-----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, C30UbF5ybsrmBmVEysuUf8wj9v6eMpb5PlmsgZyU02M3tD6n6NxEW6QjvVBDrZbI SCQz8XSlZJbsg1JFAgUDGQ== 0000853971-98-000008.txt : 19980327 0000853971-98-000008.hdr.sgml : 19980327 ACCESSION NUMBER: 0000853971-98-000008 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 14 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980326 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: STANDARD MANAGEMENT CORP CENTRAL INDEX KEY: 0000853971 STANDARD INDUSTRIAL CLASSIFICATION: LIFE INSURANCE [6311] IRS NUMBER: 351773567 STATE OF INCORPORATION: IN FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-20882 FILM NUMBER: 98574446 BUSINESS ADDRESS: STREET 1: 9100 KEYSTONE CROSSING STE 600 CITY: INDIANAPOLIS STATE: IN ZIP: 46240 BUSINESS PHONE: 3175746200 MAIL ADDRESS: STREET 1: 9100 KEYSTONE CROSSING STREET 2: SUITE 600 CITY: INDIANAPOLIS STATE: IN ZIP: 46207 10-K 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 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, 1997 or TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission file number 0-20882 STANDARD MANAGEMENT CORPORATION (Exact name of registrant as specified in its charter) Indiana 35-1773567 (State or other jurisdiction of (I.R.S. employer incorporation or organization) identification no.) 9100 Keystone Crossing, Indianapolis, Indiana 46240 (317) 574-6200 (Address of principal executive offices) (Telephone) Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, No Par Value Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of 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 held by non-affiliates of the Registrant, based upon the closing sale price of the Common Stock on March 13, 1998 as reported on The Nasdaq Stock Market, was approximately $41.5 million. Shares of Common Stock held by each executive officer and director and by each person who owns 5% or more the outstanding Common Stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes. As of March 13, 1998, Registrant had outstanding 7,094,417 shares of Common Stock. Documents Incorporated by Reference: Portions of the Registrant's definitive Proxy Statement for the Annual Meeting of Stockholders are incorporated by reference into Part III of this Form 10-K. PART I AS USED HEREIN, UNLESS THE CONTEXT OTHERWISE CLEARLY REQUIRES, "SMC", OR THE "COMPANY" REFERS TO STANDARD MANAGEMENT CORPORATION AND ITS CONSOLIDATED SUBSIDIARIES AND "STANDARD MANAGEMENT" REFERS TO STANDARD MANAGEMENT CORPORATION ON AN UNCONSOLIDATED BASIS. ALL FINANCIAL INFORMATION CONTAINED HEREIN IS PRESENTED IN ACCORDANCE WITH GENERALLY ACCEPTED ACCOUNTING PRINCIPLES ("GAAP") UNLESS OTHERWISE SPECIFIED. ITEM 1. BUSINESS OF SMC INTRODUCTION SMC is an international financial services holding company which directly and through its subsidiaries acquires and manages in force life insurance and annuity business and issues and distributes life insurance and annuity products. SMC offers unit-linked assurance products through its international subsidiaries. SMC's active subsidiaries at December 31, 1997 include: (i) Standard Life Insurance Company of Indiana ("Standard Life") and its subsidiary, Dixie National Life Insurance Company ("Dixie National Life"), (ii) Standard Management International S.A. ("Standard Management International") and its subsidiaries, Premier Life (Luxembourg) S.A. ("Premier Life (Luxembourg)") and Premier Life (Bermuda) Ltd. ("Premier Life (Bermuda)") and (iii) Standard Marketing Corporation ("Standard Marketing"). Standard Life, SMC's principal insurance subsidiary, was organized in 1934 as an Indiana-domiciled life insurer. It is licensed to write new business or service existing business in the District of Columbia and all states except New York and New Jersey. Standard Life offers flexible premium deferred annuities ("FPDAs") and whole and universal life insurance. Standard Life also generates cash flow and income from closed blocks of in force life insurance and annuities. At December 31, 1997, Standard Life's statutory assets were $367,121,000 and the aggregate of its statutory capital and surplus, asset valuation reserve ("AVR") and interest maintenance reserve ("IMR") (its "adjusted statutory capital") was $37,634,000. The ratio of Standard Life's adjusted statutory capital to its total statutory assets was 10.3% at December 31, 1997. Standard Life has a rating of "B+" ("Very Good, Secure") by A.M. Best Company, Inc. ("A.M. Best"), a rating agency. Standard Management International is a holding company organized under Luxembourg law with its registered office in Luxembourg. At December 31, 1997, Standard Management International and its subsidiaries had $160,516,000 in assets with policies in force in over 80 countries. The majority of its business is unit-linked assurance products with a range of policyholder directed investment choices coupled with a small death benefit, sold through its subsidiaries: Premier Life (Luxembourg) and Premier Life (Bermuda). At December 31, 1997, Premier Life (Luxembourg) had statutory capital and surplus of $7,288,000 and its minimum capital and surplus was $2,915,000 and Premier Life (Bermuda) had statutory capital and surplus of $1,350,000 and its minimum capital and surplus was $250,000. Standard Life owns 99.4% of Dixie National Life. At December 31, 1997, Dixie National Life's statutory assets were $35,240,000, the adjusted statutory capital was $3,865,000 and the ratio of its adjusted statutory capital to its statutory assets was 11.0%. Dixie National Life has a rating of B ("Adequate") by A.M. Best. Dixie National Life markets a variety of life insurance products throughout the Mid-South offering primarily "burial expense" policies. Standard Marketing is a wholesale distributor of life insurance and annuity products. Through its network of managing general agents and independent agents, Standard Marketing distributes life insurance and annuity products for Standard Life, Dixie National Life and Savers Life Insurance Company and for a select group of unaffiliated insurance companies. Standard Marketing earns override commission income from the sale of these products. On November 8, 1996, Standard Life acquired through merger Shelby Life Insurance Company ("Shelby Life") from Delta Life and Annuity Corporation ("DLAC"), a life insurance company located in Memphis, Tennessee (the "Shelby Merger"). The purchase price was approximately $14,650,000, including $13,000,000 in cash, 250,000 shares of restricted Common Stock (valued at $1,250,000) and acquisition costs of $400,000. Financing for the Shelby Merger was provided by senior debt of $10,000,000 and $4,000,000 in subordinated convertible debt. SMC's intent at the time it purchased Shelby Life was to cease writing new business as the new business premium volume did not justify the costs of marketing support, and to continue to earn profits from the existing business. Consistent with that intent, Shelby Life ceased writing new business effective November 1, 1996, thus eliminating marketing and sales costs and thereby reducing statutory surplus strain. Statutory accounting practices require that acquisition costs associated with new business (primarily commissions and policy issue costs) be fully expensed in the year the new business is written. Surplus strain is created when acquisition costs incurred in connection with new business reduces statutory surplus. Many states impose minimum levels of surplus as a condition to writing new business. See "Business of SMC--Regulation." The acquisition of Shelby Life was accounted for using the purchase method of accounting and SMC's consolidated financial statements include the results of Shelby Life from November 1, 1996, the effective date of acquisition. Under purchase accounting, Standard Life allocated the total purchase price of Shelby Life to the assets and liabilities acquired, based on a determination of their fair values and recorded the excess of acquisition cost over net assets acquired as goodwill, which will be amortized on a straight-line basis over 20 years. On March 18, 1996, Standard Life completed the sale of a duplicate charter associated with First International Life Insurance Company ("First International") to The Guardian Insurance and Annuity Company, Inc. ("GIAC"), a subsidiary of The Guardian Group, New York, NY. Standard Life received proceeds of approximately $10,393,000, including $1,500,000 for the charter and licenses associated with First International. Standard Life realized a net pretax gain of $1,042,000 and a tax benefit of $1,420,000 on this sale, or $2,462,000. In addition, First International, Standard Life and GIAC have entered into a series of agreements that include provisions for Standard Life to administer First International policies in force at the date of sale, and for Standard Life to continue to receive the profit stream from certain First International policies in force at the date of such sale. See "Business of SMC--Reinsurance." SMC decided in February 1996 to terminate the reinsurance agreement between Standard Reinsurance of North America Ltd. ("Standard Reinsurance") and Salamandra Joint-Stock Insurance Company in Ukraine ("Salamandra"), and not to renew the Barbados license of Standard Reinsurance due to an insignificant amount of reinsurance premium volume (less than $100,000). This resulted in the termination of Standard Reinsurance operations and the write-off of SMC's investment in Standard Reinsurance and certain intangible assets of Standard Reinsurance amounting to $156,000. The combined effect of the gain on sale of First International and related contracts, and the Standard Reinsurance write-offs, was a gain on disposal of subsidiaries of $886,000 and a tax benefit of $1,420,000, for net income effect of $2,305,836 for the year ended December 31, 1996. In June 1988, Standard Life ceded a block of business to National Mutual Life Insurance Company ("National Mutual"). Effective May 31, 1996, Standard Life terminated by recapture the reinsurance agreement with National Mutual. As a result of this recapture, Standard Life received assets of $4,826,000 and liabilities of $4,826,000, primarily ordinary life policies. In connection with this transaction, Standard Life agreed to pay National Mutual a recapture fee of $1,200,000, and Standard Life collected administration fees of $375,000 related to services provided in prior years that had not been recorded previously due to the uncertainty as to its collection. The net proceeds of $825,000 were recorded as the present value of the future profits on this block of business, which is being amortized in proportion to the emergence of profits over 20 years. This premium income and corresponding increase in reserves of $4,234,000, recorded in connection with the recapture of the reinsurance agreement with National Mutual will not recur in the future. On March 12, 1998, SMC acquired Savers Life Insurance Company ("Savers Life"), with Savers Life surviving as a wholly-owned subsidiary of SMC. Each of the 1,779,908 shares of Savers Life Common Stock outstanding was converted into 1.2 shares of SMC Common Stock plus $1.50. Each holder of Savers Life Common Stock could elect to receive the $1.50 per share portion of the merger consideration in the form of additional shares of SMC Common Stock. SMC issued approximately 2.2 million shares with a value of approximately $14.9 million and paid $2.1 million in cash (excluding acquisition costs) to acquire Savers Life. SMC increased the Amended and Restated Revolving Line of Credit Agreement with a bank (the "Amended Credit Agreement") to an amount of $20,000,000 to finance the acquisition of Savers Life. See "Liquidity and Capital Resources". Savers Life underwrites, markets and distributes annuities, life insurance, and Medicare supplement health insurance through a sales force consisting of approximately 4,000 independent brokers and is licensed to sell products in North Carolina, South Carolina, Virginia and Florida. Savers Life had total assets of $72,186,000 at December 31, 1997 and revenues of $43,047,000 for the year ended December 31, 1997. ACQUISITION STRATEGY A principal component of SMC's strategy is to grow through the acquisition of life insurance companies and blocks of in force life insurance and annuities. SMC regularly investigates acquisition opportunities in the life insurance industry that complement or are otherwise strategically consistent with its existing business. Any decision to acquire a block of business or an insurance company will depend on a favorable evaluation of various factors. SMC believes that availability of blocks of business in the marketplace will continue in response to ongoing industry consolidation and risk-based capital requirements as well as other regulatory and rating agency concerns. In addition, SMC plans to market annuity and life insurance products directly as it has done in the past. SMC currently has no plans or commitments to acquire any specific insurance business or other material assets besides Savers Life. No assurance can be given that SMC will be successful in consummating any future acquisition. SMC has the information systems and administrative capabilities necessary to add additional blocks of business without a proportional increase in operating expenses. In addition, SMC has developed management techniques for reducing or eliminating the expenses of the companies it acquires through the consolidation of their operations with those of SMC, and for increasing investment yields. Such techniques include reduction or elimination of overhead, including the acquired company's management, staff and home office, elimination of marketing expenses and, where appropriate, the substitution of Standard Marketing's network for the acquired company's current distribution system, and the conversion of the acquired company's data processing operations to SMC's system. SMC may effect its acquisitions through the purchase or exchange of shares, if the acquisition candidate is an insurance company, or an assumption reinsurance transaction, if the proposed acquisition concerns a block of business. SMC's acquisitions may be subject to certain regulatory approvals, policyholder consents and stockholder approval, when applicable. MARKETING DOMESTIC MARKETING. Standard Marketing was organized as a wholesale distribution system to provide a lower cost alternative to the traditional captive agency force. Standard Marketing has established a network of approximately 20,000 independent general agents, including Savers Life. These agents distribute a full line of life insurance and annuity products issued by Standard Life, Dixie National Life and Savers Life and a select group of unaffiliated insurance carriers that Standard Marketing represents. As part of its normal recruiting, Standard Marketing selectively recruits new agents from those formerly associated with companies acquired by SMC. Crediting rates, commissions, the perceived quality of the issuer, product features and services are generally the principal factors influencing an agent's willingness and ability to sell particular life and annuity products. SMC believes that both agents and policy owners value the service provided by SMC. Standard Marketing assists its agents in submitting and processing policy applications and helps ensure that issuing insurers pay commissions on a timely basis. Standard Life issues an annuity and pays the Standard Marketing agent's commission within 24 hours subsequent to receipt of policyholder's deposit. Standard Marketing also assists its agents with licensing applications and provides other administrative support. Standard Marketing provides marketing support for its agents, including sales seminars and other continuing education programs, point of sale materials, illustrated proposal services, toll-free access for sales inquiries and access to senior executives. In addition, Standard Marketing can introduce agents to lead services who will provide such services at discounted rates that Standard Marketing has negotiated. Standard Marketing agents offer a full portfolio of life insurance, annuity and health products that Standard Marketing has selected on the basis of their competitive position and likely consumer acceptance. Such portfolio includes FPDAs, whole and universal life insurance and critical illness products issued by Standard Life and Dixie National Life, for which Standard Marketing is the exclusive distributor, and life insurance products issued by selected unaffiliated insurers. Standard Marketing receives, directly from the insurance companies it serves, primarily affiliated insurance companies, override commissions on sales by its agents, which are in addition to the commissions paid to Standard Marketing's independent agents. The availability of override commissions provides an economic incentive to Standard Marketing to recruit agents who produce business. Standard Marketing's relationships with these companies are non-exclusive and are terminable by either party upon 30 days notice. Standard Marketing regularly evaluates the products its agents offer to determine whether products or insurers should be added to, or deleted from, the Standard Marketing portfolio. SMC does not insure any of the policies and contracts Standard Marketing's agents sell for unaffiliated insurers. Each general agent operates his own agency and is responsible for all expenses of the agency. The general agents are compensated directly by the issuing insurance companies, which perform all policy issuance, underwriting and accounting functions. SMC is not dependent on any one agent or agency for any substantial amount of its business. No single agent accounted for more than 4% of Standard Life's annual sales in 1997, and the top twenty individual agents accounted for approximately 37% of Standard Life's volume in 1997. At December 31, 1997, approximately 25% of Standard Marketing's independent agents were located in Indiana, Florida, Ohio, Georgia, California and Illinois, with the balance distributed across the country. SMC is attempting to increase the number and geographic diversity of its agents. In 1997, SMC began writing significant amounts of business in Colorado and the Mid-South due to Standard Marketing's expansion efforts. SMC does not have exclusive agency agreements with its agents and management believes most of these agents sell products similar to those sold by SMC for other insurance companies. This could result in a sales decline if SMC's products were to become relatively less competitive. Standard Life's 1997 FPDA sales increased partially due to an aggressive marketing campaign targeted to high volume sales agents and marketing companies. Also contributing to the increase in premiums was the continued development of Standard Life's distribution system through marketing support from Standard Marketing along with an aggressive program aimed at retention of key producers and expanding geographical concentration into the Mid-South and California. SAVERS LIFE MARKETING. Savers Life initially sold only annuity products through its affiliations with a network of North Carolina-based Savings and Loan institutions. In the late 1980s, the Savings and Loan industry experienced financial crises which led to a large number of mergers in that industry. Savers Life's distribution network among the Savings and Loan institutions was threatened by this merger boom, so Savers Life expanded its marketing efforts, gradually building up a network of independent brokers, while still continuing to market through certain North Carolina and South Carolina Savings and Loan institutions. Savers Life currently has approximately 4,000 active brokers. Savers Life is not dependent on any one broker or agency for any substantial amount of its business. Savers Life employs three Regional Managers, who are responsible for personally initiating and maintaining direct communications with every broker appointed by Savers Life. The Regional Managers are responsible for the recruitment and training of all new brokers. Each broker operates independently of Savers Life and is responsible for all of his or her expenses. INTERNATIONAL MARKETING. The subsidiaries of Standard Management International, Premier Life (Luxembourg) and Premier Life (Bermuda), produced aggregate new premium deposits of approximately $22,000,000, $17,000,000 and $32,000,000 during 1997, 1996 and 1995, respectively. The increase in 1997 is due to renewed marketing efforts in certain European countries, particularly in Sweden and Belgium. The decrease in 1996 is primarily due to an internal reorganization of its operational facility as well as a renewed focus on target markets which succeeded in 1997. The countries within the European Union have been the main contributor to these sales. Although SMC expects this to be the case in the future, it plans to increase marketing efforts in other parts of the world as well. Although Standard Management International anticipates as part of its long term plan to grow significantly through internal sales, acquisitions of other European insurance companies may be considered. It has designed and launched new single and regular premium products in recent years. It is also in discussions with a number of companies to form alliances to produce tailored products for their markets. It is currently the intention that Premier Life (Luxembourg) will write business within the European Union and Premier Life (Bermuda) will write international business elsewhere in the world. The market for Standard Management International's products is considered to be medium to high net worth individuals who typically have in excess of $75,000 to invest in a single premium policy and medium to high earners who have in excess of $3,000 per annum to invest in a regular premium savings product. The above individuals would come from a combination of expatriates, residents of European Union countries and from other targeted areas. The expatriate and European insurance markets are well established and highly competitive with a large number of domestic and international groups operating in, or going into, the same markets as Standard Management International. Standard Management International's products are distributed via independent agents who have established connections with these targeted individuals. Standard Management International is striving to develop into an entrepreneurial intermediary oriented organization committed to building long term relationships with high quality distributors, thereby creating a niche position. Standard Management International places the same emphasis as SMC's U.S. insurance companies on a high level of service to intermediaries and policyholders while striving to achieve low overhead costs. PRODUCTS SMC primarily markets FPDAs, whole life and universal and interest-sensitive life insurance policies and unit-linked policies. The following table sets forth the amounts and percentages of net premiums received by SMC from currently marketed products for the years ended December 31, 1997, 1996 and 1995, respectively (in thousands). Because GAAP generally excludes annuity and unit-linked products deposits, and premiums from universal and interest-sensitive life insurance from premium income, and thus does not fully reflect SMC's cash flow from new business, the premium information contained in the following table is reported using statutory accounting principles which includes deposits on annuities and unit-linked policies, and premiums from universal and interest-sensitive life insurance.
Year Ended December 31, 1997 1996 1995 Amount % Amount % Amount % Currently marketed products: FPDAs $41,066 55.5 $37,322 58.7 $12,417 25.8 Universal and 5,836 7.9 5,384 8.5 2,044 4.2 interest-sensitive life Single premium immediate 2,704 3.7 1,423 2.2 1,257 2.6 annuities Whole life 2,349 3.2 2,546 4.0 668 1.4 Unit-linked products 21,954 29.7 16,902 26.6 31,793 66.0 $73,909 100.0 63,577 100.0 48,179 100.0
FPDA sales increased in 1997 primarily due to the introduction of new products and an increase in the agency base achieved through the recruitment of high volume agents and larger managing general agencies and continued expansion of geographical concentration into such areas as California. FPDA sales increased in 1996 partially due to Standard Life decreasing the quota-share portion of business ceded pursuant to a reinsurance agreement, under which 70% of a portion of Standard Life's annuity business pursuant to the terms of the agreement produced after December 31, 1994 was ceded, to 50% at September 1, 1995, which was further decreased to 25% effective April 1, 1996. This reduction was possible since the surplus strain experienced by Standard Life was not as great as originally anticipated as a result of lower than expected sales in 1995 and the additional surplus resulting from the sale of First International. Premium deposits ceded pursuant to this reinsurance agreement reduced net premium by $8,707,000, $8,907,000 and $20,090,000 for 1997, 1996 and 1995, respectively. The increase in universal and interest-sensitive life products in 1996 is primarily due to the increase in interest-sensitive life products issued by Dixie National Life, which is included in results after October 2, 1995, the effective date of the acquisition. The increase in deposits from unit linked products in 1997 is primarily due to the renewed marketing efforts in certain European countries, particularly in Sweden and Belgium. The following table shows certain information for SMC as of the dates set forth below (in thousands):
At December 31, 1997 1996 1995 Number of annuity contracts in force 14,013 13,221{ (3)} 8,637 Interest-sensitive annuity and other financial $350,607 $333,633{ (3)} $212,500 product reserves, net of reinsurance ceded Number of life policies in force 68,571 76,219{ (4)} 63,038 Life insurance in force, net of reinsurance $ 1,178,171{ (1)} $ 1,367,675{ (4)} $826,296 ceded Number of separate contracts (primarily unit-linked products) 2,329 2,484 2,951 Total liabilities related to separate accounts $ 148,064 $128,546 $122,705 (primarily unit-linked products) {(2)}
(1) The decrease in life insurance in force is due to the termination and recapture of a reinsurance agreement effective January 1, 1997. See "Business of SMC -- Reinsurance". (2) The liabilities related to separate accounts increased in 1997 due to increased new premium deposits and higher investment returns earned by the policyholder on the separate accounts due to improved fund performance. (3) The number of annuity contracts in force and interest-sensitive annuity and other financial product reserves increased in 1996 primarily due to the increase in FPDA sales in 1996 and the Shelby merger. (4) The number of life policies and insurance in force increased in 1996, as a result of the Shelby merger. Shelby Life had 16,603 life policies and $617,688,000 insurance in force as of November 1, 1996. CURRENTLY MARKETED PRODUCTS The individual annuity business is a growing segment of the savings and retirement industry, which increased in sales from $1 billion in 1970 to more than $54 billion in 1990. The individual annuity market, which is one of SMC's primary target, comprises 42% of those sales. As the 76 million baby boomers born from 1946 through 1964 grow older, demand for insurance products is expected to grow. SMC believes that those seeking adequate retirement incomes will depend less and less on Social Security and their employers' retirement programs and more and more upon their own financial resources. Annuities currently enjoy an advantage over certain other saving mechanisms because the annuity buyer receives a tax-deferred accrual of interest on his investment during the accumulation period. Standard Life, Dixie National Life and Standard Management International all currently issue new policies. Standard Life emphasizes the issuance of FPDAs. Dixie National Life primarily sells "burial expense" life insurance policies. Standard Management International markets unit-linked products. Over 31% of all net premiums and deposits collected in 1997 by SMC from its currently marketed products, arise from the sale of unit-linked products by Standard Management International. The balance is represented by the sales of whole life and universal and interest-sensitive life insurance products by Standard Life and Dixie National Life and Standard Life's FPDAs. The portfolio of products is continuously reviewed by management, and product features and terms are adjusted in response to market conditions in an effort to remain competitive. Standard Management International's products are sold primarily in Western Europe. SMC's gross sales percentages by U.S. geographical region are summarized as follows: STATE 1997 1996 1995 Indiana 21% 18% 24% California 11 11 3 Ohio 10 16 22 Florida 10 14 11 Texas 4 4 2 Louisiana 4 2 2 Virginia 4 2 -- Colorado 4 1 -- Michigan 2 6 4 All other states {(1)} 30 26 32 Total 100% 100% 100% (1) No other state had gross sales greater than 4%. STANDARD LIFE PRODUCTS FLEXIBLE PREMIUM DEFERRED ANNUITIES. FPDAs provide for an initial deposit by an annuitant and optional additional deposits, the time and amount of which are at the discretion of the annuitant. Standard Life credits the account of the annuitant with earnings at interest rates that are revised periodically by Standard Life until the maturity date. This accumulated value is tax deferred. Revisions to interest rates on FPDAs are restricted by an initial crediting rate guaranteed for a specific period of time and a minimum crediting rate guaranteed for the term of the FPDA. At maturity, the annuitant can elect a lump sum cash payment of the accumulated value or one of the various payout options available. Standard Life's FPDAs also provide for penalty-free partial withdrawals of up to 10% annually of the accumulation value after the annuitant has held the FPDA for more than 12 months. In addition, the annuitant may surrender the FPDA at any time before the maturity date and receive the accumulated value, less any surrender charge then in effect for that contract. To protect holders of FPDAs from a sharp reduction in the credited interest rate after a FPDA is issued, Standard Life permits the FPDA holder of certain annuities to surrender the annuity during a specified period without incurring a surrender charge if the renewal crediting rate is below a stated level. This stated level of interest is referred to as the "bail-out rate" and is typically below the original crediting rate, but above the minimum guaranteed crediting rate. As of January 1, 1998, the crediting rates available on Standard Life's currently marketed FPDAs ranged from 6.8% to 12%, with new issues having an interest rate with a one year guarantee period. After the initial period, the crediting rate may be changed periodically, subject to minimum guaranteed rates from 3% to 4%. As of January 1, 1998, interest crediting rates after the initial guarantee period ranged from 5% to 6.6%. The surrender charge is initially 13% or 15% of the contract value depending on the product and decreases over the applicable penalty period of nine, ten or thirteen years. As of January 1, 1998, the bail out rate for Standard Life's FPDAs was 4.5%; most currently marketed products carry a bail out rate for only the first two years after issue. As of December 31, 1997, Standard Life had 8,855 currently marketed FPDA contracts in force. WHOLE LIFE INSURANCE. Standard Life offers two types of non-participating whole life policies: one in face amounts up to $10,000 (which is only issued upon conversion of other policies) and the other in face amounts up to $50,000. Whole life insurance products involve fixed premium payments made over time, with the stated death benefit paid in full upon the death of the insured. The whole life policy combines the death benefit with a forced savings plan. Premiums remain level over the life of the policy, with the policyholder prefunding during the early years of coverage when risk of death is low. Over time, whole life policies begin to accrue a cash value which can be made available to the policyholder net of taxes and withdrawal penalties. As of December 31, 1997, Standard Life had 551 currently marketed whole life policies in force. SINGLE PREMIUM IMMEDIATE ANNUITIES. Standard Life offers a single premium immediate annuity ("SPIA"), whereby an annuitant purchases an immediate annuity with a one-time premium deposit at the time of issuance. Standard Life begins a payout stream shortly after the time of issuance consisting of principal value plus accumulated interest credited to such annuity. This product credits interest based on an investment portfolio earned rate assumption. As of December 31, 1997, Standard Life had 691 SPIA contracts in force. UNIVERSAL LIFE. SPULs provide for an initial deposit (flexible premium universal life ("FPUL") for periodic deposits), credit interest to account values and charge the account values for mortality and administrative costs. As of January 1, 1998, the current interest rate on new sales of SPULs was 6.75% with a guaranteed interest rate of 3.4%. As of December 31, 1997, Standard Life had 88 and 286 SPUL and FPUL policies in force, respectively. CRITICAL ILLNESS. During 1997, Standard Life introduced a new critical illness product which is being offered in the United States for the first time. A critical illness policy pays a 100% lump sum cash payment when the insured survives 30 days or more after diagnosis of cancer, stroke, or heart attack. In addition, the insurer would pay 25% of the benefit amount on heart bypass surgery, Alzheimer's, deafness, or blindness. Although not intended to replace existing insurance, this product gives policyholders access to sums of money to help them through difficult situations. Included in the policy is a return of premium benefit, which would return all paid premiums (without interest) if the insured dies after 10 years, assuming the policy is still in force. This 14 year-old product has been extremely successful in South Africa, Australia, the United Kingdom, and Japan. In 1993, $15.5 billion of face amount insurance in critical illness policies was sold in the United Kingdom alone. In Japan, 500,000 policies were sold within the first 10 months of its inception, with over $6 million in total sales to date. DIXIE NATIONAL LIFE PRODUCTS Life insurance policies sold by Dixie National Life in the final expense, or burial, market include fixed premium interest sensitive policies that provide for increasing death benefits, as well as traditional whole life policies. These policies are designed to cover expenses such as funeral, last illness, monument and cemetery lot. The policies provide for a death benefit, generally not in excess of $10,000, and a level premium payment. The products include a cash value which may be borrowed by the policyholder. Dixie National Life's policies sold in other markets include interest sensitive and traditional whole life policies and forms of term policies. The interest sensitive whole life policies have a guaranteed interest rate of 5.50% on products marketed as of January 1, 1998. The interest sensitive and whole life policies include cash values which may be borrowed by the policyholder. Dixie National Life issues policies on both a participating and non-participating basis. As of December 31, 1997, Dixie National Life had 734 and 24,185 individual annuities and life policies in force, respectively. STANDARD MANAGEMENT INTERNATIONAL PRODUCTS UNIT-LINKED POLICIES. Standard Management International currently writes unit-linked life products, which are similar to U.S. produced variable life products. Separate account assets and liabilities are maintained primarily for the exclusive benefits of universal life contracts and investment contracts of which the majority represents unit-linked business where benefits on surrender and maturity are not guaranteed. They generally represent funds held in accounts to meet specific investment objectives of policyholders who bear the investment risk. Investment income and investment gains and losses within the separate accounts accrue directly to such policyholders. The fees received by Standard Management International for administrative and contract holder maintenance services performed for these separate accounts are included in SMC's statement of operations. In the past, Standard Management International also wrote investment contracts and universal life policies and to a lesser extent, traditional life policies. The investment contracts are mainly short-term single premium endowments or temporary annuities under which fixed benefits are paid to the policyholder. The terms of these contracts are such that SMC has relatively small morbidity or mortality risk. The universal life contracts are mainly regular premium and single premium endowment. The benefits payable to the policyholders are directly linked to the investment performance of the underlying assets. CLOSED BLOCKS SMC also generates cash flow and income from its closed blocks of in force life insurance and annuities. Closed blocks are blocks of in force life insurance and annuities that are not currently being marketed by SMC. The closed block designation is for internal purposes only, it does not have any legal or regulatory significance and there are no restrictions on the assets or future profits of closed blocks. The premiums received on the closed blocks were primarily from the ordinary and universal life business. This decline in premium income is expected as a result of policy lapses, surrenders and expiries from closed blocks of business. ANNUITIES. SMC's closed blocks of deferred annuities consist primarily of FPDAs and a small amount of single premium deferred annuities ("SPDAs") which, unlike FPDAs, do not provide for additional deposits. As of January 1, 1998, these deferred annuities had crediting rates ranging from 5% to 5.5% and guaranteed minimum crediting rates ranging from 3% to 5.5%. The crediting rate may be changed periodically. The contract owner is permitted to withdraw all or part of the accumulation value. SMC's closed blocks of annuities include payout annuities. Payout annuities consist of those annuities the benefits of which are being paid out over a specified time period. Payout annuities cannot be terminated by surrender or withdrawal. SMC's crediting rates on payout annuities range from 5.5% to 6.5% and cannot be changed. At December 31, 1997, SMC had 3,688 annuity contracts in force for closed blocks. ORDINARY LIFE. The ordinary life policies included in SMC's closed blocks are composed primarily of fixed premium, cash value whole life products. In addition, they include annually renewable term policies as well as five, ten and fifteen year level premium term policies. At December 31, 1997, SMC had 35,937 ordinary life policies in force for closed blocks. UNIVERSAL LIFE. Certain closed blocks include universal life business. For this business, SMC credits deposits and interest to account values and charges the account values for mortality and administrative costs. At December 31, 1997, SMC had 6,368 universal life policies in force for the Shelby Life closed block of business. REINSURANCE. In connection with financial reinsurance, Dixie National Life terminated a reinsurance agreement with Crown Life Insurance Company and received recaptured premium income of $18,186,000 and entered into a financial reinsurance agreement with Cologne Life Reinsurance Company and ceded $13,091,000 of premium income in 1996. The policies subject to the recapture of the reinsurance agreement with National Mutual were primarily ordinary life policies. See "Business of SMC -- Reinsurance." SAVERS LIFE PRODUCTS Savers Life issues and markets Medicare supplement health policies, term and whole life policies, single premium deferred annuities and SPIAs. MEDICARE SUPPLEMENT INSURANCE. Medicare supplement insurance is designed to help Medicare recipients with the portion of their medical expenses that Medicare does not cover. This product is regulated by the federal government. Each insurance company's products are identical in benefits covered. Medicare supplement plans are identified by the letters A through J. Savers Life sells plans A through G. Each plan has different benefits to the insured as well as different premium levels. Medicare supplement plans are available to anyone who is eligible for Medicare Part B and within the ages of 65 and 85 at date of issue. At the time a person initially becomes eligible for Medicare Part B ("open enrollment period"), Savers Life must offer a Medicare supplement policy to that person regardless of potential health problems of the person. If a person requests insurance coverage after the open enrollment period, Savers Life is allowed to underwrite the policy and determine insurability based on the health of the individual. Savers Life has a combination of products in its in-force block of Medicare supplement business, including pre-standardization plans and standardized plans A through G. Premiums on all of these policies can be increased only with regulatory approval in the states in which the policies were written. With the exception of South Carolina, premium rate increases can occur no more frequently than annually. South Carolina allows premium rate increases semiannually after the first policy anniversary. In addition to sales of its own products, Savers Life markets products of other companies, and for this effort, receives fee income. KEYPORT ANNUITIES. Savers Life sells annuities on behalf of Keyport Life Insurance Company ("Keyport"), a Rhode Island-based seller of annuities, through its broker network. Savers Life sells Keyport fixed annuity products that, due to their relatively high rate of interest, are very popular with Savers Life's customer base. Savers Life remits the premiums collected to Keyport and is compensated through commission agreements. QUALCHOICE OF NORTH CAROLINA PRODUCT. Savers Life entered into a two-year marketing and administrative contract with QualChoice of North Carolina ("QualChoice") in 1996 whereby Savers Life is the distribution system for the small group product offered by QualChoice. QualChoice is an HMO in a twenty-county area in the northwestern part of North Carolina offering HMO insurance coverage to both large and small groups. Small group coverage is defined as any group of employees from one to fifty. Savers Life is compensated for this effort with a marketing fee, administrative fee and commission reimbursement for its brokers. PRODUCT PROFITABILITY The profitability of the life insurance and annuity products depend to a significant degree on the maintenance of profit margins between investment results from invested assets and interest credited on insurance and annuity products. During 1997, such margins continued to be positive as a result of the increase in investment portfolio yields, which offsets the effects of sales of FPDAs in 1997 with higher and more competitive interest rates. The long-term profitability of insurance products depends on the accuracy of the actuarial assumptions that underlie the pricing of such products. Actuarial calculations for such insurance products, and the ultimate profitability of such products, are based on four major factors: (i) persistency, (ii) mortality (iii) return on cash invested by the insurer during the life of the policy and (iv) expenses of acquiring and administering the policies. The average expected remaining life of Standard Life's ordinary life business in force at December 31, 1997 was 9.0 years. This calculation was determined based upon SMC's actuarial models and assumptions as to expected persistency and mortality. Persistency is the extent to which insurance policies sold are maintained by the insured. The persistency of life insurance and annuity products is a critical element of their profitability. However, a surrender charge often applies in the early contract years and declines to zero over time. Policyholders sometimes do not pay premiums, thus causing their policies to lapse. For the years 1997, 1996 and 1995 Standard Life experienced total policy lapses of 6.5%, 6.3% and 5.1% of total policies in force at December 31 of each year, respectively. The American Council of Life Insurance 1997 Fact Book reported industry life insurance voluntary termination rates in 1996 of 17.7% for policies in force less than two years, 5.1% for policies in force for two years or more and 6.8% for all policies in force. OPERATIONS SMC emphasizes a high level of service to agents and policyholders and strives to achieve low overhead costs. SMC's principal administrative departments are its financial, policyholder services and management information services ("MIS") departments. The financial department provides accounting, budgeting, tax, investment, financial reporting and actuarial services and establishes cost control systems for SMC. The policyholder services department reviews policy applications, issues and administers policies and authorizes disbursements related to claims and surrenders. The MIS department oversees and administers SMC's information processing systems. SMC's administrative departments in the United States use a common integrated system that permits SMC to function more efficiently, control costs and maintain low overhead. SMC's MIS system serviced approximately 150,000 active and inactive policies at December 31, 1997. SMC is continually improving its MIS systems to provide for continued growth from acquisitions and sales. SMC's 1998 capital budget for systems improvements is $150,000. Also, SMC anticipates minimal expenditure to be required in the update of the MIS system for the year 2000. Standard Management International's administrative and MIS departments in Luxembourg are an autonomous unit from the systems in the United States. SMC is in the process of improving the MIS systems of Standard Management International and integrating them with the U.S. systems. INVESTMENTS Investment activities are an integral part of SMC's business; investment income of SMC's insurance subsidiaries is an important part of its total revenues. Profitability is significantly affected by spreads between rates credited on insurance liabilities and interest yield on invested assets. Substantially all credited rates on FPDAs may be changed at least annually. For the year ended December 31, 1997, the weighted average interest rate credited on SMC's interest-sensitive liability portfolio, excluding liabilities related to separate accounts, was approximately 5.58% per annum, and the weighted average net yield of SMC's investment portfolio for the year ended December 31, 1997 was 7.68% for an average interest spread of 210 basis points at December 31, 1997, compared to 205 basis points at December 31, 1996. The consistency in the average interest spread is primarily attributable to the increase in investment portfolio yields, which offsets the effects of sales of FPDAs in 1997 with higher and more competitive interest rates. Increases or decreases in interest rates could increase or decrease the average interest rate spread between investment yields and interest rates credited on insurance liabilities, which in turn could have a beneficial or adverse effect on the future profitability of SMC. Sales of fixed maturity securities that result in investment gains may also tend to decrease future average interest rate spreads. State insurance laws and regulations prescribe the types of permitted investments and limit their concentration in certain classes of investments. The following table shows SMC's pre-tax investment performance for the periods indicated (in thousands):
Year Ended December 31, 1997 1996 1995 Average invested assets{ (1)} $384,145 $285,186 $253,055 Net investment income 29,516 20,871 18,517 Weighted average annual yield{ (2)} 7.68% 7.32% 7.32% Net realized investment gains $396 $1,302 $688
(1) Average invested assets are computed by dividing the total of the amortized cost of invested assets at the beginning of the period plus the individual quarter-end balances by the number of quarterly periods plus one. The increase in average invested assets in 1997 is primarily due to the acquisition of Shelby Life effective November 1, 1997. (2) The weighted average annual yield on SMC's investment portfolio for each period is computed by dividing net investment income (exclusive of realized and unrealized gains and losses) by average invested assets for such period. The following table shows the amortized cost, gross unrealized gain (loss) and estimated fair value of SMC's investment securities all of which are available for sale (in thousands):
December 31, 1997 Gross Gross Amortized Unrealized Gain Unrealized Fair Cost (Loss) Value Fixed maturity securities: United States Treasury securities and obligations of United $27,613 $174 $(90) $27,697 States government agencies Obligations of states and political 3,790 204 (26) 3,968 subdivisions Foreign government securities 30,558 497 (3,296) 27,759 Utilities 26,606 534 (109) 27,031 Corporate bonds 223,958 8,140 (1,609) 230,489 Mortgage-backed securities 51,266 657 (60) 51,863 Redeemable preferred stock 3,581 188 (60) 3,769 Total fixed maturity 367,372 10,394 (5,190) 372,576 securities Equity securities 55 -- (3) 52 Total $367,427 $10,394 $(5,193) $372,628 December 31, 1996 Gross Gross Amortized Unrealized Gain Unrealized Fair Cost (Loss) Value Fixed maturity securities: United States Treasury securities and obligations of United $20,753 $51 $(420) $20,384 States government agencies Obligations of states and political 3,588 106 -- 3,694 subdivisions Foreign government securities 10,042 51 (166) 9,927 Utilities 31,000 295 (675) 30,620 Corporate bonds 210,977 3,086 (3,539) 210,524 Mortgage-backed securities 72,264 247 (919) 71,592 Redeemable preferred stock 527 42 -- 569 Total fixed maturity 349,151 3,878 (5,719) 347,310 securities Equity securities 58 4 -- 62 Total $349,209 $3,882 $(5,719) $347,372
The fair values for fixed maturity securities are based on quoted market prices, where available. For fixed maturity securities not actively traded, fair values are estimated using values obtained from independent pricing services or by discounting expected future cash flows using a current market rate applicable to the coupon rate, credit and maturity of the investments. SMC balances the duration of its invested assets with the expected duration of benefit payments arising from insurance liabilities. The "duration" of a security is the time-weighted present value of the security's cash flows and is used to measure a security's price sensitivity to changes in market interest rates. At December 31, 1997, the adjusted modified duration of fixed maturities and short-term investments for its U.S. insurance subsidiaries was 5.6 years compared to 5.5 years at December 31, 1996. The amortized cost and estimated fair value of fixed maturity securities at December 31, 1997 by contractual maturity are shown below (in thousands). Actual maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties and because most mortgage-backed securities provide for periodic payments throughout their lives.
