Item 1. Business
GENERAL DESCRIPTION AND HISTORY
PennCorp Financial Group, Inc. ("PennCorp" or the "Company"), incorporated in Delaware in 1989, is a holding company the principal subsidiaries of which are insurance companies with operations in Raleigh, North Carolina; Dallas and Waco, Texas; Baton Rouge, Louisiana; and Toronto, Canada. The Company's insurance subsidiaries market and underwrite fixed benefit accident and sickness insurance, life insurance and accumulation products to lower- and middle- income markets throughout the United States and Canada. The Company's insurance products are sold through several distribution channels including exclusive agents, general agents, payroll deduction programs and through financial institutions. PennCorp's only significant industry segment is insurance. Information relating to the Company's U.S. and Canadian operations appears in Note 4 of "Notes to Consolidated Financial Statements" on Page 53 hereof. For more information regarding the Company's markets, see "Insurance" and Marketing and Distribution" included herein.
During 1997 the Company restructured its operating units into three primary business units, Career Sales Division, Payroll Sales Division and Financial Services Division.
Career Sales Division includes the operations of Penn Life. Penn Life, collectively, Pennsylvania Life Insurance Company ("PLIC") and Penncorp Life Insurance Company, markets and underwrites fixed benefit accident and sickness products and, to a lesser extent, life products through a sales force exclusive to the Company throughout the United States and Canada. With the January 2, 1998 consummation of the acquisition of Southwestern Financial Corporation and Subsidiaries ("SW Financial"), the Company has been taking steps to integrate Union Bankers Insurance Company ("Union Bankers") with the Career Sales Division.
Payroll Sales Division includes the operations of AA Life, Professional Insurance Corporation ("Professional") and Occidental Life Insurance Company of North Carolina ("OLIC"). AA Life, collectively, Pioneer Security Life Insurance Company ("Pioneer Security") and its subsidiaries, American-Amicable Life Insurance Company of Texas ("American- Amicable") and Pioneer American Insurance Company ("Pioneer American"), markets and underwrites customized life insurance and accumulation products to U.S. military personnel and federal employees through a general agency force. Professional and OLIC provide individual fixed benefit and life products utilizing a network of independent agents primarily in the southeastern United States through employer-sponsored payroll deduction programs.
Financial Services Division is comprised of Integon Life Insurance Corporation ("Integon Life") and United Life & Annuity Insurance Company ("United Life"). Integon Life markets life insurance and, to a lesser extent annuity products through independent general agents who sell directly to individuals primarily in the southeastern United States. United Life principally markets fixed and variable annuities through financial institutions and independent general agents, primarily in the southern and western United States. Since its acquisition on January 2, 1998, Southwestern Life Insurance Company ("Southwestern Life") has been integrated and managed as part of the Financial Services Division.
The Company's growth strategy has emphasized the acquisition of complementary insurance operations and the utilization of the Company's several distribution channels to further penetrate its target markets. In making acquisitions, the Company has sought to broaden its distribution channels, increase its product offerings and expand its geographical presence. The Company also seeks benefits from expense reduction through the consolidation of facilities and staff and the creation of common administrative systems. Since 1990, the Company has acquired OLIC, Professional, AA Life, Integon Life, United Life and SW Financial.
RECENT DEVELOPMENTS
On February 18, 1998, the Company announced that it has engaged investment banking firms Salomon Smith Barney and Fox-Pitt, Kelton Inc. to review strategic alternatives for maximizing shareholder value, including the sale of the Company's Career Sales Division. On February 18, 1998, the Company also announced that it will incur restructuring and
other charges which, in the aggregate, are not expected to exceed $25.0 million, a significant portion of which will be recognized in the first quarter. The restructuring charge recognizes: (a) severance and related benefits incurred due to staff reductions, (b) estimated holding costs of vacated facilities, (c) the write-off of certain fixed assets and other impaired assets and (d) estimated contract termination costs.
THE SW FINANCIAL INVESTMENT
Prior to the Company's acquisition of the controlling interest in SW Financial on January 2, 1998, the Company held a significant economic interest in SW Financial. Such economic interest was derived through its direct investment of $120.0 million in SW Financial. Without giving effect to the conversion of the SW Financial convertible debentures, the Company beneficially owned 75.4% of SW Financial's outstanding common stock, including 100.0% of SW Financial's non-voting common stock and 21.0% of SW Financial's voting common stock. The Company also owned preferred stock of SW Financial and its subsidiary. In August 1997, in anticipation of the acquisition of SW Financial, the Company acquired all of SW Financial's subordinated indebtedness aggregating $40.0 million.
Through the Company's limited partnership interest in the Knightsbridge Capital Fund I, L.P. ("Knightsbridge Fund"), the Company indirectly owned an additional economic interest in SW Financial aggregating 2.6 percent.
THE KNIGHTSBRIDGE RESTRUCTURING PLAN
In February 1996, the Company's Board of Directors began discussions with Messrs. Stone and Fickes on a means of consolidating their outside business interests, including the Knightsbridge Fund, under the Company. Subsequently, Messrs. Stone and Fickes and the members of the Knightsbridge and Compensation Committees of the Company's Board developed a plan to enable the Company to manage the Knightsbridge Fund and to provide Messrs. Stone and Fickes with a compensation program that offers them compensation opportunities with economic interests aligned with stockholders generally and that provides incentives for each to make a long-term, full-time commitment to the Company.
The components of the Knightsbridge restructuring plan are as follows:
o The adoption of compensation arrangements pursuant to which Messrs. Stone and Fickes have entered into five-year employment agreements with the Company. These compensation arrangements are described in detail under the captions "Executive Compensation - Employment Agreements" in Item 11 hereof.
o The acquisition by the Company of the interests of Messrs. Stone and Fickes in Knightsbridge Management, L.L.C. ("Knightsbridge Management"), Knightsbridge Capital L.L.C. and Knightsbridge Consultants L.L.C. (collectively, "The Fickes and Stone Knightsbridge Interests").
o The acquisition by the Company from the Knightsbridge Fund and Messrs. Stone and Fickes of their respective holdings of common stock and the common stock warrants of SW Financial (collectively, "The Southwestern Financial Controlling Interest") provided that if the Amended Proposed Settlement (as defined in "Item 3 - Legal Proceedings" below) is approved by the Delaware Chancery Court after notice to the Company's stockholders, Messrs. Stone and Fickes will cancel their SW Financial common stock warrants for no additional consideration). See Item 3 - Legal Proceedings on page 22 hereof.
The acquisition of The Fickes and Stone Knightsbridge Interests and the acquisition of the Southwestern Financial Controlling Interest were approved by a vote of the stockholders of the Company at its Annual Meeting of Stockholders held on December 31, 1997 and were consummated on January 5, 1998 and January 2, 1998, respectively.
Further information regarding the SW Financial investment appears in Note 6 of "Notes to Consolidated Financial Statements" and SW Financial financial statements for the years ended December 31, 1997 and 1996 are included on pages 78 to 103 hereof. Information relating to the relationship between the Company and the Knightsbridge Fund, the acquisition of The Fickes and Stone Knightsbridge Interests and the Southwestern Financial Controlling Interest appear in Notes 15, 16 and 19 of "Notes to Consolidated Financial Statements," and in Item 13 hereof.
INSURANCE
The Company's insurance subsidiaries underwrite a variety of insurance products with the primary emphasis on modest premium policies in the accumulation, life and fixed benefit product sectors. Fixed benefit products include indemnity insurance policies in which the benefit amounts are fixed at the time of policy issue. Those products provide supplemental income payments directly to the insured who is disabled and unable to work due to accident or sickness. Life products are primarily low face amount traditional whole life or universal life products which build cash values that are available to the policyholder. Accumulation products include various forms of annuity products which are utilized by policyholders primarily as a means of tax deferred savings. Pro forma 1997 ratios and amounts include the results of SW Financial as if SW Financial was acquired January 1, 1997. Such pro forma information is provided for comparative purposes only and does not purport to be indicative of what would have occurred had the acquisition been made as of January 1, 1997, or results which may occur in the future.
The following table presents the historical percentages of consolidated insurance operations revenues derived from these product types:
The amount of annualized premium in force and policy activity by type of business for the past three years is as follows:
As a result of the acquisition of Integon life, the Company acquired a substantial block of credit insurance policies (550,152 policies at acquisition; 111,579 policies as of December 31, 1997). Integon Life no longer markets such products and nearly all of Integon Life's credit insurance is subject to a 100.0% coinsurance agreement. Such policies have been excluded from the above table.
MARKETING AND DISTRIBUTION
The Company's insurance subsidiaries collectively are licensed to market the Company's insurance products in all states (other than New York) and in the District of Columbia, all provinces of Canada, Puerto Rico and certain Caribbean countries. In addition, the Company is authorized to sell its products at U.S. military installations in foreign countries.
The Company's broadly defined markets are reached through four primary distribution channels: agents contracted exclusively with the Company, independent general agents who sell on an individual basis, independent general agents who sell through payroll deduction programs and arrangements for distribution through various financial institutions. Those market segments are further divided as follows:
Major Market Sub-Market ------------ ----------
Individual Low and moderate income households Non-English speaking households U.S. military enlistees Suburban and rural locales
Government Local governments and governmental agencies U.S. federal government Self-employed
Each of the Company's market segments may be served by each of the primary distribution channels. Additionally, though there are certain regions in which all sales forces are active, the Company's sales forces generally operate in geographically discrete regions.
The following tables illustrate, by direct cash premium collected and relative percentages, the principal marketing regions in which the Company collected in excess of $10.0 million of policy revenues for the year ended December 31, 1997.
Career Sales Division
Penn Life's agents constitute substantially all of the Company's career sales force. On a pro forma basis Union Bankers is considered part of the Career Sales Division. Penn Life is organized under a regional/branch office structure. The
regional sales managers are responsible for approximately 100 sales locations in the United States and Canada. Commissions are shared among the regional and branch office managers and the writing agent. Commissions allocated to the branch offices are used to pay "overwrite" commissions to agents who train new agents and to pay the expenses of the branch office. Any commissions allocated to the branch offices remaining after payment of "overwrite" commissions and expenses, essentially the branch "profit", are allocated among the senior sales managers and the Company. The Company retained approximately $3.1 million, $2.8 million and $2.4 million during 1997, 1996 and 1995, respectively, in profit sharing income, which is recorded as an offset to commissions. During 1997 the Company worked closely with the U.S. based career sales force to develop and implement a new compensation structure which resulted in the Company giving up its rights to a portion of the profit participation associated with the branch compensation structures. As a result, career sales force agents will receive a lower base commission structure on new business and will fully absorb all field office costs. The new compensation structure allows for bonuses to be paid to agents based upon improving persistency and new sales growth.
Management believes that the expansion of the Penn Life sales force can best be accomplished by broadening the base of sales offices. Penn Life has opened the following new offices and continues to evaluate additional geographic locations which will complement the current office network.
NEW LOCATIONS ------------- 1995 1996 1997 ---- ---- ----
Bellaire, TX Salt Lake City, UT Charlotte, NC Amarillo, TX San Antonio, TX Hughson, CA Springfield, MO Gainesville, FL Malibu, CA Gilbert, AZ Portland, OR Hollywood, FL
The Penn Life career sales force is organized into three distinct divisions: Instant Issue, Special Services and Individual Life. The Instant Issue and Special Services Divisions sell fixed benefit products and the Individual Life Division sells life products. All divisions concentrate primarily on individual sales or sales to self-employed individuals.
Instant Issue. Instant Issue agents make "cold call" door-to-door presentations and market small denomination policies that provide scheduled payments in fixed amounts to insureds who, as a result of specified types of accidents, become unable to work or who become hospitalized. The relatively modest annual premium required to purchase this policy facilitates the initial sale. Prior to 1996, the Instant Issue agent typically utilized a special field-underwritten policy form that required the applicant to answer certain questions designed to confirm that the applicant is within the Company's basic underwriting guidelines. During 1996, the Company determined that the use of field-underwritten policies needed to be curtailed for a significant number of products typically sold by this sales force. To the extent similar products are sold, the products are now primarily underwritten in the home office. Such action was instituted by management to help curb rising loss ratios in Instant Issue products.
Special Services. Instant Issue policyholders are a significant source of leads for the Special Services Division. A Special Services agent visits the policyholder's residence to collect renewal premiums on products purchased for the Instant Issue Division. The sales agent also delivers a standardized sales presentation on more comprehensive and higher premium policies. These policies either provide scheduled payments to insureds who are required to be hospitalized as the result of accident or sickness or, less frequently scheduled payments to insureds who are disabled and unable to work as a result of accident or sickness.
Individual Life. Existing policyholders are the primary source of leads for the Individual Life Division, which sells life products. The Company has worked to restructure this division, expand its product portfolio and aggressively recruit new agents. New product offerings include universal life products and term life products which have been widely accepted by the Penn Life sales force.
The Penn Life sales force is made up of approximately 1,000 agents who produce business annually. The following table sets forth information regarding the Career Sales Division:
Penn Life is continually striving to develop a core group of agents with proven ability to produce and service new business. The focus on a strong core group of agents has allowed the Company to increase productivity without a related incremental increase in agent overhead expenses.
The revenue earned by the career sales distribution system by product type is shown below:
The percentage of Career Sales Division revenue to the Company's total insurance operations revenue by product type is shown below:
Payroll Sales Division
The Payroll Sales Division includes marketing units of Professional, AA Life and OLIC. Each of the marketing units is divided into regions utilizing a hierarchical approach to managing the sales representative. Additionally, AA Life and OLIC also utilize field marketing directors and independent marketing organizations to access potential policyholders. During 1997, the Company formed Occidental Benefit Services, Inc. ("OBSI"). OBSI maintains relationships with senior industry producers who have access to a broad array of large payroll accounts (average employee base in excess of 1,000). OBSI forms joint venture relationships with the producers or employers in order to access large accounts. During 1997, OBSI formed its first such relationship resulting in access to an 18,000 person employee group in the southeastern United States.
The Payroll Sales Division markets products solely through the channels of employer-sponsored payroll deduction or government-sponsored allotment programs. Under those programs, the agent is permitted by the employer to meet on the employer's premises with its employees and to make both group and individual presentations implicitly endorsed by the employer concerning available products. If an employee elects to purchase a policy, arrangements are made with the employer to deduct the premiums from the employee's wages. The employer therefore is able to provide its employees with insurance benefits without incurring any premium costs. The Company's billing system can be integrated into the employer's payroll system without additional cost to the employer, a feature that facilitates the Company's access to employees of businesses that have not previously participated in payroll deduction programs.
The following tables set forth information regarding the Payroll Sales Division:
The revenue earned by the Payroll Sales Division by product type is shown below:
The percentage of the Payroll Sales Division revenue to the Company's total insurance operations revenue by insurance product is shown below:
Financial Services Division
The Financial Services Division includes marketing units of Integon Life and United Life and on a pro forma basis, Southwestern Life. The Financial Services Division markets products to individual customers through leads developed over time. This division utilizes field marketing directors, affiliations with independent marketing organizations, financial institutions and financial planners to reach its customer base.
The sales agents for this division often make sales presentations on a one-on-one basis with potential prospects. Sales representatives are often faced with competition from other agents and/or products from other companies.
The following tables set forth information regarding the Financial Services Division.
The revenue earned by the Financial Services Division by product type is shown below:
The percentage of the Financial Services Division revenue to the Company's total insurance operations revenue by insurance product is shown below:
PRODUCTS
General
The Company's products generally are small premium policies with defined fixed benefits or low face amount life insurance policies, each of which demonstrate stable risk characteristics. The Company's more recent acquisitions of Integon Life and United Life added a portfolio of accumulation products for which the Company actively manages pricing spreads. The acquisition of SW Financial substantially expands the Company's fixed benefit and interest sensitive life product portfolios and, to a lesser extent, accumulation products.
Product profitability is achieved through a pricing policy that is based upon conservative actuarial assumptions which take into account the underwriting risks associated with the product being sold, including lapse rates, mortality, morbidity and whether the product is underwritten in the field or by the home office, as well as the administrative expenses associated with the business. The Company, on an ongoing basis, evaluates new products for use by its sales forces.
The Company believes that, because of the characteristics of the market it serves and the nature of its products, the lapse rates for its products, although stable, tend to be higher than those experienced by other life and health insurance companies that operate in more affluent markets. The Company prices its products to reflect these higher lapse rates. To encourage policyholders to maintain their coverages with the Company, fixed benefit products generally incorporate a small fixed annual increase in benefits. Early surrender of accumulation and life products is discouraged by either their low rate of accumulation of cash values or by high surrender charges.
Fixed Benefit Products
Fixed benefit products are sold in large volume and are characterized by low average annual premiums. These products provide one or more of three principal types of benefits: (i) fixed periodic payments to an insured who becomes disabled and unable to work because of an accident and/or sickness, (ii) fixed periodic payments to an insured who becomes hospitalized, and (iii) fixed single payments that vary in amount generally for specified surgical or diagnostic procedures. Because the benefits are fixed in amount at the time of policy issuance and are not intended to provide reimbursement for medical and hospital expenses, payment amounts are not affected by inflation or the rising cost of health care services. Fixed benefit products, primarily those covering inability to work due to an accident, provide payments while the insured is disabled and unable to work, subject to the terms and conditions of the applicable policy. Fixed benefit products under which payments are made to insureds who are disabled and unable to work may be purchased with coverage for either (i) specified types of accidents, (ii) all other types of accidents, or (iii) a combination of accident and sickness. The Company's practice is to sell products that together with other similar coverages, do not provide monthly benefits in excess of $2,000 or 75% of the insured's income, if less.
Certain fixed benefit products, primarily those covering hospitalization due to sickness, provide payments during the period the insured is hospitalized. Most of the Company's fixed benefit products also provide additional fixed periodic payments to an insured who becomes hospitalized. Payments under these products are not designed to cover the actual costs of the insured's hospital stay, but merely to provide the insured with a means of paying supplemental expenses during the
hospitalization period. The Company's practice is to provide hospitalization benefits of not more than $250 per day ($1,000 if the insured requires intensive care treatment).
The accident and sickness policies also may be purchased with riders providing for fixed single payments that vary in amount generally for various surgical and diagnostic procedures. The Company's practice is to sell riders that do not provide benefit payments in excess of $5,000. If the covered procedure is performed on an out-patient basis, the insured receives one-half of the scheduled payment.
The acquisition of SW Financial expanded the Company's fixed benefits products to include long term care and medicare supplement policies. Union Bankers medicare supplement policies provide Medicare enrollees with coverage for certain medical expenses not paid in full by Medicare. In addition, Union Bankers historically marketed non-fixed benefit products such as individual major medical coverage and Preferred Provider Options ("PPO"). Subsequent to acquisition by the Company, Union Bankers has stopped accepting major medical and PPO applications, but continues to process renewals.
Life Insurance Products
Of the policy revenues attributable to life products, approximately 51.7% are related to interest sensitive life insurance policies and the remainder are related to traditional term and whole life insurance policies.
The Company designs its interest sensitive life insurance policies to avoid the early accumulation of cash values and to discourage early surrenders or terminations by imposing relatively high average surrender charges. This is done to reduce the risk of the Company's insurance subsidiaries having to liquidate investment assets to meet a liquidity demand resulting from the surrender of large numbers of life insurance policies. In addition to the basic policies, policyholders also may purchase accidental death, waiver of premium and annuity riders. The average face amount of the life insurance policies in force at December 31, 1997 was $50,100.
Accumulation Products
For policyholders seeking a convenient investment vehicle for their excess funds, the Company offers single premium deferred annuities, flexible premium deferred annuities and variable annuity products. Historically, the Company had not actively marketed accumulation products.
The acquisition of United Life provided the Company with its first platform to actively market accumulation products. Prior to its acquisition by PennCorp, Integon Life ceased marketing various annuity products as a result of changes in its ratings and financial performance.
As of December 31, 1997, the Company maintained annuity reserves aggregating $1,458.7 million at an average credited rate of interest of 5.4%. Of the $1,458.7 million of annuity reserves, approximately 48.7% were subject to surrender charges averaging 5% or more of the contractholder's account balance.
INSURANCE UNDERWRITING
Prior to 1996, most of the products offered by the instant issue sales forces, primarily accident only products, were field underwritten. Beginning in 1996, for nearly all fixed benefit products, the underwriting practice of the Company allows the home office underwriting staff to review each applicant's written application for insurance and, if applicable, an attending physician's report. In some circumstances, the Company will require a more complete medical history before issuing a policy, which may be issued with exclusionary riders. The Company's current practice is not to issue fixed benefit products to individuals in substandard risk classes to the extent permitted by law.
In general, the Company permits simplified underwriting of life products, unless the amount of requested coverage is greater than specified levels between $25,000 and $100,000, depending on the age of the applicant. If full underwriting is required, the Company reviews the policy application and an attending physician's report and may require a paramedical
examination or complete physical examination depending on the age of the applicant and the amount of coverage requested. If the total amount of coverage applied for plus any coverage in force with the Company exceeds $100,000, a prospective policyholder must submit a screening for antibodies related to Acquired Immune Deficiency Syndrome ("AIDS") , to the extent permitted by law. The life products are specifically designed and priced for the mortality risks associated with the Company's simplified underwriting procedures.
Although the increasing incidence of AIDS is expected to affect mortality adversely for the life insurance industry as a whole, the Company believes that the impact of AIDS on its operations should not be material due to the small average size of the life insurance policies sold. The Company requires and considers AIDS information to the fullest extent permitted by law in underwriting and pricing decisions. During the twelve months ended December 31, 1997, 1996 and 1995, the Company estimated it paid approximately $2.1 million, $3.2 million and $1.9 million, respectively in death benefits (representing less than 3.2% of total death benefits paid by the Company during each such period) under individual life policies due to deaths believed by the Company to be AIDS-related.
INVESTMENT PORTFOLIO
The Company's investment portfolio is managed with the objectives of maintaining high credit quality and liquidity, maximizing current income within acceptable levels of risk, minimizing market and credit risk and matching the anticipated maturities of investments to the Company's liabilities. To achieve these objectives, the portfolio consists primarily of United States and Canadian government and investment-grade fixed maturity securities, which together with high quality short-term investments accounted for approximately 78.4% and 79.7% of the Company's total invested assets at December 31, 1997 and 1996, respectively. The Company believes that the nature of its fixed benefit products, which have no inflation risk, and its life products, which limit the early accumulation of cash values, permit it to utilize this conservative investment strategy.
At December 31, 1997, 54.1% of the Company's fixed maturity bonds were rated AA or higher by Standard & Poor's and approximately 92.5% were rated BBB or higher by Standard & Poor's, respectively. All dollar amounts or percentages set forth in this discussion are based on carrying value unless otherwise indicated.
Other than issues of the United States and Canadian governments and government agencies and authorities, no single issuer represented more than 0.1% of total invested assets at December 31, 1997.
The following table summarizes the Company's investments as of December 31, 1997:
The following table summarizes the Company's investments, as of December 31, 1997, and includes SW Financial on a pro forma basis:
The table set forth below indicates the composition of the Company's fixed maturity portfolio by rating as of December 31, 1997:
The following table reflects investment results for the Company for each of the periods indicated.
The Company's investments must comply with the insurance laws of the states in which its insurance subsidiaries are domiciled and in which they are licensed as well as applicable provisions of the Company's 9 1/4% Senior Subordinated Notes due 2003. These laws and provisions prescribe the kind, quality and concentration of investments that may be made by the Company and/or its insurance subsidiaries.
REINSURANCE
In keeping with industry practice, the Company reinsures portions of its life insurance exposure with unaffiliated insurance companies under traditional indemnity reinsurance agreements. New insurance sales are reinsured above prescribed limits and do not require the reinsurer's prior approval under contracts that are renewable on an annual basis. Generally, the Company enters into indemnity reinsurance arrangements to assist in diversifying its risk and to limit its maximum loss on risks that exceed the Company's policy retention limits ranging from $25,000 to $500,000 per life, depending on insurer issue age, the product type and each subsidiary's historical practice. Generally, accidental death benefits in excess of $50,000 per life are reinsured on a bulk basis. Indemnity reinsurance does not fully discharge the Company's obligation to pay policy claims on the reinsured business. The ceding insurer remains responsible for policy claims to the extent the reinsurer fails to pay such claims. At no time during the past ten years has any present reinsurer of any continuing block of business ceded by any of the Company's insurance company subsidiaries failed to pay any policy claims with respect to such ceded business. At December 31, 1997 and 1996, of the approximately $24.6 billion and $31.5 billion of life insurance in force, approximately $4.4 billion and $5.9 billion had been ceded to reinsurers, respectively. As of December 31, 1997 the Company's principal reinsurers are Transamerica Occidental Life Insurance Company, Reassurance Company of Hanover, Cologne Life Reinsurance Co., Life Reassurance Corp. of America, Worldwide Assurance Company, Ltd., Lincoln National Life Insurance Company, Swiss Re Life & Health Insurance Company, Allianz Life Insurance Company and Phoenix Home Life Mutual Insurance Company, which collectively have reinsured approximately 66.8% of the ceded business.
YEAR 2000 ISSUES
Many computer and software programs were designed to accommodate only two digit fields to represent a given year (e.g. "97" represents 1997). It is highly likely that such systems will not be able to accurately process data containing date information for the year 2000 and beyond. The year 2000 issue has the potential to affect the Company and its subsidiaries through the disruption of the processing of business both internally and between the Company and other businesses with which it interacts.
To address the impacts of the year 2000 on its businesses, the Company has initiated a formal year 2000 assessment and remediation effort to identify and correct concerns relating to both the Company's own processing and the processing
activities for which the Company is dependent upon its business partners. The Company has engaged certain outside vendors and focused certain employees full time efforts to help in the full array of its year 2000 initiative. This includes systems assessment and monitoring advice, actual code remediation, communication and consultation with critical business partners and additional data center and testing resources. During 1997, the Company incurred approximately $1.9 million of cost associated with year 2000 compliance work. Nearly all such costs were associated with outside contractors and advisors. Over the next two years, the Company expects to incur internal and external costs associated with such expertise ranging from $9.3 million to $14.9 million, which are likely to be incurred primarily during 1998 and early 1999, and which represents approximately 25% of the Company's technology costs. Of the total range of estimated costs the Company anticipates approximately 42% of the costs to be internal allocation of resources.
Each of the operating divisions is primarily responsible for its remediation efforts with corporate oversight provided as necessary. The Company believes that the Career Sales Division has substantially completed its year 2000 assessment and remediation efforts, which will be subject to ongoing tests for the remainder of 1998. The Payroll Sales Division has completed the remediation of its largest administrative platforms, except for AA Life, and anticipates successful remediation and testing of the remaining sub-system and system interfaces during 1998. AA Life is in the process of upgrading its policy administration system to a year 2000 compliant version. AA Life will rely on contracted vendor resources in working to complete its upgrade process. The Company's Financial Services Division has only recently begun its year 2000 remediation efforts. Those efforts are dependent on the utilization of outside resources. The Company believes that the Financial Services Division has contracted with sufficient resources to be able to remediate its essential business systems. In addition, Union Bankers has committed to a strategy of utilizing third party administrative experts, who have indicated year 2000 compliance, to handle the processing of its health insurance business, thus eliminating the need for the upgrade or modification of certain existing health administration systems.
