ITEM 1. BUSINESS
(a) GENERAL DEVELOPMENT OF BUSINESS
SBM Certificate Company (the "Company") was incorporated in Minnesota in June of 1990, to assume the face-amount certificate business of SBM Company ("SBM"). Effective December 31, 1993, SBM transferred all of the Company's shares of common stock to its wholly owned subsidiary, State Bond and Mortgage Life Insurance Company ("SBM Life"). On June 14, 1995, the Company became a wholly owned subsidiary of ARM Financial Group, Inc. ("ARM") pursuant to ARM's purchase of substantially all of the assets and business operations of SBM (the "Acquisition").
On December 20,1999 ARM filed a voluntary petition for relief under the provisions of chapter 11 of the U.S. Bankruptcy Code (the "Code") in the United States Bankruptcy Court for the District of Delaware. ARM is as a debtor in possession under the Code. ARM provided retirement savings and investment products through its insurance company subsidiaries. On March 3, 2000 ARM completed the sale of its insurance subsidiaries to Western and Southern Life Insurance Company ("Western and Southern") ("the Insurance Transaction") (see Item 7 below). On March 28, 2000 ARM entered into a definitive agreement to sell the Company to 1st Atlantic Guaranty Corporation ("1st Atlantic") for a purchase price of $650,000. Of the purchase price, $250,000 will be paid directly to ARM and $400,000 will be placed in escrow for 18 months. The escrowed proceeds shall be used to fund certain indemnifications of ARM. Immediately prior to the closing of the sale of the Company, the Company shall (subject to obtaining appropriate regulatory approvals) dividend to ARM an amount equal to the Company's shareholder's equity less (i) $250,000 and (ii) estimated deferred acquisition costs net of income taxes. The dividend will be in the form of a transfer of certain securities, in kind, and the balance, if any, in cash or cash equivalents. The closing of this transaction is subject to various approvals, including that of the Bankruptcy Court, and is expected to close in the second quarter of 2000.
Pursuant to a continuing hardship exemption from the electronic filing requirements of the Securities Exchange Act of 1934 (the "1934 Act"), ARM now makes all of its public filings in paper format. Accordingly, copies of ARM's public filings filed after March 1, 2000, may be obtained from the Public Reference Department of the Securities Exchange Commission, 450 Fifth Street, NW, Washington, DC 20549. The 1999 Form 10-K for ARM will not be filed within the period prescribed by the requirements for such filings in the 1934 Act.
(b) FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS.
The Company has one business segment.
(c) NARRATIVE DESCRIPTION OF BUSINESS
The Company is an issuer of fixed-rate face-amount certificates registered under the Investment Company Act of 1940, as amended (the "1940 Act"). A face-amount certificate is an obligation of the Company requiring the Company to pay certificate holders the original invested amount of the certificate, plus a three-year fixed-rate return, at a given maturity date. The Company selects the interest rate offered on the face-amount certificates based on the short to intermediate term sections of the yield curve. Face-amount certificates, which are similar to bank certificates of deposit, generally compete with various types of individual savings products offered by banks and insurance companies that provide a fixed rate of return on investors' money. The Company's face-amount certificates are sold primarily in the Midwest.
The Company's face-amount certificates are distributed by ARM Securities Corporation ("ARM Securities"), a wholly owned subsidiary of ARM, pursuant to an Underwriting Agreement. ARM Securities currently uses a network of independent agents to sell and service the face-amount certificates. ARM Securities is registered with the Securities and Exchange Commission (the "SEC") as a broker-dealer under the provisions of the Securities Exchange Act of 1934, as amended. On April 4, 2000, ARM entered into a Stock Purchase Agreement to sell ARM Securities to ND Holdings, Inc. The sale of ARM Securities is subject to Bankruptcy Court and other regulatory approvals, and is expected to close during the second quarter. Upon the consummation of the sale of the Company it will likely need to enter into an underwriting agreement with a different broker-dealer.
The Company's gross margin is derived primarily from the margin between earnings on investments and amounts paid or credited on its fixed-rate certificate deposits ("net investment spread"). The Company's net income is determined by deducting investment and other expenses and federal income taxes from gross margin. The net investment spread is affected by general economic conditions, government monetary policy, the policies of regulatory authorities that influence market interest rates, and the Company's ability to respond to changes in such rates. Changes in market interest rates may have a negative impact on the Company's earnings.
The Company's face-amount certificate business generally competes with various types of individual savings products that offer a fixed rate of return on investors' money, especially insurance and bank products. Some of these other products are insured by governmental agencies or funds or independent third parties. The certificates offered by the Company are not guaranteed or insured by any governmental agency or fund or independent third party. The Company's business is highly competitive and the Company competes with many other companies having greater financial resources, larger sales forces, and greater access to customers. The Company's ability to offer competitive interest rates, attractive terms, and efficient service are the Company's primary basis for meeting competition.
The Company has no employees. Pursuant to an Investment Services Agreement and an Administrative Services Agreement, the Company's operations have been administered and managed by ARM. As a result of the consummation of the Insurance Transaction, the vast majority of ARM's employees, including the employees who support the Company, became employees of Integrity Life Insurance Company ("Integrity") (see Item 7 below). Employees of Integrity are assisting ARM in winding up ARM's affairs, including the administration of the Company, pursuant to a Transition Services Agreement dated March 3, 2000 (the "Transition Services Agreement"). The Transition Services Agreement has a term of eighteen months, but may be terminated by Western and Southern after six months, upon 90 days notice.
