-----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, VlR2GKYrQfffdSt3c/A1LzpcIpzH99UVbRW1OWpHKF11Yf330dkGZbLeY7fvnE76 D+BIp83Dlkm4ttzL1ujoHg== 0000897101-97-000316.txt : 19970326 0000897101-97-000316.hdr.sgml : 19970326 ACCESSION NUMBER: 0000897101-97-000316 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 11 CONFORMED PERIOD OF REPORT: 19961231 FILED AS OF DATE: 19970325 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: LIFE USA HOLDING INC /MN/ CENTRAL INDEX KEY: 0000832989 STANDARD INDUSTRIAL CLASSIFICATION: LIFE INSURANCE [6311] IRS NUMBER: 411578384 STATE OF INCORPORATION: MN FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-18485 FILM NUMBER: 97562845 BUSINESS ADDRESS: STREET 1: STE 95 INTERCHANGE N BLDG STREET 2: 300 S HWY 169 CITY: MINNEAPOLIS STATE: MN ZIP: 55426 BUSINESS PHONE: 6125467386 MAIL ADDRESS: STREET 1: SUITE 95 INTERCHANGE NORTH BUILDING STREET 2: 300 SOUTH HIGHWAY 169 CITY: MINNEAPOLIS STATE: MN ZIP: 55426 10-K 1 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K [X] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the fiscal year ended December 31, l996. [ ] 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 0-18485. Life USA HOLDING, INC. (Exact name of registrant as specified in its charter) Minnesota 41-1578384 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) Suite 95, Interchange North Building 300 South Highway 169 Minneapolis, Minnesota 55426 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (612)-546-7386 Securities registered pursuant to Section 12(b) of the Act: NONE Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.01 Par Value (Title of class) 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 l934 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 ___ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (ss.229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] The aggregate market value of the voting stock (21,262,095 shares) held by non-affiliates of the registrant as of February 14, 1997 was $207,305,426. The number of shares outstanding of the issuer's classes of common stock as of February 14, l997: Common stock, $.01 Par Value - 21,262,095 shares DOCUMENTS INCORPORATED BY REFERENCE Portions of the annual shareholders report for the year ended December 31, 1996 are incorporated by reference into Parts I and II. Portions of the proxy statement for the annual shareholders meeting to be held April 15, 1997 are incorporated by reference into Part III. PART I ITEM 1. BUSINESS GENERAL Life USA Holding, Inc. (the Company) is a national financial services holding and marketing company with $4.39 billion in consolidated assets. LifeUSA Insurance Company (LifeUSA), its largest and most significant wholly-owned subsidiary, is licensed to write and sell life insurance and several forms of annuities through independent field marketing organizations and agents in the District of Columbia and all states except New York. Universal Benefits Life, which markets and administers employee payroll deduction plans, is a division of LifeUSA. During 1996, the Company formed two additional wholly-owned subsidiaries, LifeUSA Securities, Inc. (LifeUSA Securities) and LifeUSA Marketing, Inc. (LifeUSA Marketing). LifeUSA Securities has received approval from the National Association of Securities Dealers, Inc. as a wholesale broker-dealer, will initially market a family of LifeUSA mutual funds established through a joint-venture agreement with a $16 billion asset management firm and is exploring distribution of variable life insurance and annuity contracts. LifeUSA Marketing conducts a variety of marketing activities for the Company, including the acquisition of and investment in national field marketing organizations. During 1996, LifeUSA Marketing acquired Tax Planning Seminars and a minority equity interest in Creative Marketing International Corporation, both national field marketing organizations. The Company's consolidated assets have grown from $1.01 billion at December 31, 1991 to $4.39 billion at December 31, 1996. This growth is founded upon: * Innovative products which offer long-term retirement benefits to consumers who seek protection against outliving their financial resources; * A national marketing and distribution system comprised of independent agents and home office staff; * A conservative investment portfolio with long-term investments comprised of U.S. Treasury securities, U.S. Government agency securities, foreign government obligations denominated in U.S. dollars and issued and traded in the United States, mortgage-backed securities issued or guaranteed by U.S. government corporations or agencies and investment grade corporate obligations; * Arrangements with reinsurers who are highly-rated by A. M. Best Company, Inc. (A. M. Best) which enables LifeUSA to write volumes of business that it would not otherwise have been able to write due to regulatory restrictions based on the amount of its statutory capital and surplus; and * Agreements with Allianz Life Insurance Company of North America (Allianz Life), a highly-rated insurance company, which allow LifeUSA agents to produce life insurance and annuity business on Allianz Life policies which are similar to LifeUSA policies. PRODUCTS LifeUSA has designed its products to emphasize long-term value and benefits. This is what management believes the "baby-boom" generation needs most and the insurance industry is best suited to provide -- long-term benefits in the form of income guaranteed for a lifetime. The economic concern today is not dying too soon, but living too long. By de-emphasizing short-term gain and lump sum cash benefits to those who surrender their policies, LifeUSA's products are less exposed to the disintermediation risk faced by companies selling commodity-type products. A disintermediation risk occurs when current interest rates are higher than the interest rates being earned by a company's existing investment portfolio. The risk is that policyholders will move their funds away from the company to get higher, short-term rates. If the assets supporting the policies are invested long-term to support long-term rates of return and the liabilities offer short-term liquidity, those who surrender their policies for cash take more than their fair share from the company and from persisting policyholders. Management believes that consumer demand for products that meet retirement needs is increasing and will continue to increase in the future due primarily to the aging of the United States population. Management also believes that LifeUSA's products are well-situated to take advantage of this increasing demand. The United States Census Bureau (Census Bureau) reports that persons in the 45-64 age group, as a percentage of the total United States population, will grow from 18.8% in 1990 to 28.0% in 2010. Persons over 65 years old are projected by the Census Bureau to be approximately 59 million, or 20.0% of the total United States population, by the year 2020. Despite this increase, the percentage of employed persons covered by employer-sponsored retirement plans has declined. According to the Census Bureau, only 40% of employed persons are currently covered by an employer-sponsored retirement plan. Moreover, management believes that there is increasing consumer concern as to whether government-sponsored retirement programs, such as Social Security, will continue to provide meaningful retirement benefits. There is, therefore, a growing need for individually-funded financial products to provide a stream of adequate retirement income. LifeUSA offers a portfolio of universal life insurance, annuities and benefit riders. LifeUSA's major products emphasize rewarding long-term policyholders with higher retirement stream-of-income benefits that protect against the cost of living too long. LifeUSA products are designed to appeal to the rapidly expanding retirement market of individuals and affinity groups such as employer/employee associations, unions and state, county and local government organizations (see "Marketing and Distribution" section which follows for further discussion). LifeUSA products compete against the products of other insurance companies on the basis of long-term benefits, not on the basis of short-term interest credited rates or high cash surrender values and liquidity. Policyholder persistency is encouraged by LifeUSA's increased retirement income benefit for long-term policyholders and lower benefits in case of early surrender or lapse. LifeUSA products are designed to permit long-term investment of assets by LifeUSA during the time premiums are being paid, the time benefits are accumulated and the time benefits are being paid out. This product design not only makes the products attractive to certain consumers, but also permits LifeUSA to invest exclusively in high quality, long-term securities which tend to provide higher yields than short-term securities. The target market for the Company's products are consumers with average annual incomes of $25,000 to $60,000. Management believes that this market is not adequately serviced by the insurance industry and that the features of the Company's products will be attractive to these consumers. LIFE INSURANCE PRODUCTS. At December 31, 1996, life insurance account values in force (including business produced by LifeUSA's agents for Allianz Life) aggregated $260.1 million ($174.6 million of which was ceded to reinsurers). The majority of in force life insurance business is paid in annual or more frequent installments. The following describes LifeUSA's most significant life insurance products: Universal Annuity Life(R) I and Universal Annuity Life(R) III The Universal Annuity Life (UAL) products are policies specifically designed to pay the insured as much for living as for dying. At younger ages, when the protection against premature death is needed most, the UAL products provide tax-free benefits for the policyholder's family or business. At retirement, there are a variety of annuitization options available, including the IDEA(R) (see "IDEA" section which follows for further discussion) option which allows payments to increase by as much as 60% if the insured becomes fully disabled. The UAL I and UAL III products are marketed by LifeUSA agents in all states except that product approval by regulatory authorities is pending review in New Jersey for UAL I and New Jersey and Pennsylvania for UAL III. In 1996, the UAL I and UAL III products accounted for 88% of total life insurance premiums. The UAL I and UAL III were introduced in 1990 and 1991, respectively. DUALife(SM) I and DUALife(SM) III The DUALife products are UAL policies specifically designed for dual-income families. DUALife provides simultaneous retirement income, disability and life insurance benefits for two individuals within one policy. It is specifically for families in which both individuals work and provides a death benefit, of equal amount, on both individuals. When one individual dies, a benefit is paid, but the plan continues in effect for the survivor, including cash values, retirement values and post-retirement disability benefits. The DUALife I and DUALife III products are marketed by LifeUSA agents in all states except California, Maryland, Maine, New Hampshire, New Jersey, Pennsylvania, South Carolina and Texas. In 1996, the DUALife I and DUALife III products accounted for less than 1% of total life insurance premiums. DUALife I and DUALife III were both introduced in 1995. ANNUITY PRODUCTS. LifeUSA annuities are designed to offer flexible premium payments and a variety of annuitization options to the annuitant. The product design also protects LifeUSA against the negative effects of disintermediation and other lump sum withdrawals by providing cash surrender values at amounts less than the annuitization values. To encourage persistency, LifeUSA annuities pay enhanced benefits to policyholders who allow the annuity funds to accumulate over the long term and then elect some form of income payout option rather than a lump sum cash payment. At December 31, 1996, annuity account values in force (including business produced by LifeUSA's agents for Allianz Life) totaled $4.88 billion ($3.22 billion of which was ceded to reinsurers). Over 88% of the in force annuities are single premium annuities. The following describes LifeUSA's most significant annuity products and annuity products introduced during 1996 and the first quarter of 1997: Accumulator(SM) Classic The Accumulator Classic (formerly the Accumulator 8) is ideal for the policyholder seeking an excellent return and relatively high liquidity. The policyholder receives an 8% bonus, and after just one year, can elect to receive the entire policy value over as few as five years. The Accumulator Classic accounted for approximately 46% of total annuity premiums in 1996. Approximately 5.9% of such policies annuitize by the first anniversary of the policy. The average premium paid during 1996 on Accumulator Classic annuities issued in 1996 was $25,000. The Accumulator Classic is marketed by LifeUSA agents in all states except Oregon and Washington. The average age of the insured at the issuance of the Accumulator Classic annuity is 58. The Accumulator Classic was introduced in 1988. Accumulator(SM) (Buffet) Series The Accumulator (Buffet) Series offers both high return and flexible liquidity options. Rather than just a single bonus amount and more limited choices for annuitization payouts, the Series offers the flexibility to select from a range of bonuses (5% to 10%) and corresponding payout periods (5 to 10 years). The Accumulator (Buffet) Series accounted for approximately 34% of total annuity premiums in 1996 and is marketed by LifeUSA agents in all states except California, New Jersey, Oregon and Washington. The Accumulator (Buffet) Series was introduced in 1993. IDEA(R) The IDEA -- Individual Disability Escalating Annuity -- is a revolutionary concept in single premium deferred annuity product design. With the IDEA, a policyholder will receive 60% more monthly retirement income in the event of total disability due to illness, accident or old age; the income increase is 30% in the event of partial disability. The increased income benefit is paid as long as the disability lasts, even for life. The IDEA accounted for less than 1% of total annuity premiums in 1996 and is marketed by LifeUSA agents in all states except Kansas, New Jersey, Oregon, Pennsylvania and Washington. In late 1992, the IDEA feature was added to all new UAL I and UAL III policies, with the exception of policies sold in Kansas, New Jersey, Pennsylvania and Washington. The IDEA was introduced in 1992. ANNU-A-DEX(SM) The ANNU-A-DEX is a single premium fixed annuity offering an initial 7% premium bonus, with an additional benefit tied to the performance of the S&P 500(R) Index. The appeal of the product is that one can buy a competitive fixed annuity, with principal and interest guaranteed, and should the S&P 500(R) Index outperform the annuity over a seven-year period, one-half of the incremental growth is added to the value of the annuity. While not an investment product, the ANNU-A-DEX is positioned as an alternative "safe haven" for investment funds. An investor can "lock-in" current gains and still participate, should the stock market continue to rise, all with no down-side exposure. The ANNU-A-DEX accounted for less than 1% of total annuity premiums in 1996 and is marketed by LifeUSA agents and issued by Allianz Life in all states except Florida, Indiana, New Jersey, North Dakota, Oklahoma, Oregon and Washington. The ANNU-A-DEX was introduced in 1996. IDEAL(SM) Annuity The IDEAL annuity is unique in that it provides up to 10 years of protection against interest rate changes (increases and decreases). When issued, the IDEAL annuity offers a base credited rate, plus a 1.5% annual interest bonus, both guaranteed for five years. Thus, the policyholder is protected against a decline in interest rates for the next five years. At the end of the first five-year term, the policyholder has the option to "re-enter" the policy at the interest rate being credited on new issues. The new credited rate, plus another 1.5% annual interest bonus, is then guaranteed for a new five-year term. Thus, the policyholder is also protected against a rise in interest rates. The IDEAL annuity is marketed by LifeUSA agents in all states except Connecticut, Florida, Illinois, Indiana, Maryland, Montana, New Jersey, North Carolina, North Dakota, Oklahoma, Oregon, Pennsylvania, South Carolina, Texas, Utah, Washington, West Virginia and Wisconsin. The IDEAL annuity was introduced in the first quarter of 1997. MARKETING AND DISTRIBUTION As of March 25, 1997, 146 independent field marketing organizations (FMOs) and 51,000 agents were licensed to market LifeUSA's policies and produce business for Allianz Life. All FMOs and agents are independent contractors and are responsible for their operating and marketing expenses. The FMOs coordinate and pay for the marketing of LifeUSA's products and provide recruiting, training and management of the agents contracted through them. Depending on the system it uses and the market in which it operates, an FMO may have a few agents or as many as several thousand agents. LifeUSA provides marketing support to FMOs through marketing training seminars, product demonstrations, product literature and home office support. The FMO receives a gross cash commission from LifeUSA on business produced and, within specified LifeUSA guidelines, allocates such commissions among its agents. Cash commissions as a percentage of first year premiums are higher for life insurance sales than annuity sales. Commissions are based on a percentage of the targeted annual premiums and consist of both a higher first year commission and a lower renewal commission on premiums paid on a policy after the first year. FMOs and agents are subject to a chargeback of all or a portion of the commissions paid in the event a life insurance policy is canceled or surrendered, including cancellations for the non-payment of premiums, within the first 13 months of issuance. As is customary in the industry, LifeUSA advances agents up to an aggregate of 50% of first year commissions when life insurance policies are sold even though most of the premiums have not yet been received. LifeUSA contracts include a financial guaranty by the FMOs for chargebacks and advances to the agents within the FMO's organization. Since its inception, the Company has issued its common stock or granted options to purchase its common stock to FMOs and agents as production bonuses. Management believes that these forms of equity participation provided agents in the early years with additional incentives to place profitable business with LifeUSA, to encourage policyholder persistency and to seek good underwriting risks for LifeUSA. From 1992 through March 31, 1997, stock options were granted to FMOs and agents at an exercise price which was equal to the greater of $10.00 per share or 150% of the average closing bid price for the Company's common stock for the twenty trading days immediately preceding the end of the calendar quarter for which the stock option was granted (see "Agent and Employee Ownership" section which follows for further discussion). The Company will discontinue the granting of stock options as production bonuses after stock options earned by FMOs and agents during the calendar quarter ended March 31, 1997 have been granted. Today, management believes that the Company's entire agent compensation package, which includes LifeUSA's standard cash commissions, annual cash production bonuses for major producers and Producer Perks Certificates which are redeemable for merchandise and earned by achieving certain levels of production, will, along with its proven service and product offerings, continue to encourage strong agent participation. Although LifeUSA's larger and more successful FMOs and agents tend to produce a majority of their business with LifeUSA, there is no requirement that they do so. FMOs and agents may also be contracted with other life insurance companies. Each FMO essentially serves as a "wholesaler" for LifeUSA. A typical FMO consists of one or more highly experienced individuals who have demonstrated the ability to build, manage and supervise a marketing organization that is producing, or has the potential to produce, a minimum of $500,000 in annual life and annuity commissions. During 1996, one FMO accounted for 11% of LifeUSA's total production. Although no other single FMO accounted for more than 10% of LifeUSA's total production, the top FMOs (including their respective agents) produced the following portions of LifeUSA's total business during 1996: Percent of CPCs (1) ------------------- Top 5 FMOs 32% Top 10 FMOs 49% Top 25 FMOs 81% - ---------------------------------- (1) CPCs (Combined Production Credits) are a measurement of the life insurance and annuity business produced. During 1996, the Company developed a strategy to generate additional premium production from LifeUSA's existing agents and from new production sources by making loans to or investing in FMOs and by recruiting new FMOs to sell its products. The amount of any loan or investment relates to the revenue currently generated by the FMO and the projected increase in business produced for LifeUSA by the FMO. To date, the Company has made loans to FMOs that account for 31% of the Company's 1996 life insurance and annuity production. The loans include incentives for achieving increased production. In addition, in August 1996, LifeUSA Marketing acquired Tax Planning Seminars, a national FMO that had been contracted with LifeUSA for seven years and in November 1996, acquired an equity interest in Creative Marketing International Corporation, another national FMO that had not been contracted previously with LifeUSA. The Company has made and expects to continue to make future investments by issuing shares of its common stock and paying cash from its available resources ($5.6 million of fixed maturity investments - available for sale and cash and cash equivalents as of December 31, 1996 on an unconsolidated basis), cash generated from operations, cash dividends from LifeUSA and borrowings under its $30 million line of credit (no amounts outstanding at December 31, 1996). In addition, during 1996, the Company signed marketing agreements with 31 national FMOs to market LifeUSA life insurance and annuity products for the first time. There can be no assurances that the Company's premium volume or income will be enhanced by the loans to or investments in FMOs or by the contracting of new national FMOs. Management believes that the overall reduction in employer-funded employee benefit plans, coupled with certain tax incentives for individual retirement planning, has created a large and rapidly growing market for insurance and annuity products for affinity groups such as employer/employee associations, unions, state, county and city governments and teachers. These insurance and annuity products are normally provided to such employee benefit plans through payroll deduction. The payroll deduction market offers the opportunity for multiple sales at one location. Management believes that LifeUSA's products are especially attractive in the payroll deduction market because of their emphasis on long-term value and benefits. Universal Benefits Life, a division of LifeUSA organized in 1992 to provide supplemental employee retirement plans through payroll deduction, continued to benefit from the employer-sponsored market during 1996. By the end of 1996, 38,000 employees were participating in 5,000 plans issued and administered by Universal Benefits Life. REINSURANCE In the insurance industry, one company (the ceding company) may share the rewards and risks associated with business it produces with another insurance company (the assuming company) through reinsurance. Reinsurance gives the assuming company a share of the policy premiums and future profits associated with the portion of the business that it has assumed, in exchange for commissions and expense allowances paid to the ceding company that are based on a percentage of the policy premiums. At the same time, reinsurance also requires the assuming company to pay a share of the future policy benefits associated with the portion of the business it has assumed from the ceding company. Upon the issuance of a policy, statutory accounting requires commissions and other policy issuance costs to be expensed and statutory reserves for policy benefits which in the aggregate exceed first year premiums to be established, thereby creating a statutory loss during the first year in which a life insurance policy or annuity contract is in force. As a result, the retention or assumption of new business places a strain on the insurer's statutory capital and surplus. When a company reinsures business it writes, it is generally not required to use its statutory capital and surplus to establish reserves for the portion of the business ceded to the assuming company. Rather, the assuming company generally maintains the required reserves for the portion of the business assumed from the ceding company, thereby reducing the strain on the ceding company's statutory capital and surplus. In addition, the commissions and expense allowances paid to the ceding company by the assuming company provide an additional source of working capital to be used to support the production of additional new business by the ceding company. Since its inception in 1987, LifeUSA has entered into various agreements to reinsure a substantial portion of the new life insurance and annuity business written each year. Entering into these reinsurance agreements has allowed LifeUSA to write a larger volume of business than it would otherwise have been able to write due to regulatory restrictions based on the amount of its statutory capital and surplus. In addition, under the terms of agreements between the Company and Allianz Life, LifeUSA agents have produced life insurance and annuity business on Allianz Life policies which are similar to LifeUSA's policies. LifeUSA has assumed a portion of this business under reinsurance agreements. The Company receives commissions and expense allowances on the portions of the LifeUSA life insurance and annuity products reinsured and service fees on business produced by LifeUSA's agents and written by Allianz Life. The commissions and expense allowances and service fees received on life insurance policies are approximately 150% of the first-year planned target premium and range from 12 1/2% to 18% of renewal and first-year excess premiums. The Company also receives commissions and expense allowances and service fees ranging from 6 1/2% to 22% on annuity deposits. An additional allowance equal to .20% of the account value of all annuities issued after April 1, 1991 is received as of the beginning of policy years two through ten. Since its inception, LifeUSA has modified its net retention (the percentage of new life insurance and annuity business retained by LifeUSA and assumed by LifeUSA from Allianz Life) to the extent that its statutory capital and surplus has been able to support such changes. During 1996, net retention was maintained at a constant 25% and LifeUSA produced a statutory net income of $13.2 million. As a result, the Company did not make significant capital contributions to LifeUSA during 1996. Based on currently anticipated life insurance and annuity sales, projected statutory profits from LifeUSA's mature block of in force business and the continuation of acceptable reinsurance arrangements, the Company does not expect to contribute capital to LifeUSA through 1997 in order to maintain adequate levels of statutory capital and surplus. The Company may further alter the level of its retention and assumption of new business depending upon future levels of production, capital needs and availability of alternative financing. From inception through December 31, 1996, the Company has contributed $122.5 million to LifeUSA in order to maintain LifeUSA's desired levels of statutory capital and surplus. Although the Company does not expect to contribute capital to LifeUSA through 1997 in order to maintain adequate levels of statutory capital and surplus, management believes that the combination of (i) the anticipated increase in cash flow during 1997 and the anticipated reduction in capital requirements for new business retained or assumed by LifeUSA associated with maintaining net retention at 25%, (ii) the statutory profits generated by LifeUSA on the mature business which it has retained or assumed, (iii) the $5 million in proceeds that remained at December 31, 1996 from the $30 million convertible subordinated debenture issued to Allianz Life in February 1995 and (iv) the availability of the $30 million line of credit from two of its reinsurers, will provide sufficient capital resources to support the capital needs of LifeUSA through 1997, based on currently anticipated life insurance and annuity sales and on the continuation of acceptable reinsurance arrangements. Reinsurance Ceded LifeUSA ceded from 95% to 100% of its new life insurance and annuity business to Transamerica Occidental Life Insurance Company (TOLIC) from 1987 through March 31, 1991, and from April 1, 1991 through December 31, 1992 ceded 100% of its new business equally to the following three reinsurers (the Reinsurers): * Employers Reassurance Corporation, a subsidiary of Employers Reinsurance Corporation, a member of the General Electric Company group; * Munich American Reassurance Company, a subsidiary of Munich Reinsurance Company, one of the largest German insurance companies; and * Republic-Vanguard Life Insurance Company, a member of the Winterthur Swiss Insurance Group, one of the largest Swiss insurance companies. From 1990 through 1992, TOLIC and the Reinsurers retroceded 25% to 30% of this business back to LifeUSA. Effective December 31, 1992, the retrocession agreement with the Reinsurers was terminated with respect to new business written by LifeUSA after that date. From 1993 through 1995, LifeUSA retained a portion of its new business and ceded the remainder equally to the Reinsurers. Effective January 1, 1996, Munich American Reassurance Company reduced its share of the new business ceded by LifeUSA to the Reinsurers to 20%, while both Employers Reassurance Corporation and Republic-Vanguard Life Insurance Company increased their share of this business to 40%. During 1994, an agreement was reached with TOLIC and the Reinsurers to unwind the retrocession agreements in effect from 1990 through 1992 and record all business written under the terms of those agreements as direct reinsurance. As a result, LifeUSA has accounted for all business previously retroceded to LifeUSA from TOLIC and the Reinsurers as being retained by LifeUSA and all business ultimately assumed by TOLIC and the Reinsurers as being ceded to TOLIC and the Reinsurers by LifeUSA at issuance. This change had no impact on the Company's financial position or operating results for any period presented. All disclosures in this document reflect the unwinding of the retrocession agreements as discussed in this paragraph. The following table shows the percentages of new life insurance and annuity business written by LifeUSA that have been ceded to TOLIC and the Reinsurers since inception: Life Insurance Annuity -------------- ------- September 1987 - December 1988 100% 100% January 1989 - December 1989 95 100 January 1990 - December 1990 75 75 January 1991 - December 1992 70 75 January 1993 - June 1993 65 65 July 1993 - September 1995 50 50 October 1995 - Present 75 75 Because of the initial and regular review of LifeUSA's products and operations by the reinsurers, the reinsurance arrangements have had the additional benefit of providing the Company access to the expertise of the reinsurers which has assisted in the development of underwriting standards, the analysis of product pricing and the development of actuarial assumptions. LifeUSA does not have any risk of loss with respect to the reinsured portions of the policies unless a reinsurer fails to pay its share of policy claims. LifeUSA is ultimately liable for payment to policyholders of all claims which the reinsurers fail to pay. Management does not believe, however, that LifeUSA has more than a remote exposure on the reinsured business. LifeUSA has also entered into agreements with the reinsurers whereby LifeUSA limits its mortality risk exposure to $50,000 per life. Management believes that its relations with the reinsurers are good. Reinsurance Assumed All new life insurance and annuity business produced by LifeUSA's agents and written by Allianz Life from 1987 through 1994 was ceded to TOLIC. Effective January 1, 1990, LifeUSA entered into a retrocession agreement with TOLIC to assume a portion of this business. During 1994, LifeUSA terminated the retrocession agreement with TOLIC and entered into an agreement with Allianz Life to assume a portion of this business directly from Allianz Life effective January 1, 1995. The following table shows the percentages of new life insurance and annuity business produced by LifeUSA's agents and written by Allianz Life that have been assumed by LifeUSA since inception: Life Insurance Annuity -------------- ------- September 1987 - December 1989 --% --% January 1990 - December 1990 25 25 January 1991 - December 1991 30 25 January 1992 - June 1993 50 30 July 1993 - September 1995 50 50 October 1995 - Present 25 25 AGREEMENTS WITH ALLIANZ LIFE Since 1987, under the terms of agreements between the Company and Allianz Life, LifeUSA agents have produced life insurance and annuity business on Allianz Life policies which are similar to LifeUSA policies. These agreements require the Company to provide all administrative and other home office services and to pay for all commissions due LifeUSA agents and premium taxes on the business produced for Allianz Life. For these services, Allianz Life pays service fees to the Company. LifeUSA has assumed a portion of this business under reinsurance agreements (see the preceding "Reinsurance Assumed" section for further discussion). For the years 1992 through 1996, the Company derived the following amounts of service fees from Allianz Life under the terms of these agreements: Year Ended Percent of December 31, Service Fees Revenues ----------- -------------- ----------- (In thousands) 1992 $ 49,795 34 % 1993 69,593 35 1994 58,062 28 1995 60,031 22 1996 63,222 20 UNDERWRITING All life insurance business is subject to standard underwriting procedures as agreed to by the Reinsurers, using Munich American's underwriting manual. Republic-Vanguard is the reinsurer currently charged with the responsibility of reviewing the underwriting practices of LifeUSA and performing periodic audits (once per year) of LifeUSA's compliance with underwriting procedures and results. There are minimal underwriting requirements with regard to annuity business. LifeUSA can underwrite all life policies with a face amount up to $500,000 without approval of Republic-Vanguard. Amounts above this level require individual evaluation by Republic-Vanguard. As appropriate, varying requirements, including tests, medical exams and personal financial statements, may be required at higher ages and/or larger face amounts of insurance. INVESTMENTS The Company's long-term investment portfolio is comprised of U.S. Treasury securities, U.S. Government agency securities, foreign government obligations denominated in U.S. dollars and issued and traded in the United States, mortgage-backed securities issued or guaranteed by U.S. government corporations or agencies and investment grade corporate obligations. The Company has never invested in real estate, private direct mortgages or below investment-grade securities. The Company engages Investment Advisers, Inc. (IAI), a Minneapolis-based investment advisory firm, and Allianz Investment Corporation (AIC), an affiliate of Allianz Life, to serve as the Company's investment advisers. At December 31, 1996, assets managed for customers by IAI and AIC exceed $16 billion and $19 billion, respectively. IAI and AIC effect purchases of investment securities for the Company based on the Company's guidelines. The investment philosophy of LifeUSA is reflected by investment guidelines adopted by the Board of Directors of the Company in 1990 and reaffirmed annually, as follows: SIZE: no more than 2% of the Company's invested assets in any issuer other than direct or guaranteed United States obligations, no more than 25% of invested assets in any industry, and no more than 2% of any issue other than direct or guaranteed United States obligations; QUALITY: minimum quality of "BBB-" or better, average quality "A" or better; DURATION: match to liabilities, allow for sufficient liquidity and cash flow matching; and INCOME: manage to maintain or increase income, excluding capital gains. As of December 31, 1996, the Company had cash, cash equivalents and fixed maturity investments on a consolidated basis totaling $1.90 billion, including $7.6 million in restricted deposits with state insurance authorities regulating LifeUSA. The following table summarizes the book, carrying and market values of each investment category held at December 31 (dollars in thousands):
Book % of Carrying % of Market % of 1996: Value Total Value Total Value Total - ----- ----- ----- ----- ----- ----- ----- Cash and cash equivalents $ 20,989 1.11% $ 20,989 1.10% $ 20,989 1.10% Government Treasury and Agency notes and bonds 98,982 5.24 100,909 5.30 104,537 5.46 Mortgage pass-throughs 46,085 2.44 46,804 2.46 46,836 2.45 Agency Collateralized Mortgage Obligations: CMO - Sequential pay 6,260 .33 6,260 .33 6,284 .33 CMO - Planned amortization class 615,995 32.63 615,556 32.36 616,286 32.22 CMO - Accretion directed class 23,484 1.24 23,484 1.23 23,672 1.24 CMO - Targeted amortization class 11,970 .63 11,970 .63 12,675 .66 Investment grade corporate securities: AAA+ to AAA- 36,749 1.95 36,900 1.94 37,930 1.98 AA+ to AA- 153,408 8.12 153,276 8.06 154,056 8.05 A+ to A- 485,766 25.72 491,040 25.81 493,102 25.78 BBB+ to BBB- 388,898 20.59 395,277 20.78 396,662 20.73 Non-investment grade corporate securities -- -- -- -- -- -- ----------- ------ ----------- ------ ----------- ------ Total $1,888,586 100.00% $ 1,902,465 100.00% $ 1,913,029 100.00% ========== ====== =========== ====== =========== ====== Book % of Carrying % of Market % of 1995: Value Total Value Total Value Total - ----- ----- ----- ----- ----- ----- ----- Cash and cash equivalents $ 33,222 1.95% $ 33,222 1.89% $ 33,222 1.85% Government Treasury and Agency notes and bonds 96,435 5.66 101,895 5.81 107,660 5.99 Mortgage pass-throughs 32,104 1.88 33,347 1.90 33,667 1.87 Agency Collateralized Mortgage Obligations: CMO - Sequential pay 5,445 .32 5,445 .31 5,507 .31 CMO - Planned amortization class 616,271 36.17 620,785 35.39 638,969 35.53 CMO - Accretion directed class 23,426 1.38 23,426 1.34 24,524 1.36 CMO - Targeted amortization class 11,862 .70 11,862 .68 13,228 .74 Investment grade corporate securities: AAA+ to AAA- 43,650 2.56 44,015 2.51 46,694 2.60 AA+ to AA- 123,941 7.28 129,105 7.36 132,157 7.35 A+ to A- 325,710 19.12 339,005 19.33 346,502 19.26 BBB+ to BBB- 391,379 22.98 411,980 23.48 416,454 23.14 Non-investment grade corporate securities -- -- -- -- -- -- ----------- ------ ----------- ------ ----------- ------ Total $1,703,445 100.00% $ 1,754,087 100.00% $ 1,798,584 100.00% ========== ====== =========== ====== =========== ======
The following table sets forth the investment results of the Company:
Year ended December 31, --------------------------------------------- 1996 1995 1994 ---- ---- ---- (Dollars in thousands) Weighted average investments (1) $ 1,793,926 $ 1,521,355 $ 1,072,650 Investment income (2) $ 130,032 $ 109,656 $ 75,002 Yield on weighted average investments (3) 7.25% 7.21% 6.99% Net realized gains on investments $ 1,791 $ 7,634 $ 1,183