Amortized Fair Cost Value Due in one year or less $4,560 $4,551 Due after one year through five years 31,597 32,048 Due after five years through ten years 141,805 140,972 Due after ten years 134,561 139,373 Subtotal 312,523 316,944 Redeemable preferred stock 3,581 3,769 Mortgage-backed securities 51,266 51,863 Total fixed maturity securities $367,370 $372,576
SMC's investment strategy is guided by strategic objectives established by the Investment Committee of the Board of Directors of Standard Life. SMC's major investment objectives are: (i) to ensure adequate safety of investments and to protect and enhance capital; (ii) to maximize after-tax return on investments; (iii) to match the anticipated duration of investments with the anticipated duration of policy liabilities; and (iv) to provide sufficient liquidity to meet cash requirements with minimum sacrifice of investment yield. Consistent with its strategy, SMC invests primarily in securities of the U.S. government and its agencies, investment grade utility and corporate debt securities and collateralized mortgage obligations ("CMOs"). From time to time when opportunities arise, however, below investment grade securities may be purchased. Protection against default risk is a primary consideration. SMC has determined it will not invest more than 7% of its bond portfolio in below investment grade securities. The following table sets forth the quality of SMC's fixed maturity securities as of December 31, 1997, classified in accordance with the ratings assigned by the National Association of Insurance Commissioners ("NAIC"): Percent of Fixed NAIC RATING (1) MATURITY SECURITIES 1 48% 2 47 Investment Grade 95 3-4 4 5-6 1 Below Investment Grade 5 Total fixed maturity securities 100% (1) The NAIC assigns securities quality ratings and uniform book values called "NAIC Designations," which are used by insurers when preparing their annual statements. The NAIC assigns ratings to publicly traded as well as privately-placed securities. The ratings assigned by the NAIC range from Class 1 to Class 6, with a rating in Class 1 being of the highest quality. SMC engages Conseco Capital Management Inc. ("CCM"), a wholly owned subsidiary of Conseco, Inc., to manage SMC's invested assets (other than mortgage loans, policy loans, real estate and other invested assets), subject to the direction of SMC's Investment Committee. A quarterly fee equal to .035% of the total market value of the assets under management as of the end of each quarter is paid to CCM for its investment advisory services. Approximately 14% of SMC's fixed maturity securities at December 31, 1997 is comprised of mortgage-backed securities. Investments in mortgage-backed securities include CMOs and mortgage-backed pass-through securities. Approximately 96% of the book value of the mortgage-backed securities in SMC's portfolio is backed by an agency of the U.S. government (although generally not by the full faith and credit of the U.S. government) as to the full amount of both principal and interest. Approximately 9% of the book value of mortgage-backed securities in SMC's portfolio is backed by the full faith and credit of the U.S. government as to the full amount of both principal and interest. SMC closely monitors the market value of all investments within its mortgage-backed portfolio. The following table summarizes SMC's mortgage-backed securities at December 31, 1997 (in thousands):
Estimated Avg. % of % of Avg. Life Term Amortized Fixed Fair Fixed of to Final Cost Maturities Value Maturities Investment Maturity (In Years) (In Years) Agency CMOs: Planned and target amortization $23,034 6.3% $23,142 6.2% 7.1 24.4 classes Sequential and support classes 2,150 .6 2,116 .6 4.6 26.4 Total 25,184 6.9 25,258 6.8 6.8 26.4 Non-agency CMOs: Sequential classes 1,591 .4 1,636 .4 2.8 20.6 Total CMOs 26,775 7.3 26,894 7.2 6.8 24.4 Agency mortgage-backed pass-through securities 24,491 6.7 24,969 6.7 4.6 15.9 Total mortgage- $51,266 14.0% $51,863 13.9% 6.4 19.5 backed securities
The market values for SMC's mortgage-backed securities were determined from broker-dealer market makers, internally developed methods and nationally recognized statistical rating organizations. Certain mortgage-backed securities are subject to significant prepayment risk, since, in periods of declining interest rates, mortgages may be repaid more rapidly than scheduled as individuals refinance higher rate mortgages to take advantage of the lower current rates. As a result, holders of mortgage-backed securities may receive large prepayments on their investment which cannot be reinvested at an interest rate comparable to the rate on the prepaying mortgages. SMC has addressed this risk of prepayment risk by investing 45% of its mortgage-backed investment portfolio in planned and target amortization classes. These investments are designed to amortize in a more predictable manner by shifting the primary risk of prepayment of the underlying collateral to investors in other tranches ("support classes"). Mortgage-backed pass-through securities, "sequential" and support class CMOs, which comprised approximately 55% of the book value of SMC's mortgage-backed securities at December 31, 1997, are more sensitive to this prepayment risk. SEPARATE ACCOUNTS Separate account assets and liabilities are maintained primarily for universal life contracts of which the majority represents unit-linked business where benefits on surrender and maturity are not guaranteed. They generally represent funds held in accounts to meet specific investment objectives of policyholders who bear the investment risk. Investment income and investment gains and losses accrue directly to such policyholders. UNDERWRITING Premiums charged on insurance products are based in part on assumptions about the incidence and timing of insurance claims. SMC has adopted and follows underwriting procedures for both its whole life and universal life insurance policies. To implement these procedures, SMC employs a professional underwriting staff. All underwriting decisions are made in SMC's home office. To the extent that an applicant does not meet SMC's underwriting standards for issuance of a policy at the standard risk classifications, SMC may rate or decline the application. Underwriting with respect to FPDAs is minimal. No underwriting procedures are applied to Standard Life's $10,000 conversion policy or Standard Management International's unit-linked business. Traditional underwriting procedures are not applied to policies acquired in blocks. In these cases, SMC reviews the mortality experience for recent years and compares actual experience to that assumed in the actuarial projections for the acquired policies. RESERVES In accordance with applicable insurance laws, SMC's insurance subsidiaries have established and carry as liabilities in their statutory financial statements actuarially determined reserves to satisfy their respective annuity contract and life insurance policy obligations. Reserves, together with premiums to be received on outstanding policies and interest thereon at certain assumed rates, are calculated to be sufficient to satisfy policy and contract obligations. The actuarial factors used in determining such reserves are based on statutorily prescribed mortality tables and interest rates. The reserves recorded in the consolidated financial statements included elsewhere herein are calculated based on GAAP and differ from those specified by the laws of the various states and recorded in the statutory financial statements of SMC's insurance subsidiaries. These differences arise from the use of different mortality tables and interest rate assumptions, the introduction of lapse assumptions into the reserve calculation and the use of the net level premium reserve method on all insurance business. See Note 1 of the Notes to the Consolidated Financial Statements for certain additional information regarding reserve assumptions under GAAP. To determine policy benefit reserves for its life insurance and annuity products, SMC performs periodic studies to compare current experience for mortality, interest and lapse rates with projected experience used in calculating the reserves. Differences are reflected currently in earnings for each period. SMC historically has not experienced significant adverse deviations from its assumptions. REINSURANCE Consistent with the general practice of the life insurance industry, SMC has reinsured portions of the coverage provided by its insurance products with other insurance companies under agreements of indemnity reinsurance. The policy risk retention limit on the life of any one individual does not exceed $150,000. Indemnity reinsurance agreements are intended to limit a life insurer's maximum loss on a particular risk or to obtain a greater diversification of risk. Indemnity reinsurance does not discharge the primary liability of the original insurer to the insured, but it is the practice of insurers for statutory accounting purposes (subject to certain limitations of state insurance statutes) to account for risks which have been reinsured with other approved companies, to the extent of the reinsurance, as though they are not risks for which the original insurer is liable. However, under Statement of Financial Accounting Standards No. 113 ("SFAS 113"), "Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts" these amounts are added back to policy reserves and recorded as amounts due from reinsurers. Reinsurance ceded on life insurance policies to unaffiliated companies by SMC in 1997, 1996 and 1995 represented 51.9%, 57.6% and 68.8%, respectively, of gross combined individual life insurance in force at the end of such years. Reinsurance assumed in the normal course from unaffiliated companies by SMC in 1997, 1996 and 1995 represented .02%, .02% and .03%, respectively, of net combined individual life insurance in force excluding reinsurance from GIAC described below. SMC cedes reinsurance to numerous reinsurers. At December 31, 1997, approximately $398,456,000 of the face value of life policies and reinsurance recoverable of $2,648,000 had been ceded to The Lincoln National Life Insurance Company ("Lincoln National"), $188,524,000 of the face value of life policies and reinsurance recoverable of $1,021,000 ceded to Swiss Re Life and Health ("Swiss Re") and $169,869,000 of the face value of life policies and reinsurance recoverable of $1,179,000 had been ceded to Security Life of Denver Insurance Company ("Security Life"). Lincoln National is the lead reinsurer with a total of 31.3% of total reinsurance ceded with Swiss Re and Security Life each accounting for 14.9% and 13.3%, respectively, of total reinsurance ceded by SMC's life insurance subsidiaries at December 31, 1997. The amount of life insurance business ceded to any other reinsurer is not material. Of SMC's total life insurance in force at December 31, 1997 that is reinsured, 100.0% is ceded to insurers rated "A" or better by A.M. Best. SMC historically has not experienced any material losses in collection of reinsurance receivables. Commencing January 1, 1995, SMC began to reinsure a portion of its annuity business. The primary purposes of the reinsurance agreement were to limit the net loss arising from large risks, maintain SMC's exposure to loss within capital resources, and provide additional capacity for future growth. Furthermore, these reinsurance agreements have allowed SMC to write volumes of business that it would not otherwise have been able to write due to restrictions based on its ratio of surplus to liabilities as determined by regulatory authorities in the State of Florida. By reinsuring a portion of the annuity business, the liability growth is slowed, thereby avoiding the erosion of surplus that can occur in periods of increasing sales. If SMC's ratio of surplus to liabilities falls below 4%, the State of Florida could prohibit SMC from writing new business in Florida. SMC's largest annuity reinsurer at December 31, 1997, Winterthur Life Re Insurance Company ("Winterthur"), represented $32,194,000, or 52.3% of total reinsurance recoverable, $8,707,000 of premium deposits ceded in 1997 and is rated "A" ("Excellent") by A.M. Best. From January 1, 1995 to August 31, 1995 approximately 70% of certain of Standard Life's annuity business produced was ceded. SMC decreased the quota-share portion of business ceded to 50% at September 1, 1995 and further reduced it to 25% effective April 1, 1996. This reduction was possible since the surplus strain experienced by Standard Life was not as great as originally anticipated as a result of lower than expected sales in 1995 and the increase in surplus resulting from the sale of First International. Winterthur limits dividends and other transfers by Standard Life to SMC or affiliated companies if adjusted surplus is less than 5.5% of admitted assets, $20,192,000 at December 31, 1997. On March 18, 1996, Standard Life completed the sale of First International to GIAC. Standard Life received sale proceeds of approximately $10,393,000 including $1,500,000 for the charter and licenses associated with First International. Standard Life realized a net pretax gain of $1,042,000 and a tax benefit of $1,420,000 on the sale. First International, Standard Life and GIAC have entered into a series of reinsurance and other agreements that include provisions for Standard Life to administer First International policies in force at the date of sale, and for Standard Life to continue to receive the profit stream from certain First International policies in force effective January 1, 1996. All the in force business of First International effective January 1, 1996 was ceded to GIAC through a coinsurance indemnity reinsurance agreement. Under the terms of the agreement, approximately $18,841,000 of First International's reserves and assets of $18,841,000 were ceded to GIAC as of January 1, 1996. The assets transferred included cash of $17,046,000, policy loans of $1,371,000, and net due and deferred premiums of $424,000. The in force business related to this automatic coinsurance indemnity reinsurance agreement is comprised of the following two blocks: ("Block I") -- ordinary life policies (issued in New York and New Jersey), universal life, immediate and deferred annuities (issued in New York, New Jersey and Vermont), supplemental contracts and group waivers, and ("Block II") -- ordinary life policies (not issued in New York and New Jersey) issued prior to 1989, and term life policies (issued in New York, New Jersey and Vermont) issued after 1988. Effective January 1, 1996, GIAC entered into a modified coinsurance indemnity reinsurance agreement with Standard Life with respect to Blocks I and II. Pursuant to this agreement, Standard Life administers the policies in both Block I and Block II. Under the terms of the agreement, Standard Life assumed approximately $18,841,000 of reserves for Block I and Block II from GIAC as of January 1, 1996. During 1996, Standard Life incurred and paid experience rating refunds to GIAC on Block I for profits earned in excess of specified amounts. These refunds were calculated and paid on a quarterly basis. As a result, the economic risks and benefits associated with Block I remained with GIAC. Effective January 1, 1997, GIAC and Standard Life executed Amendment I to the modified coinsurance indemnity reinsurance agreement. Under the terms of Amendment I, GIAC and Standard Life agreed to terminate effective January 1, 1997 the modified coinsurance indemnity reinsurance agreement with regard to Block I, and Block I reverted completely to GIAC. In accordance with the provisions of SFAS 60, SFAS 97, and SFAS 113 for a reinsurance assuming enterprise, in accordance with deposit accounting, Standard Life has not recorded revenue or expense during 1996 for the Block I reinsurance. A ceding commission of $1,100,000 received by First International in connection with the sale was deferred by First International in accordance with FAS 113. When First International was sold, the amount was paid to SMC by GIAC as part of First International's statutory capital and surplus. There is no experience rating refund on Block II and, accordingly, the economic risks and benefits associated with Block II remain with Standard Life. Under the terms of the reinsurance agreement, Standard Life is permitted to appoint an investment advisor subject to approval from GIAC for the Block II assets. Standard Life has appointed Gibraltar Investments as such investment advisor for Block II assets. Investment advisory fees are paid from the Block II assets and reduce Block II profits. The Block II contract was determined to be a risk transfer assumption reinsurance contract by Standard Life in accordance with SFAS 113. As part of the acquisition of First International by SMC in 1992, Standard Life entered into an indemnity reinsurance agreement with First International effective July 1, 1992. This business was subsequently assumed by Standard Life effective January 1, 1993. At the date of the sale of First International to GIAC, Standard Life ceded this block of business with policy reserves of $12,514,000 and related assets to GIAC. Consideration of $700,000 paid in connection with the purchase agreement represented additional sales proceeds. All risks and rewards related to the $700,000 have occurred and have therefore been recognized. This block of business ("Block III") consisted of term life policies (not issued in New York, New Jersey or Vermont) issued after 1988 and immediate and deferred annuities (not issued in New York, New Jersey and Vermont) and lottery annuities. Standard Life will continue to receive profits from Block III through experience rating refunds from GIAC on Block III. These experience rating refund calculations are prepared and paid on a quarterly basis for profits in excess of specified amounts. The experience rating refund payments will continue so long as any of the underlying policies remain in force. Under the terms of the reinsurance agreement, Standard Life is permitted to appoint an investment advisor subject to approval from GIAC for the Block III assets. Standard Life has appointed Gibraltar Investments as such investment advisor for Block III assets. Investment advisory fees are paid from the Block III assets and reduce the experience rating refunds. For GAAP accounting purposes, Standard Life concluded that this contract did not involve the transfer of risk to GIAC in accordance with SFAS 113. SMC decided in February 1996 to terminate the reinsurance agreement between Standard Reinsurance and Salamandra, and to not renew the Barbados license of Standard Reinsurance. This resulted in the termination of Standard Reinsurance's operations and the write-off of SMC's investment in Standard Reinsurance and certain intangible assets of Standard Reinsurance amounting to $156,000. Standard Life terminated by recapture in May 1996 the reinsurance agreement with National Mutual. Standard Life received assets of $4,826,000 and liabilities of $4,826,000, primarily ordinary life policies. In connection with this transaction, Standard Life agreed to pay National Mutual a recapture fee of $1,200,000, and Standard Life collected administration fees of $375,000 related to services provided in prior years that had not been recorded previously due to the uncertainty as to its collection. The net proceeds of $825,000 were recorded as the present value of the future profits on this block of business, which is being amortized in proportion to the emergence of profits over 20 years. The premium income, and corresponding increase in reserves, of $4,234,000, recorded in connection with the recapture of the reinsurance agreement with National Mutual will not recur in the future. In order to write an increasing amount of new business while continuing to meet the statutory requirements of the states in which it conducts its insurance operations, it has been necessary for Dixie National Life to utilize various forms of surplus relief. The principal source of surplus relief has been financial reinsurance agreements, which for GAAP purposes are treated as financing arrangements, but for statutory accounting purposes provide reserve credits that, in equal amount, increase statutory surplus. Dixie National Life has a financial reinsurance agreement that entitles it to a credit to its statutory reserves of $1,250,000 at December 31, 1997, with the amount of the credit decreasing each quarter by the amount of profit generated to Dixie National Life by the underlying block of business. COMPETITION The life insurance industry is highly competitive and consists of a large number of both stock and mutual insurance companies, many of which have substantially greater financial resources, broader and more diversified product lines and larger staffs than those possessed by SMC. There are approximately 2,000 life insurance companies in the United States which may offer insurance products similar to those marketed by SMC. Competition within the life insurance industry occurs on the basis of, among other things, product features such as price and interest rates, perceived financial stability of the insurer, policyholder service, name recognition and ratings assigned by insurance rating organizations. Additionally, when SMC bids on companies it wishes to acquire, it typically is in competition with other entities. SMC must also compete with other insurers to attract and retain the allegiance of agents. SMC believes it has been successful in attracting and retaining agents because it has been able to offer a competitive package of innovative products, competitive commission structures, prompt policy issuance and responsive policyholder service. Because most annuity business written by life companies is through agents, management believes that competition centers more on the strength of the agent relationship rather than on the identity of the insurer. Competition also is encountered from the expanding number of banks, securities brokerage firms and other financial intermediaries which are marketing insurance products and which offer competing products such as savings accounts and securities. In the case of banks, these insurance products are sold for non-affiliate insurance companies in return for a sales fee. A change in legislation may increase interest on the part of banks to begin selling annuities or to expand their existing efforts to sell annuities. The decision could result in a partial shift in the distribution of annuities from insurance agents to national banks, which, in turn, could result in a decrease in sales for SMC, or it could result in an increase in the number of annuities sold because of distribution through national banks (or securities firms), which could result in new distribution opportunities for SMC. SMC has not been involved in distribution of annuities through national banks but anticipates expansion into financial institutions with the acquisition of Savers Life. The unit-linked life insurance market in Europe is highly competitive and consists of many companies domiciled in the United Kingdom and its offshore centers, as well as many companies in Luxembourg and Ireland which sell products similar to those of Standard Management International. Standard Management International is able to develop its share of a competitive market by developing strong relationships with high-quality independent intermediaries and by continual innovation in the design of niche market products. Financial institutions, school districts, marketing companies, agents who market insurance products and policyholders use the ratings of an insurer as one factor in determining which insurer's annuity to market or purchase. Standard Life and Dixie National Life have a rating of "B+" and "B", respectively by A.M. Best. Savers Life is not rated by A.M. Best. A rating of "B+" is assigned by A.M. Best to companies which, in their opinion, have achieved very good overall performance when compared to the standards established by A.M. Best, and have a good ability to meet their obligations to policyholders over a long period of time. A rating of "B" is assigned by A.M. Best to companies which, in their opinion, have achieved good overall performance when compared to the standards established by A.M. Best. According to A.M. Best, these companies generally have an adequate ability to meet their obligations to policyholders, but their financial strength is vulnerable to unfavorable changes in underwriting or economic conditions. In evaluating a company's financial and operating performance, A.M. Best reviews the company's profitability, leverage and liquidity as well as the company's book of business, the adequacy and soundness of its reinsurance, the quality and estimated market value of its assets, the adequacy of its reserves and the experience and competence of its management. A.M. Best's ratings are based upon factors relevant to policyholders, agents, insurance brokers and intermediaries and are not directed to the protection of investors. Generally, rating agencies base their ratings on information furnished to them by the issuer and on investigations, studies and assumptions by the rating agencies. There is no assurance that any particular rating will continue for any given period of time or that it will not be changed or withdrawn entirely if, in the judgment of the rating agency, circumstances so warrant. Although a higher rating by A.M. Best or another insurance rating organization could have a favorable effect on Standard Life and Dixie National Life's business, management believes that Standard Life and Dixie National Life are able to compete on the basis of their competitive crediting rates, asset quality, strong relations with their independent agents and the quality of service to their policyholders. FEDERAL INCOME TAXATION The life insurance and annuity products marketed and issued by Standard Life and Dixie National Life generally provide the policyholder with an income tax advantage, as compared to other saving investments such as certificates of deposit and bonds, in that income taxation on the increase in value of the product is deferred until receipt by the policyholder. With other savings investments, the increase in value is taxed as earned. Life insurance benefits which accrue prior to the death of the policyholder and annuity benefits are generally not taxable until paid and life insurance death benefits are generally exempt from income tax. The tax advantage for life insurance and annuity products is provided in the Internal Revenue Code ("IRC"), and is generally followed in all states and other United States taxing jurisdictions. Accordingly, it is subject to change by Congress and the legislatures of the respective taxing jurisdictions. SMC, Standard Marketing and other U.S. non-insurance subsidiaries file a consolidated return for federal income tax purposes. Standard Life and Dixie National Life, as life insurance companies, filed separate federal income tax returns for 1996 and prior years. For 1997 and subsequent years, Standard Life and Dixie National Life are eligible to file a life/life consolidated return. As of December 31, 1997, SMC, Standard Marketing and other U.S. non-insurance subsidiaries had consolidated net operating loss carryforwards of approximately $9,320,000 for tax return purposes which expire from 2005 to 2012. At December 31, 1997, the Standard Life consolidated return had tax return net operating loss carryforwards of approximately $4,100,000, which expire in 2010 and 2012. These carryforwards will be available to reduce the taxable income of the Standard Life consolidated return. The change in ownership of Savers Life will not result in additional limitations on the use of the loss carryforwards available to Standard Life. Standard Management International is a Luxembourg holding company which is currently exempt from Luxembourg income tax. Premier Life (Bermuda) is exempt from income tax until March 2016 pursuant to a decree from the Minister of Finance. Premier Life (Luxembourg) is subject to Luxembourg income taxation (statutory corporate rate of 39.39%) and a capital tax of approximately 1% of its net equity. At December 31, 1997, Premier Life (Luxembourg) had accumulated corporate income tax loss carryforwards of approximately $3,960,000, all of which may be carried forward indefinitely. To the extent that such income is taxable under U.S. law, such income will be included in SMC's consolidated return. INFLATION The primary direct effect on SMC of inflation is the increase in operating expenses. A large portion of SMC's operating expenses consists of salaries which are subject to wage increases at least partly affected by the rate of inflation. SMC attempts to minimize the impact of inflation on operating expenses through programs to improve productivity. The rate of inflation also has an indirect effect on SMC. To the extent that the government's economic policy to control the level of inflation results in changes in interest rates, SMC's new sales of insurance products and investment income are affected. Changes in the level of interest rates also have an effect on interest spreads, as investment earnings are reinvested. FOREIGN OPERATIONS AND CURRENCY RISK SMC's foreign operations represent the Standard Management International group which consists of a Luxembourg holding company and two life insurance subsidiaries: Premier Life (Luxembourg) and Premier Life (Bermuda). Standard Management International policyholders invest in assets denominated in a broad range of currencies. Policyholders effectively bear the currency risk, if any, as these investments are matched by policyholder separate account liabilities. Therefore, their investment and currency risk is limited to premiums they have paid. Policyholders are not permitted to invest directly into options, futures and derivatives. Standard Management International could be exposed to currency fluctuations if currencies within the conventional investment portfolio or certain actuarial reserves are mismatched. The assets and liabilities of this portfolio and the reserves are continually matched by the company and at regular intervals by the independent actuary. In addition, Premier Life (Luxembourg)'s stockholder's equity is denominated in Luxembourg francs. Premier Life (Luxembourg) does not hedge it's translation risk because its stockholder's equity will remain in Luxembourg francs for the foreseeable future and no significant realized foreign exchange gains or losses are anticipated. At December 31, 1997, there is an unrealized loss from foreign currency translation adjustment of $473,000. Due to the nature of unit-linked products issued by Standard Management International, which represent over 94% of the Standard Management International portfolio, the investment risk rests with the policyholder. Investment risk for Standard Management International exists where Standard Management International makes investment decisions with respect to the remaining traditional business and for the assets backing certain actuarial and regulatory reserves. The investments underlying these liabilities mostly represent short term investments and fixed maturity securities. These short-term investments and fixed maturity securities are normally bought and/or disposed of only on the advice of independent consulting actuaries who perform an annual exercise comparing anticipated cash flows on the insurance portfolio with the cash flows from the fixed maturity securities. Any resulting material foreign currency mismatches are then covered by buying and/or selling the securities as appropriate. REGULATORY FACTORS SMC's insurance subsidiaries are subject to regulation by the insurance regulatory authorities in the jurisdictions in which they are domiciled and the insurance regulatory bodies in the other jurisdictions in which they are licensed to sell insurance. The purpose of such regulation is primarily to ensure the financial stability of insurance companies and to provide safeguards for policyholders rather than to protect the interest of stockholders. The insurance laws of various jurisdictions establish regulatory agencies with broad administrative powers relating to the licensing of insurers and their agents, the regulation of trade practices, management agreements, the types of permitted investments and maximum concentration, deposits of securities, the form and content of financial statements, rates charged by insurance companies, sales literature and insurance policies, accounting practices and the maintenance of specified reserves, capital and surplus. Each of SMC's insurance subsidiaries is required to file detailed periodic financial reports with supervisory agencies in certain of the jurisdictions in which it does business. Most states have enacted legislation regulating insurance holding companies. The insurance holding company laws and regulations vary by state, but generally require an insurance holding company and its insurance company subsidiaries licensed to do business in the state to register and file certain reports with the regulatory authorities, including information concerning capital structure, ownership, financial condition, certain intercompany transactions and general business operations. State holding company laws also require prior notice or regulatory agency approval of certain material intercompany transfers of assets within the holding company structure. As a holding company, Standard Management's ability to pay operating expenses and meet debt service obligations if any, depends on the receipt of sufficient funds, primarily through management fees, rental income, dividends and interest payments on its Surplus Debentures from its subsidiaries. Subject to the restrictions described below, Standard Management may receive dividends from its direct subsidiaries, Standard Life, Standard Management International and Standard Marketing. Dixie National Life is a subsidiary of Standard Life. Accordingly, any dividends paid by Dixie National Life to Standard Life may be paid to Standard Management only if Standard Life is entitled to pay dividends to Standard Management. Under Indiana insurance law, Standard Life may not enter into certain transactions, including management agreements and service contracts, with members of its insurance holding company system, including Standard Management, unless Standard Life has notified the Indiana Department of Insurance of its intention to enter into such transactions and the Indiana Department of Insurance has not disapproved of them within the period specified by Indiana law. Among other things, such transactions are subject to the requirement that their terms be fair and reasonable and that the charges or fees for services performed be reasonable. Pursuant to the management services agreement with Standard Management, Standard Life paid Standard Management a monthly fee of $166,667 (annual fee of $2,000,000) during 1997 for certain management services related to the production of business, investment of assets and evaluation of acquisitions. Pursuant to the management service agreements with Standard Life, Dixie National Life paid monthly payments of $83,333 (annual fee of $1,000,000) to Standard Life in 1997. Both of these agreements provide that they may be modified or terminated by the Indiana and Mississippi departments of insurance in the event of financial hardship of Standard Life or Dixie National Life. A management services agreement between SMC and Savers Life was approved by the North Carolina Department of Insurance on March 11, 1998. The management services agreement calls for the payment of $83,333 per month by Savers Life to SMC for financial and regulatory reporting, investment of assets and the production of business. SMC has agreed to receive no fee, nor shall Savers Life have an obligation to pay, unless the capital and surplus of Savers Life is $7,000,000 after the acquisition of Savers Life. The amount of capital and surplus of Savers Life at December 31, 1997 was $7,134,000. In addition, as a condition of the acquisition of Savers Life, SMC entered into an agreement with the North Carolina Department of Insurance to maintain statutory capital and surplus of Savers Life of at least $6,000,000. Dividends from Standard Life to Standard Management are limited by laws applicable to insurance companies. As an Indiana domiciled insurance company, Standard Life may pay a dividend or distribution from its surplus profits, without the prior approval of the Commissioner of the Indiana Department of Insurance, if the dividend or distribution, together with all other dividends and distributions paid within the preceding twelve months, does not exceed the greater of (i) net gain from operations or (ii) 10% of surplus, in each case as shown in its preceding annual statutory financial statements. Also, regulatory approval is required when dividends to be paid exceed unassigned surplus. For the year ended December 31, 1997, Standard Life reported statutory net gain from operations before net realized capital losses of $2,374,000 and statutory surplus of $25,923,000 which includes unassigned surplus of $1,693,000. During 1998, Standard Life can pay dividends of approximately $2,500,000 without regulatory approval. The Indiana insurance laws and regulations require that the statutory surplus of Standard Life following any dividend or distribution be reasonable in relation to its outstanding liabilities and adequate to its financial needs. The Indiana Department of Insurance may bring an action to enjoin or rescind the payment of a dividend or distribution by Standard Life that would cause its statutory surplus to be unreasonable or inadequate under this standard. Standard Management International dividends are limited to its accumulated earnings without regulatory approval. Standard Management International and Premier Life (Luxembourg) were not permitted to pay dividends in 1997 and 1996 due to accumulated losses. Premier Life (Bermuda) did not pay dividends in 1997 and 1996. SMC does not anticipate any dividends from these companies in 1998. Pursuant to the management services agreement with Standard Management, Premier Life (Luxembourg) paid Standard Management a management fee of $100,000 per year during 1997 and 1996 for certain management and administrative services. The agreement provides that it may be modified or terminated by either Standard Management or Premier Life (Luxembourg). As a North Carolina domiciled insurance company, Savers Life may pay a dividend or distribution from its capital and surplus, without the prior approval of the North Carolina Commissioner of Insurance, if the dividend or distribution together with all other dividends and distributions paid within the preceding twelve months, does not exceed the lesser of (i) net gain from operations or (ii) 10% of capital and surplus, in each case as shown in its preceding annual statutory financial statements. Savers Life was not allowed to pay a dividend in 1996 or 1997 without prior North Carolina Department of Insurance approval due to its statutory net losses in 1995 and 1996. Savers Life will not be permitted to pay dividends in 1998 without such approval. Most states, including Indiana, require administrative approval of the acquisition of 10% or more of the outstanding shares of an insurance company incorporated in the state or the acquisition of 10% or more of the outstanding shares of an insurance holding company whose insurance subsidiary is incorporated in the state. The request for approval must be accompanied by detailed information concerning the acquiring parties and the plan of acquisition. The acquisition of 10% of such shares is generally deemed to be the acquisition of "control" for the purpose of the holding company statutes. However, in many states the insurance authorities may find that "control" in fact does or does not exist in circumstances in which a person owns or controls either a lesser or a greater amount of securities. In some instances many state regulatory authorities require deposits of assets for the protection of policyholders either in those states or for all policyholders. At December 31, 1997, securities representing approximately 4% of the book value of SMC's U.S. insurance subsidiaries' invested assets were on deposit with various state treasurers or custodians. Such deposits must consist of securities that comply with the standards that the particular state has established. Assets of Standard Management International of $4,441,000 at December 31, 1997 were held by a custodian bank approved by the Luxembourg regulatory authorities to comply with local insurance laws. In recent years, the NAIC and state insurance regulators have reexamined existing laws and regulations and their application to insurance companies. This reexamination has focused on insurance company investment and solvency issues, risk-based capital guidelines, assumption reinsurance, interpretations of existing laws, the development of new laws, the interpretation of nonstatutory guidelines, the standardization of statutory accounting rules and the circumstances under which dividends may be paid. The NAIC has encouraged states to adopt model NAIC laws on specific topics such as holding company regulations and the definition of extraordinary dividends. It is not possible to predict the future impact of changing state regulation on the operations of SMC. The NAIC, as well as Indiana, Mississippi and North Carolina, has adopted RBC requirements for U.S. life/health insurance companies to evaluate the adequacy of statutory capital and surplus in relation to investment and insurance risks such as asset quality, mortality and morbidity, asset and liability matching, benefit and loss reserve adequacy, and other business factors. The RBC formula is used by state insurance regulators as an early warning tool to identify, for the purpose of initiating regulatory action, insurance companies that potentially are inadequately capitalized. The RBC guidelines are intended to be a regulatory tool only, and are not intended as a means to rank insurers generally. In addition, the formula defines minimum capital standards that supplement the previously existing system of low fixed minimum capital and surplus requirements on a state-by-state basis. Regulatory compliance is determined by a ratio of the enterprise's regulatory total adjusted capital, as defined by the NAIC, to its authorized control level RBC, as defined by the NAIC. Enterprises below specific trigger points or ratios are classified within certain levels, each of which requires specific corrective action. If a company's RBC ratio is in the Company Action Level range defined as an RBC ratio of 1.5-2, the company must submit a plan to improve its RBC ratio. The Regulatory Action Level range defined as an RBC ratio of 1-1.5 provides that regulators will order corrective actions. At the Authorized Control Level range defined as an RBC ratio of 0.7-1, regulators are authorized to take control of the company. Finally, at the Mandatory Control Level defined as ratios below 0.7, regulators must take over the company. The RBC ratios of Standard Life and Dixie National Life are all in excess of 4 at December 31, 1997. The RBC ratio of Savers Life is in excess of 3 at December 31, 1997. However, should the insurance subsidiaries' RBC position decline in the future, the insurance subsidiaries' continued ability to pay dividends and the degree of regulatory supervision or control to which they are subjected could be affected. The NAIC calculates twelve financial ratios based on statutory financial statements ("IRIS ratios") to assist state regulators in monitoring the financial condition of insurance companies. A "usual range" of results for each ratio is used as a benchmark for analysis, and a company's variation from this range may be either favorable or unfavorable. State insurance departments may make inquiries of SMC when at least four IRIS ratios are outside the usual range. These inquiries could lead to restrictions on the amount of business that may be written in an individual state. The following table presents the IRIS ratios as determined by the NAIC for SMC's insurance subsidiaries which varied from the "usual range" for 1997. Reported COMPANY RATIO NAME USUAL RANGE VALUE Standard Life..........Change in Product Mix........... . - to 5.0 ... 7.4 Dixie National Life....Net Change in Capital and Surplus.. -10 to 50 .......-11 .........Gross Change in Capital and Surplus -10 to 50 ...... -11 .........Adequacy of Investment Income...... 125 to 900.......121 .........Surplus Relief..................... -10 to 10 ........28 .........Change in Premium.................. -10 to 50 .......-82 Savers Life............Net Income to Total Income.......... .- to 0 .........0 ...............Change in Premium.................. -10 to 50 .......-23 ...............Change in Reserving Ratio.......... -20 to 20 .......-79 Explanation of Ratios: CHANGE IN PRODUCT MIX. This ratio represents the average change in the percentage of total premium from each product line during the year. The unusual ratio is due to the sale of First International and related reinsurance agreements in 1996. CHANGE IN CAPITAL AND SURPLUS. This ratio, calculated on a gross and net basis, are a measure of improvement or deterioration in the company's financial position during the year. The negative value for Dixie National Life is primarily due to continuation of reserve strengthening recorded by direct charges to surplus of approximately $600,000 in 1997. ADEQUACY OF INVESTMENT INCOME. This ratio indicates whether an insurer's investment income is adequate to meet the interest requirements of its reserves. The ratio may indicate that Dixie National Life's net investment yield is not "adequate" to meet its interest required on reserves. SURPLUS RELIEF. The positive ratio for Dixie National Life results from a financial reinsurance agreement at December 31, 1997. See "Business of SMC -- Reinsurance." CHANGE IN PREMIUM. This ratio represents the percentage change in premium from prior to current years. The negative values for Dixie National Life in 1997 relate to the surplus relief reinsurance agreement transaction in 1996 increasing premium income in 1996. The negative value for Savers Life is due to the sale of the major medical business effective July 1, 1997. NET INCOME TO TOTAL INCOME. This ratio is a measure of a company's profitability. The unusual value for Savers Life was primarily due to the statutory loss from operations recorded in 1997. CHANGE IN RESERVING RATIO. The change in reserving ratio represents the number of percentage points of difference between the reserving ratio for current and prior years. The negative value for Savers Life was due to the reserve strengthening within the life product line in the prior year. The majority of the life reserves consist of whole life policies which have higher reserve requirements than term policies. SMC attempts to manage its assets and liabilities so that income and principal payments received from investments are adequate to meet the cash flow requirements of its policyholder liabilities. The cash flows of SMC's liabilities are affected by actual maturities, surrender experience and credited interest rates. SMC periodically performs cash flow studies under various interest rate scenarios to evaluate the adequacy of expected cash flows from its assets to meet the expected cash requirements of its liabilities. SMC utilizes these studies to determine if it is necessary to lengthen or shorten the average life and duration of its investment portfolio. Because of the significant uncertainties involved in the estimation of asset and liability cash flows, there can be no assurance that SMC will be able to effectively manage the relationship between its asset and liability cash flows. In December 1995, the NAIC passed a model law for disclosure in life insurance policy illustrations which became effective on January 1, 1997. This law did not have a significant effect on SMC. New rules adopted by the NAIC are effective only to the extent adopted by the states in which SMC operates, and it is not possible to predict the future impact of changing state and federal regulation on the operations of SMC. The statutory filings of SMC's insurance subsidiaries require classifications of investments and the establishment of an AVR, an account designed to stabilize a company's statutory surplus against fluctuations in the market value of stocks and bonds, according to regulations prescribed by the NAIC. The AVR account consists of two main components: a "default component" to provide for future credit-related losses on fixed income investments and an "equity component" to provide for losses on all types of equity investments, including real estate. The NAIC requires an additional reserve, called the IMR, which consists of the portion of realized capital gains and losses from the sale of fixed income securities attributable to changes in interest rates. The IMR is required to be amortized against earnings on a basis reflecting the remaining period to maturity of the fixed income securities sold. These regulations affect the ability of SMC's insurance subsidiaries to reflect future investment gains and losses in current period statutory earnings and surplus. The amounts related to AVR and IMR for the insurance subsidiaries at December 31, 1997 are summarized as follows (in thousands): Maximum AVR AVR IMR Standard Life...........$3,236 $3,856 $8,474 Dixie National Life........214 317 149 The annual addition to the AVR for 1997 is 20% of the maximum reserve over the accumulated balance. If the calculated reserve with current year additions exceeds the maximum reserve amount, the reserve is reduced to the maximum amount. For the year ended December 31, 1997, SMC's U.S. subsidiaries each made the required contribution to the AVR. Most jurisdictions require insurance companies to participate in guaranty funds designed to cover claims against insolvent insurers. Insurers authorized to transact business in these jurisdictions are generally subject to assessments based on annual direct premiums written in that jurisdiction to pay such claims, if any. These assessments may be deferred or forgiven under most guaranty laws if they would threaten an insurer's financial strength and, in certain instances, may be offset against future state premium taxes. The incurrence and amount of such assessments have increased in recent years and may increase further in future years. The likelihood and amount of all future assessments cannot be reasonably estimated and are beyond the control of SMC. As part of their routine regulatory oversight process, approximately once every three to five years state insurance departments conduct periodic detailed examinations ("Examinations") of the books, records and accounts of insurance companies domiciled in their states. Standard Life underwent an Examination during 1996 for the five-year period ended December 31, 1995. The final report on such examination has been issued by the Indiana Department of Insurance and did not raise any significant issues. Although the federal government generally does not directly regulate the insurance industry, federal initiatives often have an impact on the business. Congress and certain federal agencies are investigating the current condition of the insurance industry (encompassing both life and health and property and casualty insurance) in the United States in order to decide whether some form of federal role in the regulation of insurance companies would be appropriate. Congress is currently conducting a variety of hearings relating in general to insurers. It is not possible to predict the outcome of any such congressional activity nor the potential effects thereof on SMC. Congressional initiatives have been introduced which are directed at repeal of the McCarran-Ferguson Act (which exempts the "business of insurance" from most federal laws to the extent it is subject to state regulation), and judicial decisions have been issued which narrow the definition of "business of insurance" for McCarran-Ferguson Act purposes. Current and proposed federal measures may also significantly affect the insurance industry including removal of barriers preventing banks from engaging in the insurance business. EMPLOYEES As of March 13, 1998, SMC had 139 employees: Standard Life had 58 employees, Savers Life had 47 employees, Standard Management International had 16 employees (9 of whom are covered by a collective bargaining agreement), Standard Marketing had 10 employees, and Standard Management had 8 employees. SMC believes that its future success will depend, in part, on its ability to continue to attract and retain highly-skilled technical, marketing, support and management personnel. Management believes that it has excellent relations with its employees. ITEM 2. PROPERTIES SMC leases approximately 31,000 square feet in an office building located at 9100 Keystone Crossing, Indianapolis, Indiana, under the terms of a lease which expires on June 1, 2001. SMC entered into a lease on March 31, 1997, for approximately 16,000 square feet in a warehouse located at 2525 North Shadeland, Indianapolis, Indiana, under the terms of a lease which expires on September 30, 1999. Standard Management International entered into a lease on November 17, 1997 for approximately 4,500 square feet in an office building located at 13A, rue de Bitbourg, L-1273 Luxembourg, Grand Duchy of Luxembourg, under the terms of a lease which expires on November 16, 2003. Dixie National Life leases approximately 1,000 square feet in an office complex located at 855 South Pear Orchard Road, Suite 305, Ridgeland, Mississippi, under the terms of a lease which expires on December 31, 1998. Savers Life owns its Home Office building containing approximately 27,000 square feet at 8064 North Point Boulevard, Winston-Salem, North Carolina. Savers Life occupies the top floor of its two story building and leases most of the first floor. ITEM 3. LEGAL PROCEEDINGS John J. Quinn resigned as an officer and director of SMC effective as of April 15, 1997. On June 19, 1997, Mr. Quinn commenced an action in the Superior Court of Marion County, Indiana, against SMC claiming that his employment agreement contained a provision to the effect that, following a termination of his employment with SMC under certain circumstances, Mr. Quinn would be entitled to receive a lump sum payment equal to the amount determined by multiplying the number of shares of SMC Common Stock subject to unexercised stock options previously granted by SMC to Mr. Quinn on the date of termination, whether or not such options were then exercisable, by the highest per share fair market value of the SMC Common Stock on any day during the six-month period ending on the date of termination. Upon payment of such amount, such unexercised stock options would be deemed to have been surrendered and canceled. Mr. Quinn further claims that his employment agreement contained an additional provision that he would be entitled to receive a lump sum payment equal to two years of annual salary, following termination of employment. Mr. Quinn has asserted to SMC that he is entitled to a lump sum termination payment of $1,654,000, and liquidated damages not exceeding $3,308,000, by virtue of his voluntarily leaving SMC's employment. SMC disputes Mr. Quinn's claims. SMC filed its Answer and Counterclaim against Mr. Quinn on September 11, 1997. SMC's investigation since the action was filed revealed a basis for the termination of Mr. Quinn's employment for cause relative to after-acquired evidence. On October 14, 1997, the Board of Directors of SMC terminated Mr. Quinn for cause effective as of March 15, 1997. Such termination will also be argued by SMC as a complete defense to all claims asserted by Mr. Quinn. The ultimate outcome of the action cannot presently be determined. Accordingly, no provision for any liability that may result has been made in the consolidated financial statements. Management believes that the conclusion of such litigation will not have a material adverse effect on SMC's consolidated financial condition. In addition, SMC is involved in various legal proceedings in the normal course of business. In most cases, such proceedings involve claims under insurance policies or other contracts of SMC. The outcomes of these legal proceedings are not expected to have a material adverse effect on the consolidated financial position, liquidity, or future results of operations of SMC based on SMC's current understanding of the relevant facts and law. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS At the Company's Annual Meeting of Stockholders held on October 22, 1997, the following individuals were elected to the Board of Directors:
Shares For Shares Withheld Stephen M. Coons 4,154,740 343,709 Martial R. Knieser 4,154,845 343,604 Paul ("Pete") B. Pheffer 4,158,515 339,934
The following proposals were approved at the Company's Annual Meeting of Stockholders:
Shares Shares Shares For Against Abstaining Approve the issuance of SMC Common Stock in connection with the acquisition by SMC of Savers Life Insurance Company 2,990,817 107,128 11,329 Approve an amendment to SMC's Amended and Restated 1992 Stock Option Plan to increase the number of shares of SMC Common Stock available for issuance pursuant thereto from 1,500,000 to 2,500,000 and to allow the Board of Directors of SMC to vary, from year to year, the number of shares subject 2,303,213 739,488 65,733 to options granted to Outside Directors Ratify the appointment of Ernst and Young LLP as principal independent auditors for the year ending December 31, 1997. 4,473,009 17,155 8,285
A total of 4,498,449 shares were present in person or by proxy at the Annual Meeting of Stockholders. EXECUTIVE OFFICERS The following table sets forth information concerning each of SMC's executive officers:
NAME AGE POSITION Ronald D. Hunter 46 Chairman of the Board, Chief Executive Officer and President Stephen M. Coons 56 Executive Vice President, General Counsel and Secretary Raymond J. Ohlson 47 Executive Vice President and Chief Marketing Officer Paul B. Pheffer 46 Executive Vice President, Chief Financial Officer and Treasurer Edward T. Stahl 51 Executive Vice President and Director of Corporate Development
RONALD D. HUNTER Mr. Hunter has been the Chairman of the Board, Chief Executive Officer and President of SMC since its formation in June 1989 and the Chairman of the Board and Chief Executive Officer of Standard Life since December 1987. Previously, Mr. Hunter held several management and sales positions in the life insurance industry with a number of companies including Conseco, Inc. (1981-1986), Aetna Life & Casualty Company (1978-1981), United Home Life Insurance Company (1975-1977) and Prudential Life Insurance Company (1972-1975). STEPHEN M. COONS Mr. Coons has been a director of SMC since August 1989. Mr. Coons has been General Counsel and Executive Vice President of SMC since March 1993 and has been Secretary of SMC since March 1994. He was of counsel to the law firm of Coons, Maddox & Koeller from March 1993 to December 31, 1996. Prior to March 1993, Mr. Coons was a partner with the law firm of Coons & Saint. He has been practicing law for 27 years. Mr. Coons served as Indiana Securities Commissioner from 1978 to 1983. RAYMOND J. OHLSON Mr. Ohlson has served as Executive Vice President and director of SMC since December 1993. He has served as President and director of Standard Marketing since August 1991. Since June 1993, Mr. Ohlson has served as President of Standard Life. Mr. Ohlson entered the life insurance business in 1971. While still in college, Mr. Ohlson qualified for the Million Dollar Round Table and is now a life member. He earned his CLU designation in 1980. Mr. Ohlson owned and operated Ohlson & Associates, an independent insurance marketing organization, from 1984 to April 1, 1994, when the assets of Ohlson & Associates were acquired by Standard Marketing. PAUL ("PETE") B. PHEFFER Mr. Pheffer has been Executive Vice President, Chief Financial Officer and Treasurer of SMC since May 1, 1997 and director of SMC since June 27, 1997. Prior to joining SMC, Mr. Pheffer was Senior Vice President -- Chief Financial Officer and Treasurer of Jackson National Life Insurance Company from 1994 to 1996 and prior to that was Senior Vice President -- Chief Financial Officer at Kemper Life Insurance Companies from 1992 to 1994. Mr. Pheffer, a CPA, received his MBA from the University of Chicago in 1988. EDWARD T. STAHL Mr. Stahl has been an Executive Vice President of SMC since its formation, has been a director of SMC from July 1989 (except for the period from January 12, 1990 to May 21, 1990) and has served as Director of Corporate Development since June 1993. Mr. Stahl was Secretary of SMC from June 1989 to March 1994. Mr. Stahl was President and Chief Operations Officer of Standard Life from May 1988 to June 1993. He has been a director of Standard Life since December 1987, and Executive Vice President and Secretary since June 1993. Mr. Stahl has served in various capacities in the insurance industry since 1966. He earned his FLMI designation in 1981, and is a member of several insurance associations. PART II ITEM 5. MARKET FOR SMC COMMON STOCK AND RELATED STOCKHOLDER MATTERS SMC Common Stock trades on Nasdaq under the symbol "SMAN." The following table sets forth, for the periods indicated, the range of the high and low sales prices of SMC Common Stock as reported by Nasdaq (after adjustment for the May 17, 1996 5% stock dividend). SMC has never paid dividends on its Common Stock. At the close of business on March 13, 1998 there were approximately 3,133 holders of record of the outstanding shares of SMC Common Stock. Although SMC Common Stock is traded on Nasdaq, no assurance can be given as to the future price of or the markets for SMC Common Stock. SMC COMMON STOCK HIGH LOW 1996 Quarter ended March 31, 1996 $4.524 $3.571 Quarter ended June 30, 1996 5.250 3.690 Quarter ended September 30, 1996 5.500 4.000 Quarter ended December 31, 1996 5.375 4.000 1997 Quarter ended March 31, 1997 6.250 4.875 Quarter ended June 30, 1997 6.000 4.625 Quarter ended September 30, 1997 7.875 5.688 Quarter ended December 31, 1997 8.375 6.500 ITEM 6. SMC SELECTED HISTORICAL FINANCIAL DATA (A) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) The selected historical financial data of SMC set forth below at and for the years ended December 31, 1997, 1996, 1995, 1994 and 1993 were derived from audited consolidated financial statements of SMC. The selected historical financial data should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the SMC Consolidated Financial Statements and related notes thereto, each included elsewhere herein.