Although the Company believes that its operating divisions, outside vendors and most critical business partners will be sufficiently compliant that the year 2000 issue should not cause a material disruption in the Company's business, there can be no assurance that there will not be material disruptions to the Company's business or an increase in the cost of the Company doing business. Although the Company believes that the year 2000 issues should not cause a material disruption in the Company's business, the Company is currently evaluating various contingency plans associated with remediation tasks which the Company believes are at a higher risk for potential failure.
COMPETITION
The accident and health and life insurance industry is highly competitive. PennCorp competes with many insurance companies and insurance holding company systems that have substantially greater capital and surplus, higher A.M. Best Company ("A.M. Best") ratings, larger and more diversified product portfolios, and access to larger agency sales forces. In the United States, there are more than 1,700 life and accident and health insurance companies, most of which compete in the states in which PennCorp conducts business.
Private insurers and voluntary and cooperative plans, such as Blue Cross and Blue Shield, provide insurance for meeting hospitalization and medical expenses. Much of this insurance is sold on a group basis. The federal and state governments also pay substantial costs of medical treatment through Medicare and Medicaid programs. Such major medical insurance generally covers a substantial amount of the medical (but not non-medical) expenses incurred by an insured as a result of major illnesses. PennCorp's fixed benefit products policies are designed to provide coverage which is supplemental to that provided by major medical insurance and may also be used to defray non-medical expenses.
PennCorp's supplemental insurance is not an alternative to major medical insurance, but is sold to complement major medical insurance by covering the gap between major medical insurance reimbursements and the total costs of an individual's health-care expense.
Thus, the Company competes directly with other insurers offering supplemental health insurance and believes that its current policies and premium rates are generally competitive with those offered by other companies selling similar types of insurance. Management believes that the Company's product and market focuses are not widespread in the insurance industry and that it generally does not face direct competition from major national insurers, although the Company
experiences competition from smaller, regional insurance companies. Management also believes that few major national insurers compete directly in the sale of fixed benefit products and life products to the primary market sub segments to which the Company is focused.
The Company's expansion of its product line to include a higher percentage of life and accumulation product revenue as compared to total revenue has resulted in a broadening of the markets in which the Company faces competition. The sale of life insurance products, and to a greater extent, the sale of accumulation products is very sensitive to an organization's A.M. Best rating, its size and perceived financial strength and the competitiveness and the financial performance of the products themselves. Like the market focus of its fixed benefit products, the Company believes that its target market is not widely served by many of the large, national insurers, but does face direct competition from smaller regional and niche-market focused companies.
REGULATORY MATTERS
Life insurance companies are subject to regulation and supervision by the states in which they transact business. The laws of the various states establish regulatory agencies with broad administrative and supervisory powers related to, among other things, granting and revoking licenses to transact business, regulating trade practices, establishing guaranty associations, licensing agents, approving policy forms, filing premium rates on certain business, setting reserve requirements, determining the form and content of required financial statements, determining the reasonableness and adequacy of capital and surplus and prescribing the type of permitted investments and the maximum concentrations of certain classes of investments. The Company's insurance subsidiaries are subject to periodic examinations by state regulatory authorities.
During 1997, six of the Company's insurance subsidiaries were subject to financial triennial examinations. Final examination reports issued by the Departments of Insurance for North Carolina and Pennsylvania resulted in a decrease in the statutory capital and surplus of approximately $37.1 million (after giving effect to certain timing differences) and requests for certain remedial action plans which the Company has filed with the respective Departments of Insurance. The most significant adjustments related to: (i) the disallowance of certain reinsurance credits, (ii) reserve strengthening and (iii) issues of timing of recognition of certain valuation issues that the Company's insurance subsidiaries reflected in their 1997 statutory statements that were deemed by the examination teams to relate to periods prior to 1997. The Company does not expect such examination reports to have a material impact on the Company's results of operations. During 1998, the Company expects United Life, and all of the Company's Texas domiciled insurance subsidiaries to be subject to examination in the normal course of exam scheduling.
Most states have enacted legislation regulating insurance holding company systems, including acquisitions of control of insurance companies, dividends, the terms of surplus debentures, the terms of transactions with affiliates, investments in subsidiaries and other related matters. Regulatory restrictions on investments in subsidiaries and affiliates requires the Company to continually review and occasionally modify or restructure the insurance subsidiaries within the insurance holding company system. The Company has ongoing dialogues with the applicable state insurance departments regarding this issue. The Company is registered as an insurance holding company system in Louisiana, North Carolina, Pennsylvania and Texas, (the domiciliary states of its insurance companies), and routinely reports to other jurisdictions in which its insurance subsidiaries are licensed.
There continues to be substantial scrutiny of the insurance regulatory framework, and a number of state legislatures have enacted legislative proposals that alter, and in many cases increase, state authority to regulate insurance companies and their holding company systems. The National Association of Insurance Commissioners ("NAIC") and state insurance regulators also have become involved in a process of re-examining existing laws and regulations and their application to insurance companies. In particular, this re-examination has focused on insurance company investment and solvency issues and, in some instances, has resulted in new interpretations of existing law, the development of new laws and the implementation of internal guidelines. The NAIC has formed committees to study and formulate regulatory proposals on such diverse issues as the use of surplus debentures, accounting for reinsurance transactions, assumption reinsurance, valuation of securities, the adoption of risk-based capital rules, the codification of Statutory Accounting Principles, and the regulation of various products offered by insurance companies.
In connection with its accreditation of states to conduct periodic insurance company examinations, the NAIC has encouraged states to adopt model NAIC laws on specific topics, such as holding company regulations and the definition of extraordinary dividends. Model legislation proposed by the NAIC to control the amount of dividends that may be paid by insurance companies without prior regulatory approval has been adopted in most states and is being considered by the legislatures of the other states. As of the date hereof, Louisiana (United Life's domiciliary state) has adopted the NAIC's most restrictive dividend test. Pennsylvania (Penn Life's domiciliary state), Texas (Pacific Life & Accident Insurance Company's ("PLAIC") AA Life's, Professional's, Integon Life's, OLIC's, Southwestern Life's and Union Bankers' domiciliary state), have adopted dividend tests that are substantially similar to that of the NAIC's model legislation, though less restrictive than that of Louisiana. Most states only allow dividends to be paid out of unassigned funds.
A dividend may be paid by PLIC if the amount of such dividend together with all dividends made in the preceding twelve months does not exceed the greater of: (i) 10% of its statutory surplus as of the end of the prior calendar year or (ii) its net income for the prior calendar year. Any dividend above the prescribed amount is an "extraordinary" dividend, and a Pennsylvania insurer may not pay an "extraordinary" dividend to its stockholders until the earlier of: (i) 30 days after the Pennsylvania Insurance Commissioner has received written notice of the declaration thereof and has not within such period disapproved such payment, or (ii) the receipt of approval from the Pennsylvania Insurance Commissioner.
Texas law permits PLAIC, AA Life, Professional, Integon Life, OLIC, Southwestern Life and Union Bankers to pay a dividend without prior consent of the Texas Insurance Commissioner if the amount paid, together with all other dividends paid in the preceding 12 months, does not exceed the greater of: (i) 10% of such insurer's surplus as regards to policyholders as of the 31st day of December next preceding, or (ii) the net gain from operations of such insurer for the 12 month period ending the 31st day of December next preceding. Any dividend above this amount would be considered an "extraordinary" dividend and could not be paid until the earlier of: (i) 30 days after the Texas Insurance Commissioner has received notice of the declaration thereof and has not within such period disapproved such payment, or (ii) the Texas Insurance Commissioner shall have approved such payment within the 30 day period.
Louisiana law permits United Life to pay a dividend without prior consent of the Louisiana Insurance Commissioner if the amount paid, together with all other dividends paid in the preceding 12 months, does not exceed the lesser of: (i) 10% of such insurer's surplus as regards to policyholders as of the 31st day of December next preceding, or (ii) the insurer's net gain from operations, not including realized capital gains, for the 12 month period ending the 31st day of December next preceding. Any dividend above this amount would be considered an "extraordinary" dividend and could not be paid until the earlier of: (i) 30 days after the Louisiana Insurance Commissioner has received notice of the declaration thereof and has not within such period disapproved such payment, or (ii) the receipt of approval from the Louisiana Insurance Commissioner. As part of its July 1996 approval of the Company's acquisition of United Life, the Louisiana Insurance Commissioner approved a dividend plan for United Life pursuant to which United Life may pay a specified amount of dividends for each of the five years following the acquisition, beginning in 1997, amounting to the lesser of the pro forma dividend amounts in such plan or the actual earnings of United Life, and conditioned on United Life maintaining a risk-based capital of at least 300% authorized control level.
On the basis of 1997 statutory financial statements filed with the state insurance regulators, the NAIC calculates twelve financial ratios to assist state regulators in monitoring the financial condition of insurance companies. A "usual range" of results for each ratio is used as a benchmark. Departure from the usual range on four or more of the ratios could lead to inquiries from individual state insurance departments. PLAIC had three ratios and Pioneer Security had two ratios outside of the usual range established by the NAIC. PLAIC and Pioneer Security are primarily holding companies for their principal assets, being the common stock of certain of the Company's insurance subsidiaries. Integon Life had none of the twelve ratios outside of the usual range. PLIC had three of the twelve ratios outside of the usual range, while OLIC had four and Peninsular had two, Professional had two, American-Amicable had none, Pioneer American had none and United Life had none of the twelve ratios outside of the usual ranges. PLIC's variances were caused primarily as a result of examination adjustments required by the Pennsylvania Department of Insurance. Remedial action was taken by the Company in 1997 and 1998. Professional's variances were caused primarily as a result of statutory losses. OLIC's and Peninsular's variances were caused primarily as a result of increased reinsurance between these two companies. Southwestern Life had no ratios, Union Bankers had three ratios, Marquette National had three ratios and Constitution had three ratios outside the usual ranges.
In the past, variances in the insurance companies' ratios have resulted in inquiries from insurance departments to which the Company has responded. The Company may receive inquiries from certain insurance departments concerning its ratio results for 1997, and there can be no assurance that such insurance departments will not take action against the insurance companies.
In December 1992, the NAIC adopted the Risk-Based Capital for Life and/or Health Insurers Model Act (the "Model Act"). The main purpose of the Model Act is to provide a tool for insurance regulators to evaluate the capital of insurers with respect to the risks assumed by them and determine whether there is a need for possible corrective action with respect to them. To date, either the Model Act or similar legislation or regulation has been adopted in all the domiciliary states of the Company's insurance subsidiaries.
The Model Act provides for four different levels of regulatory action with respect to statutory financial statements for the calendar year 1994 and thereafter, each of which may be triggered if an insurer's Total Adjusted Capital (as defined in the Model Act) is less than a corresponding "level" of risk-based capital ("RBC"). The "Company Action Level" is triggered if an insurer's Total Adjusted Capital is less than 200.0% of its "Authorized Control Level RBC" (as defined in the Model Act) or less than 250.0% of its Authorized Control Level RBC and the insurer has a negative trend. At the Company Action Level, the insurer must submit a comprehensive plan to the regulatory authority which discusses proposed corrective actions to improve its capital position. The "Regulatory Action Level" is triggered if an insurer's Total Adjusted Capital is less than 150.0% of its Authorized Control Level RBC. At the Regulatory Action Level, the regulatory authority will perform a special examination of the insurer and issue an order specifying corrective actions that must be followed. The "Authorized Control Level" is triggered if an insurer's Total Adjusted Capital is less than 100.0% of its Authorized Control Level RBC, and at that level the regulatory authority is authorized (although not mandated) to take regulatory control of the insurer. The "Mandatory Control Level" is triggered if an insurer's Total Adjusted Capital is less than 70.0% of its Authorized Control Level RBC, and at that level the regulatory authority must take regulatory control of the insurer. Regulatory control may lead to rehabilitation or liquidation of an insurer.
Calculations using the NAIC formula and the life insurance subsidiaries' statutory financial statements as of December 31, 1997, indicate that each of the insurance subsidiaries' capital substantially exceeded RBC requirements.
Certain licenses of the Company's insurance company subsidiaries are subject to limits on the amount of new business that may be written in various states. Of these license restrictions, most were imposed prior to the acquisition of the relevant insurance subsidiary by PennCorp, or relate to events occurring prior to those acquisitions. These license restrictions have not had a material adverse effect on the Company's results of operations and are not expected to have a material adverse effect in the future. In some states, a license restriction, suspension or revocation by another state may result in reciprocal regulatory action.
The Company may be required, under the solvency or guaranty laws of most states in which it does business, to pay assessments (up to certain prescribed limits) to fund policyholder losses or liabilities of insurance companies that become insolvent. Recent insolvencies of insurance companies increase the possibility that such assessments may be required. These assessments may be deferred or forgiven under most guaranty laws if they would threaten an insurer's financial strength and, in certain instances, may be offset against future premium taxes. The occurrence and amount of such assessments have increased in recent years and generally are expected to increase in future years. The Company paid approximately $2.5 million, $2.6 million and $1.7 million for the years ended December 31, 1997, 1996 and 1995, respectively, as a result of such assessments. The likelihood and amount of any other future assessments cannot be estimated and are beyond the control of the Company.
Although the federal government does not directly regulate the business of insurance, federal legislation and administrative policies in several areas, including pension regulation, age and sex discrimination, financial services regulation and federal taxation can significantly affect the insurance business.
In addition, there were proposals under consideration since 1994 at the federal and state levels regarding reforms to the health care system in the United States. Although these proposals were not adopted at the federal level, many states have adopted some form of health care reform since then. These reforms have focused on the increasing cost of health care
and insurance plans that reimburse insureds or health care providers for medical and related costs. Because the Company's fixed benefit products provide supplemental income payments directly to the insured and are not designed to reimburse health care providers, the Company does not expect such reforms to have a material adverse effect on its business.
There can be no assurance that existing insurance-related laws and regulations will not become more restrictive in the future and thereby have a material adverse effect on the operations of the Company and on the ability of the insurance companies to pay dividends or on the ability of PLAIC, Pioneer Security and Constitution Life Insurance Company ("Constitution") to make payments on their respective surplus debentures. For further information related to said surplus debentures, see "Management's Discussion and Analysis of Results of Operations and Financial Condition--Financial Condition, Liquidity and Capital Resources--Surplus Debentures and Dividend Restrictions" and Note 13 of "Notes to Consolidated Financial Statements."
RATINGS
A.M. Best assigns fifteen letter ratings to insurance companies, with the highest being "A++ (Superior)." A.M. Best ratings are based upon factors relevant to policyholders and are not directed toward the protection of investors, such as holders of the Common Stock. AA Life and United Life carry an "A- (Excellent)" rating from A. M. Best. An "A- (Excellent)" rating is the fourth highest letter rating. Professional, OLIC, Integon Life, Southwestern Life, Union Bankers, Constitution and PLIC carry a "B++ (Very Good)" rating from A.M. Best. A "B++ (Very Good)" rating is the fifth highest letter rating. A.M. Best also has a "Not Assigned" category, which contains nine classifications for companies not assigned or not eligible for an A.M. Best rating. The A.M. Best rating for Peninsular is "NA-9," which is a "no rating at the company's request." This classification was requested by the prior owner of Peninsular. The Company does not intend to seek a letter rating at this time for Peninsular from A.M. Best as Peninsular is not currently a direct writer of insurance products.
Item 2.
Item 2. Properties
FACILITIES
The Company's primary administrative offices are located in Raleigh, North Carolina and Dallas, Texas. The Company owns and occupies a home office facility comprising approximately 165,000 rentable square feet, in Raleigh, North Carolina. The Company subleases a portion of its prior Raleigh home office facility which has a lease term expiring in 1999 and requires annual lease payments of approximately $1.1 million.
The Company leases approximately 100 offices throughout its sales territories and has a separate Canadian business office facility that includes office and storage space. SFSC leases approximately 125,000 square feet in Dallas, Texas. American-Amicable owns its home office facility in Waco, Texas and United Life leases office space in Baton Rouge, Louisiana. In addition, the Company leases office space for its holding company operations in Bethesda, Maryland and New York City. The Company believes that the current makeup of its properties is adequate for its operations and, based on its recent experience, that it will be able to find suitable replacement properties on acceptable terms for any properties the Company chooses to replace or for which leases are terminated or not renewed.
Item 3.
Item 3. Legal Proceedings
In January 1996, stockholder derivative lawsuits styled Tozour Energy Systems Retirement Plan v. David J. Stone et al. and PennCorp Financial Group, Inc., C.A. No. 14775 and Lois Miller v. David J. Stone et al. and PennCorp Financial Group, Inc., C.A. No. 14795 were filed against the Company and each of its directors, individually, in the Delaware Court of Chancery. The complaint in the Miller suit has not yet been served on the Company or the other defendants. Both suits allege that the SW Financial investment involved the usurpation of a corporate opportunity and a waste of the Company's assets by Messrs. Stone and Fickes, and that the directors of the Company in approving that transaction, failed to act in good faith and breached their fiduciary duties, including the duty of loyalty to the Company and its stockholders, having favored the interests of Messrs. Stone and Fickes over the Company and its stockholders. These lawsuits seek judgments against each of the defendants for the amount of damages sustained or to be sustained by the Company as a result of the breaches of
fiduciary duty alleged in the complaint, the imposition of a constructive trust for the benefit of the Company on profits or benefits obtained by any defendant through the alleged breaches of fiduciary duty, attorney's fees and costs, and such other relief as the court determines to be just, proper or equitable.
The defendants in the Tozour Case have filed a motion seeking its dismissal on the ground that the plaintiff failed to comply with the requirements of Delaware law before instituting a derivative suit and intend to defend the lawsuit vigorously. Because the Company has not been served with the Miller complaint, no action has been taken in that case, although the Company would also defend it vigorously. The defendants believe, however, that it would not be in the best interests of the Company and its shareholders to expend considerable management and director time and to incur substantial expenses to litigate the actions. Consequently, the Company's legal advisors have met or spoken by telephone with the plaintiff's counsel on several occasions to discuss the terms of a potential settlement.
The defendants and the plaintiffs' counsel entered into a stipulation of settlement on March 28, 1997 (the "Original Proposed Settlement"). The Original Proposed Settlement consisted of the following principal elements: (i) Messrs. Stone and Fickes will cancel the 335,564 SW Financial common stock warrants they hold for no consideration enabling PennCorp to purchase the SW Financial Controlling Interest for $67.5 million, reducing the price to be paid by PennCorp for the SW Financial Controlling Interest by approximately $2.0 million, (ii) the PennCorp Board will proceed with the purchase of The Fickes and Stone Knightsbridge Interests, having received a fairness opinion of a nationally recognized investment banking firm with respect to the price to be paid for The Fickes and Stone Knightsbridge Interests, (iii) the PennCorp Board will proceed with the acquisition of the SW Financial Controlling Interest, having received a fairness opinion of a nationally recognized investment banking firm with respect to the price to be paid for the SW Financial Controlling Interest, (iv) the PennCorp Board will submit the purchases of The Fickes and Stone Knightsbridge Interests and the SW Financial Controlling Interest to a shareholder vote of a majority of the PennCorp stockholders present at a meeting and entitled to vote, and stockholders must approve both transactions, (v) Messrs. Stone and Fickes will abstain from voting on the proposals to approve the purchase of The Fickes and Stone Knightsbridge Interests and the SW Financial Controlling Interest, and (vi) the plaintiffs' counsel will be entitled to conduct confirmatory discovery.
On December 1, 1997, the defendants and the plaintiffs' counsel agreed in principle to amend the Original Proposed Settlement (as so amended, the "Amended Proposed Settlement") following the PennCorp Board's conclusion that it would be appropriate to increase the amount paid to the Knightsbridge Fund for the SW Financial Controlling Interest to compensate the limited partners for, among other things, the unexpected and substantial delay in the consummation of the purchase of the SW Financial Controlling Interest. The terms of the Amended Proposed Settlement are identical to the terms of the Original Proposed Settlement, except that the Amended Proposed Settlement provides that the Company will acquire the SW Financial Controlling Interest for $73.8 million, and will provide a one-time "price protection" payment associated with a disposition of the SW Financial Controlling Interest by PennCorp during the 12-month period ending November 25, 1998. The Amended Proposed Settlement also requires Messrs. Stone and Fickes to grant PennCorp a price protection right in the event of a sale of their Portsmouth investment.
The Amended Proposed Settlement is subject to approval by the Chancery Court after notice to PennCorp stockholders. A settlement hearing in the Court of Chancery is scheduled for May 12, 1998. Messrs. Stone and Fickes have agreed that, if the Amended Proposed Settlement is approved by the Chancery Court, they will cancel their SW Financial common stock warrants and they will not participate in the increased consideration (other than the possible price protection right) for the SW Financial Controlling Interest to the extent it relates to their $7.0 million personal investment in SW Financial, which together will reduce the price to be paid by PennCorp for the SW Financial Controlling Interest by approximately $3.7 million. Because the Knightsbridge restructuring will have the effect of substantially eliminating potential future conflicts of interest between Messrs. Stone and Fickes and PennCorp, and because the Amended Proposed Settlement will have the effect of reducing the price to be paid for the SW Financial Controlling Interest and will obviate the need to expend considerable management and director time to litigate the actions, the PennCorp Board has determined that the Amended Proposed Settlement is in the best interests of PennCorp and its shareholders and confers a substantial economic benefit on PennCorp. Accordingly, the PennCorp Board has authorized the payment to plaintiffs' counsel of legal fees of $785,000 and documented expenses not to exceed $50,000 in connection with the lawsuits and the related settlement
negotiations, if the Amended Proposed Settlement is approved by the Delaware Chancery Court after notice to PennCorp stockholders. The Company has accrued $835,000 for such costs as of December 31, 1997.
The Company is a party to various pending or threatened legal actions arising in the ordinary course of business some of which include allegations of insufficient policy illustrations and agent misrepresentations. Although the outcome of such actions is not presently determinable, management does not believe that such matters, individually or in the aggregate, would have a material adverse effect on the Company's financial position or results of operations if resolved against the Company.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
The Company held its Annual Meeting of Shareholders on December 31, 1997.
1. The election of three Class II Directors, each to hold office for a three year term expiring at the 2000 annual meeting of shareholders and/or until such director's successor shall be elected and qualified.
VOTING - -------------------------------------------------------------------------------- NUMBER OF NUMBER OF NUMBER OF SHARES BROKER SHARES FOR WITHHELD NON-VOTES ---------- -------- ---------
Allan D. Greenberg 21,980,530 448,648 0 Kenneth Roman 22,260,060 169,118 0 Maurice W. Slayton 22,260,068 169,110 0
2. The adoption of certain amendments to the Company's 1996 Stock Award and Stock Option Plan.
VOTING - -------------------------------------------------------------------------------- NUMBER OF NUMBER OF NUMBER OF NUMBER OF SHARES SHARES BROKER SHARES FOR AGAINST ABSTAINED NON-VOTES ---------- ------- --------- ---------
16,980,422 5,409,996 38,760 0
3. The adoption of an amendment to the Company's Second Restated Certificate of Incorporation increasing the number of its authorized shares of common stock from 50,000,000 to 100,000,000.
VOTING - -------------------------------------------------------------------------------- NUMBER OF NUMBER OF NUMBER OF NUMBER OF SHARES SHARES BROKER SHARES FOR AGAINST ABSTAINED NON-VOTES ---------- ------- --------- ---------
21,504,840 905,670 18,668 0
4. The adoption of an amendment to the Company's Second Restated Certificate of Incorporation to reduce the minimum required number of members constituting the Company's Board of Directors from nine to seven.
VOTING - -------------------------------------------------------------------------------- NUMBER OF NUMBER OF NUMBER OF NUMBER OF SHARES SHARES BROKER SHARES FOR AGAINST ABSTAINED NON-VOTES ---------- ------- --------- ---------
19,738,244 2,673,644 17,290 0
5. The approval of the purchase by the Company of The Fickes and Stone Knightsbridge Interests.
VOTING - -------------------------------------------------------------------------------- NUMBER OF NUMBER OF NUMBER OF NUMBER OF SHARES SHARES BROKER SHARES FOR AGAINST ABSTAINED NON-VOTES ---------- ------- --------- ---------
15,042,284 2,069,597 1,106,483 4,210,814
6. The approval of the purchase by the Company of all the outstanding common stock and common stock warrants of Southwestern Financial Corporation not already owned by the Company.
VOTING - -------------------------------------------------------------------------------- NUMBER OF NUMBER OF NUMBER OF NUMBER OF SHARES SHARES BROKER SHARES FOR AGAINST ABSTAINED NON-VOTES ---------- ------- --------- ---------
15,043,357 2,069,046 1,105,961 4,210,814
7. The approval of the adjournment of the Annual Meeting in the event there are not sufficient votes to approve the above proposals at the time of the Annual Meeting.
VOTING - -------------------------------------------------------------------------------- NUMBER OF NUMBER OF NUMBER OF NUMBER OF SHARES SHARES BROKER SHARES FOR AGAINST ABSTAINED NON-VOTES ---------- ------- --------- ---------
16,774,851 5,540,679 113,648 0
PART II
Item 5.
Item 5. Market for the Registrant's Common Equity and Related Shareholder Matters
MARKET FOR COMMON STOCK
The shares of PennCorp Financial Group, Inc. are listed on the New York Stock Exchange ("NYSE") under the ticker symbol "PFG." The following table sets forth for the calendar periods indicated, the high and low sales price per share of the Company's Common Stock as reported on the NYSE and the quarterly cash dividends declared on the Common Stock with respect to each quarter since January 1, 1996. The prices do not include mark-ups, mark-downs, or commissions. As of February 27, 1998, there are approximately 179 shareholders of record throughout the United States and abroad.
The price history as provided by NYSE and dividends for the years ended December 31, 1997 and 1996, are presented below:
(Remainder of Page Intentionally Left Blank)
Item 6.
Item 6. Selected Consolidated Financial Data
(In thousands, except per share amounts)
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
CAUTIONARY STATEMENT
Cautionary Statement for purposes of the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995. The statements below that relate to future plans, events or performances are forward-looking statements that involve a number of risks or uncertainties. Among those items that could adversely affect the Company's financial condition, results of operations and cash flows are the following: changes in regulations affecting insurance companies, interest rates, the federal income tax code (to the extent the Company's product mix includes tax deferred accumulation products), the ratings assigned to the Company's insurance subsidiaries by independent rating organizations such as A.M. Best Company ("A.M. Best") (which the Company believes are particularly important to the sale of annuity and other accumulation products) and unanticipated litigation. There can be no assurance that other factors not currently anticipated by management will not also materially and adversely affect the Company's results of operations.
GENERAL
The Company, through its operating subsidiaries, is a low cost provider of accumulation, life, and fixed benefit accident and sickness insurance products throughout the United States and Canada. The Company's products are sold through several distribution channels, including exclusive agents, general agents, financial institutions, and payroll deduction programs, and are targeted primarily to lower and middle-income individuals in rural and suburban areas. These products are primarily small premium accident and sickness insurance policies with defined fixed benefit amounts, traditional whole life and universal life insurance with low face amounts and accumulation products such as single premium deferred annuities.
The Company's financial condition and results of operations for the periods covered by this and future "Management's Discussion and Analysis of Financial Condition and Results of Operations" are or will be affected by several common factors, each of which is discussed below.
Strategic Review of Business Units. As a result of the tremendous growth the Company has experienced, the diversification of the underlying business units resulting from acquisitions over time, and the need for the Company to be able to rapidly integrate future acquisitions, the Company began a strategic business evaluation during the third quarter of 1996. The review resulted in the Company establishing three primary divisional platforms, Career Sales Division, Payroll Sales Division and Financial Services Division.
