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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the Fiscal Year Ended December 31, 2003
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from __________ to __________
Commission File Number 001-11462
DELPHI FINANCIAL GROUP, INC.
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware (302) 478-5142 13-3427277
- ------------------------------- --------------------------- ----------------
(State or other jurisdiction of (Registrant's telephone (I.R.S. Employer
incorporation or organization) number, including area code) Identification
Number)
1105 North Market Street, Suite 1230, P. O. Box 19899
8985, Wilmington, Delaware
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
Securities registered pursuant to Section 12(b) of the Act:
Class A Common Stock, $.01 par value New York Stock Exchange
---------------------------------------- -------------------------
(Title of each class) (Name of each exchange
on which registered)
Securities registered pursuant to Section 12(g) of the Act:
None
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to filing requirements
for the past 90 days.
Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
Yes [X] No [ ]
The aggregate market value of the voting stock held by nonaffiliates of the
Registrant as of June 30, 2003 was $816,164,154.
As of March 1, 2004, the Registrant had 27,051,750 shares of Class A Common
Stock and 4,177,357 shares of Class B Common Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the Registrant's 2004 Annual Meeting of
Stockholders are incorporated by reference into Part III of this Form 10-K.
This document contains certain forward-looking statements as defined in the
Securities Exchange Act of 1934, some of which may be identified by the use of
terms such as "expects," "believes," "anticipates," "intends," "judgment" or
other similar expressions. These statements are subject to various uncertainties
and contingencies, which could cause actual results to differ materially from
those expressed in such statements. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Forward-Looking Statements and
Cautionary Statements Regarding Certain Factors That May Affect Future Results."
PART I
ITEM 1. BUSINESS
Delphi Financial Group, Inc. (the "Company," which term includes the Company and
its consolidated subsidiaries unless the context indicates otherwise), is a
holding company whose subsidiaries provide integrated employee benefit services.
The Company was organized as a Delaware corporation in 1987 and completed the
initial public offering of its Class A common stock in 1990. The Company manages
all aspects of employee absence to enhance the productivity of its clients and
provides the related insurance coverages: long-term and short-term disability,
excess and primary workers' compensation, group life, travel accident and
dental. The Company's asset accumulation business emphasizes individual fixed
annuity products. The Company offers its products and services in all fifty
states and the District of Columbia. The Company's two reportable segments are
group employee benefit products and asset accumulation products. See Notes A and
R to the Consolidated Financial Statements included in this Form 10-K for
additional information regarding the Company's segments.
The Company makes available free of charge on its website at www.delphifin.com
its annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports
on Form 8-K and all amendments to these reports as soon as reasonably possible
after such material has been filed with or furnished to the Securities and
Exchange Commission.
OPERATING STRATEGY
The Company's operating strategy is to offer financial products and services
which have the potential for significant growth, which require specialized
expertise to meet the individual needs of its customers and which provide the
Company the opportunity to achieve superior operating earnings growth and
returns on its shareholders' capital.
The Company has concentrated its efforts within certain niche insurance markets,
primarily group employee benefits for small to mid-sized employers, where nearly
all of the employment growth in the American economy has occurred in recent
years. The Company also markets its group employee benefit products and services
to large employers, emphasizing unique programs that integrate both employee
benefit insurance coverages and absence management services. The Company also
operates an asset accumulation business that focuses primarily on offering fixed
annuities to individuals planning for retirement.
The Company's primary operating subsidiaries are as follows:
Reliance Standard Life Insurance Company ("RSLIC"), founded in 1907 and having
administrative offices in Philadelphia, Pennsylvania, and its subsidiary, First
Reliance Standard Life Insurance Company ("FRSLIC"), underwrite a diverse
portfolio of group life, disability and accident insurance products targeted
principally to the employee benefits market. RSLIC also markets asset
accumulation products, primarily fixed annuities, to individuals and groups. The
financial strength rating of RSLIC as of February 2004 as rated by A.M. Best was
A- (Excellent). The Company, through Reliance Standard Life Insurance Company of
Texas ("RSLIC-Texas"), acquired RSLIC and FRSLIC in November 1987.
Safety National Casualty Corporation ("SNCC") focuses primarily on providing
excess workers' compensation insurance to the self-insured market. Founded in
1942 and located in St. Louis, Missouri, SNCC is one of the oldest continuous
writers of excess workers' compensation insurance in the United States. The
financial strength rating of SNCC as of February 2004 as rated by A.M. Best was
A (Excellent). The Company, through SIG Holdings, Inc. ("SIG"), acquired SNCC in
March 1996. In 2001, SNCC formed an insurance subsidiary, Safety First Insurance
Company, which also focuses on selling excess workers' compensation products to
the self-insured market.
Matrix Absence Management, Inc. ("Matrix"), founded in 1987, provides integrated
disability and absence management services to the employee benefits market
across the United States. Headquartered in San Jose, California, Matrix was
acquired by the Company in June 1998. See "Other Transactions" and Note B to the
Consolidated Financial Statements.
-1-
GROUP EMPLOYEE BENEFIT PRODUCTS
The Company is a leading provider of group life, disability and excess workers'
compensation insurance products to small and mid-sized employers, with more than
20,000 policies in force. The Company also offers travel accident, voluntary
accidental death and dismemberment and group dental insurance. The Company
markets its group products to employer-employee groups and associations in a
variety of industries. The Company insures groups ranging from 2 to more than
5,000 individuals, although the size of an insured group generally ranges from
10 to 1,000 individuals. The Company markets unbundled employee benefit products
and absence management services as well as an Integrated Employee Benefit
program that combines both employee benefit insurance coverages and absence
management services. The Integrated Employee Benefit program, which the Company
believes helps to differentiate from competitors by offering clients improved
productivity from reduced employee absence, has enhanced the Company's ability
to market its group employee benefit products to large employers. In 2003, the
Company introduced a suite of voluntary group life, disability and accidental
death and dismemberment products that are sold to employees at their worksite.
This suite of voluntary benefits allows the employees of the Company's clients
to choose the type and amount of benefit. In underwriting its group employee
benefit products, the Company attempts to avoid concentrations of business in
any industry segment or geographic area.
The Company's group employee benefit products are sold to employer groups
primarily through independent brokers and agents. The Company's products are
marketed to brokers and agents by 114 sales representatives and managers. RSLIC
had 99 sales representatives and managers located in 25 sales offices nationwide
at December 31, 2003, up 41% from 70 sales representatives and managers at the
end of 2000. At December 31, 2003, SNCC had 12 sales representatives and
managers and Matrix had 3 sales representatives and managers. The Company's
three administrative offices and 25 sales offices also service existing
business.
The following table sets forth for the periods indicated selected financial data
concerning the Company's group employee benefit products:
Year Ended December 31,
-----------------------------------------------------------------------
2003 2002 2001
--------------------- --------------------- ----------------
(dollars in thousands)
Insurance premiums:
Core Products:
Life................................... $ 241,902 35.9% $ 210,030 37.6% $170,772 37.8%
Disability income...................... 233,437 34.7 195,052 34.9 162,602 36.0
Excess workers' compensation........... 151,522 22.5 104,170 18.6 73,404 16.2
Travel accident, dental and other...... 46,792 6.9 49,922 8.9 45,380 10.0
--------- ----- ----------- ----- -------- -----
$ 673,653 100.0% $ 559,174 100.0% $452,158 100.0%
--------- ===== ----------- ===== -------- =====
Non-Core Products:.......................
Loss portfolio transfers............... - 26,830 4,340
Reinsurance facilities................. 344 771 7,872
Other.................................. 22,039 21,724 23,624
--------- ----------- --------
22,383 49,325 35,836
--------- ----------- --------
Total insurance premiums............. $ 696,036 $ 608,499 $487,994
========= =========== ========
Sales (new annualized gross premiums):
Core Products:
Life................................... $ 68,200 31.0% $ 70,900 35.2% $ 55,606 34.9%
Disability income...................... 84,920 38.6 75,996 37.8 60,628 38.1
Excess workers' compensation........... 45,058 20.5 30,796 15.3 18,110 11.4
Travel accident, dental and other...... 21,933 9.9 23,454 11.7 24,774 15.6
--------- ----- ----------- ----- -------- -----
$ 220,111 100.0% $ 201,146 100.0% $159,118 100.0%
--------- ===== ----------- ===== -------- =====
Non-Core Products:
Loss portfolio transfers............... - 26,830 4,340
Other.................................. 14,513 13,171 28,765
--------- ----------- --------
14,513 40,001 33,105
--------- ----------- --------
Total sales.......................... $ 234,624 $ 241,147 $192,223
========= =========== ========
-2-
The profitability of group employee benefit products is affected by, among other
things, differences between actual and projected claims experience, the
retention of existing customers and the Company's ability to attract new
customers, change premium rates and contract terms and control administrative
expenses. The Company transfers its exposure to some group employee benefit
risks through reinsurance ceded arrangements with other insurance and
reinsurance companies. Under these arrangements, another insurer assumes a
specified portion of the Company's losses and loss adjustment expenses in
exchange for a specified portion of policy premiums. See "Reinsurance."
Therefore, the profitability of group employee benefit products is affected by
the amount, cost and terms of reinsurance obtained by the Company. Profitability
of certain group employee benefit products is also affected by the difference
between the yield achieved on invested assets and the discount rate used to
calculate the related reserves.
The table below shows the loss and expense ratios as a percent of premium income
for the Company's group employee benefit products for the periods indicated.
Year Ended December 31,
---------------------------------
2003 2002 2001
---- ---- ----
Loss ratio ................. 68.2% 69.2% 75.0%(1)
Expense ratio .............. 26.1 25.4 27.0
---- ---- -----
Combined ratio ......... 94.3% 94.6% 102.0%(1)
==== ==== =====
(1) The loss ratio and combined ratio for 2001 excluding the
reserve strengthening discussed in the following paragraph are
65.9% and 92.9%, respectively.