Year Ended December 31, 1997 1996 1995 1994 1993 STATEMENT OF OPERATIONS DATA: Premium income $7,100 $10,468 (e) $5,504 $4,565 $5,511 Investment Activity: Net investment income 29,516 20,871 18,517 16,057 12,171 Net realized investment gains 396 1,302 688 558 6,980 Total revenues 46,869 40,307 30,238 26,518 26,542 Interest expense and financing 2,381 805 118 47 519 costs Total benefits and expenses 43,607 36,772 (e) 28,682 30,032 22,099 Income (loss) before income taxes, extraordinary gain (charge) and cumulative effect of change in 3,262 3,535 1,556 (3,514) 4,443 (i) accounting principle Income (loss) before extraordinary gain (charge) and cumulative effect 2,645 4,265 (f) 1,313 (3,436) 2,984 (i) of change in accounting principle Net income (loss) 2,645 4,767 (g) 1,313 (3,436) 2,132 Operating income (loss) (b) 2,384 1,174 461 293 (1,936) PER SHARE DATA: (C) Income (loss) per share before extraordinary gain (charge) and cumulative effect of change in accounting $.54 $.88 (f) $.25 $(.62) $.80 (i) principle Net income (loss) .54 (g) .98 (g) .25 (.62) .57 Net income (loss), assuming dilution .48 .91 .25 (.61) .53 Operating income (loss) (b) .48 .24 .09 .05 (.52) Operating income (loss), assuming dilution (b) .43 .21 .09 .05 (.48) Weighted average common shares outstanding, assuming dilution 5,591,217 5,549,057 5,345,937 5,663,187 4,013,893 Book value per common share $8.88 $7.95 $7.73 $4.27 $7.82 Book value per common share excluding unrealized gain (loss) on $ 8.44 (h) $ 8.09 (h) $ 7.23 (h) $6.81 (h) $7.82 securities available for sale Common shares outstanding 4,876,490 5,024,270 5,205,425 5,291,455 4,954,676 BALANCE SHEET DATA (at year end): Invested assets $398,782 $370,138 $280,597 $224,926 $199,413 Assets held in separate accounts 148,064 128,546 122,705 94,301 107,173 Total assets 668,992 628,413 479,598 373,524 354,431 Long-term debt, notes payable and capital 26,141 20,697 4,191 695 -- lease obligations Class S Preferred Stock -- 1,757 -- -- -- Shareholders' equity 43,313 39,919 40,242 22,610 36,914 Shareholders' equity, excluding unrealized gain 41,142 40,665 37,660 36,021 36,918 (loss) on securities available for sale Ratio of debt to total 38% 36% 9% 3% -- capitalization (d)
NOTES TO SMC SELECTED HISTORICAL FINANCIAL DATA (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) (a)Comparison of consolidated financial information is significantly affected by the acquisitions of Standard Management International effective December 31, 1993, Dixie National Life on October 2, 1995 and Shelby Life effective November 1, 1996 and disposal of First International effective March 1, 1996. Refer to the notes to the consolidated financial statements included in SMC's Audited Consolidated Financial Statements, included elsewhere herein, for a description of business combinations. (b)Operating income represents income before extraordinary gains (charge), excluding net realized investment gains (less income taxes relating to such gains), gain on disposal of subsidiary and class action litigation and settlements. (c)All applicable shares and per share amounts have been adjusted to reflect the adoption of Statement of Financial Accounting Standards ("SFAS") No. 128, "Earning Per Share" on December 31, 1997. Refer to the notes to the consolidated financial statements included in SMC's Audited Consolidated Financial Statements, included elsewhere herein, for a description of earnings per share. (d)Total capitalization is the sum of SMC's debt (long term debt, notes payable, capital lease obligations and redeemable preferred stock) and shareholders' equity. (e)Includes recapture of premiums ceded and an increase in benefits due to an increase in reserves of $4,234 due to the termination and recapture of a reinsurance agreement with National Mutual Life Insurance Company. See "Business of SMC -- Reinsurance." (f)Does not reflect extraordinary gain of $502 ($.10 per share) on early redemption of Class S Preferred Stock for 1996. (g)Does not reflect preferred stock dividends of $97 ($.01 per share) and $208 ($.04 per share) for 1997 and 1996, respectively, on Class S Preferred Stock. (h)Excludes the effect of reporting securities available for sale at fair value and recording the unrealized gain or loss on such securities as a component of shareholders' equity, net of tax and other adjustments, which SMC began to do in 1994. Such adjustments are in accordance with SFAS No. 115 "Accounting for Certain Investments in Debt and Equity Securities", as described in the notes to the consolidated financial statements included in SMC's Consolidated Financial Statements, included elsewhere herein. (i)Before deduction of extraordinary charge of $1,301 ($.32 per share) on early extinguishment of long-term debt and cumulative effect of change in accounting principle of $449 ($.11 per share) from applying the new method of accounting for income taxes. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion highlights the principal factors affecting the results of operations and the significant changes in balance sheet items of SMC on a consolidated basis for the periods listed as well as SMC's liquidity and capital resources. This discussion should be read in conjunction with the SMC Consolidated Financial Statements and the Notes thereto appearing elsewhere herein. INTRODUCTION SMC acquired Standard Management International on December 15, 1993, Dixie National Life on October 2, 1995, Shelby Life on November 8, 1996 and Savers Life on March 12, 1998. These acquisitions are accounted for using the purchase method of accounting (effective December 31, 1993 for the Standard Management International acquisition, October 2, 1995 for the Dixie National Life acquisition, November 1, 1996 for the Shelby Life acquisition, and March 1, 1998 for the Savers Life acquisition). Therefore, these subsidiaries are included in the SMC Consolidated Financial Statements commencing with their respective acquisition effective dates. SMC disposed of First International on March 18, 1996 (effective March 1, 1996) and terminated the operations of Standard Reinsurance on March 1, 1996. PRODUCT PROFITABILITY. Margins on life insurance and annuity products are affected by interest rate fluctuations. Rising interest rates would result in a decline in the market value of assets. However, as there are positive cash flows from renewal premiums, investment income and maturities of existing assets, the need for early disposition of investment assets to meet operating cash flow requirements would be unlikely. Rising interest rates would also result in available cash flows from maturities being invested at higher interest rates, which would help support a gradual increase in new business and renewal interest rates on interest-sensitive products. A sharp, sudden rise in the interest rate environment without a concurrent increase in crediting rates could result in higher surrenders, particularly for annuities. The effect of surrenders would be to reduce earnings over the long term. Earnings in the period of the surrender could increase or decrease depending on whether surrender charges were applicable and whether such changes differed from the write-off of related deferred acquisition costs or present value of future profits. When interest rates fall, SMC generally attempts to adjust the credited interest rates subject to competitive pressures. Although SMC believes that such strategies will continue to permit it to achieve a positive spread, a significant decline in the yield on SMC's investments could adversely affect the results of operations and financial condition of SMC. PURCHASED INSURANCE BUSINESS. In accordance with industry practice, when SMC purchases additional insurance businesses it assigns a portion of the purchase price, called the present value of future profits, to the right to receive future cash flows arising from existing insurance policies. This asset is recorded when the business is purchased at the value of projected future cash flows on existing policies, less a discount to present value. As future cash flows emerge, they are treated as a recovery of this asset. Therefore, if cash flows emerging from the purchased or recaptured business during a period exactly equal the projections, they are offset by that period's amortization of the cost of the policies purchased. In that event, the only income statement effect from the purchased business is the realization of the discount that was initially deducted from the asset to reflect its present value. Changes in the future annual amortization of this asset are not expected to have a significant effect on the results of operations, because the amount of amortization is expected to be equal to the profits emerging from the purchased policies, net of interest on the unrecovered present value of future profits balance. This asset is amortized over the expected life of the related policies purchased. Present value of future profits is increased for the estimated effect of realizing unrealized investment losses and decreased for the estimated effect of realizing unrealized investment gains. In selecting the interest rate to calculate the discounted present value of the projected future profits, SMC used the risk rate of return it needs to earn in order to invest in the business being acquired or recaptured. In determining this required rate of return, SMC considers the following factors: The magnitude of the risks associated with each of the actuarial assumptions used in determining expected future cash flows (as described above). Our cost of the capital required to fund the acquisition or recapture. The likelihood of changes in projected future cash flows that might occur if there are changes in insurance regulations and tax laws. The acquired company's compatibility with other SMC activities that may favorably affect future cash flows. The complexity of the acquired company or recaptured business. Recent prices (i.e., discount rates used in determining valuations) paid by others to acquire or recapture similar blocks of business. The discount rate used to determine the present value of the projected future profits is used to determine the subsequent amortization of the cost of the purchased policies for acquisitions prior to November 19, 1992. For acquisitions subsequent to November 19, 1992, the discount rate used to amortize the unamortized balance of the present value of future profits is the crediting rate of the underlying policies. The discount rate selected may affect subsequent earnings in those instances where the purchase price of the policies exceeds the value of net assets acquired (including the value of future profits discounted at the selected interest rate). Selection of a lower (or higher) discount rate will increase (or decrease) the portion of the purchase price assigned to the present value of future cash flows and will result in an offsetting decrease (or increase) in the amount of the purchase price assigned to goodwill. The effect on subsequent earnings caused by this variation in purchase price allocation will depend on the characteristics of the policies purchased. For products where the profits emerge at relatively constant levels over an extended period of time (for example, most of SMC's immediate and deferred annuities), use of a lower rate may result in an increase in reported earnings in the early years after an acquisition followed by a decrease in earnings in later years. For products where profits emerge over a shorter period of time or in amounts that decrease over the life of the product (for example, ordinary and term life products), selection of a lower rate will generally result in a decrease in reported earnings in the early years after an acquisition followed by an increase in reported earnings in later years. For SMC, the majority of the cost of policies purchased relates to ordinary life products and the balance to deferred annuity products. The activity related to the present value of future profits of the business acquired or recaptured is summarized as follows (in thousands): YEAR ENDED DECEMBER 31,
1997 1996 1995 Balance, beginning of year $23,806 $ 15,246 $ 8,299 Amounts related to acquisitions and disposals (1,374) 9,615 7,901 Net amortization during the year (1,666) (1,249) (780) Adjustments relating to net unrealized (gain) losses on securities available for sale (229) 194 (174) Balance, end of year........................... $20,537 $ 23,806 $15,246
The percentage of future expected net amortization of the beginning balance of the present value of future profits before the effect of net unrealized gains and losses, based on the present value of future profits at December 31, 1997 and current assumptions as to future events on all policies in force, will be between 6% and 8% in each of the years 1998 through 2002. The discount rate used to calculate the present value of future profits for business acquired prior to November 19, 1992, reflected in SMC's December 31, 1997 consolidated balance sheet ranged from 7.5% to 18%. SMC used a 15% discount rate to calculate the present value of future profits on the business of the Dixie National Life acquisition, which is being amortized over 30 years as the majority of the present value of future profits related primarily to the ordinary life business. SMC used a 15% discount rate to calculate the present value of future profits on the business of the Shelby Life acquisition, which is being amortized over 20 years based on the mix of annuity and life business in Shelby Life. PRODUCED INSURANCE BUSINESS. Insurance products generate two types of profit streams: (i) from the excess of investment income earned over that credited to the policyholder and (ii) from the excess of premiums received over costs incurred for policy issuance, administration and mortality. Costs incurred in issuing new policies are deferred and recorded as deferred acquisition costs ("DAC"), which are amortized using present value techniques so that profits are realized in proportion to premium revenue for certain products and estimated gross profits for certain other products. Profits from all of these elements are recognized over the lives of the policies; no profits are recorded at the time the policies are issued. Amortization of DAC was $1,456,000, $1,221,000 and $1,142,000 for the years ended December 31, 1997, 1996 and 1995, respectively. The increase in current year amortization expense resulted primarily from increased amortization of DAC as gross profits from business sold in recent years began to emerge. DAC of $18,309,000 at December 31, 1996 and additions to policy acquisition costs of $7,005,000 for business produced during the year ended December 31, 1997 are generally being amortized over the expected lives of the policies, a period of approximately 20 years, in a constant relationship to the present value of estimated future gross profits. Interest is being accreted at 7% during year one and 5% thereafter, the projected crediting rate on the policies. DAC is increased for the estimated effect of realizing unrealized investment losses and decreased for the estimated effect of realizing unrealized investment gains. The offset to these amounts is recorded directly to shareholders' equity, net of taxes. Future expected amortization of DAC for the next five years before the effect of net realized and unrealized gains and losses, based on DAC at December 31, 1997 and current assumptions, is as follows (in thousands):
1998 1999 2000 2001 2002 Gross amortization $2,945 $2,976 $3,068 $2,858 $2,597 Interest accreted 1,079 906 736 604 483 Net amortization $1,866 $2,070 $2,332 $2,254 $2,114
The amounts included in the foregoing table do not include any amortization of DAC resulting from the sale of new products after December 31, 1997. Any changes in future annual amortization of this asset are not expected to have a significant effect on results of operations because the amount of amortization is expected to be proportionate to the profits from the produced policies, net of interest on DAC. VARIANCES BETWEEN ACTUAL AND EXPECTED PROFITS. Actual experience on purchased and produced insurance may vary from projections due to differences in renewal premiums collected, investment spreads, mortality costs, surrender benefits, persistency, administrative costs and other factors. Variances from original projections, whether positive or negative, are included in net income as they occur. To the extent that these variances indicate that future experience will differ from the estimated profits reflected in the capitalization and amortization of the cost of policies purchased or the cost of policies produced, current and future amortization rates may be adjusted. ACCOUNTING FOR ANNUITIES AND UNIVERSAL AND INTEREST-SENSITIVE LIFE PRODUCTS. The Company primarily accounts for its annuity and universal and interest-sensitive life policy deposits in accordance with Statement of Financial Accounting Standards No. 97 ("SFAS No. 97"). "Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses on the Sale of Investments". Under SFAS No. 97, a benefit reserve is established at the time of policy issuance in an amount equal to the deposits received. Thereafter, the benefit reserve is adjusted for any additional deposits, interest credited and partial or complete withdrawals. Revenues for annuities and universal and interest-sensitive life policies, other than certain non-interest sensitive annuities, consist of policy charges for surrenders and partial withdrawals, mortality and administration, and investment income earned. Such revenues do not include the annuity and universal and interest-sensitive life policy deposits. Expenses related to these products include interest credited to policyowner account balances, operating costs for policy administration, amortization of DAC and mortality costs in excess of account balances. Costs relating to the acquisition of new business, primarily commissions paid to agents, which vary with and are directly related to the production of new business, are deferred to the extent that such costs are recoverable from future profit margins. At the time of issuance, the acquisition expenses, approximately 13% of initial annuity premium deposits and 50% of premiums from universal and interest-sensitive life products for SMC, are capitalized as DAC. In accordance with SFAS No. 97, DAC with interest is amortized over the lives of the policies in a constant relationship to the present value of estimated future gross profits. UNIT-LINKED PRODUCT ACCOUNTING. Separate account assets and liabilities are maintained primarily for contracts of which the majority represents unit-linked products where benefits on surrender and maturity are not guaranteed. They generally represent funds held in accounts to meet specific investment objectives of policyholders who bear the investment risk. Investment income and investment gains and losses accrue directly to such policyholders. SMC earns income from the investment management fee it charges on such unit-linked contracts, which range from .8% to 1.2% of the value of the underlying separate accounts. DISCUSSION OF CHANGES IN THE CONSOLIDATED STATEMENT OF OPERATIONS FROM YEAR ENDED DECEMBER 31, 1997 TO YEAR ENDED DECEMBER 31, 1996 OPERATING INCOME. The income from operations (before net realized investment gains and gain on disposal of subsidiaries) was $2,384,000 in 1997, or $.48 per share, compared to $1,174,000 for 1996, or $.24 per share. The increase resulted primarily from operations in the United States producing income from operations of $664,000 for 1997 compared to a loss of $44,000 for 1996. The increase is primarily due to an increase in interest spreads on an increasing asset base. The income from international operations also increased to $1,720,000 for 1997 compared to $1,218,000 for 1996. The international operating income resulted primarily from increased fees from an increase in value of assets under separate accounts and deceased operating expenses, primarily due to the strengthening of the U.S. dollar. PREMIUM INCOME. GAAP premium income for 1997 was $7,100,000, a decrease of $3,368,000 or 32% from 10,468,000 for 1996. This decrease is attributable to the recapture of premiums ceded of $4,234,000 in 1996 due to the termination and recapture of a reinsurance agreement with National Mutual which offset the increase in premium income for the inclusion of Shelby Life in the results of operations for periods after November 1, 1996. The Shelby Life block of business recorded net premium income of $1,685,000 in 1997. Net premiums received from the sales of interest-sensitive annuities and other financial products (which are not recorded as revenues) were $49,362,000 compared to $42,347,000 for 1997 and 1996, respectively. The increase in premium deposits is partially due to an increase in gross domestic premium deposits. Gross domestic premium deposits received from interest-sensitive annuities and financial products were $58,069,000 for 1997 compared to $51,254,000 for 1996. The increase in gross domestic premium is the result of an aggressive marketing campaign targeted to high volume marketing companies. Also contributing to the increase in premiums is the continued development of SMC's distribution system through marketing support from Standard Marketing, an aggressive program aimed at retaining key producers, and an increase in the agency base achieved by expanding geographical concentration into the Mid-South and California. Since SMC's operating income is primarily a function of its investment spreads, persistency of annuity in force business mortality experience and operating expenses, a change in premium deposits in a single period does not directly cause operating income to change, although continued increases or decreases in premiums may affect the growth rate of total assets on which investment spreads are earned. NET INVESTMENT INCOME. Net investment income increased $8,645,000 or 41% to $29,516,000 for 1997 from $20,871,000 for 1996. The increase resulted from an increase in total invested assets (amortized cost) of approximately 42% from December 31, 1995 to December 31, 1997, most of which occurred in the fourth quarter of 1996 due to the acquisition of Shelby Life, and an increase in the weighted average net yield of SMC's investment portfolio (exclusive of realized and unrealized gains) to 7.68% from 7.32% for 1997 and 1996, respectively. The continued growth in SMC's total invested assets reflects increased sales of FPDAs and the inclusion of the invested assets of Shelby Life of approximately $100,000,000 in the consolidated balance sheet effective November 1, 1996. NET REALIZED INVESTMENT GAINS. Net realized investment gains decreased $906,000 or 70% to $396,000 from $1,302,000 for 1997 and 1996, respectively. Net realized investment gains fluctuate from period to period and arise when securities are sold in response to changes in the investment environment which provide opportunities to maximize return on the investment portfolio without adversely affecting the quality and overall yield of the investment portfolio. The pretax net unrealized gain on the Company's fixed maturity portfolio was $5,201,000 at December 31, 1997, compared to a pretax net unrealized (loss) of $(1,837,000) at December 31, 1996. In the absence of continued decreases in interest rates the Company may be unable to realize gains on its investment portfolio at the levels of prior years or could recognize losses from sales of securities prior to maturity. The Company's future earnings could be adversely affected to the extent it is unable to realize gains on its investment portfolio. GAIN ON DISPOSAL OF SUBSIDIARIES. On March 18, 1996, SMC completed the sale of a duplicate charter associated with First International to GIAC. SMC received sale proceeds of $10,393,000, including $1,500,000 for the charter and licenses associated with First International. Standard Life realized a net pre-tax gain of $1,042,000 on this sale. In addition, First International, Standard Life and GIAC have entered into a series of agreements that include provisions for Standard Life to retain the economic interest in certain First International policies and administer First International policies in force at the date of such sale. In an unrelated matter, SMC decided in February 1996 to terminate the reinsurance agreement between Standard Reinsurance and Salamandra, and not to renew the Barbados license of Standard Reinsurance. This resulted in a 1996 write-off of SMC's investment in Standard Reinsurance and certain intangible assets of Standard Reinsurance amounting to $156,000. The combined effect of the pre-tax gain on the sale of First International and related contracts, and the Standard Reinsurance write-offs, was $886,000 pre-tax and $2,306,000 after tax in 1996. POLICY CHARGES. Policy charges, which represent the amounts assessed against policyholder account balances for the cost of insurance, policy administration and surrenders, increased $2,961,000 or 116% to $5,512,000 for 1997 compared to $2,551,000 for 1996. The increase in policy charges resulted from an increase in policy charges for Standard Life's universal life insurance products of $1,790,000 due to the inclusion of Shelby Life in the results of operations for periods after November 1, 1996, and an increase in policy surrender charges on FPDAs of $693,000. The increase in annuity policy withdrawals and surrender charges on flexible premium deferred annuities generally corresponds to the aging and growth of SMC's annuity business in force. FEES FROM SEPARATE ACCOUNTS. Fees from separate accounts increased $215,000 or 14% to $1,779,000 for 1997 from $1,564,000 for 1996. This increase is due primarily to an increase in the value of assets held in separate accounts from $122,705,000 at December 31, 1995 to $148,064,000 at December 31, 1997. Net deposits from sales of unit-linked products by Standard Management International were $21,954,000 and $16,902,000 for 1997 and 1996, respectively. Such income fluctuates in relationship to total separate account assets and the return earned on such assets. BENEFITS AND CLAIMS. Benefits and claims decreased $821,000 or 8% to $9,098,000 for 1997 from $9,919,000 for 1996. The decrease in benefits and claims in 1997 resulted primarily from an increase in change in policy reserves of $4,234,000 in 1996 related to the termination and recapture of the reinsurance agreement with National Mutual. This decrease offset the increase in benefits and claims from adverse mortality experience and the inclusion of Shelby Life (approximately $1,152,000 in 1997) in the results of operations for periods after November 1, 1996. Throughout SMC's history, it has experienced both periods of higher and lower benefits and claims. Such volatility is not uncommon in the life insurance industry and, over extended periods of time, periods of higher claims experience tend to be offset by periods of lower claims experience. INTEREST CREDITED ON INTEREST SENSITIVE ANNUITIES AND OTHER FINANCIAL PRODUCTS. Interest credited on interest sensitive annuities and other financial products was $16,281,000 for 1997, an increase of $5,189,000 or 47% from $11,092,000 for 1996. The increase resulted from the inclusion of interest credited of $3,740,000 from Shelby Life products, increases in interest credited rates on new annuity sales and the increases in the growth in policy reserves for FPDAs from sales. At December 31, 1997, the weighted average interest credited rate for Standard Life's currently marketed annuities and other financial product liabilities was 5.58% compared to 5.27% at December 31, 1996. SALARIES AND WAGES. Salaries and wages were $5,608,000 for 1997, an increase of $555,000 or 11% from $5,053,000 for 1996. This increase was caused primarily by an increase in the average wages per employee in 1997 and an increase in the number of employees from 84 at January 1, 1996 to 92 at December 31, 1997. AMORTIZATION. Amortization expense increased $656,000 or 25% to $3,248,000 for 1997 from $2,592,000 for 1996. The increase in current year amortization expense resulted primarily from the amortization of present value of future profits of $555,000 in 1997 for the acquisition of Shelby Life. OTHER OPERATING EXPENSES. Other operating expenses decreased $320,000 or 4% to $6,991,000 for 1997 from $7,311,000 for 1996. The decrease in other operating expenses resulted primarily from eliminating in 1997 the additional cost to convert the operations and expand the marketing effort in Dixie National Life incurred in 1996 and a reduction in international operating expenses due to the strengthening of the U.S. dollar. INTEREST EXPENSE AND FINANCING COSTS. Interest expense and financing costs increased $1,576,000 or 196% to $2,381,000 for 1997 from $805,000 for 1996. The increase in interest expense and financing costs during 1997 resulted primarily from increased borrowing of $10,100,000 in November 1996 on the Amended Credit Agreement and borrowings of $4,000,000 from an unaffiliated insurance company in connection with the acquisition of Shelby Life and additional borrowings of $5,600,000 in connection with funding capital contributions to an insurance subsidiary and redemption of Class S Preferred Stock in 1997. FEDERAL INCOME TAXES. Federal income tax expense (credit) was $617,000 for 1997, compared to $(730,000) for 1996. The large credit in 1996 is primarily due to tax benefits of $1,420,000 related to the sale of First International. EXTRAORDINARY GAIN ON EARLY REDEMPTION OF REDEEMABLE PREFERRED STOCK. Extraordinary gains were recorded on the early redemption of the Class S Preferred Stock for the amounts by which the repurchase price for the Class S Preferred Stock was below its book value plus accrued and unpaid dividends. SMC recorded no extraordinary gain for 1997 compared to a $502,000 gain for 1996. Effective August 1, 1997, SMC redeemed all of its issued and outstanding Class S Preferred Stock at redemption value of $10.00 per share plus accumulated and unpaid dividends. DISCUSSION OF CHANGES IN THE CONSOLIDATED STATEMENT OF OPERATIONS FROM YEAR ENDED DECEMBER 31, 1996 TO YEAR ENDED DECEMBER 31, 1995 OPERATING INCOME. The income from operations (before net realized investment gains and gain on disposal of subsidiaries), was $1,174,000 in 1996, or $.24 per share, compared to $461,000 for 1995, or $.09 per share. The change resulted primarily from international operations producing income from operations of $1,218,000 compared a loss of to $(22,000) for 1996 and 1995, respectively. The international operating gains resulted primarily from increased management fees on an increasing separate account base due to portfolio sales in 1996 and 1995, and increased value of assets under management, coupled with a decrease in marketing costs in 1996 when compared to 1995. The income (loss) from operations in the United States decreased to $(44,000) in 1996 compared to $483,000 in 1995. The decline was attributable to an increase in interest expense from borrowings to repurchase Common Stock, Class S Preferred Stock and the purchase of Shelby Life and additional costs to convert the operations and expand the marketing effort in Dixie National Life. PREMIUM INCOME. GAAP premium income for the 1996 was $10,468,000, an increase of $4,964,000 or 90% from $5,504,000 for 1995. This increase is mainly attributable to recapture of premiums ceded of $4,234,000 due to the termination and recapture of a reinsurance agreement with National Mutual and the inclusion of Dixie National Life and Shelby Life in the results of operations for periods after October 2, 1995 and November 1, 1996, respectively. These amounts offset the decline in premiums from the cession of a portion of First International's life insurance business and the regular policy lapses, surrenders and expiries in SMC's closed blocks of business. Net premiums received from the sales of interest-sensitive annuities and other financial products (which are not recorded as revenues) were $42,347,000 compared to $17,524,000 for 1996 and 1995, respectively. The increase in premium deposits is partially due to an increase in gross domestic premium deposits. Gross domestic premium deposits received from interest-sensitive annuities and financial products were $51,254,000 for 1996 compared to $37,614,000 for 1995. The increase is the result of an aggressive marketing campaign implemented by Standard Life with increased crediting interest rates. First year interest crediting rates were increased approximately 1% on certain FPDAs sold after April 1, 1995. Also contributing to the increase in premiums is the continued development of SMC's distribution system through marketing support from Standard Marketing and an increase in the agency base achieved through the recruitment of larger managing general agencies and expanding geographical concentration into the Mid-South and California. SMC also decreased the quota-share portion of business ceded pursuant to a reinsurance agreement from 70% to 50% at September 1, 1995, which was further decreased to 25% effective April 1, 1995. Premium deposits ceded pursuant to this reinsurance agreement reduced net premium deposits by $8,907,000 in 1996 compared to $20,090,000 in 1995. NET INVESTMENT INCOME. Net investment income increased $2,354,000 or 13% to $20,871,000 for 1996 from $18,517,000 for 1995. The increase primarily resulted from an increase in total invested assets (amortized cost) of approximately 32% from 1995 to 1996, most of which occurred in the fourth quarter due to the acquisition of Shelby Life. The weighted average net yield on SMC's invested assets was 7.32% for both 1996 and 1995. The continued growth in SMC's total invested assets reflects increased sales of FPDAs and the inclusion of the invested assets of Dixie National Life of approximately $26,400,000 and Shelby Life of approximately $100,000,000 in the consolidated balance sheet effective October 2, 1995 and November 1, 1996, respectively, which was offset by the invested assets ceded in the GIAC reinsurance transaction of approximately $18,000,000. NET REALIZED INVESTMENT GAINS. Net realized investment gains increased $614,000 or 89% to $1,302,000 from $688,000 for 1996 and 1995, respectively. The increase primarily resulted from active portfolio management by SMC. Net realized investment gains fluctuate from period to period and arise when securities are sold in response to changes in the investment environment which provide opportunities to maximize return on the investment portfolio without adversely affecting the quality and overall yield of the investment portfolio. POLICY CHARGES. Policy charges increased $84,000 or 3% to $2,551,000 for 1996 compared to $2,467,000 for 1995. The increase in policy charges resulted from an increase in policy surrender charges on FPDAs of $254,000 and the inclusion of Dixie National Life and Shelby Life in operating results for periods after October 2, 1995 and November 1, 1996, respectively, for an increase of $1,359,000 which offset a decrease of $1,502,000 for the absence of policy charges from SMC's closed blocks of universal life business which were sold to GIAC through a reinsurance contract effective January 1, 1995. FEES FROM SEPARATE ACCOUNTS. Fees from separate accounts increased $270,000 or 21% to $1,564,000 for 1996 from $1,294,000 for 1995. This increase is due primarily to an increase in the value of assets held in separate accounts from $94,301,000 at December 31, 1994 to $128,546,000 at December 31, 1996 and to higher service fees being levied on certain transactions. Net deposits from sales of unit-linked products by Standard Management International were $16,902,000 and $31,793,000 for 1996 and 1995, respectively. Such income fluctuates in relationship to total separate account assets and the return earned on such assets. OTHER INCOME. Other income increased $897,000 or 236% to $1,277,000 for 1996 compared to $380,000 for 1995. The increase resulted primarily from administration fees of $316,000 and the reserve and experience refund adjustments in connection with the agreements with GIAC and increased commissions received by Standard Marketing from the sale of unaffiliated products. BENEFITS AND CLAIMS. Benefits and claims increased $4,128,000 or 71% to $9,919,000 for 1996 from $5,791,000 for 1995. The increase resulted primarily from an increase in reserves of $4,234,000 related to the termination and recapture of a reinsurance agreement with National Mutual. Throughout SMC's history, it has experienced both periods of higher and lower benefit claims. Such volatility is not uncommon in the life insurance industry and, over extended periods of time, periods of higher claims experience tend to be offset by periods of lower claims experience. INTEREST CREDITED ON INTEREST SENSITIVE ANNUITIES AND OTHER FINANCIAL PRODUCTS. Interest credited on interest sensitive annuities and other financial products was $11,092,000 for 1996, an increase of $1,083,000 or 11% from $10,009,000 for 1995. The increase resulted primarily from SMC's increase of credited interest rates on new annuity sales and the increases in the growth in policy reserves for FPDAs from sales and the inclusion of Shelby Life in the operations results effective November 1, 1996. At December 31, 1996, the weighted average interest credited rate for Standard Life's annuities and other financial product liabilities was 5.27% compared to 5.35% at December 31, 1995. SALARIES AND WAGES. Salaries and wages were $5,053,000 for 1996, an increase of $352,000 or 7% from $4,701,000 for 1995. This increase was caused primarily by an increase in incentive compensation expense of $315,000. AMORTIZATION. Amortization expense increased $548,000 or 27% to $2,592,000 for 1996 from $2,044,000 for 1995. The increase in current year amortization expense resulted primarily from increased amortization of deferred acquisition costs as gross profits from business sold in recent years began to emerge and increased surrenders and their corresponding increase in the amortization of deferred acquisition costs, and from an increase of $602,000 for the amortization of present value of future profits for the acquisitions of Dixie National Life, Shelby Life and National Mutual. These items more than offset reduced amortization of excess of cost over net assets acquired of $46,000 and present value of future profits of $120,000 due to the sale of First International. OTHER OPERATING EXPENSES. Other operating expenses increased $1,292,000 or 21% to $7,311,000 for 1996 from $6,019,000 for 1995. The increase in other operating expenses resulted primarily from the expenses of Dixie National Life and Shelby Life included in the results for the periods after October 2, 1995 and November 1, 1996, respectively and the increased expenses related to potential acquisitions and advisory fees. INTEREST EXPENSE AND FINANCING COSTS. Interest expense and financing costs increased $687,000 or 582% to $805,000 for 1996 from $118,000 for 1995. The increase in interest expense and financing costs during 1996 resulted primarily from the borrowing on the Amended Credit Agreement. The borrowing under the Amended Credit Agreement and the original credit agreement primarily occurred after December 31, 1995 in connection with the acquisition of Shelby Life and the repurchase of Common Stock and Class S Preferred Stock. LIQUIDITY AND CAPITAL RESOURCES Standard Management is a financial services holding company. The liquidity requirements of Standard Management are met primarily from management fees, equipment rental fees and payments for other charges and dividends and interest on Surplus Debentures received from Standard Management's subsidiaries as well as Standard Management's working capital. These are Standard Management's primary source of funds to pay operating expenses and meet debt service obligations. The payment of dividends and interest on Surplus Debentures and management and other fees by Standard Life to Standard Management is subject to restrictions under the insurance laws of Indiana, Standard Life's jurisdiction of domicile. These internal sources of liquidity have been supplemented in the past by external sources such as lines of credit and revolving credit agreements and long-term debt and equity financing in the capital markets. SMC reported on a consolidated GAAP basis net cash provided by operations of $7,764,000 and $1,726,000 for 1997 and 1996, respectively. Although deposits received on SMC's interest-sensitive annuities and other financial products are not included in cash flow from operations under GAAP, such funds are available for use by SMC. Cash provided by operations plus net deposits received, less net account balances returned to policyholders on interest sensitive annuities and other financial products, resulted in positive cash flow of $19,649,000 and $26,717,000 for 1997 and 1996, respectively. Cash generated on a consolidated basis is available to Standard Management only to the extent that it is generated at Standard Management level or is available to Standard Management through dividends, interest, management fees or other payments from subsidiaries. In April 1993, Standard Management instituted a program to repurchase SMC Common Stock from time to time. The purpose of the stock repurchase program is to enhance shareholder value. Standard Management had repurchased 1,134,356 shares of SMC Common Stock for $5,826,000 as of January 1, 1998. Of the repurchases, 419,026 shares were paid for through additional borrowings under the Amended Credit Agreement, 39,016 shares from the proceeds of the additional borrowings of the subordinated convertible notes, and the remainder were paid from working capital. At January 1, 1998, Standard Management was authorized to purchase an additional 365,644 shares under this program. At February 28, 1998, Standard Management had "parent company only" cash and short-term investments of $558,000. These funds are available to Standard Management for general corporate purposes. Standard Management's "parent company only" operating expenses (not including interest expense) were $3,420,000 and $3,470,000 for 1997 and 1996, respectively. Pursuant to the management services agreement with Standard Management, Standard Life paid Standard Management a monthly fee of $166,667 (annual fee of $2,000,000) during 1997 for certain management services related to the production of business, investment of assets and evaluation of acquisitions. Pursuant to the management service agreements with Standard Life, Dixie National Life paid monthly payments of $83,333 (annual fee of $1,000,000) to Standard Life in 1997. Both of these agreements provide that they may be modified or terminated by the Indiana and Mississippi departments of insurance in the event of financial hardship of Standard Life or Dixie National Life. A management services agreement between SMC and Savers Life was approved by the North Carolina Department of Insurance on March 11, 1998. The management services agreement calls for the payment of $83,333 per month by Savers Life to SMC for financial and regulatory reporting, investment of assets and the production of business. SMC has agreed to receive no fee, nor shall Savers life have an obligation to pay, unless the capital and surplus of Savers Life is $7,000,000 after the acquisition of Savers Life. The amount of capital and surplus of Savers Life at December 31, 1997 was $7,134,00. In addition, as a condition of the acquisition of Savers Life, SMC entered into an agreement with the North Carolina Department of Insurance to maintain statutory capital and surplus of Savers Life of at least $6,000,000. Pursuant to the management services agreement with Standard Management, Premier Life (Luxembourg) paid Standard Management a management fee of $25,000 per quarter during 1997 and 1996 for certain management and administrative services. The agreement provides that it may be modified or terminated by either Standard Management or Premier Life (Luxembourg). At April 1, 1995, Standard Management sold its property and equipment to an unaffiliated leasing/financing company for $1,396,000 and subsequently entered into a capital lease obligation whereby Standard Management pays a monthly rental amount of $45,000. Standard Management charges a monthly equipment rental fee to its subsidiaries for this equipment and additional equipment purchased after April 1, 1995. The amount of the rental fee income received from Standard Management's subsidiaries was $1,145,000 and $853,000 for 1997 and 1996, respectively. On November 8, 1996, Standard Life acquired through merger Shelby Life from DLAC for approximately $14,650,000, including $13,000,000 in cash, 250,000 shares of restricted SMC Common Stock (valued at $1,250,000) and $400,000 of acquisition costs. Financing for the Shelby Life transaction was provided by senior debt of $10,000,000 under the Amended Credit Agreement and $4,000,000 in subordinated convertible debt described below. The Amended Credit Agreement permits Standard Management to borrow up to $20,000,000 in the form of a seven-year reducing revolving loan arrangement. Standard Management has agreed to pay a non-use fee of .50% per annum on the unused portion of the commitment. In connection with the original and Amended Credit Agreement, Standard Management issued warrants to the bank to purchase 77,500 shares of SMC Common Stock. Borrowing under the Amended Credit Agreement may be used for contributions to surplus of insurance subsidiaries, acquisition financing, and repurchases of Class S Preferred and SMC Common Stock. The debt is secured by a Pledge Agreement of all of the issued and outstanding shares of common stock of Standard Life and Standard Marketing. Interest on the borrowing under the Amended Credit Agreement is determined, at the option of Standard Management, to be: (i) a fluctuating rate of interest based on corporate base rate announced by the bank from time to time plus 1% per annum, or (ii) a rate at LIBOR plus 3.25%. Annual principal repayments of $3,333,000 begin in March 2000 and conclude in March 2005. Indebtedness incurred under the Amended Credit Agreement is subject to certain restrictions and covenants including, among other things, certain minimum financial ratios, minimum statutory surplus requirements for the insurance subsidiaries, minimum consolidated equity requirements for Standard Management and certain investment and indebtedness limitations. At December 31, 1997, Standard Management had borrowed $16,000,000 under the Amended Credit Agreement at a weighted average interest rate of 9.062%. In connection with the acquisition of Shelby Life, Standard Management borrowed $4,000,000 from an insurance company pursuant to a subordinated convertible debt agreement which is due in December, 2003. At June 30, 1997, this subordinated convertible debt agreement was amended to the principal amount of $4,372,000 which is due July 2004 unless previously converted, and requires interest payments in cash on January 1 and July 1 of each year at 10% per annum. At June 30, 1997, SMC borrowed an additional $5,628,000 from an insurance company pursuant to another subordinated convertible debt agreement (collectively, the "Notes") which is due July 2004 unless previously converted, and requires interest payments in cash on January 1 and July 1 of each year at 10% per annum. Proceeds from the additional borrowings were used for contributions to surplus of insurance subsidiaries of $2,400,000, redemption of Class S Preferred Stock of approximately $1,840,000 and other general corporate purposes. The Notes are convertible at any time at the option of the noteholders into Common Stock at the rate of $5.747 per share. The Notes may be prepaid in whole or in part at the option of SMC commencing on July 1, 2000 at redemption prices equal to 105% of the principal amount (plus accrued interest) and declining to 102% of the principal amount (plus accrued interest). The Notes may be prepaid prior to July 1, 2000 at a redemption price equal to 101% of the principal amount plus accrued interest under certain limited circumstances. The subordinated convertible debt agreements contains terms and financial covenants substantially similar to those in the Amended Credit Agreement. Assuming the current level of debt under the Amended Credit Agreement and current interest rates at December 31, 1997 (weighted average rate of 9.062%), annual debt service in 1998 would be approximately $2,800,000 in interest paid. In addition, Standard Management has 1998 obligations under a capital lease of $151,000. From the funds borrowed by Standard Management pursuant to the Amended Credit Agreement and the subordinated convertible debt agreement, $13,000,000 was loaned to Standard Life pursuant to an Unsecured Surplus Debenture Agreement ("Surplus Debenture") which requires Standard Life to make quarterly interest payments to Standard Management at a variable corporate base rate plus 2% per annum, and annual principal payments of $1,000,000 per year beginning in 2007 and concluding in 2019. The interest and principal payments are subject to quarterly approval by the Indiana Department of Insurance, depending upon satisfaction of certain financial tests relating to levels of Standard Life's capital and surplus and general approval of the Commissioner of the Indiana Department of Insurance. Standard Management currently anticipates these quarterly approvals will be granted. Assuming the approvals are granted and the December 31, 1997 interest rate of 10.50% continues in 1998, Standard Management will receive interest income of $1,365,000 from the Surplus Debenture for 1998. Dividends from Standard Life to Standard Management are limited by laws applicable to insurance companies. As an Indiana domiciled insurance company, Standard Life may pay a dividend or distribution from its surplus profits, without the prior approval of the Commissioner of the Indiana Department of Insurance, if the dividend or distribution, together with all other dividends and distributions paid within the preceding twelve months, does not exceed the greater of (i) net gain from operations or (ii) 10% of surplus, in each case as shown in its preceding annual statutory financial statements. Also, regulatory approval is required when dividends to be paid exceed unassigned statutory surplus. For the year ended December 31, 1997, Standard Life reported statutory net gain from operations before realized capital losses of $2,374,000 and statutory surplus of $25,923,000 which includes unassigned surplus of $1,693,000. During 1998, Standard Life can pay dividends of approximately $2,500,000 without regulatory approval. As a North Carolina domiciled insurance company, Savers Life may pay a dividend or distribution from its capital and surplus, without the prior approval of the North Carolina Commissioner of Insurance, if the dividend or distribution together with all other dividends and distributions paid within the preceding twelve months, does not exceed the lesser of (i) net gain from operations or (ii) 10% of capital and surplus, in each case as shown in its preceding annual statutory financial statements. Savers Life was not allowed to pay a dividend in 1996 or 1997 without prior North Carolina Department of Insurance approval due to its statutory net losses in 1995 and 1996. Savers Life will not be permitted to pay dividends in 1998 without such approval. Standard Management anticipates the available cash from its existing working capital, plus anticipated 1998 dividends, management fees, rental income and interest payments on its Surplus Debentures receivable will be more than adequate to meet its anticipated "parent company only" cash requirements for 1998. Standard Management has a note receivable of $2,858,000 from an affiliate and a note payable of $2,858,000 to a different affiliate. This note receivable and note payable are eliminated in the consolidated financial statements. U.S. INSURANCE OPERATIONS. The principal liquidity requirements of Standard Life are its contractual obligations to policyholders, dividend, rent, management fee and Surplus Debenture payments to Standard Management and other operating expenses. The primary source of funding for these obligations has been cash flow from premium income, net investment income, investment sales and maturities and sales of FPDAs. These sources of liquidity for Standard Life significantly exceed scheduled uses. Liquidity is also affected by unscheduled benefit payments including death benefits and policy withdrawals and surrenders. The amount of withdrawals and surrenders is affected by a variety of factors such as renewal interest crediting rates, interest rates for competing products, general economic conditions, Standard Life's A.M. Best ratings (currently rated "B+") and events in the industry that affect policyholders' confidence. The policies and annuities issued by Standard Life contain provisions that allow policyholders to withdraw or surrender their policies under defined circumstances. These policies and annuities generally contain provisions which apply penalties or otherwise restrict the ability of policyholders to make such withdrawals or surrenders. Standard Life closely monitors the surrender and policy loan activity of its insurance products and manages the composition of its investment portfolios, including liquidity, in light of such activity. Changes in interest rates may affect the incidence of policy surrenders and other withdrawals. In addition to the potential effect on liquidity, unanticipated withdrawals in a changing interest rate environment could adversely affect earnings if SMC were required to sell investments at reduced values to meet liquidity demands. SMC manages the asset and liability portfolios in order to minimize the adverse earnings effect of changing market interest rates. SMC seeks assets that have duration characteristics similar to the liabilities that they support. SMC also prepares cash flow projections and performs cash flow tests under various market interest rate scenarios to assist in evaluating liquidity needs and adequacy. SMC's U.S. insurance subsidiaries currently expect available liquidity sources and future cash flows to be adequate to meet the demand for funds. Statutory surplus is computed according to rules prescribed by the NAIC, as modified by the Indiana Department of Insurance, or the state in which the insurance subsidiaries do business. Statutory accounting rules are different from GAAP and are intended to reflect a more conservative perspective. With respect to new business, statutory accounting practices require that: (i) acquisition costs (primarily commissions and policy issue costs) and (ii) reserves for future guaranteed principal payments and interest in excess of statutory rates, be expensed in the year the new business is written. These items cause a reduction in statutory surplus ("surplus strain") in the year written for many insurance products. SMC designs its products to minimize such first-year losses, but certain products continue to cause a statutory loss in the year written. For each product, SMC controls the amount of net new premiums written to manage the effect of such surplus strain. SMC's long-term growth goals contemplate continued growth in its insurance businesses. To achieve these growth goals, SMC's U.S. insurance subsidiaries will need to increase statutory surplus. Additional statutory surplus may be secured through various sources such as internally generated statutory