As a result, the Company began to realign its existing operating companies and incurred restructuring and period costs aggregating $21.4 million for the year ended December 31, 1997, directly associated with the initial divisional restructuring which will have no future economic benefit ("restructuring costs"), including the costs of employee termination benefits and relocation, early service contract termination, and facility abandonment.
In addition, on August 30, 1997 the merger agreement between Washington National Corporation ("Washington National") and the Company terminated. The Company incurred legal, accounting and financial advisory fees associated with the merger. In addition, the Company had begun to provide certain resources to Washington National including personnel to perform policy administration and claims processing function on Washington National's behalf. The aggregate advisory and administration costs incurred by the Company during 1997 were approximately $7.6 million.
On January 2, 1998, the Company acquired the Controlling Interest in SW Financial. As a result of such acquisition, the Company is able to complete its divisional restructuring which began in 1997. As a result of the Company's plans to consolidate certain of its operating locations and corporate functions, the Company expects to incur restructuring and certain other charges during 1998 not to exceed approximately $25.0 million.
On February 18, 1998, the Company announced that it had engaged investment banking firms to review strategic alternatives for maximizing shareholder value, including the sale of the Career Sales Division. The Company anticipates the disposition of the Career Sales Division within one year. See Note 19 of Notes to Consolidated Financial Statements.
Acquisitions. The Company's historical growth strategy has emphasized the acquisition of complementary insurance operations and the utilization of the Company's several distribution channels to further penetrate its target markets. In making acquisitions, the Company has sought to broaden its distribution channels, increase its product offerings and expand its geographic presence. The Company also seeks benefits from expense reduction through the consolidation of facilities and staff and the conversion to common administrative systems.
Each of the operating considerations outlined above as well as the cost of capital to the Company, expected cash flows from the target acquisition and actuarial factors, such as future premium, mortality, morbidity, surrenders, operating expenses and yields on assets held to back policy liabilities are considered and weighted in determining the relative risk of financial rewards for taking on the acquisition target.
On July 22, 1996, the Company acquired United Life & Annuity Insurance Company ("United Life") from United Companies Financial Corporation. United Life markets fixed and variable annuity products through independent agents and financial institution marketing channels.
On December 14, 1995, Southwestern Financial Corporation ("SW Financial"), a newly organized corporation formed by the Company and Knightsbridge (see Notes 15 and 16 to Notes to Consolidated Financial Statements), purchased Southwestern Life Insurance Company, Union Bankers Insurance Company and certain other related assets from I.C.H. Corporation for $260,000.
Through its initial direct investment of $120,000 in SW Financial (the "Southwestern Life Investment"), the Company beneficially owns 74.8% of SW Financial's outstanding common stock, including 100% of SW Financial's non-voting common stock, 14.3% of SW Financial's voting common stock, and 100% of SW Financial preferred stock. PennCorp is also a 16.3% limited partner in Knightsbridge. As a result, the Company has an economic interest in SW Financial aggregating 78.0 percent (for additional information regarding SW Financial see Notes 6 and 19 of "Notes to Consolidated Financial Statements").
On July 25, 1995, the Company consummated the acquisition of Integon Life Insurance Corporation ("Integon Life"). Integon Life's life and annuity products are marketed through a general agency sales force, primarily in the Southeastern United States.
The comparability of the Company's financial position, results of operations and cash flows for each of the periods presented has been affected by these acquisitions. The pro forma effects of the acquisition of United Life is described in Note 3 of Notes to Consolidated Financial Statements included elsewhere herein.
Financing Activities. As a part of each of the Company's acquisitions and as part of a long-term plan to maintain an appropriate balance in its capital structure, PennCorp has undertaken various public and private financing transactions. As a result, the Company's historical financial results reflect significant variations in financing costs including preferred stock dividends and extraordinary charges resulting from the early extinguishment of debt.
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
The Company's liquidity requirements are funded primarily by its insurance subsidiaries. The insurance subsidiaries' principal sources of cash are premiums and investment income. The insurance subsidiaries' primary uses of cash are policy claims, commissions, operating expenses, income taxes and payments to the Company for principal and interest due under surplus debentures, tax sharing payments and dividends. Both sources and uses of cash are reasonably predictable.
Financings. In March 1997, the Company entered into a $450.0 million revolving credit agreement with a syndicate of banks ("the bank credit agreement") which replaced the Company's previously outstanding $175.0 million credit agreement which had been entered into in May 1996. Borrowings under the bank credit agreement during 1997 were used to: (i) retire previously outstanding bank indebtedness aggregating $92.0 million, (ii) make capital contributions to its
insurance subsidiaries amounting to $14.9 million, (iii) the acquisition of the SW Financial subordinated indebtedness and preferred stock of Acordia aggregating a total of $65.6 million, (iv) repurchase the previously outstanding Series B Redeemable Preferred Stock in the amount of $14.7 million, (v) fund restructuring costs incurred by various operating subsidiaries aggregating $14.9 million, and (vi) for other corporate purposes.
During 1997, the Company announced a stock repurchase program in which the Company was authorized by its Board of Directors to purchase up to 4.5 million shares of common stock in the open market, through arranged transactions and otherwise. During 1997, the Company borrowed approximately $28.8 million to repurchase approximately 819,000 shares.
On August 2, 1996, the Company issued 2,875,000 shares of $3.50 Series II Convertible Preferred Stock ("Series II Convertible Preferred Stock") for net proceeds of $139.2 million. The cash raised through this offering, along with borrowings under the Company's bank credit facility, were utilized: (i) to fund the cash portion of the purchase price for United Life, aggregating $100.4 million, (ii) to fund a capital contribution of $57.3 million to United Life, and (iii) to pay related expenses of the acquisition of United Life of $9.7 million. The Company accrued or paid dividends of $10.1 million and $4.0 million during 1997 and 1996, respectively, related to the Series II Convertible Preferred Stock.
On February 28, 1996, PennCorp completed the sale of 5,131,300 shares of Common Stock, netting proceeds of $155.5 million ("February 1996 Common Stock Offering"). Proceeds from this offering were utilized to repay $80.0 million of corporate and $57.0 million of subsidiary indebtedness, and to pay $10.0 million to SW Financial's former owner in lieu of PennCorp's obligation to issue an equivalent number of shares of Common Stock.
In May 1996, the Company entered into its previously outstanding revolving credit agreement with a syndicate of banks for up to $175.0 million of funds available at any one time to replace the $100.0 million bridge facility utilized by the Company to make the investment in SW Financial, which was repaid out of the proceeds of the February 1996 Common Stock Offering. During the remainder of 1996, the Company borrowed amounts aggregating $92.0 million for: (i) the repurchase of $35.4 million in principal amount of the Company's 9 1/4% Senior Subordinated Debenture due 2003 (the "Notes") for $37.7 million, including interest and premium on early redemption of $2.3 million, (ii) the refinancing of $20.0 million of indebtedness under the previously outstanding bridge facility, (iii) the repayment of $16.5 million of amounts owed certain subsidiaries, and (iv) $17.8 million for general corporate purposes including the United Life acquisition, interest payments and common and preferred stock dividend payments.
On July 14, 1995, PennCorp issued 2,300,000 shares of $3.375 Convertible Preferred Stock ("Convertible Preferred Stock") for net proceeds of $110.5 million. On March 16, 1995, PennCorp issued 3,750,000 shares of Common Stock, for net proceeds of approximately $51.2 million. The proceeds from these two offerings were used to: (i) consummate the acquisition of Integon Life, which utilized funds totaling $33.4 million (including a capital contribution of $15.0 million), (ii) repay $28.5 million outstanding under, and subsequently cancel, a revolving credit facility, (iii) repurchase, for $34.6 million, all of the Company's Series A Preferred Stock, (iv) repay $11.2 million due to Integon Life's former parent company under a subordinated debenture, (v) pay the $15.4 million cash portion of the purchase price of Occidental Life Insurance Company of North Carolina ("OLIC") (which PennCorp purchased from Pennsylvania Life Insurance Company and its wholly-owned subsidiary, Penncorp Life Insurance Company (collectively referred to herein as "Penn Life") and subsequently contributed to Integon Life), (vi) prepay $20.0 million principal amount of subsidiary indebtedness, and (vii) make payments for general corporate purposes, including interest payments and the cancellation of certain interest rate swap agreements. The Company paid or accrued dividends on the Convertible Preferred Stock amounting to $7.8 million, $7.8 million and $3.6 million during 1997, 1996 and 1995, respectively.
As part of the financing for the Integon Life acquisition, PennCorp issued Series B Preferred Stock with an initial value of $12.8 million, which accretes at 10.4% per annum until its maturity on June 30, 1997, and Series C Preferred Stock with an initial value (subject to offset) of $17.9 million, which accretes at 9.3% per annum until its maturity on June 30, 1998. The Series C Preferred Stock's estimated initial value for financial statement purposes was approximately $16.0 million. Preferred stock dividends accreted during 1997, 1996 and 1995, on the Series B and Series C Preferred Stock amounted to $1.7 million, $2.9 million and $1.3 million, respectively. On March 14, 1997, the Company redeemed all the
outstanding Series B Preferred Stock for $14.7 million, utilizing proceeds available under the bank credit facility. On March 31, 1998, the Company plans to redeem the Series C Preferred Stock into shares of the Company's Common Stock under provision of the Series C Preferred Stock certificate of designation.
The Notes, the bank credit agreement and the Series C Preferred Stock impose certain covenants on the Company, including covenants restricting the amount of additional indebtedness the Company may incur, its ability to engage in future acquisitions and certain other business transactions, and the amount of dividends the Company may declare and pay, and requires the Company to maintain specified financial ratios and meet specified financial tests, all of which may impose limitations on the Company's future liquidity.
Surplus Debentures, Dividend Restrictions and Cash Flows. Cash generated by the Company's insurance subsidiaries is made available to PennCorp principally through periodic payments of principal and interest on surplus debentures issued by Pacific Life and Accident Insurance Company ("PLAIC") and Pioneer Security Life Insurance Company ("Pioneer Security") (collectively, the "Surplus Note Companies"). The amounts outstanding under the surplus debentures totaled $358.3 million and $367.9 million as of December 31, 1997 and 1996, respectively. The surplus debentures generally require (subject to availability of statutory capital and surplus and in some instances, regulatory approval) principal and interest payments to be made periodically in amounts sufficient to allow PennCorp to meet its cash requirements.
The Surplus Note Companies rely upon dividends and tax sharing payments from their respective insurance subsidiaries. Each of the insurance subsidiaries is in turn subject to regulatory restrictions with respect to the maximum amount of dividends that can be paid to the Surplus Note Companies without prior regulatory approval. Such dividend restrictions are primarily in the form of (i) the greater of 10% of statutory capital and surplus or statutory earnings, or (ii) the lesser of 10% of statutory capital and surplus or statutory earnings, depending upon applicable state laws. The Company believes that such restrictions will not significantly impact the Company's liquidity for the foreseeable future.
For the years ended December 31, 1997, 1996 and 1995, the Company received net payments from the Surplus Note Companies of $44.1 million, $31.9 million and $19.1 million, respectively. The Surplus Note Companies received $32.1 million, $25.8 million and $21.6 million in dividends and tax sharing payments from their respective insurance subsidiaries.
The primary cash requirements of the Company are interest payments, preferred stock dividends and common stock dividends which aggregated $47.4 million, $33.9 million and $ 24.5 million for the years ended December 31, 1997, 1996 and 1995, respectively. For the years ended December 31, 1997, 1996 and 1995, cash requirements of the Company exceeded cash made available to the Company through payments under the surplus debentures by $3.3 million, $2.0 million and $ 5.4 million, respectively. During each of these periods, the Company utilized a balance of dividends and surplus note payments from the insurance subsidiaries and borrowings under the Company's credit facilities to fund PennCorp's cash requirements. This balance resulted in what management believes to be, along with other factors, an appropriate retention of statutory capital and surplus to improve the insurance subsidiaries' A.M. Best ratings without placing an undue debt burden upon the Company.
During 1998, the maximum dividends and tax sharing payments and corresponding surplus debenture payments, without prior regulatory approval, are anticipated to be approximately $79.0 million and the Company's cash requirements are anticipated to be approximately $59.0 million. As a result of the Company's historical policy of retaining capital and surplus at the insurance subsidiary level, and as a result of the Company's simplification of its corporate structure, including the statutory merger of a number of insurance companies, combined with realignment of the insurance subsidiaries into operating divisions, the Company believes that as of December 31, 1997, its insurance subsidiaries have excess capital and surplus. The Company's own established targets for estimated risk-based capital requirements indicate that the insurance divisions could make available approximately $40.0 million to PennCorp, subject to applicable regulatory approvals.
Investments. The Company's investment portfolio is managed with the objectives of maintaining high credit quality and liquidity, maximizing current income within acceptable levels of risk, minimizing market and credit risk, and matching the anticipated maturities of investments to the Company's liabilities. The Company believes that a conservative
investment strategy fits the nature of its insurance products which have little or no inflation risk and limited build-up of cash accumulation values in earlier years.
The Company continuously evaluates its investment portfolio and the conditions under which it might sell securities, including changes in interest rates, changes in prepayment risk, liquidity needs, asset liability matching, tax planning strategies and other economic factors. Those securities that the Company believes would be subject to sale prior to the specified maturity date are included in "securities available for sale," which amounted to $2,719.0 million and $2,993.9 million at December 31, 1997 and 1996, respectively. Of those securities available for sale, 92.5% and 92.1% were rated Baa or above by Moody's Investors Services, Inc. at December 31, 1997 and 1996, respectively.
During the years ended December 31, 1997, 1996 and 1995, the Company sold $801.1 million, $378.6 million and $109.8 million of fixed maturity and equity securities, and purchased $1,021.5 million, $955.8 million and $217.8 million of fixed maturity and equity securities, respectively. Such sales and purchases were often effected to improve the quality of the investment portfolio or to avoid prepayment risks. As a result of the Company's decision to exit the private placement bond sector, the Company transferred all of its remaining assets in the fixed maturities held for investment portfolio to its fixed maturities available for sale portfolio as of April 1, 1997. In accordance with Statement of Financial Accounting Standards ("SFAS") No. 115, the Company marked all assets subject to the transfer to fair value resulting in an increase in shareholders' equity, net of applicable income taxes, of approximately $1.8 million. During 1996, the Company sold one security in its held for investment portfolio aggregating $4.9 million as a result of a dramatic deterioration in its credit rating.
During 1995, the Company established a portfolio of "trading securities" to provide the Company with the opportunity to undertake interest rate hedging strategies, to participate in short-term relative value trades and to invest in special situations with the goal of generating short-term trading profits. As a result of trading activities, the Company recognized $1.1 million, $1.3 million and $5.7 million of profits during 1997, 1996 and 1995, respectively. As of December 31, 1997, the Company held no investments in its trading portfolio.
The Company held $1,287.6 million and $1,428.3 million of mortgage-backed bonds which represented 38.8% and 38.9% of total invested assets as of December 31, 1997 and 1996, respectively. The Company invests in mortgage- backed securities in order to enhance portfolio yields and maintain a reliable cash flow stream from the invested asset portfolio. The Company maintains sophisticated models to measure the effective duration and option-adjusted duration of the consolidated investment portfolio. These models are updated on a monthly basis and are designed to allow accurate measurement of the convexity risks inherent in that percentage of the portfolio invested in mortgage-backed securities and other callable securities. The Company manages the portfolio convexity risk within the context of the overall asset and liability model and the quantification of disintermediation risk.
Mortgage loans on real estate amounted to 7.3% and 7.2% of total invested assets as of December 31, 1997 and 1996, respectively. United Life is the Company's only subsidiary which actively originates new mortgage loans. United Life invests in first mortgage loans and provides a mortgage loan warehousing facility for its former parent as a means of obtaining higher invested asset yields necessary to support competitively priced annuity products. The Company has established a reserve for loan loss which aggregated $6.0 million as of December 31, 1997. As of December 31, 1997 and 1996, the Company had non-performing loans amounting to $698,000 and $1.4 million, respectively. The Company is in various stages of foreclosure or sales of such loans. The Company believes its current loan loss provision is adequate to cover any future losses related to currently performing and non-performing loans.
Cash and short-term investments totaled $109.0 million and $102.6 million as of December 31, 1997 and 1996, respectively. At December 31, 1997 and 1996, respectively, the Company held approximately $135,000 and $12.2 million in short-term investments needed in the settlement of investment trades early in the following year.
Final Determination of Pre-Acquisition Contingencies and Purchase Price Allocation. For each of the periods presented, the Company has made certain valuation determinations with respect to pre-acquisition contingencies or allocations. For the year ended December 31, 1997, the Company determined the following with respect to certain material
acquisition contingencies or allocations: (i) the Company increased deferred tax assets and reduced associated costs in excess of net assets acquired associated with the Integon Life acquisition by $19.6 million as a result of the Company resolving certain acquisition date tax contingencies, (ii) the Company reduced both deferred tax liabilities and associated costs in excess of net assets acquired associated with the Marketing One acquisition by $1.1 million as a result of the Company resolving certain acquisition date tax contingencies, and (iii) the Company reduced costs in excess of net assets acquired and increased certain mortgage loan values by $1.1 million, associated with the acquisition of United Life, as a result of final appraisals becoming available.
For the year ended December 31, 1996, the Company determined the following with respect to certain material acquisition contingencies or allocations: (i) the Company incurred additional costs associated with the acquisition of United Life of $2.5 million, which resulted in a corresponding increase to costs in excess of net assets acquired, (ii) the Company decreased real estate and mortgage loan loss valuations of Integon Life by $6.8 million, which resulted in a decrease in costs in excess of net assets acquired of $4.4 million and deferred tax assets of $2.4 million, and (iii) the Company increased certain policy reserves of Integon Life aggregating $10.0 million, which resulted in a corresponding increase to costs in excess of net assets acquired of $10.0 million.
For the year ended December 31, 1995, the Company determined a reduction in the valuation of the Series A Preferred Stock issued in conjunction with the AA Life acquisition of $3.9 million was necessary based upon final settlement, which resulted in a corresponding reduction in costs in excess of net assets acquired.
Disintermediation Risk. With the acquisition of United Life and Integon Life, the Company significantly expanded its interest sensitive portfolio of products including universal life and accumulation products. The Company actively manages the difference in interest yields on assets backing interest sensitive liabilities and amounts credited to policyholder account balances so as to provide a margin or "spread." For the years ended December 31, 1997 and 1996, the Company had total interest sensitive liabilities aggregating $2,563.9 million and $2,685.7 million and obtained a spread on such liabilities of 2.5% and 2.1%, respectively. As part of the ongoing management of interest sensitive business, the Company annually undertakes "cash flow testing" sensitivities in which Management evaluates a range of interest rate scenarios under which credited interest rates and asset/liability durational matching may become mismatched. The Company believes that it has sufficient liquidity to withstand all reasonable scenarios established by Management.
Cash Flows From Operations. The periods covered by Management's Discussion and Analysis of Financial Condition and Results of Operations indicate cash provided by operating activities of $53.3 million, $152.1 million and $85.0 million in 1997, 1996 and 1995, respectively. The positive cash flow from operating activities is not necessarily indicative of the Company's cash flow as $275.7 million, $205.2 million and $53.2 million of cash was used to fund cash flows for interest sensitive life and accumulation products during 1997, 1996 and 1995, respectively, which are classified as financing activities in accordance with generally accepted accounting principles.
Inflation. The Company sells fixed benefit, life, and accumulation products. Approximately 48.9% of the Company's total policy revenues for the year ended December 31, 1997, were derived from fixed benefit products. These products typically provide a predetermined fixed payment that will be paid under specified conditions. Fixed benefit products are not designed to provide reimbursement for medical and related costs incurred as a result of accidents and sickness. Accordingly, payment amounts are not affected by the insured's actual cost of health care services. Because of the characteristics of its fixed benefit products, the Company believes that inflation does not have a material effect on its operations.
Subsequent Events. On December 31, 1997, at the Company's Annual Shareholders' Meeting, the shareholders approved the acquisition of the Controlling Interest in SW Financial and the acquisition of the Stone and Fickes Knightsbridge Interests. On January 2, 1998 and January 5, 1998 the Company consummated the acquisitions of the Controlling Interest in SW Financial and the Stone and Fickes Knightsbridge Interests, respectively. The acquisition of the Controlling Interest in SW Financial will expand the Company's Financial Services and Career Sales operations with similar products, distribution channels and asset mixes (see Notes 15, 16 and 19 of Notes to Consolidated Financial Statements).
On February 18, 1998, the Company announced that it had engaged investment banking firms to review strategic alternatives for maximizing shareholder value, including the sale of the Company's Career Sales Division. As a result, in the future the Company intends to account for the Career Sales Division as "businesses held for sale" (see Note 19 of "Notes to Consolidated Financial Statements").
The following unaudited pro forma selected financial data represents the Company's consolidated results of operations, as if the acquisition of the Controlling Interest in SW Financial occurred on January 1, 1997, and the pro forma consolidated financial position, as if such transaction occurred as of December 31, 1997. In addition, the following pro forma selected consolidated financial data presents the Company's consolidated results of operations for the Company's "retained businesses" (those businesses remaining after giving effect to the disposition of the Career Sales Division) as if the disposition of the Career Sales Division and the consummation of the acquisition of the Controlling Interest in SW Financial occurred January 1, 1997 and the pro forma consolidated statement of financial position as if the Career Sales Division was held for sale as of December 31, 1997. The unaudited pro forma selected financial data has been prepared for comparative purposes only and does not purport to be indicative of what would have occurred had the transactions been consummated as of January 1, 1997, or December 31, 1997, respectively, or the results of operations or financial position which may occur in the future. The retained business pro forma financial information reflects the historical results of the retained businesses and does not consider the use of proceeds likely to be derived from the disposition of the businesses held for sale. The significant subsidiaries included in businesses held for sale are PLIC and Union Bankers, a subsidiary of SW Financial.
New Accounting Pronouncements. In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income." SFAS No. 130 is effective for annual and interim periods beginning after December 15, 1997. This statement establishes standards for reporting and displaying comprehensive income and its components and requires all items to be recognized under accounting standards as comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. Examples of items to be included in the Company's presentation of comprehensive income, in addition to net income applicable to common stock, are unrealized foreign currency translation gains and losses as well as unrealized gains and losses on securities available for sale. The Company will adopt the provisions of SFAS No. 130 in 1998.
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," was also issued in June 1997 by the FASB. This Statement requires that companies disclose segment data on the basis that is used internally
by management for evaluating segment performance and allocating resources to segments. This Statement requires that a company report a measure of segment profit or loss, certain specific revenue and expense items, and segment assets. It also requires various reconciliations of total segment information to amounts in the consolidated financial statements. The Company's current definition of its business segments will not materially change from the current presentation. SFAS No. 131 is effective for fiscal years beginning after December 15, 1997.
In December 1997, the American Institute of Certified Public Accountants issued Statement of Position ("SOP") 97-3. SOP 97-3 provides: (1) guidance for determining when an entity should recognize a liability for guaranty-fund and other insurance-related assessments, (2) guidance on how to measure the liability, (3) guidance on when an asset may be recognized for a portion or all of the assessment liability or paid assessment that can be recovered through premium tax offsets or policy surcharges, and (4) requirements for disclosure of certain information. This SOP is effective for financial statements for fiscal years beginning after December 15, 1998. Early adoption is encouraged. Previously issued annual financial statements are not restated. The Company will report the effect of initially adopting this SOP in a manner similar to the reporting of a cumulative effect of a change in accounting principle. The Company is currently evaluating the financial impact, which is expected to be immaterial, as well as the changes to its related disclosures.
In February 1998, the FASB adopted SFAS No. 132 "Employers' Disclosures about Pensions and Other Postretirement Benefits." SFAS No. 132 is effective for fiscal years beginning after December 31, 1997. Earlier application is encouraged. Restatement of disclosures for earlier periods provided for comparative purposes is required. SFAS No. 132 standardizes employers' disclosures about pension and other postretirement benefits, requires additional information on changes in the benefit obligations and fair values of plan assets to facilitate financial analysis, and eliminates certain irrelevant disclosures. The Company is currently evaluating the changes to its related disclosures.
RESULTS OF OPERATIONS
The following analysis should be read in conjunction with the historical financial statements of the Company and related notes thereto contained elsewhere herein. Significant financial information, percentage changes and ratios of the Company's insurance operations (excluding realized gains and losses on sale of investments and equity in earnings of unconsolidated affiliates) are shown in the following table:
Operating Ratios. Pretax operating margin declined considerably to 12.0% of revenues during 1997 from 19.5% and 19.6% in 1996 and 1995, respectively. The significant decline in operating ratios was primarily the result of increases in benefits and insurance expense ratios. The continual increase in the benefits ratio was anticipated as a result of the Company's most recent acquisitions which shifted the product base away from lower benefit fixed benefit products to life and accumulation products.
The ratio of total policy benefits to revenues increased during 1997 to 51.7% from 48.4% and 38.9% in 1996 and 1995, respectively. The increase in the ratio of total policy benefits to revenues during 1997 was primarily attributable to the continued increase in life and accumulation products, relative to fixed benefit products, since benefits for life insurance products are typically greater, as a percentage of revenues, than benefits for fixed benefit products. Additionally,
accumulation products, such as deferred annuities, are priced to allow for the vast majority of interest earned on assets backing policy reserves to be credited to the policyholder account balance resulting in a faster growth in policy benefits than policy benefits for fixed benefit products. During 1997, Penn Life continued to experience an increase of its benefit ratios, resulting in an increase in the Company's overall benefits ratio of approximately 1.8 percent. The increase was primarily a result of Penn Life's strengthening of certain claims reserves and the impact of the 1996 conversion to a new valuation system (see below). During 1996, the Company also experienced higher than expected mortality and morbidity costs for Penn Life and OLIC, which collectively resulted in an approximately 2.0% increase in the claims incurred ratio for the Company as a whole. During 1996, the Company refined the calculation of certain policy benefit reserves which collectively aggregated approximately $443.0 million. Such refinement resulted in an increase in future policy benefits of approximately $1.3 million for 1996. The refinement will result in slightly larger increases in the change in future policy benefits in near- term reporting periods.
The Company's insurance expense ratio increased to 18.8% of revenues from 14.0% during 1996. The increase in the insurance expense ratio was primarily a result of improved gross profit margins for OLIC and Integon during 1997 as compared with those of 1996, which resulted in greater amortization of deferred acquisition costs and present value of insurance in force increasing the insurance expense ratio by approximately 1.8 percent. Also contributing to higher insurance expense ratios was amortization associated with deferred acquisition costs for AA Life which added approximately 0.7% to the insurance expense ratio. AA Life anticipates increasing levels of amortization associated with its primary new sales product, the "wealth builder." For the year ended December 31, 1996, certain interest sensitive blocks of business had significantly less amortization of deferred policy acquisition costs and present value of insurance in force, as compared to 1995 due to reduced short-term profit margins from adverse mortality. The Company believes that profit margins have stabilized and recent variability will not impact the long-term profitability of such products. However, if mortality experience would deteriorate, the ultimate recoverability of deferred policy acquisition costs and present value of insurance in force could be adversely affected.
Other operating expenses declined as a percentage of revenues to 13.8% during 1997, from 14.8% and 16.8% during 1996 and 1995, respectively. This downward trend was due to the acquisitions of United Life and Integon Life, which are administered by the Company at overhead expense rates less than the business in force prior to their respective acquisitions. Despite the growing revenue base, the Company's total underlying expense infrastructure has increased only moderately. In addition, expense costs have shifted from overhead and maintenance expenses to those more closely related to the production of new business.
