fixed maturities................ 3,048,834 35,316 29,637 3,054,513
Equity securities..................... 21,268 1,286 2 22,552
---------- ------- ------- ----------
Total available-for-sale
securities....................... $3,070,102 $36,602 $29,639 $3,077,065
========== ======= ======= ==========
</TABLE>
F-18
<PAGE> 63
ARM FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The amortized cost and estimated fair value of available-for-sale
securities, by contractual maturity, are shown below:
<TABLE>
<CAPTION>
DECEMBER 31, 1997
------------------------
ESTIMATED
COST FAIR VALUE
---------- ----------
(IN THOUSANDS)
<S> <C> <C>
Due in one year or less............................. $ 13,522 $ 13,584
Due after one year through five years............... 143,662 143,102
Due after five years through ten years.............. 335,043 333,618
Due after ten years................................. 1,300,930 1,323,169
Asset-backed securities............................. 400,276 400,426
Mortgage-backed securities.......................... 1,828,062 1,854,487
Equity securities................................... 28,177 28,342
---------- ----------
Total available-for-sale securities....... $4,049,672 $4,096,728
========== ==========
</TABLE>
Expected maturities will differ from contractual maturities because
borrowers may have the right to call or repay obligations with or without call
or prepayment penalties and because mortgage-backed and asset-backed securities
(including floating-rate securities) provide for periodic payments throughout
their lives.
During 1997, 1996 and 1995, gross gains of $45.0 million, $33.5 million and
$24.1 million, respectively, and gross losses of $36.0 million, $18.9 million
and $15.6 million, respectively, were realized on sales of fixed maturities. For
the years ended December 31, 1997 and 1996, the Company recorded losses of $4.0
million and $15.2 million related to write-downs to the fair value of
investments in fixed income securities. For the years ended December 31, 1997
and 1996, the recognition of net realized gains on investments supporting
customer deposits resulted in an increase in the amortization of value of
insurance in force of $3.0 million and $1.9 million, respectively, and in an
increase in the amortization of deferred policy acquisition costs of $0.4
million and $28,000, respectively.
In accordance with SFAS No. 115, net unrealized gains and losses on
investments classified as available-for-sale were reduced by deferred federal
income taxes and adjustments to value of insurance in force and deferred policy
acquisition costs that would have been required had such gains and losses been
realized. Net unrealized gains on available-for-sale securities reflected as a
separate component of shareholders' equity are summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1997 1996
-------- -------
(IN THOUSANDS)
<S> <C> <C>
Net unrealized gains on available-for-sale securities
before adjustments for the following:................. $ 47,056 $ 6,963
Amortization of value of insurance in force and
deferred policy acquisition costs.................. (15,825) (1,318)
Deferred federal income taxes......................... (10,931) (1,976)
-------- -------
Net unrealized gains on available-for-sale
securities....................................... $ 20,300 $ 3,669
======== =======
</TABLE>
Investments, aggregated by issuer, in excess of 10% of shareholders' equity
(before net unrealized gains on available-for-sale securities) at December 31,
1997 and 1996, other than investments in affiliates and investments issued or
guaranteed by the United States government are as follows. Such securities were
99.8% and 97.4% investment grade at December 31, 1997 and 1996, respectively.
F-19
<PAGE> 64
ARM FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
CARRYING
(IN MILLIONS) AMOUNT
------------- --------
<S> <C>
1997:
Fixed maturities:
Aames Mortgage Trust................. $ 31.7
Aircraft Lease Portfolio
Securities......................... 34.6
Bear Stearns Mortgage Securities .... 39.7
Countrywide Mortgage Backed.......... 39.1
CRAVE Trust.......................... 52.7
Delta Funding Home Equity Loan
Trust.............................. 31.6
DLJ Mortgage Acceptance
Corporation........................ 75.9
First Chicago/Lennar................. 34.5
General Electric Capital Mortgage
Services........................... 33.4
Greenwich Capital Acceptance......... 50.6
Headlands Mortgage Securities,
Inc................................ 30.5
J.P. Morgan & Company................ 35.9
LB Mortgage Trust.................... 62.9
Merit Securities Corporation......... 55.3
Norwest Asset Securities
Corporation........................ 64.5
PNC Mortgage Securities
Corporation........................ 46.7
Residential Accredit Loans........... 47.1
Residential Asset Securities Trust... 50.4
Residential Funding.................. 47.3
Salomon Brothers Mortgage Securities
VII................................ 95.4
Sears Mortgage Securities............ 29.8
Structured Asset Securities
Corporation........................ 64.6
1996:
Fixed maturities:
ABN AMRO Bank........................ 19.3
Advanta Corporation.................. 20.1
Aircraft Lease Portfolio
Securities......................... 27.4
American President Company........... 18.4
Amresco Residential Mortgage Loan.... 23.8
Augusta Funding LTD VI............... 20.0
Augusta Funding LTD VIII............. 24.8
Bear Stearns Company................. 30.4
Chevy Chase Master Credit Card
Trust.............................. 20.0
</TABLE>
<TABLE>
<CAPTION>
CARRYING
(IN MILLIONS) AMOUNT
------------- --------
<S> <C>
1996 (CONTINUED):
Fixed maturities (continued):
Commonwealth Edison Company.......... $ 19.2
Conseco Commercial Mortgage.......... 20.2
Countrywide Home Loans............... 29.1
Countrywide Mortgage Backed.......... 50.7
Delta Funding Home Equity Loan
Trust.............................. 17.9
DLJ Acceptance Corporation........... 58.7
First USA Credit Card Trust.......... 25.0
Ford Motor Corporation............... 25.0
General Electric Capital Mortgage.... 91.3
Greenwich Capital Acceptance......... 36.8
Guardian National Acceptance
Corporation........................ 21.4
J.P. Morgan & Company................ 24.8
LB Mortgage Trust.................... 27.3
Lehman Brothers Holdings............. 23.5
Matterhorn One, Ltd.................. 45.2
Merit Securities Corporation......... 30.0
Mobil Producing Nigeria.............. 19.0
National Westminster Bank............ 22.3
Paine Webber Group, Incorporated .... 29.4
Philadelphia Electric................ 18.5
Residential Funding Mortgage......... 44.0
Resolution Trust Corporation......... 47.0
Ryland Mortgage Securities
Corporation........................ 34.4
Salomon Brothers Mortgage Securities
VII................................ 22.2
Structured Asset Securities
Corporation........................ 106.2
TCI Communications, Incorporated..... 23.9
Tenaga Nasional Berhad............... 19.2
Time Warner Entertainment Company,
L.P................................ 21.6
TMS Home Equity Loan Trust........... 48.0
Wilshire Manufactured Housing
Trust.............................. 22.9
Equity securities:
Santander Finance, Ltd................. 19.2
</TABLE>
The components of investment income were:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------
1997 1996 1995
-------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
Fixed maturities................................... $300,327 $228,473 $177,123
Policy loans....................................... 8,925 8,629 7,579
Mortgage loans on real estate...................... 4,038 4,321 6,712
Cash and cash equivalents.......................... 13,514 5,705 3,096
Income from other investments...................... 3,175 2,903 1,514
-------- -------- --------
Investment income............................. $329,979 $250,031 $196,024
======== ======== ========
</TABLE>
F-20
<PAGE> 65
ARM FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
At December 31, 1997, the fair value of futures contracts, call and put
options and interest rate swaps held by the Company was $11.3 million. These
derivative financial instruments are used to hedge specific market value risks
associated with the Company's equity-indexed annuity products and separate
account seed money investments and interest rate risks associated with certain
institutional spread deposits. The derivative financial instruments are not held
for trading purposes and are classified on the Company's balance sheet as assets
held in guaranteed separate accounts. The derivative financial instruments hedge
items carried at fair value and are therefore marked to market with unrealized
gains and losses recognized through the separate account statements of
operations. The Company is exposed to credit-related losses in the event of
nonperformance by counter parties to the derivative financial instruments, but
does not expect any counter parties to fail to meet their obligations given
their high credit ratings.
4. FAIR VALUE BALANCE SHEETS
SFAS No. 107, "Disclosures About Fair Value of Financial Instruments,"
requires disclosure of fair value information about all financial instruments,
including insurance liabilities classified as investment contracts, unless
specifically exempted. The accompanying fair value balance sheets reflect fair
values for those financial instruments specifically covered by SFAS No. 107,
along with fair value amounts for other assets and liabilities for which
disclosure is permitted but not required.
The fair value of a financial instrument is the amount at which the
instrument could be exchanged in a current transaction between willing parties,
other than in a forced or liquidation sale. In cases where quoted market prices
are not available, fair values are based on estimates using present value or
other valuation techniques. Those techniques are significantly affected by the
assumptions used, including the discount rate and estimates of future cash
flows. Accordingly, the aggregate fair value amounts presented do not
necessarily represent the underlying value of the Company.
The Company's management of interest rate risk reduces its exposure to
changing interest rates through a close matching of duration, convexity and cash
flow characteristics of both assets and liabilities while maintaining liquidity
redundancies (i.e., sources of liquidity in excess of projected liquidity
needs). As a result, fair values of the Company's assets and liabilities will
tend to respond similarly to changes in interest rates.
The following methods and assumptions were used in estimating fair values:
Fixed Maturities and Equity Securities
Fair values for fixed maturities and equity securities are based on quoted
market prices, where available. For fixed maturities for which a quoted market
price is not available, fair values are estimated using internally calculated
estimates or quoted market prices of comparable instruments.
Mortgage Loans on Real Estate and Policy Loans
The carrying amount of mortgage loans on real estate and policy loans
approximates their fair value.
Cash and Cash Equivalents and Accrued Investment Income
The carrying amount of cash and cash equivalents and accrued investment
income approximates their fair value given the short-term nature of these
assets.
Assets Held in Separate Accounts and Customer Deposits in Separate Accounts
The fair value of assets held in guaranteed separate accounts is primarily
based on quoted market prices of fixed maturity securities held in such separate
accounts. The fair value of customer deposits in guaranteed separate accounts is
based on the account values of the underlying policies, plus or minus market
value
F-21
<PAGE> 66
ARM FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
adjustments. Fair values of assets and customer deposits in nonguaranteed
separate accounts is based on the quoted market prices of the underlying mutual
funds. The reduction in fair values for customer deposits in separate accounts
reflect the present value of future gross margins from net investment spread,
product charges, distribution fees, and surrender charges.
Goodwill
The carrying amount of goodwill approximates fair value.
Deferred Policy Acquisition Costs and Value of Insurance In Force
Deferred policy acquisition costs and value of insurance in force do not
appear on the fair value presentation because those values are implicitly
considered in the determination of the fair value of the corresponding customer
deposits and customer deposits in separate accounts.
Deferred Federal Income Taxes
The deferred federal income tax asset and related valuation allowance were
adjusted for federal income tax which may be incurred as a result of the
differences between the estimated fair values and carrying amounts of the assets
and liabilities.
Customer Deposits
The fair value of customer deposits for single premium immediate annuity
contracts is based on discounted cash flow calculations using rates from a
current market yield curve for assets with similar durations. The fair value
amounts of the remaining customer deposits, primarily related to deferred
annuity contracts, single premium endowment contracts, and funding agreements
and GICs, represent the estimated present value of cash flows using current
market rates and the duration of the liabilities.
Long-Term Debt and Payable to Reinsurer
The carrying amounts of long-term debt and payable to reinsurer approximate
fair value.
Other Assets and Liabilities
The fair values of other assets and liabilities are reported at their
financial statement carrying amounts.
F-22
<PAGE> 67
ARM FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
5. VALUE OF INSURANCE IN FORCE
The following provides information on the value of insurance in force
during 1997, 1996 and 1995:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------
1997 1996 1995
-------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
Amortization excluding effects of realized and unrealized
investment gains and losses.............................. $(11,798) $(10,474) $(10,490)
Interest accrued on unamortized balance.................... 2,505 3,154 3,386
-------- -------- --------
Net amortization as reported in the statements of income... (9,293) (7,320) (7,104)
Amortization related to realized investment gains and
losses(a)................................................ (2,987) (1,890) (2,562)
Change in amortization related to unrealized gains and
losses on available-for-sale securities(b)............... (13,769) 13,180 (14,170)
Addition resulting from the acquisition of SBM Life........ -- -- 61,131
Recognition of acquired tax benefits....................... -- (2,997) (18,004)
-------- -------- --------
Net change in value of insurance in force.................. (26,049) 973 19,291
Balance at beginning of period............................. 52,024 51,051 31,760
-------- -------- --------
Balance at end of period................................... $ 25,975 $ 52,024 $ 51,051
======== ======== ========
</TABLE>
- ---------------
(a) Included in Realized Investment Gains in the statements of income.
(b) Included in Change in Net Unrealized Gains and Losses on Available-for-Sale
Securities in the statements of shareholders' equity.
The interest rates used to accrue interest on the unamortized value of
insurance in force are consistent with the rates credited on acquired policies
and range from 5% to 8%. Net amortization of the value of insurance in force,
excluding the effects of realized and unrealized investment gains and losses, in
each of the following years is estimated to be: 1998 -- $7.0 million;
1999 -- $6.1 million; 2000 -- $4.9 million; 2001 -- $4.0 million; and
2002 -- $3.4 million.