The loss ratio for 2001 reflects a reserve strengthening charge which was
primarily related to an unusually high number of large losses in the Company's
excess workers' compensation business. Prior to 2001, SNCC's historical average
for losses exceeding $2.0 million in its excess workers' compensation products
was one to two per year. In 2001, however, the Company experienced seven such
losses, including two losses as a result of the terrorist attacks on the World
Trade Center. The case reserves for these seven losses totaled $15.3 million,
including $6.3 million attributable to the World Trade Center attacks. Though
the Company believed that the high number of large losses was unlikely to recur,
the Company added $24.0 million to its reserve for incurred but not reported
("IBNR") losses since its method of estimating IBNR reserves is based on past
experience. In the years subsequent to 2001, the number of large losses
experienced by the Company returned to the Company's pre-2001 historical
average. The Company also added $5.0 million to its long-term disability IBNR
reserves in 2001 for potential mental and nervous disabilities related to the
World Trade Center attacks. The reserve strengthening charge reduced 2001 net
income by $28.8 million, or $0.91 per diluted share. The loss and expense ratios
are also affected by, among other things, claims development related to prior
years and the results with respect to the Company's non-core group employee
benefit products. Such ratios can also be affected by changes in the Company's
mix of products, such as the level of premium from loss portfolio transfers
("LPTs"), from year to year. LPTs, which are classified as a non-core product
due to the episodic nature of sales, carry a higher loss ratio and a
significantly lower expense ratio as compared to the Company's other group
employee benefit products.
The Company's group life insurance products provide for the payment of a stated
amount upon the death of a member of the insured group. Policy terms are
generally one year. Accidental death and dismemberment insurance, which provides
for the payment of a stated amount upon the accidental death or dismemberment of
a member of the insured group, is frequently sold in conjunction with group life
policies and is included in premiums charged for group life insurance. The
Company reinsures risks in excess of $150,000 per individual and type of
coverage for employer-provided group life insurance policies and $100,000 per
individual for voluntary group term life policies. See "Reinsurance."
Group disability products offered by the Company, principally long-term
disability insurance, generally provide a specified level of periodic benefits
for a specified period to persons who, because of sickness or injury, are unable
to work. The Company's group long-term disability coverages are spread across
many industries. Long-term disability benefits generally are paid monthly and
typically are limited for any one employee to two-thirds of the employee's
earned income up to a specified maximum benefit. Long-term disability benefits
are usually offset by income the claimant receives from other sources, primarily
Social Security disability benefits. The Company actively manages its disability
claims, working with claimants to help them return to work as quickly as
possible. When claimants' disabilities prevent them from returning to their
original occupations, the Company, in appropriate cases, may provide assistance
in developing new productive skills for an alternative career. Premiums are
generally determined annually for disability insurance and are based upon
expected morbidity and the insured group's emerging experience, as well as
assumptions regarding operating expenses and future interest rates. Effective
October 1, 2003 for new policies and, for existing policies, the earlier of the
next policy anniversary date or October 1, 2004, the Company will reinsure risks
in excess of $7,500 (compared to $2,500 previously) in long-term disability
benefits per individual per month. See "Reinsurance" and
-3-
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity and Capital Resources - Reinsurance."
Excess workers' compensation insurance products provide coverage to employers
and groups who self-insure their workers' compensation risks. The coverage
applies to losses in excess of the applicable self-insured retentions ("SIRs" or
deductibles) of employers and groups, whose workers' compensation claims are
generally handled by third-party administrators ("TPAs"). These products are
principally targeted to mid-sized companies and other groups, particularly small
municipalities, hospitals and schools. These employers and groups are believed
to be less prone to catastrophic workers' compensation exposures and less price
sensitive than larger account business. Because excess workers' compensation
claim payments do not begin until after the self-insured's total loss payments
equal the SIR, the period from when the claim is incurred to the time claim
payments begin averages 15 years. At that point, the payments are primarily for
wage replacement, similar to the benefit provided under long-term disability
coverage, and any medical payments tend to be stable and predictable. This
family of products also includes large deductible workers' compensation
insurance, which provides coverage similar to excess workers' compensation
insurance, and a complementary product, workers' compensation self-insurance
bonds.
The pricing environment and demand for excess workers' compensation insurance
has improved substantially since 2000 due to higher primary workers'
compensation rates and disruption in the excess workers' compensation
marketplace due to difficulties experienced by some competitors, particularly
during 2000. These trends accelerated during the second half of 2001 as sharply
higher primary workers' compensation rates and rising reinsurance costs due to
the terrorist attacks on the World Trade Center increased the demand for
alternatives to primary workers' compensation. As a result, the demand for
excess workers' compensation products and the rates for such products continued
to increase. SNCC was able to obtain significant price increases in connection
with its renewals of insurance coverage during 2002 and 2003, with increases
exceeding 25% and 15%, respectively, on a substantial portion of such renewals.
SNCC has also been obtaining significant improvements in contract terms, in
particular higher SIR levels, in these renewals. On average, SIRs increased 10%
in 2002 and 13% in 2003. SNCC has continued to obtain price increases averaging
16% on its 2004 renewals and SIR levels on average are up 7%. New business
production for excess workers' compensation products increased 70% in 2002 and
46% in 2003 and the retention of existing customers was consistent with SNCC's
goals. During 2003, the Company replaced certain of its existing reinsurance
arrangements for its excess workers' compensation products. Under the
replacement arrangements, the Company reinsures excess workers' compensation
risks between $5.0 million (compared to $3.0 million previously) and $50.0
million, and a majority in proportionate amount of the risks between $50.0
million and $100.0 million, per policy per occurrence. See "Reinsurance" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity and Capital Resources - Reinsurance."
As a result of the terrorist attacks on the World Trade Center, a number of the
Company's reinsurers have excluded coverage for losses resulting from terrorism.
In November 2002, the Terrorism Risk Insurance Act of 2002 (the "Terrorism Act")
was enacted. The Terrorism Act establishes a program under which the federal
government will share with the insurance industry the risk of loss from covered
acts of international terrorism. The program terminates on December 31, 2005,
and the U.S. Secretary of the Treasury (the "Secretary") has the option to
extend it through December 31, 2006. The Terrorism Act applies to all direct
lines of property and casualty insurance written by SNCC, including excess
workers' compensation. The federal government would pay 90% of each covered loss
and the insurer would pay the remaining 10%. Each insurer has a separate
deductible before federal assistance becomes available in the event of an act of
terrorism. The deductible is based on a percentage of the insurer's direct
earned premiums from the previous calendar year. The deductible is 7%, 10% and
15% of direct earned premiums in 2003, 2004 and 2005, respectively. The maximum
after-tax loss to the Company for 2004 within the Terrorism Act deductible from
property and casualty products is approximately 1.4% of the Company's
shareholders' equity as of December 31, 2003. Any payments made by the
government under the Terrorism Act would be subject to recoupment via surcharges
to policyholders when future premiums are billed. The Terrorism Act does not
apply to the lines of insurance written by the Company's life insurance
subsidiaries.
Business travel accident as well as voluntary accidental death and dismemberment
insurance policies pay a stated amount based on a predetermined schedule in the
event of the accidental death or dismemberment of a member of the insured group.
The Company reinsures risks in excess of $150,000 per individual and type of
coverage. Group dental insurance provides coverage for preventive, restorative
and specialized dentistry up to a stated maximum benefit per individual per
year. The Company ceded 50% of its risk under dental policies with effective
dates prior to 2003 under a reinsurance arrangement and cedes 100% of its risk
under dental policies with effective dates in 2003 or later under such
arrangement. See "Reinsurance."
-4-
Non-core group employee benefit products include products that have been
discontinued, such as reinsurance facilities and excess casualty insurance,
newer products which have not demonstrated their financial potential, products
which are not expected to comprise a significant percentage of earned premiums
and products for which sales are episodic in nature, such as LPTs. Pursuant to
an LPT, the Company, in exchange for a specified one-time payment, assumes
responsibility for an existing block of disability or self-insured workers'
compensation claims. These products are typically marketed to the same types of
clients who have historically purchased the Company's disability and excess
workers' compensation products. Non-core group employee benefit products also
include primary workers' compensation for which the Company primarily receives
fee income since a significant portion of the risk is reinsured. Excess casualty
insurance consists of a discontinued excess umbrella liability program. This
program entails exposure to excess of loss liability claims from past years,
including environmental and asbestos-related claims. Net incurred losses and
loss adjustment expenses relating to this program totaled $4.4 million in 2003.
In addition, non-core group employee benefit products include bail bond
insurance and workers' compensation and property catastrophe reinsurance. See
"Reinsurance."
ASSET ACCUMULATION PRODUCTS
The Company's asset accumulation products consist of fixed annuities, primarily
single premium deferred annuities ("SPDAs") and flexible premium annuities
("FPAs"). An SPDA provides for a single payment by an annuity holder to the
Company and the crediting of interest by the Company on the annuity contract at
the applicable crediting rate. An FPA provides for periodic payments by an
annuity holder to the Company, the timing and amount of which are at the
discretion of the annuity holder, and the crediting of interest by the Company
on the annuity contract at the applicable crediting rate. Interest credited on
SPDAs and FPAs is not paid currently to the annuity holder but instead
accumulates and is added to the annuity contract's account value. This
accumulation is tax deferred. The crediting rate may be increased or decreased
by the Company subject to specified guaranteed minimum crediting rates, which
currently range from 3.0% to 5.5%. For most of the Company's annuity products,
the crediting rate may be reset by the Company annually, typically on the policy
anniversary. The Company's annuity products also include multi-year interest
guarantee products, in which the crediting rate is fixed at a stated rate for a
specified period of years, such periods ranging from three to eight years. At
December 31, 2003, the weighted average crediting rate on the Company's annuity
products as a group was 4.86%, which includes the effects of the first year
crediting rate bonus on certain newly issued products. Withdrawals may be made
by the annuity holder at any time, but some withdrawals may result in the
assessment of surrender charges, taxes, and/or tax penalties on the withdrawn
amount. In addition, the accumulated value of the annuity may be increased or
decreased under a market value adjustment ("MVA") provision if it is surrendered
during the surrender charge period. The Company does not market variable annuity
products.
These fixed annuity products are sold predominantly to individuals through
networks of independent agents. In 2003, the Company's SPDA products accounted
for $85.8 million of asset accumulation product deposits, of which $77.0 million
was attributable to the MVA annuity product, and $13.1 million was attributable
to FPA products, of which $11.6 million had an MVA feature. Four networks of
independent agents accounted for approximately 70% of the deposits from these
SPDA and FPA products during 2003, with no other network of independent agents
accounting for more than 10% of these deposits. The Company believes that it has
a good relationship with these networks.