During 1997, the Company's interest cost ratio increased modestly to 3.7% from 3.3% during 1996 after a decline from the interest cost ratio of 4.7% during 1995. The increase during 1997 was primarily a result of increased borrowings under the Company's revolving credit facility to repurchase common stock, contribute capital to the Company's insurance subsidiaries, acquire certain invested assets by non-insurance subsidiaries and fund certain of the Company's restructuring costs. The Company's overall weighted cost of indebtedness declined to 8.2% during 1997 from 8.8% during 1996. The reduction in the weighted average cost of indebtedness was due to general market conditions as the Company borrowings are primarily floating rate bank debt. The Company anticipates that the ratio of interest costs to total revenues will increase during 1998 as a result of the Company's acquisition of the Controlling Interest in SW Financial on January 2, 1998, on a leveraged basis. During 1996, the Company's interest cost ratio declined to 3.3% from 4.7% during 1995. The decline was primarily the result of the Company utilizing common and preferred stock offerings to finance acquisition activities rather than debt. The weighted average interest cost for outstanding indebtedness dropped to 8.8% for the year ended December 31, 1996, from 9.0% for the year ended December 31, 1995. The reduction in such interest costs was the result of the Company replacing subsidiary indebtedness with borrowings by the Company which carry substantially lower interest rates.
Policy Revenues. Policy revenues remained relatively constant during 1997 at $345.6 million compared to $348.1 million during 1996 after increasing from $301.9 million during 1995. The very modest decline was primarily the result of a decline in policy charges associated with accumulation products due to increased surrenders.
Fixed benefit policy revenues decreased by 0.2%, 3.1% and 1.2% to $169.0 million, $169.3 million and $174.7 million during 1997, 1996 and 1995, respectively. During 1997, 1996 and 1995, the Company's operating focus was
concentrated primarily on increasing life policy revenues to achieve a balance of life policy revenues with those of fixed benefit products. In addition, during 1996 the Company effectively ceased marketing its "instant issue" fixed benefit products and as a result of higher than anticipated loss ratios which resulted in a decline in fixed benefit policy revenues for 1997 and 1996.
Life policy revenues remained nearly constant at $169.5 million for 1997 after increasing 43.9% and 75.0% to $170.0 million and $118.1 million for the years ended 1996 and 1995, respectively. The acquisition of United Life in July 1996, and Integon Life in July 1995, added $72.4 million and $22.9 million of life policy revenues during 1996 and 1995, respectively.
Net Investment Income. The effects of a larger average invested asset base and improved average portfolio yields to 7.6% in 1997 from 7.5% during 1996 and 7.3% in 1995, resulted in net investment income increasing 29.7%, 106.0% and 97.1% in 1997, 1996 and 1995, to $273.2 million, $210.7 million and $102.3 million, respectively. The acquisitions of United Life, which added invested assets of $1,492.9 million in July 1996 and Integon Life, which added invested assets of $1,339.1 million in July 1995, contributed to the increase in investment income. During 1997 and 1996, United life incrementally added $61.4 and $49.3 million of investment income and Integon Life incrementally added $57.6 million during 1996 as a result of being included for the entire year.
Other income. For purposes of presentation of the summary of the Selected Consolidated Financial Data, "other income" includes equity in earnings of unconsolidated affiliates, income as a result of trading portfolio activity and the income generated by the third party marketing activities of Marketing One. During 1997, 1996 and 1995, income from unconsolidated affiliates aggregated $19.0 million, $21.0 million and $4.7 million, respectively, including $19.0 million, $21.0 million and $910,000 as a result of the Company's economic interest in SW Financial during 1997, 1996 and 1995, respectively. (For additional information on the operating results of SW Financial see Note 6 of Notes to Consolidated Financial Statements). During 1995, the Company included its portion of the operating results of its 49% interest in the limited partnership which owned Integon Life aggregating $3.8 million prior to the Company's consummation of the acquisition of the remaining 51% of Integon Life in July 1995.
In conjunction with the Company's acquisition and investment activities, Management is regularly presented with investment opportunities to invest in substantially undervalued securities in corporations which will likely undertake some form of restructuring. In 1995, the Company established a trading security account for such investments. The Company reported trading gains amounting to $1.1 million, $1.3 million and $5.7 million during 1997, 1996 and 1995, respectively.
Revenues generated by Marketing One aggregated $17.1 million, $20.0 million and $7.4 million during 1997, 1996 and 1995, respectively. Marketing One was acquired by the Company in August 1995.
During 1997, the Company recognized a gain from the disposition of its Panamanian operation aggregating $4.1 million.
Net Gains/Losses From Sale of Investments. The Company maintains an investment portfolio that focuses on maximizing investment income, without exposure to unwarranted interest rate and credit risk. The Company actively manages asset duration and liquidity risks. As a result of this strategy, the Company routinely sells positions in securities no longer meeting its criteria. Sales of securities during 1997, 1996 and 1995, resulted in the Company realizing gains of $17.5 million, $1.3 million and $3.8 million during 1997, 1996 and 1995, respectively. During 1997, the Company liquidated the vast majority of its equity holdings and private placement bond holdings. In addition, the Company liquidated other securities available for sale in order to meet cash flow demands associated with policyholder surrenders that in the aggregate exceeded policyholder deposits by $275.7 million. During 1995, the Company liquidated its holdings in Conning & Co. which resulted in a realized gain of $3.2 million (see Note 15 of Notes to Consolidated Financial Statements contained elsewhere herein).
Claims Incurred. Claims incurred increased 7.5%, 33.0% and 25.9% during 1997, 1996 and 1995, to $202.8 million, $188.7 million and $141.9 million, respectively. The increase in claims during 1997 resulted from strengthening
of certain claims reserves for PennLife of approximately $6.9 million, additional claims of $4.2 million as the result of the inclusion of the results of United Life for the entire year and modestly higher claims payments for AA Life and Professional as a result of growth in the underlying business, which in the aggregate increased $3.2 million. The increase in claims during 1996 was due to the addition of United Life, $3.3 million, the inclusion of Integon Life for the full year, $35.1 million, and adverse mortality experience at OLIC and Penn Life of $4.2 million and $2.6 million, respectively, when compared to the previously reported period. The Company is continuing to closely monitor the claims activity in each insurance subsidiary. During 1995, the increase in claims incurred attributable to Integon Life and AA Life, was $22.8 million and $10.3 million, respectively.
Insurance Related Expenses. Insurance related expenses (including commissions, amortization of deferred policy acquisition costs and amortization of the present value of insurance in force) increased 39.6%, 8.9% and 41.2% to $127.0 million, $91.0 million and $83.6 million during 1997, 1996 and 1995, respectively. The increase in insurance related expenses during 1997 as compared with 1996 and 1995 was primarily related to the amortization of deferred acquisition costs and the value of insurance in force as commission expenses increased slightly to $34.9 million for 1997 from $34.7 million and $31.9 million for the years ended 1996 and 1995, respectively. Of the $35.8 million increase in amortization during 1997, the inclusion of United Life for the full year resulted in additional amortization expense of $10.5 million, the amortization associated with realized gains on the sale of investments increased $9.4 million, increased gross profit margins and unlocking of lapse assumptions for increased policy surrenders resulted in additional amortization of approximately $6.0 million with the remainder of the increase due to additional amortization associated with deferred acquisition costs, primarily associated with AA Life's wealth builder products and decreased persistency of PennLife's in force block of business. The increase in the amortization of deferred acquisition costs and value of insurance in force during 1996 was primarily the result of the United Life acquisition. The increase during 1995 was the result of the Integon Life acquisition and a full year of amortization of value of business in force associated with the AA Life acquisition.
Other Operating Expenses. Other operating expenses (including general operating, overhead and policy maintenance expenses) increased during 1997 to $128.1 million compared to $90.1 million during 1996 and $80.7 million during 1995. During 1997 the $38.0 million increase in operating expenses was due to: (i) restructuring and period costs associated with the Company's restructuring aggregating $21.4 million, (ii) transaction costs associated with the terminated Washington National merger totaling $7.6 million, (iii) additional expenses aggregating $4.6 million as a result of the inclusion of United Life for the full year period, (iv) certain other non-recurring operating charges aggregating $5.1 million and (vi) increased operating expenses primarily associated with outside contracting costs for the Company's year 2000 compliance initiative which were approximately $1.9 million. The increase in operating expenses during 1996 was primarily a result of the inclusion of Marketing One for the full year period ended December 31, 1996 which increased operating expenses by $10.1 million.
Also included in other operating expense is the amortization of costs in excess of net assets acquired which aggregated $9.5 million, $8.6 million and $6.5 million for 1997, 1996 and 1995, respectively.
The Company has engaged certain outside vendors and focused certain employees full time efforts to help in the full array of its year 2000 initiative. This includes systems assessment and monitoring advice, actual code remediation, communication and consultation with critical business partners and additional data center and testing resources. The Company expects to incur internal and external costs associated with such expertise ranging from $9.3 million to $14.9 million, which are likely to be incurred primarily during 1998 and early 1999, and which represent approximately 25% of the Company's technology costs. Of the range of estimated costs, the Company anticipates approximately 42% of the costs to be internal allocation of resources.
Each of the operating divisions is primarily responsible for its remediation efforts with corporate oversight provided as necessary. The Company believes that the Career Division has substantially completed its year 2000 assessment and remediation efforts, which will be subject to ongoing tests for the remainder of 1998. The Payroll Division has completed the remediation of its largest administrative platforms, except for AA Life, and anticipates successful remediation and testing of the remaining sub-system and system interfaces during 1998. AA Life is in the process of upgrading its policy administration system to a year 2000 compliant version. AA Life will rely on contracted vendor resources in working to
complete its upgrade process. The Company's Financial Services Division has only recently begun its year 2000 remediation efforts. Those efforts are dependent on the utilization of outside resources. The Company believes that the Financial Services Division has contracted with sufficient resources to be able to remediate its essential business systems. In addition, the Financial Services Division has committed to a strategy of utilizing third party administrative experts, who have indicated year 2000 compliance, to handle the processing of its health insurance business, thus eliminating the need for the upgrade or modification of certain existing health administration systems.
Although the Company believes that its operating divisions, outside vendors and most critical business partners will be sufficiently compliant that the year 2000 issue should not cause a material disruption in the Company's business, there can be no assurance that there will not be material disruptions to the Company's business or an increase in the cost of the Company doing business. Although the Company believes that the year 2000 issues should not cause a material disruption in the Company's business, the Company is currently evaluating various contingency plans associated with remediation tasks which the Company believes are at a higher risk for potential failure.
Income Taxes. The effective tax rates for the years ended December 31, 1997, 1996 and 1995, were 39.5%, 37.0% and 35.0%, respectively. The 1997 and 1996 effective rates are higher than the statutory rate of 35% primarily due to non- deductible amortization of costs in excess of net assets acquired and foreign taxes in excess of foreign tax credits utilized. The lower effective tax rate for 1995 as compared to 1997 and 1996 is due to previously non-deductible operating losses becoming available to reduce tax on operating earnings.
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Item 8.
Item 8. Financial Statements and Supplementary Data
Page
Management's Responsibility for Financial Statements...................... 41
PennCorp Financial Group, Inc. and Subsidiaries........................... 42
Southwestern Financial Corporation and Subsidiaries....................... 78
MANAGEMENT'S RESPONSIBILITY FOR FINANCIAL STATEMENTS
The management of the Company is responsible for the preparation and fair presentation of the consolidated financial statements, financial data and other information in this annual report. They have been prepared in conformity with generally accepted accounting principles appropriate in the circumstances and include amounts based on the best estimates and judgment of management. The Company's management is also responsible for the accuracy and consistency of other financial information included in this annual report.
In recognition of its responsibility for the integrity and objectivity of data in the financial statements, the Company maintains a system of internal control over financial reporting which is designed to provide reasonable, but not absolute, assurance with respect to the reliability of the Company's financial statements. The concept of reasonable assurance is based on the notion that the cost of the internal control system should not exceed the benefits derived.
Internal auditors monitor and assess the effectiveness of the internal control system and report their findings to management and the Board of Directors throughout the year. The Company's independent auditors are engaged to express an opinion on the financial statements and with the coordinated support of the internal auditors, review the financial records and related data and test the internal control system over financial reporting.
The Audit Committee of the Board of Directors, which is composed of outside directors, serves in an oversight role to assure the integrity and objectivity of the Company's financial reporting process. The committee meets periodically with representatives of management, as well as the independent and internal auditors, to review matters of a material nature related to financial reporting and the planning, results and recommendations of audits. The independent and internal auditors have free access to the Audit Committee, without management present, to discuss any matter they believe should be brought to the attention of the committee. The committee is also responsible for making recommendations to the board of directors concerning the selection of the independent auditors.
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INDEPENDENT AUDITORS' REPORT
The Shareholders and Board of Directors of PennCorp Financial Group, Inc.
We have audited the accompanying consolidated balance sheets of PennCorp Financial Group, Inc. and subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of income, changes in shareholders' equity and cash flows for each of the years in the three-year period ended December 31, 1997. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of PennCorp Financial Group, Inc. and subsidiaries as of December 31, 1997 and 1996, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1997, in conformity with generally accepted accounting principles.
KPMG PEAT MARWICK LLP Raleigh, North Carolina March 19, 1998
PENNCORP FINANCIAL GROUP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME
See accompanying Notes to Consolidated Financial Statements
PENNCORP FINANCIAL GROUP, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
See accompanying Notes to Consolidated Financial Statements
PENNCORP FINANCIAL GROUP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
See accompanying Notes to Consolidated Financial Statements
PENNCORP FINANCIAL GROUP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
See accompanying Notes to Consolidated Financial Statements
PENNCORP FINANCIAL GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) BASIS OF PRESENTATION
PennCorp Financial Group, Inc. ("PennCorp", or the "Company") is an insurance holding company. Through its wholly-owned life insurance subsidiaries, Pennsylvania Life Insurance Company ("PLIC") and its wholly-owned subsidiary, Penncorp Life Insurance Company (collectively referred to as "Penn Life"), Peninsular Life Insurance Company ("Peninsular"), Professional Insurance Corporation ("Professional"), Pioneer Security Life Insurance Company ("Pioneer Security") and its wholly-owned subsidiaries American-Amicable Life Insurance Company of Texas and Pioneer American Insurance Company (Pioneer Security and its subsidiaries collectively referred to as "AA Life"), Integon Life Insurance Corporation ("Integon Life"), Occidental Life Insurance Company of North Carolina ("OLIC"), United Life & Annuity Insurance Company ("United Life"), Marketing One, Inc. ("Marketing One"), a third party marketing organization, and Pacific Life and Accident Insurance Company ("PLAIC"), the Company offers a broad range of accident and sickness, life, and accumulation insurance products to individuals through a sales force that is contractually exclusive to certain of the Company's subsidiaries and through general agents.
The accompanying consolidated financial statements include the accounts of the Company and its subsidiaries. All significant intercompany accounts and transactions have been eliminated. All dollar amounts presented hereafter, except share amounts, are stated in thousands.
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities as well as revenues and expenses. Accounts that the Company deems to be acutely sensitive to changes in estimates include deferred policy acquisition costs, policy liabilities and accruals, present value of insurance in force and deferred taxes. In addition, the Company must determine the requirements for disclosure of contingent assets and liabilities as of the date of the financial statements based upon estimates. As additional information becomes available, or actual amounts are determinable, the recorded estimates may be revised and reflected in operating results. Although some variability is inherent in these estimates, management believes the amounts provided are adequate. In all instances, actual results could differ from estimates.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Investments
Fixed maturities classified as held for investment are recorded at cost, adjusted for amortization of premium or discount, as the Company has the intent and ability to hold them to maturity. Fixed maturities and equity securities classified as available for sale are recorded at fair value, as they may be sold in response to changes in interest rates, prepayment risk, liquidity needs, the need or desire to increase income, capital or other economic factors. Changes in unrealized gains and losses related to securities available for sale are recorded as a separate component of shareholders' equity, net of income taxes. Securities classified as trading securities are reported at fair value with realized gains and losses and changes in unrealized gains and losses included in the determination of net income as a component of other income. The classification of securities as held for investment, available for sale or trading is generally determined at the date of purchase. The Company carries a certain equity investment in an affiliate on the equity basis of accounting as a result of its percentage ownership and lack of voting control. Mortgage-backed fixed maturity securities held for investment or available for sale are amortized using the interest method including anticipated prepayments at the date of purchase. Significant changes in estimated cash flows from original assumptions are reflected in the period of such change. Mortgage loans on real estate are recorded at cost, adjusted for amortization of premium or discount and provision for loan loss, if necessary. Policy loans, short-term investments, and other investments are recorded at cost, which approximates fair value.
As a result of the Company's decision to exit the private placement bond sector, the Company transferred all of its remaining assets in the fixed maturities held for investment portfolio aggregating $49,384 to its fixed maturities available for sale portfolio as of April 1, 1997. In accordance with Statement of Financial Accounting Standards No. 115, the
Company marked all assets subject to the transfer to fair value resulting in a net increase in shareholders' equity, net of applicable income taxes, of $1,800.
Realized investment gains and losses and declines in value which are other than temporary, determined on the basis of specific identification, are included in net income.
Accounts and Notes Receivable
Accounts and notes receivable consist primarily of agents' balances and premiums receivable from agents and policyholders. Agents' balances are partially secured by commissions due to agents in the future and premiums receivable are secured by policy liabilities. An allowance for doubtful accounts is established, based upon specific identification and general provision, for amounts which the Company estimates will not ultimately be collected.
Present Value of Insurance In Force
The present value of insurance in force represents the anticipated gross profits to be realized from future revenues on insurance in force at the date such insurance was purchased, discounted to provide an appropriate rate of return and amortized, with interest based upon the policy liability or contract rate, over the years that such profits are anticipated to be received in proportion to the estimated gross profits. Accumulated amortization was $192,049 and $144,327 as of December 31, 1997 and 1996, respectively.
Deferred Policy Acquisition Costs
Estimated costs of acquiring new business which vary with, and are primarily related to, the production of new business, have been deferred to the extent that such costs are deemed recoverable from future revenues. Such estimated costs include commissions, certain costs of policy issuance, underwriting, certain variable agency and marketing expenses and other costs directly associated with these functions to the extent such costs are determined to vary with and are primarily related to the production of new business. Costs deferred associated with accident and sickness and traditional life policies are amortized, with interest, over the anticipated premium-paying period of the related policies in proportion to the ratio of annual premium revenue to expected total premium revenue to be received over the life of the policies. Expected premium revenue is estimated by using the same mortality, morbidity and withdrawal assumptions used in computing liabilities for future policy benefits. For interest sensitive products and limited pay life products, policy acquisition costs are amortized in relation to the emergence of anticipated gross profits over the life of the policies.
Costs in Excess of Net Assets Acquired
Costs in excess of the fair value of net assets acquired are amortized on a straight-line basis primarily over 20 years. Accumulated amortization was $44,606 and $35,061 as of December 31, 1997 and 1996, respectively.
For each of the periods presented, the Company has made certain valuation determinations with respect to pre- acquisition contingencies or allocations. For the year ended December 31, 1997, the Company determined the following with respect to certain material acquisition contingencies or allocations: (i) the Company increased deferred tax assets and reduced associated costs in excess of net assets acquired associated with the Integon Life acquisition by $19.6 million as a result of the Company resolving certain acquisition date tax contingencies, (ii) the Company reduced both deferred tax liabilities and associated costs in excess of net assets acquired associated with the Marketing One acquisition by $1.1 million as a result of the Company resolving certain acquisition date tax contingencies, and (iii) the Company reduced costs in excess of net assets acquired and increased certain mortgage loan values by $1.1 million, associated with the acquisition of United Life, as a result of final appraisals becoming available.
For the year ended December 31, 1996, the Company determined the following with respect to certain material acquisition contingencies or allocations: (i) the Company incurred additional costs associated with the acquisition of United Life of $2.5 million, which resulted in a corresponding increase to costs in excess of net assets acquired, (ii) the Company
decreased real estate and mortgage loan loss valuations of Integon Life by $6.8 million, which resulted in a decrease in costs in excess of net assets acquired of $4.4 million and deferred tax assets of $2.4 million, and (iii) the Company increased certain policy reserves of Integon Life aggregating $10.0 million, which resulted in a corresponding increase to costs in excess of net assets acquired of $10.0 million.
The Company continually monitors the value of costs in excess of net assets acquired based upon estimates of future earnings. Any amounts deemed to be impaired are charged, in the period in which such impairment was determined, as an expense against earnings. For the periods presented there was no charge to earnings for the impairment of costs in excess of net assets acquired.
Policy Liabilities
Future policy benefits for traditional life insurance products generally have been computed on the net level premium method, based on estimated future investment yield, mortality, morbidity and withdrawals. Estimates used are based on experience adjusted to provide for possible adverse deviation. These estimates are periodically reviewed and compared with actual experience. Future policy benefits for interest sensitive products include the balance that accrues to the benefit of the policyholders and amounts that have been assessed to compensate the life insurance subsidiaries for services to be provided in the future.
Policy and contract claims represent estimates of both reported claims and claims incurred but not reported based on experience.
Income Taxes
Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases as well as operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
Treasury Shares
Shares purchased are recorded at cost as a reduction of shareholders' equity.
Insurance Revenue Recognition
Accident and sickness insurance premiums are recognized as revenue ratably over the time period to which premiums relate. Revenues from traditional life insurance policies represent premiums which are recognized as earned when due. Benefits and expenses are associated with earned premiums so as to result in recognition of profits over the lives of the policies. This association is accomplished by means of the provision for liabilities for future policy benefits and the deferral and amortization of policy acquisition costs.
Revenues for interest sensitive products such as universal life and annuity contracts represent charges assessed against the policyholders' account balance for the cost of insurance, surrenders and policy administration. Benefits charged to expenses include benefit claims incurred during the period in excess of policy account balances and interest credited to policy account balances.
Net Income per Common Share
In February 1997, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standard ("SFAS") No. 128, "Earnings Per Share." SFAS No. 128 supersedes and simplifies the former computation,
presentation and disclosure requirements for earnings per share outlined under Accounting Principles Board Opinion ("APB") No. 15, "Earnings Per Share." SFAS No. 128 is effective for both interim and annual financial statements issued after December 15, 1997. The Company adopted SFAS No. 128 to compute earnings per share for all periods presented.
The following is a reconciliation of net income applicable to common stock as well as common stock used to compute basic and diluted earnings per share for the years ended December 31:
The Company adopted the disclosure requirements of SFAS No. 123, "Accounting for Stock-Based Compensation," in 1996. This statement provides a choice for the accounting of employee stock compensation plans. A company may elect to use a new fair-value methodology, under which compensation cost is measured and recognized in results of operations, or continue to account for these plans under APB No. 25, "Accounting for Stock Issued to Employees", and related Interpretations. Note 12 of the Notes to Consolidated Financial Statements contains a summary of the pro forma effects to reported net income applicable to common stock and earnings per share for 1997 and 1996, as if the Company had elected to account for employee stock compensation plans utilizing the fair value methodology prescribed by SFAS No. 123.
Business Combinations
Business combinations accounted for as a purchase result in the allocation of the purchase consideration to the fair values of the assets and liabilities acquired establishing such fair values as the new accounting bases. Purchase consideration in excess of the fair value of net assets acquired is allocated to "costs in excess of net assets acquired." Should the fair value of the net assets acquired exceed the purchase consideration, such excess is utilized to reduce certain intangible assets, primarily "present value of insurance in force." Allocation of purchase price is performed in the period in which the purchase is consummated and may be preliminary. Adjustments resulting from completion of the purchase allocation process affect the value of the assets and liabilities acquired.
Foreign Currency Translation
The financial statement accounts of the Company's Canadian operations, which are denominated in Canadian dollars, are translated into U.S. dollars as follows: (i) Canadian currency assets and liabilities are translated at the rates of exchange as of the balance sheet dates and the related unrealized translation adjustments are included as a separate component of shareholders' equity, and (ii) revenues, expenses and cash flows, expressed in Canadian dollars, are translated using a weighted average of exchange rates for each of the periods presented.
Reinsurance
Financial reinsurance that does not transfer significant insurance risk is accounted for as deposits. The cost of reinsurance related to long-duration contracts is accounted for over the life of the underlying reinsured policies. Balances due to, or from, reinsurers have been reflected as assets and liabilities rather than being netted against the related account balances. Realized gains on retroactive reinsurance arrangements are deferred and amortized into net income over the estimated duration of the reinsured business.
Accounting Pronouncements Not Yet Adopted
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income." SFAS No. 130 is effective for annual and interim periods beginning after December 15, 1997. This statement establishes standards for reporting and displaying comprehensive income and its components and requires all items to be recognized under accounting standards as comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. Examples of items to be included in the Company's presentation of comprehensive income, in addition to net income applicable to common stock, are unrealized foreign currency translation gains and losses as well as unrealized gains and losses on securities available for sale. The Company will adopt the provisions of SFAS No. 130 in 1998.
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," was also issued in June 1997 by the FASB. This Statement requires that companies disclose segment data on the basis that is used internally by management for evaluating segment performance and allocating resources to segments. This Statement requires that a company report a measure of segment profit or loss, certain specific revenue and expense items, and segment assets. It also requires various reconciliations of total segment information to amounts in the consolidated financial statements. The Company's current definition of its business segments will not materially change from the current presentation. SFAS No. 131 is effective for fiscal years beginning after December 15, 1997.
In December 1997, the American Institute of Certified Public Accountants issued Statement of Position ("SOP") 97-3. SOP 97-3 provides: (1) guidance for determining when an entity should recognize a liability for guaranty-fund and other insurance-related assessments, (2) guidance on how to measure the liability, (3) guidance on when an asset may be recognized for a portion or all of the assessment liability or paid assessment that can be recovered through premium tax offsets or policy surcharges, and (4) requirements for disclosure of certain information. This SOP is effective for financial statements for fiscal years beginning after December 15, 1998. Early adoption is encouraged. Previously issued annual financial statements are not restated. The Company will report the effect of initially adopting this SOP in a manner similar
to the reporting of a cumulative effect of a change in accounting principle. The Company is currently evaluating the financial impact, which is expected to be immaterial, as well as the changes to its related disclosures.
In February 1998, the FASB adopted SFAS No. 132 "Employers' Disclosures about Pensions and Other Postretirement Benefits." SFAS No. 132 is effective for fiscal years beginning after December 31, 1997. Earlier application is encouraged. Restatement of disclosures for earlier periods provided for comparative purposes is required. SFAS No. 132 standardizes employers' disclosures about pension and other postretirement benefits, requires additional information on changes in the benefit obligations and fair values of plan assets to facilitate financial analysis, and eliminates certain irrelevant disclosures. The Company is currently evaluating the necessary changes to its related disclosures.
Reclassifications
Certain prior year amounts have been reclassified to conform to the current year presentation.
(3) ACQUISITIONS
On July 22, 1996, the Company consummated the acquisition of United Life for a total purchase price of $110,056 including expenses incurred of $9,706 and earnings through the date of consummation of the acquisition of $3,608. The fair value of net assets acquired amounted to $82,580 (as adjusted) resulting in $27,476 (as adjusted) of costs in excess of net assets acquired which will be amortized over 20 years.