6. NON-RECURRING CHARGES
The Company recorded non-recurring charges of $14.8 million for the year
ended December 31, 1997, including a one-time non-cash stock-based compensation
charge of $8.1 million (see Note 10), and costs primarily related to the
relocation and consolidation of the Company's operations facilities from
Columbus, Ohio to Louisville, Kentucky. The Company recorded a $5.0 million
non-recurring charge in 1996, including $3.2 million for facilities
consolidation charges and costs of $1.8 million primarily related to merger and
acquisition activities that did not result in a transaction.
7. DEBT
Long-Term Debt
On June 24, 1997, the Company entered into a Credit Agreement to provide
the Company with a new senior revolving credit facility. The maximum amount that
may be borrowed under this Credit Agreement is $75 million, of which $38 million
was drawn on June 24, 1997 and used to repay $38 million of outstanding
borrowings under the Company's prior Credit Agreement, which was terminated.
Borrowings under the new Credit Agreement bear a floating interest rate equal to
the London Interbank Offered Rate ("LIBOR") plus a percentage ranging from
0.325% to 0.875%, depending on the ratings of the Company's preferred stock. The
Credit Agreement has a variable annual commitment fee which can range from 0.10%
to 0.25% of the unused portion of the borrowing, depending on the ratings of the
Company's preferred stock. The Credit Agreement
F-23
<PAGE> 68
ARM FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
matures on June 24, 2002, subject to optional prepayment and contingent upon the
Company's compliance with various financial covenants.
Payable to Reinsurer
The Company holds $8.8 million of funds withheld under a modified
coinsurance reinsurance agreement related to a block of variable annuity
contracts. This liability bears a floating interest rate indexed to the LIBOR.
Repayment is scheduled for equal quarterly installments over the next five
years.
8. INCOME TAXES
The components of the provision for income tax expense consist of the
following:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------
1997 1996 1995
------- ------ ------
(IN THOUSANDS)
<S> <C> <C> <C>
Current......................................... $13,136 $2,613 $ 641
Deferred........................................ 1,003 2,554 6,385
------- ------ ------
Total income tax expense.............. $14,139 $5,167 $7,026
======= ====== ======
</TABLE>
Significant components of the deferred tax liabilities and assets as of
December 31, 1997 and 1996 were:
<TABLE>
<CAPTION>
1997 1996
------- -------
(IN THOUSANDS)
<S> <C> <C>
Deferred tax assets:
Difference between GAAP and tax reserves............... $78,404 $72,513
Net operating loss carryforward........................ 13,863 11,783
Other.................................................. 16,285 10,752
------- -------
Total deferred tax assets........................... 108,552 95,048
Valuation allowance for deferred tax assets............ (36,568) (38,798)
------- -------
Net deferred tax assets............................. 71,984 56,250
Deferred tax liabilities:
Deferred policy acquisition costs...................... 26,096 16,910
Net unrealized gains on available-for-sale
securities.......................................... 10,931 1,976
Other.................................................. 3,908 1,760
------- -------
Total deferred tax liabilities...................... 40,935 20,646
------- -------
Total deferred federal income taxes............ $31,049 $35,604
======= =======
</TABLE>
In the event that deferred tax assets are recognized on deductible
temporary differences for which a valuation allowance was provided at the date
of an acquisition, such benefits will be applied to first reduce the balance of
intangible assets related to the acquisition, such as value of insurance in
force and goodwill.
A full valuation allowance was provided on the difference between deferred
tax assets and liabilities of the Integrity Companies as of the acquisition
date, resulting in zero deferred federal income taxes at that date. Based on the
Integrity Companies' ability to generate taxable income in the post-acquisition
period and projections of future taxable income, the Integrity Companies'
valuation allowance was reduced by $8.0 million, $11.0 million and $27.9 million
during 1997, 1996 and 1995, respectively. As a result of realizing such
benefits, the value of insurance in force was reduced by $3.0 million and $18.0
million during 1996 and 1995, respectively. The balance of goodwill was also
reduced by $0.7 million during 1997 and $1.0 million during
F-24
<PAGE> 69
ARM FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
1995. Additionally, the Company has established a full valuation allowance on
its non-life net operating loss carryforwards. Realization of these carryforward
benefits is dependent on future non-life earnings.
The Company files a consolidated federal income tax return with its
non-life subsidiaries, but is not currently eligible to file with its life
insurance subsidiaries. Accordingly, Integrity and National Integrity file a
consolidated federal life insurance company income tax return.
Income tax expense differs from that computed using the federal income tax
rate of 35% for the following reasons:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------
1997 1996 1995
------- ------- ------
(IN THOUSANDS)
<S> <C> <C> <C>
Income tax expense at statutory rate........................ $14,608 $ 9,991 $6,621
Increase (decrease) in valuation allowance.................. (1,540) (5,490) 1,052
Other....................................................... 1,071 666 (647)
------- ------- ------
Total income tax expense.......................... $14,139 $ 5,167 $7,026
======= ======= ======
</TABLE>
The Company had net operating loss carryforwards of approximately $39.6
million, $33.7 million and $43.8 million at December 31, 1997, 1996 and 1995,
respectively. The net operating loss carryforwards expire in years 2005 to 2012.
F-25
<PAGE> 70
ARM FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
9. STATUTORY INFORMATION
Following is a reconciliation of income based on statutory accounting
practices prescribed or permitted by insurance regulatory authorities for the
Company's insurance subsidiaries with GAAP net income reported in the
accompanying statements of income:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1997 1996 1995
-------- ------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
Insurance subsidiaries (statutory-basis)(1)................. $ 49,718 $38,769 $ 31,179
Non-insurance companies(2).................................. 3,273 927 255
-------- ------- --------
Consolidated statutory-basis pretax operating income...... 52,991 39,696 31,434(3)
Reconciling items:
Amortization of interest maintenance reserve.............. (3,920) (4,091) (3,905)
Adjustments to customer deposits.......................... (16,004) (2,324) (5,994)
Interest expense on debt.................................. (2,517) (3,146) (3,461)
Deferral of policy acquisition costs, net of
amortization........................................... 29,331 16,223 16,650
Amortization of value of insurance in force............... (9,293) (7,320) (7,104)
Amortization of acquisition-related deferred charges and
goodwill............................................... (927) (1,991) (10,278)
Adjustments to invested asset carrying values at
acquisition date....................................... (107) (572) (769)
Non-recurring charges..................................... (14,823) (5,004) --
Realized investment gains................................. 3,192 907 4,048
Other..................................................... 3,815 (3,833) (1,705)
-------- ------- --------
GAAP-basis:
Income before income taxes................................ 41,738 28,545 18,916
Income tax expense........................................ (14,139) (5,167) (7,026)
-------- ------- --------
Net income................................................ 27,599 23,378 11,890
Dividends on preferred stock.............................. (4,750) (4,750) (4,750)
-------- ------- --------
Net income applicable to common shareholders.............. 22,849 18,628 7,140
Exclude, net of tax:
Realized investment gains.............................. (2,075) (590) (2,631)
Non-recurring charges.................................. 14,823 4,539 --
Income from defined benefit pension plan asset
management operations................................ (1,448) (350) --
-------- ------- --------
Operating earnings(4)..................................... $ 34,149 $22,227 $ 4,509
======== ======= ========
</TABLE>
- ---------------
(1) Insurance company general account and separate account statutory-basis
pretax income excluding realized gains and losses.
(2) Non-insurance company pretax income excluding amortization of
acquisition-related deferred charges, interest expense on debt, realized
investment gains and losses, and non-recurring corporate costs and charges
related to acquisition, financing and restructuring activities.
(3) Includes the results of operations of the acquired SBM businesses for the
seven months ended December 31, 1995.
(4) Net income applicable to common shareholders, excluding, net of tax,
realized investment gains and losses, non-recurring charges and income from
defined benefit pension plan asset management operations which were sold
during November 1997.
F-26
<PAGE> 71
ARM FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Dividends that the Company may receive from Integrity in any year without
prior approval of the Ohio Insurance Director are limited by statute to the
greater of (i) 10% of Integrity's statutory capital and surplus as of the
preceding December 31 and (ii) Integrity's statutory net income for the
preceding year. For 1998, the maximum dividend payments that may be paid by
Integrity to the Company without prior regulatory approval are $38.2 million.
The consolidated statutory capital and surplus of the Company's insurance
subsidiaries was $211.8 million and $163.8 million at December 31, 1997 and
1996, respectively. In addition, the consolidated statutory asset valuation
reserve ("AVR") of the Company's insurance subsidiaries was $24.9 million and
$15.6 million at December 31, 1997 and 1996, respectively (excluding statutory
voluntary investment reserves of $5.3 million and $12.5 million). The AVR is
generally added to statutory capital and surplus for purposes of assessing
capital adequacy against various measures used by rating agencies and
regulators.
The National Association of Insurance Commissioners Risk-Based Capital
("RBC") requirements attempt to evaluate the adequacy of a life insurance
company's statutory-basis adjusted capital and surplus in relation to
investment, insurance and other business risks. The RBC formula is used by the
states as an early warning tool to identify possible weakly capitalized
companies for the purpose of initiating regulatory action and is not designed to
be a basis for ranking the financial strength of insurance companies. In
addition, the formula establishes a minimum capital standard which supplements
the prevailing system of low fixed minimum capital and surplus. The RBC
requirements provide for four different levels of regulatory attention depending
on the ratio of the company's adjusted capital and surplus to its RBC. As of
December 31, 1997 and 1996, the adjusted capital and surplus of Integrity and
National Integrity are substantially in excess of the minimum level of RBC that
would require regulatory response.
10. SHAREHOLDERS' EQUITY
Preferred Stock
During 1993, the Company issued 2,000,000 shares of non-voting 9.5%
Cumulative Perpetual Preferred Stock, stated value $25, in connection with the
acquisition of the Integrity Companies. Cash dividends at a rate of 9.5% per
annum per share are payable quarterly (equivalent to an annual amount of $2.375
per share). The shares of preferred stock may not be redeemed prior to December
15, 1998. On or after December 15, 1998, the Company may, at its option, redeem
all or part of the shares at a redemption price of $25 per share.
Initial Public Offering of Common Stock
In June 1997, the Company completed an initial public offering of 9.2
million shares of Class A common stock, par value $.01 per share (the "Class A
Common Stock"), of which 5.75 million shares were sold by the Company and 3.45
million shares were sold by the Morgan Stanley Stockholders. The net proceeds of
the Offering to the Company were $78.8 million, after deducting underwriting
discounts and commissions and other expenses of the Offering payable by the
Company. On June 30, 1997, the Company used a portion of such net proceeds to
make a capital contribution to its primary insurance subsidiary, Integrity,
thereby strengthening Integrity's capital base to provide for future growth. The
Company plans to also use the net proceeds to enhance the Company's retail
market presence, to consolidate operating locations and for other corporate
purposes, which may include acquisitions.
Concurrent with the closing of the Offering, the Company amended and
restated its Certificate of Incorporation to effectuate a recapitalization such
that (i) the common equity of the Company consists of Class A Common Stock and
Class B Non-Voting Common Stock, par value $.01 per share (the "Class B Common
Stock" and, together with the Class A Common Stock, the "Common Stock"), (ii)
authorized shares of the Class A Common Stock and Class B Common Stock were
increased to 150 million shares and 50 million shares, respectively, (iii) each
outstanding share of common stock of the Company was converted into
F-27
<PAGE> 72
ARM FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
one share of Class A Common Stock, (iv) certain shares of the Class A Common
Stock owned by the Morgan Stanley Stockholders were converted into Class B
Common Stock such that, after giving effect to such conversion, but not giving
effect to the Offering, the Morgan Stanley Stockholders owned, in the aggregate,
49% of the outstanding Class A Common Stock, and (v) each share of Common Stock
was split into 706 shares of Common Stock. Holders of Class B Common Stock have
no right to vote on matters submitted to a vote of stockholders, except in
certain circumstances. Shares of the Class B Common Stock have no preemptive or
other subscription rights and are convertible into an equal number of shares of
Class A Common Stock (1) at the option of the holder thereof to the extent that,
following such conversion, the Morgan Stanley Stockholders will not, in the
aggregate, own more than 49% of the outstanding shares of Class A Common Stock,
and (2) automatically upon the transfer of such shares by any Morgan Stanley
Stockholder to a person that is not a Morgan Stanley Stockholder or an affiliate
of a Morgan Stanley Stockholder.
All references to number of shares, per share amounts and stock option data
appearing in the financial statements and notes thereto have been restated, for
all periods presented, to reflect the stock split.
Stock Options
The Company's Amended and Restated Stock Option Plan (the "Plan"),
originally adopted in December 1993, provides for granting of options to
purchase up to 2,432,170 shares of Class A common stock. In connection with the
Offering, 512,980 unallocated options were granted on a pro rata basis to
participants of the Plan with the exercise prices and vesting schedules of such
options being the average weighted exercise prices and vesting percentages of
the options previously held by such holders. As of June 30, 1997, all options of
the Plan had been issued. At December 31, 1997 a total of 2,420,897 were
outstanding and 1,399,399 were exercisable at an average price of $11.44. Prior
to the Offering, the Plan provided that the option exercise price increased at
the end of every three month period following the date of grant at a rate of 12%
per annum, compounded annually, while the option remained unexercised.