The following table sets forth for the periods indicated selected financial data
concerning the Company's asset accumulation products:
Year Ended December 31,
----------------------------------------
2003 2002 2001
---- ---- ----
(dollars in thousands)
Asset accumulation product deposits (sales) ........... $100,636 $135,046 $ 90,159
Funds under management (at period end) ................ 929,922 878,820 786,214
At December 31, 2003, funds under management consisted of $829.3 million of SPDA
liabilities and $100.6 million of FPA liabilities. Of these liabilities, $621.4
million were subject to surrender charges averaging 6.58% at December 31, 2003.
Annuity liabilities not subject to surrender charges have been in force, on
average, for 20 years.
The Company prices its annuity products based on assumptions concerning
prevailing and expected interest rates and other factors to achieve a positive
spread between its expected return on investments and the crediting rate. The
Company achieves this spread by active portfolio management focusing on matching
invested assets and related liabilities to minimize the exposure to fluctuations
in market interest rates and by the adjustment of the crediting rate on its
annuity
-5-
products. In response to changes in interest rates, the Company increases or
decreases the crediting rates on its annuity products.
In light of the annuity holder's ability to withdraw funds and the volatility of
market interest rates, it is difficult to predict the timing of the Company's
payment obligations under its SPDAs and FPAs. Consequently, the Company
maintains a portfolio of investments which are readily marketable and expected
to be sufficient to satisfy liquidity requirements. See "Investments."
OTHER PRODUCTS AND SERVICES
The Company provides integrated disability and absence management services on a
nationwide basis through Matrix, which was acquired in June 1998. See "Other
Transactions" and Note B to the Consolidated Financial Statements. The Company's
comprehensive disability and absence management services are designed to assist
clients in identifying and minimizing lost productivity and benefit payment
costs resulting from employee absence due to illness, injury or personal leave.
The Company offers services including event reporting, leave of absence
management, claims and case management and return to work management. These
services' goal is to enhance employee productivity and provide more efficient
benefit delivery and enhanced cost containment. The Company provides these
services on an unbundled basis or in a unique Integrated Employee Benefit
program that combines these services with various group employee benefit
insurance coverages. The Company believes that these integrated disability and
absence management services complement the Company's core group employee benefit
products, enhancing the Company's ability to market these core products and
providing the Company with a competitive advantage in the market for these
products.
In 1991, the Company introduced a variable flexible premium universal life
insurance policy under which the related assets are segregated in a separate
account not subject to claims of general creditors of the Company. Policyholders
may elect to deposit amounts in the account from time to time, subject to
underwriting limits and a minimum initial deposit of $1.0 million. Both the cash
values and death benefits of these policies fluctuate according to the
investment experience of the assets in the separate account; accordingly, the
investment risk with respect to these assets is borne by the policyholders. The
Company earns fee income from the separate account in the form of charges for
management and other administrative fees. The Company is not presently actively
marketing this product. The Company reinsures risks in excess of $200,000 per
individual under indemnity reinsurance arrangements with various reinsurance
companies. See "Reinsurance."
UNDERWRITING PROCEDURES
Premiums charged on insurance products are based in part on assumptions about
the incidence, severity and timing of insurance claims. The Company has adopted
and follows detailed underwriting procedures designed to assess and qualify
insurance risks before issuing its policies. To implement these procedures, the
Company employs a professional underwriting staff.
In underwriting group coverage, the Company focuses on the overall risk
characteristics of the group to be insured and the geographic concentration of
its new and renewal business. A prospective group client is evaluated with
particular attention paid to the claims experience of the group with prior
carriers, the occupations of the insureds, the nature of the business of the
client, the current economic outlook of the client in relation to others in its
industry and of the industry as a whole, the appropriateness of the benefits or
SIR applied for and income from other sources during disability. The Company's
products generally afford it the flexibility to adjust premiums charged annually
to its policyholders in order to reflect emerging mortality or morbidity
experience.
INVESTMENTS
The Company's management of its investment portfolio is an important component
of its profitability since a substantial portion of its operating income is
generated from the difference between the yield achieved on invested assets and,
in the case of asset accumulation products, the interest credited on
policyholder funds and, in the case of certain of the Company's other products,
the discount rate used to calculate the related reserves. The Company's overall
investment strategy to achieve its objectives of safety and liquidity, while
seeking the best available return, focuses on, among other things, matching of
the Company's interest-sensitive assets and liabilities and seeking to minimize
the Company's exposure to fluctuations in interest rates.
-6-
For information regarding the composition and diversification of the Company's
investment portfolio and asset/liability management, see "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Liquidity and Capital Resources" and Notes A, C and J to the Consolidated
Financial Statements.
The following table sets forth for the periods indicated the Company's pretax
investment results:
Year Ended December 31,
------------------------------------------------
2003 2002 2001
---------- ---------- ----------
(dollars in thousands)
Average invested assets (1) ........................... $2,948,135 $2,556,076 $2,312,975
Net investment income (2) ............................. 186,366 162,036 157,509
Tax equivalent weighted average annual yield (3) ...... 6.5% 6.6% 7.0%
(1) Average invested assets are computed by dividing the total of invested
assets as reported on the balance sheet at the beginning of each year
plus the individual quarter-end balances by five and deducting one-half
of net investment income.
(2) Consists principally of interest and dividend income less investment
expenses.
(3) The tax equivalent weighted average annual yield on the Company's
investment portfolio for each period is computed by dividing net
investment income, increased to reflect tax exempt interest income and
similar tax savings, by average invested assets for the period. See
"Management's Discussion and Analysis of Financial Condition and
Results of Operations - Results of Operations."
REINSURANCE
The Company participates in various reinsurance arrangements both as the ceding
insurer and as the assuming insurer. Arrangements in which the Company is the
ceding insurer afford various levels of protection against excessive loss by
assisting the Company in diversifying its risks and by limiting its maximum loss
on risks that exceed retention limits. Under indemnity reinsurance transactions
in which the Company is the ceding insurer, the Company remains liable for
policy claims if the assuming company fails to meet its obligations. To limit
this risk, the Company monitors the financial position of its reinsurers,
including, among other things, the companies' financial ratings, and in certain
cases receives collateral security from the reinsurer. Also, certain of the
Company's reinsurance agreements require the reinsurer to set up security
arrangements for the Company's benefit in the event of certain ratings
downgrades. In addition, the U.S. federal government presently provides certain
protections for insurers who issue certain property and casualty insurance
coverages. See "Business - Group Employee Benefit Products."
The Company cedes portions of the risks relating to its group employee benefit
and variable life insurance products under indemnity reinsurance agreements with
various unaffiliated reinsurers. The terms of these agreements, which are
typical for agreements of this type, provide, among other things, for the
automatic acceptance by the reinsurer of ceded risks in excess of the Company's
retention limits stated in the agreements. The Company pays reinsurance premiums
to these reinsurers which are, in general, based upon percentages of premiums
received by the Company on the business reinsured less, in certain cases, ceding
commissions and experience refunds paid by the reinsurer to the Company. These
agreements are generally terminable as to new risks by either the Company or the
reinsurer on appropriate notice; however, termination does not affect risks
ceded during the term of the agreement, which generally remain with the
reinsurer. See "Business - Group Employee Benefit Products" and Note Q to the
Consolidated Financial Statements.
In January 1998, an offering was completed whereby shareholders and
optionholders of the Company received, at no cost, rights to purchase shares of
Delphi International Ltd. ("Delphi International"), a newly-formed, independent
Bermuda insurance holding company. During 1998, the Company entered into various
reinsurance agreements with Oracle Reinsurance Company Ltd. ("Oracle Re"), a
wholly owned subsidiary of Delphi International. Pursuant to these agreements,
approximately $101.5 million of group employee benefit reserves ($35.0 million
of long-term disability insurance reserves and $66.5 million of net excess
workers' compensation and casualty insurance reserves) were ceded to Oracle Re.
The Company received collateral security from Oracle Re in an amount sufficient
to support the ceded reserves. During 2000 and 1999, Oracle Re and the Company
effected the partial recaptures of approximately $4.6 million and $10.0 million,
respectively, of the group long-term disability liabilities ceded to Oracle Re.
In October 2001, Oracle Re and the Company effected the commutation of their
reinsurance agreements, pursuant to which Oracle Re paid approximately $84.0
million to the Company (net of $11.5 million which had been held by the Company)
related to the reserves ceded to Oracle Re under such agreements. These
transactions did not have a material impact on the Company's consolidated
financial position, liquidity or net income. In furtherance of the commutation
of the reinsurance agreements, the Company agreed to waive a portion of the
amounts due to the Company under certain subordinated notes issued by
-7-
Delphi International. As a result of this waiver, the Company recognized a
pre-tax loss of $7.5 million in 2001 for the other than temporary decline in the
value of these notes. In March 2002, Delphi International repaid the adjusted
amounts due under the subordinated notes and the Company did not realize any
significant additional loss in connection with such repayment.
The Company assumes certain workers' compensation and property risks through
reinsurance. In these arrangements, the Company provides coverage for losses in
excess of specified amounts, subject to specified maximums. Coverage for losses
as a result of terrorism is generally excluded from these reinsurance treaties.
The attachment points for workers' compensation reinsurance range from $1
million to $50 million. Aggregate exposures assumed under individual workers'
compensation treaties generally range from $1 million to $3 million, with the
highest net exposure pursuant to any such treaty equal to $5 million. The
Company underwrites workers' compensation reinsurance assumed pursuant to
procedures similar to those utilized in connection with its excess workers'
compensation product. The majority of the Company's property reinsurance
provides coverage in the event of a catastrophe, generally excluding losses
resulting from terrorism. The Company underwrites its property reinsurance to
mitigate its risk by diversifying geographically and limiting its exposure on
any one treaty. On property reinsurance, the Company's risk attachment points
range from $1 million to $20 billion, with an average attachment point of $2.75
billion. The Company's aggregate exposure under a single property treaty
generally ranges from $1 million to $2 million. The highest net exposure under a
single property treaty is $2 million. The probable maximum loss on property
reinsurance is estimated to be approximately $6.6 million, net of reinstatement
premium and taxes, or less than 1% of the Company's shareholders' equity.