earnings, infusions by Standard Management with funds generated through debt or equity offerings or mergers with other life insurance companies. If additional capital is not available from one or more of these sources, SMC believes that it could reduce surplus strain through the use of reinsurance or through reduced writing of new business. During 1997, Standard Life produced a statutory net income of $1,776,000. Standard Management contributed $2,400,000 to Standard Life in 1997 to facilitate growth in premiums written. In March 1996, Standard Life sold its subsidiary, First International, and realized an increase in statutory capital and surplus of approximately $4,951,000 from the statutory gain on the sale and related reinsurance transactions. Commencing January 1, 1995, Standard Life began to reinsure a portion of its annuity business. This reinsurance agreement has allowed SMC to write volumes of business that it would not otherwise have been able to write due to regulatory restrictions based on its ratio of surplus to liabilities as determined by regulatory authorities in the State of Florida. By reinsuring a portion of the annuity business, the liability growth is slowed, thereby avoiding the erosion of surplus that occurs in periods of increasing sales. If SMC's ratio of surplus to liabilities falls below 4%, the State of Florida could prohibit SMC from writing new business in Florida. Standard Life's largest annuity reinsurer at December 31, 1997, Winterthur, is rated "A" ("Excellent") by A.M. Best. From January 1, 1995 to August 31, 1995 approximately 70% of certain of Standard Life's annuity business produced was ceded. Standard Life decreased the quota-share portion of business ceded to 50% at September 1, 1995 and further reduced it to 25% effective April 1, 1996 to reflect the reduced need for additional capital and increase current earnings potential. This reduction was possible since the surplus strain experienced by Standard Life was not as great as originally anticipated as a result of lower than expected sales in 1995 and the increase in surplus resulting from the sale of First International. In addition, Standard Life's ability to retain business was further increased by contributions to surplus of insurance subsidiaries of $2,400,000 in 1997. Winterthur limits dividends and other transfers by Standard Life to Standard Management or affiliated companies in certain circumstances. Management believes that operational cash flow of Standard Life will be sufficient to meet its anticipated needs for 1998. As of December 31, 1997, Standard Life had statutory capital and surplus for regulatory purposes of $25,923,000 compared to $22,970,000 at December 31, 1996. The increase is primarily due to the capital contribution of $2,400,000 from Standard Management in 1997. As the life insurance and annuity business produced by Standard Life and Dixie National Life increases, Standard Life expects to continue to satisfy statutory capital and surplus requirements through statutory profits, through the continued reinsurance of a portion of its new business, and through additional capital contributions by Standard Management. Net cash flow from operations on a statutory basis of Standard Life, after payment of benefits and operating expenses, was $19,588,000 and $17,921,000 for 1997 and 1996, respectively. If the need arises for cash which is not readily available, additional liquidity could be obtained from the sale of invested assets. State insurance regulatory authorities impose minimum risk-based capital requirements on insurance enterprises that were developed by the NAIC. The formulas for determining the amount of RBC specify various weighting factors that are applied to financial balances or various levels of activity based on the perceived degree of risk. Regulatory compliance is determined by a ratio (the "RBC Ratio") of the enterprise's regulatory total adjusted capital, as defined by the NAIC, to its authorized control level RBC, as defined by the NAIC. Enterprises below specific trigger points or ratios are classified within certain levels, each of which requires specified corrective action. Each of SMC's insurance subsidiaries has an RBC Ratio that is at least 400% of the minimum RBC requirements; accordingly, the subsidiaries meet the RBC requirements. Standard Life's acquisition of Shelby Life, and merger of Shelby Life into Standard Life, effective November 1, 1996 is anticipated to have a positive effect on Standard Life's liquidity and cash flows. Shelby Life ceased writing new business effective November 1, 1996, thus reducing the surplus strain normally associated with the issuance of new policies. The anticipated profits from Shelby Life's book of business are expected to exceed the related interest expense connected with the $13,000,000 of Surplus Debentures issued by Standard Life in connection with the acquisition of Shelby Life. SMC's acquisition of Savers Life at March 12, 1998 is anticipated to have a positive effect on SMC's liquidity and cash flows. SMC anticipates that existing working capital, unused proceeds from borrowings under the Amended Credit Agreement, and management fees by Savers Life will be adequate to cover debt service on the additional borrowings under the Amended Credit Agreement through 1998. INTERNATIONAL OPERATIONS. The consolidated balance sheet of SMC at December 31, 1997, includes a $1,388,000 credit representing negative goodwill on the purchase of Standard Management International which will be amortized into earnings during 1998. This amortization is a non-cash credit to SMC statement of operations. Standard Management International dividends are limited to its accumulated earnings without regulatory approval. Standard Management International and Premier Life (Luxembourg) were not permitted to pay dividends in 1997 and 1996 due to accumulated losses. Premier Life (Bermuda) did not pay dividends in 1997 and 1996. SMC does not anticipate any dividends from these companies in 1998. Due to the nature of unit-linked products issued by Standard Management International, which represent over 90% of the Standard Management International portfolio, the investment risk rests with the policyholder. Investment risk for Standard Management International exists where Standard Management International makes investment decisions with respect to the remaining traditional business and for the assets backing certain actuarial and regulatory reserves. The investments underlying these liabilities mostly represent short-term investments and fixed maturity securities. These short term investments and fixed maturity securities are normally bought and/or disposed of only on the advice of independent consulting actuaries who perform an annual analysis comparing anticipated cash flows on the insurance portfolio with the cash flows from the fixed maturity securities. Any resulting material mismatches are then covered by adjusting the securities in the investment portfolio as appropriate. FACTORS THAT MAY AFFECT FUTURE RESULTS MERGERS, ACQUISITIONS AND CONSOLIDATIONS. The U.S. insurance industry has experienced an increasing number of mergers, acquisitions, consolidations and sales of certain business lines. These consolidations have been driven by a need to reduce costs of distribution and overhead and maintain business in force. Additionally, increased competition, regulatory capital requirements and technology costs have also contributed to the level of consolidation in the industry. These forces are expected to continue as is the level of industry consolidation. FOREIGN CURRENCY RISK. Standard Management International policyholders invest in assets denominated in a wide range of currencies. Policyholders effectively bear the currency risk, if any, as these investments are matched by policyholder separate account liabilities. Therefore, their investment and currency risk is limited to premiums they have paid. Policyholders are not permitted to invest directly into options, futures and derivatives. Standard Management International could be exposed to currency fluctuations if currencies within the conventional investment portfolio or certain actuarial reserves are mismatched. The assets and liabilities of this portfolio and the reserves are continually matched by the company and at regular intervals by the independent actuary. In addition, Premier Life (Luxembourg) shareholder's equity is denominated in Luxembourg francs. Premier Life (Luxembourg) does not hedge translation risk because its stockholder's equity will remain in Luxembourg francs for the foreseeable future and no significant realized foreign exchange gains or losses are anticipated. At December 31, 1997, there was an unrealized loss from foreign currency translation adjustment of $473,000. UNCERTAINTIES REGARDING INTANGIBLE ASSETS. Included in SMC's financial statements as of December 31, 1997 are certain assets that are valued for financial statement purposes primarily on the basis of assumptions established by SMC's management. These assets include deferred acquisition costs, present value of future profits, costs in excess of net assets acquired and organization and deferred debt issuance costs. The total value of these assets reflected in the December 31, 1997 consolidated balance sheet aggregated $43,492,000 or 6% of SMC's assets. SMC has established procedures to periodically review the assumptions utilized to value these assets and determine the need to make any adjustments in such values in SMC's consolidated financial statements. SMC has determined that the assumptions utilized in the initial valuation of these assets are consistent with the current operations of SMC as of December 31, 1997. REGULATORY ENVIRONMENT. Currently, prescribed or permitted statutory accounting principles ("SAP") may vary between states and between companies. The NAIC is in the process of codifying SAP to promote standardization of methods utilized throughout the industry. Completion of this project might result in changes in statutory accounting practices for SMC's insurance subsidiaries; however, it is not expected that such changes would materially affect SMC's insurance subsidiaries' statutory capital requirements. FINANCIAL SERVICES DEREGULATION. The United States Congress is currently considering a number of legislative proposals intended to reduce or eliminate restrictions on affiliations among financial services organizations. Proposals are extant which would allow banks to own or affiliate with insurers and securities firms. An increased presence of banks in the life insurance and annuity businesses may increase competition in these markets. The Company cannot predict the impact of these proposals on the earnings of the Company. IMPACT OF YEAR 2000. Some of the Company's older computer programs were written using two digits rather than four to define the applicable year. As a result, those computer programs have time-sensitive software that recognize a date using "00" as the year 1900 rather than the year 2000. This could cause a system failure or miscalculations causing disruptions of operations, including, among other things, a temporary inability to process transactions, send billing notices, or engage in similar normal business activities. The Company has completed an assessment and will have minimal expenditures to modify or replace portions of its software so that its computer systems will function properly with respect to dates in the year 2000 and thereafter. Modifications and or replacements are estimated to be completed not later than December 31, 1998, which is prior to any anticipated impact on its operating systems. The Company believes that with modifications to existing software and conversions to new software, the Year 2000 Issue will not pose significant operational problems for its computer systems. Additionally, management has concluded that the Year 2000 Issue will not materially affect future financial results, or cause reported financial information not to be indicative of future operating results or future financial condition. SAFE HARBOR PROVISIONS. All statements, trend analyses, and other information contained in this Annual Report on Form 10-K or any document incorporated by reference herein relative to markets for the Company's products and trends in the Company's operations or financial results, as well as other statements including words such as "anticipate," "believe," "plan,""estimate,""expect,""intend," and other similar expressions, constitute forward-looking statements under the Private Securities Litigation reform Act of 1995. These forward-looking statements are subject to known and unknown risks, uncertainties and other factors which may cause actual results to be materially difference from those contemplated by the forward-looking statements. Such factors include, among other things: (1) general economic conditions and other factors, including prevailing interest rate levels, stock market performance and health care inflation, which may affect the ability of the Company to sell its products, the market value of the Company's investments and the lapse rate and profitability of the Company's policies; (2) the Company's ability to achieve anticipated levels of operational efficiencies at recently acquired companies, as well as through other cost-saving initiatives; (3) customer response to new products, distribution channels and marketing initiatives; (4) mortality, morbidity, usage of health care services and other factors which may affect the profitability of the Company's insurance products; (5) changes in the Federal income tax laws and regulation which may affect the relative tax advantages of some of the Company's products; (6) increasing competition in the sale of the Company's products; (7) regulatory changes or actions, including those relating to regulation of financial services affecting (among other things) bank sales and underwriting of insurance products, regulation of the sale, underwriting and pricing of insurance products, and health care regulation affecting the Company's supplemental health insurance products; (8) the availability and terms of future acquisitions; and (9) the risk factors or uncertainties listed from time to time in any document incorporated by reference herein. ITEM 8.CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The financial statements and supplementary data required with respect to this Item 8 are listed in Item 14(a)(1) and included in a separate section of this report. ITEM 9.CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III The Registrant will file a definitive proxy statement pursuant to Regulation 14A of the Securities Exchange Act of 1934 in connection with the Company's 1998 Annual Meeting of Shareholders, (the "Proxy Statement") not later than 120 days after the end of the fiscal year covered by this report, and certain information included therein is incorporated herein by reference. Only those sections of the Proxy Statements which specifically address the items set forth herein are incorporated by reference. Such incorporation does not include the Compensation Committee Report or the Performance Graph included in the Proxy Statement. ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information concerning SMC's directors required by this item is incorporated by reference to SMC's Proxy Statement. The information concerning SMC's executive officers required by this Item is incorporated by reference herein to the section in Part I, entitled "Executive Officers." The information regarding compliance with Section 16 of the Securities and Exchange Act of 1934 is to be set forth in the Proxy Statement and is hereby incorporated by reference. ITEM 11. EXECUTIVE COMPENSATION The information required by this Item is incorporated by reference to SMC's Proxy Statement. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this Item is incorporated by reference to SMC's Proxy Statement. ITEM 13. CERTAIN RELATIONSHIP AND RELATED TRANSACTIONS The information required by this Item is incorporated by reference to SMC's Proxy Statement. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a)(1) and (2) The response to this portion of Item 14 is submitted as a separate section of this report. (a)(3) List of Exhibits: Exhibit NUMBER DESCRIPTION OF DOCUMENT 2.1 Amended and Restated Agreement and Plan of Merger dated as of December 9, 1997 among SMC, SAC and Savers Life. (incorporated by reference to SMC's Registration Statement on Form S-4 (Registration No. 333-43023). 3.1 Amended and Restated Articles of Incorporation, as amended (incorporated by reference to SMC's Annual Report on Form 10-K (File No. 0-20882) for the year ended December 31, 1995). 3.2 Amended and Restated Bylaws of SMC as amended (incorporated by reference to SMC's Registration Statement on Form S-1 (Registration No. 33-53370) as filed with the Commission on January 27, 1993 and to Exhibit 3 of SMC's Quarterly Report on Form 10-Q (File No. 0-20882) for the quarter ended September 30, 1994). 4.1 Form of Senior Note Agreement Warrant (incorporated by reference to SMC's Registration Statement on Form S-1 (Registration No. 33-53370)). 4.2 Form of Oppbridge Partners Warrant (incorporated by reference to SMC's Registration Statement on Form S-1 (Registration No. 33-53370)). 4.3 Registration Rights Agreement, dated as of May 3, 1990 among SMC, Howard T. Cohn and Joseph J. Piazza and the first amendment thereto, dated June 4, 1990 (incorporated by reference to SMC's Registration Statement on Form S-1 (Registration No. 33-53370). 4.4 Amended and Restated Registration Rights Agreement dated as of April 15, 1997 by and between SMC and Fleet National Bank. 4.5 Form of Fleet National Bank Warrant. 4.6 Form of President's Club Warrant (incorporated by reference to SMC's Annual Report on Form 10-K (File No. 0-20882)). 4.7 Registration Rights Agreement dated as of November 8, 1996 by and between SMC and Great American Reserve Insurance Company ("Great American Reserve") (incorporated by reference to SMC's Quarterly Report on Form 10-Q (File No. 0-20882) for the quarter ended September 30, 1996). 4.8 Form of Sand Brothers & Company, Ltd. Warrant (incorporated by reference to SMC's Annual Report on Form 10-K (File No. 0-20882) for the year ended December 31, 1997). 9 Voting Trust Agreement dated as of November 8, 1996 among Delta Life and Annuity Company, Messrs. Ronald D. Hunter and Allen O. Jones, Jr., as Voting Trustees, and SMC (incorporated by reference to SMC's Registration Statement on Form S-4 (Registration No. 333-35447)). 10.1 Amended Advisory Agreement, dated as of August 1, 1991, between SMC and Conseco Capital Management, Inc., as amended, April 17, 1995 (incorporated by reference to SMC's Annual Report on Form 10-K (File No. 0-20882) for the year ended December 31, 1996). 10.2 Second Amended and Restated Employment Contract by and between SMC and Ronald D. Hunter, dated and effective, as amended, April 3, 1995 (incorporated by reference to SMC's Quarterly Report on Form 10-Q (File No. 0-20882) for the quarter ended June 30, 1995). Exhibit NUMBER DESCRIPTION OF DOCUMENT 10.3 Second Amended and Restated Employment Contract by and between SMC and Edward T. Stahl, dated and effective, as amended, April 3, 1995 (incorporated by reference to SMC's Quarterly Report on Form 10-Q (File No. 0-20882) for the quarter ended June 30, 1995). 10.4 Second Amended and Restated Employment contract by and between SMC and Raymond J. Ohlson, dated and effective, as amended, April 3, 1995 (incorporated by reference to SMC's Quarterly Report on Form 10-Q (File No. 0-20882) for the quarter ended June 30, 1995). 10.5 First Amended and Restated Employment Contract by and between SMC and Stephen M. Coons dated and effective, April 3, 1995 (incorporated by reference to SMC's Quarterly Report on Form 10-Q (File No. 0-20882) for the quarter ended June 30, 1995). 10.6 Indemnification Agreement between SMC and Stephen M. Coons and Coons & Saint, dated August 1, 1991 (incorporated by reference to SMC's Registration Statement on Form S-1 (Registration No. 33-53370) as filed with the Commission on January 27, 1993). 10.7 Standard Management Corporation Amended and Restated 1992 Stock Option Plan (incorporated by reference to the Company's Registration Statement on Form S-4 (Registration No. 333-35447) as filed with the Commission on September 11, 1997. 10.8 Lease by and between Standard Life and WRC Properties, Inc., dated February 27, 1991 (incorporated by reference to SMC's Registration Statement on Form S-1 (Registration No. 33-53370) as filed with the Commission on January 27, 1993). 10.9 Management Service Agreement between Standard Life and SMC dated August 1, 1992, as amended on January 1, 1997 (incorporated by reference to SMC's Annual Report on Form 10-K (File No. 0-20882) for the year ended December 31, 1996). 10.10 Agreement for Assumption Reinsurance between the National Organization Of Life and Health Insurance Guaranty Associations and Standard Life, concerning, The Midwest Life Insurance Company In Liquidation effective June 1, 1992 (incorporated by reference to SMC's Registration Statement on Form S-1 (Registration No. 33-53370) as filed with the Commission on January 27, 1993). 10.11 Reinsurance Agreement between Standard Life and Swiss Re Life and Health effective May 1, 1975 (incorporated by reference to SMC's Registration Statement on Form S-1 (Registration No. 33-53370) as filed with the Commission on January 27, 1993). 10.12 Reinsurance Agreement between Firstmark Standard Life Insurance Company and Swiss Re Life and Health effective February 1, 1984 (incorporated by reference to SMC's Registration Statement on Form S-1 (Registration No. 33-53370) as filed with the Commission on January 27, 1993). 10.13 Reinsurance Contract between First International and Standard Life dated July 10, 1992 (incorporated by reference to SMC's Registration Statement on Form S-1 (Registration No. 33-53370) as filed with the Commission on January 27, 1993). 10.14 Amended Reinsurance Agreement between Standard Life and Winterthur Life Re Insurance Company effective January 1, 1995 (incorporated by reference to SMC's Annual Report on Form 10-K (File No. 0-20882) for the year ended December 31, 1996). 10.15 Management Service Agreement between Premier Life (Luxembourg) and SMC dated September 30, 1994 (incorporated by reference to SMC's Annual Report on Form 10-K (File No. 0-20882) for the year ended December 31, 1994). 10.16 Assignment of Management Contract dated October 2, 1995 of Management Contract dated January 1, 1987 between DNC and Dixie National Life to Standard Life (incorporated by reference to SMC's Annual Report on Form 10-K (File No. 0-20882) for the year ended December 31, 1996). Exhibit NUMBER DESCRIPTION OF DOCUMENT 10.17 Automatic Indemnity Reinsurance Agreement between the First International and The Guardian Insurance & Annuity Company, Inc. dated and effective January 1, 1996 (incorporated by reference to SMC's Annual Report on Form 10-K (File No. 0-20882) for the year ended December 31, 1996). 10.18 Indemnity Retrocession Agreement between The Guardian Insurance & Annuity Company, Inc. and the Standard Life dated and effective January 1, 1996 (incorporated by reference to SMC's Annual Report on Form 10-K (File No. 0-20882) for the year ended December 31, 1996). 10.19 Automatic Indemnity Reinsurance Agreement between The Guardian Insurance & Annuity Company, Inc. and the Standard Life dated and effective January 1, 1996 (incorporated by reference to SMC's Annual Report on Form 10-K (File No. 0-20882) for the year ended December 31, 1996). 10.20 Administrative Services Agreement between First International and Standard Life dated and effective March 18, 1996 (incorporated by reference to SMC's Annual Report on Form 10-K (File No. 0-20882) for the year ended December 31, 1996). 10.21 Amendment No. 1 to Amended and Restated Revolving Line of Credit Agreement dated as of March 10, 1998 between SMC and Fleet National Bank. 10.22 Amended and Restated Note Agreement dated as of March 10, 1998 between SMC and Fleet National Bank in the amount of $20,000,000. 10.23 Amended and Restated Pledge Agreement dated as of March 10, 1998 between SMC and Fleet National Bank. 10.24 Revised Service Contract Agreement dated as of October 16, 1995 and effective January 1, 1995 between Standard Life and Standard Marketing (incorporated by reference to SMC's Annual Report on Form 10-K (File No. 0-20882) for the year ended December 31, 1996). 10.25 Note Agreement dated as of November 8, 1996, as amended and restated on June 30, 1997, by and between SMC and Great American Reserve in the amount of $4,371,573 (incorporated by reference to SMC's Quarterly Report on Form 10-Q (File No. 0-20882) for the quarter ended June 30, 1997). 10.26 Surplus Debenture dated as of November 8, 1996 by and between SMC and Standard Life in the amount of $13,000,000 (incorporated by reference to SMC's Quarterly Report on Form 10-Q (File No. 0-20882) for the quarter ended September 30, 1996). 10.27 Portfolio Indemnify Reinsurance Agreement between Dixie National Life and Cologne Life Reinsurance Company dated and effective December 31, 1996 (incorporated by reference to SMC's Annual Report on Form 10-K (File No. 0-20882) for the year ended December 31, 1996). 10.28 Note Agreement dated as of June 30, 1997 between SMC, Capitol American Life Insurance Company and Transport Life Insurance Company in the amount of $5,628,427 (incorporated by reference to SMC's Quarterly Report on Form 10-Q (File No. 0-20882) for the quarter ended June 30, 1997). 10.29 Senior Subordinated Convertible Note dated as of June 30, 1997 between SMC and Capitol American Life Insurance Company in the amount of $3,628,427 (incorporated by reference to SMC's Quarterly Report on Form 10-Q (File No. 0-20882) for the quarter ended June 30, 1997). 10.30 Senior Subordinated Convertible Note dated as of June 30, 1997 between SMC and Transport Life Insurance Company in the amount of $2,000,000 (incorporated by reference to SMC's Quarterly Report on Form 10-Q (File No. 0-20882) for the quarter ended June 30, 1997). Exhibit NUMBER DESCRIPTION OF DOCUMENT 10.31 Coinsurance Agreement effective as of July 1, 1997 by and between Savers Life and World Insurance Company (incorporated by reference to SMC's Registration Statement on Form S-4 (Registration No. 333-35447)). 10.32 Amendment I to the Guardian Indemnity Retrocession Agreement effective as of January 1, 1996 by and between The Guardian Insurance and Annuity Company and Standard Life (incorporated by reference to SMC's Registration Statement on Form S-4 (Registration No. 333-35447)). 10.33 Promissory Note from Ronald D. Hunter to SMC in the amount of $775,500 executed October 28, 1997 (incorporated by reference to SMC's Quarterly Report on Form 10-Q (File No. 0-20882) for the quarter ended September 30, 1997). 10.34 Reinsurance Agreement between Standard Life and Life Reassurance Corporation of America effective September 1, 1997. 10.35 Reinsurance Agreement between Standard Life and Business Men's Assurance Company of America effective September 1, 1997. 21 List of Subsidiaries of SMC 23.1 Consent of Ernst & Young LLP 23.2 Consent of KPMG Audit 24 Powers of Attorney 27 Financial Data Schedule, which is submitted electronically pursuant to Regulation S-K to the Securities and Exchange Commission for information only and not filed. The following is a list of each management contract or compensatory plan or arrangement required to be filed as an exhibit to this report. EXHIBIT NUMBER 10.2 10.3 10.4 10.5 10.7 10.33 (b) Reports on Form 8-K filed during the fourth quarter of 1997. The Company filed a Current Report on Form 8-K on October 8, 1997 relating to the signing of a letter of intent with a proposed acquisition. The Company subsequently filed a Current Report on Form 8-K on October 29, 1997 to announce the termination of negotiations regarding the proposed acquisition. The Company filed a Current Report on Form 8-K on December 23, 1997 to announce the signing of the Amended and Restated Agreement and Plan of Merger with Savers Life. SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Date: March 26, 1998 STANDARD MANAGEMENT CORPORATION RONALD D. HUNTER Ronald D. Hunter Chairman, President and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below on March 26, 1998 by the following persons on behalf of the Registrant and in the capacities indicated. RONALD D. HUNTER Ronald D. Hunter Chairman, President and Chief Executive Officer (Principal Executive Officer) * Paul B. Pheffer Director, Executive Vice President, Treasurer and Chief Financial Officer (Principal Financial Officer) * Gerald R. Hochgesang Senior Vice President -- Finance (Principal Accounting Officer) * Raymond J. Ohlson Director * Edward T. Stahl Director * Stephen M. Coons Director * Martial R. Knieser Director * Ramesh H. Bhat Director * James C. Lanshe Director * Robert A. Borns Director John J. Dillon Director * Jerry E. Francis Director *By: /s/ RONALD D. HUNTER Ronald D. Hunter Attorney-in-Fact ANNUAL REPORT ON FORM 10-K ITEM 8, ITEM 14(a)(1) AND (2),(c) AND (d) FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA LIST OF FINANCIAL STATEMENTS and FINANCIAL STATEMENT SCHEDULES CERTAIN EXHIBITS FINANCIAL STATEMENT SCHEDULES Year Ended December 31, 1997 STANDARD MANAGEMENT CORPORATION INDIANAPOLIS, INDIANA STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES INDEX TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES PAGE AUDITED CONSOLIDATED FINANCIAL STATEMENTS Report of Independent Auditors F-2 Consolidated Balance Sheets as of December 31, 1997 and 1996 F-4 Consolidated Statements of Income for the Years Ended December 31, 1997, 1996 and 1995 F-5 Consolidated Statements of Shareholders' Equity for the Years Ended December 31, 1997, 1996 and 1995 F-6 Consolidated Statements of Cash Flows for the Years Ended December 31, 1997, 1996 and 1995 F-7 Notes to Consolidated Financial Statements F-8 FINANCIAL STATEMENT SCHEDULES The following consolidated financial statement schedules are included herein and should be read in conjunction with the Audited Consolidated Financial Statements. Schedule II -- Condensed Financial Information of Registrant (Parent Company) for the Years Ended December 31, 1997, 1996 and 1995 F-27 Schedule IV -- Reinsurance for the Years Ended December 31, 1997, 1996 and 1995 F-31 Schedules not listed above have been omitted because they are not applicable or are not required, or because the required information is included in the Audited Consolidated Financial Statements or Notes thereto. REPORT OF INDEPENDENT AUDITORS Shareholders and Board of Directors Standard Management Corporation We have audited the accompanying consolidated balance sheets of Standard Management Corporation and subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of income, shareholders' equity and cash flows for each of the three years in the period ended December 31, 1997. Our audits also included the financial statement schedules listed in the Index. These financial statements and schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits. We did not audit the consolidated balance sheets at September 30, 1997 and 1996 or the consolidated statements of operations, shareholder's equity and cash flows for the three years ended September 30, 1997 of Standard Management International S.A. and subsidiaries, a wholly owned subsidiary group, which financial statements reflect assets totaling approximately 24% and 23% of the Company's consolidated assets at December 31, 1997 and 1996 and revenues totaling approximately 9%, 9% and 12% of consolidated revenues for each of the three years in the period ended December 31, 1997. Those financial statements, which as explained in Note 1 are included in the Company's consolidated balance sheets at December 31, 1997 and 1996, and the Company's consolidated statements of income, shareholders' equity and cash flows for each of the three years in the period ended December 31, 1997, were audited by other auditors whose report has been furnished to us, and our opinion, insofar as it relates to the data included for Standard Management International S.A., is based solely on the report of other auditors. 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 and the report of other auditors provide a reasonable basis for our opinion. In our opinion, based on our audits and the report of other auditors, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Standard Management Corporation and subsidiaries at December 31, 1997 and 1996, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1997 in conformity with generally accepted accounting principles. Also in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information set forth therein. Ernst & Young LLP Indianapolis, Indiana February 11, 1998 REPORT OF INDEPENDENT AUDITORS Shareholders and Board of Directors Standard Management International S.A. We have audited the consolidated balance sheets of Standard Management International S.A. and subsidiaries as at September 30, 1997 and 1996 and the related consolidated statements of operations, shareholder's equity and cash flows for each of the three years in the period ended September 30, 1997 (none of which aforementioned financial statements are separately presented herein). These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards in the United States of America. 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 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 aspects, the consolidated financial position of Standard Management International S.A. and subsidiaries as at September 30, 1997 and 1996, and the consolidated results of their operations and their cash flows for each of the three years in the period ended September 30, 1997 in conformity with generally accepted accounting principles in the United States of America. Luxembourg City, Luxembourg February 11, 1998 KPMG Audit STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
December 31, 1997 1996 ASSETS Investments: Securities available for sale: Fixed maturity securities, at fair value (amortized cost: 1997 - $372,576 $347,310 $367,372; 1996 - $349,151) Equity securities, at fair value (cost: 1997 - $55; 1996 - $58) 52 62 Mortgage loans on real estate 375 3,035 Policy loans 9,495 9,903 Real estate 2,163 546 Other invested assets 779 865 Short-term investments 13,342 8,417 Total investments 398,782 370,138 Cash 4,165 5,113 Accrued investment income 6,512 6,198 Amounts due and recoverable from reinsurers 61,596 68,811 Deferred policy acquisition costs 21,435 18,309 Present value of future profits 20,537 23,806 Excess of acquisition cost over net assets acquired 2,445 2,260 Federal income tax recoverable 1,854 2,397 Other assets 3,602 2,835 Assets held in separate accounts 148,064 128,546 Total assets $668,992 $628,413 LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities: Insurance policy liabilities $439,390 $425,324 Accounts payable and accrued expenses 6,208 6,249 Obligations under capital lease 141 637 Notes payable 26,000 20,000 Deferred federal income taxes 4,488 3,206 Excess of net assets acquired over acquisition cost 1,388 2,775 Liabilities related to separate accounts 148,064 128,546 Total liabilities 625,679 586,737 Class S Cumulative Convertible Redeemable Preferred Stock, par value $10 per share: Authorized 300,000 shares; issued and outstanding 159,889 shares in 1996 -- 1,757 Shareholders' Equity: Preferred Stock, no par value: Authorized 700,000 shares; none issued and outstanding -- -- Common Stock, no par value: Authorized 20,000,000 shares 40,646 40,481 Treasury stock (4,572) (3,528) Unrealized gain (loss) on securities available for sale 2,171 (746) Foreign currency translation adjustment (473) 691 Retained earnings 5,541 3,021 Total shareholders' equity 43,313 39,919 Total liabilities and shareholders' equity $668,992 $628,413
See accompanying notes to consolidated financial statements. STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Year Ended December 31, 1997 1996 1995 Revenues: Premium income $7,100 $10,468 $5,504 Net investment income 29,516 20,871 18,517 Net realized investment gains 396 1,302 688 Gain on disposal of subsidiaries -- 886 -- Policy charges 5,512 2,551 2,467 Amortization of excess of net assets acquired over 1,388 1,388 1,388 acquisition cost Fees from separate accounts 1,779 1,564 1,294 Other income 1,178 1,277 380 Total revenues 46,869 40,307 30,238 Benefits and expenses: Benefits and claims 9,098 9,919 5,791 Interest credited on interest-sensitive annuities and other 16,281 11,092 10,009 financial products Salaries and wages 5,608 5,053 4,701 Amortization 3,248 2,592 2,044 Other operating expenses 6,991 7,311 6,019 Interest expense and financing costs 2,381 805 118 Total benefits and expenses 43,607 36,772 28,682 Income before federal income taxes, extraordinary gain and preferred stock 3,262 3,535 1,556 dividends Federal income tax expense (credit) 617 (730) 243 Income before extraordinary gain and preferred stock 2,645 4,265 1,313 dividends Extraordinary gain on early redemption of redeemable preferred stock, -- 502 -- net of $-- federal income tax Net income 2,645 4,767 1,313 Preferred stock dividends 97 208 -- Earnings available to common shareholders $2,548 $4,559 $1,313 Earnings per common share: Income before extraordinary gain and preferred stock $ .54 $ .88 $ .25 dividends Extraordinary gain -- .10 -- Net income .54 .98 .25 Preferred stock dividends .02 .04 -- Earnings available to common shareholders $ .52 $ .94 $ .25 Earnings per common share - assuming dilutions: Income before extraordinary gain and preferred stock $ .48 $ .82 $ .25 dividends Extraordinary gain -- .09 -- Net income .48 .91 .25 Preferred stock dividends .01 .04 -- Earnings available to common shareholders - assuming $ .47 $ .87 $ .25 dilutions
See accompanying notes to consolidated financial statements. STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Year Ended December 31, Amounts Number of Shares 1997 1996 1995 1997 1996 1995 Common Stock: Balance, beginning of year $40,481 $39,808 $39,695 5,752,499 5,459,573 5,457,906 Issuance of common stock -- 100 -- -- 20,000 -- 5% common stock dividend -- 850 -- -- 272,926 -- Issuance of common stock warrants 165 285 107 -- -- -- Repurchase of common stock warrants -- (600) -- -- -- -- Gain on reissuance of treasury stock in connection -- 38 -- -- -- -- with purchase of Shelby Life Issuance of common stock in connection with -- -- 6 -- -- 1,667 exercise of stock options Balance, end of year 40,646 40,481 39,808 5,752,499 5,752,499 5,459,573 Treasury stock, at cost: Balance, beginning of year (3,528) (2,621) (2,221) (728,229) (502,025) (418,425) Treasury stock acquired (1,079) (2,126) (400) (154,903) (431,026) (83,600) 5% common stock dividend -- -- -- -- (46,402) -- Reissuance of treasury stock in connection with 35 6 -- 7,123 1,224 -- exercise of stock options Reissuance of treasury stock in connection with -- 1,213 -- -- 250,000 -- purchase of Shelby Life Balance, end of year (4,572) (3,528) (2,621) (876,009) (728,229) (502,025) Unrealized gain (loss) on securities: Balance, beginning of year (746) 2,582 (13,411) Change in unrealized gain (loss) on securities 2,917 (3,328) 15,993 available for sale, net Balance, end of year 2,171 (746) 2,582 Foreign currency translation adjustments: Balance, beginning of year 691 1,159 546 Translation adjustments for the year (1,164) (468) 613 Balance, end of year (473) 691 1,159 Retained earnings (deficit): Balance, beginning of year 3,021 (686) (1,999) Net income 2,645 4,767 1,313 5% common stock dividend, plus cash in lieu of -- (850) -- fractional shares Loss on reissuance of treasury stock (28) (2) -- Preferred stock dividend (97) (208) -- Balance, end of year 5,541 3,021 (686) Total shareholders' equity and common shares $43,313 $39,919 $40,242 4,876,490 5,024,270 4,957,548 outstanding
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (DOLLARS IN THOUSANDS)
Year Ended December 31, 1997 1996 1995 OPERATING ACTIVITIES Net income $2,645 $4,767 $1,313 Adjustments to reconcile net income to net cash provided by operating activities: Amortization of deferred policy acquisition costs 1,456 1,221 1,142 Policy acquisition costs deferred (7,005) (6,400) (1,863) Deferred federal income taxes 1,187 158 353 Depreciation and amortization 1,085 544 78 Insurance policy liabilities 9,441 4,785 6,273 Net realized investment gains (396) (1,302) (688) Accrued investment income (314) (770) 347 Extraordinary gain on early redemption of redeemable -- (502) -- preferred stock Other (335) (775) (624) Net cash provided by operating activities 7,764 1,726 6,331 FINANCING ACTIVITIES Issuance of Common Stock, net -- -- 6 Borrowings, net of debt issuance costs of $70 in 1997, $208 in 5,558 16,792 2,923 1996 and $81 in 1995 Repayments on long-term debt and obligations under capital (543) (491) (353) lease Short-term borrowings, net -- -- (550) Premiums received on interest-sensitive annuities and other financial products credited 49,362 42,347 17,524 to policyholder account balances, net of premiums ceded Return of policyholder account balances on interest-sensitive annuities and other (37,477) (17,356) (17,852) financial products, net of premiums ceded Redemption of redeemable preferred stock (1,855) (949) -- Repurchase of Common Stock warrants -- (600) -- Proceeds from common and treasury stock sales 138 100 -- Purchase of Common Stock for treasury (1,079) (2,126) (400) Net cash provided by financing activities 14,104 37,717 1,298 INVESTING ACTIVITIES Fixed maturity securities available for sale: Purchases (205,976) (249,638) (183,183) Sales 161,891 194,244 191,477 Maturities, calls and redemptions 28,380 10,254 7,812 Short-term investments, net (4,925) 11,890 (21,662) Other investments, net (2,186) (551) 4,082 Proceeds from sale of property and equipment under capital -- -- 1,396 lease Purchase of Shelby Life Insurance Company, less cash acquired -- (14,618) -- of $32 Dividends paid by Shelby Life Insurance Company to former -- (3,000) -- parent Purchase of Dixie National Life Insurance Company, less cash -- -- (3,393) acquired of $4,626 Proceeds from sale of First International Life Insurance Company, less cash transferred -- 11,327 -- to seller of $265 Net cash used by investing activities (22,816) (40,092) (3,471) Net increase (decrease) in cash (948) (649) 4,158 Cash at beginning of year 5,113 5,762 1,604 Cash at end of year $4,165 $5,113 $5,762
See accompanying notes to consolidated financial statements. STANDARD MANAGEMENT CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1997 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES ORGANIZATION Standard Management Corporation ("SMC") is an international financial services holding company, which directly and through its subsidiaries acquires and manages in force life insurance and annuity business and issues and distributes life insurance and annuity products. SMC offers unit-linked assurance products through its international subsidiaries. SMC's active subsidiaries at December 31, 1997 include: (i) Standard Life Insurance Company of Indiana ("Standard Life") and its subsidiary, Dixie National Life Insurance Company ("Dixie National Life"), (ii) Standard Management International S.A. ("Standard Management International") and its subsidiaries, Premier Life (Luxembourg) S.A. ("Premier Life (Luxembourg)") and Premier Life (Bermuda) Ltd. ("Premier Life (Bermuda)") and (iii) Standard Marketing Corporation ("Standard Marketing"). BASIS OF PRESENTATION The accompanying consolidated financial statements of SMC and its subsidiaries (the "Company") have been prepared in conformity with generally accepted accounting principles ("GAAP") and include the accounts of SMC and its majority-owned subsidiaries since acquisition or organization. All significant intercompany balances and transactions have been eliminated. The fiscal year end for Standard Management International is September 30. To facilitate reporting on the consolidated level, the fiscal year end for Standard Management International was not changed and the consolidated balance sheets and statements of operations for Standard Management International at September 30, 1997 and 1996 and for each of the three years in the period ended September 30, 1997, are included in the Company's consolidated balance sheets at December 31, 1997 and 1996 and for each of the three years in the period ended December 31, 1997. USE OF ESTIMATES The nature of the Company's insurance businesses requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Such estimates and assumptions could change in the future as more information becomes known, which could impact the amounts reported and disclosed herein. INVESTMENTS The Company classifies its fixed maturity and equity securities as available for sale and, accordingly, such securities are carried at fair value. Fixed maturity securities include bonds and redeemable preferred stocks. Changes in fair values of securities available for sale, after adjustment for deferred policy acquisition costs, present value of future profits and deferred income taxes, are reported as unrealized gains or losses directly in shareholders' equity and, accordingly, have no effect on net income. The deferred policy acquisition costs and present value of future profits adjustments to the unrealized gains or losses represent valuation adjustments or reinstatements of these assets that would have been required as a charge or credit to operations had such unrealized amounts been realized. The cost of fixed maturity securities is adjusted for amortization of premiums and discounts. The amortization is provided on a constant effective yield method over the life of the securities and is included in net investment income. Mortgage-backed and other collateralized securities, classified as fixed maturity securities in the balance sheet, are comprised principally of obligations backed by an agency of the United States government (although generally not by the full faith and credit of the United States government). The Company has reduced the risk normally associated with these investments by primarily investing in highly rated securities and in those that provide more predictable prepayment patterns. The income from these securities is recognized using a constant effective yield based on anticipated prepayments and the estimated economic life of the securities. When actual prepayments differ significantly from anticipated prepayments, the income recognized is adjusted currently to match that which would have been recorded had the effective yield been applied since the acquisition of the security. This adjustment is included in net investment income. 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Mortgage loans on real estate and policy loans are carried at unpaid principal balances and are generally collateralized. Real estate investments, which the Company has the intent to hold for the production of income, are carried at cost, less accumulated depreciation. Short-term investments are carried at amortized cost, which approximates fair value. NET REALIZED INVESTMENT GAINS OR LOSSES Net realized investment gains and losses are calculated using the specific identification method and included in the consolidated statements of income. If the values of investments decline below their amortized cost and this decline is considered to be other than temporary, the amortized cost of these investments is reduced to net realizable value and the reduction is recorded as a realized loss. FUTURE POLICY BENEFITS Liabilities for future policy benefits for deferred annuities and universal life policies are equal to full account value that accrues to the policyholder (cumulative premiums less certain charges, plus interest credited) with rates ranging from 4.5% to 12% in 1997 and 4.5% to 9% in 1996. Future policy benefits for traditional life insurance contracts are computed using the net level premium method on the basis of assumed investment yields, mortality and withdrawals which were appropriate at the time the policies were issued. Assumed investment yields are based on interest rates ranging from 6.5% to 7.5%. Mortality is based upon various actuarial tables, principally the 1965-1970 Select and Ultimate Table. Withdrawals are based upon Company experience and vary by issue age, type of coverage, and duration. RECOGNITION OF INSURANCE POLICY REVENUE AND RELATED BENEFITS AND EXPENSES Revenue for interest-sensitive annuity contracts consists of policy charges for surrenders and investment income earned. Premiums received for these annuity contracts are reflected as premium deposits and are not recorded as revenues. Expenses related to these annuities include interest credited to policyholder account balances. Revenue for universal life insurance policies consists of policy charges for the cost of insurance, policy administration charges, surrender charges and investment income earned during the period. Expenses related to universal life policies include interest credited to policyholder account balances and death benefits incurred in excess of policyholder account balances. Traditional life insurance and immediate annuity premiums are recognized as premium revenue when due over the premium paying period of the policies. Benefits are charged to expense in the period when claims are incurred and are associated with related premiums through changes in reserves for future policy benefits which results in the recognition of profit over the premium paying period of the policies. REINSURANCE Premiums, annuity policy charges, benefits and claims, interest credited and amortization expense are reported net of reinsurance ceded. Reinsurance premiums, annuity policy charges, benefits and claims, interest credited and amortization expense are accounted for on bases consistent with those used in accounting for the original policies issued and the terms of the reinsurance contracts. SEPARATE ACCOUNTS Separate accounts are maintained primarily for universal life contracts written by Standard Management International of which the majority represent unit-linked business where benefits on surrender and maturity are not guaranteed and investment contracts under which fixed benefits are paid to the policyholder and the terms of which are such that there is little or no mortality risk. Separate accounts generally represent funds maintained in accounts to meet specific investment objectives of policyholders who bear the investment risk. The Company records the related liabilities at amounts equal to the underlying assets. Investment income and investment gains and losses accrue directly to such policyholders. The assets of each account are segregated and are not subject to claims that arise out of any other business of the Company. Deposits, net investment income and realized gains and losses on separate accounts assets are not reflected in the consolidated statements of income. FOREIGN CURRENCY TRANSLATION The Company's foreign subsidiaries' balance sheets and statements of income are translated at the year end exchange rates and average exchange rates for the year, respectively. The resulting unrealized gain or loss adjustment from the translation to U.S. dollars is recorded in the foreign currency translation adjustment as a separate component of shareholders' equity. Other translation adjustments for foreign exchange gains or losses have been reflected in the consolidated statements of income. Foreign exchange gains or losses relating to policyholders' funds in separate accounts are allocated to the relevant separate account. 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) INCOME TAXES Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period in which the change is enacted. Standard Life and Dixie National Life filed separate federal income tax returns for 1996 and prior years and were taxed as separate life insurance companies. For 1997 and subsequent years, Standard Life and Dixie National Life plan to file a life/life consolidated return. SMC, Standard Marketing and other U.S. non-insurance subsidiaries are taxed as regular corporations and file a consolidated return. SMC and its U.S. non-insurance subsidiaries were eligible to consolidate with Standard Life for income tax purposes beginning in 1996, but do not currently plan to do so. Standard Management International is incorporated as a holding company in the Grand Duchy of Luxembourg and, accordingly, is not currently subject to taxation on income or capital gains. Standard Management International is subject to an annual capital tax which is calculated on the nominal value of the statutory shareholder's equity at an annual rate of .20%. Premier Life (Luxembourg) is a normal commercial taxable company and is subject to income tax at regular corporate rates (statutory corporate rate of 39.39%), and annual capital taxes amounting to approximately 1% of its net equity. Premier Life (Bermuda) is exempt from taxation on income until March 2016 pursuant to a decree from the Minister of Finance in Bermuda. To the extent that such income is taxable under U.S. law, such income will be included in SMC's consolidated return. PRESENT VALUE OF FUTURE PROFITS Present value of future profits is recorded in connection with acquisitions of insurance companies or a block of policies. The initial value is based on the actuarially determined present value of the projected future gross profits from the in-force business acquired. In selecting the interest rate to calculate the discounted present value of the projected future gross profits, the Company uses the risk rate of return believed to best reflect the characteristics of the purchased policies, taking into account the relative risks of such policies, the cost of funds to acquire the business and other factors. The value of insurance in force purchased is amortized on a constant yield basis over the estimated life of the insurance in force at the date of acquisition in proportion to the emergence of profits over a period of approximately 20 years. For acquisitions the Company made on or before November 19, 1992, the Company amortizes the asset with interest at the same discount rate used to determine the present value of future profits at date of purchase. For acquisitions after November 19, 1992, including the acquisitions of Dixie National Life and Shelby Life, the Company amortizes the asset using the interest rate credited to the underlying policies. DEFERRED POLICY ACQUISITION COSTS Costs relating to the production of new business (primarily commissions and certain costs of marketing, policy issuance and underwriting) are deferred and included in the deferred policy acquisition cost asset to the extent that such costs are recoverable from future related policy revenues. For interest-sensitive annuities and other financial products, deferred policy acquisition costs, with interest, are amortized over the lives of the policies and products in a constant relationship to the present value of estimated future gross profits, discounted using the interest rate credited to the policy. Traditional life insurance deferred policy acquisition costs are being amortized over the premium-paying period of the related policies using assumptions consistent with those used in computing policy benefit reserves. The Company reviews the recoverability of the carrying value of the deferred policy acquisition costs each year. For interest-sensitive annuities and other financial products, the Company considers estimated future gross profits in determining whether the carrying value is appropriate; for other insurance products, the Company considers estimated future premiums. In all cases, the Company considers expected mortality, interest earned and crediting rates, persistency and expenses. Amortization is adjusted retrospectively for interest-sensitive annuities and other financial products when estimates of future gross profits to be realized are revised. EXCESS OF ACQUISITION COST OVER NET ASSETS ACQUIRED The excess of the cost to acquire purchased companies over the fair value of net assets acquired is being amortized on a straight-line basis over periods that generally correspond with the benefits expected to be derived from the acquisitions, usually 20 to 40 years. Accumulated amortization was $428,000 and $314,000 at December 31, 1997 and 1996, respectively. The Company continually monitors the value of excess of acquisition cost over net assets acquired ("goodwill") based on estimates of future earnings. If it determines that goodwill has been impaired, the carrying value is reduced with a corresponding charge to expense. 