- --------------------------------------------- (1) The average book value of investments held during the year calculated on a monthly basis. (2) Before related investment expenses and excluding net realized gains on investments. (3) Excluding net realized and unrealized gains and losses on investments. As part of its asset and liability management practices, LifeUSA manages investments and credited interest rates to produce a net investment spread consistent with priced-for expectations. The investment portfolio is managed primarily by allocating new cash flows into investments which have yield, maturity and other characteristics suitable for LifeUSA's liabilities. Consistent with LifeUSA's asset and liability management practices, as of December 31, 1996, the modified duration of LifeUSA's fixed income securities was 6.01 years, compared to 6.26 years as of December 31, 1995. The percentage of the total market value of the Company's portfolio that was comprised of investment grade corporate obligations was 57% at December 31, 1996. With each corporate security acquisition, LifeUSA's external managers perform a comprehensive analysis of the credit implications and outlook of the issuing corporation and industry. Ongoing procedures are also in place for monitoring and assessing any potential deterioration or downgrade in credit quality. The Company's guidelines for investing in corporate securities does not allow the purchase of securities that are rated below investment grade by Moody's Investors Service and/or Standard & Poor's Corporation. The remainder of the Company's portfolio is comprised of government and government agency obligations. Government and government agency obligations are predominantly held in the form of Planned Amortization Class (PAC) CMOs, the most conservative type of CMO issued. These CMOs are specifically structured to provide the highest degree of protection against swings in repayments caused primarily by changes in interest rates and have virtually no risk of default. These securities are well-suited to fund the payment of the liabilities they support. Currently, the decision as to the asset type in which to invest is dictated by market conditions and relative values within the respective markets at the time of purchase. Management believes that these asset types will allow the Company to maintain high quality, consistent yields and proper maturities for the overall portfolio. As of December 31, 1996, the Company held 46%, or $878 million, of the total market value of its long term securities as available for sale. The Company believes that this percentage is a prudent level that will allow enough liquidity to meet any adverse cash flow experience. The Company continues to classify a significant portion of its investment securities as held to maturity based on its intent to hold such securities to maturity. A key feature of LifeUSA's products is the provision of bonuses to encourage policyholders to withdraw their funds over settlement periods lasting at least five years. Policyholders taking cash settlements do not receive the bonuses. This feature allows the Company to hold a significant amount of assets to maturity. Insurance regulations require LifeUSA to perform an asset adequacy analysis each year to determine if the assets are sufficient to fund future obligations. The Company's asset adequacy analysis indicates that the assets are sufficient to fund future obligations. The Company continually monitors and modifies the allocation of new assets between held to maturity and available for sale as deemed prudent based on the continuing analysis of cash flow projections and liquidity needs. Agent and Employee Ownership Historically, the Company has issued a variety of equity-based financial instruments (common stock, convertible subordinated debentures and stock options) to LifeUSA's agents and the Company's home office employees in order to provide these individuals with an ownership interest in the Company and create an important incentive to produce premiums and maintain profitable operations. From 1992 through March 31, 1997, the Company granted stock options as commission bonuses to LifeUSA's agents based on net earned commissions on business written. The Company will discontinue the granting of stock options as production bonuses after stock options earned by FMOs and agents during the calendar quarter ended March 31, 1997 have been granted. The Company also has a stock option plan for employees under which employees on the anniversary date of their employment receive options on a number of shares of common stock equal to 1% of their annual salary at an exercise price per share of not less than 150% of the market value of a share of Common Stock on the date the option is issued. The Company will continue to grant stock options to employees. Home Office Support Management believes that quality service, responsiveness and support to agents and to policyholders have been and continue to be critical to agent retention, policyholder satisfaction and cost-effective operations. As a result of their ownership interests in the Company, home office employees have a special commitment to their jobs and are therefore called "home office owners." An example of home office responsiveness created by this commitment is the "48-hour challenge." If an insurance application conforming to normal standards is not completed within 48 hours, the agent receives $100. For 1996, over 60,000 applications were submitted and only 57 challenges were paid. At December 31, 1996, the Company employed 412 full-time and 22 part-time persons, and the number of persons performing home office functions were as follows: Number of Home Office Function Employees -------------------- --------- Executive 17 Operations 174 Support 92 Marketing 57 Information Services 40 Universal Benefits Life (payroll deduction) 54 The Company's employees are not represented by a collective bargaining unit. The Company considers its general relations with its employees to be excellent. Regulation LifeUSA is subject to regulation in the 49 states in which it is authorized to do business. The laws of these states establish supervisory agencies with administrative powers related to granting and revoking licenses to transact business, approving the form and content of policies, reviewing the advertising and illustration of policies, licensing agents, establishing reserve requirements and regulating the type and amount of investments. Such regulations are primarily intended to protect policyholders. The Company is also regulated in several states as an insurance holding company. The insurance regulatory framework continues to be reviewed by various states and by the National Association of Insurance Commissioners (NAIC). Regulatory initiatives such as risk-based capital standards have been undertaken to identify inadequately capitalized companies and to reduce the risk of company insolvencies. The NAIC has established risk-based capital standards to determine the capital requirements of a life insurance company based upon the risks inherent in its operations. LifeUSA's percentage of actual total adjusted capital to authorized control level risk-based capital is well in excess of regulatory requirements. As a result of the production of statutory net income of $13.2 million during 1996, the Company did not make significant capital contributions to LifeUSA during 1996 and, based on currently anticipated life insurance and annuity sales and the continuation of reinsurance arrangements, the Company does not expect to contribute capital to LifeUSA through 1997 in order to maintain an acceptable risk-based capital ratio. The NAIC has also considered changes in the model laws for nonforfeiture values of life insurance and deferred annuity products. Since 1994, LifeUSA has made presentations to and had discussions with the Life/Health Actuarial Task Force of the NAIC, which is responsible for developing new model laws for nonforfeiture values. LifeUSA demonstrated that its two-tier products use longer-term, higher-yielding investments to provide higher retirement values to policyholders, while decreasing disintermediation and solvency risks to LifeUSA. Although it is possible that the NAIC may adopt new model laws addressing nonforfeiture values in the future, such adoption is not currently anticipated to have a significant impact on LifeUSA. NAIC committees are also considering a new annuity illustration model regulation, a new approach to statutory valuation of liabilities (reserves) and regulations for equity-indexed products. The Company is monitoring these developments and no significant impact is anticipated at this time. In December 1995, the NAIC passed a model regulation for disclosure in life insurance policy illustrations. A number of states either have adopted the model regulation by its January 1, 1997 effective date or are in the process of adopting the model regulation. LifeUSA has already completed the certification process required by the model regulation. This regulation has not had and is not anticipated to have a significant impact on LifeUSA. Insurance laws also require LifeUSA to file detailed periodic reports with the regulatory agencies in each of the states in which it writes business, and these agencies may examine LifeUSA's business and accounts at any time. Under NAIC rules, one or more of the regulatory agencies will periodically examine LifeUSA, normally at three-year intervals, on behalf of the states in which LifeUSA is licensed. During 1996, the Minnesota Department of Commerce conducted a triennial examination of LifeUSA for the three years ended December 31, 1995. The Company expects to receive the final examination report in the near future and has not been made aware of any issues or recommendations that will be material individually or in the aggregate. In April 1996, the B++ (Very Good) rating initially assigned LifeUSA in June 1994 was reaffirmed by the A.M. Best Company. The A. M. Best Company assigns the B++ rating to companies which, in its opinion, have achieved very good overall performance when compared to the standards established by the A. M. Best Company. B++ companies have a good ability to meet their obligations to policyholders over a long period of time. In December 1996, Standard & Poor's assigned LifeUSA an initial claims-paying ability rating of BBB+ (Adequate). Standard & Poor's assigns the BBB+ rating to insurers which, in its opinion, offer adequate financial security, but capacity to meet policyholder obligations is susceptible to adverse economic and underwriting conditions. The Company is subject to the Minnesota insurance holding company laws and applicable regulations which require it to file certain information regarding the Company primarily relating to ownership and transactions between it and each life insurance subsidiary, and to obtain prior approval for certain changes of control and certain extraordinary transactions, including certain distributions or dividend payments. Approval by the Minnesota Department of Commerce is required for LifeUSA to pay dividends in any 12 month period in an amount exceeding the lesser of (i) 10% of the insured's statutory earned surplus at the end of the preceding year or (ii) the insured's statutory net gain from operations, not including realized capital gains, for the year preceding the distribution, both of which are determined in accordance with the Minnesota insurance laws and regulations. Although LifeUSA did not have any earned surplus at December 31, 1996, the Department of Commerce of the State of Minnesota allowed its request to pay a $2.5 million extraordinary dividend to the Company during February of 1997. The Company does not currently intend to pay dividends to its common shareholders. Competition The industry in which the Company operates is highly competitive, with many competitors offering diverse products through various alternative marketing or distribution systems. The Company's products compete not only with life insurance and annuities but with other retirement-oriented financial products. Many of the Company's competitors have substantially greater financial resources and more established products. Nonetheless, management believes that LifeUSA's unique and innovative products will continue to attract policyholders to LifeUSA and its products. Competition for FMOs and agents with demonstrated ability is also intense. However, management believes that LifeUSA has been able to attract and will continue to be able to attract, motivate and retain productive, independent FMOs and agents by providing innovative products and quality service. Forward-Looking Statements Statements other than historical information contained in this Annual Report are considered forward-looking and involve a number of risks and uncertainties. In addition to the factors discussed in this Annual Report, there are other factors that could cause actual results to differ materially from expected results including, but not limited to, development and acceptance of new products, impact of changes in federal and state regulation, dependence upon key personnel, changes in interest rates generally and credited rates on the new business retained or assumed by LifeUSA, the level of premium production, competition and other risks described from time to time in the Company's Securities and Exchange Commission filings, including but not limited to this Form 10-K, copies of which are available from the Company without charge. ITEM 2. PROPERTIES Under leases expiring in February 2001, the Company leases approximately 144,000 square feet of office space at Interchange North Building, 300 South Highway 169, Minneapolis, Minnesota. See Note 6 of the Notes to Consolidated Financial Statements included in the annual shareholder report for the year ended December 31, 1996 as incorporated herein by reference for additional information regarding the lease commitments. Based on the Company's business plan, management believes the Company's current facilities will be adequate through 1997. ITEM 3. LEGAL PROCEEDINGS As of the date hereof, the Company was not involved in any material legal proceedings. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS There was no matter submitted to the vote of security holders during the fourth quarter of 1996. EXECUTIVE OFFICERS OF THE REGISTRANT Set forth below are the executive officers of the Company, their ages and titles:
Name Age Title ------------------- --- ---------------------------------------------------------------- Robert W. MacDonald 54 Chairman and Chief Executive Officer Margery G. Hughes 46 President and Chief Operating Officer Mark A. Zesbaugh 32 Executive Vice President, Chief Financial Officer , Treasurer and Secretary Daniel J. Rourke 67 Senior Vice President and Chief Marketing Officer Donald J. Urban 55 Senior Vice President and Director of Sales Bradley E. Barks 37 Senior Vice President Finance Bruce D. Bengtson 47 Senior Vice President and Chief Actuary
PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS MARKET INFORMATION The Company's common stock trades on the Nasdaq National Market Tier of The Nasdaq Stock Market under the symbol: "LUSA." Over-the-counter market quotations reflect inter-dealer prices without retail mark-up, mark-down or commissions and may not necessarily represent actual transactions. The following table shows the range of high and low sales prices per share of the Company's common stock as reported by Nasdaq for the periods indicated. High Low -------- -------- 1996 ------------ 4th Quarter $ 12.00 $ 8.63 3rd Quarter 9.25 7.75 2nd Quarter 9.38 7.63 1st Quarter 9.88 7.63 1995 ------------ 4th Quarter $ 9.25 $ 7.63 3rd Quarter 10.13 8.25 2nd Quarter 10.50 8.63 1st Quarter 11.38 7.19 As of February 14, 1997, there were 7,950 holders of record of the Company's common stock. On March 24, 1997, the closing sale price per share of the Company's common stock as reported by Nasdaq was $10.38. DIVIDENDS Since its inception, the Company has not paid any dividends on its common stock. Currently, the Company's Board of Directors has a policy of retaining earnings for future growth, and the Company does not anticipate paying dividends on its common stock in the near future. In addition, there are statutory and regulatory limitations upon the extent to which dividends may be paid to the Company from an insurance subsidiary, including the restriction that an insurance company may only pay dividends out of earned surplus. Approval by the Minnesota Department of Commerce is required for LifeUSA to pay dividends in any 12-month period in an amount exceeding the lesser of (i) 10% of the insured's statutory earned surplus at the end of the preceding year or (ii) the insured's statutory net gain from operations, not including realized capital gains, for the year preceding the distribution, both of which are determined in accordance with the Minnesota insurance laws and regulations. Although LifeUSA did not have any earned surplus at December 31, 1996, the Department of Commerce of the State of Minnesota allowed its request to pay a $2.5 million extraordinary dividend to the Company during February of 1997. ITEM 6. SELECTED FINANCIAL DATA Selected Consolidated Financial and Operating Data on pages 4 and 5 of the annual shareholder report for the year ended December 31, 1996 is incorporated herein by reference. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Management's Discussion and Analysis of Financial Condition and Results of Operations on pages 6 through 18 of the annual shareholder report for the year ended December 31, 1996 is incorporated herein by reference. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The consolidated financial statements included on pages 19 through 44 of the annual shareholder report for the year ended December 31, 1996 are incorporated herein by reference. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information contained on pages 4 and 5 and page 8 of Life USA Holding, Inc.'s Proxy Statement dated March 12, 1997, under the captions "Business Experience of Directors" and "Section 16(a) Beneficial Ownership Reporting Compliance" with respect to directors and executive officers of the Company, is incorporated herein by reference in response to this item. ITEM 11. EXECUTIVE COMPENSATION The information contained on pages 6 through 13 of Life USA Holding, Inc.'s Proxy Statement dated March 12, 1997, under the captions "Compensation of Directors," "Executive Compensation," "Compensation Committee Interlocks and Insider Participation," "Report of the Compensation Committee and the Stock Option Committee on Executive Compensation" and "Common Stock Price Performance Chart" with respect to executive compensation and transactions, is incorporated herein by reference in response to this item. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information contained on pages 2 and 3 of Life USA Holding, Inc.'s Proxy Statement dated March 12, 1997, under the caption "Principal Shareholders and Security Ownership of Management Table" with respect to security ownership of certain beneficial owners and management, is incorporated herein by reference in response to this item. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information contained on page 6 of Life USA Holding, Inc.'s Proxy Statement dated March 12, 1997, under the caption "Arrangements with Directors, Nominees, Executive Officers and Their Family Members" with respect to certain relationships and related transactions, is incorporated herein by reference in response to this item. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a)(1) The following consolidated financial statements of Life USA Holding, Inc. included in the annual shareholder report for the year ended December 31, 1996 are incorporated herein by reference in Item 8: Consolidated Balance Sheet as of December 31, 1996 and 1995 Consolidated Statement of Income for the years ended December 31, 1996, 1995 and 1994 Consolidated Statement of Cash Flows for the years ended December 31, 1996, 1995 and 1994 Consolidated Statement of Shareholders' Equity for the years ended December 31, 1996, 1995, and 1994 Notes to Consolidated Financial Statements Report of Independent Auditors (a)(2) The following consolidated financial statement schedules of Life USA Holding, Inc. required by Item 14(d) are included in a separate section of this Report: II Condensed Financial Information of Registrant III Supplementary Insurance Information IV Reinsurance V Valuation and Qualifying Accounts All other schedules to the consolidated financial statements required by Article 7 of Regulation S-X are not required under the related instructions or are inapplicable and therefore have been omitted. (a)(3) Listing of Exhibits The Exhibits required to be a part of this Report are listed in the Index to Exhibits which follows the Financial Statement Schedules. (b) Reports on Form 8-K None. (c) Exhibits Included in Item 14(a)(3) above. (d) Financial Statement Schedules Included in Item 14(a)(2) above. SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of l934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Life USA HOLDING, INC. By /s/ Mark A. Zesbaugh ------------------------------ Mark A. Zesbaugh Executive Vice President and Chief Financial Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. /s/ Robert W. MacDonald Chief Executive Officer March 25, 1997 - ------------------------ (Principal Executive Officer) Robert W. MacDonald and Director /s/ Mark A. Zesbaugh Chief Financial Officer March 25, 1997 - ------------------------ (Principal Financial and Mark A. Zesbaugh Accounting Officer) and Director * Director - ------------------------ Hugh Alexander * Director - ------------------------ Jack H. Blaine * Director - ------------------------ Joseph W. Carlson * Director - ------------------------ Margery G. Hughes * Director - ------------------------ Barbara J. Lautzenheiser * Director - ------------------------ Robert J. Oster * Director - ------------------------ Daniel J. Rourke * Director - ------------------------ Ralph Strangis * Director - ------------------------ Donald J. Urban *By /s/ Mark A. Zesbaugh March 25, l997 ----------------------- Mark A. Zesbaugh Attorney-in-Fact * Mark A. Zesbaugh, on his own behalf and pursuant to Powers of Attorney, dated prior to the date hereof, attested by the officers and directors listed above and filed with the Securities and Exchange Commission, by signing his name hereto does hereby sign and execute this Report of Life USA Holding, Inc. on behalf of each of the officers and directors named above, in the capacities in which the name of each appears above. SCHEDULE II Page 1 Life USA HOLDING, INC. CONDENSED FINANCIAL INFORMATION (PARENT COMPANY ONLY) BALANCE SHEET (Dollars in thousands, except per share amounts)
ASSETS December 31, December 31, 1996 1995 --------- --------- Fixed maturity investments - available for sale, at fair value (amortized cost: $5,190 at December 31, 1996 and $13,204 at December 31, 1995) $ 5,392 $ 14,333 Cash and cash equivalents 182 57 Fixed assets and leasehold improvements, net 5,652 4,160 Investments in subsidiaries, net 206,722 183,273 Deferred income taxes 1,937 998 Other assets 6,382 8,443 --------- --------- $ 226,267 $ 211,264 ========= ========= LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities: Other policyholders' funds $ 3,028 $ 2,091 Amounts due reinsurers 231 150 Accounts payable 6,617 4,478 Accrued commissions to agents 4,029 4,315 Convertible subordinated debentures 36,030 36,030 Other liabilities 3,717 7,304 --------- --------- Total liabilities 53,652 54,368 Shareholders' equity: Preferred stock, $.01 par value; 15,000,000 shares authorized, none issued -- -- Common stock, $.01 par value; 45,000,000 shares authorized, 20,953,517 shares issued and outstanding (20,279,343 shares at December 31, 1995) 210 203 Common stock to be issued, 21,384 shares (45,404 shares at December 31, 1995) 357 382 Additional paid-in capital 86,474 80,931 Notes receivable from stock sales (3,888) -- Unrealized gain on fixed maturity investments - available for sale 3,335 12,707 Retained earnings 86,127 62,673 --------- --------- Total shareholders' equity 172,615 156,896 --------- --------- $ 226,267 $ 211,264 ========= =========
SCHEDULE II Page 2 Life USA HOLDING, INC. CONDENSED FINANCIAL INFORMATION (PARENT COMPANY ONLY) STATEMENT OF INCOME (Dollars in thousands) Year ended December 31, ------------------------------ 1996 1995 1994 -------- -------- -------- Revenues: Management fees $ 32,476 $ 29,389 $ 24,707 Net investment income 1,378 1,825 1,003 Commissions and expense allowances, net 63,222 59,286 57,027 Equity in income of wholly-owned subsidiaries 21,321 16,083 10,814 Other 316 8 -- -------- -------- -------- Total revenues 118,713 106,591 93,551 Expenses: Commissions 38,133 36,483 35,113 Salaries and employee benefits 24,720 19,189 14,064 Depreciation and amortization 1,246 676 771 Interest expense 1,982 1,785 474 Other 27,609 27,168 25,892 -------- -------- -------- Total expenses 93,690 85,301 76,314 -------- -------- -------- Income before income taxes 25,023 21,290 17,237 Income taxes 1,569 2,193 2,768 -------- -------- -------- Net income $ 23,454 $ 19,097 $ 14,469 ======== ======== ======== SCHEDULE II Page 3 Life USA HOLDING, INC. CONDENSED FINANCIAL INFORMATION (PARENT COMPANY ONLY) STATEMENT OF CASH FLOWS (Dollars in thousands)
Year ended December 31, 1996 1995 1994 -------- -------- -------- Cash flows from operating activities: Net income $ 23,454 $ 19,097 $ 14,469 Adjustments to reconcile net income to net cash provided by operating activities (10,147) (1,660) (8,703) -------- -------- -------- Net cash provided by operating activities 13,307 17,437 5,766 Cash flows from investing activities: Fixed maturity investments - available for sale: Purchases -- (22,954) (861) Proceeds from maturities and principal payments on mortgage-backed securities -- 1,660 1,825 Investment in LifeUSA Insurance Company -- (23,675) (13,606) Investment in LifeUSA Securities, Inc. (285) -- -- Investment in LifeUSA Marketing, Inc. (9,250) -- -- Loans to field marketing organizations (1,219) -- -- Acquisition of Fidelity Union Life Insurance Company -- -- (1,100) Capital expenditures (2,629) (3,079) (491) -------- -------- -------- Net cash used in investing activities (13,383) (48,048) (14,233) Cash flows from financing activities: Proceeds from exercise of stock options and warrants 226 195 937 Proceeds from convertible subordinated debenture issuance -- 30,000 -- Other financing activities (25) 230 282 -------- -------- -------- Net cash provided by financing activities 201 30,425 1,219 -------- -------- -------- Net (decrease) increase in cash and cash equivalents 125 (186) (7,248) Cash and cash equivalents at beginning of the year 57 243 7,491 -------- -------- -------- Cash and cash equivalents at end of the year $ 182 $ 57 $ 243 ======== ======== ======== Cash paid during the year for interest $ 1,984 $ 1,223 $ 473 ======== ======== ======== Cash paid during the year for income taxes $ 2,032 $ 2,550 $ 2,354 ======== ======== ======== Supplemental schedule of noncash investing and financing activities: Issuance of stock upon conversion of convertible subordinated debentures $ -- $ 11 $ 309 Cancellation of convertible subordinated debentures -- -- 1 Issuance of stock to employees as compensation 1,436 831 943 Fixed assets contributed to LifeUSA Insurance Company 1,362 1,766 997
SCHEDULE III - SUPPLEMENTARY INSURANCE INFORMATION Life USA HOLDING, INC. AND SUBSIDIARIES (Dollars in thousands)
Col. A Col. B Col. C Col. D Col. E Col. F Future policy Deferred benefits, Other policy policy losses, claims claims and acquisition and loss Unearned benefits Premium Segment costs expenses (1) premiums payable revenue (2) - ------------------------------ ----------- ------------ ---------- ------------ --------- Year ended December 31, 1996: Life insurance and annuities $ 212,138 $4,078,621 $ -- $ -- $ 46,842 ========== ========== =========== ============ ========== Year ended December 31, 1995: Life insurance and annuities $ 175,296 $3,566,012 $ -- $ -- $ 35,983 ========== ========== =========== ============ ========== Year ended December 31, 1994: Life insurance and annuities $ 174,702 $2,877,447 $ -- $ -- $ 21,659 ========== ========== =========== ============ ========== [WIDE TABLE CONTINUED FROM ABOVE] Col. G Col. H Col. I Col. J Benefits, Amortization claims, of deferred Net losses and policy Other investment settlement acquisition operating Segment income expenses (3) costs expenses - ------------------------------ ----------- ------------ ---------- ---------- Year ended December 31, 1996: Life insurance and annuities $ 129,412 $ 116,931 $ 24,495 $ 138,407 ========== ========== ========== ========== Year ended December 31, 1995: Life insurance and annuities $ 109,092 $ 99,363 $ 22,096 $ 121,361 ========== ========== ========== ========== Year ended December 31, 1994: Life insurance and annuities $ 74,510 $ 65,111 $ 11,643 $ 106,527 ========== ========== ========== ==========
- ------------------------------- (1) Amounts shown are gross with respect to amounts recoverable from reinsurers of $2,166,116, $1,853,540 and $1,593,025 at December 31, 1996, 1995 and 1994, respectively. The liabilities net of related amounts recoverable from reinsurers are $1,912,505, $1,712,472 and $1,284,422 at December 31, 1996, 1995 and 1994, respectively. (2) Includes policyholder charges. (3) Includes interest credited to policyholder account values and other benefits to policyholders. Column K (Premiums written) has not been included as it does not apply to life insurance.
SCHEDULE IV - REINSURANCE Life USA HOLDING, INC. AND SUBSIDIARIES (Dollars in thousands) Col. A Col. B Col. C Col. D Col. E Col. F Percentage Ceded to Assumed of amount Gross other from other Net assumed amount companies companies amount to net ------------- ------------- ------------- ------------- ------- Year ended December 31, 1996: Life insurance in force $ 6,428,513 $ 4,747,188 $ 704,009 $ 2,385,334 29.5% ============= ============= ============= ============= ======= Premiums: Life insurance $ 61,973 $ 40,341 $ 7,254 $ 28,886 25.1% Annuities 547,748 397,566 115,461 265,643 43.5% ------------- ------------- ------------- ------------- ------- $ 609,721 $ 437,907 $ 122,715 $ 294,529 41.7% ============= ============= ============= ============= ======= Year ended December 31, 1995: Life insurance in force $ 6,270,169 $ 4,666,062 $ 730,804 $ 2,334,911 31.3% ============= ============= ============= ============= ======= Premiums: Life insurance $ 60,869 $ 38,518 $ 7,604 $ 29,955 25.4 % Annuities 585,739 312,325 167,857 441,271 38.0% ------------- ------------- ------------- ------------- ------- $ 646,608 $ 350,843 $ 175,461 $ 471,226 37.2% ============= ============= ============= ============= ======= Year ended December 31, 1994: Life insurance in force $ 5,585,565 $ 4,132,874 $ 662,138 $ 2,114,829 31.3% ============= ============= ============= ============= ======= Premiums: Life insurance $ 54,928 $ 36,271 $ 6,785 $ 25,442 26.7% Annuities 481,138 249,803 175,257 406,592 43.1% ------------- ------------- ------------- ------------- ------- $ 536,066 $ 286,074 $ 182,042 $ 432,034 42.1% ============= ============= ============= ============= =======
SCHEDULE V - VALUATION AND QUALIFYING ACCOUNTS Life USA HOLDING, INC. AND SUBSIDIARIES (Dollars in thousands) Col. A Col. B Col. C Col. D Col. E ------------------------------ Balance Charged to Balance at beginning costs and Charged to at end of period expenses other accounts Deductions of period ------------ ---------- -------------- ---------- --------- Year ended December 31, 1995: Reserve and allowances deducted from asset accounts: Valuation allowance for deferred tax assets $ 8,578(2) -- -- $ 8,578(1) --
- ----------------------------------------------------- (1) Due to the fact that an unrealized gain on fixed maturity investments - available for sale was recorded as a separate component of shareholders' equity at both December 31, 1996 and December 31, 1995, the deferred tax assets and related valuation allowance recorded at December 31, 1994 were no longer required. (2) Established to cover 100% of the deferred tax assets recorded for unrealized losses on fixed maturity investments available for sale and included in the unrealized loss on fixed maturity investments-available for sale shown as a separate component of shareholders' equity. ANNUAL REPORT ON FORM 10-K ITEM 14(a)(3) AND 14(c) EXHIBITS Life USA HOLDING, INC. INDEX TO EXHIBITS
Regulation S-K Exhibit Table Sequential Item Reference Page No. ---- -------------- ---------- Restated Articles of Incorporation of the Company................................. 3(12) Bylaws of the Company............................................................. 3(3) Amendment to Bylaws of the Company................................................ 3(7) Form of Stock Certificate......................................................... 4(11) Form of Option Certificate........................................................ 4(12) Form of Debenture filed as part of Indenture between the Company and Continental Bank, National Association............................................................. 4(8) Indenture between the Company and Continental Bank, National Association, as trustee, dated as of April 1, 1991...................... 4(8) Warrant dated as of October 1, 1992 to Lions Gate Capital, Ltd. covering 192,000 shares of common stock at an exercise price of $10.00 per share, subject to adjustment....................................... 4(16) Service Agreement dated January 27, 1988 between the Company and North American Life and Casualty Company......................... 10(2) Agreement dated April 6, 1987 with Transamerica Insurance Corporation of California........................................................ 10(1) Life Coinsurance Agreement effective September 1, 1987 between Transamerica Occidental Life Insurance Company and Universal Security Assurance Life Insurance Company and Addendum thereto............................................................. 10(3) Amendment to Life Coinsurance Agreement effective January 1, 1989.................................................................. 10(2) Addenda No. 2, 3, 4 and 5 to Life Coinsurance Agreement between LifeUSA and Transamerica Occidental Life Insurance Company................................................................ 10(13) Addenda No. 6, 7 and 8 to Life Coinsurance Agreement between LifeUSA and Transamerica Occidental Life Insurance Company....................... 10(20) Life and Annuity Retrocession Agreement effective January 1, 1990 between LifeUSA and Transamerica Occidental Life Insurance Company................................................ 10(13) Addenda No. 1, 2 and 3 to Life and Annuity Retrocession Agreement between LifeUSA and Transamerica Occidental Life Insurance Company............... 10(20) Termination Addendum to Life and Annuity Retrocession Agreement between LifeUSA and Transamerica Occidental Life Insurance Company....................... 10(20) Life and ADB YRT Retrocession Agreement between LifeUSA and Transamerica Occidental Life Insurance Company effective January 1, 1990........................................................ 10(14) Addendum No. 1 to Life and ADB YRT Retrocession Agreement between LifeUSA and Transamerica Occidental Life Insurance Company....................... 10(20) Retrocessional Agreement between LifeUSA and Transamerica Occidental Life Insurance Company effective April 1, 1991.......................................................... 10(13) Addenda No. 1, 2 and 3 to Retrocessional Agreement between LifeUSA and Transamerica Occidental Life Insurance Company............................... 10(20) Trust Agreement dated April 1, 1993 among LifeUSA Insurance Company, Continental Trust Company and Transamerica Occidental Life Insurance Company................................................................ 10(16) Restated Trust Agreement among LifeUSA Insurance Company, Continental Trust Company and Transamerica Occidental Life Insurance Company................. 10(20) Information Services Agreement with Universal Systems of America, Inc. dated as of January 1, 1993..................................... 10(13) License Agreement with Universal Systems of America, Inc. dated as of January 1, 1993...................................................... 10(13) Agreement dated September 24, 1991, between David Mitchell and Associates and Life USA Holding, Inc......................................... 10(13) Office Lease, as amended on July 25, 1989 with The Equitable Life Assurance Society of the United States........................ 10(2) Amendment No. 2 to Office Lease dated November 29, 1990........................... 10(5) Amendment No. 3 to Office Lease dated November 15, 1993........................... 10(16) Sublease Agreement dated February 3, 1992, between the Company and Tonka Corporation.................................................... 10(12) Sublease Modification Agreement dated November 5, 1993, between the Company and Tonka Corporation................................................ 10(16) Form of Indemnification Agreement dated as of December 31, 1989................... 10(2) Life USA Holding, Inc. Employee Savings Plan effective January 1, 1990.................................................................. 10(4) First Amendment to Employee Savings Plan.......................................... 10(9) Second Amendment to Employee Savings Plan......................................... 10(11) Third Amendment to Employee Savings Plan.......................................... 10(13) Fourth Amendment to Employee Savings Plan......................................... 10(17) Fifth Amendment to Employee Savings Plan.......................................... 10(17) Restated Life USA Holding, Inc. Stock Option Plan................................. 10(12) Life USA Director Option Plan..................................................... 10(16) Agreement dated June 8, 1989 among Robert W. MacDonald, Life USA Holding, Inc. and LifeUSA Insurance Company............................. 10(13) Consulting Agreement with Peyton J. Huffman dated August 1, 1993................................................................... 10(16) Life and Annuity Coinsurance Agreement effective April 1, 1991 among LifeUSA Insurance Company, Employers Reassurance Corporation, Munich American Reassurance Company and Republic-Vanguard Life Insurance Company......................................... 10(6) Addenda Nos. 1 through 4 to the Life and Annuity Coinsurance Agreement............................................................ 10(13) Addendum No. 5 to the Life and Annuity Coinsurance Agreement...................... 10(16) Addendum No. 6 to the Life and Annuity Coinsurance Agreement...................... 10(20) Life and Annuity Retrocession Agreement effective April 1, 1991 between LifeUSA Insurance Company and Employers Reassurance Corporation............................................ 10(6) Addendum No. 1 to Life and Annuity Retrocession Agreement between LifeUSA Insurance Company and Employers Reassurance Corporation................................................ 10(13) Addendum No. 2 to Life and Annuity Retrocession Agreement between LifeUSA Insurance Company and Employers Reassurance Corporation.......................................................... 10(16) Termination Addendum to the Life and Annuity Retrocession Agreement between LifeUSA Insurance Company and Employers Reassurance Corporation................................................ 10(20) Trust Agreement among LifeUSA Insurance Company, Continental Bank, N.A. and Employers Reassurance Corporation..................... 10(16) Amendment to Trust Agreement among LifeUSA Insurance Company, Continental Bank, N.A. and Employers Reassurance Corporation..................... 10(16) Life and Annuity Retrocession Agreement effective April 1, 1991 between LifeUSA Insurance Company and Munich American Reassurance Company.......................................... 10(6) Addendum No. 1 to Life and Annuity Retrocession Agreement between LifeUSA Insurance Company and Munich American Reassurance Company.............................................................. 10(13) Addendum No. 2 to Life and Annuity Retrocession Agreement between LifeUSA Insurance Company and Munich American Reassurance Company.............................................................. 10(16) Termination Addendum to Life and Annuity Retrocession Agreement between LifeUSA Insurance Company and Munich American Reassurance Company.............................................................. 10(20) Restated Trust Agreement among LifeUSA Insurance Company, Continental Bank, N.A. and Munich American Reassurance Company................... 10(16) Amendment No. 1 to Restated Trust Agreement among LifeUSA Insurance Company, Continental Bank, N.A. and Munich American Reassurance Company.............................................. 10(16) Life and Annuity Retrocession Agreement effective April 1, 1991 between LifeUSA Insurance Company and Republic-Vanguard Life Insurance Company......................................... 10(6) Addendum No. 1 to Life and Annuity Retrocession Agreement between LifeUSA Insurance Company and Republic-Vanguard Life Insurance Company........................................................... 10(13) Addendum No. 2 to Life and Annuity Retrocession Agreement between LifeUSA Insurance Company and Republic-Vanguard Life Insurance Company........................................................... 10(16) Termination Addendum to Life and Annuity Retrocession Agreement between LifeUSA Insurance Company and Republic-Vanguard Life Insurance Company........................................................... 10(20) Trust Agreement among LifeUSA Insurance Company, Continental Bank, N.A. and Republic-Vanguard Life Insurance Company.......................... 10(16) Amendment to Trust Agreement among LifeUSA Insurance Company, Continental Bank, N.A. and Republic-Vanguard Life Insurance Company.............. 10(16) Life and ADB YRT Retrocession Agreements between LifeUSA and each of Employers Reassurance Corporation, Munich American Reassurance Company and Republic-Vanguard Life Insurance Company ("Reinsurers") effective April 1, 1991.................... 10(13) Addenda No. 1 to Life and ADB YRT Retrocession Agreements......................... 10(16) Termination Addendum to Life and ADB YRT Retrocession Agreements.................. 10(20) Life and ADB YRT Reinsurance Agreement between LifeUSA and the Reinsurers effective January 1, 1993......................................... 10(13) Addendum No. 1 to Life and ADB YRT Reinsurance Agreement between LifeUSA and the Reinsurers............................................... 10(16) Addendum No. 2 to Life and ADB YRT Reinsurance Agreement between LifeUSA and the Reinsurers............................................... 10(20) Investment Management Agreement between the Company and Investment Advisers, Inc. dated April 9, 1991................................ 10(10) Stock Purchase Agreement among Allianz of America, Inc., Allianz Life Insurance Company of North America and Life USA Holding, Inc., dated November 19, 1993.................................. 10(15) Plan and Agreement of Merger By and Between LifeUSA Insurance Company and Fidelity Union Life Insurance Company...................... 10(18) Articles of Merger of LifeUSA Insurance Company into Fidelity Union Life Insurance Company............................................ 10(18) Debenture Purchase Agreement dated February 17, 1995 among Life USA Holding, Inc. and Allianz Life Insurance Company of North America................ 10(19) Variable Rate Convertible Subordinated Debenture.................................. 10(19) Conversion Protection Warrant Certificate for Purchase of Shares of Common Stock of Life USA Holding, Inc. ................................................. 10(19) Life and Annuity Coinsurance Agreement effective January 1, 1995 between Allianz Life Insurance Company of North America and LifeUSA Insurance Company............ 10(19) Trust Agreement between Allianz Life Insurance Company of North America, LifeUSA Insurance Company and Continental Trust Company.......................... 10(19) Joint Marketing Agreement entered into by and between Allianz Life Insurance Company of North America and Life USA Holding, Inc............................... 10(19) Investment Management Agreement entered into by and between LifeUSA Insurance Company and Allianz Investment Corporation............................. 10(19) Investment Management Agreement entered into by and between Life USA Holding, Inc. and Allianz Investment Corporation................................. 10(19) Addendum No. 8 to the Interests and Liabilities Agreement of Employers Reassurance Corporation with respect to the Life and Annuity Coinsurance Agreement issued to LifeUSA Insurance Company.................................... 10(21) Addendum No. 8 to the Interests and Liabilities Agreement of Munich American Reassurance Company with respect to the Life and Annuity Coinsurance Agreement issued to LifeUSA Insurance Company........................ 10(21) Addendum No. 8 to the Interests and Liabilities Agreement of Republic- Vanguard Life Insurance Company with respect to the Life and Annuity Coinsurance Agreement issued to LifeUSA Insurance Company........................ 10(21) Consulting Agreement dated April 17, 1996 between Life USA Holding, Inc. and Joseph W. Carlson..................................... 10(22) Loan Agreement dated May 17, 1996 between Life USA Holding, Inc. and Employers Reassurance Corporation and Named Lenders.......................... 10(23) Stock Pledge Agreement dated May 17, 1996 between Life USA Holding, Inc. and Employers Reassurance Corporation............................................ 10(23) Claims Administration Agreement dated December 30, 1996 between Allianz Life Insurance Company of North America and LifeUSA Insurance Company.................................................... 10.1(24) Administration and Marketing Agreement dated December 30, 1996 between Allianz Life Insurance Company of North America and Life USA Holding, Inc........................................................ 10.2(24) Employment Agreement dated January 1, 1997 between Life USA Holding, Inc. and Margery G. Hughes..................................... 10.3(24) Employment Agreement dated January 1, 1997 between Life USA Holding, Inc. and Mark A. Zesbaugh...................................... 10.4(24) Statement of Computation of Per Share Earnings (Years Ended December 31, 1996, 1995 and 1994)................................... 11(24) 1996 Annual Report to Shareholders................................................ 13(24) Subsidiaries of the Registrant.................................................... 21(24) Consent of Ernst & Young LLP...................................................... 23(24) Powers of Attorney................................................................ 24(24) Financial Data Schedule (electronic filing only).................................. 27(24)