The Company had in the past participated as an assuming insurer in a number of
reinsurance facilities. These reinsurance facilities generally are administered
by TPAs or managing underwriters who underwrite risks, coordinate premiums
charged and process claims. During 1999 and 2000, the Company terminated, on a
prospective basis, its participations in all of the reinsurance facilities in
which the Company had participated. However, the terms of such facilities
provide for the continued assumption of risks by, and payments of premiums to,
facility participants with respect to business written in the periods during
which they formerly participated in such facilities. The Company is currently a
party to certain arbitration proceedings arising out of two such facilities. See
"Legal Proceedings." Premium income from all reinsurance facilities was $0.3
million, $0.8 million and $7.9 million in 2003, 2002 and 2001, respectively, and
incurred losses from these facilities were $5.1 million, $4.7 million and $10.6
million in 2003, 2002 and 2001, respectively. The reinsurance facilities did not
constitute a significant part of the Company's operations; accordingly, the
Company's withdrawals from these facilities has not had a material impact on its
consolidated financial position, liquidity or results of operations.
LIFE, ANNUITY, DISABILITY AND ACCIDENT RESERVES
The Company carries as liabilities actuarially determined reserves for its life,
annuity, disability and accident policy and contract obligations. These
reserves, together with premiums to be received on policies in force and
interest thereon at certain assumed rates, are calculated and established at
levels believed to be sufficient to satisfy policy and contract obligations. The
Company performs periodic studies to compare current experience for mortality,
morbidity, interest and lapse rates with the experience reflected in the reserve
assumptions to determine future policy benefit reserves for these products.
Reserves for future policy benefits and unpaid claims and claim expenses are
estimated based on individual loss data, historical loss data and industry
averages and indices and include amounts determined on the basis of individual
and actuarially determined estimates of future losses. Therefore, the ultimate
liability could deviate from the amounts currently reflected in the Consolidated
Financial Statements. Differences between actual and expected claims experience
are reflected currently in earnings for each period. The Company has not
experienced significant adverse deviations from its assumptions. In the fourth
quarter of 2001, the Company added $5.0 million to its long-term disability IBNR
reserves for potential mental and nervous disability claims related to the World
Trade Center attacks.
The life, annuity, disability and accident reserves carried in the Consolidated
Financial Statements are calculated based on accounting principles generally
accepted in the United States ("GAAP") and differ from those reported by the
Company for statutory financial statement purposes. These differences arise from
the use of different mortality and morbidity tables and interest assumptions,
the introduction of lapse assumptions into the reserve calculation and the use
of the net level method on all insurance business. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations - Critical
Accounting Policies" and Note A to the Consolidated Financial Statements for
certain additional information regarding reserve assumptions under GAAP.
-8-
EXCESS WORKERS' COMPENSATION INSURANCE RESERVES
The Company carries as liabilities actuarially determined reserves for
anticipated claims and claim expenses for its excess workers' compensation
insurance and other casualty insurance products. Reserves for claim expenses
represent the estimated probable costs of investigating those claims and, when
necessary, defending lawsuits in connection with those claims. Reserves for
claims and claim expenses are estimated based on individual loss data,
historical loss data and industry averages and indices and include amounts
determined on the basis of individual and actuarially determined estimates of
future losses. Therefore, the ultimate liability could deviate from the amounts
currently reflected in the Consolidated Financial Statements.
Reserving practices under GAAP allow discounting of claim reserves related to
excess workers' compensation losses to reflect the time value of money. Reserve
discounting for these types of claims is common industry practice, and the
discount factors used are less than the annual tax-equivalent investment yield
earned by the Company on its invested assets. The discount factors are based on
the expected duration and payment pattern of the claims at the time the claims
are settled and the risk-free rate of return for U.S. government securities with
a comparable duration. Reserves for claim expenses are not discounted.
The following table provides a reconciliation of beginning and ending unpaid
claims and claim expenses for the periods indicated:
Year Ended December 31,
-------------------------------------------
2003 2002 2001
--------- --------- ---------
(dollars in thousands)
Unpaid claims and claim expenses, net of reinsurance,
beginning of period ....................................................... $ 439,147 $ 413,950 $ 302,514
Add provision for claims and claim expenses incurred, net
of reinsurance,occurring during:
Current year (1) ......................................................... 82,372 82,197 73,782
Prior years (2) .......................................................... 20,541 15,869 13,896
--------- --------- ---------
Incurred claims and claim expenses, net of reinsurance,
during the current year ......................................... 102,913 98,066 87,678
--------- --------- ---------
Deduct claims and claim expenses paid, net of reinsurance, occurring during:
Current year ............................................................. 5,165 10,915 6,014
Prior years (3) .......................................................... 57,235 61,954 (29,772)
--------- --------- ---------
Total paid ............................................................ 62,400 72,869 (23,758)
--------- --------- ---------
Unpaid claims and claim expenses, net of reinsurance, end of period ............ 479,660 439,147 413,950
Reinsurance receivables, end of period ......................................... 93,030 95,709 92,828
--------- --------- ---------
Unpaid claims and claim expenses, gross of reinsurance,
end of period ......................................................... $ 572,690 $ 534,856 $ 506,778
========= ========= =========
(1) The provision for claims and claim expenses incurred in 2001 includes a
reserve strengthening charge of $39.3 million primarily related to an
unusually high number of large losses in the Company's excess workers'
compensation business. Prior to 2001, SNCC's historical average for
losses exceeding $2.0 million in its excess workers' compensation
products was one to two per year. In 2001, however, the Company
experienced seven such losses, including two losses as a result of the
terrorist attacks on the World Trade Center. The case reserves for these
seven losses totaled $15.3 million, including $6.3 million attributable
to the World Trade Center attacks. Though the Company believed that the
high number of large losses was unlikely to recur, the Company added
$24.0 million to its reserve for IBNR losses since its method of
estimating IBNR reserves is based on past experience. In the years
subsequent to 2001, the number of large losses experienced by the
Company returned to the Company's pre-2001 historical average.
(2) In 2003 and 2002, the claims and claim expenses incurred related to
prior years reflect accretion of discounted reserves offset by favorable
claims development. In 2001, the claims and claim expenses incurred
related to prior years reflect the accretion of discounted reserves and
unfavorable claims development.
(3) In 2001, the payments of claims and claim expenses occurring in prior
years reflect the Company's receipt of $74.3 million related to the
commutation of the reinsurance agreements with Oracle Re. See "Business
- Reinsurance."
-9-
The effects of the discount to reflect the time value of money have been removed
from the amounts set forth in the loss development table which follows in order
to present the gross loss development, net of reinsurance. During 2003, 2002 and
2001, $21.5 million, $17.2 million and $9.5 million, respectively, of discount
was amortized, and $44.9 million, $34.6 million and $32.1 million, respectively,
was accrued. The loss development table below illustrates the development of
reserves from March 5, 1996 to December 31, 2003 and is net of reinsurance.
December 31,
March 5, -------------------------------------------------------------------------------------------
1996(1) 1996 1997 1998 1999 2000 2001 2002 2003
------ ---- ---- ---- ---- ---- ---- ---- ----
(dollars in thousands)
Reserve for unpaid
claims and claim
expenses, net of
reinsurance .......... $ 520,370 $ 532,923 $ 541,280 $ 422,159 $ 434,513 $ 444,061 $ 638,191 $ 680,835 $ 744,760
Cumulative amount of
liability paid:
One year later ...... 23,467 28,162 98,365 40,815 40,660 (29,990)(2) 61,954 57,235
Two years later ..... 50,713 125,020 127,481 74,571 4,020 (2) 26,398 112,639
Three years later ... 140,943 152,842 156,119 33,429(2) 54,846 71,938
Four years later .... 167,811 179,705 111,253(2) 78,981
Five years later .... 193,363 133,228(2) 150,772 114,295
Six years later ..... 153,504(2) 170,405 182,281
Seven years later ... 188,719 197,318
Eight years later ... 214,715
Liability
reestimated as of:
One year later ...... 507,375 513,402 523,430 410,875 424,187 442,624 636,125 678,535
Two years later ..... 487,830 500,964 511,602 404,559 420,420 442,807 634,578
Three years later ... 476,854 488,432 503,906 401,475 417,869 446,948
Four years later .... 476,600 487,195 500,514 396,403 423,426
Five years later .... 476,890 478,206 492,280 399,311
Six years later ..... 470,283 468,142 493,586
Seven years later ... 460,670 472,492
Eight years later ... 463,015
Cumulative redundancy
(deficiency) ......... $ 57,355 $ 60,431 $ 47,694 $ 22,848 $ 11,087 $ (2,887) $ 3,613 $ 2,300
(1) Amounts are as of or for the periods subsequent to March 5, 1996, the
date the Company acquired its workers' compensation business.
(2) The cumulative amount of liability paid through December 31, 2001
reflects the Company's receipt of $74.3 million related to the
commutation of the reinsurance agreements with Oracle Re in 2001.
The "Reserve for unpaid claims and claim expenses, net of reinsurance" line in
the table above shows the estimated reserve for unpaid claims and claim expenses
recorded at the end of each of the periods indicated. These net liabilities
represent the estimated amount of losses and expenses for claims arising in the
current year and all prior years that are unpaid at the end of each period. The
"Cumulative amount of liability paid" lines of the table represent the
cumulative amounts paid with respect to the liability previously recorded as of
the end of each succeeding period. The "Liability reestimated" lines of the
table show the reestimated amount relating to the previously recorded liability
and is based upon experience as of the end of each succeeding period. This
estimate is either increased or decreased as additional information about the
frequency and severity of claims for each period becomes available and is
reviewed. The Company periodically reviews the estimated reserves for claims and
claim expenses and any changes are reflected currently in earnings for each
period. The Company has not experienced significant adverse deviations from its
assumptions, except for the unusually high number of large losses in the
Company's excess workers' compensation business in 2001. The "Cumulative
redundancy (deficiency)" line in the table represents the aggregate change in
the net estimated claim reserve liabilities from the dates indicated through
December 31, 2003.
-10-
The table below illustrates the effects of the discount to reflect the time
value of money that was removed from the amounts set forth in the loss
development table above.