Concurrent with the Offering, the exercise prices applicable to the outstanding
options were fixed at exercise prices ranging from $11.14 per share to $12.24
per share.
Information with respect to the stock option plan is as follows:
<TABLE>
<CAPTION>
OUTSTANDING
----------------------
SHARES AVERAGE
SUBJECT TO EXERCISE
OPTION PRICE
---------- --------
<S> <C> <C>
Balance at December 31, 1994............................ 816,136 $ 7.93
Options granted....................................... 883,912 9.17
Options forfeited..................................... (14,120) 9.21
---------
Balance at December 31, 1995............................ 1,685,928 9.33
Options granted....................................... 240,040 10.01
Options exercised..................................... (3,530) 8.88
Options forfeited..................................... (38,830) 10.22
---------
Balance at December 31, 1996............................ 1,883,608 10.50
Options granted....................................... 887,587 11.45
Options exercised..................................... (7,743) 12.23
Options forfeited..................................... (342,555) 11.66
---------
Balance at December 31, 1997............................ 2,420,897 11.65
=========
</TABLE>
F-28
<PAGE> 73
ARM FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Shares under options that were exercisable were 633,282 and 306,404 as of
December 31, 1996 and 1995, respectively, at an average exercise price of $10.22
and $8.88. At December 31, 1997, outstanding option shares had exercise prices
ranging from $11.14 to $12.24 and average contractual life remaining of 1.8
years.
The Company has elected to follow Accounting Principles Board Opinion
("APB") No. 25, "Accounting for Stock Issued to Employees," and related
Interpretations in accounting for its employee stock options. As a result of the
granting of previously unallocated options and the determination of the exercise
prices for all options of the Plan which occurred in conjunction with the
Offering, a one-time non-cash stock-based compensation charge of $8.1 million
was recorded during June 1997. Such charge equals the aggregate difference
between the $15 initial public offering price of the Class A Common Stock and
the exercise prices of all of the outstanding options.
The Company adopted the disclosure-only option under SFAS No. 123,
"Accounting for Stock-Based Compensation," as of December 31, 1995. If the
accounting provisions of SFAS No. 123 had been adopted as of the beginning of
1995, the effects on 1995, 1996 and 1997 net income would have been immaterial.
In June 1997, the Company adopted the 1997 Equity Incentive Plan (the "1997
Equity Plan"). The 1997 Equity Plan provides for the granting of incentive stock
options and nonqualified stock options, stock appreciation rights, restricted
stock, performance units, and performance shares to those officers and other key
employees and consultants with potential to contribute to the future success of
the Company or its subsidiaries; provided that only employees may be granted
incentive stock options. The maximum amount of Class A Common Stock that may be
granted under the 1997 Equity Plan is 1.6 million shares, subject to adjustment
in accordance with the terms of the 1997 Equity Plan. No awards under the 1997
Equity Plan have been granted as of December 31, 1997.
Earnings per Share
The following is a reconciliation of the number of shares (denominator)
used in the basic and diluted earnings per share ("EPS") computations:
<TABLE>
<CAPTION>
1997 1996 1995
------------------- ------------------- -------------------
PER SHARE PER SHARE PER SHARE
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT
------ --------- ------ --------- ------ ---------
(SHARES IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Basic EPS........................ 20,579 $ 1.11 17,498 $1.06 14,614 $0.49
Effect of dilutive stock
options........................ 726 (0.04) -- -- -- --
------ ------ ------ ----- ------ -----
Diluted EPS...................... 21,305 $ 1.07 17,498 $1.06 14,614 $0.49
====== ====== ====== ===== ====== =====
</TABLE>
11. CONTINGENCIES
The Company is a defendant in various lawsuits in connection with the
normal conduct of its operations. Company management believes the ultimate
resolution of such litigation will not result in any material adverse impact to
the financial position of the Company.
The number of insurance companies that are under regulatory supervision has
resulted in and is expected to continue to result in assessments by state
guaranty funds to cover losses to policyholders of insolvent or rehabilitated
companies. The Company has accrued for expected non-indemnified assessments.
F-29
<PAGE> 74
ARM FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
12. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
<TABLE>
<CAPTION>
1ST QUARTER 2ND QUARTER 3RD QUARTER 4TH QUARTER
----------- ----------- ----------- -----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
1997:
Net investment spread............................ $ 18,375 $ 19,477 $ 22,087 $ 22,622
Fee income....................................... 5,520 5,538 6,470 7,083
Other income and expenses........................ (15,702) (22,107) (16,105) (14,712)
Realized investment gains........................ 2,231 420 376 165
-------- -------- -------- --------
Income before income taxes....................... 10,424 3,328 12,828 15,158
Income tax expense............................... (2,814) (3,185) (3,735) (4,405)
-------- -------- -------- --------
Net income....................................... 7,610 143 9,093 10,753
Dividends on preferred stock..................... (1,188) (1,188) (1,187) (1,187)
-------- -------- -------- --------
Net income (loss) applicable to common
shareholders.................................. 6,422 (1,045) 7,906 9,566
Exclude, net of tax:
Realized investment gains..................... (1,450) (273) (245) (107)
Non-recurring charges......................... 1,445 9,333 2,489 1,556
Income from defined benefit pension plan asset
management operations....................... (581) (272) (325) (270)
-------- -------- -------- --------
Operating earnings............................... $ 5,836 $ 7,743 $ 9,825 $ 10,745
======== ======== ======== ========
Per common and common equivalent share (diluted):
Net income (loss)............................. $ 0.37 $ (0.06) $ 0.33 $ 0.39
Operating earnings............................ $ 0.33 $ 0.42 $ 0.40 $ 0.44
1996:
Net investment spread............................ $ 14,078 $ 17,773 $ 18,003 $ 18,016
Fee income....................................... 4,162 4,201 4,964 4,506
Other income and expenses........................ (11,779) (13,967) (16,572) (15,747)
Realized investment gains (losses)............... (403) (814) (1,115) 3,239
-------- -------- -------- --------
Income before income taxes....................... 6,058 7,193 5,280 10,014
Income tax expense............................... (1,573) (1,190) (956) (1,448)
-------- -------- -------- --------
Net income....................................... 4,485 6,003 4,324 8,566
Dividends on preferred stock..................... (1,188) (1,188) (1,187) (1,187)
-------- -------- -------- --------
Net income applicable to common shareholders..... 3,297 4,815 3,137 7,379
Exclude, net of tax:
Realized investment (gains) losses............ 262 529 725 (2,106)
Non-recurring charges......................... -- -- 940 3,599
Income from defined benefit pension plan asset
management operations....................... (88) (88) (87) (87)
-------- -------- -------- --------
Operating earnings............................... $ 3,471 $ 5,256 $ 4,715 $ 8,785
======== ======== ======== ========
Per common and common equivalent share (diluted):
Net income.................................... $ 0.19 $ 0.28 $ 0.18 $ 0.42
Operating earnings............................ $ 0.20 $ 0.30 $ 0.27 $ 0.50
</TABLE>
F-30
<PAGE> 75
ARM FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
13. SEGMENT INFORMATION
Effective December 31, 1997, the Company adopted SFAS No. 131, "Disclosures
about Segments of an Enterprise and Related Information." SFAS No. 131
superseded SFAS No. 14, "Financial Reporting for Segments of a Business
Enterprise." SFAS No. 131 establishes standards for the way that public business
enterprises report information about operating segments. SFAS No. 131 also
establishes standards for related disclosures about products and services,
geographic areas, and major customers. The adoption of SFAS No. 131 did not
affect results of operations or financial position, but did affect the
disclosure of segment information.
The Company currently has four reportable segments: retail spread products
(fixed and indexed annuities and face-amount certificates), institutional spread
products (funding agreements and GICs), retail variable products (variable
annuity mutual fund options), and corporate and other. The Company's corporate
and other segment includes earnings on surplus of insurance subsidiaries and
holding company cash and investments, fee income from marketing partnerships and
broker-dealer operations, unallocated amortization expenses, and other various
corporate expenditures that are not allocated to specific products.
The Company's reportable segments are based on the characteristics of the
product or service and the markets through which the product or service is sold.
The reportable segments are each managed separately because the impact of
fluctuating interest rates and changes in the equity market environment affects
each segments' products and services differently. The Company evaluates
performance based on operating earnings. The accounting policies of the
reportable segments are the same as those described in the summary of
significant accounting policies.
F-31
<PAGE> 76
ARM FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------
1997 1996 1995
---------- ---------- ----------
(IN THOUSANDS)
<S> <C> <C> <C>
REVENUES
Retail spread products................................. $ 220,810 $ 206,296 $ 185,961
Institutional spread products.......................... 99,861 37,210 2,515
Retail variable products............................... 14,630 10,786 7,238
Corporate and other.................................... 19,289 13,572 11,658
---------- ---------- ----------
Consolidated total revenues (investment income and
fee income)..................................... $ 354,590 $ 267,864 $ 207,372
========== ========== ==========
AMORTIZATION EXPENSE
Retail spread products................................. $ 13,951 $ 10,804 $ 8,422
Retail variable products............................... 5,758 3,839 1,837
Corporate and other.................................... 927 1,503 10,055
---------- ---------- ----------
Consolidated total amortization expense........... $ 20,636 $ 16,146 $ 20,314
========== ========== ==========
EARNINGS SUMMARY
Retail spread products................................. $ 37,618 $ 34,440 $ 22,072
Institutional spread products.......................... 9,221 3,241 250
Retail variable products............................... 5,068 4,827 3,168
Corporate and other.................................... 14 (10,216) (10,622)
---------- ---------- ----------
Pretax operating earnings (before preferred stock
dividends)...................................... 51,921 32,292 14,868
Income taxes on operations............................. (13,022) (5,315) (5,609)
Preferred stock dividends.............................. (4,750) (4,750) (4,750)
---------- ---------- ----------
Operating earnings................................ 34,149 22,227 4,509
Realized investment gains.............................. 3,192 907 4,048
Non-recurring charges.................................. (14,823) (5,004) --
Income from defined benefit pension plan asset
management operations................................ 1,448 350 --
Income taxes not related to operating results.......... (1,117) 148 (1,417)
---------- ---------- ----------
Net income applicable to common shareholders...... $ 22,849 $ 18,628 $ 7,140
========== ========== ==========
ASSETS
Retail spread products................................. $3,153,040 $2,789,626 $2,887,920
Institutional spread products.......................... 2,542,350 891,936 143,156
Retail variable products............................... 1,192,875 883,483 647,132
Corporate and other.................................... 250,159 136,619 115,372
---------- ---------- ----------
Consolidated total assets......................... $7,138,424 $4,701,664 $3,793,580
========== ========== ==========
</TABLE>
14. SUBSEQUENT EVENT
Effective February 10, 1998, John Franco, the Company's Co-Chairman and
Co-Chief Executive Officer retired. Mr. Franco had shared that title with Martin
H. Ruby since the Company was founded in 1993. As part of the retirement package
for Mr. Franco, the Company will take a one-time charge of approximately $3.5
million during the first quarter of 1998. The charge will consist of (i) a $2.0
million non-cash charge for accelerating the vesting period of options held by
Mr. Franco to purchase 232,647 shares of the Company's common stock and (ii) a
$1.5 million charge for fulfilling remaining compensation agreements related to
his employment agreement.
Concurrent with Mr. Franco's retirement, Mr. Ruby assumed the role of
Chairman and Chief Executive Officer of the Company.
F-32
<PAGE> 77
PROSPECTUS
ARM FINANCIAL GROUP, INC.
PREFERRED STOCK
------------------------
ARM Financial Group, Inc. (the "Company") may issue from time to time, in
one or more series, shares of its preferred stock, par value $.01 per share (the
"Preferred Stock"), which may be issued in the form of depositary shares (the
"Depositary Shares") evidenced by depositary receipts, in amounts, at prices and
on terms to be determined at or prior to the time of any such offering. The
specific number of shares, designation, stated value and liquidation preference
of each share, issuance price, dividend rate or method of calculation, dividend
periods, dividend payment dates, voting rights, any redemption or sinking fund
provisions, any conversion or exchange provisions, and other specific terms of
each series of Preferred Stock in respect of which this Prospectus is being
delivered shall be set forth in an accompanying Prospectus Supplement (the
"Prospectus Supplement").
------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS SUPPLEMENT OR THE PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
------------------------
The Preferred Stock may be sold directly by the Company or through agents,
underwriters or dealers designated from time to time. If any agents or
underwriters of the Company are involved in the sale of the Preferred Stock, the
names of such agents or underwriters and any applicable fees, commissions or
discounts shall be set forth in the Prospectus Supplement. The net proceeds to
the Company from such sale also shall be set forth in the Prospectus Supplement.
------------------------
June 17, 1998
<PAGE> 78
CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE DEPOSITARY SHARES.