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) EXCESS OF NET ASSETS ACQUIRED OVER ACQUISITION COST The excess of the net assets acquired over the cost to acquire purchased companies ("negative goodwill"), after reducing the basis in property and equipment and other noncurrent assets to zero, is being amortized into earnings on a straight-line basis over a five year period. Accumulated amortization was $5,227,000 and $3,839,000 at December 31, 1997 and 1996, respectively. STOCK OPTIONS The Company recognizes compensation expense for its stock option plan using the intrinsic value method of accounting. Under the terms of the intrinsic value method, compensation cost is the excess, if any, of the quoted market price of the stock at the grant date, or other measurement date, over the amount an employee must pay to acquire the stock. Under the Company's stock option plans, no expense is recognized since the exercise price equals or exceeds the market price at the measurement date. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS In February 1997, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share." The Company adopted SFAS No. 128 on December 31, 1997. All earnings per share amounts for all periods presented have been restated to conform to the SFAS No. 128 requirements. SFAS No. 128 eliminates the presentation of primary earnings per share and replaces it with basic earnings per share. Basic earnings per share differs from primary earnings per share because common stock equivalents are not considered in computing basic earnings per share. Fully diluted earnings per share are replaced with diluted earnings per share. Diluted earnings per share is similar to fully diluted earnings per share, except in determining the number of dilutive shares outstanding for options and warrants, the proceeds that would be received upon the conversion of all dilutive options and warrants are assumed to be used to repurchase the Company's common shares at the average market price of such stock during the period. For fully diluted earnings per share, the higher of the average market price or ending market price was used. In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income." SFAS No. 130 defines the financial statement presentation for all changes in a company's equity during a period except those resulting from investments by owners and distributions to owners. SFAS No. 130 is effective for financial statements issued for fiscal years beginning after December 15, 1997 and will be adopted by the Company in the first quarter of 1998. Because the statement is merely a change in presentation, the Company does not expect the adoption of this statement to have any impact on the amount of net income, earnings per share or total shareholders' equity. In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information." SFAS No. 131 supersedes SFAS No. 14 "Financial Reporting for Segments of a Business Enterprise" and defines financial and descriptive information about a company's operating segments that is to be disclosed in financial statements. SFAS No. 131 is effective for financial statements issued for fiscal years beginning after December 15, 1997 and will be adopted by the Company in 1998. Currently, the Company considers its life insurance operations to be its only material operating segment. The Company is in the process of defining additional business segments and developing allocation methods to assess their performance. Once the process is completed, additional disclosures will be provided in accordance with SFAS No. 131. RECLASSIFICATIONS Certain amounts in the 1996 and 1995 consolidated financial statements and notes have been reclassified to conform with the 1997 presentation. These reclassifications had no effect on previously reported shareholders' equity or net income during the periods involved. 2. ACQUISITIONS AND DISPOSALS On November 8, 1996, Standard Life acquired through merger Shelby Life Insurance Company ("Shelby Life") from Delta Life and Annuity Corporation ("DLAC"), a life insurance company located in Memphis, Tennessee (the "Shelby Merger"). The purchase price was approximately $14,650,000, including $13,000,000 in cash, 250,000 shares of restricted Common Stock (valued at $1,250,000) and acquisition costs of $400,000. Financing for the Shelby Merger was provided by senior debt of $10,000,000 and $4,000,000 in subordinated convertible debt. The acquisition of Shelby Life was accounted for using the purchase method of accounting and the consolidated financial statements include the results of Shelby Life from November 1, 1996, the effective date of acquisition. Under purchase accounting, Standard Life allocated the total purchase price of Shelby Life to the assets and liabilities acquired, based on a determination of their fair values and recorded the excess of acquisition cost over net assets acquired as goodwill, which will be amortized on a straight-line basis over 20 years. 2. ACQUISITIONS AND DISPOSALS (CONTINUED) The following schedule summarizes the assets acquired and the liabilities assumed with the Shelby Life acquisition described above (in thousands): Assets acquired: Fixed maturity securities $ 93,376 Policy loans 2,430 Short term investments 4,725 Cash 32 Present value of future profits 7,998 Other assets 2,880 Total assets acquired 111,441 Liabilities assumed: Policy reserves 92,322 Deferred federal income taxes 376 Other liabilities 1,102 Dividends payable to DLAC 3,000 Total liabilities assumed 96,800 Net assets acquired 14,641 Excess of acquisition cost over net assets acquired 9 Total purchase price $ 14,650 The following are supplemental unaudited pro forma consolidated results of operations of the Company for year ended December 31, 1996 as if the acquisition for Shelby Life had occurred at January 1, 1996 presented at the same purchase price, based on estimates and assumptions considered appropriate (in thousands). Revenues $49,344 Income before extraordinary gain 4,242 Net income 4,536 Earnings per share: Income before extraordinary gain .83 Net income .89 Earnings per share, assuming dilution: Income before extraordinary gain .73 Net income .82 The above amounts are based upon certain assumptions and estimates which the Company believes are reasonable and do not reflect any benefit from savings which might be achieved from combined operations. The unaudited pro forma results do not necessarily represent results which would have occurred if the acquisitions had taken place on the basis assumed above, nor are they indicative of the results of future combined operations. On October 2, 1995, Standard Life completed its acquisition of 99.3% of Dixie National Life from Dixie National Corporation ("DNC"), a life insurance holding company located in Jackson, Mississippi. Dixie National Life markets a variety of life insurance products throughout the Mid-South offering primarily "burial expense" policies. The purchase price was $8,019,000, including costs of $684,000, the forgiveness of a $3,689,000 DNC note payable to Standard Life and a $1,720,000 repayment of a DNC note payable. The remaining purchase price of $1,926,000 was paid in cash from internally generated funds. The acquisition was accounted for using the purchase method of accounting and the consolidated financial statements include the results of Dixie National Life from the date of acquisition. Under purchase accounting, Standard Life allocated the total purchase price of Dixie National Life to the assets and liabilities acquired, based on a determination of their fair values. Standard Life recorded goodwill of $1,589,000 which will be amortized on a straight-line basis over 40 years. On March 18, 1996, Standard Life completed the sale of a duplicate charter associated with First International Life Insurance Company ("First International") to The Guardian Insurance and Annuity Company, Inc. ("GIAC"), a subsidiary of The Guardian Group, New York, NY. Standard Life received proceeds of approximately $10,393,000, including $1,500,000 for the charter and licenses associated with First International. Standard Life realized a net pretax gain of $1,042,000 and a tax benefit of $1,420,000 on this sale, or $2,462,000. In addition, First International, Standard Life and GIAC have entered into a series of reinsurance and other agreements that include provisions for Standard Life to administer First International policies in force at the date of sale, and for Standard Life to continue to receive the profit stream from certain First International policies in force at the date of such sale (SEE NOTE 9). 2. ACQUISITIONS AND DISPOSALS (CONTINUED) SMC decided in February 1996 to terminate the reinsurance agreement between Standard Reinsurance of North America Ltd. ("Standard Reinsurance") and Salamandra Joint-Stock Insurance Company in Ukraine ("Salamandra"), and to not renew the Barbados license of Standard Reinsurance. This resulted in the termination of Standard Reinsurance operations and the write-off of SMC's investment in Standard Reinsurance and certain intangible assets of Standard Reinsurance amounting to $156,000. 3. INVESTMENTS The amortized cost, gross unrealized gain (loss) and estimated fair value of securities available for sale are as follows (in thousands):
December 31, 1997 Gross Gross Amortized Unrealized Unrealized Fair Cost Gain (Loss) Value Securities available for sale: Fixed maturity securities: United States Treasury securities and obligations of United States $27,613 $174 $(90) $27,697 government agencies Obligations of states and political 3,790 204 (26) 3,968 subdivisions Foreign government securities 30,558 497 (3,296) 27,759 Utilities 26,606 534 (109) 27,031 Corporate bonds 223,958 8,140 (1,609) 230,489 Mortgaged-backed securities 51,266 657 (60) 51,863 Redeemable preferred stock 3,581 188 -- 3,769 Total fixed maturity 367,372 10,394 (5,190) 372,576 securities Equity securities 55 -- (3) 52 Total securities available for $367,427 $10,394 $(5,193) $372,628 sale December 31, 1996 Gross Gross Amortized Unrealized Unrealized Fair Cost Gain (Loss) Value Securities available for sale: Fixed maturity securities: United States Treasury securities and obligations of United States $20,753 $51 $(420) $20,384 government agencies Obligations of states and political 3,588 106 -- 3,694 subdivisions Foreign government securities 10,042 51 (166) 9,927 Utilities 31,000 295 (675) 30,620 Corporate bonds 210,977 3,086 (3,539) 210,524 Mortgaged-backed securities 72,264 247 (919) 71,592 Redeemable preferred stock 527 42 -- 569 Total fixed maturity 349,151 3,878 (5,719) 347,310 securities Equity securities 58 4 -- 62 Total securities available for $349,209 $3,882 $(5,719) $347,372 sale
The estimated fair values for fixed maturity securities are based on quoted market prices, where available. For fixed maturity securities not actively traded, fair values are estimated using values obtained from independent pricing services, or by discounting expected future cash flows using a current market rate applicable to the coupon rate, credit, and maturity of the investments. 3. INVESTMENTS (CONTINUED) The amortized cost and estimated fair value of fixed maturity securities at December 31, 1997 by contractual maturity are shown below (in thousands). Actual maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties and because most mortgage-backed securities provide for periodic payments throughout their lives. Amortized Fair
COST VALUE Due in one year or less $ 4,560 $ 4,551 Due after one year through five years 31,597 32,048 Due after five years through ten years 141,806 140,972 Due after ten years 134,562 139,373 Subtotal 312,525 316,944 Redeemable preferred stock 3,581 3,769 Mortgage-backed securities 51,266 51,863 Total fixed maturity securities $ 367,372 $ 372,576
The Company maintains a highly-diversified investment portfolio with limited concentration of financial instruments in any given region, industry or economic characteristic. Investments in any entity in excess of 10% of shareholders' equity at December 31, 1997, other than asset-backed securities and investments issued or guaranteed by the U.S. government or a U.S. government agency, all of which were classified as fixed maturity securities available for sale, were as follows (in thousands): Amortized Fair
INVESTMENT COST VALUE Continental Cablevision $ 5,302 $ 5,509 AMERCO 4,994 5,042 Eastern Energy Limited 4,975 5,068 Republic of Indonesia 4,636 3,596
Net investment income was attributable to the following (in thousands):
Year Ended December 31, 1997 1996 1995 Fixed maturity securities $27,151 $19,865 $17,457 Mortgage loans on real estate 123 309 152 Policy loans 618 447 305 Real estate 58 65 120 Short-term investments and other 2,098 602 990 Gross investment income 30,048 21,288 19,024 Investment expenses 532 417 507 Net investment income $29,516 $20,871 $18,517
Net realized investment gains arose from the following (in thousands):
Year Ended December 31, 1997 1996 1995 Fixed maturity securities available for sale: Gross realized gains $2,181 $2,012 $2,115 Gross realized losses 1,695 911 1,662 Net 486 1,101 453 Real estate 26 -- 124 Other gains (losses) (116) 201 111 Net realized investment gains $396 $1,302 $688
3. INVESTMENTS (CONTINUED) Life insurance companies are required to maintain certain amounts of assets with state or other regulatory authorities. At December 31, 1997 fixed maturity securities of $12,658,000 and short-term investments of $1,498,000 were held on deposit by various state regulatory authorities in compliance with statutory regulations. Additionally, fixed maturity securities of $851,000 and short-term investments of $3,590,000 of Standard Management International were held by a custodian bank approved by the Luxembourg regulatory authorities to comply with local insurance laws. 4. DEFERRED POLICY ACQUISITION COSTS AND PRESENT VALUE OF FUTURE PROFITS The activity related to the deferred policy acquisition costs of business produced is summarized as follows (in thousands):
Year Ended December 31, 1997 1996 1995 Balance, beginning of year $18,309 $10,054 $12,206 Additions 7,005 6,400 1,863 Amortization (1,456) (1,221) (1,142) Adjustment relating to net unrealized (gain) loss on (2,423) 3,076 (2,873) securities available for sale Balance, end of year $21,435 $18,309 $10,054
The activity related to the present value of future profits of the business acquired is summarized as follows (in thousands):
Year Ended December 31, 1997 1996 1995 Balance, beginning of year $23,806 $15,246 $8,299 Amounts related to acquisitions and disposals (1,374) 9,615 7,901 Interest accreted on unamortized balance 3,178 2,563 1,566 Gross amortization during the year (4,844) (3,812) (2,346) Adjustments relating to net unrealized (gain) loss on securities available for sale (229) 194 (174) Balance, end of year $20,537 $23,806 $15,246
The percentages of future expected net amortization of the beginning balance of the present value of future profits before the effect of net unrealized gains and losses, based on the present value of future profits at December 31, 1997 and current assumptions as to future events on all policies in force, will be between 6% and 8% in each of the years 1998 through 2002. The discount rate used to calculate the present value of future profits reflected in the Company's consolidated balance sheets at December 31, 1997, ranged from 7.5% to 18%. The Company used a 15% discount rate to calculate the present value of future profits on the Shelby Life and Dixie National Life acquisitions. 5. NOTES PAYABLE SMC has outstanding borrowings at December 31, 1997 pursuant to an Amended Revolving Line of Credit Agreement with a bank (the "Amended Credit Agreement") that provides for it to borrow up to $16,000,000 in the form of a seven-year reducing revolving loan arrangement. SMC has agreed to pay a non-use fee of .50% per annum on the unused portion of the commitment. In connection with the original and Amended Credit Agreement, SMC issued warrants to the bank to purchase 61,500 shares of Common Stock. Borrowings under the Amended Credit Agreement may be used for contributions to surplus of insurance subsidiaries, acquisition financing, and repurchases of Class S Cumulative Convertible Redeemable Preferred Stock ("Class S Preferred Stock") and Common Stock. The debt is secured by a Pledge Agreement of all of the issued and outstanding shares of common stock of Standard Life and Standard Marketing. Interest on the borrowings under the Amended Credit Agreement is determined, at the option of SMC, to be: (i) a fluctuating rate of interest to the corporate base rate announced by the bank from time to time plus 1% per annum, or (ii) a rate at LIBOR plus 3.25%. Annual principal repayments of $2,667,000 begin in November 1998 and conclude in November 2003. Indebtedness incurred under the Amended Credit Agreement is subject to certain restrictions and covenants including, among other things, certain minimum financial ratios, minimum consolidated 5. NOTES PAYABLE (CONTINUED) equity requirements for SMC, positive net income, minimum statutory surplus requirements for the Company's insurance subsidiaries and certain limitations on acquisitions, additional indebtedness, investments, mergers, consolidations and sales of assets. At December 31, 1997, SMC had borrowed $16,000,000 under this Amended Credit Agreement at a weighted average interest rate of 9.069%. In connection with the acquisition of Shelby Life, SMC borrowed $4,000,000 from an insurance company pursuant to a subordinated convertible debt agreement which was due in December 2003. At June 30, 1997, this subordinated convertible debt agreement was amended to the principal amount of $4,372,000 which is due July 2004 unless previously converted, and requires interest payments in cash on January 1 and July 1 of each year at 10% per annum. At June 30, 1997, SMC borrowed an additional $5,628,000 from an insurance company pursuant to another subordinated convertible debt agreement (collectively, the "Notes") which is due July 2004 unless previously converted, and requires interest payments in cash on January 1 and July 1 of each year at 10% per annum. Proceeds from the additional borrowings were used for contributions to surplus of insurance subsidiaries of $2,400,000, redemption of Class S Preferred Stock of approximately $1,840,000 (SEE NOTE 7), and other general corporate purposes. The Notes are convertible at any time at the option of the noteholders into SMC Common Stock at the rate of $5.747 per share. The Notes may be prepaid in whole or in part at the option of SMC commencing on July 1, 2000 at redemption prices equal to 105% of the principal amount (plus accrued interest) and declining to 102% of the principal amount plus accrued interest. The Notes may be prepaid prior to July 1, 2000 at a redemption price equal to 101% of the principal amount (plus accrued interest) under certain limited circumstances. The Notes are subject to certain restrictions and covenants substantially similar to those in the Amended Credit Agreement. Standard Management International has an unused line of credit of $1,615,000, with no borrowings in connection with this line of credit in 1997 or 1996. Interest expense on debt during 1997, 1996 and 1995 was $2,310,000, $773,000 and $116,000, respectively. Cash paid for interest was $1,464,000, $356,000 and $100,000 in 1997, 1996 and 1995, respectively. 6. INCOME TAXES The components of the federal income tax expense (credit), applicable to pre-tax income before extraordinary gains, were as follows (in thousands):
Year Ended December 31, 1997 1996 1995 Current taxes (credit) $(570) $(888) $(110) Deferred taxes 1,187 158 353 $617 $(730) $243
The effective tax rate on pre-tax income before extraordinary gain is lower than the statutory corporate federal income tax rate as follows (in thousands):
Year Ended December 31, 1997 1996 1995 Federal income tax expense at statutory rates (34%) $1,109 $1,202 $529 Small insurance company deduction -- -- (128) Nonrecognition of losses in SMC consolidated return and in foreign 314 543 372 subsidiaries Amortization of excess of net assets acquired over (472) (472) (472) acquisition cost Tax benefit from disposal of subsidiary -- (1,420) -- Tax benefits from capital loss carryforwards not (200) -- -- previously recognized Release of reserve for tax adjustments (100) (325) -- Other items, net (34) (258) (58) Federal income tax expense (credit) $617 $(730) $243 Effective tax rate 19% (21)% 16%
6. INCOME TAXES (CONTINUED) The Company recovered $1,313,000, $130,000 and $280,000 in federal income taxes in 1997, 1996 and 1995, respectively and paid federal income taxes of $200,000 and $900,000 in 1997 and 1996, respectively. Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for tax return purposes. Significant temporary differences included in the Company's deferred tax assets (liabilities) are as follows (in thousands):
December 31, 1997 1996 Deferred income tax assets: Unrealized loss on securities available for sale $ -- $355 Future policy benefits 9,368 8,267 Capital and net operating loss carryforwards 6,123 7,719 Other-net 1,126 1,385 Gross deferred tax assets 16,617 17,726 Valuation allowance for deferred tax assets (6,962) (8,750) Deferred income tax assets, net of valuation allowance 9,655 8,976 Deferred income tax liabilities: Unrealized gain on securities available for sale (1,820) -- Present value of future profits (6,983) (8,093) Deferred policy acquisition costs (5,340) (4,089) Total deferred income tax liabilities (14,143) (12,182) Net deferred income tax liabilities $(4,488) $(3,206)
The Company is required to establish a "valuation allowance" for any portion of its deferred tax assets which are unlikely to be realized. The valuation allowance for deferred tax assets includes $1,560,000 at December 31, 1997 with respect to corporate income tax loss carryforwards of Standard Management International which, if recognized in the future, will result in an addition to negative goodwill and be amortized into income over its remaining life. The valuation allowance for deferred tax assets includes $1,770,000 at December 31, 1997 with respect to deferred tax assets at the date of acquisition and net tax operating loss carryforwards of Dixie National Life and Shelby Life which, if recognized in the future, will result in a reduction to goodwill and be amortized into income over its remaining life by reducing goodwill amortization expense. As of December 31, 1997, SMC and its noninsurance subsidiaries had consolidated net operating loss carryforwards of approximately $9,320,000 for tax return purposes which expire from 2005 through 2012. These carryforwards will only be available to reduce the taxable income of SMC. At December 31, 1997, the Standard Life consolidated return had tax return net operating loss carryforwards of approximately $4,100,000 which expire in 2010 and 2012. These carryforwards will only be available to reduce the taxable income of the Standard Life consolidated return. At December 31, 1997, Premier Life (Luxembourg) had accumulated corporate income tax loss carryforwards of approximately $3,960,000, all of which may be carried forward indefinitely. The Internal Revenue Service has completed its examination of the Company for years through 1993 in 1996. All adjustments to taxable income determined by completed examinations, which were not material, have reduced the net operating loss carryforwards. Upon completion of the examination, a tax reserve for adjustments of $325,000 was released and recorded in income in 1996. In 1997, the Internal Revenue Service completed its examination of Standard Life through 1995. All adjustments including a tax benefit from previously expired capital loss carryforwards were settled during 1997 resulting in a net tax benefit of approximately $200,000 during 1997 and upon completion of the examination, a tax reserve for adjustments of $100,000 was released into income in 1997. 7. SHAREHOLDERS' EQUITY REDEEMABLE PREFERRED STOCK Shareholders have authorized 1,000,000 shares of Preferred Stock. Other terms, including preferences, voting and conversion rights, may be established by the Board of Directors. In March 1995, 300,000 of these shares designated as Class S Preferred Stock, $10.00 per share par value, were issued February 8, 1996. In February 1996, SMC instituted a program to repurchase from time to time up to 300,000 shares of its Class S Preferred Stock in the open market or privately negotiated 7. SHAREHOLDERS' EQUITY (CONTINUED) transactions. Through December 31, 1996, SMC had repurchased and retired 140,111 shares of its Class S Preferred Stock on the open market at a cost of $949,000. These repurchases resulted in an extraordinary gain of $502,000 in 1996. Effective as of August 1, 1997, SMC redeemed all of the issued and outstanding Class S Preferred Stock at an aggregate redemption value of $1,840,000 ($10.00 per share plus accumulated and unpaid dividends). COMMON STOCK The Company has a stock repurchase program and repurchases its Common Stock from time to time. The Company repurchased 154,903, 431,026 and 83,600 shares of Common Stock for $1,079,000, $2,126,000 and $400,000 in 1997, 1996 and 1995, respectively. At December 31, 1997, the Company is authorized to purchase an additional 365,644 shares under this program. The following table represents outstanding warrants to purchase Common Stock as of December 31, 1997: Exercise Warrants ISSUE DATE EXPIRATION DATE PRICE OUTSTANDING June 1989 December 1999 $3.5216 236,858 July 1992 June 1998 3.5296 175,800 January 1994 January 1998 7.8571 42,000 September 1995 September 1998 5.2381 4,200 November 1995 November 2002 4.5238 31,500 July 1996 July 2003 4.3750 30,000 August 1996 August 1998 4.3125 100,000 September 1996 September 1998 5.0000 25,000 September 1996 September 1999 5.5000 17,000 July 1997 July 2000 5.7500 75,000 September 1997 September 2000 7.5000 15,000 752,358 UNREALIZED GAIN (LOSS) ON SECURITIES The components of the balance sheet caption "Unrealized gain (loss) on securities available for sale" in shareholders' equity are summarized as follows (in thousands):
December 31, 1997 1996 Fair value of securities available for sale $372,628 $347,372 Amortized cost of securities available for sale 367,427 349,209 Gross unrealized gain (loss) on securities available for sale 5,201 (1,837) Adjustments for: Deferred policy acquisition costs (1,727) 696 Present value of future profits (209) 20 Deferred federal income tax recoverable (liability) (1,094) 375 Net unrealized gain (loss) on securities available for sale $2,171 $ (746)
8. STOCK OPTION PLAN SMC has a non-qualified Stock Option Plan (the "Plan") under which 2,500,000 (increased by 1,000,000 shares effective October 29, 1997) shares of Common Stock are reserved for grants of stock options to employees and directors. The purchase price per share specified in any Plan option must be at least equal to the fair market value of common stock at the grant date. Options generally become exercisable over a three-year period and have a term of 10 years. The Plan is administered by the Board of Directors and officers of SMC. The terms of the options, including the number of shares and the exercise price, are subject to the sole discretion of the Board of Directors. A total of 562,988 shares are available for future issuance for the Plan as of December 31, 1997. 8. STOCK OPTION PLAN (CONTINUED) SFAS No. 123 entitled "Accounting for Stock-Based Compensation" issued in October 1995, was adopted by the Company as of December 31, 1996. The provisions of SFAS No. 123 allow companies to either expense the estimated fair value of stock options or to continue their current practice but disclose the pro forma effects on net income and earnings per share had the fair value of the options been expensed. The Company has elected to continue its practice of recognizing compensation expense for its Plan using the intrinsic value based method of accounting and to provide the required pro forma information. Had compensation cost for the Plan been determined based on the fair value at the grant date for awards under the Plan consistent with the provisions of SFAS No. 123, the Company's pro forma net income and pro forma earnings per share would have been the following (in thousands):
Year Ended December 31, 1997 1996 1995 Net income $1,945 $3,847 $685 Earnings per share .37 .75 .13 Earnings per share, assuming .35 .71 .13 dilution
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-valuation model with the following weighted-average assumptions :
1997 1996 1995 Risk-free interest rates 5.7% 5.9% 6.6% Volatility factors .37 .49 .39 Weighted average expected life 7 years 7 years 7 years
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferrable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in subjective assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not provide a reliable single measure of the fair value of its employee stock options. Because SFAS No. 123 is effective only for awards granted after January 1, 1995, the pro forma disclosures provided may not be representative of the effects on reported net income for future years. A summary of the Company's stock option activity and related information for the years ended December 31, 1997, 1996 and 1995 is as follows:
1997 1996 1995 Weighted- Weighted- Weighted- Average Average Average Exercise Exercise Exercise Price Price Price Shares Shares Shares Options outstanding, beginning 1,446,169 $5.98 1,164,720 $6.46 520,294 $7.73 of year Exercised (17,300) 4.52 (1,224) 3.57 (1,667) 3.75 Granted 685,000 6.29 769,122 6.14 655,008 5.40 Expired or forfeited (197,049) 4.30 (486,449) 7.56 (8,915) 5.50 Options outstanding, end of 1,916,820 6.08 1,446,169 5.98 1,164,720 6.46 year Options exercisable, end of 1,467,185 1,097,028 762,374 year Weighted-average fair value of options $3.10 $3.62 $2.90 granted during the year
8. STOCK OPTION PLAN (CONTINUED) Information with respect to stock options outstanding at December 31, 1997 is as follows:
Options Outstanding Options Exercisable Weighted- Weighted- Weighted- Range of Average Average Average Exercise Number Remaining Exercise Number Exercise Prices Outstanding Contractual Price Exercisable Price Life (years) $3-$5 367,650 9 Years $4.37 231,350 $4.31 $5-$7 1,036,949 9 Years 5.98 723,614 5.76 $7-$9 492,533 5 Years 7.41 492,533 7.41 $9-$11 19,688 6 Years 9.40 19,688 9.40 1,916,820 1,467,185
9. REINSURANCE The Company's insurance subsidiaries have entered into reinsurance agreements with non-affiliated companies to limit the net loss arising from large risks, maintain their exposure to loss within capital resources, provide additional capacity for future growth, and effect sharing arrangements. The maximum amount of life insurance retained on any one life ranges from $30,000 to $150,000. Amounts of standard risk in excess of that limit are reinsured. Reinsurance premiums ceded to other insurers were $4,821,000, $2,152,000 and $4,312,000 in 1997, 1996 and 1995, respectively. Reinsurance ceded has reduced benefits and claims incurred by $5,383,000, $6,201,000 and $1,369,000 in 1997, 1996 and 1995, respectively. A contingent liability exists to the extent any of the reinsuring companies are unable to meet their obligations under the reinsurance agreements. To minimize exposure to significant losses from reinsurance insolvencies, the Company evaluates the financial condition of its reinsurers and monitors concentrations of credit risk arising from similar geographic regions, activities, or economic characteristics of the reinsurers. Based on its periodic reviews of these companies, the Company believes the assuming companies are able to honor all contractual commitments under the reinsurance agreements. The Company's largest annuity reinsurer at December 31, 1997 represented $32,194,000, or 52.3% of total reinsurance recoverable, $8,707,000 of premium deposits ceded in 1997 and is rated "A" (Excellent) by A.M. Best. From January 1, 1995 to August 31, 1995, approximately 70% of Standard Life's annuity business pursuant to the terms of the agreement produced after December 31, 1994 was ceded. Standard Life decreased the quota-share portion of business ceded pursuant to this agreement to 50% at September 1, 1995, and further reduced it to 25% effective April 1, 1996. This agreement limits dividends and other transfers by Standard Life to SMC or affiliated companies in certain circumstances. All the inforce business of First International effective January 1, 1996 was ceded to GIAC through a coinsurance indemnity reinsurance agreement. Under the terms of the agreement, approximately $18,841,000 of First International's reserves and the related assets were ceded to GIAC as of January 1, 1996. Effective at January 1, 1996, GIAC entered into a modified coinsurance indemnity reinsurance agreement with Standard Life relating to this business. Under the terms of the agreement, approximately $18,841,000 of Standard Life's reserves were assumed from GIAC as of January 1, 1996. In addition, at the date of the sale of First International to GIAC, Standard Life ceded a block of business with policy reserves of $12,514,000 and related assets to GIAC. In June 1988, Standard Life ceded a block of business to National Mutual Life Insurance Company ("National Mutual"). Effective May 31, 1996, Standard Life terminated by recapture the reinsurance agreement with National Mutual. As a result of this recapture, Standard Life received premium income, and corresponding increase in reserves, of $4,234,000 and agreed to pay National Mutual a net recapture fee of $825,000. 10. RELATED PARTY TRANSACTIONS SMC is a guarantor on a $70,000 loan to a director and officer. The guaranty will be effective until the earlier of repayment of the loan or June 25, 1999. On October 28, 1997, SMC made an interest-free loan to an officer and director of SMC, in the amount of $778,000, representing a new loan in the sum of $438,000 and consolidation of an existing loan. The principal balance of the loan was $778,000 and $338,000 at December 31, 1997 and 1996, respectively. Repayment is due within 10 days of the officer's voluntary termination or resignation as an officer of SMC. In the event of a termination of the officer's employment with SMC following a change in control, the loan is deemed to be forgiven. 10. RELATED PARTY TRANSACTIONS (CONTINUED) SMC entered into a covenant not to compete agreement with a former officer and director in February 1997, effective July 1, 1996, the date his employment agreement terminated. In accordance with the covenant not to compete agreement, the officer and director received payments of $275,000 in 1997, and will receive $125,000 in 1998 and $100,000 in 1999. 11. COMMITMENTS AND CONTINGENCIES LEASE COMMITMENTS The Company rents office and storage space under noncancellable operating leases. The Company incurred rent expense for operating leases of $932,000, $1,037,000 and $1,092,000 in 1997, 1996 and 1995, respectively. Pursuant to the terms of a lease agreement effective June 1, 1991, Standard Life has agreed to lease office space for a ten year period. After the initial ten year lease period, Standard Life may continue to lease the premises on a month to month basis at a rental of 125% of the prevailing market rate for the leased premises in effect at that time. In April 1995, SMC sold its equipment and leased it back under a capital lease. SMC has the option to renew or purchase the equipment at the end of the lease term in April 1998. The cost of the equipment was $1,396,000 and accumulated depreciation of $1,279,000 and $814,000 at December 31, 1997 and 1996, respectively. Future required minimum rental payments, by year and in the aggregate, under noncancellable capital leases and operating leases as of December 31, 1997, are as follows (in thousands): Capital Operating LEASES LEASES 1998 $144 $ 779 1999 -- 790 2000 -- 721 2001 -- 366 2002 -- 128 Thereafter -- 128 Total minimum lease payments 144 $2,912 Less amounts representing interest 3 Present value of net minimum lease payments under capital lease $141 EMPLOYMENT AGREEMENTS Certain officers are employed pursuant to executive employment agreements that create certain liabilities in the event of the termination of the covered executives following a change in control of the Company. The commitment under these agreements is approximately three times their current annual salaries. Additionally, following termination from the Company following a change in control, each executive is entitled to receive a lump sum payment equal to all unexercised stock options granted multiplied by the highest per share fair market value during the six month period ending on the date of termination. There were unexercised options outstanding to these executives to buy 1,177,880 shares at December 31, 1997. 12. LITIGATION An officer and director of SMC resigned effective as of April 15, 1997. On June 19, 1997, this former officer commenced an action in the Superior Court of Marion County, Indiana, against SMC claiming that his employment agreement contained a provision to the effect that, following a termination of his employment with SMC under certain circumstances, he would be entitled to receive certain benefits. This former officer has asserted to SMC that he is entitled to a lump sum termination payment of $1,654,000 and liquidated damages not exceeding $3,308,000 by virtue of his voluntarily leaving SMC's employment. SMC disputes those claims. SMC filed its Answer and Counterclaim on September 11, 1997. SMC's investigation since the action was filed revealed a basis for the termination of employment of the former officer for cause relative to after-acquired evidence. On October 14, 1997, the Board of Directors of SMC terminated the former officer for cause effective as of March 15, 1997. Such termination will also be argued by SMC as a complete defense to all claims asserted by the former officer. The ultimate outcome of the action cannot presently be determined. Accordingly, no provision for any liability that may result has been made in the consolidated financial statements. Management believes that the conclusion of such litigation will not have a material adverse effect on SMC's consolidated financial condition. 12. LITIGATION (CONTINUED) In addition, the Company is involved in various legal proceedings in the normal course of business. In most cases, such proceedings involve claims under insurance policies or other contracts of the Company. The outcomes of these legal proceedings are not expected to have a material adverse effect on the consolidated financial position, liquidity, or future results of operations of the Company based on the Company's current understanding of the relevant facts and law. 13. STATUTORY ACCOUNTING INFORMATION OF SUBSIDIARIES The Company's U.S. life insurance subsidiaries maintain their records in conformity with statutory accounting practices prescribed or permitted by state insurance regulatory authorities. Statutory accounting practices differ in certain respects from GAAP. In consolidation, adjustments have been made to conform the Company's domestic subsidiaries' accounts with GAAP. The Company's U.S. life insurance subsidiaries had consolidated statutory capital and surplus of $25,923,000 and $22,970,000 at December 31, 1997 and 1996, respectively, after appropriate eliminations of intercompany accounts among such subsidiaries. Consolidated net income (loss) of the Company's life insurance subsidiaries on a statutory basis, after appropriate eliminations of intercompany accounts among such subsidiaries, was $1,776,000, $3,291,000 and $(1,339,000) for the years ended December 31, 1997, 1996 and 1995, respectively. Minimum statutory capital and surplus required by the Indiana Insurance Code was $450,000 as of December 31, 1997. "Prescribed" statutory accounting practices include a variety of publications of the National Association of Insurance Commissioners ("NAIC"), as well as state laws, regulations, and general administrative rules. "Permitted" statutory accounting practices encompass all accounting practices that are not prescribed; such practices may differ from state to state, may differ from company to company within a state, and may change in the future. The NAIC currently is in the process of codifying statutory accounting practices, the result of which is expected to constitute the only source of "prescribed" statutory accounting practices. Accordingly, that project, which is expected to be completed in 1998, will likely change, to some extent, prescribed statutory accounting practices, and may result in changes to the accounting practices that insurance enterprises use to prepare their statutory financial statements. Policy reserves for Dixie National Life's fixed premium universal life policies were calculated according to the Commissioners' Reserve Valuation Method ("CRVM") for traditional whole life policies. This differs from prescribed statutory accounting practices. Effective October 2, 1995, Dixie National Life received permission from the Mississippi Insurance Department to strengthen the reserves for these policies by using the CRVM methodology as modified by the Universal Life Model Regulation. This reserve strengthening will be recorded quarterly through September 30, 1998. This permitted accounting practice increased statutory surplus by $451,000 and $1,053,000 as of December 31, 1997 and 1996, respectively. From the funds borrowed by SMC pursuant to the Amended Credit Agreement and the subordinated convertible debt agreement, $13,000,000 was loaned to Standard Life pursuant to an Unsecured Surplus Debenture Agreement ("Surplus Debenture") which requires Standard Life to make quarterly interest payments to SMC at a variable corporate base rate plus 2% per annum, and annual principal payments of $1,000,000 per year beginning in 2007 and concluding in 2019. As required by state regulatory authorities, the balance of the surplus debenture at December 31, 1997 of $13,000,000 is classified as a part of capital and surplus of Standard Life. The interest and principal payments are subject to quarterly approval by the Indiana Department of Insurance, depending upon satisfaction of certain financial tests relating to levels of Standard Life's capital and surplus and general approval of the Commissioner of the Indiana Department of Insurance. SMC's ability to pay operating expenses and meet debt service obligations is partially dependent upon the amount of dividends received from Standard Life. Standard Life's ability to pay cash dividends to SMC is, in turn, restricted by law or subject to approval by the insurance regulatory authorities of Indiana. Dividends are permitted based on, among other things, the level of preceding year statutory surplus and net income. In 1997 and 1996, Standard Life paid dividends of $1,600,000 and $1,000,000, respectively, to SMC. In 1995, Standard Life paid no dividends to SMC. During 1998, Standard Life can pay dividends of $2,592,000 without regulatory approval; Standard Life must notify the Indiana regulatory authorities of the intent to pay dividends at least thirty days prior to payment. State insurance regulatory authorities impose minimum risk-based capital requirements on insurance enterprises that were developed by the NAIC. The formulas for determining the amount of risk-based capital ("RBC") specify various weighting factors that are applied to financial balances or various levels of activity based on the perceived degree of investment and insurance risks. Regulatory compliance is determined by a ratio (the "Ratio") of the enterprise's regulatory total adjusted capital, as defined by the NAIC, to its authorized control level RBC, as defined by the NAIC. Enterprises below specific trigger points or ratios are classified within certain levels, each of which requires specified corrective action. Each of the Company's insurance subsidiaries has a Ratio that is at least 400% of the minimum RBC requirements; accordingly, the subsidiaries meet the RBC requirements. 13. STATUTORY ACCOUNTING INFORMATION OF SUBSIDIARIES (CONTINUED) The statutory capital and surplus for Premier Life (Luxembourg) was $7,288,000 and $8,243,000 at fiscal years ended 1997 and 1996, respectively, and minimum capital and surplus under local insurance regulations was $2,915,000 and $3,295,000 at fiscal years ended 1997 and 1996, respectively. The statutory capital and surplus for Premier Life (Bermuda) was $1,357,000 and $1,307,000 at fiscal years ended 1997 and 1996, respectively, and minimum capital and surplus under local insurance regulations was $250,000 at fiscal years ended 1997 and 1996. Standard Management International dividends are limited to its accumulated earnings without regulatory approval. Standard Management International and Premier Life (Luxembourg) were not permitted to pay dividends under Luxembourg law in 1997 and 1996 due to accumulated losses. 14. OPERATIONS BY GEOGRAPHIC AREA The Company operates exclusively in one business segment -- the sale and administration of life insurance business (principally annuities and other financial products). The revenues, pre-tax income and assets by geographic segment for 1997 through 1995 are as follows (in thousands):
Year Ended December 31, 1997 1996 1995 Revenues: United States $42,651 $36,524 $26,851 International 4,218 3,783 3,387 Total $46,869 $40,307 $30,238 Income before federal income taxes, extraordinary Year Ended gain and December 31, preferred stock dividends: United States $1,541 $2,313 $1,224 International 1,721 1,222 332 Total $3,262 $3,535 $1,556 At December 31, 1997 1996 1995 Assets: United States $508,476 $486,576 $343,040 International 160,516 141,837 136,558 Total $668,992 $628,413 $479,598
The states in the U.S. with the largest share of U.S. premiums collected in 1997 were Indiana (21%), California (11%), Ohio (10%), and Florida (10%). No other state accounted for more than 5% of total collected premiums. 15. FAIR VALUE OF FINANCIAL INSTRUMENTS The following discussion outlines the methods and assumptions used by the Company in estimating its fair value disclosures for its financial instrument assets and liabilities. Because fair values for all balance sheet items are not required to be disclosed pursuant to SFAS No. 107, "Disclosures about Fair Values of Financial Instruments", the aggregate fair value amounts presented herein do not necessarily represent the underlying value of the Company; likewise, care should be exercised in deriving conclusions about the Company's business or financial condition based on the fair value information presented herein. FIXED MATURITY SECURITIES: Fair values for fixed maturity securities are based on quoted market prices from broker-dealers, where available. For fixed maturity securities not actively traded, fair values are estimated using values obtained from independent pricing services, or, in the case of private placements, are estimated by discounting the expected future cash flows using current market rates applicable to the coupon rate, credit, and maturity of the investments. EQUITY SECURITIES: The fair values for equity securities are based on the quoted market prices. 15. FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED) MORTGAGE LOANS AND POLICY LOANS: The estimated fair values for mortgage loans and policy loans are estimated using discounted cash flow analyses and interest rates currently being offered for similar loans to borrowers with similar credit ratings. ASSETS AND LIABILITIES HELD IN SEPARATE ACCOUNTS: Fair values for the assets held in separate accounts are determined from broker-dealer market makers, or valuations supplied by internationally recognized statistical rating organizations. The separate account liability represents the Company's obligations to policyholders and approximates fair value. INSURANCE LIABILITIES FOR INVESTMENT CONTRACTS: Fair values for the Company's liabilities under investment-type insurance contracts are estimated using discounted cash flow calculations, based on interest rates currently being offered for similar contracts with maturities consistent with those remaining contracts being valued. The estimated fair value of the liabilities for investment contracts was approximately equal to its carrying value at December 31, 1997 and 1996, as credited rates on the vast majority of account balances approximate current rates paid on similar investments and because these rates are generally not guaranteed beyond one year. INSURANCE LIABILITIES FOR NON-INVESTMENT CONTRACTS: Fair value disclosures for the Company's reserves for insurance contracts other than investment-type contracts are not required and have not been determined by the Company. However, the Company closely monitors the level of its insurance liabilities and the fair value of reserves under all insurance contracts are taken into consideration in the Company's overall management of interest rate risk. NOTES PAYABLE: The Company believes the fair value of its variable rate long-term debt was equal to its carrying value at December 31, 1997 and 1996. The Company negotiated the terms of its Amended Credit Agreement with its lenders in November 1996. Those negotiations were based on the financial condition of the Company and market conditions at that time. The financial condition of the Company has not changed significantly since the negotiations and although market conditions have changed, the Company pays a variable rate of interest on the debt which reflects the change in market conditions. The fair value of the subordinated convertible debt is based on quoted market prices for the amount of shares convertible at December 31, 1997. The carrying amount for all other financial instruments approximates their fair values. The fair value of the Company's financial instruments is shown below using a summarized version of the Company's assets and liabilities at December 31, 1997 and 1996 (in thousands). Refer to Note 3 for additional information relating to the fair value for investments.
December 31, 1997 1996 Fair Carrying Fair Carrying Value Amount Value Amount Assets: Investments: Securities available for sale: Fixed maturity securities $372,576 $372,576 $347,310 $347,310 Equity securities 52 52 62 62 Mortgage loans on real estate 377 375 3,041 3,035 Policy loans 8,978 9,495 7,767 9,903 Other invested assets 779 779 888 865 Short-term investments 13,342 13,342 8,417 8,417 Assets held in separate 148,064 148,064 128,546 128,546 accounts Liabilities: Insurance liabilities for 350,607 350,607 333,633 333,633 investment contracts Obligations under capital lease 141 141 637 637 Notes payable 27,419 26,000 20,000 20,000 Liabilities related to separate 148,064 148,064 128,546 128,546 accounts
16. EARNINGS PER SHARE A reconciliation of the numerator and denominator of the earnings per share computation is as follows (dollars in thousands, except per share amounts):
1997 1996 1995 Numerator: Income before extraordinary gain and preferred stock $2,645 $4,265 $1,313 dividends Extraordinary gain on early redemption of redeemable -- 502 -- preferred stock Preferred stock dividends (97) (208) -- Numerator for basic earnings per share - Income available to common shareholders 2,548 4,559 1,313 Effect of dilutive securities: Preferred stock dividends 97 208 -- 14% subordinated convertible debt -- 82 -- 10% subordinated convertible debt -- -- -- 97 290 1,313 Numerator for diluted earnings per share - Income available to common sharehodlers after assumed $2,645 $4,849 $1,313 conversions Denominator: Denominator for basic earnings per share - weighted - 4,948,302 4,856,316 5,244,495 average shares Effect of dilutive securities: Stock options 182,615 24,311 5,240 Stock warrants 230,285 108,062 96,202 Convertible preferred stock 230,015 393,701 -- 14% subordinated convertible debt -- 166,667 -- 10% subordinated convertible debt -- -- -- Dilutive potential common shares 642,915 692,741 101,442 Denominator for diluted earnings per share - adjusted weighted -average 5,591,217 5,549,057 5,345,937 shares and assumed conversions Basic earnings per share $ .52 $ .94 $ .25 Diluted earnings per share $ .47 $ .87 $ .25
The Notes convertible in 1997 (SEE NOTE 5) were not included in the computation of diluted earnings per share in 1997 because the effect would be antidilutive. 17. PENDING ACQUISITION On December 9, 1997, SMC and Savers Life Insurance Company ("Savers Life") entered into an Amended and Restated Agreement and Plan of Merger (the "Merger Agreement") with Savers Life surviving as a wholly-owned subsidiary of SMC. Subject to the terms and conditions of the Merger Agreement, each share of Savers Life Common Stock outstanding immediately prior to the Effective Time (as defined in the Merger Agreement) of the Merger will be converted into 1.2 shares of SMC Common Stock plus $1.50. Each holder of Savers Life Common Stock may elect to receive the $1.50 per share portion of the merger consideration in the form of additional shares of SMC Common Stock. Assuming each holder of Savers Life Common Stock elects to receive $1.50 per share cash consideration in lieu of electing to receive shares of SMC Common Stock and a value per share of $7.00 per share, SMC will issue 2.1 million shares with a value of approximately $15 million to acquire the Savers Life Common Stock. SMC has received a commitment to increase the Amended Credit Agreement to $20,000,000 to finance the acquisition of Savers Life. The acquisition is expected to close in March 1998. Savers Life underwrites, markets and distributes annuities, life insurance, and Medicare supplement health insurance through a sales force consisting of 4,000 independent brokers and is licensed to sell products in North Carolina, South Carolina, Virginia and Florida. Savers Life had total assets of $72,186,000 at December 31, 1997 and revenues of $43,047,000 for the year ended December 31, 1997. 18. QUARTERLY FINANCIAL DATA (UNAUDITED) (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) Earnings per common and common equivalent share for each quarter are computed independently of earnings per share for the year. Due to the transactions affecting the weighted average number of shares outstanding in each quarter and due to the uneven distribution of earnings during the year, the sum of the quarterly earnings per share may not equal the earnings per share for the year. The 1996 and first three quarters of 1997 earnings per share amounts have been restated to comply with SFAS No. 128.