December 31,
March 5, ----------------------------------------------
1996(1) 1996 1997 1998 1999
--------- --------- --------- --------- ---------
(dollars in thousands)
Reserve for unpaid claims
and claim expenses
before discount:
Gross of reinsurance ..... $ 533,871 $ 549,653 $ 564,734 586,984 $ 613,693
Deduct reinsurance
recoverable ............ 13,501 16,730 23,454 164,825 179,180
--------- --------- --------- --------- ---------
Net of reinsurance ....... 520,370 532,923 541,280 422,159 434,513
Deduct discount for time
value of money ............. 164,000 168,827 176,683 113,507 127,357
--------- --------- --------- --------- ---------
Unpaid claims and claim
expenses as reported
on balance sheets, net
of discount and net of
reinsurance ................ 356,370 364,096 364,597 308,652 307,156
--------- --------- --------- --------- ---------
Reestimated unpaid claims
and claim expenses,
net of discount, as
of December
31, 2003:
Gross of reinsurance ..... 430,211 429,803 442,112 463,270 498,572
Deduct reinsurance
recoverable .......... 41,054 42,355 48,416 118,553 145,487
--------- --------- --------- --------- ---------
Net of reinsurance ....... 389,157 387,448 393,696 344,717 353,085
--------- --------- --------- --------- ---------
Discounted cumulative
(deficiency) ............... (32,787) (23,352) (29,099) (36,065) (45,929)
Add accretion of discount ..... 90,142 83,783 76,793 58,913 57,016
--------- --------- --------- --------- ---------
Cumulative redundancy
(deficiency) before
discount ................... $ 57,355 $ 60,431 $ 47,694 $ 22,848 $ 11,087
========= ========= ========= ========= =========
December 31,
---------------------------------------------
2000 2001 2002 2003
--------- --------- --------- -------
(dollars in thousands)
Reserve for unpaid claims
and claim expenses
before discount:
Gross of reinsurance ..... $ 650,765 $ 731,019 $ 776,544 $ 837,790
Deduct reinsurance
recoverable ............ 206,704 92,828 95,709 93,030
--------- -------- -------- ---------
Net of reinsurance ....... 444,061 638,191 680,835 744,760
Deduct discount for time
value of money ............. 141,547 224,241 241,688 265,100
--------- --------- --------- ---------
Unpaid claims and claim
expenses as reported
on balance sheets, net
of discount and net of
reinsurance ................ 302,514 413,950 439,147 $ 479,660
--------- --------- --------- =========
Reestimated unpaid claims
and claim expenses,
net of discount, as
of December
31, 2003:
Gross of reinsurance ..... 534,903 574,962 571,861
Deduct reinsurance
recoverable .......... 178,003 125,038 112,173
--------- --------- ---------
Net of reinsurance ....... 356,900 449,924 459,688
--------- --------- ---------
Discounted cumulative
(deficiency) ............... (54,386) (35,974) (20,541)
Add accretion of discount ..... 51,499 39,587 22,841
--------- --------- ---------
Cumulative redundancy
(deficiency) before
discount ...................... $ (2,887) $ 3,613 $ 2,300
========= ========= =========
(1) Amounts are as of or for the periods subsequent to March 5, 1996, the
date the Company acquired its workers' compensation business.
The excess workers' compensation insurance reserves carried in the Consolidated
Financial Statements are calculated in accordance with GAAP and, net of
reinsurance, are approximately $111.6 million less than those reported by the
Company for statutory financial statement purposes at December 31, 2003. This
difference is primarily due to the use of different discount factors as between
GAAP and statutory accounting principles and differences in the bases against
which such discount factors are applied. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Critical Accounting
Policies" and Note A to the Consolidated Financial Statements for certain
additional information regarding reserve assumptions under GAAP.
COMPETITION
The financial services industry is highly competitive. The Company competes with
numerous other insurance and financial services companies both in connection
with sales of insurance and asset accumulation products and integrated
disability and absence management services and in acquiring blocks of business
and companies. Many of these organizations have substantially greater asset
bases, higher ratings from ratings agencies, larger and more diversified
portfolios of insurance products and larger sales operations. Competition in
asset accumulation product markets is also encountered from the expanding number
of banks, securities brokerage firms and other financial intermediaries
marketing alternative savings products, such as mutual funds, traditional bank
investments and retirement funding alternatives.
The Company believes that its reputation in the marketplace, quality of service,
unique programs which integrate employee benefit products and absence management
services and investment returns have enabled it to compete effectively for new
business in its targeted markets. The Company reacts to changes in the
marketplace generally by
-11-
focusing on products with adequate margins and attempting to avoid those with
low margins. The Company believes that its smaller size, relative to some of its
competitors, enables it to more easily tailor its products to the demands of
customers.
REGULATION
The Company's insurance subsidiaries are regulated by state insurance
authorities in the states in which they are domiciled and the states in which
they conduct business. These regulations, among other things, limit the amount
of dividends and other payments that can be made by the Company's insurance
subsidiaries without prior regulatory approval and impose restrictions on the
amount and type of investments these subsidiaries may have. These regulations
also affect many other aspects of the Company's insurance subsidiaries'
business, including, for example, risk-based capital ("RBC") requirements,
various reserve requirements, the terms, conditions and manner of sale and
marketing of insurance products and the form and content of required financial
statements. These regulations are intended to protect policyholders rather than
investors. The Company's insurance subsidiaries are required under these
regulations to file detailed annual financial reports with the supervisory
agencies in the various states in which they do business, and their business and
accounts are subject to examination at any time by these agencies. To date, no
examinations have produced any significant adverse findings or adjustments. The
ability of the Company's insurance subsidiaries to continue to conduct their
businesses is dependent upon the maintenance of their licenses in these various
states.
From time to time, increased scrutiny has been placed upon the insurance
regulatory framework, and a number of state legislatures have considered or
enacted legislative measures that alter, and in many cases increase, state
authority to regulate insurance companies. In addition to legislative
initiatives of this type, the National Association of Insurance Commissioners
(the "NAIC") and insurance regulators are continuously involved in a process of
reexamining existing laws and regulations and their application to insurance
companies. Furthermore, while the federal government currently does not directly
regulate the insurance business, federal legislation and administrative policies
in a number of areas, such as employee benefits regulation, age, sex and
disability-based discrimination, financial services regulation and federal
taxation, can significantly affect the insurance business. It is not possible to
predict the future impact of changing regulation on the operations of the
Company and its insurance subsidiaries.
The NAIC's RBC requirements for insurance companies take into account asset
risks, insurance risks, interest rate risks and other relevant risks with
respect to the insurer's business and specify varying degrees of regulatory
action to occur to the extent that an insurer does not meet the specified RBC
thresholds, with increasing degrees of regulatory scrutiny or intervention
provided for companies in categories of lesser RBC compliance. The Company
believes that its insurance subsidiaries are adequately capitalized under the
RBC requirements and that the thresholds will not have any significant
regulatory effect on the Company. However, were the insurance subsidiaries' RBC
position to materially decline in the future, the insurance subsidiaries'
continued ability to pay dividends and the degree of regulatory supervision or
control to which they are subjected may be affected.
The Company's insurance subsidiaries can also be required, under solvency or
guaranty laws of most states in which they do business, to pay assessments to
fund policyholder losses or liabilities of insurance companies that become
insolvent. These assessments may be deferred or forgiven under most solvency or
guaranty laws if they would threaten an insurer's financial strength and, in
most instances, may be offset against future state premium taxes. SNCC
recognized expenses of $1.6 million, $1.3 million and $1.2 million in 2003, 2002
and 2001, respectively, for these types of assessments. None of the Company's
life insurance subsidiaries has ever incurred any significant costs of this
nature.
EMPLOYEES
The Company and its subsidiaries employed approximately 1,045 persons at
December 31, 2003. The Company believes that it enjoys good relations with its
employees.
OTHER SUBSIDIARIES
The Company conducts certain of its investment management activities through its
wholly-owned subsidiary, Delphi Capital Management, Inc. ("DCM"), and makes
certain investments through other wholly-owned non-insurance subsidiaries.
-12-
OTHER TRANSACTIONS
On June 30, 1998, the Company acquired Matrix, a provider of integrated
disability and absence management services to the employee benefits market. The
purchase price of $33.8 million consisted of 614,136 shares of the Company's
Class A Common Stock, $7.9 million of cash and $5.7 million of 8% subordinated
notes which matured in June 2003 (the "Subordinated Notes"). Under the terms of
the purchase agreement, additional consideration of up to $5.2 million in cash
was payable if Matrix's earnings met specified targets over the four-year period
subsequent to the acquisition. Because Matrix met all of the specified targets,
the Company paid the $5.2 million of contingent consideration in two equal
installments of $2.6 million during 2000 and 2001. See Note B to the
Consolidated Financial Statements.
In April 1999, the Company completed the disposition of its Unicover Managers,
Inc. subsidiary and a related company (collectively, "Unicover"), which were
acquired in the fourth quarter of 1998, to certain of the former owners of
Unicover. In January 2000, the Company received from Unicover's pool and
facility members and the retrocessionaires of Unicover's facilities legal
releases relating to, among other things, the Company's former ownership of
Unicover. The releases were obtained in connection with a global
Unicover-related settlement involving Reliance Insurance Company, its
retrocessionaires and a group of ceding companies and brokers. The Company
contributed to this settlement by agreeing to rescind a quota share reinsurance
contract with Reliance Insurance Company.
In the fourth quarter of 2000, the Company liquidated a substantial majority of
the investments of its investment subsidiaries. The proceeds from these sales
were used in 2001 to repay $150.0 million of outstanding borrowings under its
revolving credit facilities, to repurchase $64.0 million liquidation amount of
the Capital Securities of its subsidiary, Delphi Funding L.L.C. (the "Capital
Securities"), and to repurchase $8.0 million principal amount of its 8% Senior
Notes which matured in October 2003 (the "Matured Senior Notes").
In May 2003, the Company issued $143.8 million of 8.00% Senior Notes due 2033
(the "2033 Senior Notes") in a public offering. The proceeds from the 2033
Senior Notes were used to repay the outstanding borrowings under the Company's
revolving credit facility and to repay in full the principal amount of $66.5
million of the Matured Senior Notes. The 2033 Senior Notes, which were issued at
par value, will mature on May 15, 2033 and are redeemable at par at the option
of the Company, in whole or in part, at any time on or after May 15, 2008. The
2033 Senior Notes are not redeemable at the option of any holder of the notes
prior to maturity nor are they entitled to any sinking fund redemptions.
Interest on the 2033 Senior Notes is payable quarterly on February 15, May 15,
August 15 and November 15 of each year. The 2033 Senior Notes are senior
unsecured obligations of the Company and, as such, are effectively subordinated
to all claims of secured creditors of the Company and its subsidiaries and to
claims of unsecured creditors of the Company's subsidiaries, including the
insurance subsidiaries' obligations to policyholders. As a result of the
issuance of the 2033 Senior Notes, under the terms of the Company's revolving
credit facility, the maximum amount of borrowings available to the Company
thereunder was reduced from $150 million to $100 million and the facility was
converted to an unsecured facility, with collateral being released to the
Company. The 2033 Senior Notes were issued in denominations of $25 and multiples
of $25 and are listed on the New York Stock Exchange. See Note E to the
Consolidated Financial Statements.