SPECIFICALLY, THE UNDERWRITERS MAY OVER-ALLOT IN CONNECTION WITH THE OFFERING,
AND MAY BID FOR, AND PURCHASE, THE DEPOSITARY SHARES IN THE OPEN MARKET.
INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE
The following documents filed by the Company with the Securities and
Exchange Commission (the "Commission") are incorporated herein by reference:
(a) The Annual Report of the Company on Form 10-K for the year ended
December 31, 1997;
(b) The Quarterly Report of the Company on Form 10-Q for the quarter
ended March 31, 1998;
(c) The Current Reports of the Company on Form 8-K dated March 4,
1998, April 22, 1998 and June 1, 1998; and
(d) The description of the Company's outstanding 9 1/2% Cumulative
Perpetual Preferred Stock (the "Existing Preferred Stock") contained in the
Company's Registration Statement on Form 8-A filed with the Commission on
November 12, 1993, including any amendment or report filed for the purposes
of updating such description.
All documents filed by the Company with the Commission pursuant to Section
13(a), 13(c), 14 or 15(d) of the Securities Exchange Act of 1934, as amended
(the "Exchange Act"), subsequent to the date of this Prospectus and prior to the
termination of the offering made hereby shall be deemed to be incorporated by
reference into this Prospectus and to be a part hereof from the date of filing
of such documents. Any statement contained herein or in a document all or any
portion of which is incorporated or deemed to be incorporated by reference
herein shall be deemed to be modified or superseded for purposes of this
Prospectus to the extent that a statement contained herein or in any other
subsequently filed document which also is or is deemed to be incorporated by
reference herein modifies or supersedes such statement. Any statement so
modified or superseded shall not be deemed, except as so modified or superseded,
to constitute a part of this Prospectus. As used herein, the terms "Prospectus"
and "herein" mean this Prospectus, including the documents incorporated by
reference, as the same may be amended, supplemented, or otherwise modified from
time to time. Statements contained in this Prospectus as to the contents of any
contract or other documents referred to herein do not purport to be complete and
are qualified in all respects by reference to all of the provisions of such
contract or other document.
THE COMPANY WILL PROVIDE WITHOUT CHARGE TO EACH PERSON TO WHOM THIS
PROSPECTUS IS DELIVERED, UPON THE WRITTEN OR ORAL REQUEST OF SUCH PERSON, A COPY
OF ANY OR ALL OF THE DOCUMENTS REFERRED TO ABOVE WHICH HAVE BEEN OR MAY BE
INCORPORATED IN THIS PROSPECTUS BY REFERENCE, OTHER THAN EXHIBITS TO SUCH
DOCUMENTS WHICH ARE NOT SPECIFICALLY INCORPORATED BY REFERENCE IN SUCH
DOCUMENTS. REQUESTS FOR SUCH DOCUMENTS SHOULD BE DIRECTED TO: PETER S. RESNIK,
TREASURER, ARM FINANCIAL GROUP, INC., 515 WEST MARKET STREET, LOUISVILLE,
KENTUCKY 40202 (TELEPHONE (502) 582-7900).
No person is authorized to give any information or to make any
representations, other than those contained or incorporated by reference in this
Prospectus or the Prospectus Supplement, in connection with the offering
contemplated hereby, and, if given or made, such information or representations
must not be relied upon as having been authorized by the Company or any
underwriter, dealer or agent. This Prospectus and the Prospectus Supplement do
not constitute an offer to sell or a solicitation of an offer to buy any
securities other than the Preferred Stock to which they relate and do not
constitute an offer to sell or a solicitation of an offer to buy any securities
in any jurisdiction to any person to whom it is unlawful to make such offer or
solicitation in such jurisdiction. Neither the delivery of this Prospectus or
the Prospectus Supplement, nor any sale made hereunder or thereunder, shall,
under any circumstances, create any implication that there has been no change in
the affairs of the Company since the date hereof or thereof or
2
<PAGE> 79
that the information contained or incorporated by reference herein or therein is
correct as of any time subsequent to such date.
AVAILABLE INFORMATION
The Company is subject to the informational requirements of the Exchange
Act and, in accordance therewith, is required to file reports, proxy statements
and other information with the Commission. Such reports, proxy statements and
other information can be inspected and copied at the Public Reference Section of
the Commission at Room 1024, 450 Fifth Street, N.W., Washington, D.C. 20549, and
at the Commission's regional offices at Citicorp Center, 500 West Madison
Street, Suite 1400, Chicago, Illinois 60661 and 7 World Trade Center, Suite
1300, New York, New York 10048. Copies of the reports, proxy statements and
other information can be obtained from the Public Reference Section of the
Commission, Washington, D.C. 20549, at prescribed rates. The Commission
maintains a web site on the Internet at http://www.sec.gov that contains
reports, proxy and information statements and other information regarding
registrants that file electronically with the Commission. The Company's Existing
Preferred Stock is traded on the American Stock Exchange and such reports, proxy
statements and other information concerning the Company can be inspected at the
offices of the American Stock Exchange, 86 Trinity Place, New York, New York
10006. The Company's Class A Convertible Common Stock, par value $.01 per share
(the "Class A Common Stock") is traded on the New York Stock Exchange and such
reports, proxy statements and other information concerning the Company can be
inspected at the offices of the New York Stock Exchange, 20 Broad Street, New
York, New York 10005.
The Company has filed with the Commission a Registration Statement on Form
S-3 under the Securities Act of 1933, as amended (the "Securities Act"), with
respect to the securities offered by this Prospectus. The Registration Statement
has been filed electronically through the Commission's Electronic Data
Gathering, Analysis, and Retrieval System and may be accessed electronically by
means of the Commission's home page on the Internet at http://www.sec.gov. As
permitted by the rules and regulations of the Commission, this Prospectus does
not contain all of the information set forth in the Registration Statement. For
further information about the Company and the securities offered hereby,
reference is made to the Registration Statement and to the financial statements,
exhibits and schedules filed therewith. The statements contained in this
Prospectus about the contents of any contract or other document referred to are
not necessarily complete, and in each instance, reference is made to the copy of
such contract or other document filed as an exhibit to the Registration
Statement, each such statement being qualified in all respects by such
reference. Copies of each such document may be obtained from the Commission at
its principal office in Washington, D.C. upon payment of the charges prescribed
by the Commission.
THE COMPANY
The Company specializes in the growing asset accumulation business with
particular emphasis on retirement savings and investment products. The Company's
earnings are derived from investment spread (the difference between income
earned on investments and interest credited on customer deposits) and fee
income. The Company's retail products include a variety of fixed, indexed and
variable annuities and face-amount certificates sold through a broad spectrum of
distribution channels including independent broker-dealers, independent agents,
stockbrokers, and financial institutions. The Company offers institutional
products, such as funding agreements, installment face-amount certificates and
guaranteed investment contracts ("GICs"), directly to bank trust departments,
plan sponsors, cash management funds, corporate treasurers, and other
institutional investors.
The principal offices of the Company are located at 515 West Market Street,
Louisville, Kentucky 40202 and its telephone number is (502) 582-7900.
3
<PAGE> 80
RATIO OF EARNINGS TO COMBINED
FIXED CHARGES AND PREFERRED STOCK DIVIDENDS
The following table sets forth the consolidated ratios of earnings to
combined fixed charges and preferred stock dividends for the Company for the
periods indicated.
<TABLE>
<CAPTION>
THREE MONTHS YEARS ENDED DECEMBER 31,
ENDED ----------------------------------
MARCH 31, 1998 1997 1996 1995 1994(3) 1993(3)
-------------- ---- ---- ---- ------- -------
<S> <C> <C> <C> <C> <C> <C>
Excluding interest
credited on customer deposits(1)......... 6.4x 4.3x 3.4x 2.0x -- --
Including interest credited on customer
deposits(2).............................. 1.2x 1.1x 1.1x 1.1x -- --
</TABLE>
- ---------------
(1) In computing the ratio of earnings to combined fixed charges and preferred
stock dividends (excluding interest credited on customer deposits), combined
fixed charges and preferred stock dividends consist of interest expense on
debt, the portion of operating lease rentals representative of the interest
factor and dividends on the preferred stock of the Company on a tax
equivalent basis. Earnings are computed by adding fixed charges to pretax
income.
(2) In computing the ratio of earnings to combined fixed charges and preferred
stock dividends (including interest credited on customer deposits), combined
fixed charges and preferred stock dividends consist of interest expense on
debt, the portion of operating lease rentals representative of the interest
factor, interest credited on customer deposits, and dividends on the
preferred stock of the Company on a tax equivalent basis. Earnings are
computed by adding fixed charges to pretax income.
(3) Earnings were inadequate to cover combined fixed charges and preferred stock
dividends by $29.2 million and $41.0 million for the years ended December
31, 1994 and 1993, respectively.
USE OF PROCEEDS
Except as otherwise provided in the Prospectus Supplement, the net proceeds
from the sale of the Preferred Stock will be used for general corporate
purposes, which may include redemption of the Company's Existing Preferred
Stock, which may be redeemed on or after December 15, 1998.
4
<PAGE> 81
DESCRIPTION OF CAPITAL STOCK
GENERAL
The authorized capital stock of the Company consists of 150 million shares
of Class A Common Stock, 50 million shares of Class B Convertible Common Stock,
par value $.01 per share (the "Class B Common Stock" and, together with the
Class A Common Stock, the "Common Stock"), and 10 million shares of Preferred
Stock. The Board of Directors of the Company has the power, without further
action by the stockholders unless action is required by applicable laws or
regulations or by the terms of outstanding Preferred Stock, to issue Preferred
Stock in one or more series and to fix the voting rights, designations,
preferences and relative, participating, optional and other special rights, and
the qualifications, limitations and restrictions applicable thereto.
The rights of holders of the Preferred Stock offered hereby (the "Offered
Preferred Stock") will be subject to, and may be adversely affected by, the
rights of holders of any shares of Preferred Stock that may be issued in the
future. The Board of Directors may cause shares of Preferred Stock to be issued
in public or private transactions for any proper corporate purpose, which may
include issuance to obtain additional financing in connection with acquisitions
or otherwise, and issuance to officers, directors and employees of the Company
and its subsidiaries pursuant to benefit plans or otherwise. Shares of Preferred
Stock issued by the Company may have the effect, under certain circumstances,
alone or in combination with certain other provisions of the Company's Restated
Certificate of Incorporation dated June 24, 1997, as amended (the "Certificate
of Incorporation"), described below, of rendering more difficult or discouraging
an acquisition of the Company deemed undesirable by the Board of Directors of
the Company.
At May 26, 1998, the Company had 23,397,471 shares of Class A Common Stock
and no shares of Class B Common Stock outstanding. The Company also had
outstanding on such date 2,000,000 shares of Preferred Stock designated as the
Existing Preferred Stock. The following summary does not purport to be complete
and is subject to the detailed provisions of, and qualified in its entirety by
reference to, the Company's Certificate of Incorporation and the Company's
By-laws (the "By-laws") and to the applicable provisions of the General
Corporation Law of the State of Delaware (the "DGCL").
OFFERED PREFERRED STOCK
The following description of the terms of the Offered Preferred Stock sets
forth certain general terms and provisions of the Offered Preferred Stock to
which any Prospectus Supplement may relate. Certain other terms of any series of
Offered Preferred Stock offered by any Prospectus Supplement will be specified
in the applicable Prospectus Supplement. If so specified in the applicable
Prospectus Supplement, the terms of any series of Offered Preferred Stock may
differ from the terms set forth below. The description of the terms of the
Offered Preferred Stock set forth below and in any Prospectus Supplement does
not purport to be complete and is subject to and qualified in its entirety by
reference to the Certificate of Designations relating to the applicable series
of Offered Preferred Stock (the "Certificate of Designations"), which
Certificate of Designations will be filed as an exhibit to or incorporated by
reference in the Registration Statement of which this Prospectus forms a part.
Under the Certificate of Incorporation, the Company's Board of Directors is
authorized, without further stockholder action, to issue any or all the
authorized Preferred Stock from time to time in one or more series, and for such
consideration, and with such voting powers (not to exceed one vote per share) as
the Board may determine and to determine the designations, preferences and
relative participating, optional or other special rights, and qualifications,
limitations, or restrictions thereon, as shall be stated and expressed in the
resolution or resolutions providing for the issue thereof adopted by the Board
of Directors of the Company and as are not stated and expressed in the
Certificate of Incorporation. Prior to the issuance of each series of Preferred
Stock, the Board of Directors of the Company will adopt resolutions creating and
designating such series as a series of Preferred Stock and such resolutions will
be filed in the Certificate of Designations as an amendment to the Certificate
of Incorporation. As used herein the term "Board of Directors of the Company"
means the Board of Directors of the Company and includes any duly authorized
committee thereof. Stockholders do not have
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any preemptive rights with respect to any of the presently authorized but
unissued shares of authorized Preferred Stock. Other than the Existing Preferred
Stock described below, as of the date of this Prospectus, the Board of Directors
of the Company has not authorized any series of Preferred Stock and there are no
agreements or understandings for the issuance of any shares of Preferred Stock.