Pursuant to a Letter Agreement dated February 17, 2000 (as amended on March 1, 2000, the "WTR&A Agreement"), ARM retained Walker, Truesdell, Radick & Associates ("WTR&A") as its Restructuring Agent, to provide consulting and management services to ARM, including services related to the sale of the Company to 1st Atlantic. On March 2, 2000, WTR&A's retention was approved by the Bankruptcy Court. WTR&A is a consulting firm that specializes in crisis management, bankruptcy administration and asset liquidation services.
Like many financial services companies, which offer investment opportunities to the public, the Company is subject to regulation and supervision by federal and state regulators. The 1940 Act and rules issued by the SEC thereunder specify certain terms for face-amount certificates, the method for calculating reserve liabilities on outstanding certificates, the minimum amounts and types of investments to be deposited with a qualified custodian to support such reserve liabilities, and a variety of other restrictions on the operation and governance of a face-amount certificate company. Pursuant to statutory authority, the Minnesota Department of Commerce ("MDC") and the Illinois Secretary of State exercise supervisory powers over the Company's face-amount certificate business similar to those under the 1940 Act. In addition, the MDC conducts examinations of the Company on a periodic basis. The offer and sale of the Company's face-amount certificates also are subject to federal and state securities laws.
(d) FINANCIAL INFORMATION ABOUT FOREIGN AND DOMESTIC OPERATIONS AND EXPORT SALES
The Company has no foreign operations.
ITEM 2.
ITEM 2. PROPERTIES
The Company's and ARM's corporate executive offices (the "Corporate Offices") are located at 515 West Market Street, Louisville, Kentucky. The Corporate Offices are the location of the Company's executive officers and the primary location for ARM's accounting, legal and marketing activities and various other support personnel.
The Company's administrative offices are located in New Ulm, Minnesota, at 100 North Minnesota Street.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The Company is not a party to, nor is any of the Company's property the subject of, any material pending legal proceedings, other than ordinary litigation routine to the Company's business.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
This information is omitted in accordance with Instruction (I)(2)(c) to Form 10-K.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
There is currently no public market or trading in the common stock of the Company. All of the Company's 250,000 outstanding shares of common stock are held by ARM as of December 31, 1999. The Company has never paid cash dividends on its common stock.
The Company is subject to two principal restrictions on its ability to pay dividends in addition to the generally applicable restrictions and requirements of Minnesota corporate law. First, pursuant to Section 28(b) of the 1940 Act, the Company is required to establish and maintain qualified assets having a value not less than the aggregate of certificate reserves plus $250,000. Second, the MDC has determined that face-amount certificate companies such as the Company should maintain a ratio of shareholder's equity to total assets of a minimum of 5%. For purposes of determining compliance with both requirements, assets are based upon a valuation of available-for-sale securities reflected at amortized cost. The Company could not pay dividends if it did not meet both of these two requirements or if payment of a dividend would cause it not to meet such requirements. As of December 31, 1999, the Company had qualified assets in excess of certificate reserves plus $250,000 of $4.6 million and total assets in excess of the 5% ratio of $3.2 million.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
This information is omitted in accordance with Instruction (I)(2)(a) to Form 10-K.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RELATIONSHIP WITH ARM FINANCIAL GROUP, INC.
The Company is a wholly owned subsidiary of ARM. Pursuant to an Investment Services Agreement and an Administrative Services Agreement, the Company's operations are administered and managed by ARM.
On July 29, 1999, ARM announced that it was restructuring its institutional business and positioning its retail business and technology operations for the sale of ARM or its businesses or its assets. Following the July 29, 1999 announcement, the ratings of ARM and Integrity were significantly lowered several times by four major rating agencies, materially and adversely affecting Integrity's ability to market and maintain persistency of retail products. As a result, ARM sought protection with respect to its insurance subsidiary, Integrity, from the Ohio Department of Insurance. Integrity is domiciled in Ohio. On August 20, 1999, Integrity consented to a Supervision Order issued by the Ohio Department of Insurance. The supervision order was terminated on March 3, 2000 as a result of the consummation of the Insurance Transaction.
On December 17, 1999 ARM announced that it had signed a definitive agreement whereby Western and Southern would acquire ARM's insurance subsidiaries, Integrity and National Integrity
Life Insurance Company. The acquisition of the insurance companies by Western and Southern was implemented in a voluntary petition for relief under chapter 11 of the Bankruptcy Code filed on December 20, 1999 in the United States Bankruptcy Court for the District of Delaware. In re: ARM Financial Group, Inc., Case No.: 99-4430(Judge Walsh). The transaction was approved by the Bankruptcy Court on March 2, 2000 and closed on March 3, 2000.
Western and Southern did not acquire the Company or ARM Securities. As a result of the consummation of the Insurance Transaction, the vast majority of ARM's employees, including the employees who support the Company, became employees of Integrity Life Insurance Company ("Integrity"). (see Item 7 below). Employees of Integrity are assisting ARM in winding up ARM's affairs, including the administration of the Company, pursuant to a Transition Services Agreement dated March 3, 2000 ("the Transition Services Agreement"). The Transition Services Agreement has a term of eighteen months, but may be terminated by Western and Southern after six months, upon 90 days notice.
During the fourth quarter of 1999, the Company entered into discussions with several companies to evaluate the possibility of a sale of the Company to one of these companies. As described in Part I, Item 1(a) above, on March 28, 2000 ARM and the Company entered into a definitive agreement to sell the Company to 1st Atlantic. 1st Atlantic is a Maryland corporation currently engaged in the sale of face-amount certificates. There can be no assurance that a transaction will be consummated, or that the required approvals of the Bankruptcy Court and various other regulatory bodies will be received. If a closing cannot be consummated with 1st Atlantic, ARM may seek to sell the Company to another party, or to avail itself of other options that may be available to it, including the possible refund of currently held certificates and the dissolution of the Company (subject to regulatory approval).