In May 2003, Delphi Financial Statutory Trust I (the "Trust"), a
recently-created Connecticut statutory trust and wholly owned subsidiary of the
Company, issued $20.0 million liquidation amount of Floating Rate Capital
Securities (the "2003 Capital Securities") in a private placement. In connection
with the issuance of the 2003 Capital Securities and the related purchase by the
Company of all of the common securities of the Trust (the "2003 Common
Securities" and, collectively with the 2003 Capital Securities, the "Trust
Securities"), the Company issued $20.6 million principal amount of floating rate
junior subordinated deferrable interest debentures, due 2033 (the "2003 Junior
Debentures"). Interest on the 2003 Junior Debentures is payable quarterly on
February 15, May 15, August 15 and November 15 of each year. The interest rate
on the 2003 Junior Debentures resets quarterly to a rate equal to the London
interbank offered interest rate for three-month U.S. dollar deposits, plus 4.10%
(not to exceed 12.50%). The interest rate was 5.41% for the period from May 15,
2003 through August 15, 2003, 5.23% for the period from August 16, 2003 through
November 15, 2003, and 5.28% for the period from November 16, 2003 through
February 15, 2004. The distribution and other payment dates on the Trust
Securities correspond to the interest and other payment dates on the 2003 Junior
Debentures. The 2003 Junior Debentures are unsecured and subordinated in right
of payment to all of the Company's existing and future senior indebtedness.
Beginning in May 2008, the Company will have the right to redeem the 2003 Junior
Debentures, in whole or in part, at a price equal to 100% of the principal
amount of the debentures, plus accrued and unpaid interest to the date of
redemption.
On November 21, 2003, the Company's Board of Directors declared a 3-for-2 common
stock split effected in the form of a 50% stock dividend, which was distributed
on December 22, 2003 to stockholders of record on December 8, 2003. A total of
11,211,435 shares of common stock were issued in connection with the split, and
the aggregate amount of $0.1
-13-
million, equal to the par value of the common stock issued, was reclassified
from additional paid-in capital to common stock. The stated par value of each
share remained at $0.01. Results per share and applicable share amounts for
prior periods have been restated to reflect the stock split.
ITEM 2. PROPERTIES
The Company leases its principal executive office at 1105 North Market Street,
Suite 1230, Wilmington, Delaware under an operating lease expiring in October
2009. RSLIC leases its administrative office at 2001 Market Street, Suite 1500,
Philadelphia, Pennsylvania, under an operating lease expiring in June 2009. SNCC
owns its home office building at 2043 Woodland Parkway, Suite 200, St. Louis,
Missouri, which consists of approximately 58,000 square feet. SNCC also owns a
neighboring office building located at 2029 Woodland Parkway, St. Louis,
Missouri. The building consists of approximately 17,000 square feet and is
intended for lease to third parties. DCM and FRSLIC lease their offices at 153
East 53rd Street, 49th Floor, New York, New York under an operating lease
expiring in July 2008. Matrix leases its principal office at 5225 Hellyer
Avenue, Suite 210, San Jose, California under an operating lease expiring in
December 2006. The Company also maintains sales and administrative offices
throughout the country to provide nationwide sales support and service existing
business.
ITEM 3. LEGAL PROCEEDINGS
In the course of its business, the Company is a party to litigation and other
proceedings, primarily involving its insurance operations. In some cases, these
proceedings entail claims against the Company for punitive damages and similar
types of relief. The ultimate disposition of such pending litigation and
proceedings is not expected to have a material adverse effect on the Company's
consolidated financial position. In addition, incident to its discontinued
products, the Company is currently a party to two separate arbitrations arising
out of two accident and health reinsurance arrangements in which it and other
companies formerly were participating reinsurers. At issue in both arbitrations,
among other things, is whether certain reinsurance risks were validly ceded to
the Company. The hearings in these arbitrations are scheduled to be held in the
current year. While management believes that in both cases the Company has
substantial legal grounds for avoiding the reinsurance risks at issue, it is not
at this time possible to predict the ultimate outcome of these arbitrations, nor
is it feasible to provide reasonable ranges of potential losses. In the opinion
of management, such arbitrations, when ultimately resolved, will not
individually or collectively have a material adverse effect on the Company's
consolidated financial position.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 4A. EXECUTIVE OFFICERS OF THE COMPANY
The table below presents certain information concerning each of the executive
officers of the Company:
Name Age Position
- ----------------------------------------------------------------------------------------------
Robert Rosenkranz 61 Director of the Company; Chairman of the Board,
President and Chief Executive Officer of
the Company; Chairman of the Board of RSLIC
Robert M. Smith, Jr. 52 Director and Executive Vice President of the Company
Chad W. Coulter 41 Vice President, Secretary and General Counsel of
the Company; Vice President, General Counsel and
Assistant Secretary of RSLIC
Thomas W. Burghart 45 Vice President and Treasurer of the Company and RSLIC
Lawrence E. Daurelle 52 Director of the Company and President and Chief Executive
Officer of RSLIC
Harold F. Ilg 56 Director of the Company and Chairman of the Board of SNCC
-14-
Mr. Rosenkranz has served as the President and Chief Executive Officer of the
Company since May 1987 and has served as Chairman of the Board of Directors of
the Company since April 1989. He also serves as Chairman of the Board or as a
Director of the Company's principal subsidiaries. Mr. Rosenkranz, by means of
beneficial ownership of the corporate general partner of Rosenkranz & Company
and direct or beneficial ownership, has the power to vote all of the outstanding
shares of Class B Common Stock, which represent 49.9% of the voting power of the
Company's common stock as of March 1, 2004.
Mr. Smith has served as Executive Vice President of the Company and DCM since
November 1999 and as a Director of the Company since January 1995. He has also
served as the Chief Investment Officer of RSLIC and FRSLIC since April 2001.
From July 1994 to November 1999, he served as Vice President of the Company and
DCM. Mr. Smith also serves as a Director of the Company's principal
subsidiaries.
Mr. Coulter has served as Vice President and General Counsel of the Company and
as Vice President, General Counsel and Assistant Secretary of RSLIC, FRSLIC and
RSLIC-Texas since January 1998, and has served as Secretary of the Company since
May 2003. He also served for RSLIC in similar capacities from February 1994 to
August 1997, and in various capacities from January 1991 to February 1994. From
August 1997 to December 1997, Mr. Coulter was Vice President and General Counsel
of National Life of Vermont.
Mr. Burghart has served as Vice President and Treasurer of the Company since
April 2001 and as Vice President and Treasurer of RSLIC, FRSLIC and RSLIC-Texas
since October 2000. From March 1992 to September 2000, he served as the Second
Vice President, Actuarial Statements, of RSLIC.
Mr. Daurelle has served as a Director of the Company since August 2002. He also
has served as President and Chief Executive Officer of RSLIC, FRSLIC and
RSLIC-Texas since October 2000. He served as Vice President and Treasurer of the
Company from August 1998 to April 2001. He also serves on the Board of Directors
of RSLIC, FRSLIC and RSLIC-Texas. From May 1995 to October 2000, Mr. Daurelle
was Vice President and Treasurer of RSLIC, FRSLIC and RSLIC-Texas.
Mr. Ilg has served as a Director of the Company since August 2002. He also has
served as Chairman of the Board of SNCC since January 1999. He serves on the
Board of Directors of RSLIC and FRSLIC. From April 1999 until October 2000, he
served as President and Chief Executive Officer of RSLIC, FRSLIC, and
RSLIC-Texas. Prior to January 1999, he served as Vice Chairman of the Board of
SNCC, where he has been employed in various capacities since 1978.
-15-
PART II
ITEM 5. MARKET FOR THE COMPANY'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS
The closing price of the Company's Class A Common Stock was $39.25 on March 1,
2004. There were approximately 3,000 holders of record of the Company's Class A
Common Stock as of March 1, 2004.
The Company's Class A Common Stock is listed on the New York Stock Exchange
under the symbol DFG. The following table sets forth the high and low sales
prices for the Company's Class A Common Stock and the cash dividends paid per
share for the Company's Class A and Class B Common Stock. Prior periods have
been restated to reflect the 3-for-2 common stock split distributed in the form
of a stock dividend on December 22, 2003.
High Low Dividends
-------- -------- ------------
2002: First Quarter $ 26.45 $ 21.87 $ 0.05
Second Quarter 30.08 25.67 0.05
Third Quarter 29.00 22.57 0.05
Fourth Quarter 27.42 21.94 0.05
2003: First Quarter $ 26.46 $ 21.73 $ 0.05
Second Quarter 31.77 25.67 0.05
Third Quarter 33.63 30.33 0.05
Fourth Quarter 36.88 31.08 0.08
In 2001, the Company's Board of Directors approved the initiation of a quarterly
cash dividend payable on the Company's Class A Common Stock and Class B Common
Stock. The quarterly cash dividend was $0.05 per share during 2002 and the first
three quarters of 2003. In the fourth quarter of 2003, the Company's Board of
Directors increased the cash dividend by 50% to $0.08 per share. In the first
quarter of 2004, the Company's Board of Directors declared a cash dividend of
$0.08 per share, which was paid on the Company's Class A Common Stock and Class
B Common Stock on March 10, 2004. The Company intends to continue to pay a
quarterly dividend at this level. However, the declaration and payment of such
dividends, including the amount and frequency of such dividends, is at the
discretion of the Board and depends upon many factors, including the Company's
consolidated financial position, liquidity requirements, operating results and
such other factors as the Board may deem relevant. Cash dividend payments are
permitted under the respective terms of the Company's $100.0 million revolving
credit facility subject to certain restrictions and covenants and the 2033
Senior Notes. See Note L to the Consolidated Financial Statements.
In addition, dividend payments by the Company's insurance subsidiaries to the
Company are subject to certain regulatory restrictions. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Liquidity and Capital Resources" and "Business - Regulation."
-16-
ITEM 6. SELECTED FINANCIAL DATA
The selected financial data below should be read in conjunction with
Management's Discussion and Analysis of Financial Condition and Results of
Operations and the Consolidated Financial Statements and related notes.