- ------------------------------ (1) Filed with the Company's Registration Statement No. 33-21989 and incorporated by reference herein. (2) Filed with the Company's 1989 Annual Report on Form 10-K, as amended, and incorporated by reference herein. (3) Filed with the Company's Registration Statement No. 33-30506, as amended by Post-Effective Amendment No. 1, and incorporated by reference herein. (4) Filed with the Company's Registration Statement No. 33-37981 and incorporated by reference herein. (5) Filed with Post-Effective Amendment No. 1 to the Company's Registration Statement No. 33-37981 and incorporated by reference herein. (6) Filed with the Company's 1990 Annual Report on Form 10-K and incorporated by reference herein. (7) Filed with Pre-Effective Amendment No. 1 to the Company's Registration Statement No. 33-41359 and incorporated by reference herein. (8) Filed with Pre-Effective Amendment No. 2 to the Company's Registration Statement No. 33-41359 and incorporated by reference herein. (9) Filed with the Company's 1991 Annual Report on Form 10-K and incorporated by reference herein. (10) Filed with the Company's Quarterly Report on Form 10-Q for the period ended June 30, 1991 and incorporated by reference herein. (11) Filed with the Company's Quarterly Report on Form 10-Q for the period ended March 31, 1992 and incorporated by reference herein. (12) Filed with the Company's Registration Statement No. 33-52624 and incorporated by reference herein. (13) Filed with the Company's Registration Statement No. 33-68528 and incorporated by reference herein. (14) Filed with Amendment No. 1 to the Company's Registration Statement No. 33-68528 and incorporated by reference herein. (15) Filed with Amendment No. 1 to the Company's Registration Statement No. 33-71068 and incorporated by reference herein. (16) Filed with the Company's 1993 Annual Report on Form 10-K and incorporated by reference herein. (17) Filed with the Company's Registration Statement No. 33-81426 and incorporated by reference herein. (18) Filed with the Company's Quarterly Report on Form 10-Q for the period ended June 30, 1994 and incorporated by reference herein. (19) Filed with the Company's Current Report on Form 8-K filed March 3, 1995 and incorporated by reference herein. (20) Filed with the Company's 1994 Annual Report on Form 10-K and incorporated by reference herein. (21) Filed with the Company's Quarterly Report on Form 10-Q for the period ended September 30, 1995 and incorporated by reference herein. (22) Filed with the Company's Quarterly Report on Form 10-Q for the period ended March 31, 1996 and incorporated by reference herein. (23) Filed with the Company's Current Report on Form 8-K filed June 17, 1996 and incorporated by reference herein. (24) Filed with this Annual Report on Form 10-K. The exhibits filed with this Annual Report on Form 10-K may be obtained by writing to: Mark A. Zesbaugh Executive Vice President, Chief Financial Officer and Treasurer Life USA Holding, Inc. 300 South Highway 169 Suite 95 Minneapolis, MN 55426 EX-10.1 2 CLAIMS ADMINISTRATION AGREEMENT CLAIMS ADMINISTRATION AGREEMENT ENTERED INTO BY AND BETWEEN ALLIANZ LIFE INSURANCE COMPANY OF NORTH AMERICA OF MINNEAPOLIS, MINNESOTA (HEREINAFTER REFERRED TO AS THE "COMPANY") AND LIFEUSA INSURANCE COMPANY OF MINNEAPOLIS, MINNESOTA (HEREINAFTER REFERRED TO AS "LIFEUSA") WHEREAS, the Company desires to utilize LifeUSA's skills in adjusting and paying any claims with respect to Covered Products and New Insurance Products as those terms are defined in this Agreement; NOW, THEREFORE, in consideration for the mutual promises and undertakings set forth herein and for other good and valuable consideration, the parties hereby agree as follows: SECTION 1 - DEFINITIONS 1.1 "Covered Products" shall mean ordinary life insurance policies and annuities issued on the forms listed on the reinsurance contract dated as of January 1, 1995 (the "Reinsurance Contract") by and between the Company and LifeUSA. It is expressly understood and agreed that the Reinsurance Contract may be amended from time to time to add New Insurance Products. 1.2 "New Insurance Products" shall be life insurance and annuity products developed by LifeUSA or its parent, Life USA Holding, Inc., which are, with the approval of the Company added to those listed in the Reinsurance Contract. SECTION 2 - SERVICES 2.1 LifeUSA shall provide all services related to paying claims with respect to the Covered Products and New Insurance Products in the states listed in Schedule A hereto. LifeUSA shall provide such claims paying services in the name of and on behalf of the Company only as provided in this Agreement or as directed by the Company in writing. Except as specifically set forth in this Agreement or as authorized by the Company in writing, Holding shall not have authority to enter into any agreements on the Company's behalf or to alter or amend any of the policies relating to the Covered Products and New Insurance Products or to modify, waive or extend any of their provisions. 2.2 In connection with the claims paying services provided by LifeUSA under this Agreement, LifeUSA shall: (a) maintain all records, including but not limited to statistical and accounting records, that a life insurance company would maintain with respect to the Covered Products and New Insurance Products so as to allow the Company to make only general ledger entries in its books and records; and (b) maintain all other data which are necessary to enable the Company to prepare its annual convention statement and any other reports required by any governmental agency or reporting bureau or which are reasonably required by the Company in order that the Company may properly analyze and manage the business included under this Agreement, provided that such data will be provided by LifeUSA to the Company upon request bprovided that such data will be provided by LifeUSA to the Company upon request by the Company. 2.3 LifeUSA shall provide the claims paying services (a) in accordance with all applicable laws, regulations, bulletins and insurance department requirements, and (b) in accordance with applicable written rules, regulations, instructions and directives of the Company regarding claims adjustment and payment, or such other service standards as the parties shall mutually agree in writing from time to time. 2.4 LifeUSA shall be liable to the Company for any losses to the Company caused by negligent or intentional acts of LifeUSA, its officers, employees or agents. 2.5 LifeUSA agrees to indemnify and hold the Company harmless from and against any and all losses, costs, damages and expenses (including attorney's fees) which the Company may incur by reason of any demand or action by any person arising out of the negligence or intentional acts of LifeUSA, and the Company agrees to indemnify and hold LifeUSA harmless from and against any and all losses, costs, damages and expenses (including attorney's fees) which LifeUSA may incur by reason of any demand or action by any person arising out of the negligence or intentional acts of the Company. 2.6 If LifeUSA does not perform all of its duties and responsibilities under this Agreement after written notice and a reasonable opportunity to perform, the Company may adjust the compensation paid under Section 4 of this Agreement, or other remittances to Holding, in order to restore the Company to the position it would have occupied had Holding performed all of its duties and responsibilities. SECTION 3 - OPERATION EXPENSES LifeUSA shall be responsible for all operation expenses incurred in connection with the business subject to this Agreement, including, by way of illustration and not of limitation, such items as rentals, salaries, supplies not furnished by the Company, postage, advertising, local license fees, attorney's fees, utilities, or cost of equipment. SECTION 4 - COMPENSATION 4.1 The Company agrees to allow LifeUSA a service fee equal to (a) 0.1% of the reinsurance allowance or ceding commission (expressed as a percentage) allowed the Company under the reinsurance contract dated as of January 1, 1995 (the "Reinsurance Contracts") between the Company and LifeUSA multiplied by (b) the amount of business to which such allowance or commission is applicable. 4.2 If a policy reinsured under the Reinsurance Contract lapses at any point in time during the first 13 months, LifeUSA agrees to reimburse the Company an amount equal to the excess, if any, of the total first year service fee paid by the Company on that policy over the total first year "initial" premium paid on that policy, as defined in the Reinsurance Contract. SECTION 5 - STATUS OF LIFEUSA, ITS EMPLOYEES AND AGENTS While performing its authorities granted herein, LifeUSA shall be deemed an independent contractor, as the Company reserves no authority or right to control LifeUSA's method of performance of its duties and responsibilities hereunder. No employees of LifeUSA shall be regarded as employees of the Company, except as may be required by governing statutes. SECTION 6 - EXAMINATION OF BOOKS AND RECORDS LifeUSA shall, as often as reasonably requested by the Company, submit all books and records maintained by LifeUSA pursuant hereto for examination and review by any authorized representative of the Company and/or its quota share reinsurers; and LifeUSA shall in all things cooperate and render assistance in such examination. LifeUSA shall make copies of any such books and records and furnish them to the Company as may be requested by the Company's representatives. SECTION 7 - COMMENCEMENT AND TERMINATION 7.1 The effective date of commencement of this Agreement shall be January 1, 1997, and this Agreement shall continue for a minimum of one year and will be subject to termination upon either party giving one year advance notice of cancellation. 7.2 If either party fails to perform substantially and materially the duties and responsibilities set forth in this Agreement or fails to make required payments hereunder and such failure continues for more than 30 days after written notice delivered by the other party, the other party may terminate this Agreement notwithstanding any other provisions to the contrary. SECTION 8 - MISCELLANEOUS 8.1 This Agreement, and all rights and interests arising herefrom, shall be binding upon, and shall inure to the benefit of, the parties hereto, their representatives, successors and assigns; however, the authorities, duties and responsibilities of either LifeUSA or the Company may not be assigned by either of such parties without the written consent of the other. 8.2 This Agreement may not be modified verbally, nor may it be modified by any subsequent practice or course of dealing by the parties, or in any manner other than in writing signed by the parties hereto. No forbearance or neglect on the part of the Company to enforce any of the provisions of this Agreement shall be construed as a waiver of any of its rights or privileges hereunder, unless in each instance a written memorandum specifically expressing such waiver be made and subscribed by the President or a Vice President of the Company. No such waiver shall modify this Agreement or affect the rights of the Company with respect to any subsequent default or failure or performance by LifeUSA. 8.3 This Agreement shall be deemed to be a Minnesota contract and construed in accordance with the laws of the State of Minnesota. 8.4 This Agreement supersedes all previous agreements with respect to the subject matter herein, either oral or written, between the parties hereto. IN WITNESS WHEREOF, the parties hereto by their respective duly authorized representatives have executed this Agreement as of the dates undermentioned at: Minneapolis, Minnesota, this 30th day of December, 1996. /s/ Mark L. Solverud --------------------- Mark L. Solverud, Vice President ALLIANZ LIFE INSURANCE COMPANY OF NORTH AMERICA Minneapolis, Minnesota, this 30th day of December, 1996 /s/ Mark A. Zesbaugh --------------------- Mark A. Zesbaugh, Vice President LIFEUSA INSURANCE COMPANY EX-10.2 3 ADMINISTRATION AND MARKETING AGREEMENT ADMINISTRATION AND MARKETING AGREEMENT ENTERED INTO BY AND BETWEEN ALLIANZ LIFE INSURANCE COMPANY OF NORTH AMERICA OF MINNEAPOLIS, MINNESOTA (HEREINAFTER REFERRED TO AS THE "COMPANY") AND LIFE USA HOLDING, INC. OF MINNEAPOLIS, MINNESOTA (HEREINAFTER REFERRED TO AS "HOLDING") WHEREAS, Holding, through its subsidiary, LifeUSA Insurance Company ("LifeUSA"), has offered a line of life insurance and annuity products, and the Company desires to provide a similar line of life insurance and annuity products utilizing Holding's skills in product design and underwriting; and WHEREAS, the parties hereto entered into the Joint Marketing Agreement dated February 16, 1995 (the "Joint Marketing Agreement"); and WHEREAS, the parties desire to terminate the Joint Marketing Agreement and substitute in its place this Administration and Marketing Agreement (this "Agreement") for business written after December 31, 1996; NOW, THEREFORE, in consideration for the mutual promises and undertakings set forth herein and for other good and valuable consideration, the parties hereby agree as follows: SECTION 1 - TERMINATION OF JOINT MARKETING AGREEMENT It is hereby agreed, effective January 1, 1997, that the Joint Marketing Agreement is terminated as to new sales, and this Agreement is substituted in its place for new sales after December 31, 1996, during the term of this Agreement. SECTION 2 - DEFINITIONS 2.1 "Covered Products" shall mean ordinary life insurance policies and annuities issued on the forms listed on the reinsurance contract dated as of January 1, 1995 (the "Reinsurance Contract") by and between the Company and LifeUSA Insurance Company ("LifeUSA"), as amended or replace hereafter. It is expressly understood and agreed that the Reinsurance Contract may be amended from time to time to add New Insurance Products. 2.2 "Marketing Services" shall mean identifying prospective agents ("Prospective Agents") of the Company for purposes of marketing the Covered Products and New Insurance Products, notifying the Company of Prospective Agents and processing agent appointments and cancellations on behalf of the Company, and training and supervising all agents appointed with respect to the Covered Products and New Insurance Products. "Marketing Services" shall also include, subject to such limitations as the Company may from time to time deem appropriate, seeking approval on behalf of the Company by appropriate insurance departments, wherever required, of appointments of Prospective Agents. 2.3 "New Insurance Products" shall be life insurance and annuity products developed by Holding or its subsidiary, LifeUSA, which are, with the approval of the Company added to those listed in the Reinsurance Contract. New Insurance Products shall be products similar to those of LifeUSA written on the Company's paper. 2.4 "Operating Manuals" shall mean all written rules, regulations, instructions and directives of the Company regarding its operations, as are in effect from time to time. 2.5 "Policy Administration Services" shall mean, with respect to the Covered Products and New Insurance Products, (a) preparation and filing with state insurance departments, as appropriate all policy form filings, including premium rates, subject to such limitations as the Company may from time to time deem appropriate, (b) provision of full administration services, including billing and collecting premium, monthly processing, loan processing, valuation, policyholder statements, maintenance of policy records, processing policy cancellations, policy changes, contractual changes, reinstatements and customer inquiries, (c) designing, printing and distribution of administrative forms as they become necessary, and (d) all other administrative activities in connection with the Covered Products and New Insurance Products, including, but not limited to, maintaining necessary records and the producing of required reports such that the cash payments made between Holding and the Company, and between the Company and its reinsurers, can be accurately computed and recorded. "Policy Administrative Services" shall not include any activities related to (i) adjusting or paying claims or (ii) negotiating reinsurance on behalf of the Company. 2.6 "Services" shall mean Underwriting Services, Policy Administration Services and Marketing Services. 2.7 "Underwriting Guidelines" shall mean the Company's underwriting guidelines as in effect from time to time. Holding may recommend changes to the Underwriting Guidelines, which changes shall be subject to the Company's approval, which approval shall not be unreasonably withheld. 2.8 "Underwriting Services" shall mean, with respect to the Covered Products and New Insurance Products, processing and accepting applications and proposals for insurance, underwriting (including determination of appropriate rates), policy issuance, policy printing, processing of unscheduled policy changes, policy cancellations, routing of applications and other papers required in the underwriting process, routing of issued policies for delivery to policyholders, and all other related services. SECTION 3 - SERVICES 3.1 Holding shall provide the Services in the name of and on behalf of the Company with respect to the Covered Products and New Insurance Products in the states listed in Schedule A hereto. Holding shall provide the Services in the name of and on behalf of the Company only as provided in this Agreement or as directed by the Company in writing. Except as specifically set forth in this Agreement or as authorized by the Company in writing, Holding shall not have authority to enter into any agreements on the Company's behalf or to alter or amend any of the policies relating to the Covered Products and New Insurance Products or to modify, waive or extend any of their provisions. 3.2 In connection with the Policy Administration Services provided by Holding under this Agreement, Holding shall: (a) be responsible for all Company policies entrusted to it whether issued or not, and shall only issue policies in series; (b) be responsible for making, or causing to be made, any modifications to administrative systems required for the ongoing administration of all policies in force or new policies being issued; (c) maintain all records, including but not limited to statistical and accounting records, that a life insurance company would maintain with respect to the Covered Products and New Insurance Products so as to allow the Company to make only general ledger entries in its books and records; and (d) maintain all other data which are necessary to enable the Company to prepare its annual convention statement and any other reports required by any governmental agency or reporting bureau or which are reasonably required by the Company in order that the Company may properly analyze and manage the business included under this Agreement, provided that such data will be provided by Holding to the Company upon request by the Company. 3.3 In connection with the Marketing Services provided by Holding under this Agreement, and subject to such limitations as the Company may from time to time determine, Holding shall have the authority, on behalf of the Company, to appoint agents of the Company for the purpose of soliciting and producing the Covered Products and New Insurance Products and to remove any of such agents. The purpose of such agent appointment is to enable the agents to sell the Covered Products and New Insurance Products in those states in which they are licensed and authorized to sell products for LifeUSA in all jurisdictions listed in Schedule A hereto. Holding will also use its best efforts to cause such agents to sell the Covered Products and the New Insurance Products. Holding shall pay all costs of licensing and appointing such agents on behalf of the Company. 3.4 Holding shall use reasonable efforts to cause the Company's agents appointed with respect to the Covered Products and the New Insurance Products, who are also appointed agents of any insurer affiliate of Holding, to distribute the Company's variable universal life, variable annuity, term insurance, long-term care and other mutually agreed products of the Company (the "Non-covered Products") for compensation to Holding and pursuant to terms as mutually agreed. 3.5 The Covered Products and the New Insurance Products shall be differentiated from LifeUSA products through terms as the Company and Holding mutually agree. The Company will commit to annual first year and single premium goals for the Covered Products and the New Insurance Products prior to the beginning of each calendar year during the term of this Agreement. The goal for 1997 is $390,000,000 in first year and single premium. Six months prior to the beginning of each calendar year commencing with respect to the calendar year 1998, the Company and Holding will mutually agree to the amount of first year and single premium which can be written on the Covered Products and the New Insurance Products for the next calendar year. 3.6 Holding shall not: (e) accept applications for, bind or issue any insurance covering any risk prohibited in writing by the Company or excluded (whether by exclusion or warranty) from the Reinsurance Contract, as amended or replaced from time to time, covering business produced under this Agreement; (f) have any authority, right or responsibility with respect to any of the following activities related to the business produced under this Agreement: (i) adjusting or paying any claims; or (ii) negotiating reinsurance on behalf of the Company; (g) mass cancel policies in force that are Covered Products or New Insurance Products except upon written instructions from the Company to do so; (h) bind the Company in contravention of its Operating Manuals or Underwriting Guidelines; or (i) issue any advertising or promotional material bearing the Company's name without first obtaining the written approval of the Company. 3.7 Holding shall provide the Services (a) in accordance with all applicable laws, regulations, bulletins and insurance department requirements, (b) in accordance with applicable Operating Manuals, or such other service standards as the parties shall mutually agree in writing from time to time, and (c) in accordance with Sections 3.1 through 3.6 of this Agreement. 3.8 Holding shall be liable to the Company for any losses to the Company caused by negligent or intentional acts of Holding, its officers, employees or agents. 3.9 Holding agrees to indemnify and hold the Company harmless from and against any and all losses, costs, damages and expenses (including attorney's fees) which the Company may incur by reason of any demand or action by any person arising out of the negligence or intentional acts of Holding, and the Company agrees to indemnify and hold Holding harmless from and against any and all losses, costs, damages and expenses (including attorney's fees) which Holding may incur by reason of any demand or action by any person arising out of the negligence or intentional acts of the Company. 3.10 If Holding does not perform all of its duties and responsibilities under this Agreement after written notice and a reasonable opportunity to perform, the Company may adjust the compensation paid under Section 6 of this Agreement, or other remittances to Holding, in order to restore the Company to the position it would have occupied had Holding performed all of its duties and responsibilities. 3.11 This Agreement is not exclusive. The Company reserves the right to appoint agents in the territory covered by this Agreement for the purpose of producing business other than the Covered Products and New Insurance Products. Holding reserves, on behalf of its subsidiaries, the right of such subsidiaries to appoint agents, including agents appointed with respect to the Covered Products and New Insurance Products pursuant to this Agreement, for the purpose of producing business for such subsidiaries. SECTION 4 - PREMIUMS 4.1 All premiums received by Holding with respect to the Covered Products and New Insurance Products, either before or after termination of this Agreement, shall be held by Holding as trustee for the Company. Holding shall have the authority to draw against said funds held for and on behalf of the Company, but only for one or more of the following purposes: a. Payment of return premiums; b. Payment of policy claims and benefits; or c. Payment of reinsurance premiums for any related reinsurance the Company has obtained with respect to any of the Company's policies issued under this Agreement. 4.2 Premiums temporarily held by Holding as trustee for the Company may be invested by Holding in demand or time bank accounts as may be authorized by the Minnesota Insurance Codes as legal bank investments for Life Insurance Companies, until drawn on for one or more of the purposes set forth in Section 4.1. Holding shall promptly remit all premiums to the Company's reinsurer in accordance with the terms of the Reinsurance Contract. 4.3 The Company hereby assigns to Holding all income derived from premiums invested on behalf of the Company by Holding pursuant to the authority granted herein. 4.4 The keeping of an account with Holding on the Company's books in the form of a debtor-creditor account is to be deemed merely a record of business transacted. Neither the keeping of an account in such form, nor the rendering of same, nor failure to enforce prompt remittance, nor alteration in compensation rate, nor compromise or settlement, shall be held to waive assertion of the trust relationship as to premiums collected by Holding. It is further understood and agreed that Holding is responsible for, and guarantees to the Company, payment of all premiums on policies due and received on behalf of the Company with respect to the Covered Products and the New Insurance Products. Should Holding fail to pay the Company any such premiums received when due, Holding agrees to bear any collection or other expense, including reasonable attorney's fees and costs, expended by the Company to enforce collection from Holding. SECTION 5 - OPERATION AND ACQUISITION EXPENSES Holding shall be responsible for all operation and acquisition expenses incurred in connection with the Covered Products and New Insurance Products subject to this Agreement, including, by way of illustration and not of limitation, such items as rentals, salaries, supplies not furnished by the Company, postage, advertising, local license fees, attorney's fees, utilities, cost of equipment, agents' fees or commissions and assessments or assignments, if any, lawfully made by governmental authority, the sole liability of the Company being payment of premium taxes and payment to Holding of the compensation stipulated in Section 6 hereof. SECTION 6 - COMPENSATION 6.1 The Company agrees to allow Holding a service fee equal to (a) the reinsurance allowance or ceding commission (expressed as a percentage) allowed the Company under the Reinsurance Contract, less 0.1%, multiplied by (b) the amount of business to which such allowance or commission is applicable. Holding shall be responsible for paying all commissions due agents appointed by the Company with respect to business written by the Company and reinsured under the Reinsurance Contract. 6.2 Holding agrees to reimburse the Company for premium taxes on all business subject hereto. 6.3 If a policy reinsured under the Reinsurance Contract lapses at any point in time during the first 13 months, Holding agrees to reimburse the Company an amount equal to the excess, if any, of the total first year service fee paid by the Company under Section 6.1 on that policy over the total first year "initial" premium paid on that policy, as defined in the Reinsurance Contract. 6.4 Holding will pay all payments assessed by the various state guaranty associations based on the Covered Products business. The Company will reimburse Holding for the Company's share of such assessments based on premiums retained, net of reinsurance cessions to LifeUSA. The Company and Holding agree that assessments will be sought to be recovered either through future premium tax offsets or additional margins or inforce business. SECTION 7 - REPORTS AND REMITTANCES 7.1 Within 10 days after the end of each month, Holding shall provide the Company with a copy of the report LifeUSA sends the reinsurer under the Reinsurance Agreement. 7.2 Within 10 days after the end of each month, Holding shall report the net written premium hereunder for the month of account and remit the provision for premium taxes as stipulated in Section 6. SECTION 8 - STATUS OF HOLDING, ITS EMPLOYEES AND AGENTS While performing its authorities granted herein, Holding shall be deemed an independent contractor, as the Company reserves no authority or right to control Holding's method of performance of its duties and responsibilities hereunder. No employees of Holding shall be regarded as employees of the Company, except as may be required by governing statutes. SECTION 9 - EXAMINATION OF BOOKS AND RECORDS Holding shall, as often as reasonably requested by the Company, submit all books and records maintained by Holding pursuant hereto for examination and review by any authorized representative of the Company and/or its quota share reinsurers; and Holding shall in all things cooperate and render assistance in such examination. Holding shall make copies of any such books and records and furnish them to the Company as may be requested by the Company's representatives. SECTION 10 - OWNER OF POLICY FORMS, SUPPLIES AND LICENSES All policy forms, records and supplies furnished by the Company to Holding, as well as any policy forms or other supplies on which the Company's name appears, whether supplied by the Company or not, shall be and remain the property of the Company and shall be turned over to the Company promptly upon demand. All licenses and other material relating to governmental licensing or authorization of the Company with respect to this Agreement shall be and remain the property of the Company and shall be turned over to the Company by Holding promptly upon demand. SECTION 11 - COMMENCEMENT AND TERMINATION 11.1 The effective date of commencement of this Agreement shall be January 1, 1997, and this Agreement shall continue for a minimum of one year and will be subject to termination upon either party giving one year advance notice of cancellation. In the event of the termination of this Agreement, the Company shall not directly or indirectly (through reinsurance or otherwise) sell any life or annuity products similar to the Covered Products or the New Insurance Products during the one year following such termination. In the event of a termination of this Agreement, Holding may not directly or indirectly (through reinsurance or otherwise) sell any products similar to products of the Company other than Covered Products during one year following such termination. 11.2 If either party fails to perform substantially and materially the duties and responsibilities set forth in this Agreement or fails to make required payments hereunder and such failure continues for more than 30 days after written notice delivered by the other party, the other party may terminate this Agreement notwithstanding any other provisions to the contrary. SECTION 12 - MISCELLANEOUS 12.1 This Agreement, and all rights and interests arising herefrom, shall be binding upon, and shall inure to the benefit of, the parties hereto, their representatives, successors and assigns; however, the authorities, duties and responsibilities of either Holding or the Company may not be assigned by either of such parties without the written consent of the other. 12.2 This Agreement may not be modified verbally, nor may it be modified by any subsequent practice or course of dealing by the parties, or in any manner other than in writing signed by the parties hereto. No forbearance or neglect on the part of the Company to enforce any of the provisions of this Agreement shall be construed as a waiver of any of its rights or privileges hereunder, unless in each instance a written memorandum specifically expressing such waiver be made and subscribed by the President or a Vice President of the Company. No such waiver shall modify this Agreement or affect the rights of the Company with respect to any subsequent default or failure or performance by Holding. 12.3 This Agreement shall be deemed to be a Minnesota contract and construed in accordance with the laws of the State of Minnesota. 12.4 This Agreement supersedes all previous agreements with respect to the subject matter herein, either oral or written, between the parties hereto. IN WITNESS WHEREOF, the parties hereto by their respective duly authorized representatives have executed this Agreement as of the dates undermentioned at: Minneapolis, Minnesota, this 30th day of December, 1996. /s/ Mark L. Solverud -------------------- Mark L. Solverud, Vice President ALLIANZ LIFE INSURANCE COMPANY OF NORTH AMERICA Minneapolis, Minnesota, this 30th day of December, 1996 /s/ Mark A. Zesbaugh --------------------- Mark A. Zesbaugh, Executive Vice President LIFE USA HOLDING, INC. SCHEDULE A TO THE ADMINISTRATION AND MARKETING AGREEMENT BETWEEN ALLIANZ LIFE INSURANCE COMPANY OF NORTH AMERICA AND LIFE USA HOLDING, INC. The territory covered by this Agreement includes the following jurisdictions: All states* except: New York No other jurisdiction shall be included in the territory covered without the express written agreement of both parties. *Life USA Holding, Inc. (and its affiliates) will not act as Allianz Life Insurance Company of North America's general agent for insurance sales in the State of Connecticut and will not perform duties nor have responsibilities related thereto under this Agreement. EX-10.3 4 EMPLOYMENT AGREEMENT EMPLOYMENT AGREEMENT THIS AGREEMENT is made and entered into as of January 1, 1997 between LIFE USA HOLDING, INC., a Minnesota corporation (the "Company"), and MARGERY G. HUGHES (the "Executive"). R E C I T A L S: WHEREAS, the Executive is now and has been the President and Chief Operating Officer of the Company and serves as an officer and/or director of certain subsidiaries of the Company; WHEREAS, the Executive and the Company wish to enter into this Agreement to provide for the continued employment of Executive; and WHEREAS, the Executive and the Company are willing to enter into this Agreement upon the terms and conditions set forth herein; NOW, THEREFORE, in consideration of the mutual premises and agreements set forth herein and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereby agree as follows: 1. Employment and Duties. The parties hereby agree that, during the term of this Agreement as set forth in paragraph 2 below, the Executive shall be employed as the President and Chief Operating Officer of the Company with the duties and responsibilities attendant to such positions. In discharging such duties and responsibilities, the Executive may also serve as an executive officer and/or director of any direct or indirect subsidiary of the Company (collectively the "Subsidiaries"). The salary, other compensation and benefits provided herein may be allocated among the Company and the Subsidiaries based upon the portion of the Executive's services provided to the Company and each of the Subsidiaries, respectively, and the Executive shall assist the Company in making such allocation as the Company may reasonably request. During the term of this Agreement, the Executive shall apply on a full-time basis (allowing for usual vacations and sick leave) all of the Executive's skill and experience to the performance of the Executive's duties hereunder with the Company and the Subsidiaries. It is understood that the Executive may have other business investments and participate in charitable organizations which may, from time to time, require minor portions of Executive's time, but which shall not interfere or be inconsistent with the Executive's duties under this Agreement. The Executive shall perform the Executive's duties at the Company's principal executive offices in Minneapolis, Minnesota or at such other location as may be mutually agreed upon by the Executive and the Company; provided that the Executive shall travel to other locations at such times as may be necessary for the performance of the Executive's duties under this Agreement. 2. Term of Employment. Unless sooner terminated as provided in paragraph 4 below, the term of this Agreement shall commence on the date hereof and shall continue through December 31, 1999; provided that the term shall be automatically extended for one year on each December 31st commencing December 31, 1997 unless either party gives written notice to the other prior to the date on which the automatic extension would be effective; provided that the term shall not be extended beyond Executive's sixty-fifth (65th) birthday. 3. Compensation and Benefits. During the term of this Agreement, the Executive shall be entitled to the following compensation and benefits for service to the Company and the Subsidiaries, including service as a director of the Company or its Subsidiaries: (a) Base Salary. The Executive shall be paid a base salary at a minimum annual rate of $315,000, payable in accordance with the Company's customary payroll policy, which salary shall be reviewed and may be increased from time to time at the discretion of the Board of Directors of the Company or the Compensation Committee of the Board of Directors (the "Base Salary"); provided that the amount of the Base Salary shall not be reduced after it has been increased by the Board of Directors or the Compensation Committee without the Executive's written consent. The performance of the Executive shall be reviewed at least once each calendar year which may be at the same time as any adjustment to the Base Salary of Executive. (b) Bonus. The Executive shall, in addition to the Base Salary, also be entitled to a cash annual bonus (the "Annual Bonus") based on the achievement by the Company of performance goals established by the Board of Directors or the Compensation Committee of the Company's Board of Directors. (c) Stock Incentives. The Executive shall be eligible to receive stock options under any stock based plan from time to time adopted by the Company (the "Stock Plans"), as from time to time determined by the Board of Directors or Stock Option Committee of the Company's Board of Directors. (d) Reimbursement of Expenses. The Company shall reimburse the Executive for all business expenses properly documented in accordance with the Company's expense reimbursement policy. (e) Other Benefits. The Executive shall be entitled to participate and shall be included in any employee benefit plan, medical/dental coverage plan, life insurance plan, disability coverage plan, or similar benefit plan of the Company now existing or established hereafter which are generally applicable to executives of the Company. 