Pursuant to the WTR&A Agreement, ARM retained WTR&A as its Restructuring Agent, to provide consulting and management services to ARM, including services related to the sale of the Company to 1st Atlantic. On March 2, 2000, WTR&A's retention was approved by the Bankruptcy Court. WTR&A is a consulting firm that specializes in crisis management, bankruptcy administration and asset liquidation services.
RESULTS OF OPERATIONS
1999 COMPARED WITH 1998
Net investment income (net income excluding net realized investment gains and losses) was $408,673 and $133,733 for 1999 and 1998, respectively. The increase in net investment income was primarily attributable to a decrease in real estate expenses (due to the sale of real estate in 1998), and lower investment and other expenses.
Net investment spread, which is the difference between investment income and interest credited on certificate reserves, decreased to $0.7 million during 1999 from $0.8 million in 1998. These amounts reflect net investment spread of 1.20% and 1.12% during 1999 and 1998, respectively, between the Company's investment yield on average cash and investments and the average rate
credited on certificate reserves. The Company's investment income decreased to $2.3 million from $2.8 million for 1999 and 1998, respectively. These amounts represent investment yields of 6.20% and 6.46% on average cash and investments of $36.9 million and $43.8 million for 1999 and 1998, respectively. This decrease in annualized investment yield on cash and investments was primarily attributable to the Company investing in lower yielding securities during 1999 compared to 1998.
Interest credited on certificate reserves was $1.6 million and $2.1 million for 1999 and 1998, respectively. These amounts represent average rates of interest credited of 5.00% and 5.34% on average certificate reserves of $32.3 million and $38.7 million for 1999 and 1998, respectively. The majority of the Company's outstanding face-amount certificates are fixed-rate three year contracts. The Company monitors credited interest rates for new and renewal issues against competitive products, mainly bank certificates of deposit. Credited interest rate adjustments (up or down) on new certificates are made as the Company deems necessary. New and renewal contracts issued during 1999 have crediting rates that are generally lower than contracts that matured during that period, resulting in the overall decrease in the average crediting rate.
Investment and other expenses were $369,825 and $575,823 for 1999 and 1998, respectively. The decrease in investment and other expenses is primarily attributable to a decrease in management and investment advisory fees, deferred acquisition cost amortization and renewal commissions, and real estate expenses in 1999 of $53,093, $85,316 and $87,813, respectively, compared to 1998.
Realized investment losses (net of gains) were $470,507 and $152,977 for 1999 and 1998, respectively. Realized investment losses for 1998 include a loss of $178,795 related to the write-down to fair value and subsequent sale of the Company's real estate investment. Other realized investment gains and losses were primarily interest-rate related and attributable to the asset/liability management strategies of the Company. Fixed maturities and equity securities (i.e., non-redeemable preferred stock) classified as available-for-sale are sold during rising and falling interest rate environments which can result in period-to-period swings in interest-rate related realized investment gains and losses.
In the event that the Company experiences higher than historical levels of certificate surrenders, the Company might need to liquidate investments other than in accordance with its normal asset/liability management strategy and, as a result, the Company could experience substantial realized investment losses. If the Company requires additional capital, it is unlikely that such capital would be available from ARM. (SEE "-RELATIONSHIP WITH ARM FINANCIAL GROUP, INC.")
During 1999, net income was $36,143 compared to $30,643 in 1998. The increase was primarily attributable to an increase in net investment income partially offset by an increase in net realized investment losses.
Certificate reserves decreased $4.0 million or 11.6% during 1999, as maturities and surrenders exceeded sales and renewals. The Company believes a factor leading to the decrease was the modest increase in intermediate-term market interest rates in 1999, which enhanced the attractiveness of competing products, such as money market funds and bank certificates of deposit. For certificates reaching their maturity date during 1999 and 1998, 66% and 61%, respectively, were renewed.
1998 COMPARED WITH 1997
Net investment income was $133,733 and $258,205 for 1998 and 1997, respectively. The decrease in net investment income was primarily attributable to a decrease in net investment spread, partially offset by lower investment and other expenses.
Net investment spread decreased to $0.8 million during 1998 from $1.1 million in 1997. These amounts reflect net investment spread of 1.12% and 1.63% during 1998 and 1997, respectively, between the Company's investment yield on average cash and investments and the average rate credited on certificate reserves. The Company's investment income decreased to $2.7 million from $3.9 million for 1998 and 1997, respectively. These amounts represent investment yields of 6.46% and 7.43% on average cash and investments of $43.8 million and $52.9 million for 1998 and 1997, respectively. This decrease in investment yield on cash and investments was primarily attributable to the Company investing in more corporate and plain vanilla mortgage-backed securities during 1998 compared to 1997. As a result of this trading activity, above normal average cash balances were held, further depressing the investment yield.
Interest credited on certificate reserves was $2.1 million and $2.8 million for 1998 and 1997, respectively. These amounts represent average rates of interest credited of 5.34% and 5.80% on average certificate reserves of $38.7 million and $48.2 million for 1998 and 1997, respectively. New and renewal contracts issued during 1998 had crediting rates that were generally lower than contracts that matured during 1998, resulting in the overall decrease in the average crediting rate.
Investment and other expenses were $575,823 and $755,256 for 1998 and 1997, respectively. The decrease in investment and other expenses was primarily attributable to a decrease in management and investment advisory fees and real estate expenses in 1998 of $39,333 and $76,247, respectively, compared to 1997. In addition, there was no goodwill amortization during the year ended December 31, 1998 compared to the $23,833 for the year ended December 31, 1997. The goodwill asset became fully amortized during the second quarter of 1997.