As described under "Depositary Shares" below, the Company may, at its
option, elect to offer Depositary Shares evidenced by depositary receipts, each
representing a fraction (to be specified in the Prospectus Supplement relating
to the particular series of Offered Preferred Stock) of a share of the
particular series of Offered Preferred Stock issued and deposited with a
depositary, in lieu of offering full shares of such series of Offered Preferred
Stock. In the event that the Company elects to issue Depositary Shares, subject
to the terms of the Deposit Agreement (as defined below), each such Depositary
Share will be entitled, in proportion to the applicable fraction of a share of
Offered Preferred Stock represented by such Depositary Share, to all the rights
and preferences of the Offered Preferred Stock represented thereby (including
dividends, voting, redemption and liquidation rights). See "Depositary Shares"
below. The statements below concerning Depositary Shares, Depositary Receipts
(as defined below) and the Deposit Agreement do not purport to be complete and
are qualified in their entirety by reference to the forms of such documents,
which have been filed as exhibits to the Registration Statement of which this
Prospectus is a part.
General
The Offered Preferred Stock shall have the dividend, liquidation,
redemption, voting and conversion or exchange rights set forth below unless
otherwise specified in the applicable Prospectus Supplement. Reference is made
to the Prospectus Supplement relating to the particular series of Offered
Preferred Stock offered thereby for specific terms, including: (i) the
designation, stated value and liquidation preference of such Offered Preferred
Stock and the number of shares offered; (ii) the initial public offering price
at which such shares will be issued; (iii) the dividend rate or rates (or method
of calculation), the dividend periods, the date on which dividends shall be
payable and whether such dividends shall be cumulative or noncumulative and, if
cumulative, the dates from which dividends shall commence to cumulate; (iv) any
redemption or sinking fund provisions; (v) any conversion or exchange
provisions; and (vi) any additional dividend, liquidation, redemption, sinking
fund and other rights, preferences, privileges, limitations and restrictions of
such Offered Preferred Stock.
The Offered Preferred Stock will, when issued against payment therefor, be
fully paid and nonassessable. Unless otherwise specified in the applicable
Prospectus Supplement, the shares of each series of Offered Preferred Stock will
upon issuance rank on a parity in all respects with the outstanding shares of
Preferred Stock of the Company. Holders of the Preferred Stock will have no
preemptive rights to subscribe for any additional securities which may be issued
by the Company. Unless otherwise specified in the applicable Prospectus
Supplement, ChaseMellon Shareholder Services LLC (or its successors or assigns)
will be the transfer agent and registrar for the Offered Preferred Stock.
Dividends
The holders of the Offered Preferred Stock will be entitled to receive,
when and as declared by the Board of Directors of the Company, out of funds
legally available therefor, dividends at such rates and on such dates as will be
specified in the applicable Prospectus Supplement. Such rates may be fixed or
variable or both. If variable, the formula used for determining the dividend
rate for each dividend period will be specified in the applicable Prospectus
Supplement. Dividends will be payable to the holders of record as they appear on
the stock books of the Company on such record dates as will be fixed by the
Board of Directors of the Company. Dividends may be paid in the form of cash,
Preferred Stock (of the same or a different series) or Common Stock of the
Company, in each case as specified in the applicable Prospectus Supplement.
Dividends on any series of Offered Preferred Stock may be cumulative or
noncumulative, as specified in the applicable Prospectus Supplement. If the
Board of Directors of the Company fails to declare a dividend payable on a
dividend payment date on any Offered Preferred Stock for which dividends are
noncumulative ("Noncumulative Offered Preferred Stock"), then the holders of
such Offered Preferred Stock will have no
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right to receive a dividend in respect of the dividend period relating to such
dividend payment date, and the Company will have no obligation to pay the
dividend accrued for such period, whether or not dividends on such Offered
Preferred Stock are declared or paid on any future dividend payment dates.
The Company shall not declare or pay or set apart for payment any dividends
on any series of its Preferred Stock ranking, as to dividends, on a parity with
or junior to the outstanding Offered Preferred Stock of any series unless (i) if
such Offered Preferred Stock has a cumulative dividend ("Cumulative Offered
Preferred Stock"), full cumulative dividends have been or contemporaneously are
declared and paid or declared and a sum sufficient for the payment thereof set
apart for such payment on such Offered Preferred Stock for all dividend periods
terminating on or prior to the date of payment of any such dividends on such
other series of Preferred Stock of the Company, or (ii) if such Offered
Preferred Stock is Noncumulative Offered Preferred Stock, full dividends for the
then-current dividend period on such Offered Preferred Stock have been or
contemporaneously are declared and paid or declared and a sum sufficient for the
payment thereof set apart for such payment. When dividends are not paid in full
upon Offered Preferred Stock of any series and any other shares of preferred
stock of the Company ranking on a parity as to dividends with such Offered
Preferred Stock, all dividends declared upon such Offered Preferred Stock and
any other Preferred Stock of the Company ranking on a parity as to dividends
with such Offered Preferred Stock shall be declared pro rata so that the amount
of dividends declared per share on such Offered Preferred Stock and such other
shares shall in all cases bear to each other the same ratio that the accrued
dividends per share on such Offered Preferred Stock (which shall not, if such
Offered Preferred Stock is Noncumulative Offered Preferred Stock, include any
accumulation in respect of unpaid dividends for prior dividend periods) and such
other Preferred Stock bear to each other. Except as set forth in the preceding
sentence, unless full dividends on the outstanding Cumulative Offered Preferred
Stock of any series have been declared and paid or set apart for payment for all
past dividend periods and full dividends for the then-current dividend period on
the outstanding Noncumulative Offered Preferred Stock of any series have been
declared and paid or declared and a sum sufficient for the payment thereof set
apart for such payment, no dividends (other than in Common Stock of the Company
or other shares of the Company ranking junior to such Offered Preferred Stock as
to dividends and upon liquidation) shall be declared or paid or set aside for
payment, nor shall any other distribution be made, on the Common Stock of the
Company or on any other shares of the Company ranking junior to or on a parity
with such Offered Preferred Stock as to dividends or upon liquidation. Unless
full dividends on the Cumulative Offered Preferred Stock of any series have been
declared and paid or set apart for payment for all past dividend periods and
full dividends for the then-current dividend period on the Noncumulative Offered
Preferred Stock of any series have been declared and paid or declared and a sum
sufficient for the payment thereof set apart for such payment, no Common Stock
or any other shares of the Company ranking junior to or on a parity with such
Offered Preferred Stock as to dividends or upon liquidation shall be redeemed,
purchased or otherwise acquired for any consideration (or any moneys be paid or
made available for a sinking fund for the redemption of any such shares) by the
Company or any subsidiary of the Company except by conversion into or exchange
for shares of the Company ranking junior to such Offered Preferred Stock as to
dividends and upon liquidation.
The ability of the Company, as a holding company, to pay dividends on the
Offered Preferred Stock will be dependent upon, among other factors, the
Company's earnings, financial condition and cash requirements at the time such
payment is considered and the payment to it of dividends or principal and
interest by, or the availability of other funds from, its subsidiaries. The
Company's assets consist primarily of the capital stock of Integrity Holdings,
Inc., which owns Integrity Life Insurance Company ("Integrity") and National
Integrity Life Insurance Company ("National Integrity" and, together with
Integrity, the "Integrity Companies") (domiciled in the States of Ohio and New
York, respectively), SBM Certificate Company and ARM Securities Corporation. The
ability of the Integrity Companies to pay dividends to the Company is subject,
among other things, to regulatory restrictions of their respective states of
domicile and will depend on their statutory surplus and earnings. Because
National Integrity is a subsidiary of Integrity, dividend payments by National
Integrity to Integrity must be made in compliance with New York standards, and
the ability of Integrity to pass those dividends on to the Company is subject to
compliance with Ohio standards. From time to time, the National Association of
Insurance Commissioners and various state insurance regulators have
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considered, and may in the future consider, proposals to further restrict
dividend payments that may be made by an insurance company without regulatory
approval.
Redemption
Offered Preferred Stock may be redeemable, in whole or in part, at the
option of the Company, out of funds legally available therefor, and may be
subject to mandatory redemption pursuant to a sinking fund or otherwise, in each
case upon terms, at the times and at the redemption prices specified in the
applicable Prospectus Supplement and subject to the rights of holders of other
securities of the Company. Offered Preferred Stock redeemed by the Company will
be restored to the status of authorized but unissued shares of Preferred Stock.
The Prospectus Supplement relating to a series of Offered Preferred Stock
that is subject to mandatory redemption will specify the number of shares of
such Offered Preferred Stock that shall be redeemed by the Company in each year
commencing after a date to be specified, at a redemption price per share to be
specified, together with an amount equal to all accrued and unpaid dividends
thereon (which shall not, if such Offered Preferred Stock is Noncumulative
Offered Preferred Stock, include any accumulation in respect of unpaid dividends
for prior dividend periods) to the date of redemption. The redemption price may
be payable in cash or other property, as specified in the applicable Prospectus
Supplement.
If fewer than all the outstanding shares of Offered Preferred Stock of any
series are to be redeemed, the number of shares to be redeemed will be
determined by the Board of Directors of the Company and such shares may be
redeemed pro rata from the holders of record of such shares in proportion to the
number of such shares held by such holders (with adjustments to avoid redemption
of fractional shares) or by lot in a manner determined by the Board of Directors
of the Company.
Notwithstanding the foregoing, if any dividends, including any
accumulation, on Cumulative Offered Preferred Stock of any series are in
arrears, no Offered Preferred Stock of such series shall be redeemed unless all
outstanding Preferred Stock of such series is simultaneously redeemed, and the
Company shall not purchase or otherwise acquire any Offered Preferred Stock of
such series; provided, however, that the foregoing shall not prevent the
purchase or acquisition of Preferred Stock of such series pursuant to a purchase
or exchange offer provided such offer is made on the same terms to all holders
of the Offered Preferred Stock of such series.
Notice of redemption shall be given by mailing the same to each record
holder of the Offered Preferred Stock to be redeemed, not less than 30 nor more
than 60 days prior to the date fixed for redemption thereof, at the address of
such holder as the same shall appear on the stock books of the Company. Each
notice shall state: (i) the redemption date; (ii) the number of shares and
series of the Offered Preferred Stock to be redeemed; (iii) the redemption
price; (iv) the place or places where certificates for such Offered Preferred
Stock are to be surrendered for payment of the redemption price; (v) that
dividends on the shares to be redeemed will cease to accrue on such redemption
date; and (vi) the date upon which the holder's conversion or exchange rights,
if any, as to such shares, shall terminate. If fewer than all the shares of
Offered Preferred Stock of any series are to be redeemed, the notice mailed to
each such holder thereof shall also specify the number of shares of Offered
Preferred Stock to be redeemed from each such holder.
If notice of redemption of any shares of Offered Preferred Stock has been
given and if the funds necessary for such redemption have been set aside by the
Company, separate and apart from its other funds, in trust for the pro rata
benefit of the holders of any shares of Offered Preferred Stock so called for
redemption, from and after the redemption date for such shares, dividends on
such shares shall cease to accrue and such shares shall no longer be deemed to
be outstanding, and all rights of the holders thereof as stockholders of the
Company (except the right to receive the redemption price) shall cease. If fewer
than all the shares represented by any such certificate are redeemed, a new
certificate shall be issued representing the unredeemed shares without cost to
the holder thereof.
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Conversion or Exchange Rights
The Prospectus Supplement relating to a series of Offered Preferred Stock
that is convertible or exchangeable will state the terms on which shares of such
series are convertible or exchangeable into Common Stock of the Company or
another series of Preferred Stock.
Rights Upon Liquidation
In the event of any voluntary or involuntary liquidation, dissolution or
winding-up of the Company, the holders of Offered Preferred Stock shall be
entitled to receive out of the assets of the Company available for distribution
to stockholders, before any distribution of assets is made to holders of Common
Stock or any other class or series of shares ranking junior to such Offered
Preferred Stock upon liquidation, liquidating distributions in the amount of the
liquidation preference of such Offered Preferred Stock plus accrued and unpaid
dividends (which shall not, if such Offered Preferred Stock is Noncumulative
Offered Preferred Stock, include any accumulation in respect of unpaid dividends
for prior dividend periods). If, upon any voluntary or involuntary liquidation,
dissolution or winding-up of the Company, the amounts payable with respect to
Offered Preferred Stock of any series and any other shares of the Company
ranking as to any such distribution on a parity with such Offered Preferred
Stock are not paid in full, the holders of such Offered Preferred Stock and of
such other shares will share ratably in any such distribution of assets of the
Company in proportion to the full respective preferential amounts to which they
are entitled. After payment of the full amount of the liquidating distribution
to which they are entitled, the holders of Offered Preferred Stock of any series
will not be entitled to any further participation in any distribution of assets
by the Company.
Substantially all of the assets of the Company are owned by its
subsidiaries. Therefore, the Company's rights and the rights of its creditors
and preferred stockholders to participate in the assets of any subsidiary upon
such subsidiary's liquidation or recapitalization will be subject to (or
effectively subordinated to) the prior claims of such subsidiary's creditors (if
any) and policyholders and to the rights and preferences of such subsidiary's
preferred stockholders (if any), except to the extent that the Company may
itself be a creditor with recognized claims against the subsidiary or a holder
of preferred stock of such subsidiary.