1997 Quarters First Second Third Fourth Total revenues $12,019 $11,292 $11,599 $11,959 Components of net income: Operating income $528 $661 $537 $658 Net realized investment gains 115 21 53 72 Net income $643 $682 $590 $730 Net income per common share $ .13 $ .14 $ .12 $ .15 Net income per common share, assuming dilution $ .11 $ .12 $ .11 $ .13 1996 Quarters First Second Third Fourth Total revenues $8,856 $12,665 $7,969 $10,817 Components of net income: Operating income $214 $(187) $342 $804 Net realized investment gains 145 125 129 387 Gain on disposal of subsidiaries 2,306 -- -- -- Extraordinary gain on early redemption of 101 166 233 2 redeemable preferred stock Net income $2,766 $104 $704 $1,193 Net income per common share $ .55 $ .02 $ .15 $ .24 Net income per common share, assuming dilution $ .51 $ .02 $ .13 $ .21
Reporting the results of insurance operations on a quarterly basis requires the use of numerous estimates throughout the year, primarily in the computation of reserves, amortization of deferred policy acquisition costs and present value of future profits, and the effective rate for income taxes. It is the Company's practice to review estimates at the end of each quarter and, if necessary, make appropriate adjustments, with the effect of such adjustments being reported in current operations. Only at year-end is the Company able to assess the accuracy of its previous quarterly estimates. The Company's fourth quarter results include the effect of the difference between previous estimates and actual year-end results. Therefore, the results of an interim period may not be indicative of the results of the entire year. SCHEDULE II -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT STANDARD MANAGEMENT CORPORATION (PARENT COMPANY) CONDENSED BALANCE SHEETS (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
December 31, 1997 1996 ASSETS Investments: Investment in subsidiaries $52,005 $46,422 Surplus debenture due from Standard Life 13,000 13,000 Equity securities available for sale, at fair value (amortized 2 12 cost: 1997 - $5; 1996 -$8) Real estate 130 139 Investment in joint venture -- 320 Notes receivable from officers and directors 778 338 Short-term investments, at cost, which approximates fair value 79 124 65,994 60,355 Cash 1,327 900 Property and equipment, less accumulated depreciation of $1,636 in 1997 879 1,087 and $989 in 1996 Note receivable from affiliate 2,858 2,858 Amounts receivable from subsidiaries 1,212 638 Other assets 1,892 829 Total assets $74,162 $66,667 LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities: Obligations under capital lease $141 $637 Notes payable 26,000 20,000 Note payable to affiliate 2,858 2,858 Amounts due to subsidiaries 397 473 Other liabilities 1,453 1,023 Total liabilities 30,849 24,991 Class S Cumulative Convertible Redeemable Preferred Stock, par value $10 per share: Authorized 300,000 shares; issued and outstanding 159,889 shares in -- 1,757 1996 Shareholders' Equity: Preferred Stock, no par value: Authorized 700,000 shares; none issued and outstanding -- -- Common Stock, no par value: Authorized 20,000,000 shares; issued 5,752,499 shares 40,646 40,481 Treasury stock, at cost, 876,009 shares in 1997 and 728,229 shares in (4,572) (3,528) 1996 Unrealized gain (loss) on securities available for sale of subsidiaries 2,171 (746) Foreign currency translation adjustment of subsidiaries (473) 691 Retained earnings 5,541 3,021 Total shareholders' equity 43,313 39,919 Total liabilities and shareholders' equity $74,162 $66,667
See accompanying notes to condensed financial statements. STANDARD MANAGEMENT CORPORATION (PARENT COMPANY) CONDENSED STATEMENTS OF INCOME (DOLLARS IN THOUSANDS)
Year Ended December 31, 1997 1996 1995 Revenues: Net investment income $ -- $32 $112 Interest income from subsidiaries 1,519 357 172 Net realized investment gains -- -- 23 Loss on disposal of subsidiary -- (156) -- Other income 154 135 28 Rental income from subsidiaries 1,145 853 715 Management fees from subsidiaries 2,100 1,905 1,930 Total revenues 4,918 3,126 2,980 Expenses: Other operating expenses 3,420 3,470 2,479 Interest expense and financing costs 2,367 799 110 Interest expense on note payable to affiliate 162 161 172 Total expenses 5,949 4,430 2,761 Income (loss) before federal income taxes, equity in earnings of consolidated subsidiaries, extraordinary gain (1,031) (1,304) 219 and preferred stock dividends Federal income tax expense (credit) (76) -- (57) Income (loss) before equity in earnings of consolidated subsidiaries, extraordinary gain and preferred (955) (1,304) 276 stock dividends Equity in earnings of consolidated subsidiaries 3,600 5,569 1,037 Income before extraordinary gain and preferred 2,645 4,265 1,313 stock dividends Extraordinary gain on early redemption of redeemable -- 502 -- preferred stock, net of $-- federal income tax Net income 2,645 4,767 1,313 Preferred stock dividends 97 208 -- Earnings available to common shareholders $2,548 $4,559 $1,313
See accompanying notes to condensed financial statements. STANDARD MANAGEMENT CORPORATION (PARENT COMPANY) CONDENSED STATEMENTS OF CASH FLOWS (DOLLARS IN THOUSANDS)
Year Ended December 31, 1997 1996 1995 OPERATING ACTIVITIES Net income $2,645 $4,767 $1,313 Adjustments to reconcile net income to net cash provided by operating activities: Amortization of deferred debt issuance costs 71 32 2 Depreciation and amortization 646 564 562 Equity in earnings of subsidiaries (3,600) (5,569) (1,037) Accrued interest payable 435 320 -- Other liabilities 79 192 480 Net realized investment gain -- -- (23) Dividend from Standard Life 1,600 1,000 -- Extraordinary gain -- (502) -- Other (370) 165 (905) Net cash provided by operating activities 1,506 969 392 FINANCING ACTIVITIES Issuance of Common Stock, net -- -- 6 Borrowings, net of debt issuance costs of $70 in 1997, $208 in 1996 5,558 16,792 2,923 and $81 in 1995 Repayments on long-term debt and obligations under (543) (491) (312) capital lease Short-term borrowings, net -- -- (550) Redemption of redeemable preferred stock (1,855) (949) -- Repurchase of stock warrants -- (600) -- Proceeds from common and treasury stock sales 138 100 -- Purchase of Common Stock for treasury (503) (2,126) (822) Net cash provided by financing activities 2,795 12,726 1,245 INVESTING ACTIVITIES Investments, net (1,035) 197 653 Proceeds from sale of property and equipment under -- -- 1,396 sales leaseback Purchase of property and equipment, net (439) (246) (475) Surplus debenture contributed to Standard Life -- (13,000) -- Capital contribution to Standard Life (2,400) -- (3,000) Capital contribution to Standard Management -- -- (170) International Capital contribution to Standard Advertising, Inc. -- -- (173) Capital contribution to Standard Reinsurance -- -- (6) Net cash used by investing activities (3,874) (13,049) (1,775) Net increase (decrease) in cash 427 646 (138) Cash at beginning of year 900 254 392 Cash at end of year $1,327 $900 $254
See accompanying notes to condensed financial statements. SCHEDULE II--CONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONTINUED) STANDARD MANAGEMENT CORPORATION (PARENT COMPANY) NOTES TO CONDENSED FINANCIAL STATEMENTS DECEMBER 31, 1997 1. BASIS OF PRESENTATION For purposes of these condensed financial statements, Standard Management Corporation ("SMC") carries its investments in subsidiaries at cost plus equity in undistributed earnings of subsidiaries since date of acquisition. Net income of its subsidiaries is included in income using the equity method. These condensed financial statements should be read in conjunction with SMC's consolidated financial statements included elsewhere in this document. 2. DIVIDENDS FROM SUBSIDIARIES SMC received a cash dividend from subsidiaries of $1,600,000 and $1,000,000 in 1997 and 1996, respectively. There were no cash dividends paid to SMC from its subsidiaries in 1995. SCHEDULE IV -- REINSURANCE STANDARD MANAGEMENT CORPORATION YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 (DOLLARS IN THOUSANDS)
Percentage Ceded to Assumed of Amount Gross Other from Other Assumed Amount Companies Companies Net Amount to Net YEAR ENDED DECEMBER 31, 1997 Life insurance in force $2,447,782 $1,269,848 $237 $1,178,171 .02% Premiums Life insurance and annuities $11,735 $4,821 $-- $6,914 Accident and health insurance 17 -- -- 17 Supplementary contract and other funds 169 -- -- 169 on deposit Total premiums $11,921 $4,821 $-- $7,100 YEAR ENDED DECEMBER 31, 1996 Life insurance in force $3,000,763 $1,633,340 $252 $1,367,675 .02% Premiums Life insurance and annuities $11,862 $2,152 $-- $9,710 Accident and health insurance 21 -- -- 21 Supplementary contract and other funds 737 -- -- 737 on deposit Total premiums $12,620 $2,152 $-- $10,468 YEAR ENDED DECEMBER 31, 1995 Life insurance in force $2,316,826 $1,490,812 $282 $826,296 .03% Premiums Life insurance and annuities $9,574 $4,312 $-- $5,262 Accident and health insurance 22 -- -- 22 Supplementary contract and other funds 220 -- -- 220 on deposit Total premiums $9,816 $4,312 $-- $5,504
EX-4.4 2 AMENDED AND RESTATED REGISTRATION RIGHTS AGREEMENT EXHIBIT D Amended and Restated Registration Rights Agreement between STANDARD MANAGEMENT CORPORATION and FLEET NATIONAL BANK 1 AMENDED AND RESTATED REGISTRATION RIGHTS AGREEMENT THIS AMENDED AND RESTATED REGISTRATION RIGHTS AGREEMENT (this "AGREEMENT") is made as of April 15, 1997 by and between STANDARD MANAGEMENT CORPORATION, an Indiana corporation (the "COMPANY"), and FLEET NATIONAL BANK, a national banking association (the "STOCKHOLDER"). WHEREAS, the Company and the Stockholder entered into an Amended and Restated Revolving Line of Credit Agreement dated as of November 8, 1996 (the "Existing Credit Agreement") pursuant to which the Company was indebted to the Stockholder for up to the principal amount of $16,000,000; and WHEREAS, in connection therewith, the Company executed certain Warrants To Purchase Common Stock of the Company dated as of November 21, 1995 and July 18, 1996, respectively, in favor of the Stockholder (the "Initial Warrants"), and also entered into an Amended and Restated Registration Rights Agreement dated as of November 8, 1996 by and between the Stockholder and the Company (the "Existing Registration Rights Agreement"); and WHEREAS, the Company has requested that the Stockholder increase the funds available to the Company under the Existing Credit Agreement up to the principal amount of $20,000,000; and WHEREAS, it is a condition precedent to the Stockholder making said increase available to the Company that (i) the Existing Credit Agreement be amended pursuant to a certain Amendment No. 1 to Revolving Line of Credit Agreement and Other Loan Documents dated as of the date hereof between the Company and the Stockholder, (ii) the Company deliver an additional Warrant To Purchase Common Stock of the Company dated as of the date hereof (collectively, with the Initial Warrants, referred to herein as the "WARRANTS") entitling the Stockholder to subscribe for and purchase 12,000 additional shares of common stock of the Company; and (iii) that the Existing Registration Rights Agreement be amended and restated in its entirety; and WHEREAS, certain capitalized terms used herein are used as defined in Article 11 herein and in the Initial Warrants and the other Warrants. NOW, THEREFORE, in consideration of the mutual covenants herein contained, and intending to be legally bound hereby, the parties hereto agree as follows: 1. DEMAND REGISTRATION 1.1. REQUESTS FOR REGISTRATION. (i) At any time, a holder of Warrants or Warrant Stock may demand registration under the Securities Act of all or any portion of the Registrable Securities owned by such holder. In order to accomplish such demand, a holder shall send written notice of the demand to the Company, and such notice shall specify the number of Registrable Securities sought to be registered. Unless the Company elects, at its sole option, to make a cash payment to the holder of the Warrants or Warrant Stock as more particularly described in Section 1.1(ii) below in lieu of proceeding with a Demand Registration, the Company shall proceed with any Demand Registration requested by a holder of Warrants or Warrant Stock if the number of Registrable Securities which the Stockholders (including the holder requesting the Demand Registration) shall have elected to include in such Demand Registration pursuant to this Section 1.1 shall be at least 51% of the Warrant Stock issued or issuable upon exercise of the Warrants (excluding Warrant Stock already the subject of a Demand Registration). The minimum share amounts specified in this Section 1.1 shall be appropriately adjusted to account for any stock dividend, stock split, recapitalization, merger, consolidation, reorganization or other action as a result of which additional shares of Common Stock are issued on account of, in conversion of or in exchange for shares of outstanding Common Stock. (ii) If the holder of the Warrants or Warrant Stock makes a demand for a Demand Registration of all or a portion of the Registrable Securities owned by such holder, the Company may, instead, at its sole option, elect to make a cash payment to such holder equal to the value of the Warrants or Warrant Stock (or the portion thereof being exercised) in an amount computed using the formula set forth in Section 2.1(iii)(2) of the Warrants. 1.2. MAXIMUM NUMBER OF DEMAND REGISTRATIONS. In no event shall the total number of Demand Registrations exceed two. 1.3. PROCEDURE. Within 10 days after receipt of a demand pursuant to Section 1.1 hereof, the Company shall give written notice of such requested registration to all other Stockholders and will include in such registration, subject to the allocation provisions below, all other Registrable Securities with respect to which the Company has received written requests for inclusion within 20 days after the Company's mailing of such notice, plus any securities of the Company that the Company chooses to include on its own behalf. 1.4. EXPENSES. The Company will pay the Registration Expenses of any Demand Registration, but the Underwriting Commissions, if such Demand Registration is underwritten, will be paid by the Selling Stockholders in proportion to any Registrable Securities to be included on their behalf. 1.5. EXPENSES. The Company shall pay the Registration Expenses of the first Demand Registration, but the Underwriting Commissions, if such first Demand Registration is underwritten, will be paid by the Selling Stockholders in proportion to any Registrable Securities to be included on their behalf. The Selling Stockholders shall pay the Registration Expenses and the Underwriting Commissions, if any, of all other Demand Registrations in proportion to the Registrable Securities included on their behalf. 1.6. PRIORITY ON DEMAND REGISTRATIONS. If a Demand Registration is underwritten and the managing underwriters advise the Company in writing that in their opinion the number of Registrable Securities requested to be included exceeds the number that can be sold in such offering, at a price reasonably related to the fair value, the Company will allocate the Registrable Securities to be included in such Demand Registration, first, to the holders of Warrants and Warrant Stock PRO RATA on the basis of the number of shares of Warrant Stock for which the Company has received written requests for inclusion, and, second, to the Company, and, third, PRO RATA on the basis of the number of Registrable Securities owned by the Selling Stockholders. 1.7. SELECTION OF UNDERWRITERS. Any Demand Registration may be underwritten, at the election of the Selling Stockholders, and the selection of investment banker(s) and manager(s) and the other decisions regarding the underwriting arrangements for any such offering will be made by the Selling Stockholders; PROVIDED, HOWEVER, that the selection of investment banker(s) and manager(s) shall be subject to the consent of the Company, such consent not to be unreasonably withheld. 2. PIGGYBACK REGISTRATIONS 2.1. RIGHT TO PIGGYBACK. Whenever the Company proposes to register the offer, sale or offer and sale of any of its securities for its own behalf under the Securities Act (other than a Demand Registration), and the registration form to be used may be used for the registrations of Registrable Securities to be sold in the manner proposed by the Selling Stockholders (a "PIGGYBACK REGISTRATION"), the Company will give prompt written notice to all Stockholders and will include in such Piggyback Registration, subject to the allocation provisions below, all Registrable Securities with respect to which the Company has received written requests for inclusion within 20 days after the Company's mailing of such notice. The Company shall not select a Restricted Form that would preclude registration of the Registrable Securities that the Company has been requested to include in such registration if the Company could use another available form of registration statement which is not a Restricted form and the use of which would not give rise to added Registration Expenses. 2.2. PIGGYBACK EXPENSES. In all Piggyback Registrations, the Company will pay the Registration Expenses related to the Registrable Securities of the Selling Stockholders, but the Underwriting Commissions will be paid by the Selling Stockholders in proportion to any Registrable Securities included on their behalf. 2.3. PRIORITY ON PRIMARY REGISTRATIONS. If a Piggyback Registration is an underwritten registration on behalf of the Company, and the managing underwriters advise the Company in writing that in their opinion the number of securities requested to be included in such registration exceeds the number that can be sold in such offering, at a price reasonable related to fair value, the Company will allocate the securities to be included as follows: first, the securities the Company proposes to sell on its own behalf; second, Registrable Securities requested to be included in such registration, PRO RATA on the basis of the number of Registrable Securities owned, among the Selling Stockholders; and third, securities requested to be included in such registration by any stockholders of the Company other than the Selling Stockholders. 2.4. WITHDRAWAL OR ABANDONMENT. Nothing contained in this Section 2 shall be construed as limiting or otherwise interfering with the right of the Company to withdraw or abandon in its sole discretion any registration statement filed by it in connection with a Piggyback Registration notwithstanding the inclusion therein of Registrable Securities. 3. HOLDBACK AGREEMENTS Each of the Stockholder and the Company agree not to effect any public sale or public distribution of equity securities of the Company of any securities convertible into or exchangeable or exercisable for such securities during the 7 days prior to and the 180 days after any underwritten registration of equity securities of the Company becomes effective (except as part of such underwritten registration or except in connection with obligations of the Company existing on the effective date of the registration statement relating to such underwritten offering). 4. REGISTRATION PROCEDURES Whenever the Stockholders have requested that any Registrable Securities be registered pursuant to Section 1 of this Agreement, unless the Company elects, at its sole option, to make a cash payment to the holder of the Warrants or Warrant Stock as more particularly described in Section 1.1(ii) above in lieu of proceeding with a Demand Registration, the Company will, as expeditiously as possible, or whenever the Stockholders have requested that any Registrable Securities be registered pursuant to Section 2 of this Agreement, the Company will, to the extent applicable: (a) PREPARATION AND FILING OF REGISTRATION STATEMENT. Prepare and file with the Securities and Exchange Commission a registration statement with respect to such Registrable Securities and use its best efforts to cause such registration statement to become effective (provided that before filing a registration statement or prospectus or any amendments or supplements thereto, the Company will furnish each Selling Stockholder with copies of all such documents proposed to be filed). (b) PREPARATION AND FILING OF AMENDMENTS AND SUPPLEMENTS. Prepare and file with the Securities and Exchange Commission such amendments and supplements to such registration statement and the prospectus used in connection therewith as may be necessary to keep such registration statement effective for the greater of (x) a period of not less than 120 days or (y) until the Registrable Securities included therein have been sold. (c) COPIES OF DOCUMENTS. Furnish to each Selling Stockholder such number of copies of such registration statement, each amendment and supplement thereto and the prospectus included in such registration statement (including each preliminary prospectus), and such other documents as such Selling Stockholder may reasonably request in order to facilitate the disposition of the Registrable Securities included therein owned by such Selling Stockholder. (d) BLUE SKY QUALIFICATIONS. Use its best efforts to register or quality such Registrable Securities under such other securities or blue sky laws of such jurisdictions as the Selling Stockholders or managing underwriters may reasonably request; PROVIDED, HOWEVER, that in connection with any such registration or qualification the Company shall not be obligated to file a general consent to service of process, or to qualify to do business as a foreign corporation, or otherwise subject itself to taxation in connection with such qualification or compliance. (e) NOTIFICATION OF EFFECTIVENESS; AMENDMENTS. Notify each Selling Stockholder at any time when a prospectus relating to the Registrable Securities included therein is required to be delivered under the Securities Act within the period that the Company is required to keep the registration statement effective of the happening of any event as a result of which the prospectus included in such registration statement as theretofore amended or supplemented contains an untrue statement of a material fact or omits any material fact necessary to make the statements therein not misleading, and, at the request of any such Selling Stockholder, the Company will prepare a supplement or amendment to such prospectus so that, as thereafter delivered to the purchasers of such Registrable Securities, such prospectus will not contain an untrue statement of a material fact or omit to state any material fact necessary to make the statements therein not misleading. (f) LISTING. Cause all such Registrable Securities to be listed or included on securities exchanges on which similar securities issued by the Company are then listed or included. (g) TRANSFER AGENT AND REGISTRAR. Provide a transfer agent and registrar for all such Registrable Securities not later than the effective date of such registration statement. (h) OTHER AGREEMENTS. Enter into such customary agreement (including an underwriting agreement containing customary terms and conditions, including usual and customary indemnification provisions, in form reasonably acceptable to the Company) and take such other customary actions as may be reasonable necessary to expedite or facilitate the disposition of such Registrable Securities. (i) LETTERS FROM INDEPENDENT ACCOUNTANTS. Obtain a "cold comfort" letter addressed to the Company from its independent accountants in such form and covering such matters of the type customarily covered by "cold comfort" letters delivered by such public accountants. (j) INSPECTION OF RECORDS. Make available for inspection by any Selling Stockholder, and, upon execution of a confidentiality agreement mutually acceptable to all parties, by any underwriter participating in any disposition pursuant to such registration statement and any attorney, accountant or other agent retained by any such seller or underwriter, all financial and other records, pertinent corporate documents and properties of the Company, and cause the Company's officers, directors and employees to supply all information reasonably requested by any such seller, underwriter, attorney, accountant or agent in connection with such registration statement. 5. REPRESENTATIONS AND WARRANTIES OF THE COMPANY The Company hereby represents and warrants to the Stockholders: 5.1. DUE ORGANIZATION AND GOOD STANDING. The Company is a corporation duly organized and validly existing under the laws of its jurisdiction of incorporation and is duly qualified as a foreign corporation in each jurisdiction in which the failure to be so qualified could reasonably be expected to have a material adverse effect on the Company. 5.2. DUE AUTHORIZATION; BINDING EFFECT. The execution and delivery of this Agreement by the Company has been duly authorized by all necessary corporate action and this Agreement constitutes the legal, valid and binding obligation of the Company, enforceable against the Company in accordance with its terms. 5.3. NO VIOLATION OR DEFAULT. The execution and delivery by the Company of this Agreement does not, and the performance by the Company of its obligations hereunder will not, violate any provisions of its charter or by-laws or constitute a default under any other agreement to which the Company is a party or by which it or its assets may be bound. 6. REPRESENTATIONS AND WARRANTIES OF THE STOCKHOLDER The Stockholder represents and warrants to the Company: 6.1. DUE ORGANIZATION AND GOOD STANDING. The Stockholder is a national banking association, duly organized and validly existing under the laws of the United States of America and is duly qualified as a foreign corporation in each jurisdiction in which the failure to be so qualified could reasonably be expected to have a material adverse effect on such Stockholder. 6.2. DUE AUTHORIZATION; BINDING EFFECT. The execution and delivery of this Agreement by the Stockholder has been duly authorized by all necessary action and this Agreement constitutes the legal, valid and binding obligation of such Stockholder enforceable against such Stockholder in accordance with its terms. 6.3. NO VIOLATION. The execution and delivery of this Agreement by the Stockholder does not, and the performance by such Stockholder of its obligations hereunder will not, violate any provision of the organizational documents of such Stockholder. 6.4. NO DEFAULT. The execution and delivery of this Agreement by the Stockholder does not, and the performance by such Stockholder of its obligations hereunder will not, violate any other agreement to which such Stockholder is a party or by which any of its assets may be bound. 7. Information Regarding Selling Stockholders Each Selling Stockholder shall provide to the Company such information as may be reasonably requested by the Company for use in the preparation and filing of any registration statement covering Registrable Securities owned by such Selling Stockholder, and the obligation of the Company to include Registrable Securities in any registration statement on behalf of any Selling Stockholder shall be subject to such Selling Stockholder's providing such information as promptly as practicable. 8. Indemnification 8.1. INDEMNIFICATION BY THE COMPANY. The Company hereby indemnifies, to the extent permitted by law, each Selling Stockholder, its officers and directors, and each person who controls such holder (within the meaning of the Securities Act), against all losses, claims, damages, liabilities and expenses arising out of or resulting from any untrue or alleged untrue statement of material fact contained in any registration statement, prospectus or preliminary prospectus or any omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading except insofar as the same occurs in reliance upon and in conformity with any information furnished in writing to the Company by any Selling Stockholder expressly for use therein or is caused by any such Selling Stockholder's failure to deliver a copy of the registration statement or prospectus or any amendments or supplements thereto after the Company has furnished such Selling Stockholder with copies of the same. 8.2. INDEMNIFICATION BY THE SELLING STOCKHOLDERS. In connection with any registration statement in which a Selling Stockholder is participating, each such Selling Stockholder will furnish to the Company in writing such information as is reasonably requested by the Company for use in such registration statement or prospectus and will indemnify, to the extent permitted by law, the Company, its directors and officers and each person who controls the Company (within the meaning of the Securities Act) against any losses, claims, damages, liabilities and expenses arising out of or resulting from any untrue or alleged untrue statement of material fact or any omission or alleged omission of a material fact required to be stated in the registration statement or prospectus or any amendment thereof or supplement thereto or necessary to make the statements therein not misleading, but only to the extent that such untrue statement or omission or such alleged untrue statement or alleged omission occurs in reliance upon and in conformity with information so furnished in writing by such Selling Stockholder specifically for use in the registration statement. 8.3. PROCEDURES AS TO INDEMNIFICATION. Any person entitled to indemnification hereunder shall (i) give prompt notice to the indemnifying party of any claim with respect to which it may seek indemnification and (ii) unless in such indemnified party's reasonable judgment a conflict of interest between such indemnified and indemnifying parties may exist with respect to such claim, permit such indemnifying party to assume the defense of such claim with counsel reasonable satisfactory to the indemnified party. If such defense is assumed, the indemnifying party will not be subject to any liability for any settlement made without its consent (but such consent will not be unreasonably withheld). An indemnifying party who is not entitled to, or elects not to, assume the defense of a claim will not be obligated to pay the fees and expenses of more than one counsel for all parties indemnified by such indemnifying party with respect to such claim, unless in the reasonable judgment of any indemnified party a conflict of interest may exist between such indemnified party and any other of such indemnified parties with respect to such claim. 8.4. CONTRIBUTION. If the indemnification provided for in this Section 8 is held by a court of competent jurisdiction to be unavailable to an indemnified party with respect to any loss, liability, claim, damage, or expense referred to therein, then the indemnifying party, in lieu of indemnifying such indemnified party hereunder, shall contribute to the amount paid or payable by such indemnified party as a result of such loss, liability, claim, damage, or expense in such proportion as is appropriate to reflect the relative fault of the indemnifying party on the one hand and of the indemnified party on the other in connection with the statements or omissions that resulted in such loss, liability, claim, damage, or expense (including legal fees or expenses) as well as any other relevant equitable considerations. The relative fault of the indemnifying party and of the indemnified party shall be determined by reference to, among other things, whether the untrue or alleged untrue statement of a material fact or the omission to state a material fact relates to information supplied by the indemnifying party or by the indemnified party and the parties' relative intent, knowledge, access to information, and opportunity to correct or prevent such statement or omission. The Company and each holder of Registrable Securities agree that it would not be just and equitable if contribution pursuant to this Section 8.4 were determined by PRO RATA allocation or by any other method of allocation which does not take into account the equitable considerations referred to in the immediately preceding paragraph. Notwithstanding the provisions of this Section 8, an indemnified Holder shall not be required to contribute any amount in excess of the net proceeds received by the indemnified Holder from the sale of the Registrable Securities. No person guilty of fraudulent misrepresentation (within the meaning of Section 11(f) of the 1933 Act) shall be entitled to contribution from any person who was not guilty of such fraudulent misrepresentation. 9. Condition to the Company's Obligations In connection with an underwritten offering, it shall be a condition to the Company's obligations to include Registrable Securities on behalf of any Selling Stockholder that the underwriters agree to indemnify the Company, its directors and officers and each person who controls the Company (within the meaning of the Securities Act) against any losses, claims, damages, liabilities and expenses arising out of or resulting from any untrue or alleged untrue statement of material fact or any omission or alleged omission of a material fact required to be stated in the registration statement or prospectus or any amendment thereof or supplement thereto or necessary to make the statements therein no misleading, but only to the extent that such untrue statement or omission or such alleged untrue statement or alleged omission is contained in information furnished in writing by such underwriters on their own behalf specifically for use in preparing the registration statement. 10. FORM S-3 AND RULE 144 10.1. AVAILABILITY OF SHORT FORM. The Company represents and warrants that it meets and will use its best efforts to continue to meet the requirements which must be met by the Company in order for the Registrable Securities to be registered in a Demand Registration on Form S-3 under the Securities Act or any comparable or successor form or forms; and the Company further represents and warrants that it has registered the Common Stock and will use its best efforts to register any other Registrable Securities and maintain the registration of any securities registered under the Securities Exchange Act of 1934 in accordance with the provisions of that Act. 10.2. CONDITIONS OF RULE 144. The Company represents and warrants that it satisfies and will use its best efforts to continue to satisfy the conditions set forth in Rule 144 under the Securities Act which must be satisfied by an issuer in order for a holder of restricted securities to sell such securities under the provisions of such rule, including the timely filing of all reports required to be filed under the Securities Exchange Act of 1934, as amended. 11. Definitions 11.1. AGREEMENT. The term "AGREEMENT" shall mean this Registration Rights Agreement, as the same may be amended from time to time. 11.2. COMMON STOCK. The term "COMMON STOCK" shall mean the Common Stock, no par value, of the Company. 11.3. COMPANY. The term "COMPANY" shall have the meaning set forth in the first paragraph of this Agreement. 11.4. DEMAND REGISTRATION. The term "DEMAND REGISTRATION" shall have the meaning set forth in Section 1.1 hereof. 11.6. PIGGYBACK REGISTRATION. The term "PIGGYBACK REGISTRATION" shall have the meaning set forth in Section 2.1 hereof. 11.7. REGISTRABLE SECURITIES. The term "REGISTRABLE SECURITIES" means any Common Stock registered in the names of the Stockholders from time to time, any Warrant Stock issued or issuable upon exercise of Warrant, and any securities issued or to be issued with respect to such securities by way of a stock dividend or stock split or in connection with a combination of shares, recapitalization, merger, consolidation or other reorganization. As to any particular Registrable Securities, such securities will cease to be Registrable Securities when they have been (i) effectively registered under the Securities Act or disposed of in accordance with the registration statement covering them or (ii) transferred pursuant to Rule 144 under the Securities Act (or any similar rule then in force). 11.8. REGISTRATION EXPENSES. The term "REGISTRATION EXPENSES" means all expenses incident to the Company's performance of or compliance with this Agreement, including without limitation all registration and filing fees, fees and expenses of compliance with securities or blue sky laws, printing expenses, messenger and delivery expenses, expenses and fees for listing the securities to be registered on exchanges or trading system on which similar securities issued by the Company are then listed or included, and fees and disbursements of counsel for the Company. 11.9. RESTRICTED FORM. The term "RESTRICTED FORM" shall mean a form of registration statement under the Securities Act which imposes for its use a limitation on the maximum value or number of securities to be included therein. 11.10. SECURITIES ACT. The term "SECURITIES ACT" shall mean the Securities Act of 1933, as amended. 11.11. SELLING STOCKHOLDER. The term "SELLING STOCKHOLDER" means any Stockholder who requests inclusion of all or a portion of its shares of Registrable Securities in a Demand Registration pursuant to Sections 1 herein or a Piggyback Registration pursuant to Section 2. 11.12. SHORT FORM. The term "SHORT FORM" shall have the meaning set forth in Section 1.1 hereof. 11.13. STOCKHOLDERS. The term "STOCKHOLDER" or shall have the meaning set forth in the first paragraph hereof, and the term "STOCKHOLDERS" shall mean, collectively, the Stockholder and any other holder(s) of Warrants issued by the Company. 11.14. UNDERWRITING COMMISSIONS. The term "UNDERWRITING COMMISSIONS" means all underwriting discounts or commissions relating to the sale of securities of the Company, but excludes any expenses reimbursed to underwriters. 12. Miscellaneous 12.1. NOTICES. Any notices required hereunder shall be sent by certified or registered mail, and shall be addressed to the address of the Company's corporate headquartered in the case of any notice to the Company, and until changed by notice to the Company, to the Stockholders at their address set forth opposite their signatures hereto. 12.2. AMENDMENTS AND WAIVERS. The provisions of this Agreement may be amended and the Company may take any action herein prohibited, or omit to perform any act herein required to be performed by it, if the Company has obtained the written consent of the Stockholders which own 51% of the Registrable Securities. 12.3. SUCCESSORS AND ASSIGNS. All covenants and agreements in this Agreement by or on behalf of any of the parties hereto will bind and inure to the benefit of the respective transferees, successors and personal representatives of the Stockholders. The rights to cause the Company to register Registrable Securities pursuant to this Agreement shall follow the Warrants, and the Warrant Stock and shall be exercisable by the holders of any Warrants or Warrant Stock, including any transferees of Warrants or Warrant Stock. 12.4. GOVERNING LAW. All questions concerning the construction, validity and interpretation of this Agreement will be governed by the law of the State of Connecticut. 12.5. COUNTERPARTS. This Agreement may be executed in any number of counterparts, each of which shall be considered to be an original instrument and to be effective as of the date first written above. IN WITNESS WHEREOF, the parties have executed this Agreement as of the date first written above. STANDARD MANAGEMENT CORPORATION By STEPHEN M. COONS Name: Stephen M. Coons, Esq. Title: Executive Vice President and General Counsel FLEET NATIONAL BANK By MILDRED CHAVARRIA JONES Name: Mildred Chavarria Jones Title: Vice President EX-4.5 3 FLEET NATIONAL BANK WARRANT EXHIBIT C THIS WARRANT AND THE SHARES OF COMMON STOCK ISSUABLE UPON THE EXERCISE OF THIS WARRANT HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE "SECURITIES ACT") AND MAY NOT BE SOLD OR TRANSFERRED IN THE ABSENCE OF SUCH REGISTRATION OR AN EXEMPTION THEREFROM UNDER THE SECURITIES ACT. No. of Shares of Common Stock: Warrant No. 4 WARRANT To Purchase Common Stock of STANDARD MANAGEMENT CORPORATION THIS IS TO CERTIFY THAT FLEET NATIONAL BANK, or its registered assigns, is entitled, at any time or from time to time prior to the Expiration Date (as hereinafter defined), to purchase from Standard Management Corporation, an Indiana corporation (the "COMPANY"), 12,000 shares of Common Stock (as hereinafter defined and subject to adjustment as provided herein), in whole or in part, at a purchase price of $5.125 per share, all on the terms and conditions and pursuant to the provisions hereinafter set forth. 1 DEFINITIONS. As used in this Warrant, the following terms have the respective meanings set forth below: "ADDITIONAL SHARES OF COMMON STOCK" shall mean all shares of Common Stock issued or issuable by the Company after the Closing Date, other than the Warrant Stock. "AFFILIATE" shall have the meaning set forth in the Revolving Line of Credit Agreement. "ASSIGNED VALUE" shall mean, in respect of any share of Common Stock on any date herein specified (i) if there is a public market for Common Stock, the average closing price of the Common Stock on the largest exchange on which such shares are traded (or if not traded on an exchange, then the average of the closing bid and ask prices quoted over-the-counter) over the 10 trading days prior to the date of the determination (as such prices are reported in The Wall Street Journal or if not so reported, in any nationally recognized financial journal or newspaper), (ii) if there is no public market for Common Stock, the highest price at which shares of Common Stock are offered for sale in a public offering registered pursuant to the Securities Act or in an arms-length private offering, if any such offering is pending (unless such offer is revoked prior to such sale) on the date of determination of the Assigned Value, or (iii) if there is no public market for Common Stock and no such offering is pending, the fair market value per share of Common Stock as determined in good faith by the Company's board of directors. "BUSINESS DAY" shall mean any day that is not a Saturday or Sunday or a day on which banks are required or permitted to be closed in the State of Connecticut. "CAPITAL STOCK" means, with respect to any Person, any and all shares, interests, participations or other equivalents (however designated) of capital stock, including each class of common stock and preferred stock of such Person. "CLOSING DATE" shall mean April 15, 1997. "COMMISSION" shall mean the Securities and Exchange Commission or any other federal agency then administering the Securities Act and other federal securities laws. "COMMON STOCK" shall mean (except where the context otherwise indicates) the Common Stock, no par value, of the Company as constituted on the Closing Date, and any Capital Stock into which such Common Stock may thereafter be changed, and shall also include (i) Capital Stock of the Company of any other class (regardless of how denominated) issued to the holders of shares of Common Stock upon any reclassification thereof which is also not preferred as to dividends or assets over any other class of stock of the Company and which is not subject to redemption and (ii) shares of common stock of any successor or acquiring corporation (as defined in Section 4.7) received by or distributed to the holders of Common Stock of the Company in the circumstances contemplated by Section 4.7. "COMMON STOCK OUTSTANDING" shall mean, at any date as of which the number of shares thereof is to be determined, all issued and outstanding shares of Common Stock and shall include all shares issuable in respect of outstanding scrip or any certificates representing fractional interests in shares of Common Stock. "CONVERTIBLE SECURITIES" shall mean evidences of indebtedness, shares of stock or other securities which are convertible into or exchangeable, with or without payment of additional consideration in cash or property, for Additional Shares of Common Stock, either immediately or upon the occurrence of a specified date or a specified event. "CURRENT MARKET PRICE" shall mean, in respect of any share of Common Stock on any date herein specified, the Assigned Value per share of Common Stock as at such date. "CURRENT WARRANT PRICE" shall mean, in respect of a share of Common Stock at any date herein specified, the price at which a share of Common Stock may be purchased pursuant to exercise of this Warrant on such date. "EXPIRATION DATE" shall mean April 15, 2004. "FULLY-DILUTED OUTSTANDING" shall mean, (i) when used with reference to Common Stock, at any date as of which the number of shares thereof is to be determined, the number of shares of Common Stock Outstanding at such date and the number of shares of Common Stock which would be outstanding if the Warrants, the Company's convertible preferred stock, if any, and all other outstanding rights, options or warrants to purchase, or securities convertible into, shares of Common Stock and all security convertible or exchangeable into any of the foregoing, that are "in-the-money" were converted into or exercised or exchanged for shares of Common Stock on such date, and (ii) when used with reference to Voting Securities, at any date as of which the number of shares thereof is to be determined, the number of shares of Voting Securities Outstanding at such date and the number of shares of Voting Securities which would be outstanding if any outstanding rights, warrants or options to purchase, or securities convertible into, shares of Voting Securities and all securities convertible or exchangeable into any of the foregoing, that are "in- the-money" were converted into or exercised or exchanged for shares of Voting Securities on such date. "GAAP" shall mean generally accepted accounting principles in the United States of America as from time to time in effect. "HOLDER" shall mean the Person or Persons in whose name this Warrant or, as applicable, the Warrant Stock, is registered on the books of the Company maintained for such purpose. "INITIAL PUBLIC OFFERING" shall mean the first time a registration statement filed by the Company under the Securities Act with respect to its securities, whether on behalf of itself or otherwise, is declared effective, other than a registration statement filed on Form S-8 or any successor forms thereto. "LIEN" means any mortgage, pledge, lien, encumbrance, charge or adverse claim affecting title or resulting in an encumbrance against real or personal property, or a security interest of any kind (including, without limitation, any conditional sale or other title retention agreement or any lease in the nature thereof, and any filing of or agreement to give any financing statement under the Uniform Commercial Code (or equivalent statutes) of any jurisdiction). "MAJORITY HOLDERS" shall mean Holders of more than 50% of (i) Warrants exercisable for the aggregate number of shares of Common Stock then purchasable upon exercise of all Warrants, whether or not then exercisable, PLUS (ii) where a provision affects Holders of the Warrant Stock, the Warrant Stock. "OTHER PROPERTY" is defined in Section 4.7. "PERSON" shall have the meaning defined in the Revolving Line of Credit Agreement. "REGISTRATION RIGHTS AGREEMENT" shall mean that certain Amended and Restated Registration Rights Agreement dated as of April 15, 1997 by and between the Company and Holder. "RESTRICTED COMMON STOCK" shall mean shares of Common Stock which are, or which upon their issuance on the exercise of this Warrant would be, evidenced by a certificate bearing the restrictive legend set forth in Section 9 herein. "REVOLVING LINE OF CREDIT AGREEMENT" shall mean that certain Amended and Restated Revolving Line of Credit Agreement dated as of November 8, 1996, by and between the Company and Holder, as amended by that certain Amendment No. 1 to Amended and Restated Revolving Line of Credit Agreement and Other Loan Documents dated as of March 10, 1998 by and between the Company and Holder. "SECURITIES ACT" shall mean the Securities Act of 1933, as amended, or any similar federal statute, and the rules and regulations of the Commission thereunder, all as the same shall be in effect at the time. "SUBSIDIARY" shall have the meaning set forth in the Revolving Line of Credit Agreement. "VOTING SECURITIES" means any class of Capital Stock of a corporation or other equity shares, interests, participations, rights in or other equivalents (however designated) of a Person other than a corporation, and any rights (including without limitation debt securities convertible into Capital Stock), warrants or options exercisable or exchangeable for or convertible into such Capital Stock or other equity securities, pursuant to which the holders thereof have (or would have upon exercise, conversion or exchange) the general voting power under ordinary circumstances to vote for the election of directors, managers, trustees or general partners of any Person (irrespective of whether or not at the time any other class or classes will have or might have voting power by reason of the happening of any contingency). "VOTING SECURITIES OUTSTANDING" shall mean, at any date as of which the number of shares thereof is to be determined, all issued and outstanding shares of Voting Securities, and shall include all shares issuable in respect of outstanding scrip or any certificates representing fractional interests in shares of Voting Securities. "WARRANTS" shall mean all of the Warrants of the Company issued prior to or on the date hereof or to be issued subsequent to the date hereof pursuant to the Revolving Line of Credit Agreement, including this Warrant, and all warrants issued upon transfer, division or combination of, or in substitution for, any thereof. All Warrants shall at all times be identical as to terms and conditions, except as to date of issuance, the purchase price, the number of shares of Common Stock for which they may be exercised and the date by which such Warrants must be exercised. "WARRANT PRICE" shall mean an amount equal to (i) the number of shares of Common Stock being purchased upon exercise of this Warrant pursuant to Section 2.1 multiplied by (ii) the Current Warrant Price as of the date of such exercise. "WARRANT STOCK" shall mean the shares of Common Stock issuable to the Holders upon the exercise of this Warrant. 2 EXERCISE OF WARRANT: OTHER AGREEMENTS 3 MANNER OF EXERCISE. I. From and after the date hereof until 5:00 P.M., New York City time, on the Expiration Date, Holder may exercise this Warrant, on any Business Day, for all or any part of the number of shares of Common Stock purchasable hereunder. In order to exercise this Warrant, in whole or in part, Holder shall deliver to the Company at its principal office at 9100 Keystone Crossing, Suite 600, Indianapolis, Indiana 46240, or at the office or agency designated by the Company pursuant to Section 11, (a) a written notice of Holder's election to exercise this Warrant, which notice shall specify the number of shares of Common Stock to be purchased, (b) this Warrant, (c) payment of the Warrant Price by certified or official bank check from Holder, unless the Holder is making a cashless exercise pursuant to Section 2.1(iii) herein, and (d) if the Holder is making a cashless exercise pursuant to Section 2.1(iii) herein, a statement. Such notice shall be substantially in the form of EXHIBIT A hereto, duly executed by Holder or its agent or attorney. II. Upon receipt thereof, the Company shall, as promptly as practicable, and in any event within ten (10) Business Days thereafter, execute or cause to be executed and deliver or cause to be delivered to Holder a certificate or certificates representing the aggregate number of shares of Common Stock issuable upon such exercise as hereinafter provided. The stock certificate or certificates so delivered shall be, to the extent possible, in such denomination or denominations as such Holder shall request in the notice and shall be registered in the name of Holder or such other name as shall be designated in the notice. This Warrant shall be deemed to have been exercised and such certificate or certificates shall be deemed to have been issued, and Holder or any other Person so designated to be named therein shall be deemed to have become a holder of record of such shares for all purposes, as of the date the notice, together with the check or checks and this Warrant, is received by the Company as described above and all taxes required to be paid by Holder, if any, pursuant to Section 2.2 prior to the issuance of such shares have been paid. If this Warrant shall have been exercised in part, the Company shall, at the time of delivery of the certificate or certificates representing the Warrant Stock, deliver to Holder a new Warrant evidencing the rights of Holder to purchase the unpurchased shares of Common Stock called for by this Warrant, which new Warrant shall in all other respects be identical with this Warrant, or, at the request of Holder, appropriate notation may be made on this Warrant and the same returned to Holder. (iii) A. In lieu of paying the Warrant Price, Holder may elect to receive shares of the Company's Common Stock equal to the value of this Warrant (or the portion thereof being exercised), in which event the Company shall issue to Holder the number of shares of the Company's Common Stock computed using the following formula: X = Y (A-B) A Where: X = the number of shares of Warrant Stock to be issued to the Holder; Y = the number of shares of Warrant Stock otherwise purchasable (or the portion thereof being exercised) under this Warrant (at the date of exercise); A = the Current Market Price of one share of the Company's Common Stock (at the date of such exercise); and B = the Current Warrant Price (as adjusted to the date of such exercise). III. In lieu of paying the Warrant Price, Holder may elect to receive cash equal to the value of this Warrant (or the portion thereof being exercised), in which event the Company shall pay to Holder cash in an amount computed using the following formula: X = Y (A-B) Where: X = the amount of cash to be paid to Holder; Y = the number of shares of Warrant Stock otherwise purchasable (or the portion thereof being exercised) under this Warrant (at the date of exercise); A = the Current Market Price of one share of the Company's Common Stock (at the date of such exercise); and B = the Current Warrant Price (as adjusted to the date of such exercise). 1 PAYMENT OF TAXES. All shares of Common Stock issuable upon the exercise of this Warrant pursuant to the terms hereof shall be validly issued, fully paid and nonassessable and, to the extent permitted by law, free of liens or preemptive rights. The Company shall pay all expenses in connection with, and all taxes and other governmental charges that may be imposed with respect to, the issue or delivery thereof unless such tax is imposed by law on Holder, in which case such tax or charge shall be paid by Holder. The Company shall not be required, however, to pay any tax or other charge imposed in connection with any transfer involved in the issue of any certificate for shares of Common Stock issuable upon exercise of this Warrant in any name other than that of Holder, and in such case, the Company shall not be required to issue or deliver any stock certificate until such tax or other charge has been paid or it has been established to the satisfaction of the Company that no such tax or other charge is due. 2 OTHER AGREEMENTS. This Warrant and the Warrant Stock shall be governed by the terms of this Warrant, the Registration Rights Agreement and, to the extent applicable, the Revolving Line of Credit Agreement (the terms of which are hereby incorporated herein by this reference). Each Holder agrees to be bound by, and shall enjoy the benefits of, this Warrant, the Registration Rights Agreement and the Revolving Line of Credit Agreement. The registered holder of the Warrant Stock issued upon exercise of this Warrant (in whole or in part) shall be entitled to all rights granted pursuant to the Registration Rights Agreement and agrees to be bound by all of the obligations and limitations thereof, including the ability of the Company to elect to make a cash payment to the Holder as more particularly described in Section 1.1(ii) of the Registration Rights Agreement in lieu of proceeding with a Demand Registration (as such term is defined in the Registration Rights Agreement). 3 TRANSFER. DIVISION AND COMBINATION. 