-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Roq9Dt/ZGs2dpI05AZHZYc+wuPQeEI0qzHbtuP3uuSupC/PVRYDd8Cfv/czG4dkQ h8kpVMoTAIqwtK3lEdsITw== 0001047469-97-000905.txt : 19971016 0001047469-97-000905.hdr.sgml : 19971016 ACCESSION NUMBER: 0001047469-97-000905 CONFORMED SUBMISSION TYPE: 8-K PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19971001 ITEM INFORMATION: ITEM INFORMATION: FILED AS OF DATE: 19971015 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: SAFECO CORP CENTRAL INDEX KEY: 0000086104 STANDARD INDUSTRIAL CLASSIFICATION: FIRE, MARINE & CASUALTY INSURANCE [6331] IRS NUMBER: 910742146 STATE OF INCORPORATION: WA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 8-K SEC ACT: SEC FILE NUMBER: 001-06563 FILM NUMBER: 97696324 BUSINESS ADDRESS: STREET 1: SAFECO PLZ T-22 CITY: SEATTLE STATE: WA ZIP: 98185 BUSINESS PHONE: 2065455000 MAIL ADDRESS: STREET 1: SAFECO PLAZA T-22 CITY: SEATTLE STATE: WA ZIP: 98185 FORMER COMPANY: FORMER CONFORMED NAME: GENERAL AMERICA CORP DATE OF NAME CHANGE: 19680529 8-K 1 8-K UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 8-K CURRENT REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 October 1, 1997 Date of Report (Date of earliest event reported) SAFECO CORPORATION (Exact name of registrant as specified in Charter) WASHINGTON 1-6563 91-0742146 (State or other (Commission (IRS Employer jurisdiction of File Number) Identification No.) incorporation) SAFECO Plaza, Seattle, Washington 98185 (Address of principal executive offices) (Zip Code) (206) 545-5000 (Registrant's telephone number, including area code) -1- Item 2. Acquisition or Disposition of Assets On October 1, 1997, SAFECO Corporation, a Washington corporation ("SAFECO"), announced that it had completed its acquisition of American States Financial Corporation, an Indiana corporation ("ASFC"). On October 1, 1997, ASFC Acquisition Co., an Indiana corporation and a wholly owned subsidiary of SAFECO ("Merger Sub"), merged with and into ASFC (the "Merger"), pursuant to the terms of the Agreement and Plan of Merger (the "Merger Agreement"), dated as of June 6, 1997 by and among SAFECO, Merger Sub, and ASFC. As a result of the Merger, ASFC is now a wholly owned subsidiary of SAFECO. ASFC is an insurance holding company whose insurance subsidiaries are primarily involved in property and casualty insurance. Prior to its acquisition by SAFECO it was a public company traded on the New York Stock Exchange. SAFECO paid $47 in cash for each outstanding share of ASFC common stock, for a total cash purchase price of approximately $2.8 billion. In connection with the Merger Agreement, SAFECO also agreed to pay approximately $100 million to Lincoln National Corporation ("LNC"), an Indiana corporation and former holder of approximately 83% of the outstanding shares of ASFC common stock, in consideration for LNC's agreement to release ASFC from certain debt obligations and agreed to repay a $200 million term loan from LNC. SAFECO financed the acquisition of ASFC's common stock and the repayment of obligations to LNC from various sources, including the proceeds from (i) the issuance of $200 million aggregate principal amount of 10-year senior notes, (ii) the issuance of $850 million aggregate liquidation amount ($841.5 million net of underwriting compensation) of 40-year, SAFECO-obligated, mandatorily redeemable preferred securities that are callable after 10-years ("capital securities") by a subsidiary trust, (iii) the issuance of $1.5 billion of commercial paper, and (iv) a $600 million special dividend from its property and casualty subsidiaries. SAFECO expects to close the sale of 13,000,000 shares of its Common Stock on October 20, 1997 and intends to apply the proceeds of $595.5 million (net of underwriting commissions) to retire a like amount of commercial paper in late October 1997. Pending such uses, the net proceeds will be invested in short-term, investment-grade, interest-bearing securities. SAFECO, through a subsidiary trust, may issue an additional $150 million aggregate liquidation amount of capital securities in the fourth quarter of 1997 to retire an additional amount of commercial paper. Item 7. Financial Statements, Pro Forma Financial Information and Exhibits (a) Financial Statements of Business Acquired The financial statements of ASFC required to be filed are incorporated by reference. See exhibits 99.2 and 99.3 below. (b) Pro Forma Financial Information The required pro forma financial information is incorporated by reference. See exhibit 99.4 below. (c) Exhibits -2- 2.1 Agreement and Plan of Merger dated as of June 6, 1997 by and among ASFC, SAFECO and ASFC Acquisition Co. (filed as Exhibit 2.1 to SAFECO's report on Form 8-K dated June 6, 1997 and incorporated by reference). 99.1 Press Release issued by SAFECO on October 1, 1997. 99.2 Consolidated Balance Sheets of ASFC and Subsidiaries as of December 31, 1996 and 1995, and the related Consolidated Statements of Income, Shareholders' Equity and Cash Flows for each of the three years in the period ended December 31, 1996, together with the notes thereto and the related report of Independent Accountants (incorporated by reference to pages 34 to 57 of the ASFC Annual Report on Form 10-K for the year ended December 31, 1996 (Commission File Number 001-11733)). The Consolidated Balance Sheets and Consolidated Statements of Income, Shareholders' Equity and Cash Flows on pages 34 to 57 of the ASFC Annual Report on Form 10-K are included in this Form 8-K as Exhibit 99.2. 99.3 Consolidated Balance Sheets of ASFC and Subsidiaries as of June 30, 1997 and December 31, 1996, and the related Consolidated Statements of Income, Shareholders' Equity and Cash Flows for the Six Months Ended June 30, 1997 and 1996 (unaudited), together with the notes thereto (incorporated by reference to pages 1 to 10 of the ASFC Quarterly Report on Form 10-Q for the quarter ended June 30, 1997 (Commission File Number 001-11733)). The Consolidated Balance Sheets and Consolidated Statements of Income, Shareholders' Equity and Cash Flows on pages 1 to 10 of the ASFC Quarterly Report on Form 10-Q are included in this Form 8-K as Exhibit 99.3. 99.4 Unaudited Pro Forma Combined Condensed Financial Statements of SAFECO reflecting the acquisition of ASFC and certain related financings, as of June 30, 1997. Includes Unaudited Pro Forma Combined Condensed Balance Sheet as of June 30,1997 and Unaudited Pro Forma Combined Condensed Statements of Income for the Six Months Ended June 30, 1997 and Year Ended December 31, 1996, and related notes, incorporated by reference to pages 12 to 17 of SAFECO's prospectus dated September 15, 1997 contained in the Registration Statement on Form S-3 dated August 19, 1997 (Registration No. 333-33927). The pro forma financial information on pages 12 to 17 of the prospectus contained in the Registration Statement are included in this Form 8-K as Exhibit 99.4. -3- SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized. SAFECO CORPORATION Dated: October 15, 1997 By: /s/ H. Paul Lowber --------------------------- H. Paul Lowber Vice President, Controller and Chief Accounting Officer -4- EXHIBIT INDEX 2.1 Agreement and Plan of Merger dated as of June 6, 1997 by and among ASFC, SAFECO and ASFC Acquisition Co. (filed as Exhibit 2.1 to SAFECO's report on Form 8-K dated June 6, 1997 and incorporated by reference). 99.1 Press Release issued by SAFECO on October 1, 1997. 99.2 Consolidated Balance Sheets of ASFC and Subsidiaries as of December 31, 1996 and 1995, and the related Consolidated Statements of Income, Shareholders' Equity and Cash Flows for each of the three years in the period ended December 31, 1996, together with the notes thereto and the related report of Independent Accountants (incorporated by reference to pages 34 to 57 of the ASFC Annual Report on Form 10-K for the year ended December 31, 1996 (Commission File Number 001-11733)). The Consolidated Balance Sheets and Consolidated Statements of Income, Shareholders' Equity and Cash Flows on pages 34 to 57 of the ASFC Annual Report on Form 10-K are included in this Form 8-K as Exhibit 99.2. 99.3 Consolidated Balance Sheets of ASFC and Subsidiaries as of June 30, 1997 and December 31, 1996, and the related Consolidated Statements of Income, Shareholders' Equity and Cash Flows for the Six Months Ended June 30, 1997 and 1996 (unaudited), together with the notes thereto (incorporated by reference to pages 1 to 10 of the ASFC Quarterly Report on Form 10-Q for the quarter ended June 30, 1997 (Commission File Number 001-11733)). The Consolidated Balance Sheets and Consolidated Statements of Income, Shareholders' Equity and Cash Flows on pages 1 to 10 of the ASFC Quarterly Report on Form 10-Q are included in this Form 8-K as Exhibit 99.3. 99.4 Unaudited Pro Forma Combined Condensed Financial Statements of SAFECO reflecting the acquisition of ASFC and certain related financings, as of June 30, 1997. Includes Unaudited Pro Forma Combined Condensed Balance Sheet as of June 30,1997 and Unaudited Pro Forma Combined Condensed Statements of Income for the Six Months Ended June 30, 1997 and Year Ended December 31, 1996, and related notes, incorporated by reference to pages 12 to 17 of SAFECO's prospectus dated September 15, 1997 contained in the Registration Statement on Form S-3 dated August 19, 1997 (Registration No. 333-33927). The pro forma financial information on pages 12 to 17 of the prospectus contained in the Registration Statement are included in this Form 8-K as Exhibit 99.4. -5- EX-99.1 2 EXHIBIT 99.1 SAFECO CORPORATION COMPLETES ACQUISITION OF AMERICAN STATES FINANCIAL CORPORATION SEATTLE -- (October 1, 1997) -- SAFECO Corporation (NASDAQ: SAFC) announced today that it has completed the acquisition of American States Financial Corporation for $47 per share, or $2.8 billion. "We are very excited to finalize this acquisition and begin the next stage of combining the two companies," said Roger Eigsti, chairman and chief executive officer of SAFECO. "Together, SAFECO and American States can provide independent agents with a broad and comprehensive package of products and services that meet our customers' diverse insurance and investment needs." Founded in 1923 as the General Insurance Company of America, SAFECO today is one of the largest diversified financial corporations in the country with more than $27 billion in combined assets as of June 30, 1997, and combined 1996 revenues of $6 billion. Property and casualty insurance was SAFECO's original business and remains its largest operation. With the acquisition of American States, SAFECO ranks as the 15th largest property and casualty insurer in the country. In addition, SAFECO engages in life and health insurance and surety, and conducts commercial credit, asset management, insurance agency and financial services distribution operations, and real estate investment and management. SAFECO is headquartered in Seattle, with major operations in Washington, Indiana, Missouri, Oregon, Texas, California, Colorado, Ohio, Illinois, Georgia, Kansas, New Mexico, Wisconsin and Connecticut. The corporation employs more than 11,000 people and is represented by more than 8,000 independent agents nationwide. EX-99.2 3 EXHIBIT 99.2 REPORT OF INDEPENDENT AUDITORS Board of Directors American States Financial Corporation We have audited the accompanying consolidated balance sheets of American States Financial Corporation and subsidiaries as of December 31, 1996 and 1995, and the related consolidated statements of income, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1996. Our audits also include the financial statement schedules listed in the index at item 14(a)(2). These financial statements and schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of American States Financial Corporation and subsidiaries at December 31, 1996 and 1995, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statements and schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein. ERNST & YOUNG LLP Indianapolis, Indiana January 28, 1997 34 AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
December 31, --------------------------- 1996 1995 ---- ---- (Dollars in Thousands) ASSETS Investments: Securities available-for-sale at fair value: Fixed maturity (amortized cost: 1996 - $3,579,807; 1995 - $3,590,601) $3,763,880 $3,860,883 Equity (cost: 1996 - $362,720; 1995 - $374,232) 435,137 437,685 Mortgage loans 32,293 33,319 Short-term investments 73,276 63,170 Other invested assets 37,986 35,178 ---------- ---------- Total investments 4,342,572 4,430,235 Cash 13,610 12,708 Premium receivable, less allowance for doubtful accounts (1996 - $3,045; 1995 - $2,860) 413,444 377,802 Deferred policy acquisition costs 202,233 199,192 Properties to be sold, less valuation allowances (1996 - $26,916; 1995 - $28,350) 30,633 41,403 Property and equipment-at cost, less allowances for depreciation (1996 - $73,789; 1995 - $79,011) 31,143 29,823 Accrued investment income 64,602 66,173 Deferred federal income taxes recoverable 128,742 100,647 Cost in excess of net assets of acquired subsidiaries, less amortization (1996 - $46,036; 1995 - $42,618) 97,772 101,190 Ceded reinsurance on claims and claims expense reserves 179,445 136,939 Miscellaneous 36,887 43,073 ---------- ---------- Total Assets $5,541,083 $5,539,185 ---------- ---------- ---------- ----------
(continued on next page) SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. 35 AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Continued)
December 31, ------------------------------- 1996 1995 ---- ---- (Dollars in Thousands) LIABILITIES AND SHAREHOLDERS' EQUITY Policy liabilities and accruals: Losses, loss adjustment expense and future policy benefits $2,868,348 $2,828,337 Unearned premiums 711,955 718,478 ---------- ---------- Total policy liabilities and accruals 3,580,303 3,546,815 Commissions and other expenses 120,872 134,031 Current federal income taxes payable 5,303 7,095 Outstanding checks 69,901 67,308 Short-term debt due LNC 66,667 - Notes payable 99,511 - Debt due LNC 133,333 - Other liabilities 129,154 115,229 ---------- ---------- Total liabilities 4,205,044 3,870,478 Shareholders' equity: Common stock, no par value: 195,000,000 shares authorized, shares issued and outstanding: 1996 - 60,050,515; 1995 - 50,000,000 304,493 387,547 Net unrealized gain on securities available-for-sale 163,647 211,767 Retained earnings 867,899 1,069,393 ---------- ---------- Total shareholders' equity 1,336,039 1,668,707 ---------- ---------- Total liabilities and shareholders' equity $5,541,083 $5,539,185 ---------- ---------- ---------- ----------