4. Termination of Employment. (a) Death or Disability. In the event of the Executive's death or disability as defined in the Company's long term disability plan then in effect, the employment of the Executive hereunder shall terminate and the Company's obligation to make further Base Salary and Annual Bonus (to the extent not yet earned) payments hereunder shall thereupon terminate as of the end of the month in which such death or disability occurs. The Executive's rights to other compensation and benefits shall be determined under the Company's benefit plans and policies applicable to Company executives then in effect. (b) Termination for Cause by the Company. By following the procedure set forth in paragraph 4(e), the Company shall have the right to terminate the employment of the Executive for "Cause" in the event the Executive: (i) has repeatedly failed to perform the Executive's duties under this Agreement, which failure is willful and deliberate; (ii) has engaged in an act or acts of dishonesty which is or are intended to result in substantial personal enrichment for the Executive; (iii) has knowingly engaged in conduct which is materially injurious to the Company; (iv) is convicted of, or pleads nolo contendere to (A) any felony (other than any felony arising out of negligence), or (B) any crime or offense involving dishonesty with respect to the Company or any of the Subsidiaries; (v) has failed to comply with the covenants contained in paragraph 5 of this Agreement; or (vi) knowingly provides materially misleading information concerning the Company to the Board of Directors of the Company or any of its Subsidiaries, any governmental body or regulatory agency or to any lender or other financing source or proposed financing source of the Company or its Subsidiaries. If the employment of the Executive is terminated by the Company for Cause, the Company's obligation to make further Base Salary and Annual Bonus (to the extent not yet earned) payments hereunder shall thereupon terminate, except the Executive shall receive the Base Salary through the end of the month during which such a termination occurs. The Executive's rights to other compensation and benefits shall be determined under the Company's benefit plans and policies applicable to executives of the Company then in effect. (c) Termination for Good Reason by the Executive. By following the procedure set forth in paragraph 4(e), the Executive shall have the right to terminate the Executive's employment with the Company for "Good Reason" in the event (i) the Executive is not at all times the duly elected the President and Chief Operating Officer of the Company; (ii) there is any material reduction in the scope of the Executive's authority and responsibility; (iii) there is a reduction in the Executive's Base Salary, a material reduction in the amount of Annual Bonus for which the Executive is eligible, an amendment to any Stock Plan or employee retirement plan applicable to the Executive which is materially adverse to the Executive, or a material reduction in the other benefits to which the Executive is entitled under paragraph 3(e) above; (iv) the Company requires the Executive's principal place of employment to be anywhere other than the Company's principal executive offices, or there is a relocation of the Company's principal executive offices outside of Minneapolis/St. Paul, Minnesota metropolitan area; or (v) the Company otherwise fails to perform its obligations under this Agreement. If the employment of the Executive is terminated by the Executive for Good Reason before a Change in Control (as defined below) or following twenty-four (24) months after a Change in Control, the Executive shall be entitled to the severance benefits set forth in paragraph 4(f) below. If the employment of the Executive is terminated by the Executive for Good Reason upon or within (and including) twenty-four (24) months after a Change in Control, the Executive shall be entitled to the severance benefits set forth in paragraph 4(g) below. In addition, in the event a Change in Control has occurred and the Executive elects upon ten (10) days prior notice to the Company, to terminate employment with the Company within the sixty (60) period following the first anniversary of the Change in Control, such termination shall be considered a termination by the Executive for Good Reason and the Executive shall be entitled to the severance benefits under paragraph 4(g) below. (d) Termination Without Cause. The Company may terminate the Executive's employment without Cause prior to the expiration of the term of this Agreement. If the employment of the Executive is terminated by the Company without Cause before a Change in Control or following twenty-four (24) months after a Change in Control, the Executive shall be entitled to the severance benefits set forth in paragraph 4(f) below. If the employment of the Executive is terminated by the Company without Cause upon or within (and including) twenty-four (24) months after a Change in Control, the Executive shall be entitled to the severance benefits set forth in paragraph 4(g) below. (e) Notice and Right to Cure. (i) Termination by Company for Cause. If the Company proposes to terminate the employment of the Executive for Cause under paragraph 4(b), the Company shall give written notice to the Executive specifying the reasons for such proposed determination with particularity and, in the case of a termination for Cause under paragraph 4(b)(i), the Executive shall have a reasonable opportunity to correct any curable situation to the reasonable satisfaction of the Board of Directors of the Company, which period shall be no less than thirty (30) days from the Executive's receipt of the notice of proposed termination. Notwithstanding the foregoing, the Executive's employment shall not be terminated for Cause unless and until there shall be delivered to the Executive a copy of the resolution duly adopted by the affirmative vote of not less than the majority of the members of the Board of Directors of the Company at a meeting called and held for the purpose (after reasonable notice to the Executive and an opportunity for the Executive, together with the Executive's legal counsel, to be heard before the Board of Directors) finding that, in the opinion of the Company's Board of Directors, the Executive has engaged in conduct justifying a termination for Cause. (ii) Termination by Executive for Good Reason. If the Executive proposes to terminate the Executive's employment for Good Reason under paragraph 4(c) above (other than the last sentence of paragraph 4(c) above), the Executive shall give written notice to the Company, specifying the reason therefor with particularity. In the event the Executive proposes to terminate employment for Good Reason under paragraph 4(c)(i), (ii), (iii) or (iv) above, the termination shall be effective on the date of such notice. In the event the Executive proposed to terminate employment for Good Reason under paragraph 4(c)(v) above, the Company will have an opportunity to correct any curable situation to the reasonable satisfaction of the Executive within the period of time specified in the notice which shall not be less than thirty (30) days. If such correction is not so made or the circumstances or situation is such that it is not curable, the Executive may, within thirty (30) days after the expiration of the time so fixed within which to correct such situation, give written notice to the Company that the Executive's employment is terminated for Good Reason effective forthwith. (f) Severance Benefits. If the Executive is entitled to severance benefits under this paragraph 4(f) pursuant to paragraph 4(c) or (d) prior to a Change in Control or following twenty-four months after a Change in Control, the Executive shall be provided to the following benefits (regardless of the death or disability of the Executive after the Termination Date): (i) Base Salary. The Company shall continue to pay to the Executive the Base Salary when and as such Base Salary would have been paid from the date of termination (the "Termination Date") through the end of the term of this Agreement under paragraph 2 as if such termination did not occur and there were no further automatic extensions of the term pursuant to paragraph 2 (the "Severance Period") as if the Executive continued to be employed by the Company during the Severance Period and regardless of the death or disability of the Executive subsequent to the Termination Date. (ii) Annual Bonus. If the effective date of such termination occurs before the Annual Bonus for any preceding calendar year has been paid, the Company shall, within thirty (30) days after the Termination Date, pay to the Executive the amount of the Executive's Annual Bonus for such preceding calendar year when and as it would have been paid if the Executive remained employed by the Company. (iii) Disability, Life Insurance and Medical/Dental Coverage. The Executive shall be entitled to the disability coverage, life insurance and medical/dental coverage which the Executive and the Executive's family received under paragraph 3(e) as if the Executive continued to be employed by the Company during the Severance Period; provided that if Executive obtains new employment with comparable benefits during the Severance Period, all entitlements under this paragraph 4(f)(iii) shall cease. Nothing in this paragraph shall be construed as providing Executive with coverage under any plan of Employer to which Executive would not otherwise be entitled and in the event any coverage is unavailable, e.g., if Executive is uninsurable, Employer's obligations under this paragraph may be satisfied by paying to Executive the cost of such coverage if it were available, as determined in good faith by the Company. (iv) Stock Options. Not later than thirty (30) days after the date on which the Executive's employment terminates, the Company shall pay the Executive a lump sum cash payment equal to the amount by which the fair market value (determined as of the Termination Date) of the number of shares of stock subject to any stock option granted under the Stock Plans which was not exercisable on the Termination Date and which would have become vested and exercisable during the Severance Period if the Executive had remained employed by the Company during the Severance Period. (g) Severance Benefits for Change in Control. In the event of a Change in Control and either upon or within (and including) twenty-four (24) months after such Change in Control, the Executive terminates employment for Good Reason or the Executive's employment is terminated by the Company for any reason other Cause, then (regardless of the death or disability of the Executive after the Termination Date) the Company shall pay the Executive a lump sum cash payment within five (5) days after the Termination Date, in an amount equal to the amounts referred to in paragraph 4(f)(i), (ii) and (iv), plus the amount of the Deemed Bonus (as defined below), and the Company shall also provide the Executive the severance benefits referred to in paragraph 4(f)(iii) as provided therein. In addition, the Company shall pay the Executive the Gross-Up Payment in accordance with the following provisions: (i) Gross-Up Payment. Anything to the contrary notwithstanding, in the event it shall be determined that any payment, distribution or benefit made or provided by the Company to or for the benefit of the Executive (whether pursuant to this Agreement or otherwise) (a "Payment"), would be subject to the excise tax imposed by Section 4999 of the Internal Revenue Code of 1986, as amended, (the "Code") or any interest or penalties with respect to such excise tax (such excise tax, together with any such interest and penalties, are collectively referred to as the "Excise Tax"), then the Company shall pay the Executive in cash an amount (the "Gross-Up Payment") such that after payment by the Executive of all taxes (including any interest or penalties imposed with respect to such taxes), including but not limited to income taxes (and any interest and penalties imposed with respect thereto) and the Excise Tax, imposed upon the Gross-Up Payment, the Executive retains an amount of the Gross-up Payment equal to the Excise Tax imposed on the Payments. (ii) Determination of Gross-Up Payment. Subject to paragraph 4(g)(iii) below, all determinations required to be made under this paragraph 4(g)(i), including whether a Gross-Up Payment is required and the amount of the Gross-Up Payment, shall be made by the firm of independent public accountants selected by the Company to audit its financial statements for the year immediately preceding the Change in Control (the "Accounting Firm") which shall provide detailed supporting calculations to the Company and the Executive within thirty (30) days after the Termination Date. In the event that the Accounting Firm is serving as accountant or auditor for the individual, entity or group effecting the Change in Control, the Executive shall appoint another nationally recognized accounting firm to make the determinations required under this paragraph 4(g) (which accounting firm shall then be referred to as the "Accounting Firm"). All fees and expenses of the Accounting Firm in connection with the work it performs pursuant to this paragraph 4(g) shall be promptly paid by the Company. An Gross-Up Payment (as determined pursuant to paragraph 4(g)(i) above) shall be paid by the Company to the Executive within five (5) days of the receipt of the Accounting Firm's determination. If the Accounting Firm determines that no Excise Tax is payable by the Executive, it shall furnish the Executive with a written opinion that failure to report the Excise Tax on the Executive's applicable federal income tax return would not result in the imposition of a negligence or a similar penalty. Any determination by the Accounting Firm shall be binding upon the Company and the Executive. As a result of the uncertainty in the application of Section 4999 of the Code at the time of the initial determination by the Accounting Firm, it is possible that Gross-up Payments which will not have been made by the Company should have been made ("Underpayment"). In the event that the Company exhausts its remedies pursuant to paragraph 4(g)(iii) below, and the Executive is thereafter required to make a payment of Excise Tax, the Accounting Firm shall promptly determine the amount of the Underpayment that has occurred and any such Underpayment shall be paid by the Company to the Executive within five (5) days after such determination. (iii) Contest. The Executive shall notify the Company in writing of any claim made by the Internal Revenue Service that, if successful, would require the Company to pay a Gross-Up Payment. Such notification shall be given as soon as practicable but no later than ten (10) business days after the Executive knows of such claim and shall apprise the Company of the nature of such claim and the date on which such claim is requested to be paid. The Executive shall not pay such claim prior to the expiration of the thirty (30) day period following the date on which it gives such notice to the Company (or such shorter period ending on the date that any payment of taxes with respect to such claim is due). If the Company notifies the Executive in writing prior to the expiration of such period that it desires to contest such claim, the Employee shall: (A) give the Company any information reasonably requested by the Company relating to such claim; (B) take such action in connection with contesting such claim as the Company shall reasonably request in writing from time to time, without limitation, accepting legal representation with respect to such claim by an attorney selected by the Company and reasonably acceptable to the Executive; (C) cooperate with the Company in good faith in order effectively to contest such claim; (D) permit the Company to participate in any proceedings relating to such claim; provided, however, that the Company shall bear and pay directly all costs and expenses (including additional interest and penalties) incurred in connection with such contest and shall indemnify and hold the Executive harmless, on an after-tax basis, for any Excise Tax or income tax, including interest and penalties with respect thereto, imposed as a result of such representation and payment of costs and expenses. Without limitation on the foregoing provisions of this paragraph 4(g)(iii), the Company shall control all proceedings taken in connection with such contest and, at its sole option, may pursue or forego any and all administrative appeals, proceedings, hearings and conferences with the taxing authority in respect of such claim and may, at its sole option, either direct the Executive to pay the tax claimed and sue for a refund or contest the claim in any permissible manner, and the Executive agrees to prosecute such contest to a determination before any administrative tribunal, in a court of initial jurisdiction and in one or more appellate courts, as the Company shall determine; provided, however, that if the Company directs the Executive to pay such claim and sue for a refund, the Company shall advance the amount of such payment to the Executive, on an interest-free basis, from any Excise Tax or income tax, including interest or penalties with respect thereto, imposed with respect to such advance or with respect to any imputed income with respect to such advance; and further provided that any extension of the statute of limitations relating to payment of taxes for the taxable year of the Executive with respect to which such contested amount is claimed to be due is limited solely to such contested amount. Furthermore, the Company's control of the contest shall be limited to issues with respect to which a Gross-Up Payment would be payable hereunder and the Executive shall be entitled to settle or contest, as the case may be, any other issue raised by the Internal Revenue Service or any other taxing authority. (iv) If, after the receipt by the Executive of an amount advanced by the Company pursuant to paragraph 4(g)(iii), the Executive becomes entitled to receive any refund with respect to such claim, the Executive shall (subject to the Company's complying with the requirements of paragraph 4(g)(iii)) promptly pay to the Company the amount of such refund (together with any interest paid or credited thereon after taxes applicable thereto). If, after the receipt by the Executive of an amount advanced by the Company pursuant to paragraph 4(g)(iii), a determination is made that the Executive shall not be entitled to any refund with respect to such claim and the Company does not notify the Executive in writing of its intent to contest such denial of refund prior to the expiration of thirty (30) days after such determination, then such advance shall be forgiven and shall not be required to be repaid and the amount of such advance shall offset, to the extent thereof, the amount of Gross-Up Payment required to be paid. (h) Benefits in Lieu of Severance Pay Policy. The severance benefits provided for in this paragraph 4 are in lieu of any benefits that would otherwise be provided to the Executive under the Company's severance pay policy and the Executive shall not be entitled to any benefits under the Company's severance pay policy. (i) No Funding of Severance. Nothing contained in this Agreement or otherwise shall require the Company to segregate, earmark or otherwise set aside any funds or other assets to provide for any payments required to be made under this paragraph 4 and the rights of the Executive to the severance benefits hereunder shall be solely those of a general, unsecured creditor of the Company. However, the Company may, in its discretion, deposit cash or property, or a combination of both, equal in value to all or a portion of the amounts anticipated to be payable hereunder into a trust, the assets of which are to be distributed by such times as determined by the trustee of such trust; provided that such assets shall be subject at all times to the rights of the Company's general creditors. (j) Definitions. A "Change in Control" shall be deemed to have occurred if, prior to the expiration of the term of the Employment Agreement: (i) any "person" (as such term is used in Sections 13(d) and 14(d) of the Securities Exchange Act of 1934) (other than the Company or any of its subsidiaries or any employee benefit plan of the Company or any of its subsidiaries) becomes a beneficial owner, directly or indirectly, of securities of the Company representing 20% or more of the voting power of all of the Company's then outstanding securities; or (ii) during any period of two consecutive years individuals who at the beginning of such period constituted the Board of Directors of the Company (the "Incumbent Directors") together with any director (the "New Incumbent Director") whose nomination or election was approved by at least two-thirds of the Incumbent Directors and any New Incumbent Director who was previously elected, in each case who are directors at the time of the nomination or election of such director cease for any reason to constitute at least a majority, the Board of Directors of the Company; or (iii) the shareholders of the Company approve the sale of all, or substantially all, of the business or assets of the Company or the liquidation or dissolution of the Company. The "Deemed Bonus" shall be an amount equal to the number of calendar years (including the calendar year in which the Termination Date occurs) multiplied by the Company shall pay the Executive an amount equal to the greater of (A) the Annual Bonus paid to the Executive for the period after the Change of Control or (B) the average of the Annual Bonus paid or payable to the Executive in respect of the two calendar years immediately preceding the calendar year in which the Change in Control occurs. 5. Confidentiality; Non-Solicitation Covenant. (a) Confidentiality. The Executive agrees that, at all times, both during the Executive's employment and after the termination thereof, the Executive shall not divulge to any other person, firm or corporation, or in any way use for the Executive's own benefit, except as required in the conduct of the business of the Company or any of its Subsidiaries or as authorized in writing on behalf of the Company, any trade secrets or confidential information of the Company or its Subsidiaries obtained during the course of the Executive's employment with the Company or its Subsidiaries. The Executive also agrees that the Executive will not, either subsequent to termination of employment or during employment, except as required in the conduct of the business of the Company or any of its Subsidiaries, or as authorized in writing on behalf of the Company, interfere with or disturb or attempt to interfere with or disturb any employment, contractual or business arrangements of the Company or any of its Subsidiaries with any of its employees, agents, suppliers, customers, reinsurers or other parties with which the Company or any of its Subsidiaries has a contractual relationship, as the case may be. (b) Non-Solicitation Covenant. While the Executive is actively employed with the Company and, in the event of a termination of employment with the Company for any reason, for a period of two years after the Termination Date, the Executive agrees that, except with the prior written permission of the Board of Directors of the Company, the Executive will not offer to hire, entice away, or in any manner attempt to persuade any officer, employee, or agent of the Company or any of the Subsidiaries to discontinue his or her relationship with the Company or any of the Subsidiaries nor will the Executive directly or indirectly solicit, divert, take away or attempt to solicit any business of the Company or any of its Subsidiaries as to which Executive has acquired any knowledge during the term of the Executive's employment with the Company. (c) Remedies. If the Executive commits a breach, or threatens to commit a breach, of any of the provisions of this paragraph 5, the Company shall have the following rights and remedies, in addition to any rights and remedies otherwise available at law or equity: (i) The right and remedy to have the provisions of this paragraph 5 specifically enforced by any court having equity jurisdiction, it being acknowledged and agreed by the Executive that any such breach or threatened breach will cause irreparable injury to the Company and the Subsidiaries and that money damages will not provide an adequate remedy to the Company and the Subsidiaries; and (ii) The right and remedy to require the Executive to account for and pay over to the Company all compensation, profits, monies, accruals, increments, or other benefits, other than those payable under this Agreement, derived or received by the Executive or the enterprise in competition with the Company or any of the Subsidiaries as the result of any transactions constituting a breach of any part of this paragraph 5, and Executive agrees to account for and pay over to the Company such amounts promptly upon demand therefor. 6. Beneficiaries. In the event of the Executive's death after termination of employment, any amount or benefit payable or distributable to him pursuant to this Agreement shall be paid to the beneficiary designated by the Executive for such purpose in the last written instrument received by the Company prior to the Executive's death, if any, or, if no beneficiary has been designated, to the Executive's estate, but such designation shall not be deemed to supersede any beneficiary designation under any benefit plan of the Company. Whenever this Agreement provides for the written designation of a beneficiary of beneficiaries of the Executive, the Executive shall have the right to revoke such designation and to redesignate a beneficiary or beneficiaries by written notice to either the Company to such effect, except to the extent, if any, restricted by law. 7. Rights in the Event of Dispute. In the event of a dispute between the Company and the Executive regarding the Executive's employment or this Agreement, it is the intention of this Agreement that the dispute shall be resolved as expeditiously as possible, consistent with fairness to both sides, and that during pendency of the dispute the Executive and the Company shall be on equal footing, as follows: (a) Arbitration. Any claim or dispute relating to the Executive's employment or the terms and performance of this Agreement, shall be resolved by binding private arbitration before three arbitrators and any award rendered by any arbitration panel, or a majority thereof, may be filed and a judgment obtained in any court having jurisdiction over the parties unless the relief granted in the award is delivered within ten (10) days of the award. Either party may request arbitration by written notice to the other party. Within thirty (30) days of receipt of such notice by the opposing party, each party shall appoint a disinterested arbitrator and the two arbitrators selected thereby shall appoint a third neutral arbitrator; in the event the two arbitrators cannot agree upon the third arbitrator within then (10) days after their appointment, then the neutral arbitrator shall be appointed by the Chief Judge of Hennepin County (Minnesota) District Court. Any arbitration proceeding conducted hereunder shall be in the City of Minneapolis and shall follow the procedures set forth in the Rules of Commercial Arbitration of the American Arbitration Association, and both sides shall cooperate in as expeditious a resolution of the proceeding as is reasonable under the circumstances. The arbitration panel shall have the power to enter any relief it deems fair and just on any claim, including interim and final equitable relief, along with any procedural order that is reasonable under the circumstances. (b) Expenses of Prosecution/Defense of Claim. During the pendency of a dispute between the Company and the Executive relating to the Executive's employment or the terms or performance of this Agreement, the Company shall promptly pay the Executive's reasonable expenses of representation upon delivery of periodic billings for same, provided that (i) Executive (or a person claiming on the Executive's behalf) shall promptly repay all amounts paid hereunder at the conclusion of the dispute if the resolution thereof includes a finding that the Executive did not act in good faith in the matter in dispute or in the dispute proceeding itself, and (ii) no claim for expenses of representation shall be submitted by the Executive or any person acting on the Executive's behalf unless made in writing to the Board of Directors within one year of the performance of the services for which such claim is made. 8. No Obligation to Mitigate Damages. In the event the Executive becomes eligible to receive compensation or benefits subsequent to the termination of the Executive's employment under this Agreement, the Executive shall have no obligation to seek other employment in an effort to mitigate damages. To the extent the Executive shall accept other employment after the Executive's termination of employment, the compensation and benefits received from such employment shall not reduce the compensation and benefits otherwise due under this Agreement, except as provided in paragraph 4(f)(iii) above. 9. Other Benefits. The benefits provided under this Agreement shall, except to the extent otherwise specifically provided herein, be in addition to, and not in derogation or diminution of, any benefits that Executive or the Executive's beneficiary may be entitled to receive under any other plan or program now or hereafter maintained by the Company, or its Subsidiaries. 10. Successors. The Company shall require any successor (whether direct or indirect, by purchase, merger, consolidation, or otherwise) to all or substantially all of the business and/or assets of the Company, to expressly assume and agree to perform its obligations under this Agreement in the same manner and to the same extent that the Company would be required to perform them if no succession had taken place unless, in the opinion of legal counsel mutually acceptable to the Company and the Executive, such obligations have been assumed by the successor as a matter of law. Failure of the Company to obtain such agreement prior to the effectiveness of any such succession (unless the foregoing opinion is rendered to the Executive) shall entitle the Executive to terminate the Executive's employment and to receive the payments provided for in paragraph 4(f) above as if the Executive terminated this Agreement for Good Reason. The Executive's rights under this Agreement shall inure to the benefit of, and shall be enforceable by, the Executive's legal representative or other successors in interest, but shall not otherwise be assignable or transferable. 11. Severability. If any provision of this Agreement or the application thereof is held invalid or unenforceable, the invalidity or unenforceability thereof shall not affect any other provisions or applications of this Agreement which can be given effect without the invalid or unenforceable provision or application. 12. Survival. The rights and obligations of the parties pursuant to this Agreement shall survive the term of the employment to the extent that any performance is required hereunder after the expiration or termination of such term. 13. Notices. All notices under this Agreement shall be in writing and shall be deemed effective when delivered in person (in the Company's case, to its Secretary) or 48 hours after deposit thereof in the U.S. mails, postage prepaid, addressed, in the case of the Executive, to the Executive's last known address as carried on the personnel records of the Company and, in the case of the Company, to the corporate headquarter,s, attention of the Secretary, or to such other address as the party to be notified may specify by written notice to the other party. 14. Amendments and Construction. This Agreement may only be amended in a writing signed by the parties hereto. This Agreement shall be construed under the laws of the State of Minnesota. Paragraph headings are for convenience only and shall not be considered a part of the terms and provisions of the Agreement. IN WITNESS WHEREOF, the parties have duly executed this Agreement as of the day and year first written above. LIFE USA HOLDING, INC. By /s/ Robert W. MacDonald --------------------------- Robert W. MacDonald, Chairman and Chief Executive Officer /s/ Margery G. Hughes ---------------------- Margery G. Hughes EX-10.4 5 EMPLOYMENT AGREEMENT EMPLOYMENT AGREEMENT THIS AGREEMENT, made and entered into as of January 1, 1997 between LIFE USA HOLDING, INC., a Minnesota corporation (the "Company"), and MARK A. ZESBAUGH (the "Executive"). R E C I T A L S: WHEREAS, the Executive is now and has been the Executive Vice President and Chief Financial Officer of the Company and serves as an officer and/or director of certain subsidiaries of the Company; WHEREAS, the Executive and the Company wish to enter into this Agreement to provide for the continued employment of Executive; and WHEREAS, the Executive and the Company are willing to enter into this Agreement upon the terms and conditions set forth herein; NOW, THEREFORE, in consideration of the mutual premises and agreements set forth herein and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereby agree as follows: 1. Employment and Duties. The parties hereby agree that, during the term of this Agreement as set forth in paragraph 2 below, the Executive shall be employed as the Executive Vice President and Chief Financial Officer of the Company with the duties and responsibilities attendant to such positions. In discharging such duties and responsibilities, the Executive may also serve as an executive officer and/or director of any direct or indirect subsidiary of the Company (collectively the "Subsidiaries"). The salary, other compensation and benefits provided herein may be allocated among the Company and the Subsidiaries based upon the portion of the Executive's services provided to the Company and each of the Subsidiaries, respectively, and the Executive shall assist the Company in making such allocation as the Company may reasonably request. During the term of this Agreement, the Executive shall apply on a full-time basis (allowing for usual vacations and sick leave) all of the Executive's skill and experience to the performance of the Executive's duties hereunder with the Company and the Subsidiaries. It is understood that the Executive may have other business investments and participate in charitable organizations which may, from time to time, require minor portions of Executive's time, but which shall not interfere or be inconsistent with the Executive's duties under this Agreement. The Executive shall perform the Executive's duties at the Company's principal executive offices in Minneapolis, Minnesota or at such other location as may be mutually agreed upon by the Executive and the Company; provided that the Executive shall travel to other locations at such times as may be necessary for the performance of the Executive's duties under this Agreement. 2. Term of Employment. Unless sooner terminated as provided in paragraph 4 below, the term of this Agreement shall commence on the date hereof and shall continue through December 31, 1999; provided that the term shall be automatically extended for one year on each December 31st commencing December 31, 1997 unless either party gives written notice to the other prior to the date on which the automatic extension would be effective; provided that the term shall not be extended beyond Executive's sixty-fifth (65th) birthday. 3. Compensation and Benefits. During the term of this Agreement, the Executive shall be entitled to the following compensation and benefits for service to the Company and the Subsidiaries, including service as a director of the Company or its Subsidiaries: (a) Base Salary. The Executive shall be paid a base salary at a minimum annual rate of $250,000, payable in accordance with the Company's customary payroll policy, which salary shall be reviewed and may be increased from time to time at the discretion of the Board of Directors of the Company or the Compensation Committee of the Board of Directors (the "Base Salary"); provided that the amount of the Base Salary shall not be reduced after it has been increased by the Board of Directors or the Compensation Committee without the Executive's written consent. The performance of the Executive shall be reviewed at least once each calendar year which may be at the same time as any adjustment to the Base Salary of the Executive. (b) Bonus. The Executive shall, in addition to the Base Salary, also be entitled to a cash annual bonus (the "Annual Bonus") based on the achievement by the Company of performance goals established by the Board of Directors or the Compensation Committee of the Company's Board of Directors. (c) Stock Incentives. The Executive shall be eligible to receive stock options under any stock based plan from time to time adopted by the Company (the "Stock Plans"), as from time to time determined by the Board of Directors or Stock Option Committee of the Company's Board of Directors. (d) Reimbursement of Expenses. The Company shall reimburse the Executive for all business expenses properly documented in accordance with the Company's expense reimbursement policy. (e) Other Benefits. The Executive shall be entitled to participate and shall be included in any employee benefit plan, medical/dental coverage plan, life insurance plan, disability coverage plan, or similar benefit plan of the Company now existing or established hereafter which are generally applicable to executives of the Company. 4. Termination of Employment. (a) Death or Disability. In the event of the Executive's death or disability as defined in the Company's long term disability plan then in effect, the employment of the Executive hereunder shall terminate and the Company's obligation to make further Base Salary and Annual Bonus (to the extent not yet earned) payments hereunder shall thereupon terminate as of the end of the month in which such death or disability occurs. The Executive's rights to other compensation and benefits shall be determined under the Company's benefit plans and policies applicable to Company executives then in effect. (b) Termination for Cause by the Company. By following the procedure set forth in paragraph 4(e), the Company shall have the right to terminate the employment of the Executive for "Cause" in the event the Executive: (i) has repeatedly failed to perform the Executive's duties under this Agreement, which failure is willful and deliberate; (ii) has engaged in an act or acts of dishonesty which is or are intended to result in substantial personal enrichment for the Executive; (iii) has knowingly engaged in conduct which is materially injurious to the Company; (iv) is convicted of, or pleads nolo contendere to (A) any felony (other than any felony arising out of negligence), or (B) any crime or offense involving dishonesty with respect to the Company or any of the Subsidiaries; (v) has failed to comply with the covenants contained in paragraph 5 of this Agreement; or (vi) knowingly provides materially misleading information concerning the Company to the Board of Directors of the Company or any of its Subsidiaries, any governmental body or regulatory agency or to any lender or other financing source or proposed financing source of the Company or its Subsidiaries. If the employment of the Executive is terminated by the Company for Cause, the Company's obligation to make further Base Salary and Annual Bonus (to the extent not yet earned) payments hereunder shall thereupon terminate, except the Executive shall receive the Base Salary through the end of the month during which such a termination occurs. The Executive's rights to other compensation and benefits shall be determined under the Company's benefit plans and policies applicable to executives of the Company then in effect. (c) Termination for Good Reason by the Executive. By following the procedure set forth in paragraph 4(e), the Executive shall have the right to terminate the Executive's employment with the Company for "Good Reason" in the event (i) the Executive is not at all times the duly elected the Executive Vice President and Chief Financial Officer of the Company; (ii) there is any material reduction in the scope of the Executive's authority and responsibility; (iii) there is a reduction in the Executive's Base Salary, a material reduction in the amount of Annual Bonus for which the Executive is eligible, an amendment to any Stock Plan or employee retirement plan applicable to the Executive which is materially adverse to the Executive, or a material reduction in the other benefits to which the Executive is entitled under paragraph 3(e) above; (iv) the Company requires the Executive's principal place of employment to be anywhere other than the Company's principal executive offices, or there is a relocation of the Company's principal executive offices outside of Minneapolis/St. Paul, Minnesota metropolitan area; or (v) the Company otherwise fails to perform its obligations under this Agreement. If the employment of the Executive is terminated by the Executive for Good Reason before a Change in Control (as defined below) or following twenty-four (24) months after a Change in Control, the Executive shall be entitled to the severance benefits set forth in paragraph 4(f) below. If the employment of the Executive is terminated by the Executive for Good Reason upon or within (and including) twenty-four (24) months after a Change in Control, the Executive shall be entitled to the severance benefits set forth in paragraph 4(g) below. In addition, in the event a Change in Control has occurred and the Executive elects upon ten (10) days prior notice to the Company, to terminate employment with the Company within the sixty (60) period following the first anniversary of the Change in Control, such termination shall be considered a termination by the Executive for Good Reason and the Executive shall be entitled to the severance benefits under paragraph 4(g) below. (d) Termination Without Cause. The Company may terminate the Executive's employment without Cause prior to the expiration of the term of this Agreement. If the employment of the Executive is terminated by the Company without Cause before a Change in Control or following twenty-four (24) months after a Change in Control, the Executive shall be entitled to the severance benefits set forth in paragraph 4(f) below. If the employment of the Executive is terminated by the Company without Cause upon or within (and including) twenty-four (24) months after a Change in Control, the Executive shall be entitled to the severance benefits set forth in paragraph 4(g) below. (e) Notice and Right to Cure. (i) Termination by Company for Cause. If the Company proposes to terminate the employment of the Executive for Cause under paragraph 4(b), the Company shall give written notice to the Executive specifying the reasons for such proposed determination with particularity and, in the case of a termination for Cause under paragraph 4(b)(i), the Executive shall have a reasonable opportunity to correct any curable situation to the reasonable satisfaction of the Board of Directors of the Company, which period shall be no less than thirty (30) days from the Executive's receipt of the notice of proposed termination. Notwithstanding the foregoing, the Executive's employment shall not be terminated for Cause unless and until there shall be delivered to the Executive a copy of the resolution duly adopted by the affirmative vote of not less than the majority of the members of the Board of Directors of the Company at a meeting called and held for the purpose (after reasonable notice to the Executive and an opportunity for the Executive, together with the Executive's legal counsel, to be heard before the Board of Directors) finding that, in the opinion of the Company's Board of Directors, the Executive has engaged in conduct justifying a termination for Cause. (ii) Termination by Executive for Good Reason. If the Executive proposes to terminate the Executive's employment for Good Reason under paragraph 4(c) above (other than the last sentence of paragraph 4(c) above), the Executive shall give written notice to the Company, specifying the reason therefor with particularity. In the event the Executive proposes to terminate employment for Good Reason under paragraph 4(c)(i), (ii), (iii) or (iv) above, the termination shall be effective on the date of such notice. In the event the Executive proposed to terminate employment for Good Reason under paragraph 4(c)(v) above, the Company will have an opportunity to correct any curable situation to the reasonable satisfaction of the Executive within the period of time specified in the notice which shall not be less than thirty (30) days. If such correction is not so made or the circumstances or situation is such that it is not curable, the Executive may, within thirty (30) days after the expiration of the time so fixed within which to correct such situation, give written notice to the Company that the Executive's employment is terminated for Good Reason effective forthwith. (f) Severance Benefits. If the Executive is entitled to severance benefits under this paragraph 4(f) pursuant to paragraph 4(c) or (d) prior to a Change in Control or following twenty-four months after a Change in Control, the Executive shall be provided to the following benefits (regardless of the death or disability of the Executive after the Termination Date): (i) Base Salary. The Company shall continue to pay to the Executive the Base Salary when and as such Base Salary would have been paid from the date of termination (the "Termination Date") through the end of the term of this Agreement under paragraph 2 as if such termination did not occur and there were no further automatic extensions of the term pursuant to paragraph 2 (the "Severance Period") as if the Executive continued to be employed by the Company during the Severance Period and regardless of the death or disability of the Executive subsequent to the Termination Date. (ii) Annual Bonus. If the effective date of such termination occurs before the Annual Bonus for any preceding calendar year has been paid, the Company shall, within thirty (30) days after the Termination Date, pay to the Executive the amount of the Executive's Annual Bonus for such preceding calendar year when and as it would have been paid if the Executive remained employed by the Company. (iii) Disability, Life Insurance and Medical/Dental Coverage. The Executive shall be entitled to the disability coverage, life insurance and medical/dental coverage which the Executive and the Executive's family received under paragraph 3(e) as if the Executive continued to be employed by the Company during the Severance Period; provided that if Executive obtains new employment with comparable benefits during the Severance Period, all entitlements under this paragraph 4(f)(iii) shall cease. Nothing in this paragraph shall be construed as providing Executive with coverage under any plan of Employer to which Executive would not otherwise be entitled and in the event any coverage is unavailable, e.g., if Executive is uninsurable, Employer's obligations under this