Year Ended December 31,
----------------------------------------------------------------
2003 2002 2001 2000 1999
--------- --------- --------- --------- ---------
INCOME STATEMENT DATA: (dollars and shares in thousands, except per share data)
Insurance premiums and fee income:
Core group employee benefit products ..................... $ 673,653 $ 559,174 $ 452,158 $ 400,405 $ 357,541
Non-core group employee benefit products(1) .............. 22,383 49,325 35,836 47,285 110,381
Asset accumulation products .............................. 4,158 2,645 3,088 2,551 2,126
Other .................................................... 18,893 16,713 16,122 16,116 15,220
--------- --------- --------- --------- ---------
719,087 627,857 507,204 466,357 485,268
Net investment income(2) ................................... 186,366 162,036 157,509 184,576 180,945
Net realized investment gains (losses)(3) .................. 12,724 (28,469) (70,289) (138,047) (25,720)
(Loss) gain on extinguishment of debt and
capital securities(2) .................................... - (332) 11,456 - -
--------- --------- --------- --------- ---------
Total revenue ............................................ 918,177 761,092 605,880 512,886 640,493
Income (loss) from continuing operations(4) ................ 98,916 60,652 6,505 (3,293) 64,132
Net income (loss)(4)(5) .................................... 98,916 60,652 6,505 (3,293) 50,285
BASIC RESULTS PER SHARE(4)(6):
Income (loss) from continuing operations ................... $ 3.17 $ 1.95 $ 0.21 $ (0.11) $ 2.04
Net income (loss) .......................................... 3.17 1.95 0.21 (0.11) 1.60
Weighted average shares outstanding ........................ 31,208 31,139 30,848 30,582 31,469
DILUTED RESULTS PER SHARE(4)(6):
Income (loss) from continuing operations ................... $ 3.09 $ 1.90 $ 0.21 $ (0.11) $ 1.97
Net income (loss) .......................................... 3.09 1.90 0.21 (0.11) 1.55
Weighted average shares outstanding ........................ 32,023 31,887 31,629 30,582 32,511
CASH DIVIDENDS PAID PER SHARE(6)(7): ......................... $ 0.23 $ 0.20 $ 0.20 $ - $ -
OTHER DATA(8):
Operating earnings(5) ...................................... $ 90,645 $ 79,373 $ 44,747 $ 86,438 $ 80,850
Diluted book value per share(6)(9) ......................... $ 25.49 $ 21.83 $ 19.00 $ 17.91 $ 16.35
Return on beginning shareholders' equity
excluding net realized investment gains
(losses), (loss) gain on extinguishment
debt and capital securities and
discontinued operations (10) ............................. 13.3% 13.6% 8.3% 17.2% 14.3%
December 31,
------------------------------------------------------------------
2003 2002 2001 2000 1999
---------- ---------- ---------- ---------- ----------
BALANCE SHEET DATA: (dollars in thousands)
Total investments .................................. $3,202,754 $2,816,051 $2,427,214 $2,475,945 $2,527,763
Total assets ....................................... 4,177,532 3,734,942 3,336,146 3,440,010 3,395,688
Corporate debt(2) (11) ............................. 143,750 118,139 125,675 267,770 283,938
Company obligated mandatorily redeemable
capital securities of subsidiaries(2)(12) ........ 56,050 36,050 36,050 100,000 100,000
Shareholders' equity ............................... 798,440 681,655 581,994 538,193 501,417
Corporate debt to total capitalization ratio(13) ... 14.4% 14.1% 16.9% 29.6% 32.1%
-17-
(1) The Company in 1999 terminated its participations in the reinsurance
facilities in which it had historically participated, resulting in
lower premiums from non-core group employee benefit products in 2000,
2001, 2002 and 2003. Premiums from non-core group employee benefit
products also include premiums from LPTs, which are episodic in nature,
of $44.0 million, $13.9 million, $4.3 million, $26.8 million and $0, in
1999, 2000, 2001, 2002 and 2003, respectively. See "Business - Group
Employee Benefit Products" and "Business - Reinsurance."
(2) Net investment income declined in 2001 and 2002 primarily due to the
Company's liquidation during the fourth quarter of 2000 of a
substantial majority of the investments of its investment subsidiaries.
In 2001, the Company used the proceeds from these sales to repay $150.0
million of outstanding borrowings under its revolving credit
facilities, to repurchase $64.0 million liquidation amount of the
Capital Securities and to repurchase $8.0 million principal amount of
the Matured Senior Notes. The Company recognized a gain on
extinguishment of debt and capital securities of $11.5 million in
connection with these repurchases. In the second quarter of 2002, the
Company repurchased $10.5 million aggregate principal amount of the
Matured Senior Notes and recognized a loss on extinguishment of debt of
$0.3 million in connection with this repurchase.
(3) In 2003, 2002 and 2001, the Company recognized pre-tax losses of $13.0
million, $54.1 million, and $79.3 million, respectively, due to the
other than temporary declines in the market values of certain
securities, which are reported as net realized investment losses. In
2000, the Company realized losses of $72.5 million, related to the
liquidation of a substantial majority of the investments of its
investment subsidiaries, and $58.5 million, on closed U.S. Treasury
futures and option contracts.
(4) Results for 2001 include a charge of $0.91 per diluted share or $28.8
million, net of an income tax benefit of $15.5 million and reinsurance
coverages of $21.8 million, for reserve strengthening primarily related
to an unusually high number of large losses in the Company's excess
workers' compensation business. Included in this charge, on a pre-tax
basis, are additions to excess workers' compensation case reserves of
$9.0 million and IBNR reserves of $24.0 million. This charge also
includes reported workers' compensation losses of $6.3 million and a
$5.0 million addition to long-term disability IBNR reserves
attributable to the terrorist attacks on the World Trade Center. In the
years subsequent to 2001, the number of large losses experienced by the
Company returned to the Company's pre-2001 historical average.
As of January 1, 2003, the Company adopted Statement of Financial
Accounting Standards ("SFAS") No. 145, "Rescission of FASB Statements
No. 4, 44, and 62, Amendment of FASB Statement No. 13, and Technical
Corrections." SFAS No. 145 rescinded SFAS No. 4, which required all
gains and losses from extinguishment of debt and capital securities to
be aggregated and classified as an extraordinary item, net of the
related income tax effect. Under SFAS No. 145, gains or losses from
extinguishment of debt and capital securities are classified as income
or loss from operations in the income statement. In 2002 and 2001, the
Company had an extraordinary (loss) gain, net of the related income tax
effect, of $(0.2) million, or $(0.01) per diluted share, and $7.4
million, or $0.24 per diluted share, respectively, that was
reclassified to ongoing operations upon the adoption of SFAS No. 145.
In addition, in computing the diluted earnings per share amounts for
2001, equivalent shares attributable to in-the-money stock options,
which totaled 0.8 million, were considered in the calculation of these
per share amounts since the reclassification of the gain on
extinguishment of debt and capital securities resulted in income from
continuing operations.
Income (loss) from continuing operations and net income (loss) include
realized investment gains (losses), net of federal income tax expense
(benefit) and the (loss) gain on extinguishment of debt and capital
securities, net of federal income tax (benefit) expense, as follows:
Year Ended December 31,
-----------------------------------------------------------------
2003 2002 2001 2000 1999
---------- ---------- ---------- ---------- ----------
(dollars in thousands, except per share data)
Realized investment gains (losses), net of income tax
expense (benefit) ....................................... $ 8,271 $ (18,505) $ (45,688) $ (89,731) $ (16,718)
Basic per share amount .................................... 0.26 (0.59) (1.48) (2.94) (0.53)
Diluted per share amount .................................. 0.26 (0.58) (1.44) (2.94) (0.52)
(Loss) gain on extinguishment of debt and capital
securities, net of income tax (benefit) expense ......... - (216) 7,446 - -
Basic per share amount .................................... - (0.01) 0.24 - -
Diluted per share amount .................................. - (0.01) 0.24 - -
In 1999, the Company disposed of Unicover and recognized an after-tax
loss of $13.8 million on the disposition. See "Business - Other
Transactions."
(5) Net income is reconciled to the non-GAAP financial measure "operating
earnings" as follows:
Year Ended December 31,
-------------------------------------------------------------
2003 2002 2001 2000 1999
--------- --------- --------- --------- ---------
(dollars in thousands, except per share data)
Net income (loss) .......................................... $ 98,916 $ 60,652 $ 6,505 $ (3,293) $ 50,285
--------- --------- --------- --------- ---------
Realized investment (gains) losses ....................... (12,724) 28,469 70,289 138,047 25,720
Income tax expense (benefit) ............................. 4,453 (9,964) (24,601) (48,316) (9,002)
--------- --------- --------- --------- ---------
Realized investment (gains) losses, net of the
related income tax effect ............................ (8,271) 18,505 45,688 89,731 16,718
--------- --------- --------- --------- ---------
Loss (gain) on extinguishment of debt and
capital securities ..................................... - 332 (11,456) - -
Income tax expense (benefit) ............................. - (116) 4,010 - -
--------- --------- --------- --------- ---------
Loss (gain) on extinguishment of debt
and capital securities, net of the related
income tax effect .................................... - 216 (7,446) - -
--------- --------- --------- --------- ---------
Loss from discontinued operations, net of related
income tax effect .................................... - - - - 13,847
--------- --------- --------- --------- ---------
Operating earnings ......................................... $ 90,645 $ 79,373 $ 44,747 $ 86,438 $ 80,850
========= ========= ========= ========= =========
-18-
See Note 8 for a discussion of why management believes the presentation
of this non-GAAP financial measure provides useful information for
investors.
(6) Prior periods have been restated to reflect the 3-for-2 common stock
split effected in the form of a 50% stock dividend distributed on
December 22, 2003. In computing the earnings per share amount for 2000,
equivalent shares attributable to in-the-money stock options, which
totaled 1.0 million, were not considered in the calculation of these
per share amounts since the inclusion of these equivalent shares would
have diluted the loss from continuing operations.
(7) In 2001, the Company's Board of Directors approved the initiation of a
quarterly cash dividend payable on the Company's outstanding Class A
and Class B Common Stock. The quarterly cash dividend was $0.05 per
share during 2001 and 2002. In the fourth quarter of 2003, the
Company's Board of Directors increased the cash dividend to $0.08 per
share. During 2003, 2002 and 2001, the Company paid cash dividends on
its capital stock in the amount of $7.4 million, $6.0 million and $5.7
million, respectively. See Note L to the Consolidated Financial
Statements.