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. 36 AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME
Year Ended December 31, --------------------------------------------------- 1996 1995 1994 ---- ---- ---- (Dollars in Thousands, Except Per Share Data) Revenue: Premiums and other revenue $1,674,122 $1,746,386 $1,745,971 Net investment income 274,314 266,569 260,454 Realized gain on investments 35,538 41,044 19,936 Loss on operating properties - (28,350) - ---------- ---------- ---------- Total revenue 1,983,974 2,025,649 2,026,361 Benefits and expenses: Benefits and settlement expenses 1,248,879 1,242,270 1,271,957 Commissions 282,991 291,551 296,886 Operating and administrative expenses 206,755 236,825 208,123 Taxes, licenses and fees 37,295 45,891 49,003 Interest on debt 12,372 - 125 ---------- ---------- ---------- Total benefits and expenses 1,788,292 1,816,537 1,826,094 Income before federal income taxes 195,682 209,112 200,267 Federal income taxes (credit): Current 28,160 35,298 26,124 Deferred (2,184) (4,450) (l0,4l5) ---------- ---------- ---------- Total federal income taxes 25,976 30,848 15,709 ---------- ---------- ---------- Net income $ 169,706 $ 178,264 $ 184,558 ---------- ---------- ---------- ---------- ---------- ---------- Net income per share $ 3.03 $ 3.57 $ 3.69 ---------- ---------- ---------- ---------- ---------- ---------- Weighted average shares outstanding 55,975,238 50,000,000 50,000,000 ---------- ---------- ---------- ---------- ---------- ----------
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. 37 AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (Dollars in Thousands)
Net Unrealized Common Stock Gain (Loss) on ----------------------- Securities Number Available- Retained of Shares Amount for-Sale Earnings Total --------- ------ -------- -------- ----- Balance at January 1, 1994 . . . . . . . . . . 50,000,000 $ 387,547 $ 239,080 $1,085,571 $1,712,198 Change in unrealized gain (loss) on securities available-for-sale. . . . . . . . - - (248,190) - (248,190) Cash dividends paid to LNC . . . . . . . . . . - - - (180,000) (180,000) Net income . . . . . . . . . . . . . . . . . . - - - 184,558 184,558 ---------- ---------- ---------- ---------- ---------- Balance at December 31, 1994 . . . . . . . . . 50,000,000 387,547 (9,110) 1,090,129 1,468,566 Change in unrealized gain (loss) on securities available-for-sale. . . . . . . . - - 220,877 - 220,877 Cash dividends paid to LNC . . . . . . . . . . - - - (199,000) (199,000) Net income . . . . . . . . . . . . . . . . . . - - - 178,264 178,264 ---------- ---------- ---------- ---------- ---------- Balance at December 31, 1995 . . . . . . . . . 50,000,000 387,547 211,767 1,069,393 1,668,707 Public offering of common stock. . . . . . . . 10,000,000 215,182 - - 215,182 Common stock issued for employee benefit plans. . . . . . . . . . . . . . . . . . . . 50,515 1,162 - - 1,162 Assumption and issuance of debt in exchange with LNC. . . . . . . . . . . . . . - (299,398) - - (299,398) Change in unrealized gain (loss) on securities available-for-sale. . . . . . . . - - (48,120) - (48,120) Dividends to LNC prior to public offering: Assets dividended. . . . . . . . . . . . . . - - - (299,866) (299,866) Cash dividend. . . . . . . . . . . . . . . . - - - (46,134) (46,134) Cash dividends declared and paid after public offering ($.42 per share) . . . . . . - - - (25,200) (25,200) Net income . . . . . . . . . . . . . . . . . . - - - 169,706 169,706 ---------- ---------- ---------- ---------- ---------- Balance at December 31, 1996 . . . . . . . . . 60,050,515 $ 304,493 $ 163,647 $ 867,899 $1,336,039 ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. 38 AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31, --------------------------------------- 1996 1995 1994 ---- ---- ---- (Dollars in Thousands) CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 169,706 $ 178,264 $ 184,558 Adjustments to reconcile net income to cash provided by operating activities: Deferred policy acquisition costs 172 (280) 1,743 Premiums and fees in course of collection (35,642) 6,220 4,558 Accrual of discount on investments (18,656) (17,166) (13,113) Amortization of premium on investments 4,973 6,782 12,571 Accrued investment income (2,859) 6,253 (622) Policy liabilities and accruals (290) (95,605) (111,825) Federal income taxes (3,976) 803 (12,485) Provision for depreciation 7,549 10,535 10,453 Gain on sale of investments (35,538) (41,044) (19,936) Loss on operating properties - 28,350 - Ceded reinsurance on claims and claims expense reserves (42,506) 1,224 12,589 Other 2,419 23,554 5,302 --------- --------- --------- Net adjustments (124,354) (70,374) (110,765) --------- --------- --------- Net cash provided by operating activities 45,352 107,890 73,793 CASH FLOWS FROM INVESTING ACTIVITIES Securities available-for-sale: Purchase of investments (1,173,931) (1,002,548) (1,009,660) Sales of investments 892,669 990,781 983,684 Maturities and redemptions 58,042 68,846 110,236 Purchase of mortgage loans and other investments (10,973) (11,441) (13,441) Sale or maturity of mortgage loans and other investments 8,515 28,039 11,747 Net (increase) decrease in short-term investments (10,106) 42,275 34,653 Purchase of property and equipment, net 1,900 (4,815) (9,871) Other 11,807 (12,191) 1,989 --------- --------- --------- Net cash provided by (used in) investing activities (222,077) 98,946 109,337 CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from issuance of common stock 215,182 - - Principal payments on notes payable - - (5,000) Universal life investment contract deposits 47,240 47,805 47,285 Universal life investment contract withdrawals (13,461) (9,067) (9,330) Dividends paid (71,334) (244,000) (215,000) --------- --------- --------- Net cash provided by (used in) financing activities 177,627 (205,262) (182,045) --------- --------- --------- Net increase in cash 902 1,574 1,085 Cash at beginning of period 12,708 11,134 10,049 --------- --------- --------- Cash at end of period $ 13,610 $ 12,708 $ 11,134 --------- --------- --------- --------- --------- ---------
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. 39 AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) 1. BASIS OF PRESENTATION PRINCIPLES OF CONSOLIDATION On February 5, 1996, American States Financial Corporation (the "Company") was incorporated in the State of Indiana to serve as a holding company. The consolidated financial statements include the accounts of American States Insurance Company ("ASI") and its wholly-owned insurance subsidiaries and have been presented as if the holding company formation occurred at the earliest date presented herein. The Company was a wholly owned subsidiary of Lincoln National Corporation ("LNC") until May 22, 1996, when LNC's ownership was reduced to 83% as a result of an initial public offering by the Company. ASI has licenses to write business in all 50 states and the District of Columbia. ASI and its subsidiaries write standard commercial and personal lines, and life insurance business throughout the United States with the greatest volume in the Midwest and Pacific Northwest. All significant intercompany accounts and transactions are eliminated in consolidation. During 1994, American Union Reinsurance Company and Amstats Insurance Company were sold. These transactions had no significant effect on the results of operation for that year. HOLDING COMPANY FORMATION AND INITIAL PUBLIC OFFERING As noted above, the financial statements have been presented as if the Company had been organized at the earliest date presented herein. The formation of the Company was done in contemplation of an initial public offering. On April 22, 1996, ASI declared, and on May 15, 1996, it paid to LNC, a dividend of $300,000 consisting primarily of tax-exempt municipal securities ("Dividended Assets"). On May 16, 1996, LNC transferred all of the outstanding shares of ASI to the Company in exchange for 50,000,000 shares of Common Stock and $300,000 debt of the Company. The transfer of ASI stock to the Company by LNC in exchange for Company Common Stock and debt have been accounted for similar to a pooling of interests, thus the assets, liabilities, shareholders' equity and the results of operation of the Company and its subsidiaries have been combined at historical carrying values. On May 29, 1996, the closing date of the initial public offering, the Company issued 10,000,000 shares of Common Stock at $23 per share to the public. The net proceeds, after deduction of underwriting discounts and offering expenses were $215,182. The Company contributed $140,500 of such net proceeds to ASI to enable it to invest in taxable securities for its investment portfolio and the remainder was retained by the Company for general corporate purposes. The 50,000,000 shares held by LNC are "restricted shares" as defined by Rule 144 of the Securities Act of 1933, as amended (the "Securities Act"). Such shares may not be resold in the absence of registration under the Securities Act or exemptions from such registration including, among others, the exemption provided by Rule 144 of the Securities Act. As an affiliate of the Company, LNC is subject to certain volume restrictions on the sale of shares of the Company's Common Stock. The Company's Common Stock is publicly traded on the New York Stock Exchange under the symbol "ASX". 40 AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 2. SIGNIFICANT ACCOUNTING POLICIES INVESTMENTS Fixed maturity and equity securities (common and perpetual preferred stocks) are classified as available-for-sale and accordingly, are carried at fair value. For the mortgage-backed bond portion of the fixed maturity securities portfolio, the Company recognizes income using a constant effective yield based on anticipated prepayments and the estimated economic life of the securities. When actual prepayments differ significantly from anticipated prepayments, the effective yield is recalculated to reflect actual payments to date and anticipated future payments. The net investment in the securities is adjusted to the amount that would have existed had the new effective yield been applied since the acquisition of the securities. This adjustment is reflected in net investment income. Mortgage loans on real estate are carried at the outstanding principal balances less unaccrued discounts and allowances for losses. Short-term investments which are carried at cost, include all highly liquid debt instruments purchased with a maturity of one year or less, and the carrying value approximates fair value. Realized gains and losses on investments are recognized in net income using the specific identification method. Changes in the fair values of securities carried at fair value are reflected directly in shareholders' equity after deductions for related adjustments for deferred policy acquisition costs and deferred taxes. PROPERTY AND EQUIPMENT Property and equipment are stated at cost, less allowances for depreciation. Depreciation is computed generally by the straight-line method at rates calculated to amortize costs over the estimated useful lives of the assets. Properties to be sold are carried at the lower of amortized cost or estimated fair value, less selling costs. The difference between book value and fair value is recognized by maintaining a valuation allowance. COST IN EXCESS OF NET ASSETS OF ACQUIRED SUBSIDIARIES Cost in excess of net assets from the purchase of subsidiaries is being amortized using the straight-line method up to 40 years. The carrying value of these assets will be reviewed if the facts and circumstances suggest that it may be impaired. If the undiscounted cash flows estimated to be generated by these assets are less than the carrying amounts, an impairment loss would be recognized. USE OF ESTIMATES The nature of the insurance business requires management to make estimates and assumptions that affect the amounts reported in the financial statements. Actual results reported in future financial statements could differ from these estimates. The effects of changes in estimates are included in the operating results for the period in which such changes occur. 41 AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 2. SIGNIFICANT ACCOUNTING POLICIES (Continued) LOSSES, LOSS ADJUSTMENT EXPENSE AND FUTURE POLICY BENEFITS The liability for losses and loss adjustment expense is determined using case basis evaluation and statistical analysis and represents estimates of the ultimate net cost of all reported and unreported losses which are unpaid at year end. This liability includes estimates of future trends in claim severity and frequency and other factors which could vary as the losses are ultimately settled. Although it is not possible to measure the degree of variability inherent in such estimates, management believes that the liability for losses and loss adjustment expense is adequate. The estimates are continually reviewed and as adjustments become necessary to this liability, they are made and reflected in current operations. The reserve for losses and loss adjustment expense is stated at an amount after deduction of salvage and subrogation recoverable. At December 31, 1996, the Company has guaranteed and is contingently liable in the amount of $43,855 with respect to annuities purchased to fund structured settlements. In the normal course of settling losses, the Company has been named in various lawsuits. The ultimate settlement of these lawsuits is not expected to be material to the Company's operations. Future policy benefits on traditional life insurance have been computed using principally a net-level premium method and assumptions for investment yields, withdrawals and mortality based principally on Company experience projected at the time of policy issue, with provision for possible adverse deviations. Interest assumptions for direct individual life reserves range from approximately 4.5% for 1958 issues to 6.75% for 1996 issues. With respect to universal life and annuity products, the retrospective deposit accounting method is used. Policy reserves represent the premiums received plus accumulated interest, less mortality and administrative charges. RECOGNITION OF INCOME AND EXPENSES Premiums include property and casualty insurance premiums and life insurance premiums and contract charges earned. Direct property and casualty insurance premiums are earned ratably over the terms of the policies. Assumed reinsurance premiums are earned ratably over the terms of the original policies issued and terms of the reinsurance contracts. The reserve for unearned