paragraph may be satisfied by paying to Executive the cost of such coverage if it were available, as determined in good faith by the Company. (iv) Stock Options. Not later than thirty (30) days after the date on which the Executive's employment terminates, the Company shall pay the Executive a lump sum cash payment equal to the amount by which the fair market value (determined as of the Termination Date) of the number of shares of stock subject to any stock option granted under the Stock Plans which was not exercisable on the Termination Date and which would have become vested and exercisable during the Severance Period if the Executive had remained employed by the Company during the Severance Period. (g) Severance Benefits for Change in Control. In the event of a Change in Control and either upon or within (and including) twenty-four (24) months after such Change in Control, the Executive terminates employment for Good Reason or the Executive's employment is terminated by the Company for any reason other Cause, then (regardless of the death or disability of the Executive after the Termination Date) the Company shall pay the Executive a lump sum cash payment within five (5) days after the Termination Date, in an amount equal to the amounts referred to in paragraph 4(f)(i), (ii) and (iv), plus the amount of the Deemed Bonus (as defined below), and the Company shall also provide the Executive the severance benefits referred to in paragraph 4(f)(iii) as provided therein. In addition, the Company shall pay the Executive the Gross-Up Payment in accordance with the following provisions: (i) Gross-Up Payment. Anything to the contrary notwithstanding, in the event it shall be determined that any payment, distribution or benefit made or provided by the Company to or for the benefit of the Executive (whether pursuant to this Agreement or otherwise) (a "Payment"), would be subject to the excise tax imposed by Section 4999 of the Internal Revenue Code of 1986, as amended, (the "Code") or any interest or penalties with respect to such excise tax (such excise tax, together with any such interest and penalties, are collectively referred to as the "Excise Tax"), then the Company shall pay the Executive in cash an amount (the "Gross-Up Payment") such that after payment by the Executive of all taxes (including any interest or penalties imposed with respect to such taxes), including but not limited to income taxes (and any interest and penalties imposed with respect thereto) and the Excise Tax, imposed upon the Gross-Up Payment, the Executive retains an amount of the Gross-up Payment equal to the Excise Tax imposed on the Payments. (ii) Determination of Gross-Up Payment. Subject to paragraph 4(g)(iii) below, all determinations required to be made under this paragraph 4(g)(i), including whether a Gross-Up Payment is required and the amount of the Gross-Up Payment, shall be made by the firm of independent public accountants selected by the Company to audit its financial statements for the year immediately preceding the Change in Control (the "Accounting Firm") which shall provide detailed supporting calculations to the Company and the Executive within thirty (30) days after the Termination Date. In the event that the Accounting Firm is serving as accountant or auditor for the individual, entity or group effecting the Change in Control, the Executive shall appoint another nationally recognized accounting firm to make the determinations required under this paragraph 4(g) (which accounting firm shall then be referred to as the "Accounting Firm"). All fees and expenses of the Accounting Firm in connection with the work it performs pursuant to this paragraph 4(g) shall be promptly paid by the Company. An Gross-Up Payment (as determined pursuant to paragraph 4(g)(i) above) shall be paid by the Company to the Executive within five (5) days of the receipt of the Accounting Firm's determination. If the Accounting Firm determines that no Excise Tax is payable by the Executive, it shall furnish the Executive with a written opinion that failure to report the Excise Tax on the Executive's applicable federal income tax return would not result in the imposition of a negligence or a similar penalty. Any determination by the Accounting Firm shall be binding upon the Company and the Executive. As a result of the uncertainty in the application of Section 4999 of the Code at the time of the initial determination by the Accounting Firm, it is possible that Gross-up Payments which will not have been made by the Company should have been made ("Underpayment"). In the event that the Company exhausts its remedies pursuant to paragraph 4(g)(iii) below, and the Executive is thereafter required to make a payment of Excise Tax, the Accounting Firm shall promptly determine the amount of the Underpayment that has occurred and any such Underpayment shall be paid by the Company to the Executive within five (5) days after such determination. (iii) Contest. The Executive shall notify the Company in writing of any claim made by the Internal Revenue Service that, if successful, would require the Company to pay a Gross-Up Payment. Such notification shall be given as soon as practicable but no later than ten (10) business days after the Executive knows of such claim and shall apprise the Company of the nature of such claim and the date on which such claim is requested to be paid. The Executive shall not pay such claim prior to the expiration of the thirty (30) day period following the date on which it gives such notice to the Company (or such shorter period ending on the date that any payment of taxes with respect to such claim is due). If the Company notifies the Executive in writing prior to the expiration of such period that it desires to contest such claim, the Employee shall: (A) give the Company any information reasonably requested by the Company relating to such claim; (B) take such action in connection with contesting such claim as the Company shall reasonably request in writing from time to time, without limitation, accepting legal representation with respect to such claim by an attorney selected by the Company and reasonably acceptable to the Executive; (C) cooperate with the Company in good faith in order effectively to contest such claim; (D) permit the Company to participate in any proceedings relating to such claim; provided, however, that the Company shall bear and pay directly all costs and expenses (including additional interest and penalties) incurred in connection with such contest and shall indemnify and hold the Executive harmless, on an after-tax basis, for any Excise Tax or income tax, including interest and penalties with respect thereto, imposed as a result of such representation and payment of costs and expenses. Without limitation on the foregoing provisions of this paragraph 4(g)(iii), the Company shall control all proceedings taken in connection with such contest and, at its sole option, may pursue or forego any and all administrative appeals, proceedings, hearings and conferences with the taxing authority in respect of such claim and may, at its sole option, either direct the Executive to pay the tax claimed and sue for a refund or contest the claim in any permissible manner, and the Executive agrees to prosecute such contest to a determination before any administrative tribunal, in a court of initial jurisdiction and in one or more appellate courts, as the Company shall determine; provided, however, that if the Company directs the Executive to pay such claim and sue for a refund, the Company shall advance the amount of such payment to the Executive, on an interest-free basis, from any Excise Tax or income tax, including interest or penalties with respect thereto, imposed with respect to such advance or with respect to any imputed income with respect to such advance; and further provided that any extension of the statute of limitations relating to payment of taxes for the taxable year of the Executive with respect to which such contested amount is claimed to be due is limited solely to such contested amount. Furthermore, the Company's control of the contest shall be limited to issues with respect to which a Gross-Up Payment would be payable hereunder and the Executive shall be entitled to settle or contest, as the case may be, any other issue raised by the Internal Revenue Service or any other taxing authority. (iv) If, after the receipt by the Executive of an amount advanced by the Company pursuant to paragraph 4(g)(iii), the Executive becomes entitled to receive any refund with respect to such claim, the Executive shall (subject to the Company's complying with the requirements of paragraph 4(g)(iii)) promptly pay to the Company the amount of such refund (together with any interest paid or credited thereon after taxes applicable thereto). If, after the receipt by the Executive of an amount advanced by the Company pursuant to paragraph 4(g)(iii), a determination is made that the Executive shall not be entitled to any refund with respect to such claim and the Company does not notify the Executive in writing of its intent to contest such denial of refund prior to the expiration of thirty (30) days after such determination, then such advance shall be forgiven and shall not be required to be repaid and the amount of such advance shall offset, to the extent thereof, the amount of Gross-Up Payment required to be paid. (h) Benefits in Lieu of Severance Pay Policy. The severance benefits provided for in this paragraph 4 are in lieu of any benefits that would otherwise be provided to the Executive under the Company's severance pay policy and the Executive shall not be entitled to any benefits under the Company's severance pay policy. (i) No Funding of Severance. Nothing contained in this Agreement or otherwise shall require the Company to segregate, earmark or otherwise set aside any funds or other assets to provide for any payments required to be made under this paragraph 4 and the rights of the Executive to the severance benefits hereunder shall be solely those of a general, unsecured creditor of the Company. However, the Company may, in its discretion, deposit cash or property, or a combination of both, equal in value to all or a portion of the amounts anticipated to be payable hereunder into a trust, the assets of which are to be distributed by such times as determined by the trustee of such trust; provided that such assets shall be subject at all times to the rights of the Company's general creditors. (j) Definitions. A "Change in Control" shall be deemed to have occurred if, prior to the expiration of the term of the Employment Agreement: (i) any "person" (as such term is used in Sections 13(d) and 14(d) of the Securities Exchange Act of 1934) (other than the Company or any of its subsidiaries or any employee benefit plan of the Company or any of its subsidiaries) becomes a beneficial owner, directly or indirectly, of securities of the Company representing 20% or more of the voting power of all of the Company's then outstanding securities; or (ii) during any period of two consecutive years individuals who at the beginning of such period constituted the Board of Directors of the Company (the "Incumbent Directors") together with any director (the "New Incumbent Director") whose nomination or election was approved by at least two-thirds of the Incumbent Directors and any New Incumbent Director who was previously elected, in each case who are directors at the time of the nomination or election of such director cease for any reason to constitute at least a majority, the Board of Directors of the Company; or (iii) the shareholders of the Company approve the sale of all, or substantially all, of the business or assets of the Company or the liquidation or dissolution of the Company. The "Deemed Bonus" shall be an amount equal to the number of calendar years (including the calendar year in which the Termination Date occurs) multiplied by the Company shall pay the Executive an amount equal to the greater of (A) the Annual Bonus paid to the Executive for the period after the Change of Control or (B) the average of the Annual Bonus paid or payable to the Executive in respect of the two calendar years immediately preceding the calendar year in which the Change in Control occurs. 5. Confidentiality; Non-Solicitation Covenant. (a) Confidentiality. The Executive agrees that, at all times, both during the Executive's employment and after the termination thereof, the Executive shall not divulge to any other person, firm or corporation, or in any way use for the Executive's own benefit, except as required in the conduct of the business of the Company or any of its Subsidiaries or as authorized in writing on behalf of the Company, any trade secrets or confidential information of the Company or its Subsidiaries obtained during the course of the Executive's employment with the Company or its Subsidiaries. The Executive also agrees that the Executive will not, either subsequent to termination of employment or during employment, except as required in the conduct of the business of the Company or any of its Subsidiaries, or as authorized in writing on behalf of the Company, interfere with or disturb or attempt to interfere with or disturb any employment, contractual or business arrangements of the Company or any of its Subsidiaries with any of its employees, agents, suppliers, customers, reinsurers or other parties with which the Company or any of its Subsidiaries has a contractual relationship, as the case may be. (b) Non-Solicitation Covenant. While the Executive is actively employed with the Company and, in the event of a termination of employment with the Company for any reason, for a period of two years after the Termination Date, the Executive agrees that, except with the prior written permission of the Board of Directors of the Company, the Executive will not offer to hire, entice away, or in any manner attempt to persuade any officer, employee, or agent of the Company or any of the Subsidiaries to discontinue his or her relationship with the Company or any of the Subsidiaries nor will the Executive directly or indirectly solicit, divert, take away or attempt to solicit any business of the Company or any of its Subsidiaries as to which Executive has acquired any knowledge during the term of the Executive's employment with the Company. (c) Remedies. If the Executive commits a breach, or threatens to commit a breach, of any of the provisions of this paragraph 5, the Company shall have the following rights and remedies, in addition to any rights and remedies otherwise available at law or equity: (i) The right and remedy to have the provisions of this paragraph 5 specifically enforced by any court having equity jurisdiction, it being acknowledged and agreed by the Executive that any such breach or threatened breach will cause irreparable injury to the Company and the Subsidiaries and that money damages will not provide an adequate remedy to the Company and the Subsidiaries; and (ii) The right and remedy to require the Executive to account for and pay over to the Company all compensation, profits, monies, accruals, increments, or other benefits, other than those payable under this Agreement, derived or received by the Executive or the enterprise in competition with the Company or any of the Subsidiaries as the result of any transactions constituting a breach of any part of this paragraph 5, and Executive agrees to account for and pay over to the Company such amounts promptly upon demand therefor. 6. Beneficiaries. In the event of the Executive's death after termination of employment, any amount or benefit payable or distributable to him pursuant to this Agreement shall be paid to the beneficiary designated by the Executive for such purpose in the last written instrument received by the Company prior to the Executive's death, if any, or, if no beneficiary has been designated, to the Executive's estate, but such designation shall not be deemed to supersede any beneficiary designation under any benefit plan of the Company. Whenever this Agreement provides for the written designation of a beneficiary of beneficiaries of the Executive, the Executive shall have the right to revoke such designation and to redesignate a beneficiary or beneficiaries by written notice to either the Company to such effect, except to the extent, if any, restricted by law. 7. Rights in the Event of Dispute. In the event of a dispute between the Company and the Executive regarding the Executive's employment or this Agreement, it is the intention of this Agreement that the dispute shall be resolved as expeditiously as possible, consistent with fairness to both sides, and that during pendency of the dispute the Executive and the Company shall be on equal footing, as follows: (a) Arbitration. Any claim or dispute relating to the Executive's employment or the terms and performance of this Agreement, shall be resolved by binding private arbitration before three arbitrators and any award rendered by any arbitration panel, or a majority thereof, may be filed and a judgment obtained in any court having jurisdiction over the parties unless the relief granted in the award is delivered within ten (10) days of the award. Either party may request arbitration by written notice to the other party. Within thirty (30) days of receipt of such notice by the opposing party, each party shall appoint a disinterested arbitrator and the two arbitrators selected thereby shall appoint a third neutral arbitrator; in the event the two arbitrators cannot agree upon the third arbitrator within then (10) days after their appointment, then the neutral arbitrator shall be appointed by the Chief Judge of Hennepin County (Minnesota) District Court. Any arbitration proceeding conducted hereunder shall be in the City of Minneapolis and shall follow the procedures set forth in the Rules of Commercial Arbitration of the American Arbitration Association, and both sides shall cooperate in as expeditious a resolution of the proceeding as is reasonable under the circumstances. The arbitration panel shall have the power to enter any relief it deems fair and just on any claim, including interim and final equitable relief, along with any procedural order that is reasonable under the circumstances. (b) Expenses of Prosecution/Defense of Claim. During the pendency of a dispute between the Company and the Executive relating to the Executive's employment or the terms or performance of this Agreement, the Company shall promptly pay the Executive's reasonable expenses of representation upon delivery of periodic billings for same, provided that (i) Executive (or a person claiming on the Executive's behalf) shall promptly repay all amounts paid hereunder at the conclusion of the dispute if the resolution thereof includes a finding that the Executive did not act in good faith in the matter in dispute or in the dispute proceeding itself, and (ii) no claim for expenses of representation shall be submitted by the Executive or any person acting on the Executive's behalf unless made in writing to the Board of Directors within one year of the performance of the services for which such claim is made. 8. No Obligation to Mitigate Damages. In the event the Executive becomes eligible to receive compensation or benefits subsequent to the termination of the Executive's employment under this Agreement, the Executive shall have no obligation to seek other employment in an effort to mitigate damages. To the extent the Executive shall accept other employment after the Executive's termination of employment, the compensation and benefits received from such employment shall not reduce the compensation and benefits otherwise due under this Agreement, except as provided in paragraph 4(f)(iii) above. 9. Other Benefits. The benefits provided under this Agreement shall, except to the extent otherwise specifically provided herein, be in addition to, and not in derogation or diminution of, any benefits that Executive or the Executive's beneficiary may be entitled to receive under any other plan or program now or hereafter maintained by the Company, or its Subsidiaries. 10. Successors. The Company shall require any successor (whether direct or indirect, by purchase, merger, consolidation, or otherwise) to all or substantially all of the business and/or assets of the Company, to expressly assume and agree to perform its obligations under this Agreement in the same manner and to the same extent that the Company would be required to perform them if no succession had taken place unless, in the opinion of legal counsel mutually acceptable to the Company and the Executive, such obligations have been assumed by the successor as a matter of law. Failure of the Company to obtain such agreement prior to the effectiveness of any such succession (unless the foregoing opinion is rendered to the Executive) shall entitle the Executive to terminate the Executive's employment and to receive the payments provided for in paragraph 4(f) above as if the Executive terminated this Agreement for Good Reason. The Executive's rights under this Agreement shall inure to the benefit of, and shall be enforceable by, the Executive's legal representative or other successors in interest, but shall not otherwise be assignable or transferable. 11. Severability. If any provision of this Agreement or the application thereof is held invalid or unenforceable, the invalidity or unenforceability thereof shall not affect any other provisions or applications of this Agreement which can be given effect without the invalid or unenforceable provision or application. 12. Survival. The rights and obligations of the parties pursuant to this Agreement shall survive the term of the employment to the extent that any performance is required hereunder after the expiration or termination of such term. 13. Notices. All notices under this Agreement shall be in writing and shall be deemed effective when delivered in person (in the Company's case, to its Secretary) or 48 hours after deposit thereof in the U.S. mails, postage prepaid, addressed, in the case of the Executive, to the Executive's last known address as carried on the personnel records of the Company and, in the case of the Company, to the corporate headquarter,s, attention of the Secretary, or to such other address as the party to be notified may specify by written notice to the other party. 14. Amendments and Construction. This Agreement may only be amended in a writing signed by the parties hereto. This Agreement shall be construed under the laws of the State of Minnesota. Paragraph headings are for convenience only and shall not be considered a part of the terms and provisions of the Agreement. IN WITNESS WHEREOF, the parties have duly executed this Agreement as of the day and year first written above. LIFE USA HOLDING, INC. By /s/ Robert W. MacDonald --------------------------- Robert W. MacDonald, Chairman and Chief Executive Officer /s/ Mark A. Zesbaugh --------------------- Mark A. Zesbaugh EX-11 6 STATEMENT OF COMPUTATION OF PER SHARE EARNINGS EXHIBIT 11
STATEMENT OF COMPUTATION OF PER SHARE EARNINGS Life USA HOLDING, INC. (Dollars in thousands, except per share amounts) Year ended December 31, ----------------------------------------- 1996 1995 1994 ----------- ----------- ----------- PRIMARY Average shares outstanding and to be issued 20,767,538 20,270,532 20,124,556 Net effect of dilutive stock options and warrants having exercise prices less than the average market price of the common stock using the treasury stock method 163,482 166,688 284,491 Common equivalent shares assuming conversion of convertible subordinated debentures 2,419,411 2,084,384 -- ----------- ----------- ----------- Total common and common equivalent shares 23,350,431 22,521,604 20,409,047 =========== =========== =========== Net income $ 23,454 $ 19,097 $ 14,469 Add convertible subordinated debenture interest, net of federal income tax effect 870 757 -- ----------- ----------- ----------- Adjusted net income $ 24,324 $ 19,854 $ 14,469 =========== =========== =========== Per common and common equivalent share amount $ 1.04 $ .88 $ .71 =========== =========== =========== FULLY DILUTED Average shares outstanding and to be issued 20,767,538 20,270,532 20,124,556 Net effect of dilutive stock options and warrants, having exercise prices less than the greater of the average or the end of period market price of the common stock using the treasury stock method 215,897 172,547 300,365 Common equivalent shares assuming conversion of convertible subordinated debentures 2,419,411 2,084,384 -- ----------- ----------- ----------- Total common and common equivalent shares 23,402,846 22,527,463 20,424,921 =========== =========== =========== Net income $ 23,454 $ 19,097 $ 14,469 Add convertible subordinated debenture interest, net of federal income tax effect 870 757 -- ----------- ----------- ----------- Adjusted net income $ 24,324 $ 19,854 $ 14,469 =========== =========== =========== Per common and common equivalent share amount $ 1.04 $ .88 $ .71 =========== =========== ===========
EX-13 7 ANNUAL REPORT [LOGO] LIFEUSA(R) 1996 Annual Report COMPANY DESCRIPTION Life USA Holding, Inc. is a national financial services holding and marketing company based in Minneapolis. Its primary subsidiary, LifeUSA Insurance Company, is represented by over 130 marketing organizations nationwide and over 50,000 independent agents. Life USA Holding, Inc. common stock trades on the Nasdaq National Market tier of The Nasdaq Stock Market under the symbol LUSA. HIGHLIGHTS OF 1996 * Consolidated total revenues increased to $316.9 million in 1996 from $272.8 million in 1995. * Consolidated net income increased to $23.5 million in 1996 from $19.1 million in 1995. * Collected premiums for 1996 (including Allianz Life) increased to $1.05 billion from $1.04 billion in 1995. * Consolidated assets increased to $4.39 billion at December 31, 1996 from $3.87 billion at December 31, 1995. * Life USA Holding, Inc. entered into a $30 million line of credit agreement with two of its reinsurers in May 1996. * LifeUSA Marketing, Inc. acquired Tax Planning Seminars in August 1996. * LifeUSA Marketing, Inc. acquired a minority interest in Creative Marketing International Corporation in November 1996. * The ANNU-A-DEX(SM) equity indexed annuity was introduced in September 1996. * Life USA Holding, Inc. formed LifeUSA Securities, Inc. in March 1996. LifeUSA Securities, Inc. received approval from the National Association of Securities Dealers, Inc. as a wholesale broker-dealer in October 1996. MESSAGE TO SHAREHOLDERS Come back with me 10 years to February 26, 1987, the date our company was incorporated. Until that date, with the exception of the five original founders (plus one reinsurance actuary, a high-priced lawyer and a public relations specialist), no one had ever heard the name, "LifeUSA." Despite this anonymity, the articles of incorporation stated that Life USA Holding, Inc. ". . . was formed to become a national life insurance holding company." A presumptuous objective for a start-up company in a mature industry dominated by century-old financial giants. Almost no one gave the company much chance to survive, let alone become a force in the industry. Now come forward to today. Not only has the company survived, but the Life USA name is household in the life insurance industry. Setting new standards for product innovation, service and distribution strategies, Life USA is now one of the fastest growing, most successful companies in the industry. Ironically, it's the financial giants who have struggled to survive. Many have passed from the scene, while others have been so severely wounded by the changes of the decade that they seem to stagger from crisis to scandal. Today, Life USA, the unknown company of 1987, enters its second decade as a flourishing, highly visible company fully intent on taking its place among industry leaders with over $4 billion of assets, annual premiums in excess of $1 billion, and representation by over 50,000 agents. Life USA ended its first decade with a bang-up year. Boosted by an 11% increase in fourth quarter collected premiums, consolidated 1996 net income increased 23%, to $23.5 million or $1.04 per share, compared to $19.1 million or $.88 per share in 1995. 1996 consolidated net operating income increased 31%, to $25.0 million or $1.11 per share, compared to $19.1 million or $.88 per share in 1995. Of particular note, LifeUSA Insurance Company reported a 1996 after-tax statutory profit of $13.2 million. This is a significant improvement over the $367,000 after-tax statutory profit reported in 1995. Statutory profits are important because they are indicative of a growing block of profitable inforce business, reduce the need for external capital, are a critical measure for rating agency action, and provide the basis for potential dividends from the life insurance company to the parent. Consolidated revenues increased 16% in 1996, to $316.9 million, compared to $272.8 million in 1995. During 1996, consolidated assets increased 13%, to $4.39 billion from $3.87 billion. Consolidated net investment income increased 19% during 1996, to $129.4 million from $109.1 million reported in 1995. Total collected premiums for 1996 were $1.05 billion, a 1% increase over the $1.04 billion reported in 1995. Normally, one would not look upon a 1% increase in premiums as a positive, but in light of the current difficult sales environment for fixed income products, the results are very encouraging. A.M. Best projected that industry wide fixed annuity premium would decline approximately 30% from 1995 to 1996. For LifeUSA to post even a small gain in premiums while competing against a roaring stock market with long-term interest rates below 7%, demonstrates the underlying potency of our distribution system, not matched by many other companies. Of note is that almost 12% of our total premiums were produced by marketing organizations contracted with LifeUSA for less than two years. This lays the groundwork for even more growth in the future. Life USA has accomplished much during our first decade. We are pleased, but not satisfied. Now, it's on to the next century. We look to a combination of operational and strategic factors to foster continued success. As Life USA enters its second decade, it's time to take our story to a broader public. The process will start with a national advertising and promotional campaign, targeted to our marketing niche. The objective is to enhance the credibility and visibility of Life USA, not only with agents, but with consumers and investors as well. Ultimately, we hope this effort will translate into expanded distribution, increased sales and profits and a more meaningful valuation of the company. LifeUSA agents will start the year with two new products in their arsenal - -- the ANNU-A-DEX(SM) and the IDEAL(SM) annuity. 1 The ANNU-A-DEX is a competitive fixed annuity, offering an initial 7% premium bonus, but with an additional benefit tied to the performance of the S&P 500(R) Index. The appeal of the product is that one can buy a competitive fixed annuity, with principal and interest guaranteed, and should the S&P 500(R) Index outperform the annuity over a seven-year period, one-half of the incremental growth is added to the value of the annuity. While not an investment product, the ANNU-A-DEX is positioned as an alternative "safe haven" for investment funds. An investor can "lock-in" current gains and still participate, should the stock market continue to rise, all with no down-side exposure. The IDEAL annuity (introduced during the first quarter of 1997), is unique in that it provides up to 10 years of protection against interest rate changes - -- up or down. When issued, the IDEAL annuity offers a base credited rate, plus a 1.5% annual interest bonus, both guaranteed for five years. Thus, the policyholder is protected against a decline in interest rates for the next five years. At the end of the first five-year term, the policyholder has the option to "re-enter" the policy at the interest rate being credited on new issues. The new credited rate, plus another 1.5% annual interest bonus, is then guaranteed for a new five-year term. Thus, the policyholder is also protected against a rise in interest rates. The interest rate change protection along with other competitive benefits make this an IDEAL annuity for the consumer. A handsome compensation package makes this an IDEAL annuity for agents. Over time, this annuity could be the IDEAL stimulant needed for increased sales. LifeUSA believes that the best insurance product for the consumer and the company is one that offers exceptional long-term benefits, as opposed to a short-term, commodity-type product. This type of benefit-oriented product must be explained and sold by a knowledgeable sales person. For that reason, LifeUSA is even more committed to building the largest and strongest agent distribution system in the industry. We believe that distribution will be the key to success in the future. Not only distribution of our own products, but distribution of products for other manufacturers. If you can control distribution, you control your competitor's products. That does not necessarily mean that you own or control the distribution system, but that you own and control "access" to the distribution system. The one who wins the distribution battles of the next few years will win the war. With that in mind, in 1996, Life USA purchased Tax Planning Seminars, a large marketing organization based in Voorhees, New Jersey, and made a substantial ownership investment in Creative Marketing International Corporation, another marketing organization based in Overland Park, Kansas. These two organizations sell an aggregate of over $200 million of annual annuity premiums. There is no guarantee that LifeUSA will receive all the business these organizations produce, but we will receive first call and will profit from business sold with other companies as well as LifeUSA. Encouraged by the initial success of these two transactions, Life USA will be looking aggressively for similar opportunities in 1997 and beyond. Several years of low interest rates and a thriving stock market have caused the market for fixed annuities to shrink, but the potential market for annuities has barely been tapped. Should long-term interest rates rise above 8% and the stock market make even a modest correction, there is a vast pool of capital that will be looking for a safe haven, and LifeUSA is well-positioned to take advantage of such a circumstance. Just the same, to cover all the bases, 1997 will see the launch of LifeUSA Securities, Inc. to market a family of LifeUSA mutual funds. We are also exploring the distribution of variable life and annuity contracts issued by other companies. This action expands and helps to balance our product universe, as well as enhance our ability to attract an even broader base of distribution. 2 While nothing is guaranteed, when the momentum of our past success is combined with the fresh plans we have for the future, then it becomes clear that Life USA is well positioned for a healthy start to our second decade. In short, we are encouraged, both by our past success and future opportunities. Before we close out our first decade and move on, I would like to pause just a moment to thank all those who have been so important to our success. Living in Minnesota, we're not far from the headwaters of the Mississippi River. At the point of origin, one can easily jump across the river. As the river moves south, it gradually becomes the mighty Mississippi, not because of the volume of the water at the source, but from hundreds of creeks, streams and other rivers that flow into it. Viewing the Mississippi in all its grandeur, one cannot identify the various sources of the river because the contributions all flow together to make one great river. The same dynamics are true with a successful business. At the beginning, it was easy to identify the source of the power at Life USA. However, as the company has grown, hundreds, even thousands, of people have added their part. Today, it is impossible to break out individual contributions. They all flow together. To all of those who have believed and contributed their talents to our success, I offer a deep, sincere thanks. And, along with that goes our commitment to make our second decade even better than the first. Robert W. MacDonald CHAIRMAN AND CHIEF EXECUTIVE OFFICER Life USA Holding, Inc. CHIEF EXECUTIVE OFFICER LifeUSA Insurance Company THEN AND NOW (1987 - 1996) CONSOLIDATED RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS): 1996 1987 -------------------------- Collected Premiums ...... $1,052,458 $ 179 Total Revenues .......... 316,898 286 Net Income (Loss) ....... 23,454 (2,135) Earnings (Loss) Per Share 1.04 (.11) CONSOLIDATED BALANCE SHEET DATA AS OF DECEMBER 31 (DOLLARS IN THOUSANDS): 1996 1987 ----------------------- Fixed Maturity Investments ......... $1,881,476 $ 3,362 Total Shareholders' Equity (Deficit) 172,615 (521) 3 SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA Life USA Holding, Inc. (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
AS OF AND FOR THE YEAR ENDED DECEMBER 31 1996 - ----------------------------------------------------------------------------------------- Consolidated results of operations: Revenues ............................................................... $ 316,898 Net income ............................................................. 23,454 Adjustments to arrive at net operating income (1): Net realized gains on investments ..................................... (408) Charges for state guaranty fund assessments ........................... 1,998 ------------ Net operating income (1) ............................................... 25,044 Per share data: Fully diluted shares ................................................... 23,402,846 Convertible subordinated debenture interest addback, net of tax ........ $ 870 Net income ............................................................. 1.04 Net operating income (1) ............................................... 1.11 Consolidated financial position: Assets ................................................................. $ 4,386,723 Invested assets (fixed maturity investments and cash and cash equivalents) .......................................................... 1,902,465 Debt (convertible subordinated debentures) ............................. 36,030 Shareholders' equity: As reported ........................................................... 172,615 Excluding SFAS No. 115 ................................................ 169,280 Common stock data: Shares issued and outstanding and to be issued 20,974,901 Book value per share: As reported ........................................................... $ 8.23 Excluding SFAS No. 115 ................................................ 8.07 Closing Price ......................................................... 12.00 Financial ratios and other data: Return on invested assets--net income .................................. 1.23% Return on invested assets--net operating income (1) .................... 1.32% Return on equity--net income: As reported ........................................................... 13.59% Excluding SFAS No. 115 ................................................ 13.86% Return on equity--net operating income (1): As reported ........................................................... 14.51% Excluding SFAS No. 115 ................................................ 14.79% Debt to equity: As reported ........................................................... 20.87% Excluding SFAS No. 115 ................................................ 21.28% Closing price to net income per share .................................. 11.55x Closing price to net operating income per share (1) .................... 10.8x Closing price to book value per share: As reported ........................................................... 1.46x Excluding SFAS No. 115 ................................................ 1.49x Total market capitalization ............................................ $ 251,699