4 TRANSFER. Subject to compliance with Section 9 herein, Holder shall have the right to transfer of this Warrant and all rights hereunder and the Warrant Stock, in each case, in whole or in part. Such transfer shall be registered on the books of the Company to be maintained for such purpose, upon surrender of this Warrant or the Warrant Stock at the principal office of the Company referred to in Section 2.1 or the office or agency designated by the Company pursuant to Section 11, together with, in the case of this Warrant, a written assignment of this Warrant substantially in the form of EXHIBIT B hereto duly executed by Holder or its agent or attorney and, in the case of Warrant Stock, stock powers or other instrument of assignment duly executed, and, in each case, funds sufficient to pay any transfer taxes payable upon the making of such transfer. 5 DIVISION AND COMBINATION. This Warrant may be divided or combined with other Warrants upon presentation hereof at the aforesaid office or agency of the Company, together with a written notice specifying the names and denominations in which new Warrants are to be issued, signed by Holder or its agent or attorney. Subject to compliance with this Section 3, as to any transfer which may be involved in such division or combination, the Company shall execute and deliver a new Warrant or Warrants in exchange for the Warrant or Warrants to be divided or combined in accordance with such notice. 6 EXPENSES. The Company shall prepare, issue and deliver at its own expense (other than transfer taxes) the new Warrant or Warrants under this Section 3. 7 MAINTENANCE OF BOOKS. The Company agrees to maintain, at its aforesaid office or agency, books for the registration and the registration of transfer of the Warrants. 8 ADJUSTMENTS. The number of shares of Common Stock for which this Warrant is exercisable shall be subject to adjustment from time to time as set forth in this Section 4. The Company shall give each Holder notice of any event described below which requires an adjustment pursuant to this Section 4 at the time of such event. 9 STOCK DIVIDENDS. SUBDIVISIONS AND COMBINATIONS. If, at any time, the Company shall: I. pay holders of its Common Stock a dividend in, or otherwise make a distribution of, Additional Shares of Common Stock, II. subdivide its outstanding shares of Common Stock into a larger number of shares of Common Stock, III. combine its outstanding shares of Common Stock into a smaller number of shares of Common Stock, or IV. issue any shares of equity securities pursuant to a reclassification of shares of Common Stock, then the number of shares of Common Stock for which this Warrant is exercisable immediately after the occurrence of any such event shall be adjusted to equal the number of shares of Common Stock which a record holder of the same number of shares of Common Stock for which this Warrant is exercisable immediately prior to the occurrence of such event would own or be entitled to receive after the happening of such event. The Current Warrant Price shall be adjusted to equal the Current Warrant Price hereunder immediately prior to any such adjustment multiplied by a fraction, the numerator of which shall be the number of shares on a Fully Diluted Outstanding basis immediately prior to such adjustment and the denominator of which shall be the number of shares on a Fully Diluted Outstanding basis immediately after such event. 1 CERTAIN OTHER DISTRIBUTIONS. If, at any time, the Company shall pay holders of its Common Stock a dividend in, or otherwise distribute: I. cash, II. any evidences of its indebtedness, any shares of its stock or any other securities or property of any nature whatsoever (other than cash, Convertible Securities or Additional Shares of Common Stock), or III. any warrants or other rights to subscribe for or purchase any evidences of its indebtedness, any shares of its stock or any other securities or property of any nature whatsoever (other than cash, Convertible Securities or Additional Shares of Common Stock), then the number of shares of Common Stock for which this Warrant is exercisable shall be adjusted to equal the product of the number of shares of Common Stock for which this Warrant is exercisable immediately prior to such adjustment by a fraction (I) the numerator of which shall be the Current Market Price per share of Common Stock at the date of such payment and (II) the denominator of which shall be (x) such Current Market Price per share of Common Stock minus (y) the amount allocable to one share of Common Stock of any such cash so distributable and of the fair value (as determined in good faith by the Board of Directors of the Company) of any and all such evidences of indebtedness, shares of stock, other securities or property or warrants or other subscription or purchase rights so distributable. A reclassification of the Common Stock (other than a change in par value, or from par value to no par value or from no par value to par value) into shares of Common Stock and shares of any other class of stock shall be deemed a distribution by the Company to the holders of its Common Stock of such shares of such other class of stock within the meaning of this Section 4.2 and, if the outstanding shares of Common Stock shall be changed into a larger or smaller number of shares of Common Stock as a part of such reclassification, such change shall be deemed a subdivision or combination, as the case may be, of the outstanding shares of Common Stock within the meaning of Section 4.1. The Current Warrant Price shall be adjusted to equal the Current Warrant Price hereunder immediately prior to any such adjustment multiplied by a fraction, the numerator of which shall be the number of shares for which this Warrant is exercisable immediately prior to such adjustment and the denominator of which shall be the number of shares for which this Warrant is exercisable immediately after such adjustment, as calculated above. 1 ISSUANCE OF ADDITIONAL SHARES OF COMMON STOCK. I. If at any time the Company shall (except as hereinafter provided) issue or sell any Additional Shares of Common Stock for consideration in an amount per Additional Share of Common Stock less than the Current Market Price, then the number of shares of Common Stock for which this Warrant is exercisable shall be adjusted to equal the product obtained by multiplying the number of shares of Common Stock for which this Warrant is exercisable immediately prior to such issue or sale by a fraction (I) the numerator of which shall be the number of Fully Diluted Outstanding shares of Common Stock immediately after such issue or sale, and (II) the denominator of which shall be the number of Fully Diluted Outstanding shares of Common Stock immediately prior to such issue or sale plus the number of shares which the aggregate offering price of the total number of such Additional Shares of Common Stock would purchase at the then Current Market Price. Current Warrant Price shall be adjusted to equal the Current Warrant Price hereunder immediately prior to any such adjustment multiplied by a fraction, the numerator of which shall be the number of shares for which this Warrant is exercisable immediately prior to such adjustment, and the denominator is the number of shares for which this Warrant is exercisable immediately after such adjustment, as calculated above. II. The provisions of Section 4.3(i) shall not apply to any issuance of Additional Shares of Common Stock for which an adjustment is provided under Section 4.1. No adjustment of the number of shares of Common Stock for which this Warrant shall be exercisable shall be made under Section 4.3(i) upon the issuance of any Additional Shares of Common Stock which are issued pursuant to the exercise of any warrants, options or other subscription or purchase rights or pursuant to the exercise of any conversion or exchange rights in any Convertible Securities, if any such adjustment shall previously have been made upon the issuance of such warrants or other rights or upon the issuance of such Convertible Securities (or upon the issuance of any warrant or other rights therefor) pursuant to Section 4.4. 1 ISSUANCE OF WARRANTS, CONVERTIBLE SECURITIES OR OTHER RIGHTS. If, at any time, the Company shall take a record of the holders of its Common Stock for the purpose of entitling them to receive a distribution of, or shall in any manner (whether directly or by assumption in a merger in which the Company is the surviving corporation or otherwise) issue or sell, any warrants, options or other rights to subscribe for or purchase any Additional Shares of Common Stock or any Convertible Securities, whether or not the rights to exercise, purchase, exchange or convert thereunder are immediately exercisable, and the price per share for which Common Stock is issuable upon the exercise of such warrants, options or other rights or upon conversion or exchange of such Convertible Securities shall be less than the Current Market Price in effect immediately prior to the exercise of this Warrant, then the number of shares for which this Warrant is exercisable and the Current Warrant Price shall each be adjusted as provided in Section 4.3 on the basis that the maximum number of Additional Shares of Common Stock issuable (assuming immediate exercisability for all shares covered) pursuant to all such warrants, options or other rights or necessary to effect the conversion or exchange of all such Convertible Securities shall be deemed to have been issued as of the date of the exercise of this Warrant. No further adjustments of the number of shares for which this Warrant is exercisable or the Current Warrant Price shall be made upon the actual issue of such Common Stock or of such Convertible Securities upon exercise of such warrants or other rights or upon the actual issue of such Common Stock upon such conversion or exchange of such Convertible Securities. 2 OTHER ACTION AFFECTING WARRANT. If at any time or from time to time the Company shall take any action in respect of or affecting the Common Stock other than an action described in any of the foregoing Sections 4.1 to 4.4, inclusive, then, unless in the reasonable judgment of the Board of Directors of the Company such action will not have a materially adverse effect upon the rights of any Holder, the number of shares of Common Stock for which this Warrant is exercisable shall be adjusted in such manner and at such time as the Board of Directors of the Company may in good faith determine to be equitable under the circumstances. 3 OTHER PROVISIONS APPLICABLE TO ADJUSTMENTS UNDER SECTION 4.6. The following provisions shall be applicable to the making of adjustments of the number of shares of Common Stock for which this Warrant is exercisable provided for in this Section 4: I. COMPUTATION OF CONSIDERATION. To the extent that any Additional Shares of Common Stock or any Convertible Securities or any warrants, options or other rights to subscribe for or purchase any Additional Shares of Common Stock or any Convertible Securities shall be issued for cash consideration, the consideration received by the Company therefor shall be the amount of the cash received by the Company therefor, or, if such Additional Shares of Common Stock or Convertible Securities are offered by the Company for subscription, the subscription price, or, if such Additional Shares of Common Stock or Convertible Securities are sold to underwriters or dealers for public offering without a subscription offering, the initial public offering price (in any such case subtracting any amounts paid or receivable for accrued interest or accrued dividends and without taking into account any compensation, discounts or expenses paid or incurred by the Company for and in the underwriting of, or otherwise in connection with, the issuance thereof). To the extent that such issuance shall be for a consideration other than cash, then, except as herein otherwise expressly provided, the amount of such consideration shall be deemed to be the fair value of such consideration at the time of such issuance as determined in good faith by the Board of Directors of the Company (excluding therefrom any director designated by the transferor thereof). In case any Additional Shares of Common Stock or any Convertible Securities or any warrants, options or other rights to subscribe for or purchase such Additional Shares of Common Stock or Convertible Securities shall be issued in connection with any merger in which the Company issues any securities, the amount of consideration therefor shall be deemed to be the fair value, as determined in good faith by the Board of Directors of the Company (excluding therefrom any director designated by the transferor thereof), of such portion of the assets and business of the nonsurviving corporation as such Board in good faith shall determine to be attributable to such Additional Shares of Common Stock, Convertible Securities, warrants, options or other rights, as the case may be. The consideration for any Additional Shares of Common Stock issuable pursuant to any warrants, options or other rights to subscribe for or purchase the same shall be the consideration received by the Company for issuing such warrants, options or other rights plus the additional consideration payable to the Company upon exercise of such warrants or other rights. The consideration for any Additional Shares of Common Stock issuable pursuant to the terms of any Convertible Securities shall be the consideration received by the Company for issuing warrants, options or other rights to subscribe for or purchase such Convertible Securities, plus the consideration paid or payable to the Company in respect of the subscription for or purchase of such Convertible Securities, plus the additional consideration, if any, payable to the Company upon the exercise of the right of conversion or exchange in such Convertible Securities. In case of the issuance at any time of any Additional Shares of Common Stock or Convertible Securities in payment or satisfaction of any dividends upon any class of stock other than Common Stock, the Company shall be deemed to have received for such Additional Shares of Common Stock or Convertible Securities a consideration equal to the amount of such dividend so paid or satisfied. II. WHEN ADJUSTMENTS TO BE MADE. The adjustments required by this Section 4 shall be made whenever and as often as any specified event requiring an adjustment shall occur, except that any adjustment of the number of shares of Common Stock for which this Warrant is exercisable that would otherwise be required may be postponed (except in the case of a subdivision or combination of shares of the Common Stock, as provided for in Section 4.1) up to, but not beyond the date of exercise if such adjustment either by itself or with other adjustments not previously made adds or subtracts less than 1% of the shares of Common Stock for which this Warrant is exercisable immediately prior to the making of such adjustment. Any adjustment representing a change of less than such minimum amount (except as aforesaid) which is postponed shall be carried forward and made as soon as such adjustment, together with other adjustments required by this Section 4 and not previously made, would result in a minimum adjustment or on the date of exercise. For the purpose of any adjustment, any specified event shall be deemed to have occurred at the close of business on the date of its occurrence. III. FRACTIONAL INTERESTS. In computing adjustments under this Section 4, fractional interests in Common Stock shall be taken into account to the nearest one-tenth of a share. IV. WHEN ADJUSTMENT NOT REQUIRED. If the Company shall take a record of the holders of its Common Stock for the purpose of entitling them to receive a dividend or distribution or subscription or purchase rights and shall, thereafter and before the distribution to stockholders thereof, legally abandon its plan to pay or deliver such dividend, distribution, subscription or purchase rights, then thereafter no adjustment shall be required by reason of the taking of such record and any such adjustment previously made in respect thereof shall be rescinded and annulled. 1 REORGANIZATION, RECLASSIFICATION, MERGER, CONSOLIDATION OR DISPOSITION OF ASSETS. I. In case the Company shall reorganize its capital, reclassify its Capital Stock, consolidate or merge with or into another corporation, or sell, transfer or otherwise dispose of all or substantially all its property, assets or business to another corporation and, pursuant to the terms of such reorganization, reclassification, merger, consolidation or disposition of assets, shares of common stock of the successor or acquiring corporation, or any cash, shares of stock or other securities or property of any nature whatsoever (including warrants or other subscription or purchase rights) in addition to or in lieu of common stock of the successor or acquiring corporation ("OTHER PROPERTY"), are to be received by or distributed to the holders of Common Stock of the Company, then each Holder shall have the right thereafter to receive, upon exercise of such Warrant, the number of shares of common stock of the successor or acquiring corporation or of the Company, if it is the surviving corporation, and Other Property receivable upon or as a result of such reorganization, reclassification, merger, consolidation or disposition of assets by a holder of the number of shares of Common Stock for which this Warrant is exercisable immediately prior to such event. II. In case of any such reorganization, reclassification, merger, consolidation or disposition of assets, (a) Holder shall continue to enjoy, with respect to any shares of common stock of the successor or acquiring corporation or the Company or any Other Property consisting of Capital Stock or warrants acquired by Holder, all the rights and benefits available to Holder pursuant to this Warrant and all other agreements executed in connection with this Warrant and/or the Warrant Stock, and (b) the successor or acquiring corporation (if other than the Company) shall expressly assume the due and punctual observance and performance of each and every covenant and condition of this Warrant to be performed and observed by the Company and all the obligations and liabilities hereunder, subject to such modifications as may be deemed appropriate (as determined by resolution of the Board of Directors of the Company) in order to provide for adjustments of shares of the Common Stock for which this Warrant is exercisable which shall be as nearly equivalent as practicable to the adjustments provided for in this Section 3. III. For purposes of this Section 4.7, "COMMON STOCK OF THE SUCCESSOR OR ACQUIRING CORPORATION" shall include stock of such corporation of any class which is not preferred as to dividends or assets over any other class of stock of such corporation and which is not subject to redemption and shall also include any evidences of indebtedness, shares of stock or other securities which are convertible into or exchangeable for any such stock, either immediately or upon the arrival of a specified date or the happening of a specified event and any warrants or other rights to subscribe for or purchase any such stock. The foregoing provisions of this Section 4.7 shall similarly apply to successive reorganizations, reclassifications, mergers, consolidations or disposition of assets. IV. The Company shall not consolidate or merge with or into an Affiliate of the Company, nor sell, transfer or otherwise dispose of all or substantially all its property, assets or business to such an Affiliate unless and until (a) such consolidation, merger, sale, transfer or disposition is fair and equitable to the Company, each Holder and all holders of Warrant Stock and is on terms which are at least as favorable as those that would be obtainable in a similar transaction with an unrelated third party, and (b) each Holder shall have received, at the Company's sole cost and expense, the opinion of a financial advisor satisfactory to such Holder in such Holder's reasonable discretion to the effect that the proposed consolidation, merger, sale, transfer or disposition satisfies the conditions set forth in the immediately preceding clause (a). 1 CERTAIN LIMITATIONS. Notwithstanding anything to the contrary contained in the Company's Articles of Incorporation, Bylaws or other documents governing the terms of the Company's Capital Stock, the Company agrees not to amend its Articles of Incorporation or Bylaws, enter into any other transaction or execute any other document that would cause a reduction in the par value per share of Common Stock below the Current Warrant Price. 2 NOTICES TO WARRANT HOLDERS. 3 NOTICE OF ADJUSTMENTS. Whenever the number of shares of Common Stock for which this Warrant is exercisable is subject to adjustment pursuant to Section 4, the Company shall forthwith prepare a certificate to be executed by the chief financial officer of the Company setting forth, in reasonable detail, the event requiring the adjustment and the method by which such adjustment was calculated (including a description of the basis on which the Board of Directors of the Company determined the fair value of any evidences of indebtedness shares of stock, other securities or property or warrants or other subscription or purchase rights referred to in Section 4.6(i)), specifying the number of shares of Common Stock for which this Warrant is exercisable and (if such adjustment was made pursuant to Section 4.7) describing the number and kind of any other shares of stock or Other Property for which this Warrant is exercisable, and any change in the purchase price or prices thereof, after giving effect to such adjustment or change. The Company shall promptly cause a signed copy of such certificate to be delivered to each Holder in accordance with Section 17.1. The Company shall keep at its office or agency designated pursuant to Section 11 copies of all such certificates and cause the same to be available for inspection at said office during normal business hours by any Holder or any prospective purchaser of a Warrant designated by a Holder thereof. 4 NOTICE OF CORPORATE ACTION. If at any time: I. the Company shall take a record of the holders of its Common Stock for the purpose of entitling them to receive a dividend (other than a cash dividend payable out of earnings or earned surplus legally available for the payment of dividends under the laws of the jurisdiction of incorporation of the Company) or other distribution, or any right to subscribe for or purchase any evidences of its indebtedness, any shares of stock of any class or any other securities or property, or to receive any other right, or II. there shall be any capital reorganization of the Company, any reclassification or recapitalization of the Capital Stock of the Company or any consolidation or merger of the Company with, or any sale, transfer or other disposition of all or substantially all the property, assets or business of the Company to, another corporation, or III. there shall be a voluntary or involuntary dissolution, liquidation or winding up of the Company; then, in any one or more of such cases, the Company shall give to Holder (a) at least 20 days' prior written notice of the date on which a record date shall be selected for such dividend, distribution or right or for determining rights to vote in respect of any such reorganization, reclassification, merger, consolidation, sale, transfer, disposition, dissolution, liquidation or winding up, and (b) in the case of any such reorganization, reclassification, merger, consolidation, sale, transfer, disposition, dissolution, liquidation or winding up, at least 20 days' prior written notice of the date when the same shall take place. Such notice in accordance with the foregoing clauses also shall specify (I) with respect to clause (a), the date on which any such record is to be taken for the purpose of such dividend, distribution or right, the date on which the holders of Common Stock shall be entitled to any such dividend, distribution or right, and the amount and character thereof, and (II) with respect to clauses (a) and (b), the date on which any such reorganization, reclassification, merger, consolidation, sale, transfer, disposition, dissolution, liquidation or winding up is to take place and the time, if any such time is to be fixed, as of which the holders of Common Stock shall be entitled to exchange their shares of Common Stock for securities or other property deliverable upon such reorganization, reclassification, merger, consolidation, sale, transfer, disposition, dissolution, liquidation or winding up. Each such written notice shall be sufficiently given if addressed to Holder at the last address of Holder appearing on the books of the Company and delivered in accordance with Section 17.1. 1 NO IMPAIRMENT. The Company shall not by any action, including, without limitation, amending its articles of incorporation or through any reorganization, reclassification, merger, consolidation, sale, transfer, disposition, dissolution, winding up, issue or sale of securities or any other voluntary action, avoid or seek to avoid the observance or performance of any of the terms of this Warrant, but will at all times in good faith assist in the carrying out of all such terms and in the taking of all such actions as may be necessary or appropriate to protect the rights of Holder against impairment. Without limiting the generality of the foregoing, the Company will (i) not increase the par value of any shares of Common Stock receivable upon the exercise of this Warrant above the amount payable therefor upon such exercise immediately prior to such increase in par value, (ii) take all such action as may be necessary or appropriate in order that the Company may validly and legally issue fully paid and nonassessable shares of Common Stock upon the exercise of this Warrant, including reducing the par value of its Common Stock, and (iii) use its best efforts to obtain all such authorizations, exemptions or consents from any public regulatory body having jurisdiction thereof as may be necessary to enable the Company to perform its obligations under this Warrant. 2 RESERVATION AND AUTHORIZATION OF COMMON STOCK: REGISTRATION WITH OR APPROVAL OF ANY GOVERNMENTAL AUTHORITY. From and after the date hereof, the Company shall at all times reserve and keep available for issue upon the exercise of Warrants such number of its authorized but unissued shares of Common Stock as will be sufficient to permit the exercise in full of all outstanding Warrants. All shares of Common Stock which shall be so issuable, when issued upon exercise of any Warrant and payment therefor in accordance with the terms of such Warrant, shall be duly and validly issued and fully paid and nonassessable, and, to the extent permitted by law, free of liens or preemptive rights. Before taking any action which would result in an adjustment in the number of shares of Common Stock for which this Warrant is exercisable, the Company shall obtain all such authorizations or exemptions thereof, or consents thereto, as may be necessary from any public regulatory body or bodies having jurisdiction thereof. 3 TAKING OF RECORD: STOCK AND WARRANT TRANSFER BOOKS. In the case of all dividends or other distributions by the Company to the holders of its Common Stock with respect to which any provision of Section 4 refers to the taking of a record of such holders, the Company will in each such case take such a record as of the close of business on a Business Day. The Company will not, at any time, except upon dissolution, liquidation or winding up of the Company, close its stock transfer books or Warrant transfer books so as to result in preventing or delaying the exercise or transfer of any Warrant. 4 RESTRICTIONS OF TRANSFERABILITY. Each Warrant shall be stamped or otherwise imprinted with a legend in substantially the following form: "THIS WARRANT AND THE SHARES OF COMMON STOCK ISSUABLE UPON THE EXERCISE OF THIS WARRANT HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE "1933 ACT") AND MAY NOT BE SOLD OR TRANSFERRED IN THE ABSENCE OF SUCH REGISTRATION OR AN EXEMPTION THEREFROM UNDER THE SECURITIES ACT." 5 LOSS OR MUTILATION. Upon receipt by the Company from any Holder of evidence reasonably satisfactory to it of the ownership of and the loss, theft, destruction or mutilation of this Warrant and indemnity reasonably satisfactory to it, and in case of mutilation upon surrender and cancellation hereof, the Company will execute and deliver in lieu hereof a new Warrant of like tenor to such Holder; PROVIDED, in the case of mutilation, no indemnity shall be required if this Warrant in identifiable form is surrendered to the Company for cancellation. 6 OFFICE OF THE COMPANY. As long as any of the Warrants remain outstanding, the Company shall maintain an office or agency (which may be the principal executive offices of the Company) where the Warrants may be presented for exercise, registration of transfer, division or combination as provided in this Warrant. The Company shall notify each Holder in writing prior to any change of address of the office at which the Warrants may be presented. 7 LIMITATION OF LIABILITY. No provision hereof, in the absence of affirmative action by Holder to purchase shares of Common Stock, and no enumeration herein of the rights or privileges of Holder hereof, shall give rise to any liability of such Holder for the purchase price of any Common Stock or as a stockholder of the Company, whether such liability is asserted by the Company or by creditors of the Company. 8 CAPITALIZATION. As of April 15, 1997, there are outstanding 5,025,143 shares of Common Stock; 727,356 shares of treasury stock of the Company; and 159,289 outstanding shares of Class S preferred stock and 140,711 shares of treasury Class S preferred stock, which are convertible into a maximum number of 209,040 shares of Common Stock. 9 REGISTERED HOLDER. Notwithstanding any other provision of this Warrant, Holder and/or its affiliates may exercise this Warrant solely to the extent such exercise would not result in Holder and/or its affiliates holding, directly or indirectly, in excess of 4.99% of the outstanding Common Stock of the Company (such determination to be made by Holder), except for an exercise in connection with (i) a widely dispersed public offering of the Warrant Stock, (ii) a sale of the Warrant Stock in the secondary market pursuant to the transaction and volume limitations of Rule 144 under the Securities Act (irrespective of holding periods), or (iii) a private placement or sale, including those made pursuant to Rule 144A under the Securities Act, so long as Holder and/or its affiliates do not collectively acquire more than 2% of the Common Stock of the Company pursuant to any such transfer. 10 UNDERTAKINGS. Holder covenants with the Company that it will not exercise or attempt to exercise influence over the management or policies of the Company in connection with this Warrant or any shares of Common Stock for which this Warrant may be exercised. 11 SHAREHOLDER COMMUNICATIONS. The Company will provide the Registered Holder with copies of all written communications distributed to shareholders generally. 12 MISCELLANEOUS. 13 NOTICE GENERALLY. Any notice, demand, request, consent, approval, declaration, delivery or other communication hereunder to be made pursuant to the provisions of this Warrant shall be sufficiently given or made if in writing and either delivered in person with receipt acknowledged or sent by registered or certified mail, return receipt requested, postage prepaid, or by telecopy and confirmed by telecopy answerback, addressed as follows: I. If to any Holder or holder of the Warrant Stock, at its last known address appearing on the books of the Company maintained for such purpose. II. If to the Company at: 9100 Keystone Crossing Suite 600 Indianapolis, Indiana 46240 Attention: Stephen M. Coons, Esq. Telecopy: (317) 574-6227 or at such other address as may be substituted by notice given as herein provided. The giving of any notice required hereunder may be waived in writing by the party entitled to receive such notice. Every notice demand, request, consent, approval, declaration, delivery or other communication hereunder shall be deemed to have been duly given or served on the date on which personally delivered, with receipt acknowledged, telecopied and confirmed by telecopy answerback, or three (3) Business Days after the same shall have been deposited in the United States mail. Failure or delay in delivering copies of any notice, demand, request, approval, declaration, delivery or other communication to the person designated above to receive a copy shall in no way adversely affect the effectiveness of such notice, demand, request, approval, declaration, delivery or other communication. 1 SUCCESSORS AND ASSIGNS. This Warrant and the rights evidenced hereby (including, without limitation, those relating to the Warrant Stock) shall inure to the benefit of and be binding upon the successors of the Company and the successors and assigns of Holder. The provisions of this Warrant are intended to be for the benefit of all Holders from time to time of this Warrant and all Holders from time to time of the Warrant Stock, and shall be enforceable by any such Holder(s). 2 AMENDMENT. I. This Warrant and all other Warrants may be modified or amended or the provisions hereof waived with the written consent of the Company and the Majority Holders, PROVIDED that no such Warrant may be modified or amended to reduce the number of shares of Common Stock for which such Warrant is exercisable or to increase the Warrant Price without the prior written consent of Holder thereof. II. No waivers of, or exceptions to, any term, condition or provision of this Warrant, in any one or more instances, shall be deemed to be, or construed as, a further or continuing waiver of any such term, condition or provision. 1 SEVERABILITY. Wherever possible, each provision of this Warrant shall be interpreted in such manner as to be effective and valid under applicable law, but if any provision of this Warrant shall be prohibited by or invalid under applicable law, such provision shall be ineffective to the extent of such prohibition or invalidity, without invalidating the remainder of such provision or the remaining provisions of this Warrant. 2 HEADINGS. The headings used in this Warrant are for the convenience of reference only and shall not, for any purpose, be deemed a part of this Warrant. 3 GOVERNING LAW. This Warrant shall be governed by the laws of the State of Connecticut, without regard to the provisions thereof relating to conflict of laws. IN WITNESS WHEREOF, the Company has caused this Warrant to be duly executed. Dated: April 15, 1997 STANDARD MANAGEMENT CORPORATION By:STEPHEN M. COONS Name: Stephen M. Coons, Esq. Its: Executive Vice President and General Counsel -2- EXHIBIT A SUBSCRIPTION FORM [To be executed only upon exercise of Warrant] The undersigned registered owner of this Warrant irrevocably exercises this Warrant for the purchase of _______ shares of Common Stock of the Company, and herewith makes payment in the amount of $________ therefor, and requests that certificates for the shares of Common Stock hereby purchased (and any securities or other property issuable upon such exercise) be issued in the name of and delivered to ___________, whose address is ____________ and, if such shares of Common Stock shall not include all of the shares of Common Stock issuable as provided in this Warrant, that a new Warrant of like tenor and date for the balance of the shares of Common Stock issuable hereunder be delivered to the undersigned. In lieu of paying the purchase price, I hereby make a cashless exercise of this Warrant for the purchase of _______ shares of Common Stock of the Company pursuant to Section 2.1(iii) of this Warrant and request that [$______] [certificates representing _____ shares] be [paid][issued] and delivered to _______, whose address is ____________. ____________________________________ (Name of Registered Owner) (Signature of Registered Owner) (Street Address) (City) (State) (Zip Code) -2- EXHIBIT B ASSIGNMENT FORM FOR VALUE RECEIVED the undersigned registered owner of this Warrant hereby sells, assigns and transfers unto the Assignee named below all of the rights of the undersigned under this Warrant, with respect to the number of shares of Common Stock set forth below: NAME AND ADDRESS OF ASSIGNEE No. of Shares of Common Stock and does hereby irrevocably constitute and appoint __________________ attorney-in-fact to register such transfer on the books of ______________________ maintained for the purpose, with full power of substitution in the premises. Dated: Print Name: Signature: Witness: NOTICE: The signature on this assignment must correspond with the name as written upon the face of the within Warrant in every particular, without alteration or enlargement or any change whatsoever. -2- EX-10.21 4 RESTATED REVOLVING LINE OF CREDIT AGREEMENT AMENDMENT NO. 1 TO REVOLVING LINE OF CREDIT AGREEMENT AND OTHER LOAN DOCUMENTS Dated as of March 10, 1998 This AMENDMENT NO. 1 TO REVOLVING LINE OF CREDIT AGREEMENT AND OTHER LOAN DOCUMENTS between STANDARD MANAGEMENT CORPORATION, an Indiana corporation (the "Borrower"), and FLEET NATIONAL BANK, a national banking association (formerly known as Shawmut Bank Connecticut, National Association) (the "Bank"). PRELIMINARY STATEMENT. A. The Borrower and the Bank have entered into an Amended and Restated Revolving Line of Credit Agreement dated as of November 8, 1996 (the "Existing Credit Agreement"; the terms defined therein being used herein as therein defined unless otherwise defined herein). B. The Borrower and the Bank have agreed to amend the Existing Credit Agreement, the Note and the other Loan Documents to increase the principal amount available thereunder from $16,000,000 to $20,000,000. SECTION 1 AMENDMENTS TO EXISTING CREDIT AGREEMENT AND NOTE. I. EXISTING CREDIT AGREEMENT. The Existing Credit Agreement and the Note are, effective as of the date hereof and subject to the satisfaction of the conditions precedent set forth in Section 2 hereof, hereby amended as follows: (i) COMMITMENT. The term "Commitment" contained in Section 2.1 is hereby modified to read as follows: "Commitment" means the obligation of the Bank to make the Loans to the Borrower under this Agreement up to the aggregate principal amount not to exceed at any time outstanding Twenty Million Dollars ($20,000,000), as such amount may be reduced or otherwise modified from time to time. (ii) REDUCTION OF COMMITMENT. Section 2.2 is hereby deleted in its entirety and the following is substituted in lieu thereof: The Commitment shall be reduced to (i) $16,666,667 on March 10, 2000 so that, for the period beginning March 10, 2000 through March 9, 2001, the Revolving Credit Loans made by the Bank to the Borrower shall not in the aggregate exceed $16,666,667; (ii) $13,333,334 on March 10, 2001 so that, for the period beginning March 10, 2001 through March 9, 2002, the Revolving Credit Loans made by the Bank to the Borrower shall not in the aggregate exceed $13,333,334; (iii) $10,000,001 on March 10, 2002 so that, for the period beginning March 10, 2002 through March 9, 2003, the Revolving Credit Loans made by the Bank to the Borrower shall not in the aggregate exceed $10,000,001; (iv) $6,666,668 on March 10, 2003 so that, for the period beginning March 10, 2003 through March 9, 2004, the Revolving Credit Loans made by the Bank to the Borrower shall not in the aggregate exceed $6,666,668; (v) $3,333,335 on March 10, 2004 so that, for the period beginning March 10, 2004 through March 10, 2005, the Revolving Credit Loans made by the Bank to the Borrower shall not in the aggregate exceed $3,333,335. (iii) TERMINATION DATE. The term "Termination Date" set forth in Section 1.1 is hereby modified to read as follows: "Termination Date" means the earlier to occur of (a) March 10, 2005, (b)(i) the final date on which all the indebtedness due under the Subordinated Instruments (as defined below) is paid in full, or (ii) the occurrence of a default or event of default under the Subordinated Instruments, whichever comes first, and (c) such earlier date as payment of the Loans shall be due (whether by acceleration or otherwise). For purposes herein, the term "Subordinated Instruments" means, collectively, the Note Agreement dated as of June 30, 1997 by and between the Borrower and each of Capitol American Life Insurance Company ("Capital American") and Transport Life Insurance Company ("Transport"), the Senior Subordinated Convertible Note dated June 30, 1997 in the principal amount of $3,628,427 made by the Borrower in favor of Capitol American, the Senior Subordinated Convertible Note dated June 30, 1997 in the principal amount of $2,000,000 made by the Borrower in favor of Transport, the Amended and Restated Note Agreement dated as of November 8, 1996, as amended and restated on June 30, 1997, by and between the Borrower and Great American Rese,rve Insurance Company 1 ("GARCO"), the Amended and Restated Senior Subordinated Convertible Note dated November 8, 1996, as amended and restated as of June 30, 1997 in the principal amount of $4,371,573 made by the Borrower in favor of GARCO, and any and all documents executed in connection therewith, and including any amendments of any of the foregoing. (iv) CLOSING FEE. In order to induce the Bank to enter into this Amendment, the Borrower agrees to pay to the Bank a closing fee in an amount equal to $40,000 on the date of this Agreement. (v) COMMITMENT FEE. In order to induce the Bank to enter into this Amendment, the Borrower agrees to pay to the Bank a commitment fee on $4,000,000 at the rate of one- quarter of one percent (1/4 of 1%) per annum, based on a year of 360 days for the actual days elapsed, payable for the period beginning on April 18, 1997 and ending on March 9, 1998. (vi) USE OF PROCEEDS. The $4,000,000 increase in the Commitment afforded to the Borrower pursuant to this Amendment shall be used by the Borrower to finance the transactions contemplated under the Amended and Restated Agreement and Plan of Merger dated as of December 9, 1997 among the Borrower, Standard Acquisition Corporation and Savers Life Insurance Company, a North Carolina domestic stock insurance company (the "Plan of Merger"). (vii) WARRANTS. In order to induce the Bank to enter into this Amendment, the Borrower shall deliver to the Bank on or prior to the date hereof, a Warrant, in the form attached hereto as EXHIBIT C, entitling the Bank to subscribe for and purchase 12,000 additional shares of common stock of the Borrower (said Warrant being referred to herein as the "Fourth Warrant"). The Bank has the immediate right under the Fourth Warrant to purchase 12,000 shares of common stock of the Borrower. The Bank acknowledges that the maximum number of shares of common stock of the Borrower which the Bank shall be entitled to purchase under the Fourth Warrant is 12,000 and that such shares must be purchased on or before April 15, 2004 pursuant to the terms of the Fourth Warrant. (viii) ACCOUNTING TERMS. The section reference preceding the heading "Accounting Terms" on page 9 of the Existing Credit Agreement shall be corrected to refer to Section 1.2. (ix) DEBT. Section 8.2 of the Existing Credit Agreement shall be modified to allow the Borrower to enter into the transactions contemplated under the Subordinated Instruments, provided, however, that the Borrower acknowledges that any and all amendments to the Subordinated Instruments shall be conditioned upon the written consent of the Bank. II. NOTE. The Note is, effective as of the date hereof and subject to the satisfaction of the conditions precedent set forth in Section 2 hereof, hereby amended and restated in its entirety in the form of EXHIBIT A hereto. SECTION 1 CONDITIONS OF EFFECTIVENESS. This Amendment shall become effective when, and only when, the Bank shall have received counterparts of this Amendment executed by the Borrower and the Bank, and Section 1 hereof shall become effective when, and only when, the Bank shall have additionally received all of the following documents, each document (unless otherwise indicated) being dated the date of receipt thereof by the Bank (which date shall be the same for all such documents), in form and substance satisfactory to the Bank: I. The executed Amended and Restated Note in the form of EXHIBIT A hereto. II. The executed Amended and Restated Pledge Agreement in the form of EXHIBIT B hereto, together with certificates representing the Pledged Shares referred to therein, accompanied by undated stock powers executed in blank. III. The Fourth Warrant. IV. The executed Amended and Restated Registration Rights Agreement in the form of EXHIBIT D hereto. V. Evidence with respect to the consummation of the merger described in the Plan of Merger. VI. Evidence of all applicable insurance regulatory approvals, if any, which are necessary or required in connection with the Borrower's execution, delivery and performance of the Loan Documents. VII. A schedule of insurance then in effect pursuant to Section 7.5 of the Existing Credit Agreement. VIII. Certified copies of (i) the resolutions of the Borrower approving this Amendment and the matters contemplated hereby and thereby and (ii) all documents evidencing other necessary corporate action and governmental approvals, if any, with respect to this Amendment and the matters contemplated hereby. IX. A certificate of the Secretary or an Assistant Secretary of the Borrower certifying the names and true signatures of the officers of the Borrower, authorized to sign this Amendment and the other documents to be delivered hereunder. X. A certificate of existence for each of the Borrower, Standard Life, Standard Marketing, Dixie National and Savers Life Insurance Company. XI. A favorable opinion of counsel for the Borrower (which may be delivered by in-house counsel) to the effect that this Amendment, and the Amended and Restated Note have been duly authorized, executed and delivered by the Borrower, and such instruments constitute the legal, valid and binding obligations of the Borrower enforceable against the Borrower in accordance with their respective terms, with references therein to the Credit Agreement to mean the Existing Credit Agreement as amended by this Amendment. XII. A certificate signed by a duly authorized officer of each Borrower stating that: XIII. The representations and warranties contained in herein, in Article 6 of the Existing Credit Agreement and in each other Loan Document are true and correct on and as of the date of such certificate as though made on and as of such date; XIV. No event has occurred and is continuing which constitutes a Default or Event of Default; and XV. There has been no material adverse change in the business, management, operations, properties, prospects or condition (financial or otherwise) of the Borrower or any of its respective Affiliates or Subsidiaries since November 8, 1996. XVI. Acknowledgment agreements executed by Capitol American, Transport and GARCO with respect to the subordination of the indebtedness owed under the Subordinated Instruments to the indebtedness owed to the Bank under the Note. XVII. Any other closing items reasonably required by the Bank. SECTION 1 REPRESENTATIONS AND WARRANTIES OF THE BORROWERS. Each Borrower represents and warrants as follows: I. The execution, delivery and performance by the Borrower of this Amendment, the Amended and Restated Note and the Loan Documents, as amended hereby, to which it is a party have been duly authorized by all necessary action and do not and will not: (a) require any consent or approval of its shareholders; (b) contravene its certificate of incorporation and bylaws; (c) violate any provision of, or require any filing, registration, consent or approval under, any law, rule, regulation (including, without limitation, Regulation U), order, writ, judgment, injunction, decree, determination or award presently in effect having applicability to the Borrower or any of its Subsidiaries or Affiliates; (d) result in a breach of or constitute a default or require any consent under any indenture or loan or credit agreement or any other agreement, lease or instrument to which such Borrower is a party or by which it or its properties may be bound or affected; (e) result in, or require, the creation or imposition of any Lien, upon or with respect to any of the properties now owned or hereafter acquired by such Borrower; or (f) cause the Borrower (or any Subsidiary or Affiliate, as the case may be) to be in default under any such law, rule, regulation, order, writ, judgment, injunction, decree, determination or award or any such indenture, agreement, lease or instrument. II. This Amendment, the Amended and Restated Note and each other Loan Document, as amended hereby, to which the Borrower is a party is, or when delivered under this Amendment will be, a legal, valid and binding obligation of the Borrower enforceable against the Borrower in accordance with its terms, except to the extent that such enforcement may be limited by applicable bankruptcy, insolvency and other similar laws affecting creditors' rights generally. III. There are no actions, suits or proceedings pending or, to the knowledge of the Borrower, threatened, against or affecting the Borrower or any of its Subsidiaries before any court, governmental agency or arbitrator, which may, in any one case or in the aggregate, materially adversely affect the ability of the Borrower to perform its obligation under this Amendment, the Amended and Restated Promissory Note or any of the other Loan Documents, as amended hereby. SECTION 1 REFERENCE TO AND EFFECT ON THE LOAN DOCUMENTS. I. Upon the effectiveness of Section 1 hereof, on and after the date hereof each reference in the Existing Credit Agreement to "this Agreement," "hereunder," "hereof," "herein" or words of like import, and each reference in the other Loan Documents to the Credit Agreement and Note, shall mean and be a reference to the Existing Credit Agreement and Note, as amended hereby. In addition, each reference in the other Loan Documents to the "Loan Documents" shall mean and be a reference to the Existing Credit Agreement and Note, as amended hereby, together with each of the other documents to be delivered pursuant to Section 2 of this Amendment. II. Except as specifically amended above and except to the extent that any of the Loan Documents are substituted for and replaced by the documents to be delivered pursuant to Section 2 of this Amendment, the Existing Credit Agreement and the Note, and all other Loan Documents, shall remain in full force and effect and are hereby ratified and confirmed. III. The execution, delivery and effectiveness of this Amendment shall not, except as expressly provided herein, operate as a waiver of any right, power or remedy of the Bank under any of the Loan Documents, nor constitute a waiver of any provision of any of the Loan Documents. SECTION 1 COSTS, EXPENSES AND TAXES. The Borrower agrees to pay on demand all costs and expenses, if any (including, without limitation, reasonable counsel fees and expenses), in connection with the enforcement (whether through negotiations, legal proceedings or otherwise) of this Amendment, the Amended and Restated Note and the other instruments and documents to be delivered hereunder, including, without limitation, reasonable counsel fees and expenses in connection with the enforcement of rights under this Section 5. In addition, the Borrower shall pay any and all stamp and other taxes payable or determined to be payable in connection with the execution and delivery of this Amendment, the Amended and Restated Note and the other instruments and documents to be delivered hereunder, and agree to save the Bank harmless from and against any and all liabilities with respect to or resulting from any delay in paying or omission to pay such taxes. SECTION 1.11837.11838.63.0 EXECUTION IN COUNTERPARTS. This Amendment may be executed in any number of counterparts and by different parties hereto in separate counterparts, each of which when so executed and delivered shall be deemed to be an original and all of which taken together shall constitute but one and the same instrument. SECTION 2.11837.11838.63.0 GOVERNING LAW. This Amendment shall be governed by, and construed in accordance with, the laws of the State of Connecticut. IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be executed by their respective officers thereunto duly authorized, as of the date first above written. STANDARD MANAGEMENT CORPORATION BySTEPHEN M. COONS Name: Stephen M. Coons, Esq. Title: Executive Vice President and General Counsel FLEET NATIONAL BANK By MILDRED CHAVARRIA JONES Name: Mildred Chavarria Jones Title: Vice President EX-10.22 5 NOTE AGREEMENT EXHIBIT A AMENDED AND RESTATED NOTE $20,000,000 March 10, 1998 STANDARD MANAGEMENT CORPORATION, a corporation organized under the laws of Indiana (the "Borrower"), for value received, hereby promises to pay to the order of FLEET NATIONAL BANK, a national banking association having an office at 777 Main Street, Hartford, Connecticut (the "Bank"), the principal sum of TWENTY MILLION DOLLARS ($20,000,000), or, if less, the amount loaned by the Bank to the Borrower pursuant to the Revolving Line of Credit Agreement referred to below, in lawful money of the United States of America and in immediately available funds, on the date(s) and in the manner provided in said Agreement. The Borrower also promises to pay interest on the unpaid principal balance hereof, for the period such balance is outstanding, at said principal office, in like money, at the rates of interest as provided in the Agreement described below, on the date(s) and in the manner provided in said Agreement. The date and amount of each type of loan made by the Bank to the Borrower under this Note and the Agreement referred to below, and each payment of principal thereof, shall be recorded by the Bank on its books and, prior to any transfer of this Note (or, at the discretion of the Bank, at any other time), endorsed by the Bank on the schedule attached hereto or any continuation thereof. This is the Note referred to in that certain Amended and Restated Revolving Line of Credit Agreement dated as of November 8, 1996 by and between the Borrower and the Bank, as amended by that certain Amendment No. 1 to Amended and Restated Revolving Line of Credit Agreement dated as of the date hereof by and between the Borrower and the Bank (as further amended from time to time the "Agreement"), and evidences the Loans issued by the Bank thereunder. All terms not defined herein shall have the meanings given to them in the Agreement. The Agreement provides for the acceleration of the maturity of principal upon the occurrence of certain Events of Default and for prepayments on the terms and conditions specified therein. The Borrower waives presentment, notice of dishonor, protest and any other notice or formality with respect to this Note. This Note is being substituted for and replaces that certain Note dated November 8, 1996 in the principal amount of $16,000,000 made by the Borrower in favor of the Bank. Nothing herein shall be construed to constitute payment or discharge of any of the indebtedness due and owing under said prior promissory note. This Note shall be governed by, and interpreted and construed in accordance with, the laws of the State of Connecticut. STANDARD MANAGEMENT CORPORATION By STEPHEN M. COONS Name:Stephen M. Coons, Esq. Title:Executive Vice President and General Counsel 1 Amount of Loan Amount of Payment Balance DATE Outstanding Notation By EX-10.23 6 RESTATED PLEDGE AGREEMENT EXHIBIT B AMENDED AND RESTATED PLEDGE AGREEMENT AMENDED AND RESTATED PLEDGE AGREEMENT, dated as of March 10, 1998, between FLEET NATIONAL BANK, a national banking association (the "Bank"), and STANDARD MANAGEMENT CORPORATION, an Indiana corporation (the "Pledgor"). WHEREAS, the Pledgor is the owner of all of the issued and outstanding capital stock (the "Pledged Shares") of Standard Life Insurance Company of Indiana, an Indiana corporation ("Standard Life"), and of Standard Marketing Corporation, an Indiana corporation ("Standard Marketing," and collectively referred to herein with Standard Life as the "Subsidiaries"); and WHEREAS, the Bank and the Pledgor entered into an Amended and Restated Revolving Line of Credit Agreement dated as of November 8, 1996 (the "Existing Credit Agreement") pursuant to which the Bank agreed to make certain loans to