premiums is computed by the semi-monthly pro rata method. Life insurance premiums on traditional life business are generally earned when due. Revenues for universal life and investment products consist of policy charges for the cost of insurance, policy administration charges, amortization of policy initiation fees, and surrender charges assessed against policyholder account balances during the period. Expenses related to these products include interest credited to policyholder account balances and death benefits incurred in excess of policyholder account balances. Commissions, premium taxes, and certain other expenses incurred in the acquisition of business are deferred and amortized as the related premiums are earned. Acquisition costs that are not recoverable from future premiums and related investment income are expensed. The amounts of acquisition costs amortized were $338,012, $359,840 and $359,747 in 1996, 1995 and 1994, respectively. FEDERAL INCOME TAXES A consolidated federal income tax return is filed by LNC and includes the Company. Pursuant to an agreement with LNC, the Company provides for income taxes on the basis of a separate return calculation. The taxes computed are remitted to or collected from LNC. 42 AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 2. SIGNIFICANT ACCOUNTING POLICIES (Continued) PENSION PLAN AND OTHER RETIREMENT BENEFITS A qualified non-contributory defined benefit retirement plan covers substantially all employees. Benefits are based on total years of service and the highest 60 months of compensation during the last 10 years of employment. The plan is funded by contributions to tax-exempt trusts consistent with requirements of federal law and regulations. Contributions are intended to provide not only the benefits attributed to service to date, but also those expected to be earned in the future. Plan assets consist principally of listed equity securities, corporate obligations, and United States government bonds. The Company also sponsors an unfunded, nonqualified, supplemental defined benefit pension plan for certain employees. Further, the Company sponsors an unfunded defined benefit plan that provides postretirement medical and life insurance benefits to full-time employees who have worked 10 years and attained age 55 while in service with the Company. The plan is contributory, with retiree contributions adjusted annually, and contains other cost-sharing features such as deductibles and coinsurance. Eligible employees also participate in a defined contribution plan. The Company's contribution to the plan is equal to a participant's pre-tax contribution, not to exceed 6% of base pay, multiplied by a percentage, ranging from 25% to 150%, which varies according to certain incentive criteria as determined by the Board of Directors. Expense for this plan amounted to $5,297, $6,644 and $11,419 in 1996, 1995 and 1994, respectively. STOCK OPTIONS The Company utilizes the intrinsic value method of accounting to determine whether compensation expense should be recognized in conjunction with its stock option incentive plan. Using the intrinsic value method, compensation cost is the excess, if any, of the quoted market price of the stock at the grant date, or other measurement date, over the amount an employee must pay to acquire the stock. Since all options are granted at market price, the Company has not recognized compensation expense relating to the stock option incentive plan. RECLASSIFICATIONS Amounts from prior periods have been reclassified to conform to the 1996 presentation. Net income and shareholders' equity have not been affected by these reclassifications. 43 AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 3. INVESTMENTS The cost, unrealized gains and losses and fair value of securities available-for-sale are as follows:
Securities Available-for-Sale ----------------------------------------------------- Amortized Unrealized Unrealized Cost Gains Losses Fair Value ---- ----- ------ ---------- DECEMBER 31, 1996 United States treasury securities and other United States government agencies . . . . . . . . . . . . . . . . . . . $ 188,574 $ 7,583 $ 320 $ 195,837 Obligations of states and political subdivisions . . . . . 1,965,798 131,626 1,323 2,096,101 Corporate securities . . . . . . . . . . . . . . . . . . . 1,052,694 49,929 8,721 1,093,902 Mortgage-backed securities . . . . . . . . . . . . . . . . 298,733 4,365 2,282 300,816 Redeemable preferred stocks . . . . . . . . . . . . . . . . 74,008 3,590 374 77,224 ----------- ----------- ----------- ----------- Total fixed maturity securities . . . . . . . . . . . . . . 3,579,807 197,093 13,020 3,763,880 Common and perpetual preferred stocks . . . . . . . . . . . 362,720 76,475 4,058 435,137 ----------- ----------- ----------- ----------- $ 3,942,527 $ 273,568 $ 17,078 $ 4,199,017 ----------- ----------- ----------- ----------- ----------- ----------- ----------- ----------- DECEMBER 31, 1995 United States treasury securities and other United States government agencies . . . . . . . . . . . . . . . . . . . $ 301,547 $ 27,097 $ 86 $ 328,558 Obligations of states and political subdivisions . . . . . 2,222,697 153,728 2,211 2,374,214 Corporate securities . . . . . . . . . . . . . . . . . . . 679,983 77,831 692 757,122 Mortgage-backed securities . . . . . . . . . . . . . . . . 312,705 11,326 320 323,711 Redeemable preferred stocks . . . . . . . . . . . . . . . . 73,669 3,985 376 77,278 ----------- ----------- ----------- ----------- Total fixed maturity securities . . . . . . . . . . . . . . 3,590,601 273,967 3,685 3,860,883 Common and perpetual preferred stocks . . . . . . . . . . . 374,232 71,306 7,853 437,685 ----------- ----------- ----------- ----------- $ 3,964,833 $ 345,273 $ 11,538 $ 4,298,568 ----------- ----------- ----------- ----------- ----------- ----------- ----------- -----------
Fair values for fixed maturity securities are based on quoted market prices, where available. For fixed maturity securities not actively traded, fair values are estimated using values obtained from independent pricing services or, in the case of private placements, are estimated by discounting expected future cash flows using a current market rate applicable to the yield, credit quality, and maturity of the investments. The fair values for equity securities are based on quoted market prices. The amortized cost and estimated fair value of fixed maturity securities at December 31, 1996, by contractual maturity, is shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations without call or prepayment penalties. Amortized Fair Cost Value ---- ----- Available-for-sale: Due in one year or less . . . . . . . . . . $ 120,401 $ 121,124 Due after one year through five years . . . 728,552 776,878 Due after five years through ten years. . . 1,214,593 1,277,075 Due after ten years . . . . . . . . . . . . 1,217,528 1,287,987 ------------ ------------ 3,281,074 3,463,064 Mortgage-backed securities . . . . . . . . . . 298,733 300,816 ------------ ------------ $ 3,579,807 $ 3,763,880 ------------ ------------ ------------ ------------ 44 AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 3. INVESTMENTS (Continued) Major categories of investment income are summarized as follows:
1996 1995 1994 ----------- ----------- ----------- Fixed maturity: Tax exempt. . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 123,608 $ 134,506 $ 145,940 Taxable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 120,571 100,611 81,000 ----------- ----------- ----------- 244,179 235,117 226,940 Equity. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21,048 23,328 26,759 Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11,348 11,938 11,754 ----------- ----------- ----------- 276,575 270,383 265,453 Less investment expense. . . . . . . . . . . . . . . . . . . . . . . 2,261 3,814 4,999 ----------- ----------- ----------- Net investment income. . . . . . . . . . . . . . . . . . . . . . . . $ 274,314 $ 266,569 $ 260,454 ----------- ----------- ----------- ----------- ----------- ----------- The change in unrealized gain (loss) on securities available-for-sale is as follows: 1996 1995 1994 ----------- ----------- ----------- Fixed maturity securities available-for-sale . . . . . . . . . . . . . $ (86,209) $ 308,589 $ (346,946) Equity securities available-for-sale . . . . . . . . . . . . . . . . . 8,964 44,921 (46,001) ----------- ----------- ----------- Net change in unrealized gain (loss) on securities available-for-sale . . . . . . . . . . . . . . . . . . . . . . . . . (77,245) 353,510 (392,947) Adjustment for effect on other balance sheet accounts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,214 (11,877) 11,116 Less deferred income taxes . . . . . . . . . . . . . . . . . . . . . . 25,911 (120,756) 133,641 ----------- ----------- ----------- Change in unrealized gain (loss) included in shareholders' equity . . . . . . . . . . . . . . . . . . . . . . . . $ (48,120) $ 220,877 $ (248,190) ----------- ----------- ----------- ----------- ----------- ----------- The realized gain (loss) on investments is summarized as follows: 1996 1995 1994 ----------- ----------- ----------- Available-for-sale: Fixed maturity Gross gain. . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 9,975 $ 5,816 $ 18,977 Gross loss. . . . . . . . . . . . . . . . . . . . . . . . . . . . (11,505) (5,063) (11,300) Equity securities Gross gain. . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 54,169 $ 63,123 $ 36,663 Gross loss. . . . . . . . . . . . . . . . . . . . . . . . . . . . (16,413) (24,264) (29,942) Other, net of expenses . . . . . . . . . . . . . . . . . . . . . . . (688) 1,432 5,538 ----------- ----------- ----------- Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 35,538 $ 41,044 $ 19,936 ----------- ----------- ----------- ----------- ----------- -----------
The Company has estimated the fair value of its investment in mortgage loans on real estate to be $33,943 and $35,591 at December 31, 1996 and 1995, respectively. This estimate was established using a discounted cash flow method based on rating, maturity and future income when compared to the expected yield for mortgages having similar characteristics. 45 AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 3. INVESTMENTS (Continued) The Company had no impaired loans at the end of December 31, 1996 or 1995. A reconciliation of the mortgage loan allowance for losses is as follows:
1995 1994 ----------- ----------- Balance at beginning of year . . . . . . . . . . . . . . . . . . . . $ 4,435 $ 5,968 Provisions for losses. . . . . . . . . . . . . . . . . . . . . . . . 155 76 Releases due to recoveries . . . . . . . . . . . . . . . . . . . . . - (1,222) Releases due to sales. . . . . . . . . . . . . . . . . . . . . . . . (4,330) (387) Transfers to other invested assets . . . . . . . . . . . . . . . . . (260) - ----------- ----------- Balance at end of year . . . . . . . . . . . . . . . . . . . . . . . $ - $ 4,435 ----------- ----------- ----------- -----------
The carrying value of short-term investments and other invested assets approximate fair value. 4. LIABILITY FOR LOSSES AND LOSS ADJUSTMENT EXPENSES Activity in the liability for losses and loss adjustment expense for property and casualty operations is summarized as follows:
1996 1995 1994 ----------- ----------- ----------- Balance as of January 1, net of related reinsurance recoverables . . . . $ 2,294,458 $ 2,377,245 $ 2,458,465 Add: Provision for losses and loss adjustment expense occurring in the current year, net of reinsurance . . . . . . . . . . . . . . . . . . 1,245,580 1,233,627 1,318,224 Decrease in estimated losses and loss adjustment expense occurring in prior years, net of reinsurance . . . . . . . . . . . . (45,705) (39,917) (91,984) ----------- ----------- ----------- Incurred losses and loss adjustment expense during the current year, net of reinsurance . . . . . . . . . . . . . . . . . . . . . . 1,199,875 1,193,710 1,226,240 Deduct: Losses and loss adjustment expense payments for losses, net of reinsurance, occurring during: Current year. . . . . . . . . . . . . . . . . . . . . . . . . . . 653,977 613,580 617,425 Prior years . . . . . . . . . . . . . . . . . . . . . . . . . . . 578,664 662,917 690,035 ----------- ----------- ----------- 1,232,641 1,276,497 1,307,460 ----------- ----------- ----------- Balance as of December 31, net of related reinsurance recoverables . . . 2,261,692 2,294,458 2,377,245 Reinsurance recoverables on losses and loss adjustment expenses at end of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . 164,413 120,117 119,458 ----------- ----------- ----------- Liability for losses and loss adjustment expense, gross of related reinsurance recoverables, at end of year . . . . . . . . . . . . . . . $ 2,426,105 $ 2,414,575 $ 2,496,703 ----------- ----------- ----------- ----------- ----------- -----------