- ----------------------------- 1) Net operating income equals net income, excluding, net of related income taxes: (i) net realized gains on investments and the corresponding increases in amortization of deferred policy acquisition costs and other benefits to policyholders and (ii) charges for state guaranty fund assessments. In 1993, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 109, "Accounting for Income Taxes." Under SFAS No. 109, deferred tax assets and liabilities are determined based on differences between the financial reporting basis and the tax basis of the Company's assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. Prior to the adoption of SFAS No. 109, income tax expense was based on items of income and expense that were reported in different years in the financial statements and tax returns and were measured at the tax rate in effect in the year the difference originated. As permitted by SFAS No. 109, the Company restated its 1992 financial statements. 4 (WIDE TABLE CONTINUED) FIVE YEAR AVERAGE COMPOUND 1995 1994 1993 1992 GROWTH RATE - -------------------------------------------------------------------------------- $ 272,781 $ 206,313 $ 199,685 $ 145,800 22.78% 19,097 14,469 15,115 9,870 39.44% (1,828) (641) (989) (1,877) 1,877 1,704 624 961 - --------------------------------------------------------------- 19,146 15,532 14,750 8,954 59.95% 22,527,463 20,424,921 19,439,945 14,887,306 $ 757 N/A N/A N/A 0.88 $ 0.71 $ 0.78 $ 0.66 26.87% 0.88 0.76 0.76 0.60 45.46% $ 3,867,539 $ 3,065,271 $ 2,394,471 $ 1,537,375 34.08% 1,754,087 1,249,321 899,998 447,386 49.20% 36,030 6,041 6,351 8,336 156,896 106,916 107,204 38,898 43.44% 144,189 123,836 107,204 38,898 42.88% 20,324,747 20,179,617 19,978,118 14,262,937 $ 7.72 $ 5.30 $ 5.37 $ 2.73 32.62% 7.09 6.14 5.37 2.73 32.10% 8.00 7.25 18.88 11.13 1.09% 1.16% 1.68% 2.21% 1.09% 1.24% 1.64% 2.00% 12.17% 13.53% 14.10% 25.37% 13.24% 11.68% 14.10% 25.37% 12.20% 14.53% 13.76% 23.02% 13.28% 12.54% 13.76% 23.02% 22.96% 5.65% 5.92% 21.43% 24.99% 4.88% 5.92% 21.43% 9.08x 10.23x 24.28x 16.78x 9.1x 9.5x 24.9x 18.5x 1.04x 1.37x 3.52x 4.08x 1.13x 1.18x 3.52x 4.08x $ 162,598 $ 146,302 $ 377,087 $ 158,675 Also, in 1993, the Company implemented SFAS No. 113, "Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts." SFAS No. 113 requires the reporting of assets and liabilities relating to ceded life insurance contracts on a gross basis rather than the previous practice of reporting these items net of reinsurance. In accordance with Financial Accounting Standards Board (FASB) Interpretation No. 39, "Offsetting of Amounts Related to Certain Contracts," the Company presents assets and liabilities related to its annuity contracts on a gross basis. Total assets and liabilities for all periods presented have been increased to reflect the implementation of SFAS No. 113 and FASB Interpretation No. 39. In 1994, the Company adopted SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities." Beginning January 1, 1994, under the provisions of SFAS No. 115, held to maturity investments are carried at amortized cost and available for sale investments are carried at fair value, with unrealized gains and losses reported as a separate component of shareholders' equity. 5 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS LIFE USA HOLDING, INC. GENERAL The following analysis of the results of operations and financial condition of Life USA Holding, Inc. (the Company) and its wholly-owned subsidiaries, LifeUSA Insurance Company (LifeUSA), LifeUSA Securities, Inc. (LifeUSA Securities) and LifeUSA Marketing, Inc. (LifeUSA Marketing), should be read in conjunction with the Company's consolidated financial statements and notes thereto included elsewhere in this Annual Report. During 1996, the Company formed two wholly-owned subsidiaries: LifeUSA Securities and LifeUSA Marketing. LifeUSA Securities has received approval from the National Association of Securities Dealers, Inc. as a wholesale broker-dealer, will initially market a family of LifeUSA mutual funds established through a joint-venture agreement with a $16 billion asset management firm and is exploring distribution of variable life insurance and annuity contracts. LifeUSA Marketing conducts a variety of marketing activities for the Company, including the acquisition of and investment in national field marketing organizations. The results of operations and financial condition of LifeUSA Securities and LifeUSA Marketing, both individually and in the aggregate, are not material to the 1996 consolidated financial statements of the Company. Therefore, the analysis that follows will focus primarily on the Company and LifeUSA. Since its inception in 1987, LifeUSA has entered into various agreements to reinsure a substantial portion of the new life insurance and annuity business written each year. Entering into these reinsurance agreements has allowed LifeUSA to write a larger volume of business than it would otherwise have been able to write due to regulatory restrictions based on the amount of its statutory capital and surplus. Since April 1, 1991, LifeUSA has ceded a substantial portion of its new life insurance and annuity business to the following three reinsurers (the Reinsurers): * Employers Reassurance Corporation, a subsidiary of Employers Reinsurance Corporation, a member of the General Electric Company group; * Munich American Reassurance Company, a subsidiary of Munich Reinsurance Company, one of the largest German insurance companies; and * Republic-Vanguard Life Insurance Company, a member of the Winterthur Swiss Insurance Group, one of the largest Swiss insurance companies. Effective October 1, 1995, LifeUSA began ceding 75% of its new life insurance and annuity business to the Reinsurers. From July 1, 1993 through September 30, 1995, LifeUSA ceded 50% of its new life insurance and annuity business to the Reinsurers. LifeUSA receives commissions and expense allowances on business ceded to the Reinsurers. Since 1987, under the terms of agreements between the Company and Allianz Life Insurance Company of North America (Allianz Life), LifeUSA agents have produced life insurance and annuity business on Allianz Life policies which are similar to LifeUSA agents for Allianz Life. Effective October 1, 1995, LifeUSA began assuming 25% of the new life insurance and annuity business produced by its agents for Allianz Life. From July 1, 1993 through September 30, 1995, LifeUSA assumed 50% of the new life insurance and annuity business produced by LifeUSA agents for Allianz Life. The reduction in LifeUSA's net retention (the percentage of new life insurance and annuity business retained by LifeUSA and assumed by LifeUSA from Allianz Life) from 50% to 25%, effective October 1, 1995, is one of the primary reasons for several fluctuations discussed in the Results of Operations section that follows. For comparative purposes, LifeUSA's net retention was a constant 25% throughout 1996, 50% for the first nine months and 25% for the last three months of 1995 and a constant 50% throughout 1994. These reductions will be referred to as "the October 1, 1995 reduction in LifeUSA's net retention" during the remainder of this document. 6 The following table shows LifeUSA's life insurance and annuity in force information at December 31 (in millions): 1996 1995 -------- -------- Life insurance account values: All policies produced by LifeUSA agents (1) $ 260.1 $ 216.0 Direct and assumed business (2) ........... 223.4 185.6 Net of reinsurance (3) .................... 85.5 69.1 Life insurance face amounts: All policies produced by LifeUSA agents (1) 8,171.2 7,939.0 Direct and assumed business (2) ........... 7,104.0 6,924.7 Net of reinsurance (3) .................... 2,860.2 2,923.7 Annuity account values: All policies produced by LifeUSA agents (1) 4,876.7 4,369.7 Direct and assumed business (2) ........... 3,496.3 3,183.3 Net of reinsurance (3) .................... 1,655.5 1,574.1 - ------------------------------ (1) Includes all policies produced by LifeUSA agents, including policies produced by LifeUSA agents for Allianz Life. (2) Includes all LifeUSA policies and the portion of policies produced by LifeUSA agents for Allianz Life that have been assumed by LifeUSA. (3) Includes the portion of LifeUSA policies that have been retained by LifeUSA and the portion of policies produced by LifeUSA agents for Allianz Life that have been assumed by LifeUSA. Reference is made to Note 2 (Reinsurance) to the December 31, 1996 consolidated financial statements for further details regarding the Company's reinsurance agreements. 7 RESULTS OF OPERATIONS In 1996, the Company generated increases in collected life insurance premiums and annuity deposits, invested assets and life insurance and annuities in force. As a result, revenues from policyholder charges, net investment income and commissions and expense allowances increased. Expenses incurred for interest credited to policyholder account values and commissions also increased during 1996 for similar reasons. Primarily as a result of these factors, net income and earnings per share for 1996 increased 23% and 18%, respectively, compared to the corresponding results achieved during 1995. In addition, the combination of two non-operating items (net realized gains on investments and charges for state guaranty fund assessments) had a slight negative effect on 1996 net income and earnings per share. PREMIUMS AND DEPOSITS. Total collected premiums and deposits, including premiums and deposits on policies produced by LifeUSA agents for Allianz Life, were $1.05 billion, $1.04 billion and $915.5 million in 1996, 1995 and 1994, respectively, and represented an increase of 1% in 1996 compared to 1995 and an increase of 14% in 1995 compared to 1994. The following table shows the amounts of premiums and deposits collected, ceded and retained for the three years (in thousands):
YEAR ENDED DECEMBER 31, ---------------------------------- 1996 1995 1994 ---------------------------------- Collected Premiums and Deposits (1): LifeUSA: Life: First year .......................................... $ 12,731 $ 16,451 $ 16,197 Single and renewal .................................. 49,242 44,418 38,731 ---------------------------------- Total Life ......................................... 61,973 60,869 54,928 Annuities ............................................ 547,748 585,739 481,138 ---------------------------------- Total LifeUSA collected premiums and deposits ..... 609,721 646,608 536,066 Allianz Life: Life: First year .......................................... 3,261 4,693 5,318 Single and renewal .................................. 14,817 13,010 10,839 ---------------------------------- Total Life ......................................... 18,078 17,703 16,157 Annuities ............................................ 424,659 379,588 363,319 ---------------------------------- Total Allianz Life collected premiums and deposits 442,737 397,291 379,476 ---------------------------------- Total collected premiums and deposits ........... $1,052,458 $1,043,899 $915,542 ================================== 8 YEAR ENDED DECEMBER 31, -------------------------------------- 1996 1995 1994 -------------------------------------- Premiums and Deposits Not Retained or Assumed (2): LifeUSA: Life: First year ........................................... $ 8,416 $ 8,351 $ 8,443 Single and renewal ................................... 31,925 30,167 27,828 ------------------------------ Total Life .......................................... 40,341 38,518 36,271 Annuities ............................................. 397,566 312,325 249,803 ------------------------------ Total LifeUSA premiums and deposits not retained ... 437,907 350,843 286,074 Allianz Life: Life: First year ............................................ 2,228 2,377 2,661 Single and renewal .................................... 8,596 7,722 6,711 ------------------------------ Total Life .......................................... 10,824 10,099 9,372 Annuities ............................................. 309,198 211,731 188,062 ------------------------------ Total Allianz Life premiums and deposits not assumed 320,022 221,830 197,434 ------------------------------ Total premiums and deposits not retained or assumed .............................. $757,929 $572,673 $483,508 ============================== Retained or Assumed Premiums and Deposits(3): LifeUSA: Life: First year ........................................... $ 4,315 $ 8,100 $ 7,754 Single and renewal ................................... 17,317 14,251 10,903 ------------------------------ Total Life .......................................... 21,632 22,351 18,657 Annuities ............................................. 150,182 273,414 231,335 ------------------------------ Total LifeUSA retained premiums and deposits ....... 171,814 295,765 249,992 Allianz Life: Life: First year ........................................... 1,033 2,316 2,657 Single and renewal ................................... 6,221 5,288 4,128 ------------------------------ Total Life .......................................... 7,254 7,604 6,785 Annuities ............................................. 115,461 167,857 175,257 ------------------------------ Total Allianz Life assumed premiums and deposits ... 122,715 175,461 182,042 ------------------------------ Total retained or assumed premiums and deposits ... $294,529 $471,226 $423,034 ==============================
- ------------------------------- (1) Includes premiums and deposits related to all policies produced by LifeUSA agents, including policies produced by LifeUSA agents for Allianz Life. (2) Includes premiums and deposits related to LifeUSA policies that have been ceded by LifeUSA to the Reinsurers and premiums and deposits related to policies produced by LifeUSA agents for Allianz Life that have not been assumed by LifeUSA. (3) Includes premiums and deposits related to LifeUSA policies that have been retained by LifeUSA and premiums and deposits related to policies produced by LifeUSA agents for Allianz Life that have been assumed by LifeUSA. LifeUSA invests these premiums and deposits for the purpose of providing future benefits to its policyholders. Reference is made to Note 2 (Reinsurance) to the December 31, 1996 consolidated financial statements for further details regarding the Company's reinsurance agreements. 9 REVENUES. Total revenues were $316.9 million, $272.8 million, and $206.3 million in 1996, 1995 and 1994, respectively. The increase in total revenues of 16% in 1996 compared to 1995 was primarily due to the increase in policyholder charges and net investment income generated by the growth in life insurance and annuities in force and invested assets and the increase in commissions and expense allowances associated with the October 1, 1995 reduction in LifeUSA's net retention. The increase in total revenues of 32% in 1995 compared to 1994 was primarily due to the growth in life insurance and annuities in force and invested assets, net realized gains recorded on investment sales and the increase in commissions and expense allowances associated with the October 1, 1995 reduction in LifeUSA's net retention and the increase in collected premiums and deposits in 1995 compared to 1994. Policyholder charges, which represent the amounts assessed against policy account balances for the cost of insurance, policy administration and surrenders, increased 30%, or $10.9 million, in 1996 compared to 1995, and 66%, or $14.3 million, in 1995 compared to 1994, reflecting the growth in LifeUSA's net retained life insurance and annuities in force. Increases in net investment income of 19%, or $20.3 million, in 1996 compared to 1995, and 46%, or $34.6 million, in 1995 compared to 1994, are primarily attributable to increases in invested assets (fixed maturity investments and cash and cash equivalents) to $1.90 billion at December 31, 1996 from $1.75 billion at December 31, 1995 and $1.25 billion at December 31, 1994. The weighted average annual yield on invested assets (exclusive of realized and unrealized gains and losses) was 7.44% at December 31, 1996, compared to 7.46% at December 31, 1995 and 1994. In accordance with generally accepted accounting principles, net realized gains on investments had the following impact on the amortization of deferred policy acquisition costs, other benefits to policyholders, net income and earnings per share for 1996, 1995 and 1994 (dollars in millions, except per share amounts): 1996 1995 1994 -------------------- Net realized gains on investments ......... $1.8 $7.6 $1.2 Increase in: Amortization of deferred policy acquisition costs .................................... .7 2.8 .1 Other benefits to policyholders ........... .5 2.0 .1 -------------------- Income before income taxes ................ .6 2.8 1.0 Income taxes .............................. .2 .9 .3 -------------------- Net income ................................ $ .4 $1.9 $ .7 -------------------- Earnings per share ........................ $.02 $.08 $.03 ==================== The total of the increases in amortization of deferred policy acquisition costs and other benefits to policyholders as a percentage of net realized gains on investments is greater in 1996 and 1995 than in 1994 due to the fact that the majority of the gains recorded in 1996 and 1995 were a result of the sale of securities which supported policyholder liabilities, while the majority of the gains recorded in 1994 were a result of the sale of securities which supported the Company's shareholders' equity. Net commissions and expense allowances on premiums and deposits collected on reinsured policies and service fees on business produced for Allianz Life increased 15%, or $17.9 million, in 1996 compared to 1995. The increase was due primarily to the October 1, 1995 reduction in LifeUSA's net retention. The increase in net commissions and expense allowances of 10%, or $10.9 million, in 1995 compared to 1994 was due primarily to the increase in collected premiums and deposits in 1995 and the October 1, 1995 reduction in LifeUSA's net retention. 10 The following table shows the amounts of net commissions and expense allowances for 1996, 1995 and 1994 (in thousands):
1996 1995 1994 ---------------------------------- LifeUSA: Life: First year ............................................. $ 10,263 $ 9,746 $ 9,183 Single and renewal ..................................... 5,246 5,039 4,694 -------------------------------- Total Life ............................................ 15,509 14,785 13,877 Annuities ............................................... 59,003 45,776 37,995 -------------------------------- Total LifeUSA ........................................ 74,512 60,561 51,872 Allianz Life: Life: First year ............................................. 3,336 4,746 5,336 Single and renewal ..................................... 2,227 1,941 1,634 -------------------------------- Total Life ............................................ 5,563 6,687 6,970 Annuities ............................................... 58,431 53,344 51,093 -------------------------------- Total Allianz Life ................................... 63,994 60,031 58,063 Lapse policy chargebacks ................................. (772) (746) (1,036) -------------------------------- Total commissions and expense allowance, net......... $137,734 $119,846 $108,899 ================================
- ------------------------------- The above table includes commissions and expense allowances related to LifeUSA policies that have been ceded by LifeUSA to the Reinsurers and service fees related to policies produced by LifeUSA agents for Allianz Life. The Company pays a lapse policy chargeback to the Reinsurers when a life insurance policy that has been ceded lapses before the end of 13 months. The chargeback paid for each policy is equal to the excess of the allowances received over the premiums received. Reference is made to Note 2 (Reinsurance) to the December 31, 1996 consolidated financial statements for further details regarding the Company's reinsurance agreements. EXPENSES. Total expenses were $279.8 million, $242.8 million and $183.3 million in 1996, 1995 and 1994, respectively. The increase in total expenses of 15% in 1996 compared to 1995 was primarily due to growth in life insurance and annuities in force and the increase of 32% in 1995 compared to 1994 was primarily due to growth in life insurance and annuities in force and increased production. Increases in interest credited to policyholder account values of 18%, or $14.9 million, in 1996 compared to 1995 and 45%, or $26.3 million, in 1995 compared to 1994 reflect the growth in LifeUSA's life insurance and annuities in force. The increases in other benefits to policyholders of 18%, or $2.7 million, in 1996 compared to 1995 and 119%, or $8.0 million, in 1995 compared to 1994 reflect the growth in LifeUSA's life insurance and annuities in force, the additional accrual of bonuses to be paid to policyholders (the primary component of other benefits to policyholders) that is generated by the net realized gains on investments described above and the revisions made to the estimates in the models used to accrue for bonuses to be paid to policyholders described below. Amortization of deferred policy acquisition costs increased 11%, or $2.4 million, in 1996 compared to 1995 and 90%, or $10.5 million, in 1995 compared to 1994 reflecting the increase in gross profits due to a growing, more mature block of in force business, the additional amortization of deferred policy acquisition costs that is generated by the net realized gains on investments described above and the revisions made to the estimates in the models used to amortize deferred policy acquisition costs described below. 11 LifeUSA uses models to estimate future gross profits and allocate current gross margins in order to amortize deferred policy acquisition costs and accrue for bonuses to be paid to policyholders (the primary component of other benefits to policyholders). In accordance with Statement of Financial Accounting Standards (SFAS) No. 97, "Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments," LifeUSA is required to make revisions to the estimates in these models and adjust amortization accordingly. During 1996, 1995 and 1994, revisions were made to the estimates in the models used to amortize deferred policy acquisition costs and accrue for bonuses to be paid to policyholders. The cumulative effect of these revisions increased pretax income by $2.7 million in 1996, decreased pretax income by $200,000 in 1995 and increased pretax income by $1.4 million in 1994. The following table shows comparative rates for lapses, surrenders and annuitizations for 1996, 1995 and 1994:
1996 1995 1994 --------------------------- Annualized first year lapse rate for life insurance policies (excluding single premium) ................................. 20.7% 21.1% 20.6% Cumulative annualized first year surrender rate for annuities 1.1 1.1 1.1 Cumulative annualized first year annuitization rate for annuities .................................................. 5.9 6.0 6.2
The impact on estimated gross profits of actual policy experience, including the rates shown above, is consistent with the assumptions in the models used by LifeUSA to compute deferred policy acquisition cost amortization. Utilizing the actual policy experience and appropriate assumptions for future periods, these models indicate that deferred policy acquisition costs are fully recoverable. Commissions to agents increased 12%, or $8.5 million, in 1996 compared to 1995 due to the increase in collected premiums and deposits discussed above and the October 1, 1995 reduction in LifeUSA's net retention which resulted in less commissions being deferred in 1996 than were deferred in 1995, partially offset by the decline in collected first year life premiums, which receive the highest commission rates paid by LifeUSA. Commissions to agents increased 12%, or $7.6 million, in 1995 compared to 1994 due to the increase in collected premiums and deposits discussed above and due to the October 1, 1995 reduction in LifeUSA's net retention which resulted in less commissions being deferred in 1995 than were deferred in 1994. Taxes, licenses and fees decreased 54%, or $4.1 million, in 1996 compared to 1995. This decrease was primarily due to the combined impact of a $1.8 million refund of state premium taxes paid in prior years that was received during 1996 and changes made in the method of accruing for premium taxes, partially offset by the slight increase in charges for state guaranty fund assessments recorded during 1996. The increase in taxes, licenses and fees of 16%, or $1.1 million in 1995 compared to 1994 is primarily due to the increase in charges related to state guaranty fund assessments recorded during 1995. The Company holds a reserve for future assessments that is based on current data from various industry sources that monitor the status of open and closed insolvencies and is adjusted as assessments are received. Charges for state guaranty fund assessments, including adjustments made to the Company's reserve for future assessments, represented $3.1 million, $3.0 million and $2.6 million of total taxes, licenses and fees recorded in 1996, 1995 and 1994, respectively. Operating expenses increased 30%, or $12.7 million, in 1996 compared to 1995. This increase was primarily due to the growth in LifeUSA's life insurance and annuities in force and the October 1, 1995 reduction in LifeUSA's net retention which resulted in less operating expenses being deferred in 1996 than were deferred in 1995. Operating expenses increased 17%, or $6.2 million, in 1995 compared to 1994. This increase was also primarily due to the growth in LifeUSA's life insurance and annuities in force and the October 1, 1995 reduction in LifeUSA's net retention which resulted in less operating expenses being deferred in 1995 than were deferred in 1994. 12 Income taxes were $13.6 million in 1996, $10.9 million in 1995 and $8.6 million in 1994. The effective income tax rates for 1996, 1995 and 1994 were 36.7%, 36.3% and 37.2%, respectively. NET INCOME. Net income was $23.5 million in 1996, $19.1 million in 1995 and $14.5 million in 1994 which represents an increase in net income of 23% in 1996 compared to 1995 and 32% in 1995 compared to 1994. Earnings per share were $1.04 in 1996, $.88 in 1995 and $.71 in 1994 which represents an increase of 18% in 1996 compared to 1995 and 24% in 1995 compared to 1994. The following table shows net operating income (net income, excluding, net of related income taxes, net realized gains on investments and the corresponding increases in amortization of deferred policy acquisition costs and other benefits to policyholders and charges for state guaranty fund assessments) and earnings per share, the effect of those items considered to be non-operating and net income and earnings per share for 1996, 1995 and 1994, respectively (income in millions):
1996 1995 1994 -------------------------------------------- INCOME EPS INCOME EPS INCOME EPS -------------------------------------------- Net operating income and earnings per share $25.1 $1.11 $19.1 $.88 $15.5 $.76 Increase (decrease) net income and earnings per share: Net realized gains on investments ......... .4 .02 1.9 .08 .7 .03 Change for state guaranty fund assessments (2.0) (.09) (1.9) (.08) (1.7) (.08) ------------------------------------------- Net income and earnings per share ......... $23.5 $1.04 $19.1 $.88 $14.5 $.71 ===========================================
LIQUIDITY AND CAPITAL RESOURCES During 1996, the Company's primary sources of cash were (i) service fees received by the Company for business produced by LifeUSA's agents for Allianz Life, (ii) management fees from LifeUSA, (iii) proceeds from the $30 million convertible subordinated debenture purchased by Allianz Life in February 1995, and (iv) interest earned on invested assets. A substantial portion of the Company's operating expenses is attributable to services provided to LifeUSA, such as employees, data processing, facilities and supplies, which are reimbursed by LifeUSA through management fees. LifeUSA is expected to have sufficient cash to provide reimbursement through 1997, based on currently anticipated life insurance and annuity sales and on the continuation of acceptable reinsurance arrangements. In addition, LifeUSA has made a formal request to the Commissioner of the State of Minnesota Department of Commerce to pay a $2.5 million cash dividend to the Company during 1997. LifeUSA's ability to pay dividends in the future is also subject to compliance with Minnesota insurance laws and regulations. In May 1996, the Company entered into an agreement with two of its Reinsurers which provides a long-term line of credit in the amount of $30 million. Funds drawn against the line of credit can be used to fund certain investments and acquisitions which the Company may make, capital contributions to LifeUSA or capital expenditures. As of December 31, 1996, the Company had no outstanding borrowings under this line of credit. The Company's cash needs consist of (i) capital contributions to LifeUSA to permit increases in sales volume and retention or assumption of new life insurance and annuity business produced by LifeUSA agents and to provide LifeUSA sufficient capital and surplus to maintain adequate capital ratios, (ii) commission advances to agents, (iii) payment of interest on the Company's convertible subordinated debentures, (iv) operating expenses, including expenses in connection with the efforts to increase the production of LifeUSA's existing agents and expand the size of LifeUSA's field force, and (v) investments in marketing organizations expected to increase premium production volume for LifeUSA. Management believes that the combination of (i) the anticipated increase in cash flow during 1997 and the anticipated reduction in capital requirements for new business retained or assumed by LifeUSA associated with the October 1, 1995 13 reduction in LifeUSA's net retention, (ii) the statutory profits generated by LifeUSA on the mature business which it has retained or assumed, (iii) the $5 million in proceeds that remained at December 31, 1996 from the $30 million convertible subordinated debenture issued to Allianz Life in February 1995, (iv) the availability of the $30 million line of credit from two of its Reinsurers, and (v) cash generated by operations, will provide sufficient capital resources to support the capital needs of LifeUSA and meet all the Company's cash needs in the ordinary course of business through 1997, based on currently anticipated life insurance and annuity sales and on the continuation of acceptable reinsurance arrangements. The Company's future investments in marketing organizations may require additional capital during 1997. For LifeUSA to retain or assume life insurance and annuity business, LifeUSA must maintain a sufficient level of statutory capital and surplus as established by the regulatory authorities in the jurisdictions where LifeUSA is licensed to do business. As LifeUSA retains and assumes business, it is required to expense commissions and other policy issuance costs for statutory accounting purposes and to establish statutory reserves for policy benefits, thereby creating a statutory loss and reducing statutory surplus in the first year of the policy. The anticipated profits from the retained or assumed business are realized over the remaining period that the policies are in force. As a result of the October 1, 1995 reduction in LifeUSA's net retention, the need for additional capital to cover the statutory loss from such business has been reduced. During 1996, LifeUSA produced a statutory net income of $13.2 million. As a result, the Company did not make significant capital contributions to LifeUSA during 1996. In addition, based on currently anticipated life insurance and annuity sales, projected statutory profits from LifeUSA's mature block of in force business and the continuation of acceptable reinsurance arrangements, the Company does not expect to contribute capital to LifeUSA through 1997 in order to maintain adequate levels of statutory capital and surplus. As of December 31, 1996, LifeUSA had statutory capital and surplus for regulatory purposes of $87.3 million compared to $75.7 million at December 31, 1995. Assuming continuation of the current level of retention and assumption of new business and the expected level of life insurance and annuity business produced by LifeUSA agents, LifeUSA expects to continue to satisfy statutory capital and surplus requirements for 1997 primarily through statutory profits on its mature block of retained inforce business. In the future the Company may alter the level of its retention and assumption of new business depending upon future levels of production, capital needs and availability of alternative financing. The Company has developed a strategy to generate additional premium production from LifeUSA's existing agents and from new production sources by making loans to or investing in marketing organizations and by recruiting new marketing organizations to sell its products. The amount of any loan or investment relates to the revenue currently generated by the marketing organization and the projected increase in business produced for LifeUSA by the marketing organization. To date, the Company has made loans to marketing organizations that account for 31% of the Company's 1996 life insurance and annuity production. The loans include incentives for achieving increased production. In addition, in August 1996, LifeUSA Marketing acquired Tax Planning Seminars, a national marketing organization that had been contracted with LifeUSA for seven years and in November 1996, acquired an equity interest in Creative Marketing International Corporation, another national marketing organization that had not been contracted previously with LifeUSA. The Company has made and expects to continue to make future investments by issuing shares of its common stock and paying cash from its available resources ($5.6 million of fixed maturity investments -- available for sale and cash and cash equivalents as of December 31, 1996 on an unconsolidated basis), cash generated from operations, cash dividends from LifeUSA and borrowings under its $30 million line of credit (no amounts outstanding at December 31, 1996). In addition, during 1996, the Company signed marketing agreements with 31 national marketing organizations to market LifeUSA life insurance and annuity products for the first time. There can be no assurances that the Company's premium volume or income will be enhanced by the loans to or investments in marketing organizations or by the contracting of new national marketing organizations. 14 REGULATORY ENVIRONMENT. LifeUSA is subject to regulation in the 49 states in which it is authorized to do business. The laws of these states establish supervisory agencies with administrative powers related to granting and revoking licenses to transact business, approving the form and content of policies, reviewing the advertising and illustration of policies, licensing agents, establishing reserve requirements and regulating the type and amount of investments. Such regulations are primarily intended to protect policyholders. The Company is also regulated in several states as an insurance holding company. The insurance regulatory framework continues to be reviewed by various states and by the National Association of Insurance Commissioners (NAIC). Regulatory initiatives such as risk-based capital standards have been undertaken to identify inadequately capitalized companies and to reduce the risk of company insolvencies. The NAIC has established risk-based capital standards to determine the capital requirements of a life insurance company based upon the risks inherent in its operations. LifeUSA's percentage of actual total adjusted capital to authorized control level risk-based capital is well in excess of regulatory requirements. As a result of the production of statutory net income of $13.2 million during 1996, the Company did not make significant capital contributions to LifeUSA during 1996 and, based on currently anticipated life insurance and annuity sales and the continuation of reinsurance arrangements, the Company does not expect to contribute capital to LifeUSA through 1997 in order to maintain an acceptable risk-based capital ratio. The NAIC has also considered changes in the model laws for nonforfeiture values of life insurance and deferred annuity products. Since 1994, LifeUSA has made presentations to and had discussions with the Life/Health Actuarial Task Force of the NAIC, which is responsible for developing new model laws for nonforfeiture values. LifeUSA demonstrated that its two-tier products use longer-term, higher-yielding investments to provide higher retirement values to policyholders, while decreasing disintermediation and solvency risks to LifeUSA. Although it is possible that the NAIC may adopt new model laws addressing nonforfeiture values in the future, such adoption is not currently anticipated to have a significant impact on LifeUSA. NAIC committees are also considering a new annuity illustration model regulation, a new approach to statutory valuation of liabilities (reserves) and regulations for equity-indexed products. The Company is monitoring these developments and no significant impact is anticipated at this time. In December 1995, the NAIC passed a model regulation for disclosure in life insurance policy illustrations. A number of states either have adopted the model regulation by its January 1, 1997 effective date or are in the process of adopting the model regulation. LifeUSA has already completed the certification process required by the model regulation. This regulation has not had and is not anticipated to have a significant impact on LifeUSA. Insurance laws also require LifeUSA to file detailed periodic reports with the regulatory agencies in each of the states in which it writes business, and these agencies may examine LifeUSA's business and accounts at any time. Under NAIC rules, one or more of the regulatory agencies will periodically examine LifeUSA, normally at three-year intervals, on behalf of the states in which LifeUSA is licensed. During 1996, the Minnesota Department of Commerce conducted a triennial examination of LifeUSA for the three years ended December 31, 1995. The Company expects to receive the final examination report in the near future and has not been made aware of any issues or recommendations that will be material individually or in the aggregate. In April 1996, the B++ (Very Good) rating initially assigned LifeUSA in June 1994 was reaffirmed by the A.M. Best Company. The A. M. Best Company assigns the B++ rating to companies which, in its opinion, have achieved very good overall performance when compared to the standards established by the A. M. Best Company. B++ companies have a good ability to meet their obligations to policyholders over a long period of time. 15 In December 1996, Standard & Poor's assigned LifeUSA an initial claims-paying ability rating of BBB+ (Adequate). Standard & Poor's assigns the BBB+ rating to insurers which, in its opinion, offer adequate financial security, but capacity to meet policyholder obligations is susceptible to adverse economic and underwriting conditions. INVESTMENTS. As of December 31, 1996, the Company had cash, cash equivalents and fixed maturity investments on a consolidated basis totaling $1.90 billion, including $7.6 million in restricted deposits with state insurance authorities regulating LifeUSA. The following table summarizes the book, carrying and market values of each investment category held at December 31 (dollars in thousands):
BOOK % OF CARRYING % OF MARKET % OF 1996 VALUE TOTAL VALUE TOTAL VALUE TOTAL - ------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents ............ $ 20,989 1.11% $ 20,989 1.10% $ 20,989 1.10% Government Treasury and Agency notes and bonds ..................... 98,982 5.24 100,909 5.30 104,537 5.46 Mortgage pass-throughs ............... 46,085 2.44 46,804 2.46 46,836 2.45 Agency Collateralized Mortgage Obligations: CMO -- Sequential pay .............. 6,260 .33 6,260 .33 6,284 .33 CMO -- Planned amortization class .. 615,995 32.63 615,556 32.36 616,286 32.22 CMO -- Accretion directed class .... 23,484 1.24 23,484 1.23 23,672 1.24 CMO -- Targeted amortization class . 11,970 .63 11,970 .63 12,675 .66 Investment grade corporate securities: AAA+ to AAA- ....................... 36,749 1.95 36,900 1.94 37,930 1.98 AA+ to AA- ......................... 153,408 8.12 153,276 8.06 154,056 8.05 A+ to A- ........................... 485,766 25.72 491,040 25.81 493,102 25.78 BBB+ to BBB- ....................... 388,898 20.59 395,277 20.78 396,662 20.73 Non-investment grade corporate securities .......................... -- -- -- -- -- -- -------------------------------------------------------------------------- Total ................................ $1,888,586 100.00% $1,902,465 100.00% $1,913,029 100.00% ==========================================================================
BOOK % OF CARRYING % OF MARKET % OF 1995 VALUE TOTAL VALUE TOTAL VALUE TOTAL - ------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents ............ $ 33,222 1.95% $ 33,222 1.89% $ 33,222 1.85% Government Treasury and Agency notes and bonds ..................... 96,435 5.66 101,895 5.81 107,660 5.99 Mortgage pass-throughs ............... 32,104 1.88 33,347 1.90 33,667 1.87 Agency Collateralized Mortgage Obligations: CMO -- Sequential pay .............. 5,445 .32 5,445 .31 5,507 .31 CMO -- Planned amortization class .. 616,271 36.17 620,785 35.39 638,969 35.53 CMO -- Accretion directed class .... 23,426 1.38 23,426 1.34 24,524 1.36 CMO -- Targeted amortization class . 11,862 .70 11,862 .68 13,228 .74 Investment grade corporate securities: AAA+ to AAA- ....................... 43,650 2.56 44,015 2.51 46,694 2.60 AA+ to AA- ......................... 123,941 7.28 129,105 7.36 132,157 7.35 A+ to A- ........................... 325,710 19.12 339,005 19.33 346,502 19.26 BBB+ to BBB- ....................... 391,379 22.98 411,980 23.48 416,454 23.14 Non-investment grade corporate securities .......................... -- -- -- -- -- -- -------------------------------------------------------------------------- Total ................................ $1,703,445 100.00% $1,754,087 100.00% 1,798,584 100.00% ==========================================================================
16 As part of its asset and liability management practices, LifeUSA manages investments and credited interest rates to produce a net investment spread consistent with priced-for expectations. As of December 31, 1996, the weighted average credited interest rate for deferred annuities and life insurance policies was 4.74% and the weighted average yield on the assets backing liabilities was 7.48%. As of December 31, 1995, this weighted average credited interest rate was 5.14% and the weighted average yield on the assets backing liabilities was 7.52%. Investment income from the assets backing liabilities exceeded interest credited to policyholders by $24.2 million during 1996. The investment portfolio is managed primarily by allocating new cash flows into investments which have yield, maturity and other characteristics suitable for LifeUSA's expected policyholder liabilities. Consistent with LifeUSA's asset and liability management practices, as of December 31, 1996, the modified duration of LifeUSA's fixed income securities was 6.01 years, compared to 6.26 years as of December 31, 1995. The percentage of the total market value of the Company's portfolio that was comprised of investment grade corporate obligations was 57% at December 31, 1996. With each corporate security acquisition, LifeUSA's external managers perform a comprehensive analysis of the credit implications and outlook of the issuing corporation and industry. Ongoing procedures for monitoring and assessing any potential deterioration or downgrade in credit quality are also in place. The Company's guidelines for the acquisition of corporate securities does not allow the purchase of securities that are rated below investment grade by Moody's Investors Service and Standard & Poor's Corporation. The remainder of the Company's portfolio is comprised of government and government agency obligations. Government and government agency obligations are predominantly held in the form of Planned Amortization Class (PAC) CMOs, the most conservative type of CMO issued. These CMOs are specifically structured to provide the highest degree of protection against swings in repayments caused primarily by changes in interest rates and have virtually no risk of default. These securities are well-suited to fund the payment of the liabilities they support. Currently, the decision of the asset type in which to invest is dictated by market conditions and relative values within the respective markets at the time of purchase. Management believes that these asset types will allow the Company to maintain high quality, consistent yields and proper maturities for the overall portfolio. As of December 31, 1996, the Company held 46%, or $878 million of the total market value of its long term securities as available for sale. The Company believes that this percentage is a prudent level that will allow enough liquidity to meet any adverse cash flow experience. The Company continues to classify a significant portion of its investment securities as held to maturity based on its intent to hold such securities to maturity. A key feature of LifeUSA's products is the provision of bonuses to encourage policyholders to withdraw their funds over settlement periods lasting at least five years. Policyholders taking cash settlements do not receive the bonuses. This feature allows the Company to hold a significant amount of assets to maturity. Insurance regulations require LifeUSA to perform an asset adequacy analysis each year to determine if the assets are sufficient to fund future obligations. The Company's asset adequacy analysis indicates that the assets are sufficient to fund future obligations. The Company continually monitors and modifies the allocation of new assets between held to maturity and available for sale as deemed prudent based on the continuing analysis of cash flow projections and liquidity needs. At December 31, 1996, the Company's shareholders' equity and book value per share were $172.6 million and $8.23, respectively, compared to $156.9 million and $7.72, respectively, at December 31, 1995. Excluding the effect of the net unrealized gain on fixed maturity investments -- available for sale reported as a separate component of shareholders' equity in accordance with SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities," the Company's shareholders' equity and book value per share were $169.3 million and $8.07, respectively, at December 31, 1996, compared to $144.2 million and $7.09, respectively, at December 31, 1995. 17 Statements other than historical information contained in this Report are considered forward-looking and involve a number of risks and uncertainties. In addition to the factors discussed in this Report, there are other factors that could cause actual results to differ materially from expected results including, but not limited to, development and acceptance of new products, impact of changes in federal and state regulation, dependence upon key personnel, changes in interest rates generally and credited rates on the new business retained or assumed by LifeUSA, the level of premium production, competition and other risks described from time to time in the Company's Securities and Exchange Commission filings, including but not limited to the Form 10-K, copies of which are available from the Company without charge. 18 LIFE USA HOLDING, INC. CONSOLIDATED BALANCE SHEET (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