Voting Rights
Except as indicated below or in the applicable Prospectus Supplement, or
except as expressly required by applicable law, the holders of the Offered
Preferred Stock will not be entitled to vote.
Whenever dividends on any shares of Cumulative Offered Preferred Stock
shall be in arrears for six consecutive quarterly periods, the holders of such
shares of Cumulative Offered Preferred Stock (voting separately as a class with
all other series of cumulative preferred stock upon which like voting rights
have been conferred and are exercisable) will be entitled to vote for the
election of two additional directors of the Company at the next annual meeting
of stockholders and at each subsequent meeting until all dividends accumulated
on such shares of Cumulative Offered Preferred Stock shall have been fully paid
or set aside for payment. In such case, the entire Board of Directors of the
Company will be increased by two directors.
So long as any shares of Offered Preferred Stock remain outstanding, the
Company shall not, without the affirmative vote of the holders of at least
two-thirds of the votes of the shares of Offered Preferred Stock outstanding at
the time, given in person or by proxy, at a meeting (voting separately as one
class): (i) authorize, create or issue, or increase the authorized or issued
amount of, any class or series of stock ranking prior to the Offered Preferred
Stock with respect to payment of dividends or the distribution of assets upon
liquidation, dissolution or winding-up, or (ii) amend, alter or repeal the
provisions of the Certificate of Incorporation, including the Certificate of
Designations relating to the Offered Preferred Stock, whether by merger,
consolidation or otherwise, so as to materially and adversely affect any right,
preference, privilege or voting power of such shares of Offered Preferred Stock
or the holders thereof; provided, however, that any increase in the amount of
the authorized Preferred Stock or any outstanding series of Preferred Stock or
any other capital stock of the Company, or the creation and issuance of other
series of Preferred Stock including the Offered Preferred Stock, or of any other
capital stock of the Company, in each case ranking on a parity with or junior to
the Offered Preferred Stock with respect to the payment of dividends and the
distribution of
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assets upon liquidation, dissolution or winding-up shall not be deemed to
materially and adversely affect such rights, preferences, privileges or voting
powers.
The foregoing voting provisions will not apply if, at or prior to the time
when the act with respect to which such vote would otherwise be required shall
be effected, all outstanding shares of Offered Preferred Stock shall have been
redeemed or sufficient funds shall have been deposited in trust to effect such
redemption.
DEPOSITARY SHARES
The description set forth below of certain material provisions of the
Deposit Agreement (as defined below) and of the Depositary Shares and Depositary
Receipts (as defined below) is subject to and qualified in its entirety by
reference to the forms of Deposit Agreement and Depositary Receipt relating to
the Offered Preferred Stock, which will be filed or incorporated by reference,
as the case may be, as exhibits to the Registration Statement of which this
Prospectus forms a part at or prior to the issuance of Depositary Shares. The
particular terms of any Depositary Shares, any Depositary Receipts and any
Deposit Agreement relating to a particular series of Offered Preferred Stock
which vary from the terms set forth below will be set forth in the applicable
Prospectus Supplement.
General
The Company may, at its option, elect to offer fractional shares of Offered
Preferred Stock, rather than full shares of Offered Preferred Stock. In such
event, the Company will issue receipts for Depositary Shares, each of which will
represent a fraction (to be set forth in the Prospectus Supplement relating to a
particular series of Offered Preferred Stock) of a share of a particular series
of Offered Preferred Stock as described below.
The shares of any series of Offered Preferred Stock represented by
Depositary Shares will be deposited under a Deposit Agreement (the "Deposit
Agreement") between the Company and a bank or trust company selected by the
Company having its principal office in the United States and having a combined
capital and surplus of at least $50,000,000 (the "Preferred Stock Depositary").
Subject to the terms of the Deposit Agreement, each owner of a Depositary Share
will be entitled, in proportion to the applicable fraction of a share of Offered
Preferred Stock represented by such Depositary Share, to all the rights and
preferences of the Offered Preferred Stock represented thereby (including
dividend, voting, redemption, conversion and liquidation rights).
The Depositary Shares will be evidenced by depositary receipts issued
pursuant to the Deposit Agreement (the "Depositary Receipts"). Depositary
Receipts will be distributed to those persons purchasing the fractional shares
of Offered Preferred Stock in accordance with the terms of the applicable
Prospectus Supplement.
Pending the preparation of definitive Depositary Receipts, the Preferred
Stock Depositary may, upon the written order of the Company or any holder of
deposited Offered Preferred Stock, execute and deliver temporary Depositary
Receipts which are substantially identical to, and entitle the holders thereof
to all the rights pertaining to, the definitive Depositary Receipts. Depositary
Receipts will be prepared thereafter without unreasonable delay, and temporary
Depositary Receipts will be exchangeable for definitive Depositary Receipts.
Dividends and Other Distributions
The Preferred Stock Depositary will distribute all cash dividends or other
cash distributions received in respect of the deposited Offered Preferred Stock
to the record holders of Depositary Shares relating to such Offered Preferred
Stock in proportion to the number of such Depositary Shares owned by such
holders.
In the event of a distribution other than in cash, the Preferred Stock
Depositary will distribute property received by it to the record holders of
Depositary Shares entitled thereto. If the Preferred Stock Depositary determines
that it is not feasible to make such distribution, it may, with the approval of
the Company, sell such property and distribute the net proceeds from such sale
to such holders.
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Redemption of Preferred Stock
If a series of Offered Preferred Stock represented by Depositary Shares is
to be redeemed, the Depositary Shares will be redeemed from the proceeds
received by the Preferred Stock Depositary resulting from the redemption, in
whole or in part, of such series of Offered Preferred Stock held by the
Preferred Stock Depositary. The Depositary Shares will be redeemed by the
Preferred Stock Depositary at a price per Depositary Share equal to the
applicable fraction of the redemption price per share payable in respect of the
shares of Preferred Stock so redeemed. Whenever the Company redeems shares of
Offered Preferred Stock held by the Preferred Stock Depositary, the Preferred
Stock Depositary will redeem as of the same date the number of Depositary Shares
representing shares of Offered Preferred Stock so redeemed. If fewer than all
the Depositary Shares are to be redeemed, the Depositary Shares to be redeemed
will be selected by the Preferred Stock Depositary by lot or pro rata or by any
other equitable method as may be determined by the Preferred Stock Depositary.
Withdrawal of Preferred Stock
Any holder of Depositary Shares may, upon surrender of the Depositary
Receipts at the corporate trust office of the Preferred Stock Depositary (unless
the related Depositary Shares have previously been called for redemption),
receive the number of whole shares of the related series of Offered Preferred
Stock and any money or other property represented by such Depositary Receipts.
Holders of Depositary Shares making such withdrawals will be entitled to receive
whole shares of Offered Preferred Stock on the basis set forth in the related
Prospectus Supplement for such series of Offered Preferred Stock, but holders of
such whole shares of Offered Preferred Stock will not thereafter be entitled to
deposit such Offered Preferred Stock under the Deposit Agreement or to receive
Depositary Receipts therefor. If the Depositary Shares surrendered by the holder
in connection with such withdrawal exceed the number of Depositary Shares that
represent the number of whole shares of Offered Preferred Stock to be withdrawn,
the Preferred Stock Depositary will deliver to such holder at the same time a
new Depositary Receipt evidencing such excess number of Depositary Shares.
Voting Deposited Offered Preferred Stock
Upon receipt of notice of any meeting at which the holders of any series of
deposited Offered Preferred Stock are entitled to vote, the Preferred Stock
Depositary will mail the information contained in such notice of meeting to the
record holders of the Depositary Shares relating to such series of Offered
Preferred Stock. Each record holder of such Depositary Shares on the record date
(which will be the same date as the record date for the relevant series of
Offered Preferred Stock) will be entitled to instruct the Preferred Stock
Depositary as to the exercise of the voting rights pertaining to the amount of
the Offered Preferred Stock represented by such holder's Depositary Shares. The
Preferred Stock Depositary will endeavor, insofar as practicable, to vote the
amount of such series of Offered Preferred Stock represented by such Depositary
Shares in accordance with such instructions, and the Company will agree to take
all reasonable actions that may be deemed necessary by the Preferred Stock
Depositary in order to enable the Preferred Stock Depositary to do so. The
Preferred Stock Depositary will vote all shares of any series of Offered
Preferred Stock held by it proportionately with instructions received, to the
extent it does not receive specific instructions from the holders of Depositary
Shares representing such series of Offered Preferred Stock.
Amendment and Termination of the Deposit Agreement
The form of Depositary Receipt evidencing the Depositary Shares and any
provision of the Deposit Agreement may at any time be amended by agreement
between the Company and the Preferred Stock Depositary. However, any amendment
that imposes additional charges or materially and adversely alters any
substantial existing right of the holders of Depositary Shares will not be
effective unless such amendment has been approved by the holders of at least a
majority of the affected Depositary Shares then outstanding. Every holder of an
outstanding Depositary Receipt at the time any such amendment becomes effective,
or any transferee of such holder, shall be deemed, by continuing to hold such
Depositary Receipt, or by reason of the acquisition thereof, to consent and
agree to such amendment and to be bound by the Deposit Agreement as amended
thereby. The Deposit Agreement automatically terminates if (i) all outstanding
Depositary Shares
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have been redeemed; or (ii) each share of Offered Preferred Stock has been
converted into or exchanged for Common Stock; or (iii) there has been a final
distribution in respect of the Offered Preferred Stock in connection with any
liquidation, dissolution or winding-up of the Company and such distribution has
been distributed to the holders of Depositary Shares. The Deposit Agreement may
be terminated by the Company at any time and the Preferred Stock Depositary will
provide notice of such termination to the record holders of all outstanding
Depositary Receipts not less than 30 days prior to the termination date, in
which event the Preferred Stock Depositary will deliver or make available for
delivery to holders of Depositary Shares, upon surrender of such Depositary
Shares, the number of whole or fractional shares of the related series of
Offered Preferred Stock as are represented by such Depositary Shares.
Charges of Depositary; Taxes and Other Governmental Charges
The Company will pay all transfer and other taxes and governmental charges
arising solely from the existence of the depositary arrangements. The Company
will pay all charges of the Preferred Stock Depositary in connection with the
initial deposit of the relevant series of Offered Preferred Stock and any
redemption of such Offered Preferred Stock. Holders of Depositary Receipts will
pay other transfer and other taxes and governmental charges and such other
charges or expenses as are expressly provided in the Deposit Agreement to be for
their accounts.
Resignation and Removal of Depositary
The Preferred Stock Depositary may resign at any time by delivering to the
Company notice of its intent to do so, and the Company may at any time remove
the Preferred Stock Depositary, any such resignation or removal to take effect
upon the appointment of a successor Preferred Stock Depositary and its
acceptance of such appointment. Such successor Preferred Stock Depositary must
be appointed within 60 days after delivery of the notice of resignation or
removal and must be a bank or trust company having its principal office in the
United States and having a combined capital and surplus of at least $50,000,000.
Miscellaneous
The Preferred Stock Depositary will forward all reports and communications
from the Company which are delivered to the Preferred Stock Depositary and which
the Company is required to furnish to the holders of the deposited Preferred
Stock.
Neither the Preferred Stock Depositary nor the Company will be liable if it
is prevented or delayed by law or any circumstances beyond its control from
performing its obligations under the Deposit Agreement. The obligations of the
Company and the Preferred Stock Depositary under the Deposit Agreement will be
limited to performance in good faith of their duties thereunder and they will
not be obligated to prosecute or defend any legal proceeding in respect of any
Depositary Shares, Depositary Receipts or shares of Preferred Stock unless
satisfactory indemnity is furnished. The Company and the Preferred Stock
Depositary may rely upon written advice of counsel or accountants, or upon
information provided by holders of Depositary Receipts or other persons believed
to be competent and on documents believed to be genuine.
EXISTING PREFERRED STOCK
General
The Company has designated 2,300,000 authorized shares of Preferred Stock
as the Existing Preferred Stock and has issued 2,000,000 of such shares. The
Existing Preferred Stock of the Company is traded on the American Stock Exchange
under the symbol ARM Pr. The following description of the Existing Preferred
Stock is qualified in its entirety by reference to the Company's Certificate of
Incorporation and the Certificate of Designations, Preferences and Rights
relating to the Existing Preferred Stock (the "Existing Certificate of
Designations"), which is filed with the Secretary of State of the State of
Delaware and incorporated by reference as an exhibit to the Registration
Statement of which this Prospectus is a part.
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Holders of the Existing Preferred Stock do not have, by virtue of such
ownership, any preemptive rights with respect to any shares of capital stock of
the Company or any other securities of the Company convertible into or carrying
rights or options to purchase any such shares. The Existing Preferred Stock has
a perpetual maturity and is not subject to any sinking fund or other obligation
of the Company to redeem or retire the Existing Preferred Stock.