The reconciliation shows a decrease to the liability for estimated losses and loss adjustment expense arising in prior years. Such reserve adjustments, which affected current operations during each of the years, resulted from developed losses from prior years being different than were anticipated when the liability for losses and loss expense were originally estimated. Favorable development trends are partially a result of the change the Company has initiated in its underwriting and claims adjudication practices. These development trends have been considered in establishing the current year liabilities. 46 AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 4. LIABILITY FOR LOSSES AND LOSS ADJUSTMENT EXPENSES (Continued) Included in the liability for losses and loss adjustment expense, net of related reinsurance recoverables, is the liability for environmental and asbestos losses of $250,521 and $241,216 as of December 31, 1996 and 1995, respectively. In establishing liabilities for losses and loss adjustment expense related to environmental and asbestos matters, management considers facts currently known and the current state of the law and coverage litigation. Liabilities are recognized for known losses, including the cost of related litigation, when sufficient information has been developed to indicate the involvement of a specific insurance policy and management can reasonably estimate its liability. In addition, liabilities have been established to cover additional exposures on both known and unasserted losses. Estimates of the liabilities are reviewed and updated continually. Developed case law and adequate claim history do not exist for a portion of the Company's environmental and asbestos exposure, especially because significant uncertainty exists about the outcome of coverage litigation and whether past loss experience will be representative of future loss experience. Management believes the estimated liabilities provided for environmental and asbestos losses at December 31, 1996, are adequate; however, it is reasonably possible that a change in estimate of the required liability could occur in the future. It is not possible to provide a meaningful estimate of a range of possible outcomes at this time. The Company writes personal and commercial lines of property and casualty insurance throughout the United States. As a result, the Company is always at risk that there could be significant losses arising in certain geographic areas from catastrophes, such as earthquakes and hurricanes. In 1996 the Company's property catastrophe reinsurance program, its "primary coverage", provided protection of 93% of $150,000, or approximately $139,500, in excess of a $30,000 retention per occurrence. In 1997, the Company's primary coverage will provide protection of 90% of $150,000, or approximately $135,000, in excess of a $30,000 retention per occurrence. In addition, in 1997 the Company has also purchased an additional coverage layer of 90% of $100,000, or $90,000, in excess of its primary coverage. This additional 1997 layer provides protection solely for non-California earthquake exposure. The Company's policies providing earthquake, hurricane and related coverage in the midwest, western and southeastern coastal areas of the United States could expose the Company to losses exceeding its reinsurance limits. Although the exposure exists, the Company has not encountered losses in excess of its reinsurance limits during the past twenty years. It is also possible that catastrophes could have an adverse effect on the Company's reinsurers. As the Company is not relieved of its primarv obligation to the policyholder in a reinsurance transaction, an event or series of events which render uncollectible any amounts due from its reinsurers could have a material adverse effect on the Company. The following is a reconciliation of the activity in the liability for losses and loss adjustment expense for property and casualty operations to the consolidated balance sheets and statements of income:
1996 1995 1994 ----------- ----------- ----------- Property and casualty incurred losses and loss adjustment expense during the current year, net of reinsurance. . . . . . . . . . . . . . $ 1,199,875 $ 1,193,710 $ 1,226,240 Life insurance benefits and settlement expenses, net of reinsurance . . . . . . . . . . . . . . . . . . . . . . . . . . 49,004 48,560 45,717 ----------- ----------- ----------- Benefits and settlement expenses, net of reinsurance . . . . . . . . . . $ 1,248,879 $ 1,242,270 $ 1,271,957 ----------- ----------- ----------- ----------- ----------- ----------- Liability for property and casualty losses and loss adjustment expense, at end of year. . . . . . . . . . . . . . . . . . . . . . . . $ 2,426,105 $ 2,414,575 $ 2,496,703 Liability for life future policy benefits, at end of year. . . . . . . . 442,243 413,762 381,532 ----------- ----------- ----------- Liability for losses, loss adjustment expense and future policy benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 2,868,348 $ 2,828,337 $ 2,878,235 ----------- ----------- ----------- ----------- ----------- -----------
47 AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 4. LIABILITY FOR LOSSES AND LOSS ADJUSTMENT EXPENSES (Continued)
1996 1995 1994 ----------- ----------- ----------- Reinsurance recoverables on property and casualty losses and loss adjustment expenses, at end of year. . . . . . . . . . . . . . . . . . $ 164,413 $ 120,117 $ 119,458 Reinsurance recoverables on life future policy benefits, at end of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15,032 16,822 18,705 ----------- ----------- ----------- Ceded reinsurance on claims and claims expense reserves, at end of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 179,445 $ 136,939 $ 138,163 ----------- ----------- ----------- ----------- ----------- -----------
5. NOTES PAYABLE AND DEBT DUE LNC In conjunction with the formation of the Company, $100,000 of debt was assumed from LNC ("Assumed Debt"). The Assumed Debt is governed by an agreement between the Company and LNC (the "Assumption Agreement") which provides for the payment by the Company of the currently outstanding 7 1/8% notes due July 15, 1999, originally issued to the public by LNC on July 15, 1992. LNC continues to be the primary obligor of this public debt; however, pursuant to the Assumption Agreement, the Company will make a $100 million principal payment on July 15, 1999 to repay the holders of the public debt. The Assumption Agreement also provides that interest at 7 1/8% is payable semi-annually by the Company. Also in conjunction with the formation of the Company, a $200,000 term note was issued to LNC ("Term Note"). The Term Note will pay interest quarterly at a rate of 50 basis points over the rate on three year Treasury Notes through November 14, 1997, 50 basis points over the rate on two year Treasury Notes from November 15, 1997 through November 14, 1998 and 50 basis points over the rate on one-year Treasury Bills from November 15, 1998 through the maturity date. The current rate of interest on the Term Note is 6.7%. The Term Note will be payable in three equal principal payments due on August 15, 1997, 1998 and 1999. Pursuant to the provisions on the Term Note, the Company will have the right to prepay the Term Note at any time. The Term Note also contains covenants that will, among other things, (i) require the Company to maintain certain levels of adjusted consolidated net worth (as defined in the Term Note), and (ii) restrict the ability of the Company to incur indebtedness in excess of 50% of its adjusted consolidated net worth and to enter into a major corporate transaction unless the Company is the survivor and would not be in default. In 1996, the Company incurred and paid interest cost of $12,372 and $7,218, respectively. Minimum repayments on the outstanding Assumed Debt and Term Note at December 31, 1996 are scheduled as follows: 1997 (included in short-term debt due LNC) . . . . . . . . . . . $ 66,667 1998 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66,667 1999 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 166,667 On May 29, 1996, the Company entered into a revolving credit agreement with third party financial institutions in which the Company may borrow and repay amounts up to a maximum of $200,000 (the "Line of Credit"). Borrowings using the Line of Credit will bear interest generally at variable rates tied to LIBOR, an adjusted certificate of deposit rate or other short-term indices. No debt was outstanding using the Line of Credit at December 31, 1996. 48 AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 6. FEDERAL INCOME TAXES Federal income taxes paid in 1996, 1995 and 1994 were $29,952, $30,045, and $28,556, respectively. The effective tax rate on pre-tax income is lower than the prevailing corporate federal income tax rate. A reconciliation of this difference is as follows:
1996 1995 1994 ----------- ----------- ----------- Tax on pre-tax income at 35% . . . . . . . . . . . . . . . . . . . . . . $ 68,489 $ 73,189 $ 70,093 Add (deduct) tax effect of: Tax exempt bond interest . . . . . . . . . . . . . . . . . . . . . . . (42,286) (47,174) (51,333) Dividends earned . . . . . . . . . . . . . . . . . . . . . . . . . . . (5,482) (5,513) (6,028) 15% of tax exempt interest and dividends received deduction. . . . . . 6,660 7,311 7,828 Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,196 1,196 1,219 Other. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (2,601) 1,839 (6,070) ----------- ----------- ----------- Federal income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . $ 25,976 $ 30,848 $ 15,709 ----------- ----------- ----------- ----------- ----------- ----------- Significant components of net deferred tax assets and liabilities are as follows: 1996 1995 ----------- ----------- Deferred tax assets: Unearned premium reserve . . . . . . . . . . . . . . . . . . . . . . . $ 48,286 $ 48,916 Discounting of losses and loss adjustment expense reserve. . . . . . . 162,094 165,991 Other postretirement benefits. . . . . . . . . . . . . . . . . . . . . 25,596 24,926 Sale/leaseback of building . . . . . . . . . . . . . . . . . . . . . . 7,758 8,000 Nondeductible accruals . . . . . . . . . . . . . . . . . . . . . . . . 21,432 22,879 Other. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24,591 29,607 ----------- ----------- Total deferred tax assets. . . . . . . . . . . . . . . . . . . . . . . . 289,757 300,319 Deferred tax liabilities: Deferred acquisition costs . . . . . . . . . . . . . . . . . . . . . . (64,411) (72,496) Net unrealized gains on securities . . . . . . . . . . . . . . . . . . (88,117) (114,028) Other. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (8,487) (13,148) ----------- ----------- Total deferred tax liabilities . . . . . . . . . . . . . . . . . . . . . (161,015) (199,672) ----------- ----------- Net deferred tax asset . . . . . . . . . . . . . . . . . . . . . . . . . $ 128,742 $ 100,647 ----------- ----------- ----------- -----------
As defined by previous life insurance company tax law, certain amounts were accumulated tax free in a special memorandum account designated as "Policyholders' Surplus Account" and generally are not subject to federal income taxes until distributed to stockholders. The aggregate accumulation in this account is $17,623 at December 31, 1996. No provision has been made for federal income taxes on this account since distributions are not presently contemplated. 7. RESTRICTIONS ON SHAREHOLDERS' EQUITY Generally, the net assets of the Company's insurance subsidiaries available for transfer to ASFC are limited to the amounts that the insurance subsidiaries' net assets, as determined in accordance with statutory accounting practices, exceed minimum statutory capital requirements; however, payments of such amounts as dividends may be subject to approval by regulatory authorities. At December 31, 1996, $7,200 of consolidated shareholders' equity represents net assets of the Company's insurance subsidiaries that cannot be transferred in the form of dividends, loans or advances to ASFC. 49 AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 8. RECONCILIATION WITH STATUTORY ACCOUNTING POLICIES Net income of ASI and subsidiaries, as determined in accordance with statutory accounting practices, was $171,822, $197,058 and $177,654, for 1996, 1995 and 1994, respectively. Consolidated statutory shareholder's equity for ASI was $965,987 and $ 1,010,992 at December 31, 1996 and 1995, respectively. 9. EMPLOYEE BENEFIT PLANS PENSION PLAN. The funded status of the defined benefit pension plan and the amount recognized in the balance sheet are as follows:
1996 1995 ----------- ----------- Actuarial present value of benefit obligation: Vested . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (146,298) $ (134,836) Non vested . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (5,751) (7,909) ----------- ----------- Accumulated benefit obligation . . . . . . . . . . . . . . . . . . . . . (152,049) (142,745) Effect of future compensation increases. . . . . . . . . . . . . . . . . (44,999) (48,595) ----------- ----------- Projected benefit obligation . . . . . . . . . . . . . . . . . . . . . . (197,048) (191,340) Plan assets available for benefits . . . . . . . . . . . . . . . . . . . 187,445 172,913 ----------- ----------- Projected benefit obligation in excess of plan assets. . . . . . . . . . (9,603) (18,427) Unrecognized prior service cost. . . . . . . . . . . . . . . . . . . . . 2,209 2,561 Unrecognized net loss. . . . . . . . . . . . . . . . . . . . . . . . . . 7,342 19,355 ----------- ----------- Prepaid (accrued) pension cost included in the balance sheet . . . . . . $ (52) $ 3,489 ----------- ----------- ----------- ----------- Assumptions used in the foregoing calculations are as follows: 1996 1995 1994 ----------- ----------- ----------- Assumed rate on plan assets. . . . . . . . . . . . . . . . . . . . . . . 9.0% 9.0% 9.0% Weighted average discount rate . . . . . . . . . . . . . . . . . . . . . 7.0 7.0 8.0 Future compensation trends . . . . . . . . . . . . . . . . . . . . . . . 4.5 5.0 5.0 The change in discount rate increased the accumulated benefit obligation by $17,800 as of December 31, 1995. Net pension cost for the defined benefit pension plans includes the following components: 1996 1995 1994 ----------- ----------- ----------- Service cost benefits earned . . . . . . . . . . . . . . . . . . . . . . $ 9,418 $ 8,091 $ 8,982 Interest cost on projected benefit obligation. . . . . . . . . . . . . . 12,482 11,322 10,189 Actual return on assets. . . . . . . . . . . . . . . . . . . . . . . . . (17,547) (31,425) 3,338 Net amortization and deferral. . . . . . . . . . . . . . . . . . . . . . 2,850 20,708 (13,779) Impact of realignment of field operations (see Note 14). . . . . . . . . - 3,029 - ----------- ----------- ----------- Net periodic pension cost. . . . . . . . . . . . . . . . . . . . . . . . $ 7,203 $ 11,725 $ 8,730 ----------- ----------- ----------- ----------- ----------- ----------- POSTRETIREMENT BENEFIT PLAN. The postretirement defined benefit plan is unfunded; however, the details of the amount included in other liabilities are as follows: 1996 1995 ----------- ----------- Accumulated postretirement benefit obligation: Retirees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 28,538 $ 34,715 Fully eligible active plan participants. . . . . . . . . . . . . . . . 11,774 12,746 Other active plan participants . . . . . . . . . . . . . . . . . . . . 16,146 16,384 ----------- ----------- 56,458 63,845 Unrecognized net gain. . . . . . . . . . . . . . . . . . . . . . . . . . 16,648 7,378 ----------- ----------- Accrued postretirement benefit cost. . . . . . . . . . . . . . . . . . . $ 73,106 $ 71,223 ----------- ----------- ----------- -----------
50 AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 9. EMPLOYEE BENEFIT PLANS (Continued) Assumptions used in the foregoing calculation at December 31 are as follows:
1996 1995 1994 ----------- ----------- ----------- Discount rate. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7.0% 7.0% 8.0% Rate of compensation increases . . . . . . . . . . . . . . . . . . . . . 4.5 5.0 5.0 Net periodic postretirement benefit cost includes the following components: 1996 1995 1994 ----------- ----------- ----------- Service cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,685 $ 1,395 $ 2,033 Interest cost. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,700 4,057 4,373 Net amortization and deferral. . . . . . . . . . . . . . . . . . . . . . (1,104) (1,120) (115) ----------- ----------- ----------- Net periodic benefit cost. . . . . . . . . . . . . . . . . . . . . . . . $ 4,281 $ 4,332 $ 6,291 ----------- ----------- ----------- ----------- ----------- -----------
The calculation of the accumulated postretirement benefit obligation assumes a weighted-average annual assumed rate of increase in the per capita cost of covered benefits (i.e., health care cost trend rate) of 8.5% for 1997 gradually decreasing to 5.0% by 2005. The health care cost trend rate assumption has a significant effect on the amounts reported. For example, increasing the assumed health care cost trend rates by one percentage point in each year would increase the accumulated postretirement benefit obligation at December 31, 1996 by $3,952, and the aggregate of the service and interest cost components of net periodic postretirement benefit cost for 1996 by $431. INCENTIVE PLANS. Prior to the initial public offering, certain employees of the Company participated in various incentive plans maintained by LNC. In conjunction with the initial public offering, the Company established various incentive plans for eligible employees that provide for the issuance of stock options, restricted stock, stock appreciation rights, phantom stock or cash. These plans are comprised primarily of stock option incentive plans. Stock options are granted at the market price on the date of grant and, subject to termination of employment, expire 10 years from the date of grant. The options are exercisable in 25% increments on the option issuance anniversary in the four years following issuance. The maximum number of shares which can be granted from the stock option incentive plan is 1,000,000 from the inception of the plan to the plan expiration date on July 1, 2000. During 1996, options for 199,400 shares were granted with an exercise price of $23 per share. None of these options were exercisable nor were any forfeited during the year. In addition, 50,515 restricted shares of the Company's Common Stock were issued to key personnel. The shares are restricted from sale or trade for three years after grant except in a situation relating to death or disability. In addition, at the time restrictions lapse, compensation equal to the amount of dividends that would have been paid during the period the shares were restricted is paid to the personnel. The Company utilizes the intrinsic value method of accounting to determine whether compensation expense should be recognized in conjunction with its stock option incentive plan. As the amount the employee must pay to acquire the stock is equal to the quoted market price of the stock at the grant date, no compensation expense has been recognized for stock option incentive plans. Had compensation expense for the Company's stock option incentive plans for options been determined based on the estimated fair value at the grant date for awards under those plans, the Company's pro forma net income and earnings per share for 1996 would have been $168,266 or $3.01 per share, a decrease of $1,440 or $.02 per share. The effects on 1996 pro forma net income and earnings per share of expensing the estimated fair value of stock options are not necessarily representative of the effects on reported net income for future years due to factors such as the vesting period of the stock options and the potential for issuance of additional stock options in future years. 51 AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 9. EMPLOYEE BENEFIT PLANS (Continued) The fair value of options granted during 1996 were estimated as of the date of grant using a Black-Scholes option pricing model. The option pricing assumptions include a dividend yield of 3.7%; an expected volatility of 30%; a risk-free interest rate of 6.8%; and an expected life of 9 years. The average fair value per option granted during 1996 was $11.12 based on these assumptions. 10. RENT EXPENSE The principal leased property is the home office which is leased through a sale-leaseback agreement. The agreement,which was entered into in 1984, provides for a 25 year lease period with options to renew for six additional terms of five years each. The agreement also provides the Company with the right of first refusal to purchase the property during the term of the lease, including renewal periods, at a price as defined in the agreements. In addition, the Company has the option to purchase the leased property at fair market value as defined in the agreements on the last day of the initial 25 year lease period ending in 2009 or the last day of any of the renewal periods. Rent expense included in benefits and expenses amounted to approximately $16,980, $16,123 and $16,898 in 1996, 1995 and 1994, respectively. At December 31, 1996, future minimum payments, by year and in the aggregate, for noncancelable operating leases with initial or remaining terms of one year or more consisted of the following: 1997 . . . . . . . . . . . . . . . $10,052 1998 . . . . . . . . . . . . . . . 8,808 1999 . . . . . . . . . . . . . . . 8,969 2000 . . . . . . . . . . . . . . . 10,279 2001 . . . . . . . . . . . . . . . 9,938 2002 and thereafter. . . . . . . . 77,750 52 AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 11. REINSURANCE ACTIVITIES The principal sources of reinsurance assumed are national and state associations. Reinsurance is ceded to other companies for risks which exceed retention limits and to provide for catastrophic claims. The effect of reinsurance on premiums written and earned is as follows:
Earned Written ------------------------------------ Property- Property- Casualty Casualty Life Total -------- -------- ---- ----- 1996 Direct . . . . . . . . . . . . . . $1,642,016 $1,650,216 $58,975 $1,709,191 Assumed . . . . . . . . . . . . . . 8,905 15,622 2,596 18,218 Ceded . . . . . . . . . . . . . . . (50,034) (48,603) (4,684) (53,287) ---------- ---------- ------- ---------- Net . . . . . . . . . . . . . . . $1,600,887 $1,617,235 $56,887 $1,674,122 ---------- ---------- ------- ---------- ---------- ---------- ------- ---------- 1995 Direct . . . . . . . . . . . . . . $1,674,470 $1,689,668 $57,872 $1,747,540 Assumed . . . . . . . . . . . . . . 43,481 46,562 2,870 49,432 Ceded . . . . . . . . . . . . . . . (46,391) (46,635) (3,951) (50,586) ---------- ---------- ------- ---------- Net . . . . . . . . . . . . . . . $1,671,560 $1,689,595 $56,791 $1,746,386 ---------- ---------- ------- ---------- ---------- ---------- ------- ---------- 1994 Direct . . . . . . . . . . . . . . $1,657,930 $1,686,388 $54,469 $1,740,857 Assumed . . . . . . . . . . . . . . 55,557 61,031 2,060 63,091 Ceded . . . . . . . . . . . . . . . (58,028) (53,977) (4,000) (57,977) ---------- ---------- ---------- ---------- Net . . . . . . . . . . . . . . . $1,655,459 $1,693,442 $52,529 $1,745,971 ---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Benefits and settlement expenses were reduced by $33,821, $22,904 and $24,399 in 1996, 1995 and 1994, respectively, as a result of ceded reinsurance arrangements. The Company remains contingently liable with respect to losses reinsured in the event any reinsurer is unable to meet obligations assumed. 12. OTHER TRANSACTIONS WITH AFFILIATES On March 29, 1995, the Company purchased 4,986,507 shares, or 29.22% of EMPHESYS Financial Group, Inc. from LNC for $193,227. This investment was accounted for using the equity method and resulted in earnings of $6,449 being included in net investment income through September 30, 1995. On August 22, 1995, a tender offer was extended by Humana, Inc. and on October 7, 1995, the Company tendered its investment in EMPHESYS stock resulting in an after-tax loss of $9,004. In January of 1996, the Company agreed to assume $63.7 million of liabilities, primarily loss and loss adjustment expense reserves, from an affiliate of LNC, on a closed block of specialty lines business. The Company received $63.7 million in assets, primarily cash, as part of the transaction. This run-off business covers primarily property, casualty, accident and health exposures on sports, leisure and entertainment venues. 53 AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 12. OTHER TRANSACTIONS WITH AFFILIATES (Continued) In addition to the above, the Company has various other transactions with LNC and its affiliates in the normal course of operations. These transactions include systems, strategic planning and management advice, financial services, investment services, legal services, accounting services, and assistance with employee benefits, information services, data processing, actuarial, marketing and human resources. In addition, the Company pays to LNC affiliates investment advisory fees. In 1996, 1995 and 1994, the Company paid LNC and its affiliates fees totaling $10,145, $10,454, and $7,614. At December 31, 1995, the Company had $37,910 invested in LNC's short-term investment pool. During 1996, the Company established its own short-term investment pool. In addition, the Company had $31,037 and $40,072, at cost, invested in mutual funds administered by a subsidiary of LNC with a fair value of $40,088 and $41,198 at December 31, 1996 and 1995, respectively. The Company provides supervision and administrative services to wholly-owned property and casualty insurance subsidiaries of LNC. In 1996, 1995 and 1994, LNC paid the Company fees totaling $432, $924, and $625, respectively. LNC paid the Company $7,425, $6,277 and $5,298 during 1996, 1995 and 1994 for administrative services and insurance coverages provided by the Company to LNC. The Company paid LNC $2,757, $6,935 and $2,601 during 1996, 1995 and 1994 for services rendered by LNC to purchase corporate insurance coverages. The Company's life insurance subsidiary paid LNC $4,267, $3,042 and $3,528 during 1996, 1995 and 1994 for reinsurance coverages. 54 AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 13. SEGMENT INFORMATION The Company, operates within the property/casualty and the life insurance industry through a network of independent agents. The property/casualty insurance industry is further broken down into commercial, personal and reinsurance business in runoff. Revenues, pre-tax operation income and identifiable assets for the property/casualty, life and holding company segments are as follows:
Year Ended December 31, ----------------------- 1996 1995 1994 ---- ---- ---- Revenue Property/casualty operations Net premiums earned and other revenue: Personal $ 690,799 $ 684,091 $ 684,903 Commercial 925,680 1,005,364 1,003,209 Reinsurance business in runoff 755 140 5,330 Net investment income 238,227 233,759 230,945 Net realized gain on investments 34,370 38,778 19,228 Loss on operating properties - (28,350) - ---------- ---------- ---------- Total property/casualty operations 1,889,831 1,933,782 1,943,615 ---------- ---------- ---------- Life operations Net premiums earned and other revenue $ 56,888 $ 56,791 $ 52,529 Net investment income 33,975 32,810 29,509 Net realized gain on investments 1,161 2,266 708 ---------- ---------- ---------- Total life operations 92,024 91,867 82,746 Holding company Net investment income $ 2,112 $ - $ - Net realized gain on investments 7 - - ---------- ---------- ---------- Total holding company 2,119 - - ---------- ---------- ---------- Net revenues $1,983,974 $2,025,649 $2.026,361 ---------- ---------- ---------- ---------- ---------- ---------- Pre-tax income Property/casualty operations Underwriting gain (loss): Personal $ (59,955) $ (32,789) $ (49,800) Commercial (1,537) 45,762 4,533 Reinsurance business in runoff (26,639) (69,826) (23,777) Net investment income 238,227 233,759 230,945 Net realized gain on investments 34,211 38,778 19,228 Loss on operating properties - (28,350) - ---------- ---------- ---------- Total property/casualty operations 184,307 187,334 181,129 Total life operations 21,993 21,778 19,138 Holding company (10,618) - - ---------- ---------- ---------- Total pre-tax income $ 195,682 $ 209,112 $ 200,267 ---------- ---------- ---------- ---------- ---------- ----------
55 AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 13. SEGMENT INFORMATION (Continued) 1996 1995 ---- ---- Identifiable assets Property/casualty operations. . . . . . . . . . $4,907,722 $4,981,343 Life operations . . . . . . . . . . . . . . . . 585,726 560,325 Holding company . . . . . . . . . . . . . . . . 1,663,690 1,668,707 Eliminations. . . . . . . . . . . . . . . . . . (1,616,055) (1,671,190) ---------- ---------- Total identifiable assets . . . . . . . . . . $5,541,083 $5,539,185 ---------- ---------- ---------- ---------- The operating expenses of the Company have all been considered to be allocable to the segments since the Company's activities were all directly related to those segments through December 31, 1996. Capital expenditures and depreciation expense are not material. 14. REALIGNMENT OF FIELD OPERATIONS In November 1995, the Company approved a realignment plan which included the consolidation of the field operations from 20 divisional offices into four regional offices. Certain of the locations will be converted to service offices. Those operating properties owned by the Company that will not be used as a regional office will be sold. For each location to be downsized, job classifications, positions to be eliminated and individuals impacted were identified and severance benefits were communicated. This process was started in 1995 with the majority of the Realignment occurring in 1996 and the balance to be completed in 1997. Management estimated that the costs of realignment and valuation allowance for the sale of the operating properties based on independent appraisals with net carrying value representing the lower of cost or market, net of taxes, approximated $13,700 and $18,500, respectively, and was charged to income in 1995; accordingly, net income decreased $32,200. During 1996, the Company sold 4 of the divisional offices. At December 31, 1995, the Company had estimated that it would incur approximately $21,000 related to the various costs associated with the realignment plan and had accrued such costs. Through December 31, 1996, approximately $14,000 of the accrued costs have been paid. Management believes the balance of $7,000 is adequate to cover future expected payments. 