Realized investment losses were $152,977 and $268,002 for 1998 and 1997, respectively. Realized investment losses for 1998 included loss of $178,795 related to the write-down to fair value and subsequent sale of the Company's real estate investment. Other realized investment gains and losses were primarily interest-rate related and attributable to the asset/liability management strategies of the Company. Fixed maturities and equity securities (i.e., non-redeemable preferred stock) classified as available-for-sale are sold during rising and falling interest rate environments which can result in period-to-period swings in interest-rate related realized investment gains and losses.
During 1998, net income was $30,643 compared to $94,688 in 1997. The decrease was primarily attributable to a decrease in net investment income.
Certificate reserves decreased $11.1 million or 24.5% during 1998, as maturities and surrenders exceeded sales and renewals. The Company believes a significant factor leading to the decrease was that the certificate of deposit marketplace was very competitive, as many financial institutions
offered special high rates to induce customers to open new accounts. For face-amount certificates reaching their maturity date during 1998 and 1997, 61% and 64%, respectively, were renewed.
ASSET PORTFOLIO REVIEW
The Company primarily invests in securities with fixed maturities with the objective of providing reasonable returns while limiting liquidity and credit risks. The Company's investments in fixed maturities were 100% and 97% investment grade as of December 31, 1999 and 1998, respectively. Investment grade securities are those classified as 1 or 2 by the National Association of Insurance Commissioners, or where such classifications are not available, securities are classified by a nationally recognized statistical rating organization (i.e., Standard & Poor Corporation's rating of BBB- or above). Additionally, the Company's investment portfolio has no exposure to real estate, mortgage loans and common equity securities. As of December 31, 1999, the Company held no securities that had defaulted on principal or interest payments.
Fixed maturities include mortgage-backed and asset-backed securities, corporate securities, U.S. Treasury securities and other government obligations. Mortgage-backed securities ("MBSs"), which include pass-through securities and collateralized mortgage obligations ("CMOs"), totaled $10.3 million at December 31, 1999, representing 30.1% of total qualified assets (48.0% at December 31, 1998). The Company's investments in CMOs represented 29.2% and 46.7% of the Company's qualified assets as of December 31, 1999 and 1998, respectively. MBSs, including CMOs, are subject to risks associated with prepayments of the underlying mortgage loans. Prepayments cause these securities to have actual maturities different from those expected at the time of purchase. The degree to which a security is susceptible to either an increase or decrease in yield due to prepayment speed adjustments is influenced by the difference between its amortized cost and par, the relative sensitivity of the underlying mortgages backing the assets to prepayments in a changing interest rate environment and the repayment priority of the securities in the overall securitization structure. Prepayment sensitivity is evaluated and monitored, giving full consideration to the collateral characteristics, such as weighted average coupon rate, weighted average maturity and the prepayment history of the specific loan pool. Additionally, the Company routinely projects three-year liability and asset cash flows to monitor the level of liquidity for maturing face-amount certificates.
Based on the provisions of Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity Securities," the Company currently classifies its fixed maturity and equity securities as available-for-sale. Such securities are carried at fair value and changes in fair value, net of related deferred income taxes, are charged or credited directly to shareholder's equity. Fluctuations in interest rates during 1999 resulted in unrealized losses of $825,522 at December 31, 1999 compared to unrealized gains of $70,448 (net of $37,942 in deferred income taxes) at December 31, 1998. Volatility in reported shareholder's equity occurs as a result of the application of SFAS No. 115, which requires some assets to be carried at fair value while other assets and all liabilities are carried at historical values. As a result, adjusting the shareholder's equity for changes in the fair value of the Company's fixed maturities and equity securities without reflecting offsetting changes in the value of the Company's liabilities or other
assets creates volatility in reported shareholder's equity but does not reflect the underlying economics of the Company's business.
LIQUIDITY AND FINANCIAL RESOURCES
As of December 31, 1999, the Company had $4.6 million of qualified assets in excess of the minimum amount required by the 1940 Act and the rules and regulations promulgated thereunder by the SEC, as computed in accordance with Section 28(b) of the 1940 Act. In addition, the MDC has historically recommended to the Company that face-amount certificate companies should maintain a ratio of shareholder's equity to total assets of a minimum of 5% based upon a valuation of available-for-sale securities reflected at amortized cost for purposes of this calculation. Under this formula, the Company's capital ratio was 14.0% at December 31, 1999. The Company has never paid cash dividends on its common stock in order to maintain and increase capital resources.
The primary liquidity requirement of the Company relates to its payment of certificate maturities and surrenders. The principal sources of cash to meet such liquidity requirements are investment income and proceeds from maturities and redemptions of investments.
At December 31, 1999, cash and cash equivalents totaled $14.4 million, an increase of $11.1 million from December 31, 1998. Due to the uncertainty surrounding ARM and the ownership of the Company significantly higher levels of cash and cash equivalents were maintained in 1999. The Company's aim is to manage its cash and cash equivalents position so as to satisfy short-term liquidity needs. In connection with this management of cash and cash equivalents, the Company may invest idle cash in short duration fixed maturities to capture additional yield when short-term liquidity requirements permit.
Cash flows of $2.1 million, $2.2 million and $4.0 million were generated from operating activities in 1999, 1998 and 1997, respectively. These cash flows resulted principally from investment income, less management and investment advisory fees and commissions paid. Proceeds from sales, redemptions and maturities of investments generated $37.0 million, $50.1 million and $93.1 million in cash flows during 1999, 1998 and 1997, respectively, which were offset by purchases of investments of $22.5 million, $49.3 million and $79.5 million, respectively.