The United Life acquisition has been accounted for as a purchase transaction in accordance with generally accepted accounting principles, and accordingly, all assets and liabilities acquired were recorded at fair value as of the acquisition date which became the new accounting basis.
On July 25, 1995, the Company consummated the acquisition of Integon Life for a total purchase price of $48,596 including acquisition expenses of approximately $3,200. The fair value of net assets acquired amounted to $28,575 (as adjusted) resulting in $20,021 (as adjusted) of costs in excess of net assets acquired which will be amortized over 20 years.
The acquisition of Integon Life was initiated on January 20, 1995, when the Company and its subsidiaries entered into a series of related agreements to acquire all of the issued and outstanding capital stock of Salem Holding Corporation (formerly Integon Life Corporation), including the purchase for $15,000 in cash, of a 49% limited partnership interest in the ultimate limited partner that controlled Integon Life. Prior to the consummation of the acquisition, the Company's 49% equity interest in the net income of Integon Life, which aggregated $3,808, was reported on the equity method of accounting as undistributed earnings in unconsolidated affiliates for the period from January 20, 1995 to July 25, 1995.
The Integon Life acquisition has been accounted for as a purchase transaction in accordance with generally accepted accounting principles, and accordingly, assets and liabilities acquired have been recorded as a step purchase with fair values determined as of January 20, 1995 and July 25, 1995, which became the new cost basis.
The following unaudited pro forma financial information represents the Company's consolidated results of operations as if the United Life acquisition occurred as of January 1, 1996. This unaudited pro forma financial information has been prepared for comparative purposes only and does not purport to be indicative of what would have occurred had the acquisition been made as of January 1, 1996, or results which may occur in the future.
(4) FOREIGN INFORMATION AND BUSINESS SEGMENT INFORMATION
The Company's only reportable industry segment is life insurance, and its only significant foreign operations are conducted in Canada. Within the life insurance segment the Company's significant lines of business include fixed benefit, life and accumulation products. Assets and related investment income are allocated based upon related insurance liabilities which are backed by such assets. Other operating expenses are allocated in relation to the mix of related revenues.
The components of operations were as follows for the years ended December 31:
Total assets were as follows as of December 31:
(5) INVESTMENTS
The following investments, other than obligations of the U.S. Government or agencies thereof, individually exceeded 10% of total shareholders' equity as of December 31:
The amortized cost and fair value of investments in fixed maturities held for investment were as follows as of December 31:
The amortized cost and fair value of investments in fixed maturities available for sale were as follows as of December 31:
The amortized cost and fair value of fixed maturities available for sale as of December 31, 1997, by contractual maturity, are shown below:
Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without prepayment penalties.
Included in fixed maturities held for investment as of December 31, 1996, are below investment-grade securities with an amortized cost, which approximates fair value, of $34,624.
Included in fixed maturities available for sale as of December 31, 1997 and 1996, are below investment-grade securities with an amortized cost of $165,511 and $91,590 and a fair value of $167,518 and $92,494, respectively. Included in fixed maturities available for sale as of December 31, 1997, are unrated securities with an amortized cost of $26,563 and a fair value of $36,175.
As of December 31, 1997, net unrealized appreciation in equity securities available for sale of $173 consisted of gross unrealized gains of $242, less gross unrealized losses of $69. As of December 31, 1996, net unrealized appreciation in equity securities available for sale of $3,356 consisted of gross unrealized gains of $4,047, less gross unrealized losses of $691.
Fair values for fixed maturity securities were provided by independent pricing services using market quotations, prices provided by market makers, or estimates of fair values obtained from yield data relating to investment securities with similar characteristics. The fair values for equity securities were determined using market quotations from principal public exchange markets.
The Company's commercial and residential mortgage portfolios had carrying values $240,879 and $264,732, respectively, and, fair values of approximately $248,052 and $269,142, respectively, as of December 31, 1997 and 1996. The fair values for mortgage loans on real estate are estimated using the quoted market prices for securities collateralized
by similar mortgage loans, adjusted for the differences in loan characteristics. For mortgage loans on real estate where quoted market prices are not available, the fair values are estimated using discounted cash flow analysis and interest rates for loans with similar credit ratings.
As of December 31, 1997, commercial and residential mortgage loan investments were concentrated in the following states:
Investments with a carrying value of $68,219 and $62,767 were on deposit with certain regulatory authorities as of December 31, 1997 and 1996, respectively.
Realized, and changes in unrealized gains and losses, on investments were as follows for the years ended December 31:
The Company had non-income producing fixed maturity investments with an amortized cost of $ -- and $17,115 as of December 31, 1997 and 1996, respectively.
On September 1, 1997, the Company purchased $25,000 of ACO Acquisition Corp. (subsequently re-named Acordia, Inc. ("Acordia") subordinated indebtedness and $20,000 of ACO Brokerage Holdings Corporation ("ACO"), an affiliate of Acordia, preferred stock. The Acordia subordinated notes pay interest on a current basis at 12.5%, per annum, payable in semi-annual installments. The ACO preferred stock dividends are payable in cash (subject to certain restrictions), or in-kind at the option of ACO, at a rate of 17 percent. Acordia is an insurance broker specializing in the marketing of commercial property and casualty programs. Acordia is 28.6% owned by Knightsbridge Capital Fund I, L.P.
("Knightsbridge"). PennCorp received fees aggregating $1,100 from Acordia for its underwriting and participation in the subordinated notes and preferred stock offering. Knightsbridge Management, L.L.C. ("KM") received sponsor fees and other fees aggregating $1,714 from Acordia for its role in consummating the Acordia acquisition.
(6) SOUTHWESTERN LIFE INVESTMENT
On December 14, 1995, Southwestern Financial Corporation ("SW Financial"), a newly organized corporation formed by the Company and Knightsbridge (see Notes 15 and 16) purchased Southwestern Life Insurance Company, Union Bankers Insurance Company and certain other related assets from I.C.H. Corporation for $260,000.
Through its initial direct investment of $120,000 in SW Financial (the "Southwestern Life Investment"), the Company beneficially owns 74.8% of SW Financial's outstanding common stock, including 100% of SW Financial's non-voting common stock, 14.3% of SW Financial's voting common stock, and 100% of SW Financial preferred stock. PennCorp is also a 16.3% limited partner in Knightsbridge. As a result, the Company has an economic interest in SW Financial aggregating 78.0 percent. Retained earnings of the Company include undistributed earnings of SW Financial aggregating $40,919, $21,947 and $910 as of December 31, 1997, 1996 and 1995, respectively.
On August 5, 1997, the Company purchased $40,000 of SW Financial Subordinated Notes (the "SW Financial Notes") from the liquidating trust for the creditors of ICH Corporation, SW Financial's former parent. SW Financial had issued the SW Financial Notes as part of the acquisition consideration paid to the liquidating trust. The SW Financial Notes were purchased by the Company at par and are included in other investments. Interest due under the SW Financial Notes is currently set at 7.0%, per annum.
On January 2, 1998, the Company acquired the SW Financial Controlling Interest (see Note 19).
The Company accounts for its investment in SW Financial utilizing the equity method. The consolidated condensed results of operations and financial position of SW Financial, are provided below:
(7) DEFERRED POLICY ACQUISITION COSTS AND PRESENT VALUE OF INSURANCE IN FORCE
Information relating to deferred policy acquisition costs is as follows for the years ended December 31:
As a part of the purchase accounting for the Company's acquisitions, a present value of insurance in force asset is established which represents the value of the right to receive future cash flows from insurance contracts existing at the date of acquisition. Such value is the actuarially determined present value of the projected cash flows from the acquired policies, discounted at an appropriate risk rate of return.
The methods used by the Company to value the fixed benefit, life, and accumulation products purchased are consistent with the valuation methods used most commonly to value blocks of insurance business. It is also consistent with the basic methodology generally used to value insurance assets. The method used by the Company includes identifying the future cash flows from the acquired business, the risks inherent in realizing those cash flows and the rate of return the Company believes it must earn in order to accept the risks inherent in realizing the cash flows, and determining the value of the insurance asset by discounting the expected future cash flows by the discount rate the Company requires.
The discount rate used to determine such values is the rate of return required in order to invest in the business being acquired. In selecting the rate of return, the Company considered the magnitude of the risks associated with the type of business acquired and actuarial factors described in the following paragraph, cost of capital available to the Company to fund the acquisition, compatibility with other Company activities that may favorably affect future profits, and the complexity of the acquired company.
Expected future cash flows used in determining such values are based on actuarial determinations of future premium collection, mortality, morbidity, surrenders, operating expenses and yields on assets held to back policy liabilities as well as other factors. Variances from original projections, whether positive or negative, are included in income as they occur and will affect the present value of insurance in force amortization rates for insurance products accounted for under SFAS No. 97. To the extent that these variances indicate that future cash flows will differ from those included in the original scheduled amortization of the present value of insurance in force, future amortization may be adjusted. Recoverability of the present value of insurance in force is evaluated annually and appropriate adjustments are then determined and reflected in the financial statements for the applicable period.
Information related to the present value of insurance in force is as follows:
Expected gross amortization of the present value of insurance in force, based upon current assumptions and accretion of interest at a policy liability or contract rate ranging from 3.5 to 14.5 percent, for the next five years is as follows:
(8) FUTURE POLICY BENEFITS
The liability for future policy benefits consists of reserves for fixed benefit, life and accumulation products. For interest sensitive life and annuity products, the liability for future policy benefits is equal to the accumulated fund value. Fund values are equal to the premium received and interest credited to the fund value less deductions for mortality costs and expense charges. Current declared interest rates credited range from 4.0 to 6.75 percent. Mortality costs and expense charges are established by the Company based upon its experience and cost structure and in accordance with policy terms.
For traditional life products, the liability for future policy benefits is based primarily upon Commissioners' Standard Ordinary Tables with interest rates ranging from 2.5 to 6.0 percent. Fixed benefit products establish a liability for future policy benefits equal to the excess of the present value of future benefits to or on behalf of the policyholder over the future net premium discounted at interest rates ranging primarily from 4.5 to 8.0 percent. Traditional life products and fixed benefit products future policy benefits may also be determined using Company experience as to mortality, morbidity and lapses with a provision for adverse deviation. The Company may vary assumptions by year of policy issue.
The following table presents information on changes in the liability for accident and sickness claims for the years ended December 31:
(9) NOTES PAYABLE
The outstanding principal amounts of the notes payable consist of the following as of December 31:
The fair value of amounts outstanding as notes payable for the years ended December 31, 1997 and 1996, amounted to $364,914 and $215,341, respectively. All recorded amounts other than the Senior Subordinated Notes approximate market as they carry variable rates of interest which adjust at least every 90 days. The fair value of the Senior Subordinated Notes is determined based upon quotes from market makers.
The aggregate maturities of notes payable during each of the five years after December 31, 1997, are as follows: 1998, $617; 1999, $668; 2000, $724; 2001, $951; 2002, $242,149.
All of the Company's debt obligations contain financial and operating covenants. The Company and its subsidiaries were in compliance with or had received waivers from all applicable covenants as of December 31, 1997.
For the year ended December 31, 1996, the Company realized an after-tax extraordinary charge of $2,372. The charge represents (i) the write-off of $816 of deferred financing costs related to the retirement of certain indebtedness of the Company and its subsidiaries, and (ii) the write-off of $1,556 of deferred financing, swap cancellation and other costs related to the repurchase of approximately $35,354 in principal amount of the Senior Subordinated Notes.
(10) INCOME TAXES
The Company and a number of its non-insurance subsidiaries file a consolidated federal income tax return with a July 31 year end, which differs from its financial year end. Marketing One and its subsidiaries file a consolidated federal income tax return with a December 31 year end. The life insurance subsidiaries file federal income tax returns on a calendar year basis with either PLAIC or Pioneer Security as the parent of the particular consolidated life insurance company tax group.
Total income taxes were allocated as follows for the years ended December 31:
The provisions for income tax expense (benefit) attributable to income before income taxes, equity in earnings of unconsolidated affiliates and extraordinary charge are as follows for the years ended December 31:
Taxes computed using the federal statutory rate of 35% are reconciled to the Company's actual income tax expense attributable to income before extraordinary charge as follows for the years ended December 31:
Temporary differences between the financial statement carrying amounts and tax bases of assets and liabilities that give rise to the deferred tax assets and liabilities relate to the following as of December 31:
The valuation allowance for deferred tax assets as of January 1, 1997 and 1996, was $15,892 and $17,157, respectively. The net change in the total valuation allowance for the years ended December 31, 1997 and 1996, was a decrease of $5,525 (including $5,000 that was used to reduce costs in excess of net assets acquired) and $1,265, respectively. During 1997, an additional $14,635 increase to the deferred tax asset was used to reduce costs in excess of net assets acquired related to the Integon Life acquisition as acquisition date tax contingencies were resolved. If recognized as a tax benefit, a portion of the December 31, 1997, valuation allowance totaling $2,349 would be allocated to reduce costs in excess of net assets acquired.
In assessing the realization of deferred taxes, management considers whether it is more likely than not that some portion or all of the deferred tax assets will be realized. The ultimate realization of deferred tax assets is dependent on the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment. Based upon those considerations, management believes it is more likely than not that the Company will realize the benefits of these deductible differences, net of the existing valuation allowance as of December 31, 1997.
As of December 31, 1997, the Company has life consolidated net operating loss carryforwards of approximately $99,823 for tax return purposes. In addition, OLIC and Peninsular have available, on a separate return basis, acquired net operating loss carryforwards of approximately $10,417. The utilization of acquired net operating loss carryforwards is limited in any one year to the lesser of (i) the life insurance group's consolidated taxable income or (ii) the subsidiary's taxable income computed on a separate return basis.
The approximate net operating loss carryforwards for income tax purposes expire as follows:
Under provisions of the Life Insurance Company Tax Act of 1959, certain special deductions were allowed to life insurance companies for federal income tax purposes. These special deductions were repealed by the Tax Reform Act of 1984, and the untaxed balances were frozen at their December 31, 1983 levels. These balances aggregate approximately $42,301 for the Company's life insurance subsidiaries and are subject to taxation if certain levels of premium income or life insurance reserves are not maintained, or if the life insurance companies make excess distributions to shareholders. It is not expected that a tax would become due on any such balance and no deferred income taxes have been provided. However, if such tax were to become payable, it would amount to approximately $14,805.
(11) PREFERRED AND COMMON STOCK
The Company issued 2,875,000 shares of $50 redemption value $3.50 Series II Convertible Preferred Stock (the "Series II Convertible Preferred Stock") on August 2, 1996. The Series II Convertible Preferred Stock is convertible at the option of the holder, unless previously redeemed, into 1.4327 shares of common stock for each share, subject to adjustment in certain events. Dividends accrued and unpaid as of December 31, 1997 and 1996, were $1,677. As of December 31, 1997, the estimated fair value of the Series II Convertible Preferred Stock, based upon market-maker quotes, was $166,750.
On July 25, 1995, the Company issued 127,500 shares of 10% Series B Preferred Stock and 178,500 shares of 9% Series C Preferred Stock to fund a portion of the Integon Life purchase price. The Series B Preferred Stock and the Series C Preferred Stock are mandatorily redeemable on or before June 30, 1997 and June 30, 1998, respectively. The redemption price of the Series C Preferred Stock is subject to certain offsets related to the Integon Life stock purchase agreement. Dividends accrued and unpaid were $ -- , and $1,939 on the Series B Preferred Stock and $3,867 and $2,175 on the Series C Preferred Stock, respectively, as of December 31, 1997 and 1996. On March 15, 1997, the Company redeemed all of the previously outstanding Series B preferred stock at its stated redemption value of $14,705.
The Company issued 2,300,000 shares of $50 redemption value $3.375 Convertible Preferred Stock (the "Convertible Preferred Stock") on July 14, 1995. The Convertible Preferred Stock is convertible at the option of the holder, unless previously redeemed, into 2.2124 shares of common stock for each share, subject to adjustment in certain events. Dividends accrued and unpaid as of December 31, 1997 and 1996 were $1,617. As of December 31, 1997, the estimated fair value of the Convertible Preferred Stock, based upon active market quotes, was $186,599.
In conjunction with the acquisition of AA Life in August 1994, the Company issued 450,000 shares of nonvoting Series A Preferred Stock, $0.01 per share par value and $100 per share redemption value. The Series A Preferred Stock was redeemed on August 25, 1995, from the proceeds received from the issuance of the Convertible Preferred Stock. During 1995, the Company paid or accrued dividends on the Series A Preferred Stock amounting to $1,725.
(12) STOCK OPTIONS AND WARRANTS
The Company has established two management stock option plans, the 1992 Stock Option Plan which set aside up to 475,635 shares for grant and the 1996 Stock Option Plan which set aside up to 2,800,000 shares for grant. Options granted under the 1992 Stock Option Plan are deemed to be in four equal units which are earned over four years from the date of grant and are exercisable during a one-year period immediately following the fourth anniversary of the date of grant. The 1996 Stock Option Plan allows for awards of stock or options subject to such terms, conditions, and restrictions, and/or limitations, if any, as the Stock Option Committee of the Board of Directors deems appropriate.
The Company has also established a senior management stock award plan ("Warrant Plan"). The Warrant Plan allows for grants to senior executive officers of PennCorp and Directors of PennCorp who are not executive officers of the Company. Grant prices are determined based on the average price of the shares traded on the date of grant. Warrants granted under the Warrant Plan are determined by the Compensation Committee and are exercisable at such times and in such amounts as the Compensation Committee shall determine, but no warrant granted under the Warrant Plan will be exercisable more than ten years after the date of grant. Upon change of control (as defined) of PennCorp, all outstanding warrants become immediately vested and exercisable, and any warrants that remain unexercised shall be canceled and replacement warrants shall be issued by the surviving entity.
As part of an employment agreement effective August 1990, the Company issued to a former officer of the Company, warrants to purchase up to 570,760 shares of the common stock of the Company at any time up to 10 years from the date of the agreement. The warrants are exercisable at a price of $4.00 per share which was fair value on the date of grant.
The Company has established a U.S. Sales Manager incentive stock option plan in which the senior sales manager of one of the Company's insurance subsidiaries may earn stock options in the amount of 275,000 shares over a five-year period, subject to achieving certain performance goals, in addition to an initial grant of 100,000 options. Such options are vested immediately as earned, except for the initial 100,000 which vest in September 1999, and option prices range from $15 per share, for the initial 100,000 options, to the fair value of the common stock of the Company on the date of grant for those shares subject to performance goals.
The following table summarizes data relating to stock options and warrants activity and associated weighted average option exercise price information for the years ended December 31:
The following table summarizes information concerning outstanding and exercisable options and warrants as of December 31, 1997:
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As allowed under the provisions of SFAS No. 123, the Company applies APB Opinion 25 and related Interpretations in accounting for its stock option and warrant plans and, accordingly, does not recognize compensation cost based on fair value as a component of net income applicable to common stock. If the Company had elected to recognize compensation cost based on the fair value of the options and warrants as of the grant date, estimated utilizing the Black- Scholes multiple options approach prescribed by SFAS No. 123, the Company's net income applicable to common stock as well as earnings per share would have been reduced by the pro forma amounts indicated in the following table:
(13) STATUTORY ACCOUNTING AND DIVIDEND RESTRICTIONS
Cash generated by the Company's insurance subsidiaries is made available to PennCorp principally through periodic payments of principal and interest on surplus debentures issued by PLAIC and Pioneer Security (collectively, the "Surplus Note Companies"). The amounts outstanding under the surplus debentures totaled $358,346 and $367,900 as of December 31, 1997 and 1996, respectively. These surplus debentures generally require (subject to availability of statutory capital and surplus and in some instances, regulatory approval) principal and interest payments to be made periodically in amounts sufficient to allow PennCorp to meet its cash requirements.
Dividend payments by the Company's insurance subsidiaries are limited by, or subject to the approval of the insurance regulatory authority of each subsidiary's state of domicile. Such dividend requirements and approval processes vary significantly from state to state. In 1998, the insurance subsidiaries (including SW Financial), subject to availability of cash, statutory capital and surplus and regulatory approval, will be able to pay a maximum of $56,749 in dividends to the Surplus Note Companies (including SW Financial). In 1998, the Surplus Note Companies, subject to availability of cash and the dividend capacity of the insurance subsidiaries, could pay a maximum of $76,408 on surplus note payments to the Company.
Statutory capital and surplus of the Company's life insurance subsidiaries as reported to regulatory authorities at December 31, 1997 and 1996, totaled $299,062 and $264,080, respectively. Shareholders' equity of the Company's life insurance subsidiaries included in the consolidated balance sheet totaled $755,365 and $580,334 at December 31, 1997 and 1996, respectively. Statutory net income (loss) of the Company's life insurance subsidiaries as reported to regulatory authorities totaled $18,776, ($28,600) and $13,579 for the years ended December 31, 1997, 1996, and 1995, respectively. Surplus note interest expense of $34,758, $51,254 and $24,170 for the years ended December 31, 1997, 1996, and 1995, respectively, is included in statutory net income (loss).
The Company's Canadian branch and Canadian subsidiary report to Canadian regulatory authorities based upon Canadian statutory accounting principles that vary in some respects from U.S. statutory accounting principles. Consolidated Canadian net assets based upon Canadian statutory accounting principles were $51,428 and $51,567 as of December 31, 1997 and 1996, respectively.
Remittances to PLIC from the Canadian operations totaled $ --, $ -- and $2,485 for the years ended December 31, 1997, 1996 and 1995, respectively.
(14) RETIREMENT AND PROFIT SHARING PLANS
On October 1, 1990, the Company established a defined contribution retirement plan (the "Defined Contribution Plan") for all employees of the Company who have attained age 21, and for certain agents whose commission earnings represent more than 50% of their income from the Company. Contributions to the Defined Contribution Plan are made pursuant to salary deferral elections by participants in an amount equal to 1% to 15% of their annual compensation. In addition, the Company makes matching contributions in an amount equal to 50% of each participant's salary deferral to a maximum of 3% of annual compensation. The Defined Contribution Plan also provides for a discretionary employer profit sharing contribution, which is determined annually by the Board of Directors for the succeeding plan year. Profit sharing contributions are credited to participants' accounts on the basis of their respective compensation in accordance with a formula that provides a higher percentage contribution for compensation in excess of the federal Social Security wage base. Salary deferral contribution accounts are at all times fully vested, while matching contribution accounts vest ratably from one to two years of service, and profit sharing contribution accounts vest ratably from one to five years of service. All participant accounts are fully vested at death, disability or attainment of age 65. Payment of vested benefits under the Defined Contribution Plan may be elected by a participant in a variety of forms of payment. The Company's funding policy is to contribute annually an amount that can be deducted for federal income tax purposes. Expenses related to this plan for the years ended December 31, 1997, 1996 and 1995, amounted to $1,483, $1,520 and $1,335, respectively.
The Company has an established bonus plan for insurance subsidiary officers. The amount available to pay awards for any year is determined by a committee of senior executives of the Company and is subject to the review and recommendation of the Compensation Committee and approval of the Board of Directors of the Company. Awards are based primarily on the income growth of the Company and the performance of eligible participants. The Company accrued or paid $1,417, $1,144 and $691 under this plan during the years ended December 31, 1997, 1996 and 1995, respectively.
If the Company meets established performance goals, the Company's two most senior officers are eligible to receive annual cash bonuses based primarily on annual growth rates in diluted earnings per share. Bonus awards range from 0% to 200% of a predetermined target annually. During 1997 and 1996, the Company did not accrue for such bonuses as the employment arrangements containing the bonus plan were contingent upon the purchase by the Company of The Fickes and Stone Knightsbridge Interests (see Notes 15 and 16 below).
Postretirement benefits are accrued (but not funded) for eligible retirees only as all plans are closed to future retirees. The plans principally cover certain costs associated with medical insurance coverage.
For the year ended December 31, 1997, the postretirement benefit liability was calculated assuming an annual trend rate in health care inflation ranging from 7% to 8% in 1998 grading down to 5% in 2004 and after. If the health care cost trend rate assumption increased by 1%, the accumulated postretirement benefit obligation as of December 31, 1997, would increase $419 or 3 percent.
(15) RELATED PARTY TRANSACTIONS
Related party transactions described herein include those transactions not included elsewhere in the Notes to Consolidated Financial Statements.
During 1995, two of the Company's officers and directors, Messrs. Stone and Fickes, formed a fund, Knightsbridge, for the purpose of making equity and equity linked investments in companies engaged primarily in the life insurance industry. Knightsbridge has received subscriptions for approximately $92,000 in limited partnership interests, including a $15,000 subscription from the Company. The general partner of Knightsbridge is Knightsbridge Capital L.L.C. ("Knightsbridge Capital"), the members of which are David J. Stone and Steven W. Fickes. Allan D. Greenberg, a member of the Company's Board of Directors, formerly owned a 5% interest in Knightsbridge Capital which was purchased by Messrs. Stone and Fickes. The general partner of Knightsbridge cannot be removed by the limited partners, unless a court has finally determined that the general partner has committed a willful and material breach of the limited partnership agreement.
In the second half of 1995, the Company and Knightsbridge determined that a joint venture strategy was in the best interest of both parties. As part of that joint venture, Knightsbridge provides PennCorp with a right of first refusal with respect to all insurance transactions considered by Knightsbridge. The joint venture entity formed for this purpose is KM. PennCorp participates in 45% of the net distributable income of KM.
The Company has established an independent committee of the Board of Directors to oversee the relationship between PennCorp and Knightsbridge. KM has the primary responsibility for negotiating the terms of, and arranging the financing for PennCorp or PennCorp/Knightsbridge shared transactions. Certain of those individuals involved in the daily operations of KM are also officers of the Company.
KM receives management fees from all of its limited partners, including the Company, for the management of Knightsbridge. KM also receives payment in kind consideration in lieu of additional management fees from PennCorp for providing corporate and financial management services to the Company. Fees received by KM from the Knightsbridge limited partners including PennCorp, as well as the management fees paid in kind by the Company are subject to offset in future periods based upon a portion of transaction fees generated by KM.
On December 31, 1997, at the Company's annual shareholders meeting, shareholders approved a restructuring of the Knightsbridge relationship which included the following transactions (see Notes 16 and 19); (i) Messrs. Stone and Fickes entered into five-year employment agreements which include the contingent issuance of options to purchase 559,000 shares of Common Stock to both Messrs. Stone and Fickes, (ii) the acquisition of The Fickes and Stone Knightsbridge Interests, and (iii) the acquisition of The Fickes and Stone Interests in SW Financial, subject to certain contingencies.
For the years ended December 31, 1997, 1996 and 1995, PennCorp paid or accrued $2,385, $2,548 and $3,900 in transaction fees and expenses to KM related to the Washington National, United Life and SW Financial transactions, respectively. During 1997 and 1996, certain of the Company's affiliates and subsidiaries paid management fees to KM amounting to $5,325 and $3,333, respectively. SW Financial and United Life incurred KM investment advisory fees totaling $4,358, $2,426 and $ -- during 1997, 1996 and 1995, respectively. In addition during 1996, PennCorp received a $1,000 stand-by commitment fee from SW Financial for contingent financing on a real estate transaction. SW Financial did not draw upon the commitment which has expired.
As required by the joint venture agreement, all bonuses paid to officers of KM who are also officers of PennCorp must be approved by the Compensation Committee of the Board of Directors of PennCorp. During 1995, the Company paid or accrued for KM incentive bonuses to certain individuals who are officers of PennCorp and KM totaling $2,565. Such bonuses were expensed in the accompanying financial statements.