15. CONTINGENCIES The Company is routinely involved in pending or threatened legal proceedings. Those proceedings sometimes involve alleged breaches of contract, torts (including bad faith and fraud claims) and miscellaneous other causes of action. Some of the pending litigation includes claims for punitive damages in addition to compensatory damages and other relief. While the aggregate dollar amounts involved in these legal proceedings cannot be determined with certainty, the amounts at issue could have a significant effect on the Company's results of operations. However, based upon information presently available, and in light of legal and other defenses available to the Company, management does not believe that any of these routine proceedings will have a material adverse effect on the financial results or operations of the Company. 56 AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 15. CONTINGENCIES (Continued) On February 14, 1996, three of the Company's property and casualty insurance subsidiaries were among 23 underwriters of real property insurance named defendants in a case brought in the United States District Court for the Western District of Missouri alleging that their underwriting, sales and marketing practices violated a number of civil rights laws (including, without limitation, the Fair Housing Act). The plaintiffs seek to represent themselves and a putative class of similarly situated persons in the State of Missouri. This action seeks injunction relief, unspecified compensatory damages, punitive damages and attorneys' fees. In response to motions filed by the defendants, the court dismissed the conspiracy court by Order dated October 2, 1996 but has required that the defendants answer the remaining counts and discovery has now begun. Management believes, based upon current information, that the Company's underwriting, sales and marketing practices have complied in all material respects with the applicable requirements of both state and federal law. The Company intends to vigorously defend this action. On August 29, 1996, the first of two actions were brought in Missouri state courts alleging that underinsured motorist insurance coverage sold in that state by three of the Company's property and casualty insurance subsidiaries constitutes "phantom coverage" when sold at limits equal to the State's financial responsibility requirements. In both actions, the plaintiffs seek to represent themselves and a putative class of similarly situated persons in the State of Missouri. The actions seek both compensatory and punitive damages based upon a number of legal theories, including, without limitation, breach of fiduciary duty, negligence, breach of contract, unjust enrichment and misrepresentation. While it is too early to fully evaluate the plaintiffs' allegations, the potential defenses available or the size of the putative class of plaintiffs, management does not believe, based upon current information, that the allegations have merit and it therefore intends to defend these actions vigorously. 57 EX-99.3 4 EXHIBIT 99.3 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 1997 OR [ ] 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 1-11733 AMERICAN STATES FINANCIAL CORPORATION INDIANA NO. 35-1976549 State of Incorporation I.R.S. Employer Identification No. 500 NORTH MERIDIAN STREET INDIANAPOLIS, INDIANA 46204-1275 (317) 262-6262 Address of principal executive offices Telephone Number Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [x] No [ ] Shares of common stock outstanding as of July 1, 1997: 60,050,515 DOCUMENTS INCORPORATED BY REFERENCE: Certain portions of the Registrant's Form 8-K, dated June 6, 1997 are incorporated by reference in Part II of this Form 10-Q. The exhibit index to this report is located on page 23. PART I - FINANCIAL INFORMATION ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
June 30, December, 31 1997 1996 ---------- ------------ (Dollars in Thousands) ASSETS Investments: Securities available-for-sale at fair value: Fixed maturity (amortized cost: 1997 - $3,618,363; 1996 - $3,579,807) $3,787,582 $3,763,880 Equity (cost: 1997 - $362,082; $1996 - $362,720) 460,560 435,137 Mortgage loans 21,871 32,293 Short-term investments 74,194 73,276 Other invested assets 39,450 37,986 ---------- ---------- Total investments 4,383,657 4,342,572 Cash 19,338 13,610 Premium receivable 482,774 413,444 Deferred policy acquisition costs 212,250 202,233 Properties to be sold 23,218 30,633 Property and equipment 31,800 31,143 Accrued investment income 64,932 64,602 Current federal income taxes recoverable 4,968 --- Deferred federal income taxes recoverable 121,066 128,742 Cost in excess of net assets of acquired subsidiaries 96,063 97,772 Ceded reinsurance on claims and claims expense reserves 175,149 179,445 Miscellaneous 36,658 36,887 ---------- ---------- Total assets $5,651,873 $5,541,083 ---------- ---------- ---------- ----------
(continued on next page) SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. 2 AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (CONTINUED)
June 30, December, 31 1997 1996 ---------- ------------ (Dollars in Thousands) LIABILITIES AND SHAREHOLDERS' EQUITY Policy liabilities and accruals: Losses, loss adjustment expense and future policy benefits $2,854,688 $2,868,348 Unearned premiums 746,058 711,955 ---------- ---------- Total policy liabilities and accruals 3,600,746 3,580,303 Commissions and other expenses 103,702 120,872 Current federal income taxes payable --- 5,303 Outstanding checks 64,128 69,901 Short-term debt due LNC 66,667 66,667 Notes payable 99,607 99,511 Debt due LNC 133,333 133,333 Other liabilities 166,731 129,154 ---------- ---------- Total liabilities 4,234,914 4,205,044 Shareholders' equity: Common stock, no par value: 195,000,000 shares authorized, shares issued and outstanding: 1997 and 1996 - 60,050,515 304,500 304,493 Net unrealized gain on securities available-for-sale 171,494 163,647 Retained earnings 940,965 867,899 ---------- ---------- Total shareholders' equity 1,416,959 1,336,039 ---------- ---------- Total liabilities and shareholders' equity $5,651,873 $5,541,083 ---------- ---------- ---------- ----------
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. 3 AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME
Three Months Ended Six Months Ended June 30, June 30, 1997 1996 1997 1996 ---------- ------------ ---------- ----------- (Dollars in Thousands, Except Per Share Data) Revenue: Premiums and other revenue $ 429,821 $ 424,483 $ 853,097 $ 848,477 Net investment income 66,525 66,156 133,003 134,489 Realized gain on investments 9,756 7,374 19,443 28,470 Gain on operating properties 4,208 --- 6,671 --- ---------- ----------- ---------- ----------- Total revenue 510,310 498,013 1,012,214 1,011,436 Benefits and expenses: Benefits and settlement expenses 323,369 332,342 620,910 655,905 Commissions 71,657 72,510 140,762 144,382 Operating and administrative expenses 46,949 51,051 98,960 102,224 Taxes, licenses and fees 11,120 8,322 21,857 20,240 Interest on debt 5,227 1,835 10,392 1,835 ---------- ----------- ---------- ----------- Total benefits and expenses 458,322 466,060 892,881 924,586 Income before federal income taxes 51,988 31,953 119,333 86,850 Federal income taxes (credit): Current 4,842 (1,530) 17,617 14,401 Deferred 2,907 3,724 3,450 (4,223) ---------- ----------- ---------- ----------- Total federal income taxes 7,749 2,194 21,067 10,178 ---------- ----------- ---------- ----------- Net income $ 44,239 $ 29,759 $ 98,266 $ 76,672 ---------- ----------- ---------- ----------- ---------- ----------- ---------- ----------- Net income per share $ .74 $ .55 $ 1.64 $ 1.48 ---------- ----------- ---------- ----------- ---------- ----------- ---------- ----------- Weighted average shares outstanding 60,050,515 53,644,692 60,050,515 51,832,414 ---------- ----------- ---------- ----------- ---------- ----------- ---------- -----------
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. 4 AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Six Months Ended June 30, 1997 1996 ---------- ----------- (Dollars in Thousands) Common stock: Balance at beginning of period $ 304,493 $ 387,547 Public offering of common stock --- 215,482 Common stock issued for employee benefit plans 7 1,161 Assumption and issuance of debt in exchange with LNC --- (299,398) ---------- ----------- Balance at end of period 304,500 304,792 Net unrealized gain (loss) on securities available-for-sale: Balance at beginning of period 163,647 211,767 Change during the period 7,847 (97,793) ---------- ----------- Balance at end of period 171,494 113,974 Retained earnings: Balance at beginning of period 867,899 1,069,393 Dividend of assets to LNC prior to public offering --- (299,866) Dividends declared and paid on Common Stock ($.42 per share) (25,200) (46,134) Net income 98,266 76,672 ---------- ----------- Balance at end of period 940,965 800,065 ---------- ----------- Total shareholders' equity $1,416,959 $ 1,218,831 ---------- ----------- ---------- -----------
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. 5 AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
Six Months Ended June 30, 1997 1996 --------- --------- (Dollars in Thousands) CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 98,266 $ 76,672 Adjustments to reconcile net income to cash provided by (used in) operating activities: Deferred policy acquisition costs (9,149) (4,270) Premiums and fees in course of collection (69,330) (37,052) Accrual of discount on investments (9,445) (9,617) Amortization of premium on investments 2,034 2,767 Accrued investment income (331) (1,800) Policy liabilities and accruals 4,183 76,793 Federal income taxes (6,821) (25,110) Provisions for depreciation 3,761 3,850 Gain on sale of investments (19,443) (28,470) Gain on operating properties (6,671) --- Ceded reinsurance on claims and claims expense reserves 4,296 (36,914) Other (11,359) (21,514) --------- --------- Net adjustments (118,275) (81,337) --------- --------- Net cash used in operating activities (20,009) (4,665) CASH FLOWS FROM INVESTING ACTIVITIES Securities available-for-sale: Purchase of investments (335,737) (753,087) Sales of investments 280,360 583,064 Maturities and redemptions 45,070 38,401 Purchase of mortgage loans and other investments (3,836) (7,011) Sale or maturity of mortgage loans and other investments 11,684 3,945 Net increase in short-term investments (918) (59,495) Net sale (purchase) of property and equipment 9,669 (4,472) Other 28,379 16,518 --------- --------- Net cash provided by (used in) investing activities 34,671 (182,137) CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from issuance of common stock 7 215,482 Universal life investment contract deposits 25,334 24,837 Universal life investment contract withdrawals (9,075) (6,605) Dividends paid (25,200) (46,134) --------- --------- Net cash provided by (used in) financing activities (8,934) 187,580 Net increase (decrease) in cash 5,728 778 Cash at beginning of period 13,610 12,708 --------- --------- Cash at end of period $ 19,338 $ 13,486 --------- --------- --------- ---------
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. 6 AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following notes should be read in conjunction with the notes to consolidated financial statements included in the American States Financial Corporation Form 10-K dated February 26, 1997. Unless the context otherwise indicates; (1) the "Company" refers to American States Financial Corporation and its wholly-owned, consolidated subsidiaries; (ii) "ASI" refers to American States Insurance Company, the Company's sole direct wholly-owned subsidiary, and its consolidated subsidiaries; and (iii) the "Subsidiaries" refer to the direct and indirect subsidiaries of the Company, which include ASI and its subsidiaries. Operating results for the six months ended June 30, 1997 are not necessarily indicative of the results that may be expected for the full year ending December 31, 1997. 1. ORGANIZATION AND BASIS OF PRESENTATION On February 5, 1996, the Company was incorporated in the State of Indiana to serve as the holding company for ASI. The formation of the Company was done in contemplation of an initial public offering. On April 22, 1996, ASI declared, and on May 15, 1996, it distributed to its parent, Lincoln National Corporation ("LNC"), a dividend of $300 million, consisting primarily of tax-exempt securities ("Dividended Assets"). On May 16, 1996, LNC transferred all of the outstanding shares of ASI to the Company in exchange for 50,000,000 shares of the Company's common stock. Concurrently with the transfer of the ASI stock, the Company assumed $100 million of LNC debt ("Assumed Debt") and issued a $200 million note to LNC (the "Term Note"). On May 29, 1996, the Company issued 10,000,000 shares of common stock at $23 per share to the public (the "Offering"). The net proceeds from the Offering (after deduction of underwriting discounts and offering expenses) were $215.2 million. The Company contributed $140.5 million of such net proceeds to ASI to enable it to invest in taxable securities for its investment portfolio to partially replace the Dividended Assets. The remainder of the net proceeds were retained by the Company for general corporate purposes. As a result of the Offering, LNC's ownership was reduced to approximately 83%. The 50,000,000 shares held by LNC are "restricted shares" as defined by Rule 144 of the Securities Act of 1993, as amended (the "Securities Act"). Such shares may not be resold in the absence of registration under the Securities Act or exemptions from such registration, including, among others, the exemption provided by Rule 144 under the Securities Act. As an affiliate of the Company, LNC is subject to certain volume restrictions on the sale of shares of the Company's common stock. The Company's common stock is publicly traded on the New York Stock Exchange under the symbol "ASX". The transfer of ASI stock to the Company by LNC in exchange for Company common stock and the Assumed Debt and Term Note have been accounted for similar to a pooling of interests in the consolidated financial statements of the Company, in that the assets, liabilities, shareholders' equity and the results of operation of the Company and its subsidiaries have been combined at historical carrying values. The consolidated financial statements as of and for the six months ended June 30, 1997 and 1996, are unaudited. In the opinion of management, these financial statements include all adjustments, consisting only of normal recurring items, which are necessary to present fairly the Company's financial position and results of operations on a basis consistent with that of prior audited consolidated financial statements. The balance sheet at December 31, 1996, has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. Significant intercompany balances and transactions have been eliminated. Certain amounts from prior periods were reclassified to conform to the 1997 presentation. Net income and shareholders' equity have not been affected by these reclassifications. 