YEAR 2000
ARM completed its Year 2000 compliance project as it relates to the Company prior to December 31, 1999. The costs of ARM's Year 2000 initiatives were not material to ARM's results of operations or financial condition. Likewise, costs to the Company that related to Year 2000 compliance were not material to the Company's results of operations or financial condition.
To date, the Company has experienced no major interruption of business activities. Even though ARM has assessed and continues to assess third party issues, it has no direct ability to influence the compliance actions of such parties. Accordingly, while ARM believes its actions in this regard should have the effect of reducing Year 2000 risks, it is unable to eliminate them or to estimate the ultimate effect Year 2000 risks will have on ARM's operations.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Company's financial statements begin on page. Reference is made to the Index to Financial Statements on page herein. There is no additional supplementary data filed herein.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
There have been no changes in or disagreements with independent accountants on accounting, auditing, or financial reporting matters.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
This information is omitted in accordance with Instruction (I)(2)(c) to Form 10-K.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
This information is omitted in accordance with Instruction (I)(2)(c) to Form 10-K.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
This information is omitted in accordance with Instruction (I)(2)(c) to Form 10-K.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
This information is omitted in accordance with Instruction (I)(2)(c) to Form 10-K.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) DOCUMENTS FILED AS PART OF THIS REPORT
1. FINANCIAL STATEMENTS.
See financial statements index on page of this document for a listing of financial statements and related report of independent auditors included in this report.
2. FINANCIAL STATEMENT SCHEDULES
The following financial statement schedules of the Company and the related Report of Independent Auditors are incorporated herein as follows:
Report of Independent Auditors
Schedule I Investments in Securities of Unaffiliated Issuers-December 31, 1999 Schedule V Qualified Assets on Deposit-December 31, 1999 Schedule VI Certificate Reserves-Year Ended December 31, 1999 Schedule XII Valuation and Qualifying Accounts-December 31, 1999
Schedules required by Article 6 of Regulation S-X for face-amount certificate investment companies other than those listed are omitted because they are not required, are not applicable, or equivalent information has been included in the financial statements and notes thereto, or elsewhere herein.
3. EXHIBITS
See Exhibit Index on page 15 of this report.
(b) REPORTS ON FORM 8-K
No reports on Form 8-K were filed by the Company during the fourth quarter of 1999.
SBM CERTIFICATE COMPANY EXHIBIT INDEX
* Previously filed as indicated and incorporated herein by reference.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned; thereunto duly authorized, on April 11, 2000.
SBM Certificate Company Walker, Truesdell, Radick and Associates, Inc. Restructuring Agent
By: /s/ Hobart G. Truesdell -------------------------------------------
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 in the capacities indicated on the 11th day of April 2000.
NAME TITLE ---- -----
/s/ PAUL J. HOUK Director - ------------------------------------------------------ Paul J. Houk
/s/ ROBERT J. MARSHALL, JR. Director - ------------------------------------------------------ Robert J. Marshall, Jr.
/s/ WALTER L. SALES Director - ------------------------------------------------------ Walter L. Sales
SBM CERTIFICATE COMPANY
REPORT OF INDEPENDENT AUDITORS
Board of Directors SBM Certificate Company
We have audited the accompanying balance sheets of SBM Certificate Company as of December 31, 1999 and 1998, and the related statements of operations, shareholder's equity, and cash flows for each of the three years in the period ended December 31, 1999. Our audits also included the financial statement schedules listed in the Index at Item 14(a). These financial statements and schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. 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 financial statements referred to above present fairly, in all material respects, the financial position of SBM Certificate Company at December 31, 1999 and 1998, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1999, in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.
The accompanying financial statements have been prepared assuming that SBM Certificate Company will continue as a going concern. As more fully described in Note 2, SBM Certificate Company is a wholly owned subsidiary of ARM Financial Group, Inc. On a consolidated basis, ARM Financial Group, Inc. reported a net loss of $271 million for 1999 and has a capital deficiency. These conditions raise substantial doubt about ARM Financial Group Inc.'s ability to continue as a going concern. Because of the aforementioned conditions relating to ARM Financial Group Inc., and the uncertainties surrounding its plans to address its liquidity problems, the parent company's actions could have a substantial effect on the Company's operations, therefore, there is also substantial doubt about whether SBM Certificate Company will continue as a going concern. (Management's plans in regard to these matters are also described in Note 2.) The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty.
Louisville, Kentucky March 31, 2000
SBM CERTIFICATE COMPANY BALANCE SHEETS
SBM CERTIFICATE COMPANY BALANCE SHEETS (CONTINUED)
SEE ACCOMPANYING NOTES.
SBM CERTIFICATE COMPANY STATEMENTS OF OPERATIONS
SEE ACCOMPANYING NOTES.
SBM CERTIFICATE COMPANY STATEMENTS OF SHAREHOLDER'S EQUITY
SEE ACCOMPANYING NOTES.
SBM CERTIFICATE COMPANY STATEMENTS OF CASH FLOWS
SEE ACCOMPANYING NOTES.
SBM CERTIFICATE COMPANY
NOTES TO FINANCIAL STATEMENTS
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION
SBM Certificate Company (the "Company") has been a wholly owned subsidiary of ARM Financial Group, Inc. ("ARM") since June 14, 1995.
NATURE OF OPERATIONS
The Company is an issuer of face-amount certificates and is registered under the Investment Company Act of 1940 (the "1940 Act"). A face-amount certificate is an obligation of the Company requiring the Company to pay certificate holders the original invested amount of the certificate, plus a three-year fixed-rate return, at a given maturity date. The Company's face-amount certificates are sold primarily in the Midwest. Face-amount certificates, which are similar to bank certificates of deposit, generally compete with various types of individual savings products offered by banks and insurance companies that provide a fixed rate of return on investors' money.