DECEMBER 31, DECEMBER 31, 1996 1995 -------------------------- ASSETS Investments: Fixed maturity investments (Note 3): Available for sale, at fair value (amortized cost: $864,400 at December 31, 1996 and $761,553 at December 31, 1995) ................... $ 878,279 $ 812,195 Held to maturity, at amortized cost (fair value: $1,013,761 at December 31, 1996 and $953,167 at December 31, 1995) ................... 1,003,197 908,670 Policy loans .............................................................. 23,908 19,789 -------------------------- Total investments ..................................................... 1,905,384 1,740,654 Cash and cash equivalents ................................................... 20,989 33,222 Accrued investment income ................................................... 27,834 23,510 Future policy benefits recoverable and amounts due from reinsurers (Note 2) ................................................... 2,179,999 1,862,311 Deferred policy acquisition costs ........................................... 212,138 175,296 Other assets ................................................................ 40,379 32,546 -------------------------- $ 4,386,723 $ 3,867,539 ========================== LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities: Future policy benefits .................................................... $ 4,078,621 $ 3,566,012 Other policyholders' funds ................................................ 5,381 4,453 Amounts due reinsurers (Note 2) ........................................... 23,605 27,303 Accrued commissions to agents ............................................. 10,243 11,364 Taxes, licenses and fees payable .......................................... 17,868 18,913 Accounts payable .......................................................... 6,967 4,771 Convertible subordinated debentures (Note 5) .............................. 36,030 36,030 Deferred income taxes ..................................................... 12,924 19,640 Other liabilities ......................................................... 22,469 22,157 -------------------------- Total liabilities ........................................................ 4,214,108 3,710,643 Commitments and contingencies (Notes 2 and 4) Shareholders' equity (Notes 7 and 11): Preferred stock, $.01 par value; 15,000,000 shares authorized, none issued .................................................. -- -- Common stock, $.01 par value; 45,000,000 shares authorized, 20,953,517 shares issued and outstanding (20,279,343 shares at December 31, 1995) .................................................... 210 203 Common stock to be issued, 21,384 shares (45,404 shares at December 31, l995) ....................................................... 357 382 Additional paid-in capital ................................................ 86,474 80,931 Notes receivable from stock sales ......................................... (3,888) -- Net unrealized gain on fixed maturity investments -- available for sale (Note 3) .............................................. 3,335 12,707 Retained earnings ......................................................... 86,127 62,673 -------------------------- Total shareholders' equity ............................................... 172,615 156,896 -------------------------- $ 4,386,723 $ 3,867,539 ==========================
SEE ACCOMPANYING NOTES. 19 LIFE USA HOLDING, INC. CONSOLIDATED STATEMENT OF INCOME (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
YEAR ENDED DECEMBER 31, --------------------------------------- 1996 1995 1994 --------------------------------------- Revenues: Policyholder charges .................................. $ 46,842 $ 35,983 $ 21,659 Net investment income (Note 3) ........................ 129,412 109,092 74,510 Net realized gains on investments (Note 3) ............ 1,791 7,634 1,183 Commissions and expense allowances, net (Note 2) ...... 137,734 119,846 108,899 Other ................................................. 1,119 226 62 --------------------------------------- Total revenues ....................................... 316,898 272,781 206,313 Expenses: Interest credited to policyholder account values ............................................... 99,517 84,665 58,405 Other benefits to policyholders ....................... 17,414 14,698 6,706 Amortization of deferred policy acquisition costs ................................................ 24,495 22,096 11,643 Commissions ........................................... 80,093 71,575 63,988 Taxes, licenses and fees .............................. 3,596 7,734 6,678 Operating expenses .................................... 54,718 42,052 35,861 --------------------------------------- Total expenses ....................................... 279,833 242,820 183,281 --------------------------------------- Income before income taxes .............................. 37,065 29,961 23,032 Income taxes (Note 8) ................................... 13,611 10,864 8,563 --------------------------------------- Net income .............................................. $ 23,454 $ 19,097 $ 14,469 ======================================= Income per common and common equivalent share: Primary ............................................... $ 1.04 $ .88 $ .71 ======================================= Fully diluted ......................................... $ 1.04 $ .88 $ .71 ======================================= Number of shares used in per share calculation: Primary ............................................... 23,350,431 22,521,604 20,409,047 Fully diluted ......................................... 23,402,846 22,527,463 20,424,921
SEE ACCOMPANYING NOTES. 20 LIFE USA HOLDING, INC. CONSOLIDATED STATEMENT OF CASH FLOWS (DOLLARS IN THOUSANDS)
YEAR ENDED DECEMBER 31, ------------------------------------ 1996 1995 1994 ------------------------------------ Cash flows from operating activities: Net income ............................................ $ 23,454 $ 19,097 $ 14,469 Adjustments to reconcile net income to net cash used in operating activities: Accretion of discount on investments, net ........... (2,441) (4,344) (4,439) Net realized gains on investments ................... (1,791) (7,634) (1,183) Policy acquisition costs deferred ................... (38,992) (65,460) (60,664) Amortization of deferred policy acquisition costs ... 24,495 22,096 11,643 Convertible subordinated debentures (Note 5) ........ -- (11) (310) Deferred income tax (benefit) provision ............. (1,669) 2,180 4,032 Changes in operating assets and liabilities (Note 10) (13,347) (7,594) (10,864) Stock compensation (Note 7) ......................... 1,436 831 943 ----------------------------------- Net cash used in operating activities ................... (8,855) (40,839) (46,373) Cash flows from investing activities: Fixed maturity investments-available for sale: Purchases ........................................... (152,389) (397,171) (320,904) Proceeds from sales ................................. 42,542 382,606 63,646 Proceeds from maturities and principal payments on mortgage-backed securities ......................... 9,081 4,984 5,319 Transfer from fixed maturity investments-held to maturity ........................................... -- (339,470) -- Fixed maturity investments-held to maturity: Purchases ........................................... (102,603) (442,085) (116,233) Proceeds from maturities and principal payments on mortgage-backed securities ......................... 10,227 9,532 11,488 Transfer to fixed maturity investments-available for sale ............................................... -- 339,470 -- Investments in and loans to field marketing organizations ...................................... (10,469) -- -- Acquisition of Fidelity Union Life Insurance Company .. -- -- (1,100) ----------------------------------- Net cash used in investing activities ................... (203,611) (442,134) (357,784) Cash flows from financing activities: Receipts from universal life and investment products .. 294,529 471,226 432,034 Withdrawals on universal life and investment products . (208,523) (140,462) (80,401) Interest credited to policyholders .................... 99,517 84,665 58,405 Proceeds from exercise of stock options and warrants .. 226 195 937 Proceeds from convertible subordinated debenture issuance ............................................. -- 30,000 -- Other financing activities ............................ 14,484 12,851 4,709 ----------------------------------- Net cash provided by financing activities ............... 200,233 458,475 415,684 ----------------------------------- Net (decrease) increase in cash and cash equivalents .... (12,233) (24,498) 11,527 Cash and cash equivalents at beginning of the year ...... 33,222 57,720 46,193 ----------------------------------- Cash and cash equivalents at end of the year ............ $ 20,989 $ 33,222 $ 57,720 =================================== Cash paid during the year for interest .................. $ 1,984 $ 1,223 $ 473 =================================== Cash paid during the year for income taxes .............. $ 16,263 $ 8,000 $ 6,634 ===================================
SEE ACCOMPANYING NOTES. 21 LIFE USA HOLDING, INC. CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (DOLLARS IN THOUSANDS)
NUMBER OF COMMON COMMON STOCK SHARES STOCK --------------------- Balance at December 31, 1993 ................................... 19,978,118 $200 Cumulative effect of change in accounting principle............. Issuance of common shares to Employee Savings Plan ............. 81,734 1 Issuance of shares through conversion of convertible subordinated debentures ....................................... 17,019 0 Issuance of shares through exercise of options ................. 74,581 1 Issuance of shares through exercise of warrants ................ 16,134 0 Conversion repurchase .......................................... 1,794 0 Common stock to be issued-shares, net of 191,262 shares issued ......................................... 10,237 Change in net unrealized gain (loss) on fixed maturity investments -- available for sale.............................. Net income...................................................... -------------------- Balance at December 31, 1994 ................................... 20,179,617 202 Issuance of common shares to Employee Savings Plan ............. 95,028 1 Issuance of shares through conversion of convertible subordinated debentures ....................................... 571 0 Issuance of shares through exercise of options ................. 26,627 0 Common stock to be issued-shares, net of 122,226 shares issued . 22,904 Change in net unrealized gain (loss) on fixed maturity investments -- available for sale.............................. Net income...................................................... -------------------- Balance at December 31, 1995 ................................... 20,324,747 203 Issuance of common shares to Employee Savings Plan ............. 167,457 2 Issuance of shares through field marketing organization loan program ....................................................... 478,262 5 Issuance of shares through exercise of options ................. 28,455 0 Common stock to be issued-shares, net of 674,174 shares issued . (24,020) Change in net unrealized gain on fixed maturity investments -- available for sale.............................. Net income...................................................... -------------------- Balance at December 31, 1996 ................................... 20,974,901 $210 ====================
SEE ACCOMPANYING NOTES. 22 (WIDE TABLE CONTINUED)
NET UNREALIZED NOTES GAIN (LOSS) ON COMMON ADDITIONAL RECEIVABLE FIXED MATURITY TOTAL STOCK TO PAID-IN FROM INVESTMENTS- RETAINED SHAREHOLDERS' BE ISSUED CAPITAL STOCK SALES AVAILABLE FOR SALE EARNINGS EQUITY - ----------------------------------------------------------------------------------------- $ 192 $77,705 $29,107 $107,204 $ 831 831 (943) 942 -- 308 308 839 840 97 97 4 4 914 914 (17,751) (17,751) 14,469 14,469 - ----------------------------------------------------------------------------------------- 163 79,895 (16,920) 43,576 106,916 (831) 830 -- 11 11 195 195 1,050 1,050 29,627 29,627 19,097 19,097 - ----------------------------------------------------------------------------------------- 382 80,931 12,707 62,673 156,896 (1,436) 1,434 -- 3,883 $(3,888) -- 226 226 1,411 1,411 (9,372) (9,372) 23,454 23,454 - ----------------------------------------------------------------------------------------- $ 357 $86,474 $(3,888) $ 3,335 $86,127 $172,615 =========================================================================================
SEE ACCOMPANYING NOTES. 23 LIFE USA HOLDING, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1996, 1995 AND 1994 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES BASIS OF PRESENTATION Life USA Holding, Inc. (the Company) was incorporated on February 26, 1987 in the State of Minnesota for the purpose of acquiring, managing and funding the operations of a life insurance company. During 1987, the Company acquired Financial Assurance, Incorporated (FAI), a Colorado domiciled stock life insurance company, authorized to issue life insurance products in 40 states and the District of Columbia. After the acquisition, the Company changed the name of FAI to LifeUSA Insurance Company, which conducts its life insurance business under the registered trade name of "LifeUSA." During 1994, the Company acquired Fidelity Union Life Insurance Company (FULICO), a Minnesota domiciled shell life insurance company authorized to issue life insurance products in 49 states (excluding only New York) and the District of Columbia, and subsequently merged LifeUSA and FULICO into a single company. The surviving company retained the LifeUSA name and is domiciled in Minnesota, where the Company is headquartered. LifeUSA sells a variety of innovative life insurance and annuity products which offer long-term retirement benefits to consumers who seek protection against outliving their financial resources. These products are sold by a national marketing and distribution system comprised of independent agents and home office staff. During 1996, the Company formed two additional wholly-owned subsidiaries, LifeUSA Securities, Inc. (LifeUSA Securities) and LifeUSA Marketing, Inc. (LifeUSA Marketing). LifeUSA Securities has received approval from the National Association of Securities Dealers, Inc. as a wholesale broker-dealer, will initially market a family of LifeUSA mutual funds established through a joint-venture agreement with a $16 billion asset management firm and is exploring distribution of variable life insurance and annuity contracts. LifeUSA Marketing conducts a variety of marketing activities for the Company, including the acquisition of and investment in national field marketing organizations. During 1996, LifeUSA Marketing acquired Tax Planning Seminars and a minority equity interest in Creative Marketing International Corporation, both national field marketing organizations. The accompanying consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, LifeUSA, LifeUSA Securities and LifeUSA Marketing. All intercompany accounts and transactions have been eliminated in consolidation. INVESTMENTS Effective January 1, 1994, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 115, "Accounting for Certain Investments in Debt and Equity Securities." The adoption of SFAS No. 115 increased the carrying value of available for sale investments by $1.8 million. This amount was offset by a reduction in deferred policy acquisition costs of $.4 million and the recording of a $.6 million deferred tax liability, resulting in a net unrealized gain of $.8 million which was recorded as a separate component of shareholders' equity. The Company classifies investments at the time of purchase as held to maturity or available for sale. Investments which the Company has the ability and positive intent to hold to maturity are so classified and carried at amortized cost. All other investments are classified as available for sale and carried at fair value, with unrealized gains and losses reported as a separate component of shareholders' equity. The Company anticipates prepayments in the accounting for discounts and premiums related to its Collateralized Mortgage Obligation (CMO) investments. As differences arise between actual and anticipated prepayments, the effective yield of CMOs is recalculated to reflect actual prepayments to date and anticipated future prepayments. The net investment in the CMOs is then adjusted to the amount that would have existed had the new effective yield been applied since the acquisition of the CMOs. 24 Realized gains and losses on sales of available for sale investments are recorded as revenue using the specific identification method. In addition, the amortization of deferred policy acquisition costs and other benefits to policyholders are adjusted for gains and losses realized on sales of available for sale investments which support policyholder liabilities. Changes in the fair value of available for sale investments are reflected directly in shareholders' equity, net of related adjustments for deferred policy acquisition costs and deferred taxes and related valuation allowances that would have been recorded if these investments would have been sold as of the balance sheet date. Investments that are determined to have a decline in value that is other than temporary are written down to estimated fair value. This value becomes the investment's new cost basis and the amount of the write down is recorded as a realized loss. CASH AND CASH EQUIVALENTS The Company considers investments with a maturity at the date of their acquisition of three months or less to be cash equivalents. The carrying amounts reported in the balance sheet for these financial instruments are based on cost and approximate fair value. ACCOUNTING FOR CEDED COMMISSIONS AND EXPENSE ALLOWANCES Commissions and expense allowances, and the expenses associated with these revenues, are recognized in the period in which life insurance premiums and annuity deposits are ceded. The net cost of reinsurance for life insurance policies is realized ratably over the life of the affected business in relation to gross profits. ACCOUNTING FOR LIFE INSURANCE POLICIES AND ANNUITY CONTRACTS Revenues from universal life insurance, single premium life insurance and annuities represent amounts assessed against policyholders and are reported in the period that the amounts are assessed. The liability for future policy benefits for universal life insurance, single premium life insurance and annuities is equal to the sum of the balance that accrues to the benefit of policyholders, any amounts that have been assessed to compensate the insurer for services to be performed over future periods, an accrual for future retirement bonuses and any amounts previously assessed against policyholders that are refundable on termination of the contract. The liability for contracts in a payout status is based on the 1983 Individual Annuity Table at interest rates ranging from 5.5% to 8.5%. The Company reports assets and liabilities related to ceded life insurance and annuity contracts on a gross basis. Specifically, account values ceded to reinsurers are reflected as a receivable and the liability for future policy benefits is recorded on a gross basis. For business written directly, LifeUSA defers the cost of acquiring new business, principally sales compensation, policy issue costs, underwriting and other related sales expenses. LifeUSA defers the same proportion of costs of acquiring new business as the proportion of business retained. For business produced by LifeUSA's agents for Allianz Life Insurance Company of North America (Allianz Life) and assumed by LifeUSA, the amount of the allowance paid by LifeUSA to Allianz Life as the cost of acquiring new business is deferred. These deferred costs are amortized over the lives of the policies in proportion to the estimated gross profits expected to be realized on the policies. ACCOUNTING FOR STOCK-BASED COMPENSATION PLANS In accordance with the provisions of SFAS No. 123, "Accounting for Stock-Based Compensation," the Company applies Accounting Principles Board Opinion (APB) No. 25, "Accounting for Stock Issued to Employees" and related Interpretations in accounting for its stock option plans. Note 7 to the Consolidated Financial Statements contains a summary of the pro forma effects to reported net income and earnings per share for 1996 and 1995 as if the Company had elected to recognize compensation cost based on the fair value of the options granted as prescribed by SFAS No. 123. 25 STATE GUARANTY FUND ASSESSMENTS The Company uses the accrual basis of accounting to record its liability for state guaranty fund assessments. The liability recorded includes a provision for anticipated assessments that is calculated using data available from various industry sources that monitor the current status of open and closed insolvencies and report the premium base utilized by each state in calculating amounts assessed to individual insurers. Although additional provisions may be required, the Company is currently unaware of any significant pending assessments requiring accrual. The Company has also established an asset for assessments expected to be recovered through future premium tax offsets. Although changing legislative initiatives may affect the right to offset, the Company is currently unaware of any such initiatives affecting the recoverability of the asset recorded at December 31, 1996. In December 1996, the American Institute of Certified Public Accountants released an exposure draft of a proposed Statement of Position (SOP) titled "Accounting by Insurance and Other Enterprises for Guaranty-Fund and Certain Other Insurance-Related Assessments," for the purpose of soliciting comments on all matters addressed by the proposed SOP. Because the proposed SOP may be changed significantly prior to its issuance as a final document, the Company has not determined the impact of the proposed SOP on its financial position or operating results. INCOME PER SHARE Primary income per share is computed based on the weighted average number of shares outstanding, assuming conversion of all stock options and warrants having exercise prices less than the average market price of the common stock using the treasury stock method. The dilutive effect of debentures considered to be common stock equivalents is included in the primary earnings per share calculation using the if-converted method. Fully diluted income per share is computed based on the weighted average number of shares outstanding assuming conversion of all stock options and warrants having exercise prices less than the greater of the average or the year-end market price of the common stock using the treasury stock method. The dilutive effect of all debentures is included in the fully diluted earnings per share calculation using the if-converted method. INCOME TAXES Deferred tax assets and liabilities are determined based on differences between the financial reporting basis and the tax basis of the Company's assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. USE OF ESTIMATES IN PREPARATION OF FINANCIAL STATEMENTS The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. NEW FINANCIAL ACCOUNTING STANDARDS In June 1996, the Financial Accounting Standards Board (FASB) issued SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." SFAS No. 125 is effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after December 31, 1996, and is to be applied prospectively. Retroactive application of SFAS No. 125 is not permitted. The Company is in the process of evaluating whether SFAS 125 applies to annuity business written directly by LifeUSA that is ceded under the terms of reinsurance agreements and therefore has not been able to determine the impact of adoption on its financial position or operating results. If found to be applicable, SFAS No. 125 will be adopted by the Company in the first quarter of 1997. RECLASSIFICATIONS Certain 1995 and 1994 amounts have been reclassified to conform to the 1996 presentation. 26 2. REINSURANCE Since its inception in 1987, LifeUSA has entered into various agreements to reinsure a substantial portion of the new life insurance and annuity business written each year. Entering into these reinsurance agreements has allowed LifeUSA to write a larger volume of business than it would otherwise have been able to write due to regulatory restrictions based on the amount of its statutory capital and surplus. In addition, under the terms of agreements between the Company and Allianz Life, LifeUSA agents have produced life insurance and annuity business on Allianz Life policies which are similar to LifeUSA policies. LifeUSA has assumed a portion of this business under reinsurance agreements. The Company receives commissions and expense allowances on the portions of the LifeUSA life insurance and annuity products reinsured and service fees on business produced by LifeUSA's agents and written by Allianz Life. The commissions and expense allowances and service fees received on life insurance policies are approximately 150% of the first-year planned target premium and range from 12-1/2 % to 18% of renewal and first-year excess premiums. The Company also receives commissions and expense allowances and service fees ranging from 6-1/2 % to 22% on annuity deposits. An additional allowance equal to .20% of the account value of all annuities issued after April 1, 1991 is received as of the beginning of policy years two through ten. REINSURANCE CEDED LifeUSA ceded from 95% to 100% of its new life insurance and annuity business to Transamerica Occidental Life Insurance Company (TOLIC) from 1987 through March 31, 1991, and from April 1, 1991 through December 31, 1992, ceded 100% of its new business equally to the following three reinsurers (the Reinsurers): * Employers Reassurance Corporation, a subsidiary of Employers Reinsurance Corporation, a member of the General Electric Company group; * Munich American Reassurance Company, a subsidiary of Munich Reinsurance Company, one of the largest German insurance companies; and * Republic-Vanguard Life Insurance Company, a member of the Winterthur Swiss Insurance Group, one of the largest Swiss insurance companies. From 1990 through 1992, TOLIC and the Reinsurers retroceded 25% to 30% of this business back to LifeUSA. Effective December 31, 1992, the retrocession agreement with the Reinsurers was terminated with respect to new business written by LifeUSA after that date. From 1993 through 1996, LifeUSA retained a portion of its new business and ceded the remainder equally to the Reinsurers. Effective January 1, 1996, Munich American Reassurance Company reduced its share of the new business ceded by LifeUSA to the Reinsurers to 20%, while both Employers Reassurance Corporation and Republic-Vanguard Life Insurance Company increased their share of this business to 40%. During 1994, an agreement was reached with TOLIC and the Reinsurers to unwind the retrocession agreements in effect from 1990 through 1992 and record all business written under the terms of those agreements as direct reinsurance. As a result, LifeUSA has accounted for all business previously retroceded to LifeUSA from TOLIC and the Reinsurers as being retained by LifeUSA and all business ultimately assumed by TOLIC and the Reinsurers as being ceded to TOLIC and the Reinsurers by LifeUSA at issuance. This change had no impact on the Company's financial position or operating results for any period presented. All disclosures in these notes reflect the unwinding of the retrocession agreements as discussed in this paragraph. 27 The following table shows the percentages of new life insurance and annuity business written by LifeUSA that have been ceded to TOLIC and the Reinsurers since inception: LIFE INSURANCE ANNUITY -------------- ------- September 1987 - December 1988.. 100% 100% January 1989 - December 1989 ... 95 100 January 1990 - December 1990 ... 75 75 January 1991 - December 1992 ... 70 75 January 1993 - June 1993 ....... 65 65 July 1993 - September 1995 ..... 50 50 October 1995 - Present ......... 75 75 The reinsurance agreements require the Reinsurers' approval of policy forms and terms of LifeUSA's products reinsured by the Reinsurers. Under these agreements, $437.9 million, $350.8 million and $286.1 million of premiums and deposits were ceded to the Reinsurers and TOLIC by LifeUSA for the years ended December 31, 1996, 1995 and 1994, respectively. When a life insurance policy ceded to TOLIC or the Reinsurers lapses before the end of 13 months, the Company has agreed to pay a chargeback equal to the excess of the allowances received over the premiums received. As of December 31, 1996 and 1995, the reserve for lapsed policy chargebacks was $700,000 and $650,000, respectively. Reporting assets and liabilities related to reinsurance ceded on a gross basis reflects the possibility that reinsured risks could become a liability to the Company in the event the Reinsurers or TOLIC become unable to meet the obligations they have assumed. Any restriction, limitation or condition imposed by the Reinsurers could have a material effect on LifeUSA's ability to write new business if LifeUSA was not able to replace the current reinsurers. REINSURANCE ASSUMED All new life insurance and annuity business produced by LifeUSA's agents and written by Allianz Life from 1987 through 1994 was ceded to TOLIC. Effective January 1, 1990, LifeUSA entered into a retrocession agreement with TOLIC to assume a portion of this business. During 1994, LifeUSA terminated the retrocession agreement with TOLIC and entered into an agreement with Allianz Life to assume a portion of this business directly from Allianz Life effective January 1, 1995. Under these agreements, $122.7 million, $175.5 million and $182.0 million of premiums and deposits were assumed by LifeUSA from Allianz Life and TOLIC for the years ended December 31, 1996, 1995 and 1994, respectively. The following table shows the percentages of new life insurance and annuity business produced by LifeUSA's agents and written by Allianz Life that have been assumed by LifeUSA since inception: LIFE INSURANCE ANNUITY -------------- ------- September 1987 - December 1989.. --% --% January 1990 - December 1990 ... 25 25 January 1991 - December 1991 ... 30 25 January 1992 - June 1993 ....... 50 30 July 1993 - September 1995 ..... 50 50 October 1995 - Present ......... 25 25 28 MAINTENANCE EXPENSES The Company is obligated to continue servicing the underlying life insurance and annuity policies written directly by LifeUSA or produced by LifeUSA's agents for Allianz Life. For policies issued prior to 1991, the Company believes that the present value of anticipated future expenses required to service policies that have been ceded will exceed the present value of anticipated future renewal allowances by $250,000, and has accrued a liability for that amount. This requires estimating renewal allowances and servicing costs many years into the future, and it is possible that actual future renewal allowances and servicing costs will not conform to the assumptions inherent in the current estimation of allowances and costs. Management continuously monitors actual renewal allowance and servicing cost experience as it emerges and, should material changes in the assumptions occur, the liability will be modified to the extent that the present value of future servicing costs is expected to exceed the present value of future renewal allowances. 3. INVESTMENTS The amortized cost and fair value of fixed maturity investments as of December 31 are as follows (in thousands):
GROSS GROSS AMORTIZED UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE --------------------------------------------------- 1996: AVAILABLE FOR SALE U.S. Treasury securities and obligations of U.S. government corporations and agencies $ 11,839 $ 1,023 $ 19 $ 12,843 Foreign government obligations ............ 59,096 1,432 509 60,019 Investment grade corporate obligations .... 611,958 19,264 7,592 623,630 Mortgage-backed securities ................ 181,507 1,969 1,689 181,787 --------------------------------------------------- $ 864,400 $23,688 $9,809 $ 878,279 =================================================== HELD TO MATURITY U.S. Treasury securities and obligations of U.S. government corporations and agencies. $ 17,409 $ 3,382 $ -- $ 20,791 Foreign government obligations ............ 10,638 325 79 10,884 Investment grade corporate obligations .... 452,863 7,768 2,511 458,120 Mortgage-backed securities ................ 522,287 8,791 7,112 523,966 --------------------------------------------------- $1,003,197 $20,266 $9,702 $1,013,761 ===================================================
29
GROSS GROSS AMORTIZED UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE --------------------------------------------------- 1995: AVAILABLE FOR SALE U.S. Treasury securities and obligations of U.S government corporations and agencies . $ 11,518 $ 1,581 $ 3 $ 13,096 Foreign government obligations ............ 58,100 3,882 -- 61,982 Investment grade corporate obligations .... 521,320 39,423 -- 560,743 Mortgage-backed securities ................ 170,615 5,884 125 176,374 ------------------------------------------------- $761,553 $50,770 $128 $812,195 ================================================= HELD TO MATURITY U.S. Treasury securities and obligations of U.S government corporations and agencies . $ 16,148 $ 4,978 $ -- $ 21,126 Foreign government obligations ............ 10,669 787 -- 11,456 Investment grade corporate obligations .... 351,725 17,131 -- 368,856 Mortgage-backed securities ................ 530,128 21,671 70 551,729 ------------------------------------------------- $908,670 $44,567 $ 70 $953,167 =================================================
Fair values for investments are based on quoted market prices. No holdings of any issuer are greater than 5% of the Company's total investments in fixed maturities, other than direct or guaranteed obligations of the United States government or United States government corporations and agencies. The foreign government obligations held are denominated in U.S. dollars and issued and traded in the United States. The amortized cost and fair value of fixed maturity investments at December 31, 1996, by contractual maturity, are as follows (in thousands):
AVAILABLE FOR SALE HELD TO MATURITY -------------------------------------------------- AMORTIZED FAIR AMORTIZED FAIR COST VALUE COST VALUE -------------------------------------------------- Due in one year or less .............. $ 5,224 $ 5,285 $ -- $ -- Due after one year through five years 11,898 11,892 157,624 156,887 Due after five years through ten years 301,185 315,358 185,171 189,984 Due after ten years .................. 364,586 363,957 138,115 142,924 -------------------------------------------------- 682,893 696,492 480,910 489,795 Mortgage-backed securities ........... 181,507 181,787 522,287 523,966 ------------------------------------------------- Total ................................ $ 864,400 $878,279 $1,003,197 $1,013,761 ==================================================
Expected maturities in the foregoing table may differ from contractual maturities because borrowers may have the right to prepay obligations with or without prepayment penalties. 30 During 1996, 1995 and 1994, the Company sold certain investments classified as available for sale. Proceeds from these sales were immediately reinvested in investments of a similar high grade as those investments sold. Gross gains of $1.9 million, $9.4 million and $2.0 million were realized on these sales in 1996, 1995 and 1994, respectively. Gross losses of $.1 million, $1.8 million and $.8 million were realized on these sales in 1996, 1995 and 1994, respectively. The recognition of these net realized gains resulted in an increase in the amortization of deferred policy acquisition costs and an increase in other benefits to policyholders of $1.2 million, $4.8 million and $.2 million in 1996, 1995 and 1994, respectively. As permitted by the special report entitled "A Guide to Implementation of Statement 115 on Accounting for Certain Investments in Debt and Equity Securities -- Questions and Answers," issued by the FASB in November 1995, the Company transferred certain securities from held to maturity to available for sale on November 20, 1995. Prior to their transfer, the held to maturity securities were carried at a total amortized cost of $339.5 million. Unrealized gains of $1.1 million were recorded upon transferring these securities to available for sale, where they are carried at fair value. The components of net investment income are as follows (in thousands): YEAR ENDED DECEMBER 31, ----------------------------------- 1996 1995 1994 ----------------------------------- Fixed maturities ............ $ 128,629 $ 106,566 $ 73,458 Cash and cash equivalents.... 1,403 3,090 1,544 Policy loans ................ 519 356 249 Agent advances .............. 94 133 74 ----------------------------------- 130,645 110,145 75,325 Investment expenses ......... (1,233) (1,053) (815) ----------------------------------- Net investment income ....... $ 129,412 $ 109,092 $ 74,510 =================================== LifeUSA has entered into investment management agreements with Investment Advisers, Inc. (IAI) and Allianz Investment Corporation, an affiliate of Allianz Life. For their services, IAI and Allianz Investment Corporation are paid a fee based on the market value of investments at the end of each quarter. For the years ended December 31, 1996, 1995 and 1994, LifeUSA paid a total of $1.0 million, $.8 million and $.6 million, respectively, for investment management services. Fixed maturity investments with a total carrying value of $7.6 million are on deposit with various states in support of statutory requirements as of December 31, 1996. The net unrealized gain on fixed maturity investments -- available for sale included in shareholders' equity consists of the following at December 31 (in thousands): 1996 1995 -------------------- Gross unrealized gain on fixed maturity investments -- available for sale ........ $ 13,879 $ 50,642 Adjustments for: Deferred tax liability ................. (4,858) (17,725) Deferred policy acquisition costs ...... (8,748) (31,093) Deferred tax asset ..................... 3,062 10,883 -------------------- Net unrealized gain on fixed maturity investments -- available for sale ........ $ 3,335 $ 12,707 ==================== 31 4. LINE OF CREDIT On May 17, 1996, the Company entered into a line of credit agreement with two of the Reinsurers that can be used to fund certain investments and acquisitions the Company may make, capital contributions to LifeUSA or capital expenditures. The maximum borrowing allowed under this agreement is $30 million (no amounts outstanding at December 31, 1996). Borrowings under the line of credit may be made through May 17, 1999, will mature on March 31, 2001 and will be subject to mandatory repayments from 25% of excess cash flow (as defined) for the prior calendar year on June 30, 1999 and March 31, 2000. The line of credit agreement contains various financial covenants, including maintenance of minimum levels of consolidated tangible net worth for the Company and statutory capital and surplus and risk-based capital for LifeUSA. The Company is required to pay a commitment fee of 1/4 of 1% per annum on the average daily unused portion of the credit line. 5. CONVERTIBLE SUBORDINATED DEBENTURES During 1995, Allianz Life purchased a 15-year, $30 million convertible subordinated debenture from the Company. The interest rate on the convertible subordinated debenture is fixed at 5% per annum for the first five years. In years 6 through 15, the debenture will be amortized in equal semi-annual payments of $1.5 million, with interest set annually at LIBOR (London Interbank Offering Rate) plus 1% per annum. During the first five years, Allianz Life may convert the debenture into the Company's common stock at $12.40 per share (subject to customary anti-dilution adjustments). During years 6 through 10, the conversion price is the higher of $12.40 per share (subject to customary anti-dilution adjustments) or two times the Company's GAAP (Generally Accepted Accounting Principles) book value per share, as calculated at the end of the month preceding conversion. The debenture may be redeemed by the Company at any time without penalty. Contemporaneous with the issuance of the debenture to Allianz Life, the Company also issued Allianz Life, for no additional consideration, a conversion protection warrant to acquire 2.4 million shares of the Company's common stock at $12.40 per share, which is only exercisable if the debenture is redeemed prior to February 17, 2000 and the average trading price for the Company's common stock has not been at least $15.625 per share for any consecutive 45 trading days. The conversion protection warrant expires on the earlier of (i) February 17, 2000, or (ii) 30 days after the Company has notified Allianz Life that the average trading price for the Company's common stock has been at least $15.625 per share for any consecutive 45 trading days. The agreements also grant Allianz Life preemptive rights to acquire additional shares of the Company's common stock equal to 10.5% of (i) the number of shares of the Company's common stock deemed outstanding for the purpose of computing fully diluted earnings per share under the treasury stock method of accounting as of the end of the month immediately preceding the notice of exercise of preemptive rights, less (ii) 22,857,142. The exercise price per share is equal to the lesser of (i) $12.40 or (ii) the weighted average price at which shares of the Company's common stock have been issued subsequent to February 17, 1995, subject to certain exceptions and customary anti-dilution adjustments. Allianz Life also has observer rights at the meetings of the Boards of Directors of the Company and LifeUSA so long as the convertible debt is held by Allianz Life or its affiliates, or 2.0 million shares of the Company's common stock are owned by Allianz Life or its affiliates. In addition, in the event that the convertible debt is converted in its entirety into the Company's common stock and so long as Allianz Life owns at least 2.0 million shares of the Company's common stock, Allianz Life will have the right to designate one director of the Company and one director of LifeUSA. 