7 AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 1. ORGANIZATION AND BASIS OF PRESENTATION (Continued) The Company underwrites property and casualty insurance, concentrating on providing commercial insurance to small to medium-sized businesses and preferred personal lines coverages to individuals. As a complement to its property and casualty operations, the Company also markets life insurance. The Company writes business throughout the United States with the greatest volume in the Midwest and Pacific Northwest. 2. CHANGE IN ACCOUNTING PRINCIPLE In February 1997, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 128 ("FAS 128"), EARNINGS PER SHARE which the Company will adopt in the fourth quarter of 1997. Earlier adoption is not permitted. In accordance with FAS 128, the Company will present "basic" and "diluted" earnings per share on the face of the income statement regardless of the difference between the two calculations. When calculating the diluted earnings per share, the treasury stock method will be applied using the average market price for the period rather than the higher of the average market price or the ending market price. Using the terms of FAS 128, the basic and diluted earnings per share for the first six months of 1997 would be $1.64. The basic and diluted earnings per share for the first six months of 1996 would be $1.48. In June of 1997, the FASB issued Statement 130, "Reporting Comprehensive Income". Statement 130 is effective for fiscal years beginning after December 15, 1997 and ASFC will adopt it in the first quarter of 1998. Adoption will have no effect on net income but will require the reporting of "comprehensive income," which will include net income and certain items currently reported in stockholders' equity. The FASB issued Statement 131, "Disclosures about Segments of an Enterprise and Related Information" in June of 1997. FAS 131 changes the way companies report information about business segments in annual financial statements and requires the reporting of selected segment information in their interim reports. FAS 131 is effective for financial statements for periods beginning after December 15, 1997 except that providing interim information in the initial year (1998) may be deferred until 1999. ASFC plans on providing the required segment information in its 1998 annual report and in its interim reports beginning in 1999. FAS 131 has no effect on net income. 3. FEDERAL INCOME TAXES A consolidated federal income tax return is filed by LNC and includes the Company. Pursuant to an agreement with LNC, the Company provides for income taxes on the basis of a separate return calculation. The taxes computed are remitted to or collected from LNC. The effective tax rate on pre-tax income is lower than the prevailing corporate federal income tax rate primarily due to tax-exempt interest on municipal securities. 8 AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 4. NOTES PAYABLE AND DEBT DUE LNC The Assumed Debt is governed by an agreement between the Company and LNC (the "Assumption Agreement") which provides for the payment by the Company of the currently outstanding 7 1/8% notes due July 15, 1999, originally issued to the public by LNC on July 15, 1992. LNC will continue to be the primary obligor of this public debt; however, pursuant to the Assumption Agreement, the Company is obligated to make a $100 million principal payment on July 15, 1999 to repay the holders of the public debt. The Assumption Agreement also provides that interest at 7 1/8% is payable semi-annually by the Company. The Term Note will pay interest quarterly at a rate of 50 basis points over the rate on three year Treasury Notes through and including November 14, 1997, 50 basis points over the rate on two year Treasury Notes from November 15, 1997 through and including November 14, 1998 and 50 basis points over the rate on one-year Treasury Bills from November 15, 1998 through the maturity date. The current rate on the Term Note is 6.7%. The Term Note is payable in three equal principal payments due on August 15, 1997, 1998 and 1999. Pursuant to the provisions on the Term Note, the Company will have the right to prepay the Term Note at any time. The Term Note also contains covenants that will, among other things, (i) require the Company to maintain certain levels of adjusted consolidated net worth (as defined in the Term Note), and (ii) restrict the ability of the Company to incur indebtedness in excess of 50% of its adjusted consolidated net worth and to enter into a major corporate transaction unless the Company is the survivor and would not be in default. However, as disclosed in Note 6 to the Notes to Consolidated Financial Statements, LNC will be paid the outstanding balance and accrued but unpaid interest thereon of the Assumed Debt and Term Note pursuant to terms of the pending Agreement and Plan of Merger by and among ASFC, SAFECO Corporation and ASFC Acquisition Co. if and when the sale is consummated. On May 29, 1996, the Company entered into a revolving credit agreement in which the Company may borrow and repay amounts up to a maximum of $200 million (the "Line of Credit"). Borrowings using the Line of Credit will bear interest generally at variable rates tied to LIBOR, an adjusted certificate of deposit rate or other short-term indices. No debt was outstanding using the Line of Credit at June 30, 1997. 5. CONTINGENCIES On February 14, 1996, three of the Company's property and casualty insurance subsidiaries were among 23 underwriters of real property insurance named defendants in a case alleging that their underwriting, sales and marketing practices violated a number of civil rights laws (including, without limitation, the Fair Housing Act). It was also alleged that the defendants' actions constituted a civil conspiracy. Brought in the United States District Court for the Western District of Missouri, the plaintiffs sought to represent themselves and a putative class of similarly situated persons in the State of Missouri. This action sought injunctive relief, unspecified compensatory damages, punitive damages and attorney's fees. In response to motions filed by the defendants, the court dismissed the conspiracy count by Order dated October 2, 1996 but required that the defendants answer the remaining counts. On June 19, 1997 the court denied class certification and dismissed the case for lack of standing. On July 17, 1997 the same plaintiffs filed a separate action against the same three property and casualty subsidiaries of the Company. 9 AMERICAN STATES FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 5. CONTINGENCIES (Continued) The plaintiffs in this new case have asked that it be certified as a class action and make substantially the same allegations and seek substantially the same remedies as were sought in the original case. In addition, the plaintiffs filed a notice of appeal in the original case on July 18, 1997. Management believes, based upon current information, that the Company's underwriting, sales and marketing practices have complied in all material respects with the applicable requirements of both state and federal law. The Company intends to defend these actions vigorously. On August 29, 1996, the first of two actions were brought in Missouri state courts alleging that underinsured motorist insurance coverage sold in that state by three of the Company's property and casualty insurance subsidiaries constitutes "phantom coverage" when sold at limits equal to the State's financial responsibility requirements. In both actions, the plaintiffs sought to represent themselves and a putative class of similarly situated persons in the State of Missouri. Both actions sought compensatory and punitive damages based upon a number of legal theories, including, without limitation, breach of fiduciary duty, negligence, breach of contract, unjust enrichment and misrepresentation. A motion to consolidate the two cases has been entered. Discovery has begun. Management does not believe, based upon current information, that the allegations have merit and it therefore intends to defend the consolidated action vigorously. 6. RECENT DEVELOPMENTS On June 6, 1997, ASFC entered into an Agreement and Plan of Merger dated as of the same date (the "Merger Agreement"), by and among ASFC, SAFECO Corporation ("Buyer") and ASFC Acquisition Co., a wholly owned subsidiary of Buyer ("Buyer Sub"). The Merger Agreement provides for, among other things, the merger of Buyer Sub with and into ASFC (the "Merger"), with ASFC surviving the Merger as a wholly owned subsidiary of Buyer. Pursuant to the Merger Agreement and upon consummation of the Merger each outstanding share of Common Stock of ASFC ("ASFC Common Stock") will be converted into the right to receive $47 in cash without interest thereon. Consummation of the Merger is subject to certain conditions, including, among others, (a) the approval by certain state insurance regulators of the Merger and (b) compliance with applicable provisions of the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended (the "HSR Act"). Early termination of the HSR Act waiting period was received on July 15, 1997. In connection with the Merger Agreement, LNC and Buyer entered into a Voting, Support and Indemnification Agreement dated June 6, 1997 (the "Voting Agreement"), certain sections of which were agreed to and acknowledged by ASFC. Pursuant to the Voting Agreement, LNC agreed, among other things, (a) to vote all ASFC Common Stock held by it or any of its subsidiaries in favor of the Merger, the Merger Agreement and the transactions contemplated thereby, (b) to grant Buyer an irrevocable proxy in all ASFC Common Stock held by it or any of its subsidiaries for purposes of a vote at a meeting of the holders of ASFC Common Stock held to consider the Merger and (c) to allocate between LNC and Buyer certain tax and employee benefits liabilities; and Buyer agreed, among other things, to pay to LNC (a) $100 million plus an amount equal to the accrued but unpaid interest on the outstanding 7 1/8% notes due July 15, 1999, originally issued to the public by LNC on July 15, 1992, in consideration of the termination of the agreement relating to the Assumed Debt, and (b) the outstanding principle balance of, plus accrued but unpaid interest on, the Term Note, in consideration of the surrender of the Term Note by LNC to ASFC for cancellation. 10 EX-99.4 5 EXHIBIT 99.4 UNAUDITED PRO FORMA COMBINED CONDENSED FINANCIAL STATEMENTS The following unaudited pro forma combined condensed statements of income of the Company for the six months ended June 30, 1997 and for the year ended December 31, 1996 present results for the Company as if the Acquisition, the Offerings and the other financings consummated by the Company in connection with the Acquisition (including the Related Financings, as hereinafter defined) had occurred at January 1, 1996. See "Capitalization." The accompanying unaudited pro forma combined condensed balance sheet as of June 30, 1997 gives effect to the Acquisition, the Offerings and the other financings consummated by the Company in connection with the Acquisition (including the Related Financings) as if they had occurred as of June 30, 1997. The unaudited pro forma combined condensed financial statements do not purport to represent the Company's financial position or the operating results that would have been achieved had the Acquisition been consummated as of the dates indicated and should not be construed as projecting the Company's future financial position or operating results. The unaudited pro forma combined condensed financial statements do not reflect any projected revenue increases or cost savings. The pro forma adjustments are based on available information and certain assumptions that the Company currently believes are reasonable under the circumstances. The unaudited pro forma combined condensed financial statements should be read in conjunction with the accompanying notes thereto, the historical consolidated financial statements of SAFECO as of and for the year ended December 31, 1996 and the six months ended June 30, 1997 and the historical consolidated financial statements of ASFC as of and for the year ended December 31, 1996 and the six months ended June 30, 1997, in each case incorporated by reference in this Prospectus. The pro forma adjustments are applied to the historical financial statements to account for, among other things, the Acquisition using the purchase method of accounting. Under purchase accounting, the total purchase cost for the Acquisition has been allocated to the assets and liabilities of ASFC based on their fair values. Allocations are subject to valuations as of the date of the Acquisition based on appraisals and other studies which are not yet completed. Accordingly, the final allocations will be different from the amounts reflected herein. Although the final allocations will differ, the unaudited pro forma combined condensed financial statements reflect management's best estimates based on currently available information as of the date of this Prospectus. As part of the Acquisition, SAFECO and Lincoln National Corporation ("Lincoln National"), as the majority shareholder of ASFC, jointly elected to treat the purchase of ASFC by SAFECO as an asset acquisition for federal income tax purposes pursuant to Section 338(h)(10) of the Internal Revenue Code of 1986, as amended. This election allows the Company to deduct the amortization of goodwill recorded in the Acquisition, thereby significantly improving the Company's future cash flows. 1 PRO FORMA COMBINED CONDENSED BALANCE SHEET AS OF JUNE 30, 1997 (UNAUDITED)