BASIS OF PRESENTATION
The financial statements are prepared in accordance with accounting principles generally accepted in the United States.
INVESTMENTS
Fixed maturities and equity securities are classified as available-for-sale. Available-for-sale securities are stated at fair value, with the unrealized gains and losses, net of taxes, reported as a separate component of shareholder's equity in accordance with Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity Securities." The amortized cost of fixed maturities classified as available-for-sale is adjusted for amortization of premiums and accretion of discounts to maturity, or in the case of mortgage-backed securities, over the estimated life of the security. Such amortization or accretion is computed using the interest method and is included in investment income. Anticipated prepayments on mortgage-backed securities are considered in determining the effective yield on such securities. If a difference arises between anticipated and actual prepayments, the carrying value of the investment is adjusted with a corresponding charge or credit to investment income. Interest and dividends are included in investment income. Certificate loans are carried at their unpaid principal balances. Cash and cash equivalents consist of highly liquid investments with maturities of three months or less from the time of purchase. Security transactions are accounted for on the date the order to buy or sell is executed. Realized gains and losses on the sale of investments are determined based upon the specific identification method.
DEFERRED ACQUISITION COSTS
Costs of issuing new face-amount certificates, principally commissions, have been deferred. These costs are amortized on a straight-line basis over the initial maturity period of the certificates which is three years.
FACE-AMOUNT CERTIFICATE RESERVES
Face-amount certificates issued by the Company entitle certificate holders, who have made either single or installment payments, to receive a definite sum of money at maturity. Certificate reserves accrue interest, and cash surrender values are less than accumulated certificate reserves prior to maturity dates. The reserve accumulation rates, cash surrender values, and certificate reserves, among other matters, are governed by the 1940 Act.
INCOME TAXES
The Company uses the liability method of accounting for income taxes. The Company files a consolidated federal income tax return with ARM and ARM's other non-life insurance subsidiaries. Pursuant to a tax sharing agreement, the consolidated income tax due is allocated among the companies based on each company's proportionate share of taxable income. When tax benefits are recognized for losses, (capital and operating) to the extent they can be used in the consolidated return, the company that originally generated the loss is reimbursed by the benefited company. However, in the event that no consolidated tax is owed, the tax sharing agreement does not require ARM to reimburse its subsidiaries for the use of a subsidiary's losses to offset ARM income.
USE OF ESTIMATES
The preparation of financial statements requires management of the Company to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.
2. MATERIAL EVENTS OF PARENT COMPANY
As discussed in Note 1, the Company is a wholly owned subsidiary of ARM, and pursuant to an Investment Services Agreement and an Administrative Services Agreement, the Company's operations are administered and managed by ARM. On July 29, 1999, ARM announced that it was restructuring its institutional business and positioning its retail business and technology operations for the sale of ARM or its businesses or its assets. Following the July 29, 1999 announcement, the ratings of ARM and Integrity were significantly lowered several times by four major rating agencies, materially and adversely affecting Integrity's ability to market and maintain persistency of retail products. As a result, ARM sought protection with respect to its insurance subsidiary, Integrity, from the Ohio Department of Insurance. Integrity is domiciled in Ohio. On August 20, 1999, Integrity consented to a Supervision Order issued by the Ohio Department of Insurance. The supervision order was terminated on March 3, 2000 as a result of the consummation of the Insurance Transaction.
On December 17, 1999 ARM announced that it had signed a definitive agreement whereby Western and Southern Life Insurance Company ("Western and Southern") would acquire ARM's
insurance subsidiaries, Integrity Life Insurance Company ("Integrity") and National Integrity Life Insurance Company. The acquisition of the insurance companies by Western and Southern was implemented in a voluntary petition for relief under chapter 11 of the Bankruptcy Code filed on December 20, 1999 in the United States Bankruptcy Court for the District of Delaware. In re: ARM Financial Group, Inc., Case No.: 99-4430(Judge Walsh). On March 3, 2000 ARM completed the sale of its insurance subsidiaries to Western and Southern ("the Insurance Transaction").
Western and Southern did not acquire the Company or ARM Securities. As a result of the consummation of the Insurance Transaction, the vast majority of ARM's employees, including the employees who support the Company, became employees of Integrity (see Item 7 below). Employees of Integrity are assisting ARM in winding up ARM's affairs, including the administration of the Company, pursuant to a Transition Services Agreement dated March 3, 2000 ("the Transition Services Agreement"). The Transition Services Agreement has a term of eighteen months, but may be terminated by Western and Southern after six months, upon 90 days notice.
During the fourth quarter of 1999, the Company entered into discussions with several companies to evaluate the possibility of a sale of the Company to one of these companies. On March 28, 2000 ARM entered into a definitive agreement to sell the Company to 1st Atlantic Guaranty Corporation ("1st Atlantic") for a purchase price of $650,000. Of the purchase price, $250,000 will be paid directly to ARM and $400,000 will be placed in escrow for 18 months. The escrowed proceeds shall be used to fund certain indemnifications of ARM. Immediately prior to the closing of the sale of the Company, the Company shall (subject to obtaining appropriate regulatory approvals) dividend to ARM an amount equal to the Company's shareholder's equity less (i) $250,000 and (ii) estimated deferred acquisition costs net of income taxes. The dividend will be in the form of a transfer of certain securities, in kind, and the balance, if any, in cash or cash equivalents. The closing of this transaction is subject to various approvals, including that of the Bankruptcy Court, and is expected to close in the second quarter of 2000.