In August 1995, the Company sold its preferred and common stock position in a company which has historically provided investment management services to the PennCorp insurance subsidiaries and for which a senior executive officer of the investment management firm is a member of the PennCorp Board of Directors. Fees paid for such investment management services amounted to $1,083, $895 and $738 during 1997, 1996 and 1995, respectively.
During 1997, the Company's insurance subsidiaries paid management and commitment fees aggregating $444 to investment funds managed by a member of the Board of Directors.
Certain individuals, who are shareholders and directors of PennCorp, and affiliates of these individuals, provide services to the Company. During 1997, 1996 and 1995, payments aggregating $250, $250 and $210, respectively, were made to these individuals and their affiliates for services provided in connection with the Company's acquisition activity.
At December 31, 1997, an insurance subsidiary entered into a reinsurance agreement with Southwestern Life to coinsure certain annuities which had GAAP policy liabilities of $256,673. Cash of $50,000 and securities were transferred which had fair values equal to statutory policy liabilities of $255,195. No gain or loss was recognized on the transaction.
(16) OTHER COMMITMENTS AND CONTINGENCIES
On December 31, 1997, PennCorp shareholders approved the acquisition of the Controlling Interest in SW Financial through the assignment by Fickes, Stone and Knightsbridge ("the Controlling Parties") of certain rights, including common stock and common stock equivalents of SW Financial. The controlling Parties will receive aggregate cash consideration ranging from $73,777 to $77,444 (not including expenses) depending upon the outcome of certain contingencies.
In addition, PennCorp shareholders approved the acquisition of the interests of Messrs. Stone and Fickes in Knightsbridge Management, L.L.C. ("Knightsbridge Management"), Knightsbridge Capital L.L.C. and Knightsbridge Consultants L.L.C. (collectively, "The Fickes and Stone Knightsbridge Interests") for total consideration estimated to be $10,000. Fickes and Stone will each receive consideration in the form of estimated annual payments of $330 due April 15, 1997, each year through 2001 and issuance by PennCorp of 173,160 shares of PennCorp Common Stock to each of Fickes and Stone on April 15, 2001.
As part of the Knightsbridge restructuring plan as approved, PennCorp must acquire Fickes and Stone's co- investment in Acordia for $5,200, which amount represents Fickes' and Stone's actual cost.
The Company and its subsidiaries are obligated under operating leases, primarily for office space. Rent expense, net of sublease income, was $5,178, $8,416 and $8,489 in 1997, 1996 and 1995, respectively.
In January 1996, stockholder derivative lawsuits styled Tozour Energy Systems Retirement Plan v. David J. Stone et al and the PennCorp Financial Group, Inc., C.A. No. 14775 (the "Tozour Case") and Lois Miller v. David J. Stone et al, and the PennCorp Financial Group, Inc., C. A. No. 14795 (the "Miller Complaint") were filed against the Company and each of its directors, individually, in the Delaware Court of Chancery. The complaint in the Miller suit has not yet been served on the Company or the other defendants. Both suits allege that the SW Financial Investment involved the usurpation of a corporate opportunity and a waste of the Company's assets by Messrs. Stone and Fickes, and that the directors of the Company in approving that transaction, failed to act in good faith and breached their fiduciary duties, including the duty of loyalty to the Company and its stockholders, having favored the interests of Messrs. Stone and Fickes over the Company and its stockholders. These lawsuits seek judgments against each of the defendants for the amount of damages sustained, or to be sustained, by the Company as a result of the breaches of fiduciary duty alleged in the complaint, the imposition of a constructive trust for the benefit of the Company on profits or benefits obtained by any defendant through the alleged breaches of fiduciary duty, attorney's fees and costs, and such other relief as the court determines to be just, proper or equitable.
The defendants in the Tozour Case have filed a motion seeking its dismissal on the ground that the plaintiff failed to comply with the requirements of Delaware law before instituting a derivative suit and intend to defend the lawsuit vigorously. Because the Company has not been served with the Miller Complaint, no action has been taken in that case, although the Company would also defend it vigorously. The defendants believe, however, that it would not be in the best interests of the Company and its shareholders to expend considerable management and director time and to incur substantial expenses to litigate the actions. Consequently, the Company's legal advisors have met or spoken by telephone with the plaintiffs' counsel on several occasions to discuss the terms of a potential settlement.
The defendants and the plaintiffs' counsel entered into a stipulation of settlement on March 28, 1997 (the "Original Proposed Settlement"). The Original Proposed Settlement consisted of the following principal elements: (i) Messrs. Stone and Fickes will cancel the 335,564 SW Financial common stock warrants they hold for no consideration enabling PennCorp to purchase the SW Financial Controlling Interest for $67.5 million, reducing the price to be paid by PennCorp for the SW Financial Controlling Interest by approximately $2.0 million, (ii) the PennCorp Board will proceed with the purchase of The Fickes and Stone Knightsbridge Interests, having received a fairness opinion of a nationally recognized investment banking firm with respect to the price to be paid for The Fickes and Stone Knightsbridge Interests, (iii) the PennCorp Board will proceed with the acquisition of the SW Financial Controlling Interest, having received a fairness opinion of a nationally recognized investment banking firm with respect to the price to be paid for the SW Financial Controlling Interest, (iv) the PennCorp Board will submit the purchases of The Fickes and Stone Knightsbridge Interests and the SW Financial Controlling Interest to a shareholder vote of a majority of the PennCorp stockholders present at a meeting and entitled to vote, and stockholders must approve both transactions, (v) Messrs. Stone and Fickes will abstain from voting on the proposals to approve the purchase of The Fickes and Stone Knightsbridge Interests and the SW Financial Controlling Interest, and (vi) the plaintiffs' counsel will be entitled to conduct confirmatory discovery.
On December 1, 1997, the defendants and the plaintiffs' counsel agreed in principle to amend the Original Proposed Settlement (as so amended, the "Amended Proposed Settlement") following the PennCorp Board's conclusion that it would be appropriate to increase the amount paid to the Knightsbridge Fund for the SW Financial Controlling Interest to compensate the limited partners for, among other things, the unexpected and substantial delay in the consummation of the purchase of the SW Financial Controlling Interest. The terms of the Amended Proposed Settlement are identical to the terms of the Original Proposed Settlement, except that the Amended Proposed Settlement provides that the Company will acquire the SW Financial Controlling Interest for $73.8 million, and will provide a one-time "price protection" payment associated with a disposition of the SW Financial Controlling Interest by PennCorp during the 12-month period ending November 25, 1998. The Amended Proposed Settlement also requires Messrs. Stone and Fickes to grant PennCorp a price protection right in the event of a sale of their Portsmouth investment.
The Amended Proposed Settlement is subject to approval by the Chancery Court after notice to PennCorp stockholders. A settlement hearing is scheduled for May 12, 1998 in the Chancery Court. As discussed above, Messrs. Stone and Fickes have agreed that, if the Amended Proposed Settlement is approved by the Chancery Court, they will cancel their SW Financial common stock warrants and they will not participate in the increased consideration (other than the possible price protection right) for the SW Financial Controlling Interest to the extent it relates to their $7,000 personal investment in SW Financial, which together will reduce the price to be paid by PennCorp for the SW Financial Controlling Interest by approximately $3,667. Because the Knightsbridge restructuring will have the effect of substantially eliminating potential future conflicts of interest between Messrs. Stone and Fickes and PennCorp, and because the Amended Proposed Settlement will have the effect of reducing the price to be paid for the SW Financial Controlling Interest and will obviate the need to expend considerable management and director time to litigate the actions, the PennCorp Board has determined that the Amended Proposed Settlement is in the best interests of PennCorp and its shareholders and confers a substantial economic benefit on PennCorp. Accordingly, the PennCorp Board has authorized the payment to plaintiffs' counsel of legal fees of $785 and documented expenses not to exceed $50 in connection with the lawsuits and the related settlement negotiations, if the Amended Proposed Settlement is approved by the Delaware Chancery Court after notice to PennCorp stockholders. Such amounts were expensed in the accompanying financial statements.
The Company is a party to various pending or threatened legal actions arising in the ordinary course of business some of which include allegations of insufficient policy illustrations and agent misrepresentations. Although the outcome of such actions is not presently determinable, management does not believe that such matters, individually or in the aggregate, would have a material adverse effect on the Company's financial position or results of operations if resolved against the Company.
Effective January 1, 1996, the Company outsourced the vast majority of its data center operations and administrative systems programming to a third party vendor. The processing agreement extends through December 2002 and requires the Company or its insurance subsidiaries to make payments ranging from approximately $8,399 to $9,248 during each of the contract years. The contract has standard provisions for early cancellation, including breakage fees.
The life insurance companies are required to be members of various state insurance guaranty associations in order to conduct business in those states. These associations have the authority to assess member companies in the event that an insurance company conducting business in that state is unable to meet its policyholder obligations. Assessments from guaranty associations, which have not been material, are recorded as assessments when received.
The Company has a contingent obligation for mortgage loans previously sold aggregating $10,719 as a result of the Company acting as a servicing conduit.
(17) REINSURANCE
In the normal course of business, the Company reinsures portions of certain policies that it underwrites to limit disproportionate risks. The Company retains varying amounts of individual insurance up to a maximum retention of $500 on any life. Amounts not retained are ceded to other insurance enterprises or reinsurers on an automatic or facultative basis.
The Company cedes varying amounts of certain accident and sickness policies up to a maximum cession of $800, as well as varying portions of certain disability income policies on a facultative basis.
Reinsurance contracts do not relieve the Company from its obligations to policyholders. Therefore, the Company is contingently liable for recoverable unpaid claims and policyholder liabilities ceded to reinsurers in the unlikely event that assuming reinsurers are unable to meet their obligations. The Company evaluates the financial condition of its reinsurers to minimize its exposure to significant losses from reinsurer insolvencies. The effect of reinsurance on policy revenues earned is as follows:
Fees incurred for financial reinsurance were approximately, $145 in 1997, $265 in 1996, and $339 in 1995.
(18) RESTRUCTURING AND OTHER CHARGES
As a result of the Company's initiative to implement an operating division structure, the Company recorded a cumulative pre-tax restructuring charge of $19,071 during the three month period ended March 31, 1997. The restructuring charge recognizes: (a) severance and related benefits incurred due to staff reductions ($5,355), (b) estimated holding costs of vacated facilities ($6,166), (c) the write-off of certain fixed assets and other impaired assets ($1,526), (d) estimated contract termination costs ($24), and (e) the write-off of the Company's investment in certain foreign operations which will be closed ($6,000). As of December 31, 1997 the Company had charged against the accrual $2,411 of severance and related benefits, $1,916 of vacated facilities costs, $332 of fixed asset write-offs and $5,551 associated with the exit of the Company from certain foreign operations. During the three month period ended December 31, 1997, the Company re-evaluated such charge and reduced remaining accruals by $2,300 as a result of final determination of certain obligations.
The Company incurred $4,652 of pre-tax incremental costs associated with the restructuring during 1997. Such costs are included in the Company results of operations as underwriting and other general and administrative costs.
In addition during the year ended December 31, 1997, the Company incurred $7,646 of pre-tax transaction costs associated with the terminated Washington National merger agreement. Such costs are included in the Company results of operations.
During 1995, the Company had a restructuring charge of $3,943.
(19) SUBSEQUENT EVENTS
The Company initiated a redemption, effective March 31, 1998, of the Series C Preferred Stock into shares of the Company's Common Stock under provision of the Series C Preferred Stock certificate of designation.
On January 2, 1998, the Company acquired the Controlling Interest in SW Financial for aggregate cash consideration ranging from $73,777 to $77,444 (excluding anticipated acquisition expenses) depending upon the outcome of certain contingencies (see Note 16). As a result of the Company's plans to consolidate certain of its operating locations and corporate functions, the Company expects to incur restructuring and certain other charges during 1998 not to exceed approximately $25.0 million.
On January 5, 1998, the Company acquired the Fickes and Stone Knightsbridge interests (see Note 16).
On February 18, 1998, the Company announced that it had engaged investment banking firms to review strategic alternatives for maximizing shareholder value, including the sale of the Company's Career Sales Division.
The following unaudited selected pro forma financial information has been prepared to illustrate the pro forma effects of (i) the acquisition of the controlling interest of SW Financial including the financing thereof, (ii) the acquisition of the Fickes and Stone Knightsbridge Interests, including the financing thereof ((i) and (ii) collectively the SW Financial pro forma) and (iii) the impact of the Company's decision to dispose of the Career Sales Division ((i), (ii) and (iii) collectively the Retained Businesses pro forma). The pro forma statement of operations for the year ended December 31, 1997 gives effect to the foregoing as though each had occurred on January 1, 1997. The selected pro forma balance sheet information as of December 31, 1997, gives effect to the foregoing as through each had occurred on December 31, 1997. The selected pro forma financial information is not necessarily indicative of either future results or the results that might have occurred had the transactions occurred on January 1, 1997 or December 31, 1997 as the case might be.
The acquisitions of the SW Financial Controlling Interest and the Fickes and Stone Knightsbridge Interests will be accounted for using the purchase method of accounting. The total purchase price of the acquisitions will be allocated to the tangible and intangible assets and liabilities acquired based upon their respective values as of the respective consummation dates. The allocation of the aggregate purchase price reflected in the selected pro forma financial information is preliminary. The final allocation of the purchase price is upon determination of the fair values of the acquired assets and liabilities; however, that allocation is not expected to differ materially from the preliminary allocation. The Company's decision to dispose of the Career Sales Division in a period of time not likely to exceed one year will result in the assets and liabilities of the Career Sales Division to be considered "assets and liabilities held for sale," and as such will be segregated from those of the retained businesses for purposes of presentation of the Company's financial position. In addition, the Company will be required to provide certain information regarding the impact of the Career Sales Division on the Company's consolidated results. The following unaudited selected pro forma financial information is intended to summarize such transactions. The retained businesses pro forma information reflects the historical results of the retained businesses and does not consider the use of proceeds likely to be derived from the disposition of the businesses held for sale. The significant subsidiaries included in businesses held for sale are PLIC and Union Bankers, a subsidiary of SW Financial.
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(20) UNAUDITED QUARTERLY FINANCIAL DATA
The following is a summary of the quarterly results of operations for the years ended December 31, 1997 and 1996:
The Company's fourth quarter 1997 reported loss was primarily a result of reserve strengthening aggregating $12,373 associated with the businesses held for sale and certain non-recurring charges including transaction costs, period restructuring costs and other costs aggregating $5,222, associated with the retained businesses. In addition, the Company unlocked certain actuarial assumptions on interest sensitive blocks of business resulting in additional amortization of deferred policy acquisition costs and present value of insurance in force amounting to $6,944.
INDEPENDENT AUDITORS' REPORT
Board of Directors Southwestern Financial Corporation:
We have audited the accompanying consolidated balance sheets of Southwestern Financial Corporation and subsidiaries as of December 31, 1997 and 1996 and the related consolidated statements of income, shareholders' equity, and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Southwestern Financial Corporation and subsidiaries as of December 31, 1997 and 1996 and the results of their operations and their cash flows for the years then ended in conformity with generally accepted accounting principles.
KPMG Peat Marwick LLP Dallas, Texas March 19, 1998
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS as of December 31,1997 and 1996 (In thousands, except share information)
See accompanying Notes to Consolidated Financial Statements.
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME for the Years Ended December 31, 1997 and 1996 (In thousands)
See accompanying Notes to Consolidated Financial Statements.
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY for the Years Ended December 31, 1997 and 1996 (In thousands)
See accompanying Notes to Consolidated Financial Statements.
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS for the Years Ended December 31, 1997 and 1996 (In thousands)
See accompanying Notes to Consolidated Financial Statements.
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 1997 and 1996 (In thousands)
1. Basis of Presentation
On December 14, 1995 (the acquisition date), Southwestern Financial Corporation (SWF or the Company), a newly organized corporation, was formed by PennCorp Financial Group, Inc. (PennCorp) and Knightsbridge Capital Fund I, L.P. (Knightsbridge). A wholly-owned subsidiary of SWF acquired from I.C.H. Corporation (ICH), Southwestern Life Insurance Company (Southwestern Life) and its wholly-owned subsidiary, Constitution Life Insurance Company (Constitution) and its 83% owned subsidiary, ICH Funding Corp. (ICH Funding), and Union Bankers Insurance Company (Union Bankers) and its wholly-owned subsidiary, Marquette National Life Insurance Company (Marquette). In addition, a wholly-owned subsidiary of SWF acquired from ICH substantially all of the assets and liabilities of Facilities Management Installation, Inc. (FMI), which had provided management services to ICH's insurance companies. The acquisition was accounted for as a purchase in accordance with generally accepted accounting principles (GAAP) and, accordingly, the purchase price was allocated to assets and liabilities acquired based on estimates of their fair value as of the acquisition date, which became the new cost basis. Subsequently, the insurance companies were reorganized such that Constitution became the parent of Southwestern Life and Union Bankers. Effective January 2, 1998, PennCorp acquired Knightsbridge's interest in SWF and SWF became a wholly-owned subsidiary of PennCorp. (See Note 16).
In August 1997, the Company acquired from ICH the remaining 17% interest in ICH Funding and certain other assets and released ICH from indemnification obligations relative to certain tax, litigation and other matters. Minority interest in ICH Funding, totaling $1,486 at December 31, 1996 is included in accrued expenses and other liabilities as of December 31, 1996.
SWF and its subsidiaries market and underwrite a broad range of life insurance, annuities and accident and health products to individuals through a sales force of independent agents. The insurance subsidiaries are licensed to write business in 48 states, the District of Columbia and Guam. Approximately 27.4% of the total direct premium of the Company's insurance subsidiaries was generated from business written in Texas. No other states accounted for more than 10% of the direct premium of the Company in 1997.
The accompanying consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the reported amounts of revenues and expenses during the reporting period. Accounts that the Company deems to be acutely sensitive to changes in estimates include deferred policy acquisition costs, future policy benefits, policy and contract claims and present value of insurance in force. In addition, the Company must determine requirements for disclosure of contingent assets and liabilities as of the date of the financial statements based upon estimates. In all instances, actual results could differ from estimates.
2. Summary of Significant Accounting Policies
(a) Investments
Fixed maturity and equity securities classified as available for sale are recorded at fair value, as they may be sold in response to changes in interest rates, prepayment risk, liquidity needs, the need or desire to increase income or capital and other economic factors. Changes in unrealized gains and losses related to securities available for sale are recorded as a separate component of shareholders' equity, net of applicable taxes and amount attributable to deferred policy acquisition costs and present value of insurance in force related to universal life and investment-type products. Mortgage-backed securities are amortized using the interest method including
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. Summary of Significant Accounting Policies (Continued)
anticipated prepayments at the date of purchase. Significant changes in estimated cash flows from original assumptions are reflected in the period of such change. Mortgage loans on real estate are recorded at cost, adjusted for the provision for loan losses, if necessary. Policy loans are recorded at cost. Short-term investments purchased with maturities generally less than three months are recorded at cost, which approximates market. All short-term investments are considered to be cash equivalents.
Real estate, substantially all of which was acquired through foreclosure, is recorded at the lower of fair value, minus estimated costs to sell, or cost. If the fair value of the foreclosed real estate minus estimated costs to sell is less than cost, a valuation allowance is provided for the deficiency. Increases in the valuation allowance are charged to income.
Collateral loans are carried at their aggregate unpaid principal balances.
The Company regularly evaluates the carrying value of their investments based on current economic conditions, past credit loss experience and other circumstances. A decline in net realizable value that is other than temporary is recognized as a realized investment loss and a reduction in the cost basis of the investment. The Company discounts expected cash flows in the computation of net realizable value of its investments, other than certain mortgage-backed securities. In those circumstances where the expected cash flows of residual interest and interest-only mortgage-backed securities, discounted at a risk-free rate of return, result in an amount less than the carrying value, a realized loss is reflected in an amount sufficient to adjust the carrying value of a given security to its fair value.
Realized investment gains and losses and declines in value which are other than temporary, determined on the basis of specific identification, are included in the determination of net income.
(b) Insurance Revenue Recognition
Accident and health insurance premiums are recognized as revenue ratably over the time period to which premiums relate. Revenues from traditional life insurance policies represent premiums which are recognized as earned when due. Benefits and expenses are associated with earned premiums so as to result in recognition of profits over the lives of the policies. This association is accomplished by means of the provision for liabilities for future policy benefits and the deferral and amortization of policy acquisition costs.
Revenues for interest sensitive products such as universal life and annuity contracts represent charges assessed against the policyholders' account balance for the cost of insurance, surrenders and policy administration. Benefits charged to expenses include benefit claims incurred during the period in excess of policy account balances and interest credited to policy account balances.
(c) Policy Liabilities and Accruals
Liabilities for future policy benefits for traditional life products generally have been computed on the net level premium method, based on estimated future investment yield, mortality, and withdrawals. For accident and health products, liabilities for future policy benefits are established equal to the excess of the present value of future benefits to or on behalf of policyholders over discounted net future premiums. Estimates used are based on the Company's experience adjusted to provide for possible adverse deviation. These estimates are periodically
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. Summary of Significant Accounting Policies (Continued)
reviewed and compared with actual experience. Liabilities for future policy benefits for interest sensitive products include the balance that accrues to the benefit of the policyholders and amounts that have been assessed to compensate the life insurance subsidiaries for services to be provided in the future.
Policy and contract claims represent estimates of reported claims and claims incurred but not reported based on experience.
(d) Accounts and Notes Receivable
Accounts and notes receivable consist primarily of agents' balances and premium receivable from agents and policyholders. Agents' balances are partially secured by commissions due to agents in the future and premiums receivable are secured by policy liabilities. An allowance for doubtful accounts is established, based upon specific identification and general provision, for amounts which the Company estimates will not ultimately be collected.
(e) Deferred Policy Acquisition Costs
Estimated costs of acquiring new business which vary with, and are primarily related to, the production of new business, have been deferred to the extent that such costs are deemed recoverable from future revenues. Such estimated costs include commissions and certain costs of policy issuance and underwriting. Costs deferred on accident and health and traditional life policies are amortized, with interest, over the anticipated premium-paying period of the related policies in proportion to the ratio of annual premium revenue to expected total premium revenue to be received over the life of the policies. Expected premium revenue is estimated by using the same mortality, morbidity and withdrawal assumptions used in computing liabilities for future policy benefits. For interest sensitive products and limited pay life products, policy acquisition costs are amortized in relation to the emergence of anticipated gross profits over the life of the policies.
(f) Present Value of Insurance In Force
The present value of insurance in force represents the anticipated gross profits to be realized from future revenues on insurance in force at the date such insurance was purchased, discounted to provide an appropriate rate of return and amortized, with interest, based on credited rate, over the years that such profits are anticipated to be received in proportion to the estimated gross profits. Accumulated amortization was $35,386 and $22,889 as of December 31, 1997 and 1996, respectively.
(g) Deferred Debt Issuance Costs
Deferred debt issuance costs, which are included in other assets, represent costs incurred in connection with obtaining long-term debt financing which have been capitalized and are being amortized on an interest yield method over the terms of the respective debt. Deferred costs totaled $2,530 and $3,309 which are net of accumulated amortization of $1,580 and $801 at December 31, 1997 and 1996, respectively.
(h) Costs in Excess of Net Assets Acquired
Costs in excess of the fair value of net assets acquired are amortized on a straight-line basis over 30 years. Accumulated amortization totaled $8,260 and $4,130 at December 31, 1997 and 1996, respectively.
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. Summary of Significant Accounting Policies (Continued)
(i) Recoverability of Long-lived Assets
The Company continually monitors long-lived assets and certain intangible assets, such as costs in excess of net assets acquired and present value of insurance in force, for impairment. An impairment loss is recorded in the period in which the carrying value of the assets exceeds the fair value or expected future cash flows. Any amounts deemed to be impaired are charged, in the period in which such impairment was determined, as an expense against earnings. For the period presented there was no charge to earnings for the impairment of long-lived assets.
(j) Income Taxes
Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to (i) temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, and (ii) operating losses and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which the temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
(k) Reinsurance
Financial reinsurance that does not transfer significant insurance risk is accounted for as a deposit and is reflected as a component of due from reinsurers. The cost of reinsurance related to long-duration contracts is accounted for over the life of the underlying reinsurance policies. Balances due to, or from, reinsurers have been reflected as assets and liabilities rather than reducing the related account balances.
3. Investments
Investments in a single entity, other than obligations of the U.S. Government or agencies thereof, totaling in excess of 10% of total shareholders equity at December 31, 1997 and 1996 are listed below:
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. Investments (Continued)
The amortized cost and fair value of investments in fixed maturities available for sale at December 31, 1997 and 1996 by categories of securities are as follows:
The amortized cost and fair value of fixed maturities at December 31, 1997, by contractual maturity, are shown below:
Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without prepayment penalties.
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. Investments (Continued)
Investments with a fair value of $119,695 and $121,617 were on deposit with certain regulatory authorities at December 31, 1997 and 1996, respectively.
Included in fixed maturities available for sale at December 31, 1997 and 1996, are below investment-grade securities with amortized costs of $71,467 and $40,177, respectively, and fair values of $74,227 and $39,955, respectively. Included in fixed maturities available for sale as of December 31, 1997, are unrated securities with an amortized cost and fair value of $11,811.
During 1997, the Company purchased $7,650 of subordinated indebtedness of ACO Acquisition Corp., which was subsequently re-named Acordia, Inc. (Acordia). The Acordia subordinated notes pay interest on a current basis at 12.5% per annum, payable in semi-annual installment. Acordia is an insurance broker specializing in the marketing of commercial property and casualty programs. Acordia is 28.6% owned by Knightsbridge.
In addition, during 1997, the Company acquired 41,605 shares of redeemable preferred stock of Portsmouth Financial Group, Inc. (Portsmouth) for $4,161. The preferred stock pays dividends of 18.0% of which 12.5% is in cash with the remainder in the form of additional preferred stock. The shares are mandatorily redeemable on June 30, 2002. Portsmouth underwrites, acquires, and holds to receipt of benefits, life insurance contracts covering individuals facing terminal illnesses. Portsmouth is owned by Knightsbridge and its affiliates. The Company has agreed, subject to required regulatory approvals to make up to a $10,000 preferred equity investment in Portsmouth.
The Company had non-income producing investments at December 31, 1997 with an amortized cost and fair value as follows:
At December 31, 1997 net unrealized appreciation of equity securities of $391 consisted of gross unrealized gains of $415, less unrealized losses of $24. At December 31, 1996 net unrealized appreciation of $170 consisted of gross unrealized gains of $207, less unrealized losses of $37.
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. Investments (Continued)
Following is an analysis of net gains (losses) from sale of investments for the years ended December 31, 1997 and 1996:
For the year ended December 31, 1997, net realized gains on sale of fixed maturities consisted of gross gains of $2,779 and gross losses of $2,226. For the year ended December 31, 1996, net realized gains on sale of fixed maturities consisted of gross gains of $2,923 and gross losses of $1,538.