32 Prior to 1993, the Company's agents and employees earned convertible subordinated debentures as compensation. At December 31, 1996, $6.0 million of these debentures are outstanding. The debentures bear an 8% fixed interest rate which is payable annually. The debentures mature on June 30, 2000 or sooner at the option of the Company or mandatorily upon the sale of the Company. Subject to certain conditions, the debentures may be converted into shares of the Company's common stock at a conversion price of $22.50 per share through June 30, 1997. This conversion price increases by $1.50 per year up to a maximum of $27.00 per share. The debentures are subordinate to all present and future indebtedness of the Company, including lease obligations. During 1995 and 1994, $11,000 and $309,000 of debentures were converted to 571 and 17,019 shares of common stock, respectively. The Allianz Life debenture is a common stock equivalent for the purpose of calculating the Company's primary earnings per share, while the debentures outstanding to the Company's agents and employees are not considered to be common stock equivalents. 6. LEASES The Company leases office space, telephone equipment and furniture under operating leases expiring in various years through February 2001, with rights to lease additional office space at specified future dates and options to renew the leases for office space for an additional eight years and ten months from the expiration date. The office lease payments are subject to adjustment for real estate taxes and maintenance expenses. Rent expense on these operating leases charged to operations was $1.5 million, $1.3 million and $1.4 million for the years ended December 31, 1996, 1995 and 1994, respectively. Minimum future rental payments under noncancelable operating leases having remaining terms in excess of one year as of December 31, 1996 are as follows (in thousands): 1997..................... $1,913 1998..................... 1,938 1999..................... 2,132 2000..................... 2,132 2001..................... 356 ------ $8,471 ====== 7. CAPITAL STRUCTURE PREFERRED STOCK The Board of Directors has the authority to designate additional classes of preferred stock and the rights and preferences of any class of preferred stock from the 15 million authorized preferred shares. The issuance of preferred stock may adversely affect various rights, including voting rights, of the common shareholders and may be used as an anti-takeover device. STOCK WARRANTS In September 1992, the Company entered into an agreement with Lions Gate Capital Ltd. (Lions Gate) whereby Lions Gate assisted the Company in investor relations matters through August 1993. As compensation for its services, Lions Gate was issued a warrant to acquire 192,000 shares of common stock. Lions Gate could elect monthly to receive all or a part of each month's compensation in cash instead of that month's portion of the warrant. The number of shares under this warrant was reduced by the amount of cash compensation Lions Gate elected to receive. Lions Gate received cash totaling $15,500 during the period covered by the agreement. As of December 31, 1996 and 1995, there were outstanding warrants originally issued to Lions Gate for 176,500 shares of common stock at an exercise price of $10.00 per share, subject to certain adjustments. These warrants expire on September 30, 1997. No further warrants are issuable to Lions Gate. 33 COMMON STOCK TO BE ISSUED In connection with employee and Company contributions to the Life USA Holding, Inc. Employee Savings Plan (Savings Plan), 21,384 shares of common stock are to be issued at a price of $12.00 per share at December 31, 1996 and 45,404 shares of common stock were to be issued at prices of $8.00 to $9.00 per share at December 31, 1995 to employee accounts under the Savings Plan. NOTES RECEIVABLE FROM STOCK SALES During 1996, the Company issued common stock to several of its field marketing organizations (FMOs) in exchange for promissory notes in order to provide additional incentives for the FMOs to increase the life insurance and annuity business produced for LifeUSA or through LifeUSA under its joint marketing agreement with Allianz Life. The shares of common stock issued for the account of the FMO are held in the possession of the Company as security for the repayment of the promissory note. The promissory notes bear interest at the rate of 8% per annum compounded monthly and payable at maturity (the fifth anniversary of the date of the note). STOCK OPTION PLANS The Company has elected to follow APB No. 25 and related Interpretations in accounting for its stock options because, as discussed below, the alternative fair value accounting provided for under SFAS No. 123 requires the use of highly subjective option valuation models that were developed for use in valuing publicly traded stock options. Under APB No. 25, no compensation cost is recognized since the exercise price of the Company's stock options is equal to, or greater than, the market price of the underlying stock on the date of grant. The binomial and Black and Scholes option valuation models were developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its stock options. To further facilitate the use of the information disclosed, a range of reasonable values also is presented with the Company's pro forma information to reflect the variability of the results of the valuation process that would arise from changes made to the assumptions. Pro forma information regarding net income and earnings per share is required by SFAS No. 123, and has been determined using binomial option valuation models as if the Company had accounted for its employee stock options under the fair value method of that Statement. The assumptions used for each stock option plan are included in the discussion of that specific plan. In 1990, the Company established the Life USA Holding, Inc. 1990 Stock Option Plan (the 1990 Stock Option Plan). The 1990 Stock Option Plan provides for the granting of stock options to employees and consultants of the Company. An aggregate of 4 million shares of common stock is reserved for issuance upon the exercise of the options granted. The purchase price of the shares of common stock subject to options granted under the 1990 Stock Option Plan is determined by a committee of the Board of Directors and cannot be less than 100% of the fair market value on the date the option is granted for incentive stock options and cannot be less than 85% of the fair market value on the date the option is granted for non-qualified options. No options may be granted under the 1990 Stock Option Plan after September 2000. The option vesting period and exercise period are determined by the committee at the date of the grant. The vesting periods range from zero to four years. During 1996, the committee determined that the life of all outstanding employee stock options issued with a five year life would be extended to ten years and all future employee stock option grants would be issued with a life of ten years. The additional expense related to the grant extensions is disclosed separately in the 1996 pro forma disclosures. 34 Based upon this information, the following assumptions were used in determining the SFAS 123 expense associated with the 1990 Stock Option Plan. The volatility used was 38.03% and 36.89% for 1996 and 1995, respectively; the risk free interest rates ranged from 5.04% to 6.38% and 5.88% to 6.05% for 1996 and 1995, respectively; and the expected option life was seven years and four years for 1996 and 1995, respectively. Exercise prices for options outstanding as of December 31, 1996 ranged from $6.00 to $28.00. A summary of the Company's stock option activity for the 1990 Stock Option Plan, and related information for the years ended December 31 follows (in thousands, except exercise price amounts):
1996 1995 ----------------------------------------------------------- WEIGHTED-AVERAGE WEIGHTED-AVERAGE OPTIONS EXERCISE PRICE OPTIONS EXERCISE PRICE ----------------------------------------------------------- Outstanding -- beginning of year ......... 2,289 $10.26 2,103 $10.10 Granted equal to market .................. 373 8.77 67 8.88 Granted above market ..................... 151 12.96 165 12.76 Exercised ................................ (29) 7.00 (27) 6.05 Canceled ................................. (64) 11.50 (19) 15.48 ----------------------------------------------------------- Outstanding -- end of year ............... 2,720 10.21 2,289 10.26 =========================================================== Exercisable -- end of year ............... 1,858 $10.39 1,376 $10.27 =========================================================== Weighted-average fair value of options granted during the year (using SFAS 123 assumptions) ........................ $ 4.21 $ 2.70 ===========================================================
The following table summarizes information concerning outstanding and exercisable options at December 31, 1996 (in thousands, except exercise price and remaining contractual life amounts):
OPTIONS OUTSTANDING OPTIONS EXERCISABLE ----------------------------------------------------------- WEIGHTED-AVERAGE REMAINING RANGE OF CONTRACTUAL WEIGHTED-AVERAGE WEIGHTED-AVERAGE EXERCISE PRICES LIFE NUMBER EXERCISE PRICE NUMBER EXERCISE PRICES - -------------------------------------------------------------------------------------------------- $ 6.00 - 9.00 7.2 977 $ 7.45 640 $ 6.78 $ 9.01 - 13.50 7.6 1,519 10.93 994 11.14 $13.51 - 20.25 7.5 180 15.70 180 15.70 $20.26 - 28.00 6.8 44 24.52 44 24.52
Beginning in 1992, the Company granted stock options as commission bonuses to LifeUSA's agents (Agent Option Plan) based on net earned commissions on business written. An aggregate of 4,797,843 shares of the Company's common stock is reserved for issuance upon the exercise of these options. The purchase price of shares of common stock subject to these options is the greater of $10.00 per share or 150% of the average closing bid price for the Company's common stock for the twenty days immediately preceding the end of the calendar quarter for which the stock option is granted. These options vest immediately upon issuance and expire on the December 31st in the fifth year following the date of grant. Based upon this information, the following assumptions were used in determining the SFAS 123 expense associated with the Agent Option Plan. The volatility used was 36.89% for 1996 and 1995; the risk free interest rates ranged from 6.10% to 6.15% and 5.95% to 6.05% for 1996 and 1995, respectively; and the expected option life was four years for 1996 and 1995. 35 Exercise prices for options outstanding as of December 31, 1996 ranged from $10.00 to $27.28. A summary of the Company's stock option activity for the Agent Option Plan, and related information for the years ended December 31 follows (in thousands, except exercise price amounts):
1996 1995 -------------------------------------------------------- WEIGHTED-AVERAGE WEIGHTED-AVERAGE OPTIONS EXERCISE PRICE OPTIONS EXERCISE PRICE -------------------------------------------------------- Outstanding -- beginning of year ........ 3,482 $14.93 2,406 $15.60 Granted above market .................... 664 12.79 1,088 13.48 Canceled ................................ (111) 15.88 (12) 15.88 -------------------------------------------------------- Outstanding -- end of year .............. 4,035 14.56 3,482 14.93 ======================================================== Exercisable -- end of year .............. 4,035 $14.56 3,482 $14.93 ======================================================== Weighted-average fair value of options granted during the year (using SFAS 123 assumptions) ....................... $ 2.37 $ 1.93 ========================================================
The following table summarizes information concerning outstanding and exercisable options at December 31, 1996 (in thousands, except exercise price and remaining contractual life amounts):
OPTIONS OUTSTANDING OPTIONS EXERCISABLE ----------------------------------------------------------- WEIGHTED-AVERAGE RANGE OF REMAINING WEIGHTED-AVERAGE WEIGHTED-AVERAGE EXERCISE PRICES CONTRACTUAL LIFE NUMBER EXERCISE PRICE NUMBER EXERCISE PRICE - -------------------------------------------------------------------------------------------------- $ 9.01 - 13.50 3.4 1,833 $11.56 1,833 $11.56 $13.51 - 20.25 3.1 1,852 15.49 1,852 15.49 $20.26 - 28.00 2.0 350 25.29 350 25.29
During 1993, the Company established the LifeUSA Director Option Plan (Director Option Plan) which provides for the granting of stock options to members of the Company's Board of Directors who are not and have not been full-time employees of the Company or any of its subsidiaries. Each such director receives a non-qualified stock option to purchase 1,000 shares of common stock for each meeting of the Board of Directors attended. The price of the option will be equal to the fair market value of the stock on the date of the meeting. An aggregate of 100,000 shares of common stock is reserved for issuance upon the exercise of the options granted. These options vest immediately, are exercisable six months and one day after issuance, and expire on the earlier of five years from issuance or one year after the director ceases to be a member of the Board of Directors. Based upon this information, the following assumptions were used in determining the SFAS 123 expense associated with the Director Option Plan. The volatility used was 36.89% for 1996 and 1995; the risk free interest rates ranged from 6.03% to 6.10% and 5.88% to 5.99% for 1996 and 1995, respectively; and the expected option life was four years for 1996 and 1995. 36 Exercise prices for options outstanding as of December 31, 1996 ranged from $8.25 to $19.50. A summary of the Company's stock option activity for the Director Option Plan, and related information for the years ended December 31 follows (in thousands, except exercise price amounts):
1996 1995 -------------------------------------------------------- WEIGHTED-AVERAGE WEIGHTED-AVERAGE OPTIONS EXERCISE PRICE OPTIONS EXERCISE PRICE -------------------------------------------------------- Outstanding -- beginning of year ........ 45 $11.67 25 $13.88 Granted equal to market ................. 20 8.78 20 8.92 -------------------------------------------------------- Outstanding -- end of year .............. 65 10.78 45 11.67 ======================================================== Exercisable -- end of year .............. 55 $11.12 35 $12.55 ======================================================== Weighted-average fair value of options granted during the year (using SFAS 123 assumptions) ....................... $ 3.28 $ 3.32 ========================================================
The following table summarizes information concerning outstanding and exercisable options at December 31, 1996 (in thousands, except exercise price and remaining contractual life amounts):
OPTIONS OUTSTANDING OPTIONS EXERCISABLE ----------------------------------------------------------- WEIGHTED-AVERAGE RANGE OF REMAINING WEIGHTED-AVERAGE WEIGHTED-AVERAGE EXERCISE PRICES CONTRACTUAL LIFE NUMBER EXERCISE PRICE NUMBER EXERCISE PRICE - -------------------------------------------------------------------------------------------------- $ 6.00 - 9.00 3.8 30 $ 8.57 25 $ 8.59 $ 9.01 - 13.50 3.1 25 10.23 20 10.44 $13.51 - 20.25 1.9 10 18.81 10 18.81
For purposes of pro forma disclosures, the estimated fair value of the options is charged to expense in the year of grant. The expense generated as a result of the grant of agent options has been reduced by the amount that would be deferred as a cost of acquiring new business. This amount has been calculated using a method consistent with that utilized by LifeUSA to defer commissions paid to agents. The Company's pro forma information follows (in thousands, except for earnings per share information):
1996 1995 - ----------------------------------------------------------------------------------------------------- RANGE OF VALUES RANGE OF VALUES ---------------- ---------------- SFAS 123 HIGH LOW SFAS 123 HIGH LOW ------------------------------------------------------------------- Reported net income ......... $23,454 $23,454 $23,454 $19,097 $19,097 $19,097 Additional expense: 1990 Stock Option Plan: Original grants ........ (1,273) (1,626) (444) (362) (512) (154) Grant extensions ....... (3,628) (5,091) (981) -- -- -- Agent Option Plan ........ (998) (1,512) (320) (867) (1,393) (225) Director Option Plan ..... (38) (49) (21) (38) (50) (21) ------------------------------------------------------------------- Pro forma net income ........ $17,517 $15,176 $21,688 $17,830 $17,142 $18,697 =================================================================== Pro forma earnings per share: Primary .................. $ .79 $ .69 $ .97 $ .82 $ .79 $ .86 =================================================================== Fully diluted ............ $ .78 $ .68 $ .96 $ .82 $ .79 $ .86 ===================================================================
37 SAVINGS PLAN In 1990, the Company adopted the Savings Plan. An aggregate of 700,000 shares of common stock is reserved for issuance by the Savings Plan. All permanent employees age 18 and over are eligible to participate in the Savings Plan. Participants may contribute from 1% to 15% of their annual salary to the Savings Plan, and the Company will match these contributions at a percentage to be determined annually at the discretion of the Company. The Company may also contribute a discretionary profit sharing amount, determined annually. Contributions made to the Savings Plan by the Company are invested in common stock of the Company. During the years of 1996, 1995 and 1994, the Company matched the participants' contributions dollar-for-dollar up to 6% of their annual salaries. The Company's expense for the years ended December 31, 1996, 1995 and 1994, was $.9 million, $.7 million and $.6 million, respectively. DIVIDENDS The ability of the Company to pay dividends is limited because a majority of the Company's revenues is produced by LifeUSA, and distributions by LifeUSA to the Company are subject to approval and other limitations imposed by the Department of Commerce of the State of Minnesota. Although LifeUSA has made a formal request of the Department of Commerce of the State of Minnesota for approval to pay a $2.5 million dividend to the Company during 1997, the Company does not currently intend to pay dividends. 8. INCOME TAXES Income taxes consist of the following (in thousands): YEAR ENDED DECEMBER 31, -------------------------------- 1996 1995 1994 -------------------------------- Current: Federal ...... $14,459 $ 8,312 $4,197 State ........ 821 372 334 -------------------------------- Total current.... 15,280 8,684 4,531 Deferred ........ (1,669) 2,180 4,032 -------------------------------- $13,611 $10,864 $8,563 ================================ The reconciliation between income tax expense and the amount computed by applying the statutory federal income tax rate for the years ended December 31 is as follows (in thousands):
1996 1995 1994 ------------------------------------------------------------------ PROVISION RATE PROVISION RATE PROVISION RATE ------------------------------------------------------------------ Income taxes based on the statutory rate... $12,973 35.0% $10,486 35.0% $8,061 35.0% State income tax, net of federal benefit... 453 1.2 183 .6 231 1.0 Other ..................................... 185 .5 195 .7 271 1.2 ------------------------------------------------------------------ Income taxes .............................. $13,611 36.7% $10,864 36.3% $8,563 37.2% ==================================================================
38 The components of the deferred tax (benefit) provision for the years ended December 31 are as follows (in thousands): 1996 1995 1994 ------------------------------------ Deferred policy acquisition costs.... $ 3,548 $ 12,810 $ 15,453 Future policy benefits .............. (3,840) (10,173) (10,373) Deferred agent compensation ......... 49 (534) (745) State guaranty fund assessments ..... (1,109) (729) 211 Other ............................... (317) 806 (514) ------------------------------------ $(1,669) $ 2,180 $ 4,032 ==================================== Significant components of the Company's deferred tax assets and liabilities are as follows (in thousands): DECEMBER 31, ------------------ 1996 1995 ------------------ Deferred tax assets: Future policy benefits .............. $52,143 $48,303 Unrealized gains/losses on investments ........................ 3,062 10,883 Deferred agent compensation ......... 2,664 2,713 State guaranty fund assessments ..... 1,723 641 Other ............................... 5,930 5,513 ------------------ Total gross deferred tax assets ........ 65,522 68,053 Deferred tax liabilities: Deferred policy acquisition costs.... 67,536 63,988 Unrealized gains/losses on investments ........................ 4,858 17,725 State guaranty fund assessments ..... 878 905 Other ............................... 5,174 5,075 ------------------ Total gross deferred tax liabilities.... 78,446 87,693 ------------------ Net deferred tax liability ............. $12,924 $19,640 ================== The Company began filing life-nonlife consolidated income tax returns in 1994. The Internal Revenue Service is currently auditing the Company's and LifeUSA's federal income tax returns for the years 1992 and 1991. The outcome of the examination is not known at this time. 9. RELATED PARTY TRANSACTIONS The Company incurred legal fees of $.4 million, $.4 million and $.3 million for the years ended December 31, 1996, 1995 and 1994, respectively, from the law firm of which one of its directors and one officer of the Company are members. Members of such firm beneficially owned 328,830 shares of the Company at December 31, 1996, or approximately 1.6% of the then outstanding shares. The Company incurred actuarial and other consulting fees of $.7 million, $.9 million and $.9 million for the years ended December 31, 1996, 1995 and 1994, respectively, from the firm of which one of its directors is a member. The Company incurred legal and other consulting fees of $.1 million, $.1 million, and $.2 million for the years ended December 31, 1996, 1995 and 1994, respectively, from the firm of which one of its directors is a member. 39 10. STATEMENT OF CASH FLOWS SUPPLEMENTAL DISCLOSURES Changes in operating assets and liabilities consist of (in thousands):
YEAR ENDED DECEMBER 31, --------------------------------- 1996 1995 1994 --------------------------------- Increase in policy loans ................................ $ (1,553) $ (1,666) $ (1,520) Increase in accrued investment income ................... (4,324) (14,091) (4,221) Increase in future policy benefits recoverable and amounts due from reinsurers ............................ (7,678) (5,768) (4,962) Decrease (increase) in other assets ..................... 2,636 (14,867) (4,287) Increase (decrease) in other policyholders' funds ....... 928 (48) 1,608 (Decrease) increase in amounts due reinsurers ........... (3,698) 12,242 2,669 (Decrease) increase in accrued commissions to agents .... (1,121) 2,859 306 (Decrease) increase in taxes, licenses and fees payable ................................................ (1,045) 13,542 3,024 Increase (decrease) in accounts payable ................. 2,196 565 (36) Increase (decrease) in other liabilities ................ 312 (362) (3,445) --------------------------------- $(13,347) $ (7,594) $(10,864) =================================- Supplemental schedule of noncash financing activities: Issuance of stock upon conversion of convertible subordinated debentures ................. $ -- $ 11 $ 309 Cancellation of convertible subordinated debentures .......................................... -- -- 1 Issuance of stock to employees as compensation ........................................ 1,436 831 943
11. STATUTORY CAPITAL AND SURPLUS LifeUSA, domiciled in Minnesota, prepares its statutory financial statements in accordance with accounting practices prescribed or permitted by the Department of Commerce of the State of Minnesota. LifeUSA does not utilize any accounting practices in the preparation of its statutory financial statements which differ from those prescribed by the Department of Commerce of the State of Minnesota. At December 31, 1996 and 1995, LifeUSA had statutory capital and surplus of $87.3 million and $75.7 million, respectively, as reported to regulatory authorities. During 1996 and 1995, the Company contributed to LifeUSA a total of $1.4 million and $25.4 million, respectively, to increase LifeUSA's statutory capital and surplus. LifeUSA has made a formal request to the Department of Commerce of the State of Minnesota for approval to pay a $2.5 million cash dividend to the Company during 1997. LifeUSA's ability to pay dividends in the future is also subject to compliance with Minnesota insurance laws and regulations. Statutory net income for the years ended December 31, 1996 and 1995 was $13.2 million and $.4 million, respectively, while the statutory net loss for the year ended December 31, 1994 was $12.5 million. Differences between net income and statutory results of operations arise primarily from deferred policy acquisition costs, future policy benefits, deferred income taxes, amortization of licenses and noncash transactions relating to agent advances. 40 12. QUARTERLY FINANCIAL DATA (UNAUDITED)
QUARTER ENDED ------------------------------------------------------ MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31 ------------------------------------------------------ (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 1996: Revenues ................... $73,554 $77,429 $84,032 $81,883 Net income ................. 4,621 5,666 6,762 6,404 Income per common and common equivalent share: Primary ................. .21 .25 .30 .28 Fully diluted ........... .21 .25 .30 .28 1995: Revenues ................... 59,868 70,132 64,202 78,580 Net income ................. 3,706 4,959 3,823 6,609 Income per common and common equivalent share: Primary ................. .18 .23 .18 .30 Fully diluted ........... .18 .23 .18 .30
The results for the quarters ended December 31 were impacted by the following items (dollars in thousands, except per share amounts):
1996 1995 ------------------------------------------------------- INCREASE (DECREASE) INCREASE (DECREASE) ------------------------------------------------------- NET INCOME PER SHARE NET INCOME PER SHARE ------------------------------------------------------- Net realized gains on investments ......... $ -- $ -- $ 1,870 $ .08 Charges for state guaranty fund assessments (1,487) (.06) (1,415) (.06) Reduction of state premium tax expense .... 1,838 .08 -- -- Adjustments made to annual production based accruals ................ (938) (.04) 590 .03 Revisions made to the estimates in the models used to amortize deferred policy acquisition costs and accrue for bonuses to be paid to policyholders .............. 1,184 .05 -- --
41 13. FAIR VALUE OF FINANCIAL INSTRUMENTS The following methods and assumptions were used by the Company in estimating the fair value of its financial instruments: CASH AND CASH EQUIVALENTS AND POLICY LOANS The carrying amounts reported in the balance sheet for these financial instruments approximate fair value. INVESTMENT CONTRACTS The fair value of the Company's liabilities for deferred annuity contracts is estimated to be the cash surrender value of each contract. The cash surrender value represents the policyholder's account balance less applicable surrender charges. The fair value of liabilities for supplemental contracts without life contingencies and in-benefit annuity contracts is estimated by discounting estimated cash flows using appropriate market interest rates. The fair value of the Company's deferred policy acquisition costs is not required to be disclosed. However, in the event that the fair value of the liabilities for deferred annuity contracts, supplemental contracts without life contingencies and in-benefit annuity contracts were realized (i.e., the business is sold or completely ceded to a third party), the deferred policy acquisition cost asset with a carrying value of $167.9 million and $155.4 million at December 31, 1996 and 1995, respectively, would have a fair value of $0. CONVERTIBLE SUBORDINATED DEBENTURES The fair value of convertible subordinated debentures is estimated using discounted cash flow analyses, based on interest rates for similar types of financial instruments with maturities consistent with those remaining for the debentures. The carrying amounts and fair values of the Company's financial instruments are as follows (in thousands):
DECEMBER 31, 1996 DECEMBER 31, 1995 ------------------------------------------------------------ CARRYING VALUE FAIR VALUE CARRYING VALUE FAIR VALUE ------------------------------------------------------------ ASSETS Fixed maturity investments: Available for sale .................... $ 878,279 $ 878,279 $ 812,195 $ 812,195 Held to maturity ...................... 1,003,197 1,013,761 908,670 953,167 Policy loans ............................. 23,908 23,908 19,789 19,789 Cash and cash equivalents ................ 20,989 20,989 33,222 33,222 Future policy benefits recoverable and amounts due from reinsurers ............. 2,065,817 1,999,158 1,766,833 1,633,730 LIABILITIES Investment contracts: Deferred annuities .................... $2,884,403 $2,562,624 $2,651,463 $2,359,788 Supplementary contracts and in-benefit annuities ................. 954,150 984,832 716,648 749,391 Convertible subordinated debentures ...... 36,030 39,633 36,030 32,813
42 Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company's holdings of a particular financial instrument. Because no market exists for a significant portion of the Company's financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. Changes in assumptions could significantly affect the estimates. Fair value estimates are based on existing balance sheet financial instruments without attempting to estimate the value of estimated future business and the value of assets and liabilities that are not considered financial instruments. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in the estimates. 43 REPORT OF INDEPENDENT AUDITORS The Board of Directors Life USA Holding, Inc. We have audited the accompanying consolidated balance sheets of Life USA Holding, Inc. 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. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Life USA Holding, Inc. 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. In 1994, as discussed in Note 1 to the consolidated financial statements, the Company adopted Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities." /s/ Ernst & Young LLP Minneapolis, Minnesota January 31, 1997 44 MANAGEMENT'S RESPONSIBILITY FOR FINANCIAL REPORTING The management of Life USA Holding, Inc. is responsible for the consolidated financial statements, accompanying notes and all other information presented in this Annual Report. The consolidated financial statements have been prepared in conformity with generally accepted accounting principles appropriate in the circumstances and include amounts based on the best estimates and judgments of management. In order to safeguard assets and to maintain the integrity and objectivity of data in these financial statements, Life USA Holding, Inc. maintains a comprehensive system of internal accounting controls. These controls are supported by the careful selection and training of qualified personnel and an appropriate division of responsibilities. In addition, an integral part of the comprehensive system of internal control is an effective internal audit department. The Life USA Holding, Inc. internal audit department systematically evaluates the adequacy and effectiveness of internal accounting controls and measures adherence to established policies and procedures. The management of Life USA Holding, Inc. believes that as of December 31, 1996, its system of internal control is adequate to accomplish the objectives discussed herein. The financial statements for the years ended December 31, 1996, 1995 and 1994 have been audited by Ernst & Young LLP, independent auditors. Their audits were made in accordance with generally accepted auditing standards and included a review of the system of internal controls to the extent necessary to express an opinion on the financial statements. The audit committee of the Board of Directors, comprised solely of outside directors, meets regularly with the independent auditors, management and internal auditors to review the scope and results of the audit work performed. The independent auditors have unrestricted access to the audit committee, without the presence of management, to discuss the results of their audit, the adequacy of internal accounting controls and the quality of financial reporting. /s/ Robert W. MacDonald - ------------------------- Robert W. MacDonald Chairman and Chief Executive Officer /s/ Mark A. Zesbaugh - ------------------------- Mark A. Zesbaugh Executive Vice President and Chief Financial Officer 45 LIFE USA HOLDING, INC. BOARD OF DIRECTORS Robert W. MacDonald, CLU Chairman Chief Executive Officer Margery G. Hughes President Chief Operating Officer Mark A. Zesbaugh, CPA, CFA, FLMI Executive Vice President Chief Financial Officer Treasurer and Secretary Daniel J. Rourke, CLU Senior Vice President Chief Marketing Officer Donald J. Urban Senior Vice President Director of Sales Joseph W. Carlson, FLMI Consultant Ralph Strangis Counsel to the Company Member of the Law Firm Kaplan, Strangis and Kaplan, P.A. Robert J. Oster Private Venture Capital Investor Jack H. Blaine President National Organization of Life and Health Insurance Guaranty Associations Hugh Alexander Member of Alexander Law Firm, P.C. Barbara J. Lautzenheiser Lautzenhieser & Associates OFFICERS Robert W. MacDonald, CLU Chairman Chief Executive Officer Margery G. Hughes President Chief Operating Officer Mark A. Zesbaugh, CPA, CFA, FLMI Executive Vice President Chief Financial Officer Treasurer and Secretary Daniel J. Rourke, CLU Senior Vice President Chief Marketing Officer Donald J. Urban Senior Vice President Director of Sales Bradley E. Barks, FSA, MAAA, CPA Senior Vice President Finance Bruce D. Bengtson, FSA, MAAA Senior Vice President Chief Actuary Bruce J. Parker Assistant Secretary Member of the Law Firm Kaplan, Strangis and Kaplan, P.A - --------------- VICE PRESIDENTS Jo-Anne S. Halek Kimberly A. Lees - ---------------- ANNUAL MEETING The annual meeting of the shareholders of Life USA Holding, Inc. will be held on April 15, 1997 at the Interchange Tower, 600 South Highway 169, Minneapolis, Minnesota 55426. All shareholders are invited to attend. CORPORATE INFORMATION CORPORATE OFFICE 300 South Highway 169 Minneapolis, Minnesota 55426 612-546-7386 General Counsel Kaplan, Strangis and Kaplan, P.A Minneapolis, Minnesota Independent Auditors Ernst & Young LLP Minneapolis, Minnesota Transfer Agent Harris Trust and Savings Bank Chicago, Illinois - ---------------- REINSURANCE PARTNERS Allianz Life Insurance Company of North America Minneapolis, Minnesota Employers Reassurance Corporation Overland Park, Kansas Munich American Reassurance Company Atlanta, Georgia Republic-Vanguard Life Insurance Company Dallas, Texas Transamerica Occidental Life Insurance Company Charlotte, North Carolina FORM 10-K The Life USA Holding, Inc. Form 10-K can be obtained by writing to Mark A. Zesbaugh, Chief Financial Officer, 300 South Highway 169, Minneapolis, Minnesota 55426. SHAREHOLDER INFORMATION Life USA Holding, Inc. common stock trades on the Nasdaq National Market tier of The Nasdaq Stock Market under the symbol: "LUSA." No dividends have been paid since inception. 1995 1996 --------------- -------------- HIGH LOW HIGH LOW -------------------------------- 1st Quarter $11-3/8 $7-3/16 $9-7/8 $7-5/8 2nd Quarter $10-1/2 $ 8-5/8 $9-3/8 $7-5/8 3rd Quarter $10-1/8 $ 8-1/4 $9-1/4 $7-3/4 4th Quarter $ 9-1/4 $ 7-5/8 $ 12 $8-5/8 As of December 31, 1996, there were 5,093 holders of record of the Company's common stock. 46 LIFEUSA INSURANCE COMPANY BOARD OF DIRECTORS Robert W. MacDonald, CLU Chief Executive Officer Daniel J. Rourke, CLU Chairman Donald J. Urban President Margery G. Hughes Executive Vice President Mark A. Zesbaugh, CPA, CFA, FLMI Senior Vice President Treasurer Jacqueline K. Katrein, CPA Senior Vice President Support Division Chief Financial Officer Joseph W. Carlson, FLMI Consultant Ralph Strangis Counsel to the Company Member of the Law Firm Kaplan, Strangis and Kaplan, P.A. Robert J. Oster Private Venture Capital Investor Stephen M. Kerns Insurmark David A. Sunderland Sunderland Insurance Services Joseph R. Lehman, CFP, CLU Life Sales Edward A. Omert Roster Financial OFFICERS Robert W. MacDonald, CLU Chief Executive Officer Daniel J. Rourke, CLU Chairman LifeUSA Insurance Company Chairman and Chief Executive Officer Universal Benefits Life Division Donald J. Urban President Margery G. Hughes Executive Vice President Mark A. Zesbaugh, CPA, CFA, FLMI Senior Vice President Treasurer Ronald L. Berger, CPA Senior Vice President Information & Technology Denise M. Blizil Senior Vice President Operating Division Secretary Linda K. Burm Senior Vice President Chief Operating Officer Universal Benefits Life Division Jacqueline K. Katrein Senior Vice President Support Division Chief Financial Officer Charles M. Kavitsky Senior Vice President Sales and Marketing VICE PRESIDENTS Robin Aeshliman Leo J. Anderson, FLMI Rolf D. Baglien, CPA Kevin J. Boyce Caroyln K. Cosgrove, FLMI Michael A. Eitel, CPA Lorraine M. Frankewicz John T. Helgerson, CLU Susan L. Kumpula Lane A. Kurle, FLMI Robert L. Miller Kathaleen A. Morrow Janet M. Neary David K. Sandberg, ASA, MAAA Susan K. Swanson Cathy H. Waldhauser, FSA, MAAA Kevin E. Walker, FLMI Deborah J. Wesenberg, FLMI, FALU, CLU Scott A. Wheeler, CPA, CLU, FLMI - ---------------- ASSISTANT VICE PRESIDENTS Kristi K. Bizer, CPA, FLMI Lisa B. Carlson Brenda Z. Duenwald Jeffrey R. Girod Amelia L. Jensen John R. Kraft Richard P. Lapcinski Leslie J. LeQue Neil H. McKay, FSA, MAAA Rodney D. Meyer, ALHC, FLMI Lisa M. Nicholson Philip B. Rosenbaum, CPA, FLMI Sharyl L. Schultz, CLU Roxanne M. Watercott Ann M. Yaggie 47 LIFEUSA(R) 300 South Highway 169 Minneapolis, Minnesota 55426 EX-21 8 SUBSIDIARIES OF THE REGISTRANT EXHIBIT 21 SUBSIDIARIES OF THE REGISTRANT State or other jurisdiction of Name of subsidiary incorporation or organization - ------------------ ----------------------------- LifeUSA Insurance Company Minnesota LifeUSA Securities, Inc. Minnesota LifeUSA Marketing, Inc. Minnesota EX-23 9 CONSENT OF INDEPENDENT AUDITORS EXHIBIT 23 Consent of Independent Auditors We consent to the incorporation by reference in this Annual Report (Form 10-K) of Life USA Holding, Inc. of our report dated January 31, 1997 included in the 1996 Annual Report to Shareholders of Life USA Holding, Inc. Our audits also included the financial statement schedules of Life USA Holding, Inc. listed in item 14(a). These schedules are the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, the financial statements schedules referred to above, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein. We also consent to the incorporation by reference in the Registration Statement (Form S-8 No. 33-38610) pertaining to the Life USA Holding, Inc. Employee Stock Option Plan, the Registration Statement (Form S-8 No. 33-38821) pertaining to the Life USA Holding, Inc. Employee Savings Plan, and the Registration Statement (Form S-3 No. 33-71068) pertaining to the Life USA Holding, Inc. Option Bonus Program of our report dated January 31, 1997 with respect to the consolidated financial statements incorporated herein by reference, and our report included in the preceding paragraph with respect to the financial statement schedules included in this Annual Report (Form 10-K) of Life USA Holding, Inc. /s/ Ernst & Young LLP Minneapolis, Minnesota March 25, 1997 EX-24 10 POWER OF ATTORNEY POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS, that LIFE USA HOLDING, INC., a Minnesota corporation (the "Company"), and each of the undersigned directors of the Company, hereby constitutes and appoints Robert W. MacDonald and Mark A. Zesbaugh and each of them (with full power to each of them to act alone) its/his true and lawful attorney-in-fact and agent, for it/him and on its/his behalf in its/his name, place and stead, in any and all capacities to sign, execute, affix its/his seal thereto and file the Annual Report on Form 10-K for the year ended December 31, 1996 under the Securities Exchange Act of 1934, as amended, including any amendment or amendments thereto, with all exhibits and any and all documents required to be filed with respect thereto with any regulatory authority. There is hereby granted to said attorneys, and each of them, full power and authority to do and perform each and every act and thing, requisite and necessary to be done in respect of the foregoing as fully as it/he or itself/himself might or could do if personally present, thereby ratifying and confirming all that said attorneys-in-fact and agents, or any of them, may lawfully do or cause to be done by virtue hereof. This Power of Attorney may be executed in any number of counterparts, each of which shall be an original, but all of which taken together shall constitute one and the same instrument and any of the undersigned directors may execute this Power of Attorney by signing any such counterpart. IN WITNESS WHEREOF, LIFE USA HOLDING, INC. has caused this Power of Attorney to be executed in its name by its President on the 15th day of January, 1997. LIFE USA HOLDING, INC. By /s/ Margery G. Hughes ------------------------ Margery G. Hughes, President The undersigned directors of LIFE USA HOLDING, INC. have hereunto set their hands as of the 15th day of January, 1997. /s/ Hugh Alexander /s/ Robert J. Oster - ---------------------------- ------------------------ Hugh Alexander Robert J. Oster /s/ Jack H. Blaine /s/ Daniel J. Rourke - ---------------------------- ------------------------ Jack H. Blaine Daniel J. Rourke /s/ Joseph W. Carlson /s/ Ralph Strangis - ---------------------------- ------------------------ Joseph W. Carlson Ralph Strangis /s/ Margery G. Hughes /s/ Donald J. Urban - ---------------------------- ------------------------ Margery G. Hughes Donald J. Urban /s/ Barbara J. Lautzenheiser /s/ Mark A. Zesbaugh - ---------------------------- ------------------------ Barbara J. Lautzenheiser Mark A. Zesbaugh /s/ Robert W. MacDonald - ---------------------------- Robert W. MacDonald EX-27 11 FINANCIAL DATA SCHEDULE
7 YEAR DEC-31-1996 JAN-01-1996 DEC-31-1996 878,279 1,003,197 1,013,761 0 0 0 1,905,304 20,989 0 212,138 4,386,723 4,078,621 0 0 5,381 36,030 0 0 210 172,405 4,386,723 0 129,412 1,791 185,695 116,931 24,495 138,407 37,065 13,611 23,454 0 0 0 23,454 1.04 1.04 0 0 0 0 0 0 0
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