HISTORICAL ------------------------- PRO FORMA ADJUSTMENTS PRO AMERICAN INCREASE NOTE FORMA SAFECO STATES (DECREASE) REFERENCE COMBINED ----------- ------------ --------------- --------- ---------- (IN MILLIONS) ASSETS: Investments: Fixed maturities available-for-sale, at market value. . . $12,238.2 $3,787.6 $(600.0) (a) $15,425.8 Fixed maturities held-to-maturity, at amortized cost. . . 2,698.1 - 2,698.1 Marketable equity securities, at market value . . . . . . 1,501.1 460.6 1,961.7 Mortgage loans. . . . . . . . . . . . . . . . . . . . . . 460.3 21.9 482.2 Real estate . . . . . . . . . . . . . . . . . . . . . . . 614.6 - 614.6 Short-term investments. . . . . . . . . . . . . . . . . . 110.1 74.2 184.3 Other invested assets . . . . . . . . . . . . . . . . . . 59.4 39.4 98.8 ---------- -------- ------- --- --------- Total investments . . . . . . . . . . . . . . . . . . . 17,681.8 4,383.7 (600.0) 21,465.5 Cash. . . . . . . . . . . . . . . . . . . . . . . . . . . . 80.5 19.3 (42.0) (b) 57.8 Accrued investment income . . . . . . . . . . . . . . . . . 247.6 64.9 312.5 Finance receivables . . . . . . . . . . . . . . . . . . . . 913.8 - 913.8 Premiums and other service fees receivable. . . . . . . . . 486.9 482.8 969.7 Reinsurance recoverables. . . . . . . . . . . . . . . . . . 129.9 175.1 305.0 Deferred policy acquisition costs . . . . . . . . . . . . . 411.6 212.3 623.9 Deferred federal income taxes recoverable . . . . . . . . . - 121.1 102.5 (b) 0.0 (223.6) (b) Land, buildings and equipment for company use . . . . . . . 171.7 31.8 203.5 Cost in excess of net assets of acquired subsidiaries . . . 41.1 96.1 (96.1) (b) 1,525.1 1,484.0 (b) Other assets. . . . . . . . . . . . . . . . . . . . . . . . 223.9 64.8 288.7 Separate account assets . . . . . . . . . . . . . . . . . . 662.2 - 662.2 ---------- -------- ------- --------- Total assets. . . . . . . . . . . . . . . . . . . . . . . $21,051.0 $5,651.9 $ 624.8 $27,327.7 ---------- -------- ------- --------- ---------- -------- ------- --------- LIABILITIES AND STOCKHOLDERS' EQUITY: Losses, adjustment expense and future policy benefits . . . $2,128.8 $2,854.7 (c) $4,983.5 Unearned premiums . . . . . . . . . . . . . . . . . . . . . 981.7 746.1 1,727.8 Funds held under deposit contracts. . . . . . . . . . . . . 10,402.8 - 10,402.8 Short-term debt . . . . . . . . . . . . . . . . . . . . . . 906.3 66.7 $ (66.7) (a) 1,644.8 738.5 (a) Long-term debt. . . . . . . . . . . . . . . . . . . . . . . 434.9 232.9 (232.9) (a) 634.9 200.0 (a) Other liabilities . . . . . . . . . . . . . . . . . . . . . 669.3 334.5 41.0 (b) 1,044.8 (d) Current federal income taxes payable. . . . . . . . . . . . 12.3 - 12.3 Deferred federal income taxes payable . . . . . . . . . . . 482.1 - (223.6) (b) 258.5 Separate account liabilities. . . . . . . . . . . . . . . . 662.2 - 662.2 ---------- -------- ------- --------- Total liabilities . . . . . . . . . . . . . . . . . . . . 16,680.4 4,234.9 456.3 21,371.6 Company-obligated, mandatorily redeemable capital securities of subsidiary trusts holding solely junior subordinated debentures of the Company. . . . . . . . . . 990.0 (a) 990.0 ---------- -------- ------- --------- Common stock. . . . . . . . . . . . . . . . . . . . . . . . 227.9 304.5 (304.5) (e) 823.4 595.5 (a) Retained earnings . . . . . . . . . . . . . . . . . . . . . 3,190.4 941.0 (941.0) (e) 3,190.4 Unrealized appreciation of investment securities, net of tax 956.6 171.5 (171.5) (e) 956.6 Unrealized loss from foreign currency translation, net of tax. . . . . . . . . . . . . . . . . . . . . . . . (4.3) - (4.3) ---------- -------- ------- --------- Total stockholders' equity. . . . . . . . . . . . . . . . 4,370.6 1,417.0 (821.5) 4,966.1 ---------- -------- ------- --------- Total liabilities and stockholders' equity. . . . . . . . $21,051.0 $5,651.9 $ 624.8 $27,327.7 ---------- -------- ------- --------- ---------- -------- ------- ---------
2 PRO FORMA COMBINED CONDENSED STATEMENT OF INCOME FOR THE SIX MONTHS ENDED JUNE 30, 1997 (UNAUDITED)
HISTORICAL ------------------------- PRO FORMA ADJUSTMENTS PRO AMERICAN INCREASE NOTE FORMA SAFECO STATES (DECREASE) REFERENCE COMBINED ---------- ------------ --------------- --------- ---------- (IN MILLIONS, EXCEPT PER SHARE AMOUNTS) REVENUES: Insurance: Property and casualty earned premiums . . . . . . . . . . $1,176.4 $ 824.1 $2,000.5 Life and health premiums and other revenues . . . . . . . 134.9 29.0 163.9 --------- -------- --------- Total . . . . . . . . . . . . . . . . . . . . . . . . . 1,311.3 853.1 2,164.4 Real estate . . . . . . . . . . . . . . . . . . . . . . . . 32.7 - 32.7 Finance . . . . . . . . . . . . . . . . . . . . . . . . . . 41.0 - 41.0 Asset management. . . . . . . . . . . . . . . . . . . . . . 11.7 - 11.7 Other . . . . . . . . . . . . . . . . . . . . . . . . . . . 25.1 6.7 31.8 Net investment income . . . . . . . . . . . . . . . . . . . 583.7 133.0 $(16.2) (f) 700.5 Realized investment gain. . . . . . . . . . . . . . . . . . 40.8 19.4 60.2 --------- -------- ------- --------- Total revenues. . . . . . . . . . . . . . . . . . . . . . 2,046.3 1,012.2 (16.2) 3,042.3 --------- -------- ------- --------- EXPENSES: Losses, adjustment expense and policy benefits. . . . . . . 1,210.3 620.9 1,831.2 Commissions . . . . . . . . . . . . . . . . . . . . . . . . 226.6 148.3 374.9 Interest. . . . . . . . . . . . . . . . . . . . . . . . . . 37.4 10.4 17.9 (f) 65.7 Other . . . . . . . . . . . . . . . . . . . . . . . . . . . 284.9 122.4 24.8 (f) 431.3 (0.8) (f) Amortization of deferred policy acquisition costs . . . . . 223.1 169.0 392.1 Deferral of policy acquisition costs. . . . . . . . . . . . (236.1) (178.1) (414.2) --------- -------- ------- --------- Total expenses. . . . . . . . . . . . . . . . . . . . . . 1,746.2 892.9 41.9 2,681.0 --------- -------- ------- --------- Income before income taxes . . . . . . . . . . . . . . . . . 300.1 119.3 (58.1) 361.3 Provision (benefit) for federal income taxes . . . . . . . . 71.4 21.0 (13.1) (g) 79.3 --------- -------- ------- --------- Income before distributions on capital securities. . . . . . 228.7 98.3 (45.0) 282.0 Distributions on capital securities, net of tax. . . . . . . - - 26.8 (h) 26.8 --------- -------- ------- --------- Net income available to common stockholders. . . . . . . . . $228.7 $98.3 $(71.8) $ 255.2 --------- -------- ------- --------- --------- -------- ------- --------- Net income per share of common stock: Income before realized gain . . . . . . . . . . . . . . . . $ 1.60 $ 1.56 Realized gain . . . . . . . . . . . . . . . . . . . . . . . .21 .27 --------- --------- Net income per share . . . . . . . . . . . . . . . . . . . . $ 1.81 $ 1.83 --------- --------- --------- --------- Weighted average shares outstanding. . . . . . . . . . . . . 126.3 (i) 139.3
3 PRO FORMA COMBINED CONDENSED STATEMENT OF INCOME FOR THE YEAR ENDED DECEMBER 31, 1996 (UNAUDITED)
HISTORICAL ------------------------ PRO FORMA ADJUSTMENTS PRO AMERICAN INCREASE NOTE FORMA SAFECO STATES (DECREASE) REFERENCE COMBINED ---------- ------------ --------------- --------- ---------- (IN MILLIONS, EXCEPT PER SHARE AMOUNTS) REVENUES: Insurance: Property and casualty earned premiums . . . . . . . . . . $2,275.4 $1,617.2 $3,892.6 Life and health premiums and other revenues . . . . . . . 265.9 56.9 322.8 --------- -------- --------- Total . . . . . . . . . . . . . . . . . . . . . . . . . 2,541.3 1,674.1 4,215.4 Real estate . . . . . . . . . . . . . . . . . . . . . . . . 79.9 - 79.9 Finance . . . . . . . . . . . . . . . . . . . . . . . . . . 75.7 - 75.7 Asset management. . . . . . . . . . . . . . . . . . . . . . 23.2 - 23.2 Other . . . . . . . . . . . . . . . . . . . . . . . . . . . 38.5 - 38.5 Net investment income . . . . . . . . . . . . . . . . . . . 1,116.7 274.3 $ (32.4) (f) 1,358.6 Realized investment gain. . . . . . . . . . . . . . . . . . 90.1 35.6 125.7 --------- -------- ------- --------- Total revenues. . . . . . . . . . . . . . . . . . . . . 3,965.4 1,984.0 (32.4) 5,917.0 --------- -------- ------- --------- EXPENSES: Losses, adjustment expense and policy benefits. . . . . . . 2,362.7 1,248.9 3,611.6 Commissions . . . . . . . . . . . . . . . . . . . . . . . . 415.7 283.0 698.7 Interest. . . . . . . . . . . . . . . . . . . . . . . . . . 72.4 12.4 35.8 (f) 120.6 Other . . . . . . . . . . . . . . . . . . . . . . . . . . . 552.6 243.8 49.5 (f) 844.4 (1.5) (f) Amortization of deferred policy acquisition costs . . . . . 426.9 338.0 764.9 Deferral of policy acquisition costs. . . . . . . . . . . . (443.4) (337.8) (781.2) --------- -------- ------- --------- Total expenses. . . . . . . . . . . . . . . . . . . . . 3,386.9 1,788.3 83.8 5,259.0 --------- -------- ------- --------- Income before income taxes . . . . . . . . . . . . . . . . . 578.5 195.7 (116.2) 658.0 Provision (benefit) for federal income taxes . . . . . . . . 139.5 26.0 (26.2) (g) 139.3 --------- -------- ------- --------- Income before distributions on capital securities. . . . . . 439.0 169.7 (90.0) 518.7 Distributions on capital securities, net of tax. . . . . . . - - 53.6 (h) 53.6 --------- -------- ------- --------- Net income available to common stockholders. . . . . . . . . $ 439.0 $ 169.7 $ (143.6) $ 465.1 --------- -------- ------- --------- --------- -------- ------- --------- Net income per share of common stock: Income before realized gain . . . . . . . . . . . . . . . . $ 3.02 $ 2.75 Realized gain . . . . . . . . . . . . . . . . . . . . . . . .46 .59 --------- --------- Net income per share . . . . . . . . . . . . . . . . . . . . $ 3.48 $ 3.34 --------- --------- --------- --------- Weighted average shares outstanding. . . . . . . . . . . . . 126.1 (i) 139.1
4 NOTES TO UNAUDITED PRO FORMA COMBINED CONDENSED FINANCIAL STATEMENTS (IN MILLIONS, EXCEPT SHARE AMOUNTS) (a) The following adjustments reflect the funding of the Acquisition: SOURCES: Proceeds from issuance of commercial paper (after application of the net proceeds of the Offerings and the issuance of an additional $150 aggregate liquidation amount of capital securities). . . . . . . . $ 738.5 Proceeds from issuance of 6 7/8% Notes due 2007 (the "Senior Notes"). . . . . . . . . . . . . . . . . . . 200.0 Net proceeds from issuance of capital securities. . . . . . 990.0 Net proceeds from issuance of common stock. . . . . . . . . 595.5 Dividend from SAFECO's property and casualty subsidiaries. . . . . . . . . . . . . . . . . . . . . . . 600.0 -------- Total. . . . . . . . . . . . . . . . . . . . . . . . . $3,124.0 -------- -------- USES: Purchase price of outstanding shares of common stock of American States (60,093,615 shares x $47) . . . . . . . . $2,824.4 Retirement of American States debt. . . . . . . . . . . . . 299.6 -------- Total. . . . . . . . . . . . . . . . . . . . . . . . . $3,124.0 -------- -------- (b) The following adjustments result from the allocation of the purchase price for the Acquisition based on the fair value of the net assets acquired: DEBIT (CREDIT) -------- ASSETS: Record the direct out-of-pocket costs of the Acquisition. . $ (42.0) Adjustment to reflect the deferred tax benefit of purchase accounting adjustments. . . . . . . . . . . . . . . . . . 102.5 Net American States' deferred tax asset against SAFECO's deferred tax liability. . . . . . . . . . . . . . . . . . (223.6) Eliminate American States' goodwill . . . . . . . . . . . . (96.1) Record the excess of the cost to acquire American States over the fair value of net assets acquired (goodwill) . . 1,484.0 LIABILITIES: Adjustments to other liabilities: Record lease-related fair value adjustments . . . . . . . $ (18.0) Record the estimated liability for change of control and other costs for certain executive officers and employees of American States. . . . . . . . . . . . . . (30.0) Increase liability for pension obligations. . . . . . . . (9.6) Reduce liability for postretirement obligations . . . . . 16.6 -------- Total adjustments to other liabilities. . . . . . . . . $ (41.0) -------- -------- (c) Adjustments of unpaid loss and loss adjustment expense resulting from the Company's evaluation of American States' reserves will be recorded in operations in the period determined. The Company expects to record $40.0 of additional reserves in the fourth quarter of 1997, which will result in an after-tax charge of $26.0 for such quarter. (d) The Company expects to accrue in the fourth quarter of 1997 an estimated liability of $23.0 ($15.0 after-tax) for first-year incentive commissions on certain American States' personal lines business. (CONTINUED ON NEXT PAGE) 5 (CONTINUED FROM PREVIOUS PAGE) (e) Adjustment to eliminate American States' equity: Common stock. . . . . . . . . . . . . . . . . . . . . . . . $ (304.5) Retained earnings . . . . . . . . . . . . . . . . . . . . . (941.0) Unrealized gain . . . . . . . . . . . . . . . . . . . . . . (171.5) (f) The following adjustments reflect the annual income statement effect of the pro forma adjustments. The income statement adjustments for the six-month period ended June 30, 1997 are equal to one-half of the annual amounts presented: ANNUAL INCREASE (DECREASE) IN PRETAX INCOME --------------- Investment income: Loss of investment income due to dividend from SAFECO's property and casualty subsidiaries ($600.0 x 5.4%, rate based on market yields for tax-exempt securities at September 5, 1997) . . . . $ (32.4) Interest expense: Retire existing American States debt ($100.0 x 7 1/8%, $200.0 x 6.7%). . . . . . . . . . . . . . . . . . . $ 20.5 Commercial paper interest expense ($738.5 x 5.7%) . . (42.1) Senior Notes interest expense ($200.0 x 7.1%) . . . . (14.2) ------- Total interest expense effect . . . . . . . . . . (35.8) ------- Record the amortization of goodwill over 30 years. . . . . (49.5) Record amortization of unfavorable lease obligation. . . . 1.5 ------- Total pretax income effect. . . . . . . . . . . . $(116.2) ------- ------- (g) Record income tax expense (benefit) of the pro forma adjustments . . . . . . . . . . . . . . . . . . . . $ (26.2) (h) Distributions on capital securities, net of tax ($1,000 x 8.25% = 82.5) x (100% - 35%). . . . . . . $ 53.6 The interest rate on the Senior Notes and the distribution rate on the capital securities are based on effective cost, including the cost of an interest rate lock, of the Senior Notes and $850 aggregate liquidation value of 8.072% capital securities (the "8.072% Capital Securities") issued on July 15, 1997. The Company issued $1,500 of commercial paper in late September 1997 ($750 on September 26, 1997 and $750 on September 29, 1997) at interest rates ranging from 5.65% to 5.70% and maturities ranging from October 20, 1997 to January 29, 1998 and used all but $16 to finance the Acquisition. The Company, through a subsidiary trust, may issue an additional $150 aggregate liquidation amount of capital securities in 1997 to retire a like amount of commercial paper. (i) Reflects the issuance of shares of Common Stock at a public offering price of $47.50 per share and gross proceeds of $617.5. 6 -----END PRIVACY-ENHANCED MESSAGE-----