Following are changes in unrealized appreciation (depreciation) on investments for the years ended December 31, 1997 and 1996:
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. Investments (Continued)
Major categories of net investment income for the years ended December 31, 1997 and 1996 consist of the following:
At December 31, 1997 and 1996 the Company held mortgage loans principally involving commercial real estate with carrying values of $51,070 and $59,993, respectively, net of an allowance for losses of $680 and $1,000 at December 31, 1997 and 1996, respectively. Estimated fair values of mortgage loans totaled $51,816 and $59,993 at December 31, 1997 and 1996, respectively. The average outstanding loan balances were approximately $1,027 and $955 at December 31, 1997 and 1996, respectively. At December 31, 1997 mortgage loan investments were concentrated in the following states:
During 1996, the Company had a limited partnership investment representing a 50% interest in a partnership, GSSW, L.P. (GSSW) formed to acquire through auction certain mortgage loans and real estate formerly held by failed savings and loan associations. Effective December 31, 1996, GSSW liquidated the general partner interests through distribution of certain assets at fair value, sold substantially all remaining investments and utilized the proceeds to buy the limited partnership interest not owned by the Company. As a result of these transactions, the Company became the parent of GSSW, realized earnings on GSSW of $13,171, received net cash distributions of $47,520 and paid PennCorp, a shareholder, a fee of $1,000 as guarantor in GSSW's sale of assets.
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. Investments (Continued)
Following is an analysis of the investment in the GSSW limited partnership for the year ended December 31, 1996:
At December 31, 1997 and 1996, the accounts of GSSW are consolidated into the accompanying consolidated balance sheet.
4. Policy Liabilities and Accruals
For interest sensitive life products and annuity products, the liability for future policy benefits is equal to the accumulated fund value. Fund values are equal to the excess premium received and interest credited to the fund value less deductions for mortality costs and expense charges. Current interest rates credited range from 4% to 8%. Mortality costs and expense charges are established by the Company based upon its experience and cost structure.
For traditional life products, the liability for future policy benefits has been computed by the net level premium method based on estimated future investment yield, mortality, and withdrawal experience. Reserve interest assumptions are graded and range from 6.25% to 7.375%. For accident and health products, liabilities for future policy benefits are established equal to the excess of the present value of future benefits to or on behalf of policyholders over future net premiums discounted at interest rates ranging primarily from 6.5% to 8.0%. The future policy benefits of traditional life products and accident and health products are determined using mortality, morbidity and withdrawal assumptions that reflect the experience of the Company modified as necessary to reflect anticipated trends and to include provisions for possible unfavorable deviations. The assumptions vary by plan, year of issue and duration.
The Company has carefully monitored a block of interest sensitive life policies where overall financial performance was not satisfactory. During the third quarter of 1997, management implemented certain corrective actions. These actions included reduction in credited interest rates, increased monthly expense charges and cost of insurance increases on selected policy forms. As a result, reserves on this block were reduced approximately $17,000.
Policy and contract claims include provisions for reported claims in process of settlement, valued in accordance with the terms of the related policies and contracts, as well as provisions for claims incurred and unreported based on the Company's prior experience.
While management believes the estimated amounts included in financial statements for policy liabilities and accruals are adequate, such estimates may be more or less than the amounts ultimately paid when the claims are settled. In addition, the Company is involved in certain litigation regarding policyholder benefits. The Company intends to vigorously defend its position relative to these claims; however, if unsuccessful, the level of reserves currently provided could be adversely effected.
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. Policy Liabilities and Accruals (Continued)
Total policy liabilities and accruals consist of the following as of December 31, 1997 and 1996:
The following table presents information on changes in the liability for policy and contract claims for the years ended December 31, 1997 and 1996:
As a result of changes in estimates of insured events in prior years, the liability for policy and contract claims decreased, net of reinsurance, by $6,012 in 1997 and $2,646 in 1996.
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. Notes Payable
The outstanding principal amounts of notes payable at December 31, 1997 and 1996 consist of the following:
Interest costs under the revolving bank debt totaled $7,860 and $8,128 for the years ended December 31, 1997 and 1996, respectively. The interest rate of the debt is based on, at the Company's option, either a floating rate (based on the base rate of the First National Bank of Chicago) plus a margin of 1.75% or a Eurodollar rate (based on the London Interbank Offered Rate or LIBOR) plus a margin of 2.75%. At December 31, 1997, the effective rate of the revolving loan was approximately 9.13%. The revolving bank debt was repaid on January 2, 1998.
Interest costs under the bank term debt totaled $2,229 and $2,250 for the years ended December 31, 1997 and 1996, respectively. The interest rate of the term debt is based on, at the Company's option, either a floating rate (based on the base rate of the First National Bank of Chicago) plus a margin of 2.25% or a Eurodollar rate (based on LIBOR) plus a margin of 3.25%. At December 31, 1997, the effective rate of the term loans was approximately 9.63%. The bank term debt was repaid on January 2, 1998.
As part of the consideration for the acquisition of Southwestern Life, Union Bankers, Constitution and Marquette from ICH, the Company issued to ICH a $40,000 aggregate principal amount of SWF's 7.0% Convertible Subordinated Notes due 2005. The notes are convertible into an aggregate 3,200,000 shares of common stock of SWF, of which 800,000 will be Class B non-voting common stock. In the aggregate the shares upon conversion represent approximately 21.2% of SWF's fully diluted shares at closing before giving effect to certain warrants outstanding. During 1997, PennCorp acquired the notes from the liquidating trust for the creditors of ICH for $40,000 plus accrued interest. The Convertible Notes are unsecured obligations and are subordinate in right of payment to SWF's bank debt and all of the indebtedness of SWF. Interest costs under the Convertible Notes totaled $2,800 for the years ended December 31, 1997 and 1996. The Company agreed to maintain sufficient cash and cash equivalents to fund the interest payments on the Convertible Notes for the first three years. At December 31, 1997 and December 31, 1996, restricted cash and short-term investments totaled $3,339 and $5,959, respectively.
In conjunction with the bank debt, the Company entered into interest rate protection agreements in the form of a series of interest rate caps in the notional amount of $62,500 which expire May 1998. These entitle the Company to revenue should three-month LIBOR exceed the cap rate of 7.5%. At December 31, 1997, three-month LIBOR was 5.81%.
6. Preferred and Common Stock
On December 14, 1995, the Company issued 210,000 shares of Series A preferred stock with a liquidation value of $21,000 to PennCorp and one of its subsidiaries. The Series A preferred stock accrues dividends at a rate of 10.0% per annum, compounded quarterly and is mandatorily redeemable at December 31, 2005. Dividends on the Series A preferred stock are payable in cash, or at SWF's option, are payable in kind. The Series A preferred stock is not redeemable at the option of the Company but at maturity will be required to be redeemed for approximately $56 million in cash assuming no cash dividend distributions. If the Company fails to satisfy its mandatory redemption obligation, the holders of the Series A preferred stock
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. Preferred and Common Stock (Continued)
will be entitled to elect 49.0% of the members of the Board of SWF and, upon receipt of regulatory approval, a majority of the directors of SWF. The Series A preferred stock is senior preferred stock. The holders of the Series A preferred stock are entitled to class voting rights under certain circumstances, including in connection with a merger of SWF or a sale of all or substantially all its assets or the authorization or issuance of senior or pari passu preferred stock, and as otherwise provided by law. For the years ended December 31, 1997 and 1996, 24,180 and 21,900 additional shares were issued with a redemption value of $2,418 and $2,190, respectively in lieu of cash to satisfy dividend requirements.
In addition, certain of PennCorp's insurance subsidiaries purchased $10,000 liquidation value of 5.5% Mandatorily Redeemable Preferred Stock, par value $0.01 per share (the 5.5% Preferred Stock) of Southwestern Life Acquisition Corporation, a wholly-owned subsidiary of SWF. During 1996 SLAC was dissolved and the 5.5% Preferred Stock was exchanged for 5.5% Preferred Stock of Southwestern Life Companies, Inc. (SLC), also a wholly-owned subsidiary of SWF. The 5.5% Preferred Stock accrues dividends payable in cash or, subject to certain conditions, through the issuance of additional shares of 5.5% Preferred Stock. The 5.5% Preferred Stock is not subject to optional redemption and matures on December 31, 2005. If SLC fails to satisfy its mandatory redemption obligation or if dividends payable on the 5.5% Preferred Stock are in arrears for four or more quarterly dividend periods, the holders of the 5.5% Preferred Stock will be entitled to elect 49.0% of the members of the Board of Directors of SLC and, upon receipt of regulatory approval, a majority of the Board of Directors of SLC. The 5.5% Preferred Stock is the only preferred stock of SLC authorized for issuance. The holders of the 5.5% Preferred Stock are entitled to class voting rights under certain circumstances, including in connection with a merger of SLC or a sale of all or substantially all its assets or the authorization or issuance of senior pari passu preferred stock, and as otherwise provided by law. For the years ended December 31, 1997 and 1996, 59 and 59 additional shares were issued with a redemption value of $594 and $590, respectively in lieu of cash to satisfy dividend requirements.
7. Income Taxes
The Company and its non-insurance subsidiaries file a consolidated federal income tax return. The Company's life insurance subsidiaries also file a consolidated federal income tax return.
Total income taxes for the years ended December 31, 1997 and 1996 are as follows:
Income taxes computed using the prevailing corporate tax rate of 35% are reconciled to the Company's actual income tax expense attributable to income for the years ended December 31, 1997 and 1996, as follows:
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. Income Taxes (Continued)
Temporary differences, including $1,956 in 1997 of deferred tax assets transferred in association with a reinsurance contract with an affiliate, between the financial statement carrying amounts and tax bases of assets and liabilities that give rise to the deferred tax assets (liabilities) at December 31, 1997 and 1996 relate to the following:
The valuation allowances at December 31, 1997 and 1996, are attributable to deferred tax assets principally arising from differences in the book and tax bases of invested assets subject to capital gains treatment that existed as of the date of acquisition of the company's insurance subsidiaries. To the extent that income tax benefits relative to such tax assets are ultimately realized, the reduction in the related valuation allowance would be allocated to reduce costs in excess of net assets acquired.
In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will be realized. The ultimate realization of deferred tax assets is dependent on the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment. Based upon those considerations, management believes it is more likely than not that the Company will realize the benefits of these deductible differences, net of the existing valuation allowance at December 31, 1997.
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. Deferred Policy Acquisition Costs and Present Value of Insurance in Force
Deferred policy acquisition costs represent commissions and certain costs of policy issuance and underwriting. Information relating to these costs for the years ended December 31, 1997 and 1996, is as follows:
As part of the purchase accounting for the Company's acquisitions, a present value of insurance in force asset is established which represents the value of the right to receive future cash flows from insurance contracts existing at the date of acquisition. Such value is the actuarially determined present value of the projected cash flows from the acquired policies, discounted at an appropriate risk rate of return.
The methods used by the Company to value the health, life and annuity products purchased are consistent with the valuation methods used most commonly to value blocks of insurance business. It is also consistent with the basic methodology generally used to value insurance assets. The method used by the Company includes identifying the future cash flows from the acquired business, the risks inherent in realizing those cash flows, the rate of return the Company believes it must earn in order to accept the risks inherent in realizing the cash flows, and determining the value of the insurance asset by discounting the expected future cash flows by the discount rate the Company requires.
The discount rate used to determine such values is the rate of return required in order to invest in the business being acquired. In selecting the rate of return, the Company considered the magnitude of the risks associated with actuarial factors described in the following paragraph, cost of capital available to the Company to fund the acquisition, compatibility with other Company activities that may favorably affect future profits, and the complexity of the acquired company.
Expected future cash flows used in determining such values are based on actuarial determinations of future premium collection, mortality, morbidity, surrenders, operating expenses and yields on assets held to back policy liabilities as well as other factors. Variances from original projections, whether positive or negative, are included in income as they occur. To the extent that these variances indicate that future cash flows will differ from those included in the original scheduled amortization of the value of the insurance in force, current and future amortization may be adjusted. Recoverability of the value of insurance in force is evaluated annually and appropriate adjustments are then determined and reflected in the financial statements for the applicable period.
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. Deferred Policy Acquisition Costs and Present Value of Insurance in Force (Continued)
Information related to the present value of insurance in force for the years ended December 31, 1997 and 1996 is as follows:
Expected amortization, based upon current assumptions and accretion of interest at a policy liability or contract rate ranging from 5.5% to 6.6% for the next five years of the present value of insurance in force is as follows:
9. Statutory Accounting and Dividend Restrictions
Pursuant to the terms of the surplus debenture issued by Constitution to the benefit of SLC, a non-insurance subsidiary of SWF, Constitution may make principal and interest payments to the extent that Constitution's surplus, excluding the statutory carrying value of Southwestern Life and Union Bankers, exceeds $1,200. Constitution's surplus at December 31, 1997 was $174,715, of which $161,098 was attributable to its ownership of Southwestern Life and Union Bankers.
The Company's cash flow is derived principally from dividends and principal and interest payments owed on the surplus debenture by Constitution. The principal source of repayment of the surplus debenture is dividends from Constitution's subsidiaries, Southwestern Life and Union Bankers. Generally, the net assets of the insurance subsidiaries available for transfer to the Company are limited to the greater of the subsidiary net gain from operations during the preceding year or 10% of the subsidiary net statutory surplus as of the end of the preceding year as determined in accordance with accounting practices prescribed or permitted by insurance regulatory authorities. Payment of dividends in excess of such amounts would generally require approval by the regulatory authorities. Based upon Constitution's earned surplus at December 31, 1997, no dividends can be paid to its parent without prior regulatory approval.
The insurance subsidiaries prepare their statutory financial statements in accordance with accounting practices prescribed or permitted by their respective state insurance departments. Prescribed statutory accounting practices include state laws, regulations, and general administrative rules, as well as a variety of publications of the National Association of Insurance Commissioners (NAIC). Permitted statutory accounting practices encompass all accounting practices that are approved by insurance regulatory authorities; such practices differ from state to state, and may differ from company to company within
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. Statutory Accounting and Dividend Restrictions (Continued)
a state, and may change in the future. Furthermore, the NAIC has a project to codify statutory accounting practices, the result of which is expected to constitute the only source of "prescribed" statutory accounting practices. Accordingly, that project, will likely change to some extent prescribed statutory accounting practices, and may result in changes to the accounting practices that insurance enterprises use to prepare their statutory financial statements.
Statutory capital and surplus of the Company's life insurance subsidiaries as reported to regulatory authorities at December 31, 1997 and 1996 totaled approximately $174,715 and $177,510, respectively. Statutory net income (loss) of the Company's life insurance subsidiaries as reported to regulatory authorities totaled ($2,521) and $24,919 for the years ended December 31, 1997 and 1996.
10. Reinsurance
In the normal course of business, the Company reinsures portions of certain policies that it underwrites to limit disproportionate risks. The Company retains varying amounts of individual insurance up to a maximum retention of $500 on any life. Amounts not retained are ceded to other insurance enterprises or reinsurers on an automatic or facultative basis.
Reinsurance contracts do not relieve the Company from its obligations to policyholders. Therefore, the Company is contingently liable for recoverable unpaid claims and policyholder liabilities ceded to reinsurers in the unlikely event that assuming reinsurers are unable to meet their obligations. The Company evaluates the financial condition of its reinsurers to minimize its exposure to significant losses from reinsurer insolvencies. The effect of reinsurance on policy revenues earned and the related benefits incurred by such reinsurers for the years ended December 31, 1997 and 1996 is as follows:
Effective July 1, 1996, Union Bankers entered into reinsurance agreements with Cologne Life Reinsurance Company ("Cologne") to coinsure 80% of its Medicare supplement business in force on July 1, 1996 and to coinsure 80% of its Medicare policies issued on or after July 1, 1996. The Company recorded a deferred gain on the transaction of $53,893 as of July 1, 1996, which is being amortized into income over the life of the business. For the year ended December 31, 1997 and for the period from July 1, 1996 to December 31, 1996 $14,222 and $6,445, respectively of the deferred gain has been recognized and is included in other income. The Company is not subject to any negative experience adjustments if the ceded business is unprofitable; however, the Company may participate in a portion of future earnings from the ceded business after Cologne recovers its initial ceding commission plus interest at a specified rate. Union Bankers retained administration for the ceded block of business and is reimbursed by Cologne for administrative costs at the rate of 8.5% of ceded renewal premiums and 11.5% of ceded first year premiums.
Southwestern Life previously ceded a block of annuities under a reinsurance agreement with Employees Reassurance Corporation (ERC). Such reinsurance, accounted for as a financing arrangement, is not reflected in the accompanying financial statements except for the risk fees paid to ERC. The reinsurance agreement was terminated as of November 30,
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. Reinsurance (Continued)
1997.Statutory surplus provided by this treaty totaled $8,714 at December 31, 1996. Risk fees paid to the reinsurer were 2% of the net amount of surplus provided, but not less than a minimum fee of $40 per quarter, and totaled $110 and $222 for the years ended December 31, 1997 and 1996, respectively. Amounts due from reinsurers included amounts due from ERC of $121,016 at December 31, 1996. The underlying assets held by ERC had carrying values of $121,016 and fair values of $122,639 at December 31, 1996.
At December 31, 1997, Southwestern Life entered into a reinsurance agreement with Integon Life Insurance Corporation (Integon), an indirect wholly-owned subsidiary of PennCorp, to coinsure certain annuities which had GAAP policy liabilities of $256,673. Cash of $50,000 and securities were transferred at a cost basis of $198,793 which had fair values equal to statutory policy liabilities of $255,195. The present value of insurance in force which Integon had recorded on these policies was estimated to be $2,291. Because Southwestern Life and Integon are affiliates, the historical GAAP book value of the securities and the present value of insurance in force at Integon was retained by Southwestern Life. Rather than record a loss of $3,634, which is net of taxes of $1,956, on a GAAP basis, Southwestern Life recorded a "deemed dividend" of this amount as a direct charge to its paid in capital. In addition, the change in unrealized investment gain (loss) associated with the transferred securities is recorded as an adjustment to prior unrealized gains.
11. Retirement and Profit Sharing Plans
The Company has a defined contribution retirement plan (Defined Contribution Plan) for all employees who have attained age 21 and completed a year of service. Contributions to the Plan are made pursuant to salary deferral elections by participants in an amount equal to 1% to 15% of their annual compensation. In addition, the Company makes matching contributions in an amount equal to 50% of each participant's salary deferral to a maximum of 3% of annual compensation. The Defined Contribution Plan also provides for a discretionary employer profit sharing contribution, which is determined annually by the Board of Directors for the succeeding plan year. Profit sharing contributions are credited to participant's accounts on the basis of their respective compensation. Salary deferral contribution accounts are at all times fully vested, while matching contribution and profit sharing contribution accounts vest ratably from one to five years of service. All participant accounts are fully vested at death, disability or attainment of age 65. Payment of vested benefits under the Defined Contribution Plan may be elected by a participant in a variety of forms of payment. Expenses related to this plan for the years ended December 31, 1997 and 1996 amounted to $936 and $696, respectively.
In addition, the Company has a bonus plan for certain key officers. The amount available to pay awards for any year is determined by a committee of senior executives of the Company and is subject to approval of the Board of Directors of the Company. Awards are based on the performance of the Company and the performance of eligible participants. The Company accrued or paid $1,350 and $1,700 under this plan during the years ended December 31, 1997 and 1996, respectively.
The Company provides certain health care and life insurance benefits for retired employees. Employees meeting certain age and length of service requirements become eligible for these benefits. The Company's obligation for accrued postretirement
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. Retirement and Profit Sharing Plans (Continued)
health and welfare benefits is unfunded. Following is an analysis of the change in the liability for accrued postretirement benefits for the years ended December 31, 1997 and 1996:
For measurement purposes, an 5.5% annual rate increase in the health care cost trend rate was assumed for 1998; the rate was assumed to decrease gradually to 4.0% by the year 2015 and remain at that level thereafter. The health care cost trend rate assumption has a significant effect on the amounts reported. To illustrate, increasing the assumed health care cost trend rates by one percentage point in each year would increase the accumulated postretirement health care benefit obligation as of December 31, 1997 by $767 and the aggregate of the service and interest components of net periodic postretirement health care benefit cost for 1997 by $127. The weighted average discount rate used in determining the accumulated postretirement benefit obligation was 7.0%.
12. Related Party Transactions
Related party transactions described herein include those transactions not included elsewhere in the Notes to Consolidated Financial Statements.
The Company and its subsidiaries have management and services agreements with entities affiliated with Knightsbridge, a shareholder. In connection with an Advisory and Management Services Agreement with Knightsbridge Management, L.L.C., the Company pays an annual fee of $1,500 plus expenses. Each insurance subsidiary has an Investment Management Agreement with Knightsbridge Consultants, L.L.C. For the years ended December 31, 1997 and 1996, fees incurred totaled $1,871 and $1,658, respectively.
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
12. Related Party Transactions (Continued)
The Company agreed to pay PennCorp, a shareholder, $1,000 in conjunction with the GSSW transaction in 1996 (see Note 3). The Company paid interest of $1,400 in 1997 in conjunction with PennCorp's acquisition of the Company's 7.0% convertible subordinated note.
The Company provides services for a wholly-owned subsidiary of PennCorp. The Company charges the subsidiary for its direct costs and a share of overhead costs based upon time and utilization studies. These costs totaled approximately $5,178 during 1997.
13. Other Commitments and Contingencies
The Company and its subsidiaries are obligated under operating leases, primarily for office space. Rent expense was $2,169 in 1997 and $2,058 in 1996. There was no significant sublease income in 1997 or 1996.
Certain lawsuits have been brought against the Company's life insurance subsidiaries in the normal course of the insurance business involving the settlement of various matters and seeking compensatory and in some cases punitive damages. Management believes that the ultimate settlement of all such litigation will not have a materially adverse effect on the Company's consolidated financial position or results of operation.
The life insurance companies are required to be members of various state insurance guaranty associations in order to conduct business in those states. These associations have the authority to assess member companies in the event that an insurance company conducting business in that state is unable to meet its policyholder obligations. In some states, these assessments can be partially recovered through a reduction in future premium taxes. The insurance subsidiaries paid assessments of $980 in 1997 and $1,357 in 1996. Based on information currently available, the insurance subsidiaries have accrued $3,194 at December 31, 1997 for future assessments, net of future premium tax reductions.
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
14. Other Operating Information
Underwriting and other administrative expenses for the years ended December 31, 1997 and 1996 are as follows:
15. Financial Instruments
The following is a summary of the carrying value and fair value of the Company's financial instruments at December 31, 1997 and 1996:
The following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments:
Cash and Short-term Investments, Agent and Premium Receivables: The carrying value of short-term investments and amounts receivable approximate their fair value due to the short-term maturity of these instruments.
Fixed Maturities and Equities Available for Sale: Fair values for fixed maturities available for sale are based on quoted market prices, where available. For fixed maturities not actively traded, fair values are estimated using values obtained from independent pricing services or are estimated based on expected future cash flows using a current market rate applicable to the yield, credit quality, and maturity of the investments. The fair values for equity securities are based on quoted market prices.
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
15. Financial Instruments (Continued)
Mortgage and Collateral Loans: The fair values for mortgage and collateral loans are estimated using discounted cash flow analyses, based on interest rates currently being offered for similar loans to borrowers with similar credit ratings. Loans with similar characteristics are aggregated for purposes of the calculations.
Other Investments: The fair value of Company's investment in residual interests in mortgage-backed securities was obtained from an independent broker-dealer. The fair values of other miscellaneous invested assets have not been estimated due to their relative immateriality.
Interest rate cap: The fair value of the interest rate cap is $0 as the current interest rate is below the cap rate.
Policy Loans: Policy loans are an integral part of life insurance policies which the Company has in force and, in the Company's opinion, cannot be valued separately. These loans typically carry an interest rate that is tied to the crediting rate applied to the related policy and contract reserves.
Notes Payable: Fair values of the Company's bank obligations approximate carrying values due to the variable interest structure. The fair value of the Company's convertible note payable is not valued at December 31, 1997 as it was owned by PennCorp and canceled in February 1998.
Universal Life and Investment Contract Liabilities: The carrying value and fair values for the Company's liabilities under universal life and investment-type insurance contracts are the same as the interest rates credited to these products are periodically adjusted by the Company to reflect market conditions. The fair values of liabilities under all insurance contracts are taken into consideration in the overall management of interest rate risk, which minimizes exposure to changing interest rates through the matching of investment maturities with amounts due under insurance contracts.
16. Subsequent Event
On January 2, 1998, PennCorp acquired all of the outstanding common stock held by Knightsbridge and certain other parties for aggregate cash consideration ranging from $73,777 to $77,444 (excluding anticipated acquisition expenses) depending upon the outcome of certain contingencies. As a result, SWF became a wholly-owned subsidiary of PennCorp. After the acquisition of the common stock, PennCorp repaid SWF's bank revolving debt in the amount of $90,250 and its bank term debt in the amount of $24,500. Consequently, the Company will realize an extraordinary charge in 1998 for the writeoff of deferred costs of $2,571 associated with these loans. In addition, PennCorp canceled the $40,000 SWF note it acquired from ICH.
On February 18, 1998, PennCorp announced that it had engaged investment banking firms to review strategic alternatives for maximizing shareholder value, including the sale of certain divisions, which include Union Bankers, Constitution, Marquette and affiliated service providing companies ("SW Financial businesses held for sale"). As of and for the year ended December 31, 1997, the total assets, excess of liabilities over assets, total revenues and net loss of the SW Financial businesses held for sale aggregated $530,866, $49,697, $109,387 and $5,201, respectively.
SOUTHWESTERN FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
PART III
Item 10.
Item 10. Directors and Executive Officers of the Registrant
Information required by this Item is incorporated by reference to "Election of Directors" and "Executive Officers" in the Company's Proxy Statement for its 1998 Annual Meeting of the Shareholders.
Item 11.
Item 11. Executive Compensation
Information required by this Item is incorporated by reference to "Director-Fees", "Executive Compensation and Other Information" and "Compensation Committee Interlocks and Insider Participation" in the Company's Proxy Statement for its 1998 Annual Meeting of Shareholder, except that the information required by paragraphs (k) and (l) of Item 402 of Regulation S-K and set forth in such Proxy Statement is specifically not incorporated by reference.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management
Information required by this Item is incorporated by reference to "Security Ownership of Certain Beneficial Owners and Management" in the Company's Proxy Statement for its 1998 Annual Meeting of Shareholders.
Item 13.
Item 13. Certain Relationships and Related Transactions
Information required by this Item is incorporated by reference to "Compensation Committee Interlocks and Insider Participation" and "Certain Transactions" in the Company's Proxy Statement for its 1998 Annual Meeting of Shareholders.
(Remainder of Page Intentionally Left Blank)
PART IV
Item 14.
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) Documents
1. The financial statements of PennCorp Financial Group, Inc. and Subsidiaries set forth on pages 43 through 77, and the Independent Auditors' Report set forth on page 42 hereof are in response to the information required by this Item.
2. An index to the financial statement schedules required to be filed by Item 8 of this Report on Form 10-K is set forth immediately before the attached financial statement schedules on page 111 of this filing.