Dividends
Holders of shares of the Existing Preferred Stock are entitled to receive,
when, as and if declared by the Board of Directors of the Company, cash
dividends at a rate of 9 1/2% per annum per share, payable quarterly on the
fifteenth day of March, June, September and December of each year, or, if such
date is not a business day, on the next succeeding business day. Dividends are
cumulative, accrue from the date of original issue and are payable to holders of
record of the Existing Preferred Stock as they appear on the books of the
Company on such respective dates, not exceeding 60 days preceding such dividend
payment date, as may be fixed by the Board of Directors of the Company in
advance of the payment of each particular dividend. Dividends on the Existing
Preferred Stock accrue whether or not the Company has earnings, whether or not
there are funds legally available for the payment of such dividends and whether
or not such dividends are declared and will accumulate to the extent they are
not paid on the dividend payment date for the quarter for which they accrue. All
dividends paid with respect to shares of Existing Preferred Stock are paid pro
rata to the holders entitled thereto. Accruals of dividends do not bear
interest.
The Existing Preferred Stock ranks prior to the Common Stock of the
Company. Before any dividends (other than dividends payable in Common Stock) on
any class or series of stock of the Company ranking junior to the Existing
Preferred Stock as to dividends or upon liquidation shall be declared or paid or
set apart for payment, the holders of shares of the Existing Preferred Stock are
entitled to receive full cumulative cash dividends, but only when and as
declared by the Board of Directors, at the annual rate set forth above. When
dividends are not paid in full upon the Existing Preferred Stock, any dividends
declared or paid upon shares of Existing Preferred Stock and any class or series
of stock ranking on a parity with the Existing Preferred Stock ("Dividend Parity
Stock") shall be declared or paid, as the case may be, pro rata so that the
amount of dividends declared or paid, as the case may be, per share on the
Existing Preferred Stock and such Dividend Parity Stock in all cases bear to
each other the same ratio that accumulated and unpaid dividends per share on the
shares of Existing Preferred Stock and such Dividend Parity Stock bear to each
other. Unless full accumulated dividends on all outstanding shares of the
Existing Preferred Stock have been paid, the Company may not declare or pay or
set apart for payment any dividends or make any distribution in cash or other
property on, or redeem, purchase or otherwise acquire, any other class or series
of stock ranking junior to the Existing Preferred Stock either as to dividends
or upon liquidation.
The amount of dividends payable per share for each full quarterly dividend
period is computed by dividing the 9 1/2% annual rate by four and multiplying
the resulting rate by $25. The amount of dividends payable for the initial
dividend period or any period shorter than a full dividend period is computed on
the basis of a 360-day year of twelve 30-day months.
Optional Redemption
The shares of Existing Preferred Stock may not be redeemed prior to
December 15, 1998. On or after December 15, 1998, the Company may, at its
option, redeem all or a part of the shares of Existing Preferred Stock at any
time and from time to time, upon at least 30 but not more than 60 days' notice,
at a redemption price of $25 per share, plus an amount equal to all accrued and
unpaid dividends and distributions thereon (the "redemption price"), whether or
not declared, to the date fixed for redemption.
The Company shall, on or prior to the date fixed for redemption, but not
earlier than 45 days prior to the redemption date, deposit with its transfer
agent or other redemption agent, as a trust fund, a sum sufficient to redeem the
shares called for redemption, with irrevocable instructions and authority to
such agent to give or complete the required notice of redemption and to pay the
holders of such shares the redemption price upon surrender of their
certificates. Such deposit shall be deemed to constitute full payment of such
shares to their
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holders and from and after the date of such deposit, notwithstanding that any
certificates for such shares shall not have been surrendered for cancellation,
the shares represented thereby shall no longer be deemed outstanding, the right
to receive dividends and distributions shall cease to accrue from and after the
redemption date, and all rights of the holders of the Existing Preferred Stock
called for redemption as stockholders of the Company will cease and terminate,
except the right to receive the redemption price, without interest, upon the
surrender of their respective certificates.
Unless full accumulated dividends on all outstanding shares of the Existing
Preferred Stock shall have been or contemporaneously are declared and paid or
set apart for payment for all past dividend periods, the Existing Preferred
Stock may not be redeemed unless all the outstanding Existing Preferred Stock is
redeemed and neither the Company nor any subsidiary may purchase any shares of
the Existing Preferred Stock otherwise than pursuant to a purchase offer made on
the same terms to all holders of Existing Preferred Stock, provided that the
Company may complete the purchase or redemption of shares of Existing Preferred
Stock for which a purchase contract was entered into, or notice of redemption of
which was initially given, prior to any time at which the Company becomes in
arrears with respect to any dividends.
Notice of redemption shall be mailed to each holder of Existing Preferred
Stock to be redeemed at the address shown on the books of the Company not fewer
than 30 days nor more than 60 days prior to the redemption date. If less than
all of the outstanding shares of Existing Preferred Stock are to be redeemed,
the Company will select the shares to be redeemed by lot, pro rata (as nearly as
may be practicable), or in such other equitable manner as the Board of Directors
may determine.
Voting Rights
Except as indicated herein or provided by law, the holders of Existing
Preferred Stock are not entitled to vote.
Whenever dividends on the Existing Preferred Stock are in arrears for at
least six quarterly dividends, whether or not consecutive, the holders of
Existing Preferred Stock (voting as a class with all other series of authorized
Preferred Stock ranking on a parity with the Existing Preferred Stock either as
to dividends or upon liquidation and upon which like voting rights have been
conferred and are exercisable) will be entitled to vote for the election of two
additional directors on the terms set forth below until, in the case of the
Existing Preferred Stock, all past dividends in arrears on the Existing
Preferred Stock shall have been paid in full. Holders of all such series of
authorized Preferred Stock which are granted such voting rights (none of which
is currently outstanding), together with the Existing Preferred Stock, will vote
as a single class. In such case, the Board of Directors of the Company will be
increased by two directors, and the holders of all such series of authorized
Preferred Stock, together with the holders of Existing Preferred Stock, will
have the exclusive right as a class, as outlined above, to elect two directors
(the "Additional Directors") at the next annual meeting of stockholders or at a
special meeting of holders of all such series of authorized Preferred Stock and
the Existing Preferred Stock. At any time when such voting rights shall have
vested, a proper officer of the Company shall, upon written request of holders
of record of 10% of the shares of Existing Preferred Stock then outstanding,
call a special meeting of holders of all such series of authorized Preferred
Stock and the Existing Preferred Stock for the purpose of such election. For
purposes of the foregoing, each share of Existing Preferred Stock shall have one
vote per share, except that when any other series of authorized Preferred Stock
shall have the right to vote with the Preferred Stock as a single class on any
matter, then the Preferred Stock and such other series of authorized Preferred
Stock shall have with respect to such matters one vote per $25 of stated
liquidation preference. Upon termination of the right of the holders of all such
series of authorized Preferred Stock to vote for directors, the term of office
of all directors then in office elected by all such series of authorized
Preferred Stock voting as a class shall terminate. For so long as the holders of
all such series of authorized Preferred Stock shall have the right to vote for
directors, any vacancy in the office of an Additional Director may be filled
(except in the case of the removal of an Additional Director) by a person
appointed by the remaining Additional Director. In the case of the removal of an
Additional Director, or, if there is no remaining Additional Director, the
vacancy may be filled by a person elected by the holders of all such series of
authorized Preferred Stock.
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The affirmative vote or consent of the holders of at least two-thirds of
the outstanding shares of the Existing Preferred Stock, voting as a class, will
be required to (i) authorize, create or issue, or increase the authorized or
issued amount of shares of, any class or series of stock ranking prior to the
Existing Preferred Stock, either as to dividends or upon liquidation, or (ii)
amend, alter or repeal (whether by merger, consolidation or otherwise) any
provision of the Certificate of Incorporation or of the Certificate of
Designations so as to materially and adversely affect the preferences, special
rights or powers of the Preferred Stock; provided, however, that any increase in
the authorized Preferred Stock or the creation and issuance of any other series
of authorized Preferred Stock ranking on a parity with or junior to the Existing
Preferred Stock shall not be deemed to materially and adversely affect such
preferences, special rights or powers.
Except as set forth above or as required by law, the holders of Existing
Preferred Stock will not be entitled to vote on any merger or consolidation
involving the Company or a sale of all or substantially all of the assets of the
Company.
Liquidation Rights
In the event of any liquidation, dissolution or winding-up of the Company,
whether voluntary or involuntary, before any payment or distribution of the
assets of the Company or proceeds thereof (whether capital or surplus) shall be
made to or set apart for the holders of any class or series of stock of the
Company ranking junior to the Existing Preferred Stock upon liquidation, holders
of the Existing Preferred Stock shall be entitled to receive $25 per share (the
"stated liquidation preference"), plus an amount equal to all dividends (whether
or not earned or declared) accrued and unpaid to the date of final distribution
(together with the stated liquidation preference, the "preferential amount"),
but such holders shall not be entitled to any further payment. If, upon any
liquidation, dissolution or winding-up of the Company the assets of the Company,
or proceeds thereof, distributable among the holders of shares of Preferred
Stock and any other class or series of stock ranking on a parity with the
Preferred Stock as to payments upon liquidation, dissolution or winding-up shall
be insufficient to pay in full the preferential amount payable on all such
shares of stock, then such assets, or the proceeds thereof, shall be distributed
among such holders ratably in accordance with the respective amounts that would
be payable on such shares if all amounts payable thereon were paid in full. The
voluntary sale, conveyance, lease, exchange or transfer (for cash, shares of
stock, securities or other consideration) of all or substantially all the
property or assets of the Company to, or a consolidation or merger of the
Company with or into, one or more other corporations (whether or not the Company
is the corporation surviving such consolidation or merger) will not be deemed to
be a liquidation, dissolution or winding-up, voluntary or involuntary.
Transfer Agent
The transfer agent, dividend disbursing agent and registrar for the
Existing Preferred Stock is ChaseMellon Shareholder Services LLC.
COMMON STOCK
General
At May 26, 1998, the Company had 23,397,471 shares of Class A Common Stock
and no shares of Class B Common Stock outstanding.
Class A Common Stock and Class B Common Stock
Holders of Class A Common Stock are entitled to one vote for each share of
Class A Common Stock on each matter submitted to a vote of stockholders,
including the election of directors. Holders of Class A Common Stock are not
entitled to cumulative voting. Shares of Class A Common Stock have no preemptive
or other subscription rights and were, until May 13, 1998, convertible by the
Morgan Stanley Stockholders into an equal number of shares of Class B Common
Stock.
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Holders of Class B Common Stock have no right to vote on matters submitted
to a vote of stockholders, except (i) as otherwise required by law; and (ii)
that the holders of Class B Common Stock shall have the right to vote as a class
on any amendment, repeal or modification to the Certificate of Incorporation
that adversely affects the powers, preferences or special rights of the holders
of the Class B Common Stock. Shares of Class B Common Stock have no preemptive
or other subscription rights and are convertible into an equal number of shares
of Class A Common Stock (x) at the option of the holder thereof to the extent
that, following such conversion, the Morgan Stanley Stockholders will not, in
the aggregate, own more than 49% of the outstanding shares of Class A Common
Stock; and (y) automatically upon the transfer of such shares by any Morgan
Stanley Stockholder to a person that is not a Morgan Stanley Stockholder or an
affiliate of a Morgan Stanley Stockholder.
The Morgan Stanley Stockholders sold their interests in the Company on May
13, 1998. Accordingly, the shares of Class A Common Stock are no longer
convertible into shares of Class B Common Stock, there are no shares of Class B
Common Stock outstanding and the Certificate of Incorporation does not authorize
the issuance of any additional shares of Class B Common Stock.
Dividends
All holders of Common Stock are entitled to receive such dividends or other
distributions, if any, as may be declared from time to time by the Board of
Directors in its discretion out of funds legally available therefor, subject to
the prior rights of any Preferred Stock then outstanding, and to share equally,
share for share, in such dividends or other distributions as if all shares of
Common Stock were a single class. Dividends or other distributions declared or
paid in shares of Common Stock, or options, warrants or rights to acquire such
stock or securities convertible into or exchangeable for shares of such stock,
are payable to all of the holders of Common Stock ratably according to the
number of shares held by them, in shares of Class A Common Stock to holders of
that class of stock and in shares of Class B Common Stock to holders of that
class of stock. Delaware law generally requires that dividends be paid only out
of the Company's surplus or current net profits in accordance with the DGCL.
Liquidation
Subject to the rights of any holders of Preferred Stock outstanding, upon
the dissolution, liquidation or winding-up of the Company, the holders of Common
Stock are entitled to share equally and ratably in the assets available for
distribution after payments are made to the Company's creditors.
Full Payment and Nonassessability
All of the outstanding shares of Common Stock are fully paid and
nonassessable.
Listing
The Class A Common Stock is listed on the New York Stock Exchange under the
symbol "ARM."
Registrar and Transfer Agent
ChaseMellon Shareholder Services LLC is the registrar and transfer agent
for the Common Stock.