(8) In addition to financial measures presented in the consolidated
financial statements prepared in accordance with GAAP, the Company also
uses certain non-GAAP financial measures to analyze and report its
financial results. Management believes these non-GAAP financial
measures are informative when analyzing the trends relating to the
Company's insurance operations. These measures exclude realized
investment gains and losses, gains and losses on extinguishment of debt
and capital securities and discontinued operations because these items
arise from events that, to a significant extent, are within
management's discretion and can fluctuate significantly, thus
distorting comparisons between periods. Investment gains and losses may
be realized based on management's decision to dispose of an investment
or management's judgment that a decline in the market value of an
investment is other than temporary. Gains and losses on extinguishment
of debt and capital securities may be realized based on management's
decision to repay or repurchase debt. Thus, realized investment gains
and losses and gains and losses on extinguishment of debt and capital
securities are not reflective of the Company's ongoing earnings
capacity, and trends in the earnings of the Company's underlying
insurance operations can be more clearly identified without the effects
of these gains and losses. For these reasons, management uses these
measures to assess performance and make operating decisions, and the
Company understands that analysts and investors typically utilize
measures of this type when evaluating the financial performance of
insurers. However, gains and losses of these types, particularly as to
investments, are likely to occur periodically and should not be
considered nonrecurring items. Further, these non-GAAP financial
measures should not be considered a substitute for GAAP measures as an
indication of the Company's overall performance and may not be
calculated in the same manner as similarly titled captions in other
companies' financial statements.
(9) Diluted book value per share is calculated by dividing shareholders'
equity (as determined in accordance with GAAP), as increased by the
proceeds and tax benefit from the assumed exercise of outstanding
in-the-money stock options, by total shares outstanding, also increased
by shares issued upon the assumed exercise of the options and deferred
shares.
(10) Return on beginning shareholders' equity, excluding net realized
investment gains (losses), (loss) gain on extinguishment of debt and
capital securities and discontinued operations is calculated by
dividing operating earnings by beginning shareholders' equity, as
determined as of the beginning of each year. Return on beginning
shareholders' equity, excluding net realized investment gains (losses),
(loss) gain on extinguishment of debt and capital securities and
discontinued operations for 2001 excluding losses related to the
reserve strengthening was 13.7%. GAAP-basis return on beginning equity
is as follows:
Year Ended December 31,
-------------------------------------------------
2003 2002 2001 2000 1999
-------- ----- ---- ----- ----
Return on beginning shareholders' equity.. 14.5% 10.4% 1.2% N/A 8.9%
See Note 8 for a discussion of why management believes the presentation
of this non-GAAP financial measure provides useful information for
investors.
(11) In May 2003, the Company issued $143.8 million of the 2033 Senior
Notes. See "Business - Other Transactions" and Note E to the
Consolidated Financial Statements.
(12) In May 2003, the Trust issued $20.0 million liquidation amount of
Floating Rate Capital Securities in a private placement. See "Business
- Other Transactions" and Note K to the Consolidated Financial
Statements.
(13) The corporate debt to total capitalization ratio is calculated by
dividing long-term corporate debt by the sum of the Company's long-term
corporate debt, Company-obligated mandatorily redeemable capital
securities of subsidiaries and shareholders' equity.
-19-
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
INTRODUCTION
The Company, through its subsidiaries, underwrites a diverse portfolio of group
employee benefit products, primarily group life, disability, and excess workers'
compensation insurance. Revenues from this group of products are primarily
comprised of earned premiums and investment income. The profitability of group
employee benefit products is affected by, among other things, differences
between actual and projected claims experience, the retention of existing
customers and the Company's ability to attract new customers, change premium
rates and contract terms and control administrative expenses. The Company
transfers its exposure to some group employee benefit risks through reinsurance
ceded arrangements with other insurance and reinsurance companies. Therefore,
the profitability of group employee benefit products is affected by the amount,
cost and terms of reinsurance obtained by the Company. Profitability of certain
group employee benefit products is also affected by the difference between the
yield achieved on invested assets and the discount rate used to calculate the
related reserves. The Company is currently experiencing particularly favorable
market conditions for its excess workers' compensation products, and believes
that this trend will continue for some time, due to the growing shift among
employers toward self-insuring their workers' compensation risks in light of
higher primary workers' compensation rates. For its other group employee benefit
products, the Company is maintaining its underwriting discipline under
competitive market conditions, and is increasing the size of its sales force in
order to enhance its focus on the small case niche (insured groups of 10 to 500
individuals), including employers which are first-time providers of these
employee benefits, which it believes to offer opportunities for superior
profitability.
The Company also operates an asset accumulation business that focuses primarily
on offering fixed annuities to individuals. Deposits from the Company's asset
accumulation business consist of new annuity sales, which are recorded as
liabilities rather than as premiums. Revenues from the Company's asset
accumulation business are primarily comprised of investment income earned on the
funds under management. The profitability of asset accumulation products is
primarily dependent on the spread achieved between the return on investments and
the interest credited to annuity holders. The Company is disciplined in setting
the crediting rates offered on its asset accumulation products in order to
achieve its targeted interest rate spreads on these products, and is willing to
accept lower levels of sales on these products when market conditions make these
targeted spreads more difficult to achieve.
The following discussion and analysis of the results of operations and financial
condition of the Company should be read in conjunction with the Consolidated
Financial Statements and related notes. The preparation of financial statements
in conformity with GAAP requires management, in some instances, to make
judgments about the application of these principles. The amounts of assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period could differ materially from
the amounts reported if different conditions existed or different judgments were
utilized. A discussion of how management applies certain critical accounting
policies is presented below under the caption "Critical Accounting Policies" and
should be read in conjunction with the following discussion and analysis of
results of operations and financial condition of the Company. In addition, a
discussion of uncertainties and contingencies which can affect actual results
and could cause actual results to ultimately differ materially from those
described below can be found under the caption "Forward-Looking Statements And
Cautionary Statements Regarding Certain Factors That May Affect Future Results."
RESULTS OF OPERATIONS
2003 COMPARED TO 2002
Summary of Results. Net income was $98.9 million, or $3.09 per diluted share, in
2003 as compared to $60.7 million, or $1.90 per diluted share, in 2002. Net
income in 2003 and 2002 included realized investment gains (losses) (net of the
related income tax effects) of $8.3 million, or $0.26 per diluted share, and
$(18.5) million, or $(0.58) per diluted share, respectively. Net income in 2002
also included a loss on extinguishment of debt (net of an income tax benefit) of
$0.2 million, or $0.01 per diluted share. The increase in net income in 2003 is
also attributable to growth in income from group employee benefit products and
net investment income partially offset by an increase in interest expense.
Premiums from the Company's core group employee benefit products increased 20%
in 2003 and the combined ratio (loss ratio plus expense ratio) remained at the
same level as 2002. Net investment income increased 15% in 2003 primarily due to
a 15% increase in average invested assets. The increase in interest expense
resulted from the Company's issuance of the 2033 Senior Notes and the 2003
Capital Securities.
-20-
Management believes the non-GAAP financial measure of "operating earnings" is
informative when analyzing the trends relating to the Company's insurance
operations. Operating earnings exclude realized investment gains and losses and
gains and losses on extinguishment of debt, because these items arise from
events that, to a significant extent, are within management's discretion and can
fluctuate significantly, thus distorting comparisons between periods. Investment
gains and losses may be realized based on management's decision to dispose of an
investment or management's judgment that a decline in the market value of an
investment is other than temporary. Gains and losses on extinguishment of debt
may be realized based on management's decision to repay or repurchase debt.
Thus, realized investment gains and losses and gains and losses on
extinguishment of debt are not reflective of the Company's ongoing earnings
capacity, and trends in the earnings of the Company's underlying insurance
operations can be more clearly identified without the effects of these gains and
losses. For these reasons, management uses the measure of operating earnings to
assess performance and make operating decisions, and the Company understands
that analysts and investors typically utilize measures of this type when
evaluating the financial performance of insurers. However, gains and losses of
these types, particularly as to investments, are likely to occur periodically
and should not be considered as nonrecurring items. Further, operating earnings
should not be considered a substitute for net income as an indication of the
Company's overall performance and may not be calculated in the same manner as
similarly titled captions in other companies' financial statements.
Operating earnings for the Company, consisting of net income adjusted to exclude
realized investment gains (losses) and a loss on extinguishment of debt (both
net of the related income tax effects), were $90.6 million, or $2.83 per diluted
share, in 2003 as compared to $79.4 million, or $2.49 per diluted share, in
2002. The increase in operating earnings in the current period is primarily
attributable to the growth in income from group employee benefit products and
net investment income partially offset by the increase in interest expense.
Premium and Fee Income. Premium and fee income in 2003 was $719.1 million as
compared to $627.9 million in 2002, an increase of 15%. Premiums from core group
employee benefit products increased 20% to $673.7 million in 2003 from $559.2
million in 2002. This increase reflects normal growth in employment and salary
levels for the Company's existing customer base, price increases, and strong
production of new business. Core group employee benefit products include group
life, disability, excess workers' compensation, travel accident and dental
insurance. See "Business - Group Employee Benefit Products." Premiums from
excess workers' compensation insurance for self-insured employers increased 45%
to $151.5 million in 2003 from $104.2 million in 2002. This increase was
primarily due to the favorable pricing environment and strong demand for this
product driven by a growing shift among employers toward self-insuring their
workers' compensation risks due to higher primary workers' compensation rates.
SNCC obtained average price increases above 15% in connection with its renewals
of insurance coverage during 2003, and has continued to obtain significant
improvements in contract terms, in particular higher SIR levels, in these
renewals. On average, SIRs increased 13% in 2003. SNCC has continued to obtain
average price increases of 16% on its 2004 renewals and SIR levels on average
are up 7%. New business production, which represents the amount of new
annualized premium sold, for excess workers' compensation products increased 46%
to $45.1 million in 2003 from $30.8 million in 2002. In addition, retention of
existing customers for excess workers' compensation products in 2003 was higher
than in 2002. Premiums from the Company's other core group employee benefit
products increased 15% to $522.1 million in 2003 from $455.0 million in 2002,
reflecting an improvement in the retention of existing customers and strong
production growth in 2002. New business production for the Company's other core
group employee benefit products was $175.1 million in 2003 and $170.4 million in
2002. The level of production achieved in 2003 reflects the Company's
maintaining its underwriting discipline under competitive market conditions for
these products and across-the-board price increases on new long-term disability
business to reflect the lower discount rates on reserves implemented in 2003.
The Company continues to implement price increases for certain existing
disability and group li