3. Exhibits
2.1 Purchase Agreement among I.C.H. Corporation, SWL Holding Corporation, Care Financial Corporation, Facilities Management Installation, Inc. and Southwestern Financial Corporation, Southwestern Financial Services Corporation and PennCorp Financial Group, Inc., dated as of December 1, 1995 and Addendum to Purchase Agreement dated as of December 14, 1995. (6)
2.2 Amended and Restated Stock Purchase Agreement between United Companies Financial Corporation and Pacific Life and Accident Insurance Company dated as of July 24, 1996. (4)
3.1 Restated By-Laws of PennCorp Financial Group, Inc. (12)
3.2 Third Restated Certificate of Incorporation of PennCorp Financial Group, Inc. (20)
4.1 Certificate of Elimination for Series A Cumulative Preferred Stock. (5)
4.2 Certificate of Designation of Series B Preferred Stock. (5)
4.3 Certificate of Designation of Series C Preferred Stock. (5)
4.4 Corrected Certificate of Designation of $3.375 Convertible Preferred Stock. (5)
4.5 Certificate of Designation of $3.50 Series II Convertible Preferred Stock (3)
4.6 Indenture between PennCorp Financial Group, Inc. and The Bank of New York, as trustee, with respect to 9 1/4% Senior Subordinate Notes due 2003. (11)
10.1 Surplus Debenture Number Four in the original principal amount of $162,539,890, issued by Pacific Life and Accident Insurance Company to PennCorp Financial Group, Inc., dated January 1, 1994. (10)
10.2 Surplus Debenture Number Five in the original principal amount of $17,606,203, issued by Pacific Life and Accident Insurance Company to PennCorp Financial Group, Inc., dated September 29, 1994. (9)
10.3 Surplus Debenture Number Six in the original principal amount of $55,000,000, issued by Pacific Life and Accident Insurance Company to PennCorp Financial Group, Inc., dated July 24, 1996. (14)
10.4 10% Promissory Note in the original principal amount of $30,661,996, issued by American-Holdings Corporation to Pennsylvania Life Insurance Company, dated July 1, 1996. (14)
10.5 Certificate of Contribution in the original principal amount of $54,332,790 issued by Integon Financial Life Insurance Corporation to Integon Life Corporation, dated July 25, 1995. (5)
MANAGEMENT COMPENSATION RELATED AGREEMENTS
10.6 Intentionally omitted.
10.7 PennCorp Financial, Inc. Retirement and Savings Plan. (13)
10.8 PennCorp Financial, Inc. Executive Officer Incentive Plan. (13)
10.9 PennCorp Financial Group, Inc. 1992 Stock Option Plan. (13)
10.10 PennCorp Financial Group, Inc. Senior Management Warrant Award Program. (13)
10.11 Form of Restricted Stock Agreement by and between PennCorp Financial Group, Inc. and certain participants, effective as of April 1, 1994. (9)
10.12 Employment Agreement between PennCorp Financial Group, Inc. and David J. Stone entered into June 7, 1996. (14)
10.13 Employment Agreement between PennCorp Financial Group, Inc. and Steven W. Fickes entered into June 7, 1996. (14)
10.14 Amendment Number One to Employment Agreement between PennCorp Financial Group, Inc. and David J. Stone dated April 28, 1997. (15)
10.15 Amendment Number One to Employment Agreement between PennCorp Financial Group, Inc. and Steven W. Fickes dated April 28, 1997. (15)
10.16 Amendment No. 2 to Employment Agreement between PennCorp Financial Group, Inc. and David J. Stone entered into January 5, 1998. (1)
10.17 Amendment No. 2 to Employment Agreement between PennCorp Financial Group, Inc. and Steven W. Fickes entered into January 5, 1998. (1)
10.18 Executive Retention Agreement between Charles Lubochinski and PennCorp Financial Group, Inc. (1)
10.19 Schedule of similar Executive Retention Agreements. (1)
10.20 PennCorp Financial Group, Inc. 1996 Stock Award and Stock Option Plan. (14)
10.21 Amendment Number One to PennCorp Financial Group, Inc. 1996 Stock Award and Stock Option Plan. (20)
10.22 PennCorp Financial Group, Inc. 1996 Senior Executive Annual Incentive Award Plan. (14)
10.23 Real Estate Purchase and Sale Agreement between Peoples Security Life Insurance Company and PennCorp Financial Group, Inc., dated March 24, 1995. (8)
10.24 Registration Rights Agreement dated as of December 14, 1995, between PennCorp Financial Group, Inc., I.C.H. Corporation, SWL Holding Corporation and Care Financial Corporation. (6)
10.25 Conversion, Standstill and Registration Rights Agreement between United Companies Financial Corporation and PennCorp Financial Group, Inc. dated as of July 24, 1996. (14)
10.26 Registration Rights Agreement dated as of August 2, 1996, by and among PennCorp Financial Group, Inc., Smith Barney Inc., Donaldson, Lufkin & Jenrette Securities Corporation and Merrill Lynch, Pierce, Fenner & Smith Incorporated. (14)
10.27 Stockholders Agreement dated December 14, 1995 between Southwestern Financial Corporation and the Security holders listed on the signature pages thereof. (6)
10.28 Credit Agreement dated March 12, 1997 by and among PennCorp Financial Group, Inc. and The Chase Manhattan Bank, The First National Bank of Chicago, and NationsBank, NA., as Managing Agents, Fleet National Bank, Mellon Bank, N.A., Bank of Montreal, CIBC Inc., and Dresdner Bank AG, New York Branch and Grand Cayman Branch as Co-Agents and The Bank of New York, as Administrative Agent. (16)
10.29 Revision Agreement, dated as of May 30, 1997, by and among United Companies Financial Corporation, PennCorp Financial Group, Inc., Pacific Life and Accident Insurance Company and each additional party set forth on the signature pages thereto. (17)
10.30 Amendment to Surplus Debenture in the original principal amount of $73,000,000 issued by Pioneer Security Life Insurance Company to American-Amicable Holdings Corporation, dated May 17, 1996. (17)
10.31 Second Amendment to Surplus Debenture in the original principal amount of $73,000,000 issued by Pioneer Security Life Insurance Company to American-Amicable Holdings Corporation, effective January 1, 1997. (17)
10.32 Third Amendment to Surplus Debenture in the original principal amount of $73,000,000 issued by Pioneer Security Life Insurance Company to American-Amicable Holdings Corporation, effective May 14, 1997. (17)
10.33 Amendment to Surplus Debenture Number Four in the original principal amount of $162,539,890, issued by Pacific Life and Accident Insurance Company to PennCorp Financial Group, Inc., effective January 1, 1997. (17)
10.34 Second Amendment to Surplus Debenture Number Four in the original principal amount of $162,539,890, issued by Pacific Life and Accident Insurance Company to PennCorp Financial Group, Inc., effective May 14, 1997. (17)
10.35 Amendment to Surplus Debenture Number Five in the original principal amount of $17,606,203, issued by Pacific Life and Accident Insurance Company to PennCorp Financial Group, Inc., effective January 1, 1997. (17)
10.36 Second Amendment to Surplus Debenture Number Five in the original principal amount of $17,606,203, issued by Pacific Life and Accident Insurance Company to PennCorp Financial Group, Inc., effective May 14, 1997. (17)
10.37 Amendment to Surplus Debenture Number Six in the original principal amount of $55,000,000, issued by Pacific Life and Accident Insurance Company to PennCorp Financial Group, Inc., effective January 1, 1997. (17)
10.38 Second Amendment to Surplus Debenture Number Six in the original principal amount of $55,000,000, issued by Pacific Life and Accident Insurance Company to PennCorp Financial Group, Inc., effective May 14, 1997. (17)
10.39 Note Purchase, Release and Settlement Agreement, dated July 13, 1997, executed by Lone Star Liquidating Trust, PennCorp Financial Group, Inc. and Southwestern Financial Corporation . (18)
10.40 Amended and Restated Assignment Agreement dated as of January 2, 1998 by and between PennCorp Financial Group, Inc. and Knightsbridge Capital Fund I, L.P. (19)
10.41 Amended and Restated Assignment Agreement dated as of January 2, 1998 by and between PennCorp Financial Group, Inc., David J. Stone, Steven W. Fickes, the Steven Wayne Fickes, Jr. Trust dated December 21, 1995 and the Kathryn Elizabeth Fickes Trust dated December 21, 1995. (19)
12 Computation of ratio of earnings to fixed charges. (1)
21 List of subsidiaries of the Registrant. (1)
22.1 Auditors consent. (1)
22.2 Auditors consent. (1)
27 Financial Data Schedule. (1)
(1) Filed herewith.
(2) Such exhibit is incorporated by reference to the Form 8-K dated November 25, 1996, which was filed with the Securities and Exchange Commission by PennCorp Financial Group, Inc. on December 4, 1996, providing a copy of the Amended and Restated Agreement and Plan of Merger with Washington National Corporation.
(3) Such exhibit is incorporated by reference to the Registration Statement on Form S-3 (Registration No. 333- 13285) of PennCorp Financial Group, Inc. filed with the Securities and Exchange Commission on October 10, 1996.
(4) Such exhibit is incorporated by reference to the Form 8-K dated July 24, 1996 which was filed with the Securities and Exchange Commission by PennCorp Financial Group, Inc. on August 8, 1996 relating to the financial statements and pro forma financial information of United Companies Life Insurance Company.
(5) Such exhibit is incorporated by reference to the Annual Report on Form 10-K for the fiscal year ended December 31, 1995 of PennCorp Financial Group, Inc.
(6) Such exhibit is incorporated by reference to the Form 8-K dated December 14, 1995 which was filed by PennCorp Financial Group, Inc. with the Securities and Exchange Commission on December 28, 1995 related to its investment in Southwestern Financial Corporation.
(7) Such exhibit is incorporated by reference to the Form 8-A dated July 11, 1995 which was filed by PennCorp Financial Group, Inc. with the Securities and Exchange Commission on July 12, 1995.
(8) Such exhibit is incorporated by reference to the Quarterly Report on Form 10-Q for the three months ended June 30, 1995 of PennCorp Financial Group, Inc.
(9) Such exhibit is incorporated by reference to the Quarterly Report on Form 10-Q for the three months ended September 30, 1994 of PennCorp Financial Group, Inc.
(10) Such exhibit is incorporated by reference to the Quarterly Report on Form 10-Q for the three months ended June 30, 1994 of PennCorp Financial Group, Inc.
(11) Such exhibit is incorporated by reference to the Annual Report on Form 10-K for the fiscal year ended December 31, 1993 of PennCorp Financial Group, Inc.
(12) Such exhibit is incorporated by reference to the Annual Report on Form 10-K for the fiscal year ended December 31, 1992 of PennCorp Financial Group, Inc.
(13) Such exhibit is incorporated by reference to the Registration Statement on Form S-1 (Registration No. 33-50530) of PennCorp Financial Group, Inc. filed on August 6, 1992.
(14) Such exhibit is incorporated by reference to the Annual Report on Form 10-K for the fiscal year ended December 31, 1996 of PennCorp Financial Group, Inc.
(15) Such exhibit is incorporated by reference to Amendment Number 2 to the Annual Report on Form 10-K for fiscal year ended December 31, 1996 of PennCorp Financial Group, Inc.
(16) Such exhibit is incorporated by reference to the Amendment Number 1 to Annual Report on Form 10-K for the fiscal year ended December 31, 1996 of PennCorp Financial Group, Inc.
(17) Such exhibit is incorporated by reference to the Quarterly Report on Form 10-Q for the three months ended June 30, 1997 of PennCorp Financial Group, Inc.
(18) Such exhibit is incorporated by reference to the Quarterly Report on Form 10-Q for the three months ended September 30, 1997 of PennCorp Financial Group, Inc.
(19) Such exhibit is incorporated by reference to the Form 8-K dated January 13, 1998 which was filed with the Securities and Exchange Commission by PennCorp Financial Group, Inc. on January 13, 1998 relating to the acquisition of common stock and common stock warrants of Southwestern Financial Corporation not previously owned by PennCorp Financial Group, Inc.
(20) Such exhibit is incorporated by reference to the Registration Statement on Form S-8 (Registration No. 333-48629) of PennCorp Financial Group, Inc. filed on March 24, 1998.
(b) Reports on Form 8-K.
A report on Form 8-K, dated November 14, 1997, was filed with the Securities and Exchange Commission by PennCorp Financial Group, Inc. on November 14, 1997, providing restated financial statements of PennCorp Financial Group, Inc. for each of the years in the three year period ended December 31, 1996 as well as the three month periods ended March 31, 1997 and 1996 and the three and six month periods ended June 30, 1997 and 1996.
SIGNATURES
Pursuant to the requirements of Section 13 or Section 15(d) of the Securities Exchange Act of 1934, PennCorp Financial Group, Inc. has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
PENNCORP FINANCIAL GROUP, INC. (Registrant)
By: /s/ David J. Stone ------------------------ David J. Stone Chairman of the Board, Chief Executive Officer and Director (Principal Executive Officer) Date: March 30, 1998
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
/s/ Steven W. Fickes - ---------------------------------- Steven W. Fickes President, Chief Financial Officer and Director(Principal Financial and Accounting Officer)
Date: March 30, 1998
/s/ Kenneth Roman - ---------------------------------- Kenneth Roman Director
Date: March 30, 1998
/s/ Maurice W. Slayton - ---------------------------------- Maurice W. Slayton Director
Date: March 30, 1998
/s/ Allan D. Greenberg - ---------------------------------- Allan D. Greenberg Director
Date: March 30, 1998
/s/ Thomas A. Player - ---------------------------------- Thomas A. Player Director
Date: March 30, 1998
/s/ Bruce W. Schnitzer - ---------------------------------- Bruce W. Schnitzer Director
Date: March 30, 1998
/s/ David C. Smith - ---------------------------------- David C. Smith Director
Date: March 30, 1998
/s/ David J. Stone - ---------------------------------- David J. Stone Chairman of the Board, Chief Executive Officer and Director (Principal Executive Officer)
Date: March 30, 1998
PENNCORP FINANCIAL GROUP, INC. AND SUBSIDIARIES INDEX TO FINANCIAL STATEMENTS AND SCHEDULES
Financial Statements:
Reference is made to data appearing on pages 43 through 77, and to the Independent Auditors' Report appearing on page 42 hereof.
Schedules:* Page
Independent Auditors' Report - Financial Statement Schedules.... Ex. 22
Schedule II Condensed Financial Information of Registrant. 112 Schedule III Supplementary Insurance Information........... 115 Schedule IV Reinsurance................................... 116 Schedule V Valuation and Qualifying Accounts............. 117
* All other schedules have been omitted as they are not applicable or not required, or the information is given in the financial statements, notes hereto or in other schedules.
SCHEDULE II
PENNCORP FINANCIAL GROUP, INC. (PARENT COMPANY ONLY)
CONDENSED STATEMENTS OF INCOME For the years ended December 31, 1997, 1996 and 1995 ($ in thousands)
See accompanying independent auditors' report.
SCHEDULE II
PENNCORP FINANCIAL GROUP, INC. (PARENT COMPANY ONLY)
CONDENSED BALANCE SHEETS As of December 31, 1997 and 1996 ($ in thousands)
See accompanying independent auditors' report.
SCHEDULE II PENNCORP FINANCIAL GROUP, INC. (PARENT COMPANY ONLY)
CONDENSED STATEMENTS OF CASH FLOWS For the years ended December 31, 1997, 1996 and 1995 ($ in thousands)
See accompanying independent auditors' report.
SCHEDULE III
PENNCORP FINANCIAL GROUP, INC.
SUPPLEMENTARY INSURANCE INFORMATION For the years ended December 31, 1997, 1996 and 1995 ($ in thousands)
See accompanying independent auditors' report
SCHEDULE IV
PENNCORP FINANCIAL GROUP, INC.
REINSURANCE For the years ended December 31, 1997, 1996, and 1994 ($ in thousands)
See accompanying independent auditors' report.
SCHEDULE V
PENNCORP FINANCIAL GROUP, INC.
VALUATION AND QUALIFYING ACCOUNTS For the years ended December 31, 1997, 1996 and 1995 (In thousands)
See accompanying independent auditors' report.
INDEX TO EXHIBITS
2.1 Purchase Agreement among I.C.H. Corporation, SWL Holding Corporation, Care Financial Corporation, Facilities Management Installation, Inc. and Southwestern Financial Corporation, Southwestern Financial Services Corporation and PennCorp Financial Group, Inc., dated as of December 1, 1995 and Addendum to Purchase Agreement dated as of December 14, 1995. (6)
2.2 Amended and Restated Stock Purchase Agreement between United Companies Financial Corporation and Pacific Life and Accident Insurance Company dated as of July 24, 1996. (4)
3.1 Restated By-Laws of PennCorp Financial Group, Inc. (12)
3.2 Third Restated Certificate of Incorporation of PennCorp Financial Group, Inc. (20)
4.1 Certificate of Elimination for Series A Cumulative Preferred Stock. (5)
4.2 Certificate of Designation of Series B Preferred Stock. (5)
4.3 Certificate of Designation of Series C Preferred Stock. (5)
4.4 Corrected Certificate of Designation of $3.375 Convertible Preferred Stock. (5)
4.5 Certificate of Designation of $3.50 Series II Convertible Preferred Stock (3)
4.6 Indenture between PennCorp Financial Group, Inc. and The Bank of New York, as trustee, with respect to 9 1/4% Senior Subordinate Notes due 2003. (11)
10.1 Surplus Debenture Number Four in the original principal amount of $162,539,890, issued by Pacific Life and Accident Insurance Company to PennCorp Financial Group, Inc., dated January 1, 1994. (10)
10.2 Surplus Debenture Number Five in the original principal amount of $17,606,203, issued by Pacific Life and Accident Insurance Company to PennCorp Financial Group, Inc., dated September 29, 1994. (9)
10.3 Surplus Debenture Number Six in the original principal amount of $55,000,000, issued by Pacific Life and Accident Insurance Company to PennCorp Financial Group, Inc., dated July 24, 1996. (14)
10.4 10% Promissory Note in the original principal amount of $30,661,996, issued by American-Holdings Corporation to Pennsylvania Life Insurance Company, dated July 1, 1996. (14)
10.5 Certificate of Contribution in the original principal amount of $54,332,790 issued by Integon Financial Life Insurance Corporation to Integon Life Corporation, dated July 25, 1995. (5)
MANAGEMENT COMPENSATION RELATED AGREEMENTS
10.6 Intentionally omitted.
10.7 PennCorp Financial, Inc. Retirement and Savings Plan. (13)
10.8 PennCorp Financial, Inc. Executive Officer Incentive Plan. (13)
10.9 PennCorp Financial Group, Inc. 1992 Stock Option Plan. (13)
10.10 PennCorp Financial Group, Inc. Senior Management Warrant Award Program. (13)
10.11 Form of Restricted Stock Agreement by and between PennCorp Financial Group, Inc. and certain participants, effective as of April 1, 1994. (9)
10.12 Employment Agreement between PennCorp Financial Group, Inc. and David J. Stone entered into June 7, 1996. (14)
10.13 Employment Agreement between PennCorp Financial Group, Inc. and Steven W. Fickes entered into June 7, 1996. (14)
10.14 Amendment Number One to Employment Agreement between PennCorp Financial Group, Inc. and David J. Stone dated April 28, 1997. (15)
10.15 Amendment Number One to Employment Agreement between PennCorp Financial Group, Inc. and Steven W. Fickes dated April 28, 1997. (15)
10.16 Amendment No. 2 to Employment Agreement between PennCorp Financial Group, Inc. and David J. Stone entered into January 5, 1998. (1)
10.17 Amendment No. 2 to Employment Agreement between PennCorp Financial Group, Inc. and Steven W. Fickes entered into January 5, 1998. (1)
10.18 Executive Retention Agreement between Charles Lubochinski and PennCorp Financial Group, Inc. (1)
10.19 Schedule of similar Executive Retention Agreements. (1)
10.20 PennCorp Financial Group, Inc. 1996 Stock Award and Stock Option Plan. (14)
10.21 Amendment Number One to PennCorp Financial Group, Inc. 1996 Stock Award and Stock Option Plan. (20)
10.22 PennCorp Financial Group, Inc. 1996 Senior Executive Annual Incentive Award Plan. (14)
10.23 Real Estate Purchase and Sale Agreement between Peoples Security Life Insurance Company and PennCorp Financial Group, Inc., dated March 24, 1995. (8)
10.24 Registration Rights Agreement dated as of December 14, 1995, between PennCorp Financial Group, Inc., I.C.H. Corporation, SWL Holding Corporation and Care Financial Corporation. (6)
10.25 Conversion, Standstill and Registration Rights Agreement between United Companies Financial Corporation and PennCorp Financial Group, Inc. dated as of July 24, 1996. (14)
10.26 Registration Rights Agreement dated as of August 2, 1996, by and among PennCorp Financial Group, Inc., Smith Barney Inc., Donaldson, Lufkin & Jenrette Securities Corporation and Merrill Lynch, Pierce, Fenner & Smith Incorporated. (14)
10.27 Stockholders Agreement dated December 14, 1995 between Southwestern Financial Corporation and the Security holders listed on the signature pages thereof. (6)
10.28 Credit Agreement dated March 12, 1997 by and among PennCorp Financial Group, Inc. and The Chase Manhattan Bank, The First National Bank of Chicago, and NationsBank, NA., as Managing Agents, Fleet National Bank, Mellon Bank, N.A., Bank of Montreal, CIBC Inc., and Dresdner Bank AG, New York Branch and Grand Cayman Branch as Co-Agents and The Bank of New York, as Administrative Agent. (16)
10.29 Revision Agreement, dated as of May 30, 1997, by and among United Companies Financial Corporation, PennCorp Financial Group, Inc., Pacific Life and Accident Insurance Company and each additional party set forth on the signature pages thereto. (17)
10.30 Amendment to Surplus Debenture in the original principal amount of $73,000,000 issued by Pioneer Security Life Insurance Company to American-Amicable Holdings Corporation, dated May 17, 1996. (17)
10.31 Second Amendment to Surplus Debenture in the original principal amount of $73,000,000 issued by Pioneer Security Life Insurance Company to American-Amicable Holdings Corporation, effective January 1, 1997. (17)
10.32 Third Amendment to Surplus Debenture in the original principal amount of $73,000,000 issued by Pioneer Security Life Insurance Company to American-Amicable Holdings Corporation, effective May 14, 1997. (17)
10.33 Amendment to Surplus Debenture Number Four in the original principal amount of $162,539,890, issued by Pacific Life and Accident Insurance Company to PennCorp Financial Group, Inc., effective January 1, 1997. (17)
10.34 Second Amendment to Surplus Debenture Number Four in the original principal amount of $162,539,890, issued by Pacific Life and Accident Insurance Company to PennCorp Financial Group, Inc., effective May 14, 1997. (17)
10.35 Amendment to Surplus Debenture Number Five in the original principal amount of $17,606,203, issued by Pacific Life and Accident Insurance Company to PennCorp Financial Group, Inc., effective January 1, 1997. (17)
10.36 Second Amendment to Surplus Debenture Number Five in the original principal amount of $17,606,203, issued by Pacific Life and Accident Insurance Company to PennCorp Financial Group, Inc., effective May 14, 1997. (17)
10.37 Amendment to Surplus Debenture Number Six in the original principal amount of $55,000,000, issued by Pacific Life and Accident Insurance Company to PennCorp Financial Group, Inc., effective January 1, 1997. (17)
10.38 Second Amendment to Surplus Debenture Number Six in the original principal amount of $55,000,000, issued by Pacific Life and Accident Insurance Company to PennCorp Financial Group, Inc., effective May 14, 1997. (17)
10.39 Note Purchase, Release and Settlement Agreement, dated July 13, 1997, executed by Lone Star Liquidating Trust, PennCorp Financial Group, Inc. and Southwestern Financial Corporation . (18)
10.40 Amended and Restated Assignment Agreement dated as of January 2, 1998 by and between PennCorp Financial Group, Inc. and Knightsbridge Capital Fund I, L.P. (19)
10.41 Amended and Restated Assignment Agreement dated as of January 2, 1998 by and between PennCorp Financial Group, Inc., David J. Stone, Steven W. Fickes, the Steven Wayne Fickes, Jr. Trust dated December 21, 1995 and the Kathryn Elizabeth Fickes Trust dated December 21, 1995. (19)
12 Computation of ratio of earnings to fixed charges. (1)
21 List of subsidiaries of the Registrant. (1)
22.1 Auditors consent. (1)
22.2 Auditors consent. (1)
27 Financial Data Schedule. (1)
(1) Filed herewith.
(2) Such exhibit is incorporated by reference to the Form 8-K dated November 25, 1996, which was filed with the Securities and Exchange Commission by PennCorp Financial Group, Inc. on December 4, 1996, providing a copy of the Amended and Restated Agreement and Plan of Merger with Washington National Corporation.
(3) Such exhibit is incorporated by reference to the Registration Statement on Form S-3 (Registration No. 333- 13285) of PennCorp Financial Group, Inc. filed with the Securities and Exchange Commission on October 10, 1996.
(4) Such exhibit is incorporated by reference to the Form 8-K dated July 24, 1996 which was filed with the Securities and Exchange Commission by PennCorp Financial Group, Inc. on August 8, 1996 relating to the financial statements and pro forma financial information of United Companies Life Insurance Company.
(5) Such exhibit is incorporated by reference to the Annual Report on Form 10-K for the fiscal year ended December 31, 1995 of PennCorp Financial Group, Inc.
(6) Such exhibit is incorporated by reference to the Form 8-K dated December 14, 1995 which was filed by PennCorp Financial Group, Inc. with the Securities and Exchange Commission on December 28, 1995 related to its investment in Southwestern Financial Corporation.
(7) Such exhibit is incorporated by reference to the Form 8-A dated July 11, 1995 which was filed by PennCorp Financial Group, Inc. with the Securities and Exchange Commission on July 12, 1995.
(8) Such exhibit is incorporated by reference to the Quarterly Report on Form 10-Q for the three months ended June 30, 1995 of PennCorp Financial Group, Inc.
(9) Such exhibit is incorporated by reference to the Quarterly Report on Form 10-Q for the three months ended September 30, 1994 of PennCorp Financial Group, Inc.
(10) Such exhibit is incorporated by reference to the Quarterly Report on Form 10-Q for the three months ended June 30, 1994 of PennCorp Financial Group, Inc.
(11) Such exhibit is incorporated by reference to the Annual Report on Form 10-K for the fiscal year ended December 31, 1993 of PennCorp Financial Group, Inc.
(12) Such exhibit is incorporated by reference to the Annual Report on Form 10-K for the fiscal year ended December 31, 1992 of PennCorp Financial Group, Inc.
(13) Such exhibit is incorporated by reference to the Registration Statement on Form S-1 (Registration No. 33-50530) of PennCorp Financial Group, Inc. filed on August 6, 1992.
(14) Such exhibit is incorporated by reference to the Annual Report on Form 10-K for the fiscal year ended December 31, 1996 of PennCorp Financial Group, Inc.
(15) Such exhibit is incorporated by reference to Amendment Number 2 to the Annual Report on Form 10-K for fiscal year ended December 31, 1996 of PennCorp Financial Group, Inc.
(16) Such exhibit is incorporated by reference to the Amendment Number 1 to Annual Report on Form 10-K for the fiscal year ended December 31, 1996 of PennCorp Financial Group, Inc.
(17) Such exhibit is incorporated by reference to the Quarterly Report on Form 10-Q for the three months ended June 30, 1997 of PennCorp Financial Group, Inc.
(18) Such exhibit is incorporated by reference to the Quarterly Report on Form 10-Q for the three months ended September 30, 1997 of PennCorp Financial Group, Inc.
(19) Such exhibit is incorporated by reference to the Form 8-K dated January 13, 1998 which was filed with the Securities and Exchange Commission by PennCorp Financial Group, Inc. on January 13, 1998 relating to the acquisition of common stock and common stock warrants of Southwestern Financial Corporation not previously owned by PennCorp Financial Group, Inc.
(20) Such exhibit is incorporated by reference to the Registration Statement on Form S-8 (Registration No. 333-48629) of PennCorp Financial Group, Inc. filed on March 24, 1998.