Pursuant to a Letter Agreement dated February 17, 2000 (as amended on March 1, 2000, the "WTR&A Agreement"), ARM retained Walker, Truesdell, Radick & Associates ("WTR&A") as its Restructuring Agent, to provide consulting and management services to ARM, including services related to the sale of the Company to 1st Atlantic. On March 2, 2000, WTR&A's retention was approved by the Bankruptcy Court. WTR&A is a consulting firm that specializes in crisis management, bankruptcy administration and asset liquidation services.
3. INVESTMENTS
The amortized cost and estimated fair values of available-for-sale securities were as follows:
The amortized cost and estimated fair value of fixed maturity securities by contractual maturity are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or repay obligations with or without call or prepayment penalties and because mortgage-backed and asset-backed securities provide for periodic payments throughout their life.
Gross gains of $101,621, $123,867 and $765,664 and gross losses of $572,128, $95,449 and $1,082,809 were realized on sales of fixed maturities classified as available-for-sale for the year ended December 31, 1999, 1998, and 1997, respectively.
Gross gains of $23,459 and $49,143 were recognized on equity securities sold during 1998 and 1997, respectively. Gross losses of $1,062, were recognized on equity securities sold for the year ended December 31, 1998. There were no gross losses recognized on equity securities sold for the year ended December 31, 1997. There were no gross gains or losses recognized on equity securities sold for the year ended December 31, 1999.
During 1998, the Company sold its sole investment in real estate and realized a loss of $178,795 associated with the transaction.
4. COMPREHENSIVE INCOME
Comprehensive income is the change in equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources, including net income and the change in unrealized gains or losses on the Company's available-for-sale securities.
The following table shows, for available-for-sale securities, a reconciliation of the net unrealized gain (loss) arising during the period and the change in net unrealized gains (losses) as reported on the accompanying statements of shareholder's equity. Amounts are reported net of related tax at the 35% statutory rate.
5. CERTIFICATE RESERVES
Total certificate reserves at December 31 are summarized as follows:
* Minimum interest rates on advance payments are generally the same as the rates on scheduled installment payments. Interest credited on advance payments, however, is accruing at 5.00% and will continue at that rate through 2000.
6. FAIR VALUES OF FINANCIAL INSTRUMENTS
The following disclosure of the estimated fair values of financial instruments is made in accordance with the requirements of SFAS No. 107, "Disclosures About Fair Value of Financial Instruments." The estimated fair value amounts have been determined using available market information and appropriate valuation methodologies. However, considerable judgement was required to develop these estimates. Accordingly, the estimates are not necessarily indicative of the amounts which could be realized in a current market exchange. The use of different market assumptions or estimation methodologies may have a material effect on the estimated fair value amounts.
The following methods and assumptions were used in estimating fair values:
FIXED MATURITIES AND EQUITY SECURITIES Fair values for investments in securities are based on quoted market prices, where available. For fixed maturities and equity securities for which a quoted market price is not available, fair values are estimated using internally calculated estimates or quoted market prices of comparable instruments.
CERTIFICATE LOANS
The carrying value of certificate loans approximates their fair value.
CASH AND CASH EQUIVALENTS
The carrying amounts of cash and cash equivalents approximate their fair value given the short-term nature of these assets.
CERTIFICATE RESERVES
The fair value of certificate reserves is based on a discounted cash flow analysis, using the current interest rate offered on new certificates of 5.00% at December 31, 1999 and 1998.
OTHER INVESTED ASSETS, OTHER ASSETS, ACCOUNTS PAYABLE AND OTHER LIABILITIES
The financial statement carrying amounts of other invested assets, other assets, accounts payable and other liabilities are deemed to be a reasonable approximation of their fair value.
7. FEDERAL INCOME TAXES
Deferred federal income taxes reflect the net tax effects of (i) temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes, and (ii) operating and capital losses. Significant components of the deferred tax liabilities and assets as of December 31, 1999 and December 31, 1998 were:
The Company's net operating loss carryforward of $166,915 at December 31, 1998 was fully utilized in 1999.
The components of the provision for federal income tax expense consist of the following:
In the event that future tax assets are recognized on deductible temporary differences for which a valuation allowance was provided at the Acquisition date, such benefits are applied to first reduce the balance of goodwill. During 1997, goodwill was reduced by $89,262 as a result of realizing such
benefits. No such benefits were realized in 1999 and 1998. The 1997 reduction in the valuation allowance of $314,521 reduced the goodwill balance to zero.
Federal income tax expense differs from that computed by using the federal income tax rate of 35% as shown below.
The Company files a consolidated federal income tax return with ARM and ARM's other non-life insurance subsidiaries. At December 31, 1999 and 1998, ($28,282) and $103,373 were due to/(from) ARM, respectively, pursuant to the tax sharing agreement, related to ordinary losses.
8. RELATED PARTY TRANSACTIONS
Management and investment advisory fee expenses reflected in the accompanying financial statements represent allocations of expenses from ARM. These allocations include amounts for administrative and investment services, including use of property, equipment and facilities. The allocations are currently based on the proportion which such business and assets managed represents of all of ARM's and its subsidiaries' business activities. The allocations were $154,042, $207,135, and $246,468 for the years ended December 31, 1999, 1998, and 1997, respectively. Management believes that the methods used to allocate such expenses are reasonable.
The Company has paid ARM Securities Corporation, an affiliate, $140,145, $325,523 and $314,805 for the years ended 1999, 1998 and 1997, respectively, for sales commissions and other issuance, underwriting and sales expenses.
9. SHAREHOLDER'S EQUITY AND REGULATORY MATTERS
The Company is subject to two principal restrictions relating to its regulatory capital requirements. First, under the 1940 Act, the Company is required to establish and maintain qualified
assets (as defined in Section 28(b) of the 1940 Act) having a value not less than the aggregate of certificate reserves plus $250,000 ($30.4 million and $34.3 million at December 31, 1999 and 1998, respectively). The Company had qualified assets (at amortized cost) of $34.9 million and $38.2 million at those respective dates.