CERTIFICATE OF INCORPORATION AND BY-LAWS
Stockholders' rights and related matters are governed by the DGCL, the
Certificate of Incorporation and the By-laws. Certain provisions of the
Certificate of Incorporation and By-laws, which are summarized below, may have
the effect, either alone or in combination with each other, of discouraging or
making more difficult a tender offer or takeover attempt that is opposed by the
Company's Board of Directors but that a stockholder might consider to be in its
best interest. Such provisions may also adversely affect prevailing market
prices for the Offered Preferred Stock.
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Classified Board of Directors and Related Provisions
The Certificate of Incorporation provides for the classification of the
Board of Directors into three classes with each class of directors serving
staggered three-year terms. The term of the initial Class I directors will
terminate on the date of the 1998 annual meeting of stockholders; the term of
the initial Class II directors will terminate on the date of the 1999 annual
meeting of stockholders; and the term of the initial Class III directors shall
terminate on the date of the 2000 annual meeting of stockholders. At each annual
meeting of stockholders beginning in 1998, successors to the class of directors
whose term expires at that annual meeting will be elected for a three-year term.
Accordingly, approximately one-third of the Company's Board of Directors will be
elected each year. In addition, subject to certain limited exceptions, if the
number of directors is changed, any increase or decrease shall be apportioned
among the classes so as to maintain the number of directors in each class as
nearly equal as possible, and any additional director of any class elected to
fill a vacancy resulting from an increase in such class shall hold office for a
term that shall coincide with the remaining term of that class, but in no case
will a decrease in the number of directors shorten the term of any incumbent
director. Subject to the rights of holders of any outstanding preferred stock
issued by the Company, vacancies on the Board of Directors may be filled only by
the Board of Directors, the stockholders acting at an annual meeting or, if the
vacancy is with respect to a director elected by a voting group, by action of
any other directors elected by such voting group or such voting group.
The Certificate of Incorporation also provides that, subject to the rights
of holders of any preferred stock then outstanding and any requirements of law,
directors may be removed only for cause.
Action by Written Consent; Special Meeting
Any action required or permitted to be taken at an annual or special
meeting of stockholders will not be permitted to be taken by written consent in
lieu of a meeting of stockholders, and, thus, stockholders will only be
permitted to take action at an annual or special meeting called in accordance
with the By-laws. The Certificate of Incorporation and By-laws provide that
special meetings of stockholders may only be called by the Chief Executive
Officer of the Company or by a majority of the Board of Directors. Special
meetings may not be called by the stockholders.
Advance Notice Requirements for Stockholder Proposals and Director Nominations
The Certificate of Incorporation and By-laws establish advance notice
procedures with regard to stockholder proposals and the nomination, other than
by or at the direction of the Board of Directors or a committee thereof, of
candidates for election as directors. These procedures provide that the notice
of stockholder proposals and stockholder nominations for the election of
directors at an annual meeting must be in writing and received by the Secretary
of the Company not less than 60 days nor more than 90 days prior to the
anniversary date of the previous year's annual meeting or, if the date of the
annual meeting is not within 30 days before or after the anniversary date of the
previous year's annual meeting, not later than the close of business on the
tenth day following the day on which notice of the date of such meeting was
mailed or public disclosure of the date of the meeting of stockholders was made,
whichever first occurs. The notice of stockholder nominations must set forth
certain information with respect to the stockholder giving the notice and with
respect to each nominee.
Indemnification
The Certificate of Incorporation and By-laws provide that the Company shall
advance expenses to and indemnify each director and officer of the Company to
the fullest extent permitted by law.
Amendments
Stockholders may adopt, alter, amend or repeal provisions of the By-laws
only by vote of the holders of 80% or more of the outstanding Common Stock and
any other voting securities. In addition, the affirmative vote of the holders of
80% or more of the outstanding Common Stock and any other voting securities is
required to amend certain provisions of the Certificate of Incorporation,
including filling vacancies on the
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Board of Directors, removal of directors only for cause, prohibiting stockholder
action by written consent, prohibiting the calling of special meetings by
stockholders, approval of amendments to the By-laws and the provisions referred
to above relating to the classification of the Company's Board of Directors.
LIMITATIONS ON DIRECTORS' LIABILITY
The Certificate of Incorporation provides that no director of the Company
shall be personally liable to the Company or its stockholders for monetary
damages for any breach of fiduciary duty as a director, except for liability:
(i) for any breach of the director's duty of loyalty to the Company or its
stockholders; (ii) for acts or omissions not in good faith or which involve
intentional misconduct or a knowing violation of law; (iii) in respect of
certain unlawful dividend payments or stock redemptions or purchases or (iv) for
any transaction from which the director derived an improper personal benefit.
The effect of these provisions is to eliminate the rights of the Company and its
stockholders (through stockholders' derivative suits on behalf of the Company)
to recover monetary damages against a director for breach of fiduciary duty as a
director (including breaches resulting from grossly negligent behavior), except
in the situations described above. These provisions do not limit the liability
of directors under federal securities laws and do not affect the availability of
equitable remedies such as an injunction or rescission based upon a director's
breach of his duty of care.
SECTION 203 OF THE DELAWARE GENERAL CORPORATION LAW
Section 203 of the DGCL prohibits certain transactions between a Delaware
corporation and an "interested stockholder," which is defined as a person who,
together with any affiliates and/or associates of such person, beneficially
owns, directly or indirectly, 15% or more of the outstanding voting shares of a
Delaware corporation. This provision prohibits certain business combinations
(defined broadly to include mergers, consolidations, sales or other dispositions
of assets having an aggregate value of 10% or more of the consolidated assets of
the corporation, and certain transactions that would increase the interested
stockholder's proportionate share ownership in the corporation) between an
interested stockholder and a corporation for a period of three years after the
date the interested stockholder acquired its stock, unless: (i) the business
combination is approved by the corporation's board of directors prior to the
date the interested stockholder acquired shares; (ii) the interested stockholder
acquired at least 85% of the voting stock of the corporation in the transaction
in which it became an interested stockholder or (iii) the business combination
is approved by a majority of the board of directors and by the affirmative vote
of two-thirds of the outstanding voting stock owned by disinterested
stockholders at an annual or special meeting. A Delaware corporation, pursuant
to a provision in its certificate of incorporation or by-laws, may elect not to
be governed by Section 203 of the DGCL. The Company has not made such an
election and, as a result, the Company is subject to the provisions of Section
203 of the DGCL.
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PLAN OF DISTRIBUTION
The Company may sell any series of Offered Preferred Stock or Depositary
Shares (collectively, the "Offered Securities") in one or more of the following
ways from time to time: (i) to or through underwriters or dealers, (ii) directly
to purchasers, or (iii) through agents. The Prospectus Supplement with respect
to any Offered Securities will set forth (i) the terms of the offering of the
Offered Securities, including the name or names of any underwriters, dealers or
agents, (ii) the purchase price of the Offered Securities and the proceeds to
the Company from such sale, (iii) any underwriting discounts and commissions or
agency fees and other items constituting underwriters' or agents' compensation,
(iv) any initial public offering prices, (v) any discounts or concessions
allowed or reallowed or paid to dealers and (vi) any securities exchange on
which such Offered Securities may be listed. Any initial public offering price,
discounts or concessions allowed or reallowed or paid to dealers may be changed
from time to time.
If underwriters are used in the sale, the Offered Securities will be
acquired by the underwriters for their own account and may be resold from time
to time in one or more transactions, including negotiated transactions, at a
fixed public offering price or at varying prices determined at the time of sale.
The Offered Securities may be offered to the public either through underwriting
syndicates represented by one or more managing underwriters or directly by one
or more firms acting as underwriters. The underwriter or underwriters with
respect to a particular underwritten offering of Offered Securities will be
named in the Prospectus Supplement relating to such offering and, if an
underwriting syndicate is used, the managing underwriter or underwriters will be
set forth on the cover of such Prospectus Supplement. Unless otherwise set forth
in the Prospectus Supplement relating thereto, the obligations of the
underwriters to purchase the Offered Securities will be subject to certain
conditions precedent, and the underwriters will be obligated to purchase all the
Offered Securities if any are purchased.
In connection with underwritten offerings of the Offered Securities and in
accordance with applicable law and industry practice, underwriters may
over-allot or effect transactions which stabilize, maintain or otherwise affect
the market price of the Offered Securities at levels above those which might
otherwise prevail in the open market, including by entering stabilizing bids,
effecting syndicate covering transactions or imposing penalty bids. A
stabilizing bid means the placing of any bid, or the effecting of any purchase,
for the purpose of pegging, fixing or maintaining the price of a security. A
syndicate covering transaction means the placing of any bid on behalf of the
underwriting syndicate or the effecting of any purchase to reduce a short
position created in connection with the offering. A penalty bid means an
arrangement that permits the managing underwriter to reclaim a selling
concession from a syndicate member in connection with the offering when Offered
Securities originally sold by the syndicate member are purchased in syndicate
covering transactions. Such transactions may be effected on a stock exchange, in
the over-the-counter market, or otherwise. Underwriters are not required to
engage in any of these activities. Any such activities, if commenced, may be
discontinued at any time.
If dealers are utilized in the sale of Offered Securities, the Company will
sell such Offered Securities to the dealers as principals. The dealers may then
resell such Offered Securities to the public at varying prices to be determined
by such dealers at the time of resale. The names of the dealers and the terms of
the transaction will be set forth in the Prospectus Supplement relating thereto.
Offered Securities may be sold directly by the Company to one or more
institutional purchasers, or through agents designated by the Company from time
to time, at a fixed price, or prices, which may be changed, or at varying prices
determined at time of sale. Any agent involved in the offer or sale of the
Offered Securities in respect to which this Prospectus is delivered will be
named, and any commissions payable by the Company to such agent will be set
forth in the Prospectus Supplement relating thereto. Unless otherwise indicated
in the Prospectus Supplement, any such agent will be acting on a best efforts
basis for the period of its appointment.
If so indicated in the Prospectus Supplement, the Company will authorize
agents, underwriters or dealers to solicit offers from certain types of
institutions to purchase Offered Securities from the Company at the public
offering price set forth in the Prospectus Supplement pursuant to delayed
delivery contracts (the "Contracts") providing for payment and delivery on a
specified date or dates in the future. Such Contracts will
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not be subject to any conditions except (a) the purchase by an institution of
the Offered Securities covered by its Contracts shall not at the time of
delivery be prohibited under the laws of any jurisdiction in the United States
to which such institution is subject and (b) if the Offered Securities are being
sold to underwriters, the Company shall have sold to such underwriters the total
principal amount of the Offered Securities less the principal amount thereof
covered by the Contracts. The Prospectus Supplement will set forth the
commission payable for solicitation of such Contracts.
Agents, dealers and underwriters may be entitled, under agreements with the
Company, to indemnification by the Company against certain civil liabilities,
including liabilities under the Securities Act of 1933, as amended, or to
contribution with respect to payments that such agents, dealers or underwriters
may be required to make in respect thereof. Agents, dealers and underwriters may
be customers of, engage in transactions with, or perform services for the
Company in the ordinary course of business.
Each series of Offered Securities will be a new issue of securities and
will have no established trading market. Any underwriters to whom Offered
Securities are sold for public offering and sale may make a market in such
Offered Securities, but such underwriters will not be obligated to do so and may
discontinue any market making at any time without notice. The Offered Securities
may or may not be listed on a national securities exchange. No assurance can be
given that there will be a market for the Offered Securities.
The place and time of delivery of the Preferred Stock are set forth in the
Prospectus Supplement.
LEGAL MATTERS
The validity of the Offered Preferred Stock will be passed upon for the
Company by Shearman & Sterling, 599 Lexington Avenue, New York, New York 10022,
and, if underwriters are utilized, on behalf of such underwriters by such
counsel, which will be named in the Prospectus Supplement, as such underwriters
may select.
EXPERTS
The consolidated financial statements and financial statement schedules for
the Company at December 31, 1997 and 1996, and for each of three years in the
period ended December 31, 1997, appearing in and/or incorporated by reference
into this Prospectus and Registration Statement have been audited by Ernst &
Young LLP, independent auditors, as set forth in their reports thereon appearing
elsewhere herein and/or incorporated herein by reference, and are included
and/or incorporated by reference in reliance upon such reports given upon the
authority of such firm as experts in accounting and auditing.
ERISA MATTERS FOR PENSION PLANS AND INSURANCE COMPANIES
The Offered Preferred Stock may, subject to certain legal restrictions, be
purchased and held by an employee benefit plan (a "Plan") subject to Title I of
the Employee Retirement Income Security Act of 1974, as amended ("ERISA"), or an
individual retirement account or an employee benefit plan subject to section
4975 of the Internal Revenue Code of 1986, as amended (the "Code"). A fiduciary
of a Plan must determine that the purchase and holding of Offered Preferred
Stock is consistent with its fiduciary duties under ERISA and does not result in
a non-exempt prohibited transaction as defined in section 406 of ERISA or
section 4975 of the Code. Employee benefit plans that are governmental plans (as
defined in section 3(32) of ERISA) and certain church plans (as defined in
section 3(33) of ERISA) are not subject to Title I of ERISA or section 4975 of
the Code. The Offered Preferred Stock may, subject to certain legal
restrictions, be purchased and held by such plans.
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ARM FINANCIAL LOGO