For purposes of determining compliance with the foregoing provisions, qualified assets are valued in accordance with District of Columbia Insurance Laws (the "D.C. Laws") as required by the 1940 Act. Qualified assets for which no provision for valuation is made in the D.C. Laws are valued in accordance with rules, regulations, or orders prescribed by the SEC. These values are the same as the financial statement carrying values, except that for financial statement purposes, fixed maturities and equity securities classified as available-for-sale are carried at fair value. For qualified asset purposes, fixed maturities classified as available-for-sale are valued at amortized cost and equity securities are valued at cost.
Second, the Minnesota Department of Commerce ("MDC") has historically recommended to the Company that face-amount certificate companies should maintain a ratio of shareholder's equity to total assets of a minimum of 5% based upon a valuation of available-for-sale securities at amortized cost for purposes of this calculation. Under this formula, the Company's capital ratio was 14.0% and 12.6% at December 31, 1999 and 1998, respectively.
Pursuant to the required calculations of various states, the provisions of the certificates, depository agreements, and the 1940 Act, qualified assets of the Company were deposited with independent custodians to meet certificate liability requirements as of December 31, 1999 and 1998, as shown in the following table. Certificate loans, secured by applicable certificate reserves, are deducted from certificate reserves in computing deposit requirements.
Qualified assets on deposit consisted of investment securities, at cost plus accrued interest at December 31, 1999 and 1998.
SBM CERTIFICATE COMPANY
INDEX TO FINANCIAL STATEMENT SCHEDULES
DECEMBER 31, 1999
Schedules required by Article 6 of Regulation S-X other than those listed are omitted because they are not required, are not applicable, or equivalent information has been included in the financial statements and notes thereto, or elsewhere herein.
S-1
SBM CERTIFICATE COMPANY
SCHEDULE I--INVESTMENTS IN SECURITIES OF UNAFFILIATED ISSUERS
DECEMBER 31, 1999
S-2
SBM CERTIFICATE COMPANY
SCHEDULE I--INVESTMENTS IN SECURITIES OF UNAFFILIATED ISSUERS (CONTINUED)
DECEMBER 31, 1999
S-3
SBM CERTIFICATE COMPANY
SCHEDULE I--INVESTMENTS IN SECURITIES OF UNAFFILIATED ISSUERS (CONTINUED)
DECEMBER 31, 1999
(a) See Note 1 to the financial statements regarding the determination of cost and fair value. (b) The aggregate cost of investments in securities of unaffiliated issuers for federal income tax purposes was $20,502,683 at December 31, 1999. (c) These securities are redeemable preferred stocks. (d) These securities are non-redeemable preferred stock.
S-4
SBM CERTIFICATE COMPANY
SCHEDULE V--QUALIFIED ASSETS ON DEPOSIT
DECEMBER 31, 1999
S-5
SBM CERTIFICATE COMPANY
SCHEDULE VI--CERTIFICATE RESERVES PART I - SUMMARY OF CHANGES
YEAR ENDED DECEMBER 31, 1999
NOTES TO PART I (a) Transfer to/from other certificate reserves upon conversion. (b) Direct interest payment to certificate holders.
S-6
SBM CERTIFICATE COMPANY
SCHEDULE VI--CERTIFICATE RESERVES (CONTINUED) PART I - SUMMARY OF CHANGES (CONTINUED)
YEAR ENDED DECEMBER 31, 1999
S-7
SBM CERTIFICATE COMPANY
SCHEDULE VI--CERTIFICATE RESERVES (CONTINUED) PART II - INFORMATION REGARDING INSTALLMENT CERTIFICATES CLASSIFIED BY AGE GROUPINGS
YEAR ENDED DECEMBER 31, 1999
S-8
SBM CERTIFICATE COMPANY
SCHEDULE VI--CERTIFICATE RESERVES (CONTINUED) PART II - INFORMATION REGARDING INSTALLMENT CERTIFICATES CLASSIFIED BY AGE GROUPINGS (CONTINUED)
YEAR ENDED DECEMBER 31, 1999
S-9
SBM CERTIFICATE COMPANY
SCHEDULE VI--CERTIFICATE RESERVES (CONTINUED) PART II - INFORMATION REGARDING INSTALLMENT CERTIFICATES CLASSIFIED BY AGE GROUPINGS (CONTINUED)
YEAR ENDED DECEMBER 31, 1999
S-10
SBM CERTIFICATE COMPANY
SCHEDULE VI--CERTIFICATE RESERVES (CONTINUED) PART II - INFORMATION REGARDING INSTALLMENT CERTIFICATES CLASSIFIED BY AGE GROUPINGS (CONTINUED)
YEAR ENDED DECEMBER 31, 1999
S-11
SCHEDULE XII-VALUATION AND QUALIFYING ACCOUNTS
(1) The valuation allowance was increased as a result of establishing a full valuation allowance on deferred tax assets for unrealized losses on assets available-for-sale. The increase in valuation allowance resulted in a reduction of shareholders' equity.
(2) The capital loss carryover was utilized during 1998, and therefore the related valuation allowance was released.
(3) In the event that deferred tax assets are recognized on deductible temporary differences for which a valuation allowance was provided at the date of an acquisition, such benefits are applied to first reduce the balance of intangible assets related to the acquisition, and then income tax expense. As such, the Company reduced its valuation allowance with an offsetting reduction to goodwill. After goodwill was reduced to zero during 1997, the reduction in valuation allowance resulted in a reduction of income taxes.
S-12