the Pledgor in the principal amount of up to $16,000,000; and WHEREAS, as of the date hereof, the Bank and the Pledgor are entering into an Amendment No. 1 to Amended and Restated Revolving Line of Credit Agreement and Other Loan Documents (the Existing Credit Agreement, as amended by said Amendment No. 1 and as it may hereafter be amended or otherwise modified from time to time, being hereinafter referred to as the "Revolving Line of Credit Agreement"; terms used herein and not otherwise defined having the meaning set forth therein) in order to increase the Commitment of the Bank to make Revolving Credit Loans to the Pledgor under the Existing Credit Agreement in the principal amount of up to $20,000,000; and WHEREAS, it is a condition precedent to the making of the Loans by the Bank to the Pledgor under the Revolving Line of Credit Agreement that the Pledgor shall have made the pledge and granted the Bank a perfected security interest in the Pledged Shares as contemplated by this Amended and Restated Pledge Agreement; and WHEREAS, each of the parties hereto desires to take such other actions as may be necessary or desirable so that the Bank will have a perfected security interest in the Pledged Shares; and WHEREAS, all terms used herein and not otherwise defined shall have the meanings set forth in the Revolving Line of Credit Agreement. NOW THEREFORE, in consideration of the premises contained herein and in order to induce the Bank to make the Loans under the Revolving Line of Credit Agreement, the parties hereto hereby agree as follows: SECTION I. PLEDGE AND GRANT OF SECURITY. The Pledgor hereby pledges to the Bank and grants to the Bank a security interest in the following (the "Pledged Collateral"): II. the Pledged Shares and the certificates representing the Pledged Shares, and all dividends, cash, instruments and other property from time to time received, receivable or otherwise distributed in respect of or in exchange for any or all of the Pledged Shares; III. all additional shares of stock of any issuer from time to time acquired by the Pledgor in substitution for or in addition to the Pledged Shares or otherwise in any manner, and the certificates representing such substituted or additional shares, and all dividends, cash, instruments and other property from time to time received, receivable or otherwise distributed in respect of or in exchange for any or all of such shares; and IV. all proceeds of any and all of the foregoing Pledged Collateral. SECTION V. SECURITY FOR OBLIGATIONS. (VI. This Agreement secures the payment of all obligations of the Pledgor to the Bank under the Revolving Line of Credit Agreement, the Note and the other Loan Documents, now or hereafter existing, whether for principal, interest, fees, expenses or otherwise, and all obligations of the Pledgor now or hereafter existing under this Agreement (all such obligations of the Pledgor being the "Obligations"). (VII. The Pledgor immediately shall cause to be duly and properly filed all necessary financing statements in all locations required by applicable law in order to effectuate the perfected security interest contemplated hereby, including immediately filing amendments or other financing statements upon any substitution or addition to the Pledged Collateral. SECTION VIII. DELIVERY OR OTHER TRANSFER OF PLEDGED COLLATERAL. All certificates or instruments representing or evidencing the Pledged Collateral shall be delivered to and held by the Bank pursuant hereto and shall be in suitable form for transfer by delivery, or shall be accompanied by duly executed instruments of transfer or assignment in blank, all in form satisfactory to the Bank. SECTION IX. REPRESENTATIONS AND WARRANTIES. The Pledgor represents and warrants as follows: (X. The Pledged Shares have been duly authorized and validly issued and are fully paid and non-assessable. (XI. The Pledgor is the legal and beneficial owner of the Pledged Collateral, free and clear of any lien, security interest, option or other charge or encumbrance except for the security interest created by this Agreement. (XII. The pledge of, and grant of a security interest in, the Pledged Collateral pursuant to this Agreement creates a valid and perfected first priority security interest in the Pledged Collateral, securing the payment of the Obligations. (XIII. All filings and other actions necessary or desirable to perfect and protect the security interest created by this Agreement have been duly made or taken, as the case may be, including the filings of UCC financing statements on Form UCC-1 in the locations set forth on Schedule A attached hereto, which filings are the only filings necessary to perfect the Bank's security interest in the Pledged Collateral. Except for such financing statements as may have been filed in favor of the Bank relating to the security interest created by this Agreement, no effective financing statement or other instrument similar in effect covering all or any part of the Pledged Collateral is on file in any recording office. (XIV. No authorization, approval, or other action by, and no notice to or filing with, any governmental authority or regulatory body is required either (i) for the pledge of, and grant of a security interest in, the Pledged Collateral by the Pledgor pursuant to this Agreement or for the execution, delivery or performance of this Agreement by the Pledgor or (ii) for the exercise by the Bank of the voting or other rights provided for in this Agreement or the remedies in respect of the Pledged Collateral pursuant to this Agreement. (XV. Each of Standard Life and Standard Marketing are wholly-owned subsidiaries of the Pledgor. In addition, more than 99% of the outstanding shares of stock of Dixie National are owned by Standard Life. (XVI. The Pledged Shares constitute one hundred percent (100%) of the issued and outstanding shares of stock of each of Standard Life and Standard Marketing as indicated on Schedule I attached hereto. (XVII. The Pledged Shares are not subject to any shareholder or other agreement relating to the sale, pledge, transfer or disposition of the Pledged Shares. SECTION A. PERFECTION OF SECURITY INTEREST IN PROCEEDS OR ADDITIONAL PLEDGED COLLATERAL. In order to perfect the security interest of the Bank in any proceeds of the Pledged Collateral or any additional shares of stock or indebtedness which may be acquired by or otherwise come into the possession of the Pledgor in substitution for or in addition to any of the Pledged Collateral, the Pledgor shall cause to be delivered to the Bank any cash or other property payable in consideration of the sale of any Pledged Shares and all certificates representing the Pledged Shares or other securities among the Pledged Collateral, along with duly executed instruments of transfer or assignment in blank. SECTION XVIII. VOTING RIGHTS; DIVIDENDS, ETC. (XIX. So long as no Event of Default (as defined in the Revolving Line of Credit Agreement) shall have occurred and be continuing: XX. The Pledgor shall be entitled to exercise any and all voting and other consensual rights pertaining to the Pledged Collateral or any part thereof for any purposes not inconsistent with the terms of this Agreement or the Revolving Line of Credit Agreement. XXI. The Pledgor shall be entitled to receive and retain any and all dividends and interest paid in respect of the Pledged Collateral; PROVIDED, HOWEVER, that any and all (A) dividends and interest paid or payable other than in cash in respect of, and instruments and other property received, receivable or otherwise distributed in respect of, or in exchange for, any Pledged Collateral; (B) dividends and other distributions paid or payable in cash in respect of any Pledged Collateral in connection with a partial or total liquidation or dissolution or in connection with a reduction of capital, capital surplus or paid-in-surplus; and (C) cash paid, payable or otherwise distributed in respect of principal of, or in redemption of, or in exchange for, any Pledged Collateral, shall be delivered forthwith to the Bank to hold as Pledged Collateral and shall, if received by the Pledgor, be received in trust for the benefit of the Bank, be segregated from the other property or funds of the Pledgor, and be forthwith delivered to the Bank as Pledged Collateral in the same form as so received (with any necessary endorsement). (XXII. Upon the occurrence and during the continuance of an Event of Default: XXIII. All rights of the Pledgor to exercise the voting and other consensual rights which it would otherwise be entitled to exercise pursuant to Section 6(a)(i) hereof and to receive the dividends and interest payments which it would otherwise be authorized to receive and retain pursuant to Section 6(a)(ii) hereof shall cease, and all such rights shall thereupon become vested in the Bank, which shall thereupon have the sole right to exercise such voting and other consensual rights and to receive and hold as Pledged Collateral such dividends and interest payments. The Bank agrees to promptly notify the Pledgor of any such vesting of rights pursuant to this Section 6(b)(i), provided that the failure to give such notice shall not affect the validity of any such vesting or otherwise impair the rights or remedies of the Bank hereunder or otherwise. XXIV. All dividends and interest payments which are received by the Pledgor contrary to the provisions of paragraph (i) of this Section 6(b) shall be received in trust for the benefit of the Bank or its nominee, shall be segregated from other funds of the Pledgor and shall be forthwith paid over to the Bank or its nominee, as Pledged Collateral in the same form as so received (with any necessary endorsement). SECTION XXV. TRANSFERS AND OTHER LIENS; ADDITIONAL SECURITIES. (XXVI. The Pledgor agrees that it will not (i) sell or otherwise dispose of, or grant any option with respect to, any of the Pledged Collateral, or (ii) create or permit to exist any lien, security interest, or other charge or encumbrance upon or with respect to any of the Pledged Collateral, except for the security interest under this Agreement. (27. The Pledgor agrees that it will cause each of the Subsidiaries to deliver directly to the Bank or its nominee any stock or other securities which may be issued in addition to, in substitution for or as a dividend or distribution relating to any of the Pledged Collateral, and the Pledgor will promptly take any other action reasonably requested by the Bank to pledge to the Bank immediately upon acquisition thereof by the Pledgor (whether directly or indirectly), such additional shares of stock or other securities or indebtedness to be included in the Pledged Collateral. (28. The Pledgor agrees that it will cause Standard Life not to (i) sell, pledge, assign or otherwise dispose of, or grant any option with respect to, any of the capital stock of Dixie National, or (ii) create or permit to exist any lien, security interest, or other charge or encumbrance upon or with respect to any of the capital stock of Dixie National. SECTION 29. BANK MAY PERFORM. If the Pledgor fails to perform any agreement contained herein, the Bank may itself perform, or cause performance of, such agreement, and the expenses of the Bank incurred in connection therewith shall be payable by the Pledgor under Section 11. SECTION 30. REASONABLE CARE. The Bank shall be deemed to have exercised reasonable care in the custody and preservation of the Pledged Collateral in its possession if the Pledged Collateral is accorded treatment substantially equal to that which the Bank accords its own property. SECTION 31. REMEDIES UPON DEFAULT. If any Event of Default shall have occurred and be continuing: (32. The Bank may exercise in respect of the Pledged Collateral, in addition to other rights and remedies provided for herein or otherwise available to it, all the rights and remedies of a secured party on default under the Uniform Commercial Code in effect in the State of Connecticut at that time (the "Code") (whether or not the Code applies to the affected Collateral), and may also, without notice except as specified below, sell the Pledged Collateral or any part thereof in one or more parcels at public or private sale, at any exchange, broker's board or at any of the Bank's offices or elsewhere, for cash, on credit or for future delivery, and upon such other terms as the Bank may deem commercially reasonable. The Bank agrees to attempt to obtain the reasonable value of the Pledged Collateral upon any such sale. The Pledgor agrees that, to the extent notice of sale shall be required by law, at least ten days' notice to the Pledgor of the time and place of any public sale or the time after which any private sale is to be made shall constitute reasonable notification. The Bank shall not be obligated to make any sale of Pledged Collateral regardless of notice of sale having been given. The Bank may adjourn any public or private sale from time to time by announcement at the time and place fixed therefor, and such sale may, without further notice, be made at the time and place to which it was so adjourned. (33. Any cash held by the Bank as Pledged Collateral and all cash proceeds received by the Bank in respect of any sale of, collection from, or other realization upon all or any part of the Pledged Collateral may, in the discretion of the Bank, be transferred to the Bank as collateral for, and/or then or at any time thereafter applied in whole or in part by the Bank against all or any part of the Obligations in such order as the Bank shall elect. Any surplus of such cash or cash proceeds held by the Bank and remaining after payment in full of all the Obligations shall be paid over to the Pledgor or to whomsoever may be lawfully entitled to receive such surplus. SECTION 34. FEES AND EXPENSES. The Pledgor will upon demand pay to the Bank the amount of any and all reasonable expenses, including the reasonable fees and expenses of its counsel and of any experts and agents, which the Bank may incur in connection with (a) the administration of this Agreement, (b) the custody or preservation of, or the sale of, collection from, or other realization upon, any of the Pledged Collateral, (c) the exercise or enforcement of any of the rights of the Bank hereunder or (d) the failure by the Pledgor to perform or observe any of the provisions hereof. SECTION 35. AMENDMENTS; ETC. No amendment or waiver of any provisions of this Agreement nor consent to any departure herefrom, shall in any event be effective unless, in the case of an amendment, the same shall be in writing and signed by the Pledgor and the Bank and, in the case of a waiver and consent, the same shall be in writing and signed by the Bank, and then such waiver or consent shall be effective only in the specific instance and for the specific purpose for which given. SECTION 36. ADDRESSES FOR NOTICES. All notices and other communications provided for hereunder shall be in writing (including telegraphic communication) and mailed, telegraphed or delivered, If to the Pledgor: Standard Management Corporation 9100 Keystone Crossing Indianapolis, Indiana 46240 Attention: Stephen M. Coons, Esq. Executive Vice President and General Counsel If to the Bank: Fleet National Bank 777 Main Street Hartford, Connecticut 06115 Attention: Mildred Chavarria Jones Vice President or as to any party at such other address as shall be designated by such party in a written notice to each other party complying as to delivery with the terms of this Section. All such notices and other communications shall, when mailed or telegraphed, respectively, be effective when deposited in the mails or delivered to the telegraph company or in the case of personal delivery, upon delivery, in each case, addressed as aforesaid, except that with respect to notice to the Bank hereunder, the same shall be effective only upon receipt. SECTION 37. FURTHER ASSURANCES. The Pledgor agrees that at any time and from time to time, at the expense of the Pledgor, the Pledgor will promptly execute and deliver all further instruments and documents, and take all further action, that may be necessary or desirable, or that the Bank may reasonably request, in order to perfect and protect any security interest granted or purported to be granted hereby or to enable the Bank to exercise and enforce its rights and remedies hereunder with respect to any Pledged Collateral. SECTION 38. CONTINUING SECURITY INTERESTS; TRANSFER OF NOTE. This Agreement shall create a continuing security interest in the Pledged Collateral and shall (a) remain in full force and effect until payment in full of the Obligations, (b) be binding upon the Pledgor, its successors and assigns, (c) be binding upon the Bank, its successors and assigns and (d) inure to the benefit of the Bank and its successors, transferees and assigns. Upon the payment in full of the Obligations, the Pledgor shall be entitled to the return, upon its request and at its expense, of such of the Pledged Collateral as shall not have been sold or otherwise applied pursuant to the terms hereof. SECTION 39. GOVERNING LAW; TERMS. This Agreement shall be governed by and construed in accordance with the laws of the State of Connecticut. Unless otherwise defined herein or in the Revolving Line of Credit Agreement, terms defined in Articles 8 or 9 of the Uniform Commercial Code in the State of Connecticut are used herein as therein defined. 2 IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be duly executed and delivered as of the date first above written. FLEET NATIONAL BANK By: MILDRED CHAVARRIA JONES Name: Mildred Chavarria Jones Title: Vice President STANDARD MANAGEMENT CORPORATION By: STEPHEN M. COONS Name: Stephen M. Coons, Esq. Title: Executive Vice President and General Counsel 2 SCHEDULE A Locations for Filing UCC FINANCING STATEMENTS ON FORM UCC-1 Office of the Secretary of State of Indiana Marion, Indiana County Recorder Office 2 SCHEDULE I Attached to and forming a part of that certain Amended and Restated Pledge Agreement dated as of March 10, 1998 by and between STANDARD MANAGEMENT CORPORATION and FLEET NATIONAL BANK
Percentage Stock of STOCK Class of Certificate Number of Outstanding ISSUER STOCK NO(S). PAR VALUE SHARES SHARES Standard Life Common 1 None 897,033 100% Insurance Company of Indiana Standard Marketing Common 1 None 1,000 100% Corporation
EX-10.34 7 REINSURANCE AGREEMENT WITH LIFE RE REINSURANCE AGREEMENT #6550-1 (AUTOMATIC YEARLY RENEWABLE TERM BULK UNIVERSAL LIFE) (hereinafter referred to as "Agreement") between STANDARD LIFE INSURANCE COMPANY OF INDIANA (INDIANAPOLIS, INDIANA) (hereinafter referred to as the "Company") and LIFE REASSURANCE CORPORATION OF AMERICA (STAMFORD, CONNECTICUT) (hereinafter referred to as "Life Re") EFFECTIVE: SEPTEMBER 1, 1997 LIFE REASSURANCE CORPORATION OF AMERICA 969 HIGH RIDGE ROAD STAMFORD, CT 06905 TABLE OF CONTENTS PREAMBLE 1 ARTICLE I - METHOD OF REINSURANCE AND INSURANCE 1 1. Effective Date 1 2. Method 1 3. Amounts 1 4. Minimum Amounts 2 ARTICLE II - AUTOMATIC REINSURANCE 2 1. Insurance 2 2. Coverages 3 3. Jumbo Risk 3 4. Waiver Acceptance and Participation Limits 3 5. Regular Limits of Retention 3 ARTICLE III - FACULTATIVE REINSURANCE 3 ARTICLE IV - PROCEDURES FOR REPORTING 4 1. General Information 4 2. Self-Administered Reporting 4 ARTICLE V - PREMIUMS 6 1. Life Insurance and Waiver 6 2. Associated Riders 6 3. Premium Taxes 7 4. Payments 7 5. Nonpayment of Reinsurance Premiums 7 6. Interest on Delinquent Payments 7 7. Misstatements 7 ARTICLE VI - CLAIMS 8 1. Notice 8 2. Contested Claims 8 3. Expenses 8 4. Misstatements 9 5. Payment 9 6. Assistance and Advice 9 ARTICLE VII - REDUCTIONS, REINSTATEMENTS & CHANGES 9 1. Reductions and Terminations 9 2. Reinstatements 10 3. Nonforfeiture Benefits 10 4. Contractual Conversions and Exchanges 10 5. Non Contractual Exchanges 11 6. Program of Internal Replacement 11 LIFE RE AGREEMENT #6550-1 Table of Contents . . . ARTICLE VIII - DAC TAX 11 ARTICLE IX - RECAPTURE 12 1. Standards for Recapture 12 2. Method of Recapture 12 ARTICLE X - INSOLVENCY 12 ARTICLE XI - ARBITRATION 13 ARTICLE XII - GENERAL PROVISIONS 14 1. Reinsurer's Right of Notice of Unusual Practices 14 2. Policy Forms and Rates 14 3. Reinsurance Conditions 14 4. Errors and Omissions 15 5. Offset 15 6. Inspection 15 7. Entire Agreement 15 8. Amendment 15 9. Counterparts 16 10. No Assignment 16 11. Binding Effect 16 12. Notices 16 ARTICLE XIII - DURATION OF AGREEMENT 17 ARTICLE XIV - EXECUTION 18 SCHEDULE A - Retention Limits, Automatic Binding Limits, Plans Covered SCHEDULE B - Reporting Forms SCHEDULE C PART I - Premium Rates PART II - Percentages SCHEDULE D - Discounts LIFE RE AGREEMENT #6550-1 PREAMBLE This Reinsurance Agreement ("Agreement") is entered into by and between STANDARD LIFE INSURANCE COMPANY OF INDIANA, an Indiana insurance corporation (the "Company") and LIFE REASSURANCE CORPORATION OF AMERICA, a Connecticut insurance corporation ("Life Re"). The Company and Life Re mutually agree to reinsure on the terms and conditions set forth in this Agreement. This Agreement is solely between the Company and Life Re, and performance of the obligations of each party under this Agreement will be rendered solely to the other party. In no instance will anyone other than the Company or Life Re have any rights under this Agreement. ARTICLE I - METHOD OF REINSURANCE AND INSURANCE 1. EFFECTIVE DATE The reinsurance under this Agreement is effective as of SEPTEMBER 1, 1997. 2. METHOD Reinsurance of life insurance risks ("Life Insurance") under this Agreement and waiver of premium benefits ("Waiver") is on the yearly renewable term ("YRT") plan for the amount at risk under the policy reinsured. The Company will cede and Life Re will accept reinsurance under the policies or plans set forth in Schedule A, written by the Company on citizens of the United States or Canada, domiciled in the United States or Canada at the time of application. The policies set forth in Schedule A that are reinsured under this Agreement are hereinafter referred to collectively as "Reinsured Policies" and individually as a "Reinsured Policy." Said policies will have been underwritten in accordance with the Company's individual ordinary life underwriting rules and practices. 3. AMOUNTS For the purpose of this Agreement, the reinsured amount at risk (R) is calculated as follows: (1) For Option 1: R = D - X - A, where D = Death benefit X = The Company's retention A = The Accumulation Fund Value or Cash Value, whichever is applicable under base plan LIFE RE AGREEMENT #6550-1 (2) For Option 2: R = D - X, where D = Death benefit X = The Company's retention 4. MINIMUM AMOUNTS Amounts of initial reinsurance less than $5,000 will not be ceded under this Agreement. ARTICLE II - AUTOMATIC REINSURANCE 1. INSURANCE The Company will cede and Life Re will accept automatically reinsurance in amounts not exceeding the binding limits per life in Schedule A of this Agreement. If the Company has more than one agreement with Life Re, the total amount per life automatically ceded to Life Re under all agreements combined will not exceed the automatic binding limit available to the Company under the agreement with the highest binding authority. Life Re will accept automatic reinsurance when (a) the Company already has for its own account its maximum limit of retention on the risk and for this reason alone is not retaining any portion of the insurance applied for on a current application, and (b) in the Company's opinion there has been no adverse change in the insurability of the risk since the Company's last acceptance for its own retention. A risk as defined in the following categories is not eligible for reinsurance under this paragraph: (a) A jumbo risk as defined in paragraph 3 below. (b) A risk which has been sent to Life Re or any other reinsurer for facultative underwriting consideration. (c) Life Insurance resulting from a group conversion, where full evidence of insurability has not been secured. (d) Any risk which is not fully underwritten or any risk where the Company has not followed its usual underwriting practice. The liability of Life Re on any automatic reinsurance under this Agreement begins and ends at the same time as that of the Company, provided that such an automatic application shall not have been submitted to Life Re or to any other reinsurer for facultative underwriting consideration. LIFE RE AGREEMENT #6550-1 2. COVERAGES Life Insurance, Waiver for an amount not greater than the corresponding life insurance, and Associated Riders are exclusively the coverages or risks reinsured automatically under this Agreement. Life Re will not participate in a unilateral enhancement of policy provisions unless agreed to in writing prior to the granting of the enhancement. Life Insurance includes both basic policies and term riders providing life insurance protection. 3. JUMBO RISK A jumbo risk is one where the papers of the Company, including all papers that are part of the current application, indicate that the person to be insured has or will have total insurance in force with all companies greater than: LIFE All Ages $10,000,000 4. WAIVER ACCEPTANCE AND PARTICIPATION LIMITS Life Re's maximum acceptance limit for Waiver is $2,000,000 per life, and the maximum participation limit for such benefits is $3,000,000 per life. 5. REGULAR LIMITS OF RETENTION The Company may modify its regular limits of retention, detailed in Schedule A, by giving thirty days' written notice to Life Re. The amount of reinsurance to be ceded and accepted automatically after the new limits take effect will be determined by mutual written agreement by Life Re and the Company. ARTICLE III - FACULTATIVE REINSURANCE The Company may choose to submit for consideration by Life Re, a request for any amount of reinsurance of the coverages in Article II that the Company may require. Reinsurance may be requested for any amount without regard for the limits of retention detailed in Schedule A, but the Company will notify Life Re promptly of any changes in its limits of retention. LIFE RE AGREEMENT #6550-1 When the Company requests facultative reinsurance, the application will be made by submitting to Life Re a mutually agreeable form. The Company will send to Life Re any and all information the Company has about the risk, including without limitation, copies of the application, medical examiners' reports, attending physicians' statements, inspection reports, and other reports and other papers bearing on the insurability of the risk. Promptly upon receipt of the application, Life Re will analyze the risk and notify the Company of Life Re's decision and Life Re's classification of the risk. If the Company elects to accept Life Re's unconditional offer of acceptance for reinsurance of the risk, the Company will notify Life Re within 120 days of Life Re's offer. The liability of Life Re on any facultative reinsurance under this Agreement begins and ends at the same time as that of the Company, provided that: (a) Life Re has given the Company an unconditional offer of acceptance after the application for reinsurance, AND (b) the Company has notified Life Re of its acceptance of such offer within 120 days of said offer. ARTICLE IV - PROCEDURES FOR REPORTING 1. GENERAL INFORMATION Life Re will accept, on a self administered basis, reinsurance in amounts per life up to the amounts set forth in Schedule A. 2. SELF-ADMINISTERED REPORTING The Company will remit a check for the balance indicated in the monthly statements to Life Re along with the reporting form set forth in Schedule B or a mutually agreed upon form submitted by the Company. If a balance is due the Company, it will be remitted by Life Re promptly. Within ten (10) days following the close of each calendar month, the Company will forward to Life Re on computer tape or other acceptable form, reports in substantial conformity with the following: A. MONTHLY NEW BUSINESS REPORT (1) policy number; (10) amount reinsured; (2) full name of insured; (11) automatic/facultative indicator; (3) date of birth; (12) state of residence; (4) sex; (13) table rating; (5) issue age; (14) flat extra (amount + number of years); (6) policy date; (15) death benefit option (UL products); (7) underwriting; (16) amount at risk classification; (8) plan of insurance; (17) transaction code; (9) amount issued; (18) currency if other than U.S.; and (19) qualified pension (yes/no). LIFE RE AGREEMENT #6550-1 B. MONTHLY CONVERSION REPORT The Company will furnish Life Re with a separate listing of reinsurance policies that are conversions or replacements to the plan(s) as stated in Schedule A. The listing should provide the following information: (1) 1 through 19 in 2.A above; (4) attained age; (2) original policy date; (5) duration; and (3) original policy number; (6) effective date if other than policy date. C. MONTHLY PREMIUM REPORT The Company will furnish Life Re a listing of all reinsurance policies issued or renewing during the past month accompanied by the reinsurance premiums for such policies. The listing should be segregated into first year issues and renewals and should provide the following information: (1) 1 through 19 in 2.A above; (2) current amount at risk; and (3) the net reinsurance premium due for each reinsured policy with the premium for life and each supplemental benefit separated. D. MONTHLY CHANGE REPORT The Company will report the details of all policy terminations and changes on the reinsured policies. In addition to the data indicated in 2.A, above, the report should provide information about the nature, the effective date, and the financial result of the change with respect to reinsurance. E. MONTHLY POLICY EXHIBIT REPORT The Company will provide a summary of new issues, terminations, recaptures, changes, death claims and reinstatements during the month and the inforce reinsurance at the end of the month. F. QUARTERLY INFORCE AND RESERVE LISTING Within ten (10) days after the close of each calendar quarter, the Company will furnish Life Re with a listing of reinsurance in force by policy, by year of issue and include statutory reserves for the same. The listing must show sufficient detail such that reserve calculations can be independently verified by Life Re's auditors and examiners. The listing should be segregated into first year issues and renewals and should provide the following information: 1 through 19 in 2.A above For the fourth quarter, Federal Income Tax reserves must also be furnished. They may be included in the fourth quarter statutory report or they may be submitted separately, but in the same format as the statutory report. LIFE RE AGREEMENT #6550-1 G. ELECTRONIC DATA TRANSMISSION If the Company reports its reinsurance transactions via electronic media, the Company will consult with Life Re to determine the appropriate reporting format. Should the Company subsequently desire to make changes in the data format or the code structure, the Company will communicate such changes to Life Re prior to the use of such changes in reports to Life Re. ARTICLE V - PREMIUMS 1. LIFE INSURANCE AND WAIVER Premiums per $1,000 for Life Insurance are shown in Part I of Schedule C and will be multiplied by the percentages shown in Part II of Schedule C. The premiums per $1,000 are applied to the amount of life reinsurance as outlined in Article I. A policy fee, when applicable, is charged in each year in addition to the premium based on amount of life reinsurance. Life Re anticipates that these premiums will be continued indefinitely for all business ceded under this Agreement. For the purpose of satisfying requirements for deficiency reserves imposed by various state insurance departments, Life Re will guaranty for renewal the greater of the premiums provided in this Agreement or premiums based on the 1980 CSO Table at 2.5% interest. When the Company charges a flat extra premium, whether alone or in addition to a premium based on a multiple table, the Company will pay this premium less the discounts detailed in Schedule D, on the reinsurance amount in addition to the standard or multiple table premium for the rating and plan of reinsurance. Premium for Waiver will be paid at the same rate as the Company charges for the benefit on which reinsurance with Life Re is based. Discounts for waiver are detailed in Schedule D. 2. ASSOCIATED RIDERS Benefits under Associated Riders are shown in Schedule A, Plans Covered. Premiums for these benefits, when they are included in the coverage under this Agreement, are detailed in Parts I and II of Schedule C. Discounts are outlined in Schedule D. LIFE RE AGREEMENT #6550-1 3. PREMIUM TAXES Life Re will not reimburse the Company for state premium taxes on reinsurance premiums received from the Company. 4. PAYMENTS Premiums are payable monthly in advance. If reinsurance is reduced, terminated, increased or reinstated, monthly, pro-rata adjustment will be made by Life Re and the Company on all premium items except policy fees. 5. NONPAYMENT OF REINSURANCE PREMIUMS The payment of reinsurance premiums is a condition precedent to the liability of Life Re under this Agreement. If the Company does not pay premiums to Life Re as provided in this Agreement and such amounts are more than 120 days in arrears, Life Re will have the right to terminate the reinsurance under this Agreement. 6. INTEREST ON DELINQUENT PAYMENTS If the Company is more than 90 days in arrears in remitting premiums to Life Re, such premiums will be considered delinquent and interest will be added to the amount to be remitted. Interest will be calculated from (i) the time the premiums are due Life Re to (ii) the date the Company pays the premium to Life Re. The rate of interest charged on delinquent payments will be equal to the rate listed in the Federal Reserve Statistical Release, as promulgated by the Board of Governors of the Federal Reserve System, for the monthly average of Corporate bonds, Moody's seasoned Aaa (the "Interest Rate"). 7. MISSTATEMENTS If the insured's age or sex was misstated and the amount of insurance on the Company's policies is adjusted, the Company and Life Re will share the adjustment in proportion to the amount of liability of each at the time of issue of the policies. Premiums will be recalculated for the correct age or sex and amounts according to the proportion as above and adjusted without interest. If the insured is still alive, the method above will be used for past years and the amount of reinsurance and premium will be adjusted for the future to the amount that would have been correct at issue. LIFE RE AGREEMENT #6550-1 ARTICLE VI - CLAIMS 1. NOTICE The Company will notify Life Re promptly after receipt of any information on a claim where reinsurance is involved. The Company will furnish to Life Re as soon as possible the completed reinsurance claim form and copies of all claim papers and proofs. However, if the amount reinsured with Life Re is more than the amount retained by the Company and the claim is contestable, all papers in connection with such claim, including all underwriting and investigation papers must be submitted to Life Re for its recommendation before admission of any liability on the part of the Company. 2. CONTESTED CLAIMS Whenever the Company has formed a preliminary opinion that a claim might be denied or contested, and prior to any final action by the Company indicating to the claimant that the claim is being denied or contested, the Company will give Life Re the opportunity to review the complete claim file. Life Re will review this file promptly and, at its option, (a) pay Life Re's full share as if the claim was not contested, in full discharge of Life Re's obligation to the Company for that claim, or (b) after consultation with the Company join in the contest, or ratify the denial, in which case Life Re will communicate to the Company in writing Life Re's decision to participate in the contest, or ratify the denial, with respect to that claim. 3. EXPENSES Life Re will share in the claim expense of any contest or compromise of a claim in the same proportion that the amount at risk reinsured under this Agreement bears to the total risk of the Company on all policies being contested by the Company, and Life Re will share in the total amount of any reduction in liability in the same proportion. Claim expense will include without limitation the cost of investigation, legal fees, court costs, and interest charges. Compensation of salaried officers and employees and any possible extra-contractual damages will not be considered covered expenses. Life Re will not be liable for expenses incurred in connection with a dispute or contest arising out of conflicting claims of entitlement to policy proceeds or benefits. LIFE RE AGREEMENT #6550-1 4. MISSTATEMENTS In the event of an increase or reduction in the amount of the Company's insurance on any policy reinsured hereunder because of an overstatement or understatement of age or misstatement of sex, established after the death of the insured, the Company and Life Re will share in such increase or reduction in proportion to their respective amounts at risk under that policy. 5. PAYMENT For Life Insurance, Life Re will pay its share in a lump sum to the Company, without regard to the form of claim settlement of the Company. For a Waiver claim, the Company will continue to pay premiums for reinsurance except the premium for disability reinsurance. Life Re will pay its proportionate share of the gross premium waived by the Company on the original policy, including its share of the premiums for benefits that remain in effect during disability. 6. ASSISTANCE AND ADVICE At the request of the Company, Life Re will advise the Company on any claim concerning business reinsured under this Agreement and, when such a claim appears to be of doubtful validity, Life Re will assist the Company in its determination of liability and in the best procedure to follow with respect to the claim. ARTICLE VII - REDUCTIONS, REINSTATEMENTS & CHANGES 1. REDUCTIONS AND TERMINATIONS Reinsurance amounts are calculated in terms of coverages on the life of a person. If any of the Company's policies or riders on the person are reduced or terminated, the reinsurance in force will be reduced by the corresponding amount. The reduction will not be applied to force the Company to reassume more than its regular retention limit at the time of the reduction for the age at issue, mortality rating and form of the policy or policies for which reinsurance is being terminated. The reduction first will be applied to reinsurance, if any, on the particular policy reduced. If the reduction exceeds the amount of reinsurance on that policy, the reduction will then be applied to reinsurance on other policies on that life in the order in which the policies were effected, i.e., the first effected will be the first terminated or reduced. If reinsurance has been ceded to more than one reinsurer, the reduction in Life Re's reinsurance will be in proportion to the reduction in the total. After the proportion has been determined, the rules above will be used. LIFE RE AGREEMENT #6550-1 2. REINSTATEMENTS (a) AUTOMATIC REINSURANCE A policy of the Company, ceded to Life Re on an automatic basis, that was reduced, terminated, or lapsed, if reinstated by the Company under its regular rules, will be reinstated automatically to the amount that would be in force had the policy not been reduced, terminated, or lapsed. (b) FACULTATIVE REINSURANCE A Reinsured Policy ceded to Life Re that was reduced, terminated, or lapsed, on a facultative basis, (i) will require approval by Life Re prior to reinstatement if the Company has retained less than 50% of the risk, or (ii) will be reinstated automatically by Life Re if the Company has retained more than 50% of the risk and reinstates the Reinsured Policy under its regular rules. Upon reinstatement, reinsurance for the policy will be for the amount that would be in force had the policy not been reduced, terminated, or lapsed. In connection with all reinstatements the Company will pay Life Re all reinsurance premiums and interest in like manner as the Company has received under its policy. 3. NONFORFEITURE BENEFITS Life Re will not participate in nonforfeiture benefits. 4. CONTRACTUAL CONVERSIONS AND EXCHANGES In the event of a contractual conversion or exchange (i.e., conversion or exchange that requires no evidence of insurability) Life Re will reinsure the risk resulting from such conversion or exchange at the rates and percentages shown in Parts I and II of Schedule C on point-in-scale basis (using the original issue age and duration from the original issue) and the discounts of Schedule D on a point-in-scale basis. The reinsured amount at risk on the policy or policies being converted may not exceed the current reinsured amount at risk on the policy or policies being converted or exchanged. If the conversion or exchange results in an increase of risk, the amount of increase will be subject to evidence of insurability. LIFE RE AGREEMENT #6550-1 5. NON CONTRACTUAL EXCHANGES Non contractual exchanges are subject to evidence of insurability. Premiums for the risk resulting from the exchange will be reflected in Parts I and II of Schedule C. 6. PROGRAM OF INTERNAL REPLACEMENT Should the Company, its affiliates, successors, or assigns, initiate a program of internal replacement, as defined below, that would include any of the risks reinsured hereunder, the Company will immediately notify the reinsurer. For each risk reinsured hereunder that has been replaced under a program of internal replacement, the reinsurer shall have the option, at its sole discretion, of either treating the risks reinsured as recaptured, or continuing reinsurance on the new policy under this Agreement. The term "program of internal replacement" shall mean any program offered to a class of policy owners in which a policy or any portion of a policy is exchanged for another policy, not reinsured under this Agreement, which is written by the Company, its affiliates, successors, or assigns. ARTICLE VIII - DAC TAX Life Re and the Company hereby agree to the following pursuant to Section 1.848-2(g)(8) of the Income Tax Regulation under Section 848 of the Internal Revenue Code of 1986, as amended. (a) The term "party" will refer to either Life Re or the Company as appropriate. (b) The terms used in this Article are defined by reference to Regulation 1.848-2. The term "net consideration" will refer to either net consideration as defined in Regulation Section 1.848- 2(f) or gross amount of premiums and other consideration as defined in Regulation Section 1.848-3(b) as appropriate. (c) Each party shall attach a schedule to its federal income tax return which identifies the relevant reinsurance agreements for which the joint election under the Regulation has been made. (d) The party with net positive consideration, as defined in the Regulation promulgated under Code Section 848, for such agreement for each taxable year, shall capitalize specified policy acquisition expenses with respect to such agreement without regard to the general deductions limitation of Section 848(c)(1). (e) Each party agrees to exchange information pertaining to the amount of net consideration under such agreement each year to ensure consistency. LIFE RE AGREEMENT #6550-1 ARTICLE IX - RECAPTURE 1. STANDARDS FOR RECAPTURE If the Company increases its maximum retention from the maximum limit of retention set forth in Schedule A, the Company may elect to recapture that portion of each Reinsured Policy equal to the difference between the Company's new limit of retention and the Company's old limit of retention, subject to the provisions of this Article IX. If the Company elects this type of recapture, the Company may only recapture Reinsured Policies that meet both of the following requirements: (a) Reinsured Policies that have been in force for ten (10) years and (b) Reinsured Policies for which the Company maintained its maximum limit of retention at the time the Reinsured Policy was issued. 2. METHOD OF RECAPTURE If the Company elects to recapture, the Company will notify Life Re in writing within ninety days from the effective date of the increase in its limit of retention. If the Company elects to recapture one Reinsured Policy under this provision, the Company must recapture every Reinsured Policy that meets the requirements set forth in Article IX, Section 1, above. Recapture for each Reinsured Policy will occur on the later to occur of (a) the next anniversary of the Reinsured Policy or (b) the tenth (10th) anniversary of the Reinsured Policy. The amount of reinsurance on the Reinsured Policy will be reduced so that the total amount of risk retained by the Company will be equal to the Company's maximum limit of retention. If two or more reinsurers have reinsurance on the same Reinsured Policy, Life Re's portion of the reduction will be in proportion to Life Re's share of the total reinsurance on the Reinsured Policy. ARTICLE X - INSOLVENCY All reinsurance under this Agreement will be paid on demand by Life Re directly to the Company, its liquidator, receiver, or statutory successor, on the basis of the liability of the Company under the policy or policies reinsured without diminution because of the insolvency of the Company. In the event of the insolvency of the Company, the liquidator, receiver, or statutory successor of the Company will give written notice to Life Re of a pending claim against Life Re or the Company on any policy reinsured within a reasonable time after the claim is filed in the conservation, liquidation, or insolvency proceedings. While the claim is pending, Life Re may investigate and interpose, at its own expense, in the proceedings where the claim is to be adjudicated, any defenses which it may deem available to the Company or its liquidator, receiver, or statutory successor. The expense incurred by Life Re will be charged, subject to court approval, against the Company as an expense of the conservation, liquidation, or insolvency to the extent of a proportionate share of the benefit that accrues to the Company as a result of the defenses by Life Re. Where two or more reinsurers are involved and a majority in interest elect to defend a claim, the expense will be apportioned in accordance with the terms of this Agreement as if the expense had been incurred by the Company. ARTICLE XI - ARBITRATION Life Re and the Company intend that any dispute between them under or with respect to this Agreement be resolved without resort to any litigation. Accordingly, Life Re and the Company agree that they will negotiate diligently and in good faith to agree on a mutually satisfactory resolution of any such dispute; PROVIDED, HOWEVER, that if any such dispute cannot be so resolved by them within sixty calendar days (or such longer period as the parties may agree) after commencing such negotiations, Life Re and the Company agree that they will submit such dispute to arbitration in the manner specified in, and such arbitration proceeding will be conducted in accordance with, the rules of the American Arbitration Association. The arbitration hearing will be before a panel of three arbitrators, each of whom must be a present or former officer of a life insurance or life reinsurance company. Life Re and the Company will each appoint one arbitrator by written notification to the other party within thirty calendar days after the date of the mailing of the notification initiating the arbitration. These two arbitrators will then select the third arbitrator within sixty calendar days after the date of the mailing of the notification initiating arbitration. If either Life Re or the Company fails to appoint an arbitrator, or should the two arbitrators be unable to agree upon the choice of a third arbitrator, the president of the American Arbitration Association or of its successor organization or (if necessary) the president of any similar organization designated by lot of Life Re and the Company within thirty calendar days after the request will appoint the necessary arbitrators. The vote or approval of a majority of the arbitrators will decide any question considered by the arbitrators; PROVIDED, HOWEVER, that if no two arbitrators reach the same decision, then the average of the two closest mathematical determinations will constitute the decision of all three arbitrators. The place of arbitration will be Stamford, Connecticut. Each decision (including without limitation each award) of the arbitrators will be final and binding on all parties and will be nonappealable, and (at the request of either Life Re or the Company) any award of the arbitrators may be confirmed by a judgment entered by any court of competent jurisdiction. No such award or judgment will bear interest. Each party will be responsible for paying (a) all fees and expenses charged by its respective counsel, accountants, actuaries, and other representatives in conjunction with such arbitration and (b) one-half of the fees and expenses charged by each arbitrator. ARTICLE XII - GENERAL PROVISIONS 1. REINSURER'S RIGHT OF NOTICE OF UNUSUAL PRACTICES In providing reinsurance facilities to the Company under this Agreement, Life Re has granted the Company considerable authority with respect to automatic binding power, reinstatements, claim settlements, and the general administration of the reinsurance account. To facilitate transactions, Life Re has required the minimum amount of information and documentation possible, reflecting its utmost faith and confidence in the Company. Life Re assumes that, except as otherwise notified by the Company, the underwriting, claims and other insurance practices employed by the Company with respect to reinsurance ceded under this Agreement are generally consistent with the customary and usual practices of the insurance industry as a whole. If the Company changes or modifies its practices or engages in exceptional or uncustomary practices, the Company agrees to make those practices known to Life Re before assigning any liability to Life Re with respect to any reinsurance issued under such practices. 2. POLICY FORMS AND RATES Upon request, the Company will furnish Life Re with a copy of its application forms, policy and rider forms, premium and non-forfeiture value manuals, reserve tables, actuarial memoranda, and any other forms or tables needed for proper handling of reinsurance under this Agreement. Life Re must agree in writing before incurring additional liability resulting from any changes to policies, policy riders or amendments reinsured under this Agreement. 3. REINSURANCE CONDITIONS The reinsurance is subject to the same limitations and conditions as the insurance under the policy or policies written by the Company on which the reinsurance is based. LIFE RE AGREEMENT #6550-1 4. ERRORS AND OMISSIONS If either the Company or Life Re unintentionally fails to perform an obligation that affects this Agreement and such failure results in an error on the part of the Company or Life Re, the error will be corrected by restoring both the Company and Life Re to the positions they would have occupied had no such error occurred. For business reported but not covered under the provisions of this Agreement, Life Re shall be obligated only for the return of premium paid, plus interest as provided below. Any amounts due under this Section 4 will bear interest at a rate agreed upon by the Company and Life Re or at a rate equal to the Interest Rate as described in Article V.6. 5. OFFSET Any amount which either the Company or Life Re is contractually obligated to pay to the other party may be paid out of any amount which is due and unpaid under this Agreement. The application of this offset provision will not be deemed to constitute diminution in the event of insolvency. 6. INSPECTION Upon reasonable notice, Life Re may inspect any and all books, records, documents or similar information relating to or affecting reinsurance under this Agreement at the home office of the Company during normal business hours. 7. ENTIRE AGREEMENT This Agreement and the Schedules attached hereto supersede all prior discussions and written and oral agreements between the parties with respect to the subject matter of this Agreement. This Agreement and the Schedules attached hereto contain the sole and entire agreement between the parties hereto with respect to the subject matter hereof. 8. AMENDMENT This Agreement may be modified or amended only with a written instrument properly signed on behalf of the Company and Life Re. LIFE RE AGREEMENT #6550-1 9. COUNTERPARTS This Agreement may be executed simultaneously in any number of counterparts, each of which will be deemed an original, but all of which will constitute one and the same instrument. 10. NO ASSIGNMENT Except as otherwise provided herein, neither party hereto may assign this Agreement or any right hereunder or part hereof without the prior written consent of the other party hereto. 11. BINDING EFFECT This Agreement is binding upon and will inure to the benefit of the parties and their respective successors and permitted assignees. 12. NOTICES Any notice, request, instruction, or other document to be given hereunder by any party hereto to the other party hereto will be in writing and (a) delivered personally, (b) sent by facsimile, (c) delivered by overnight express, or (d) sent by registered or certified mail, postage prepaid, as follows: If to the Company, to: Standard Life Insurance Company of Indiana 9100 Keystone Crossing Indianapolis, IN 46240 Attention: Reinsurance Administration Facsimile: 317/574-6272 If to Life Re, to: Life Reassurance Corporation of America 969 High Ridge Road Stamford, Connecticut 06905 Attention: Vice President, Administration Facsimile: 203/321-3200 LIFE RE AGREEMENT #6550-1 or at such other address for a party as will be specified by like notice. Each notice or other communication required or permitted under this Agreement that is addressed as provided in this Article XII will, if delivered personally or by overnight express, be deemed given upon delivery; will, if delivered by facsimile or similar facsimile transmission, be deemed delivered when electronically confirmed; and will, if delivered by mail in the manner described above, be deemed given on the third business day after the day it is deposited in a regular depository of the United States Mail. Please send all cash remittances to: Life Reassurance Corporation of America P.O. Box 1797 Stamford, Connecticut 06904 ARTICLE XIII - DURATION OF AGREEMENT This Agreement will be effective on and after the effective date stated in Article I. It is unlimited in duration but may be amended by mutual consent of the Company and Life Re. This Agreement may be terminated as to new reinsurance by either party giving 90 days' written notice to the other. Termination as to new reinsurance does not affect existing reinsurance. Existing reinsurance will remain in force until termination of the Company's policy or policies on which the reinsurance is based in accordance with the terms of this Agreement. Notwithstanding the foregoing, Life Re may terminate this Agreement as to new and existing reinsurance in the event the Company does not pay premiums to Life Re, as provided in Article V. LIFE RE AGREEMENT #6550-1 ARTICLE XIV - EXECUTION IN WITNESS WHEREOF, Life Re and the Company have executed this Agreement on the dates set forth below. STANDARD LIFE INSURANCE COMPANY OF INDIANA Date: December 8, 1997 By: Edward T. Stahl Place: Indianapolis, IN Title: Executive Vice President and Secretary Witness: Carla J. James LIFE REASSURANCE CORPORATION OF AMERICA Date: September 29, 1997 By: Claudia Cannatara Place: Stamford, CT Title: Vice President Witness: Sarah L. Komar LIFE RE AGREEMENT #6550-1 AGREEMENT NUMBER 6550-1 RETENTION LIMITS A. LIFE The Company will cede 100% of the excess over the retention shown below: AGES RETENTION 0 - 80 $25,000 B. WAIVER OF PREMIUM Same as Life LIFE RE'S SHARE Life Re's share of the ceded reinsurance amount will be 50%. AUTOMATIC BINDING LIMITS A. LIFE Fourteen times the retention up to a maximum of $350,000, of which Life Re's share is 50% or $175,000. B. WAIVER OF PREMIUM Same as Life PLANS COVERED The preceding schedules refer to insured lives whose surnames begin with the letters A through Z under the following plans: PLAN Secure Life (Form ULS197U) RIDERS Waiver of Premium Term Insurance Rider Spouse Term Rider AGREEMENT NUMBER 6550-1 Reinsurance premiums will be based on Standard Life Insurance Company's upper band ($100,000+) cost of insurance rates, age last birthday, multiplied by the following percentages: YEAR SELECT NON-SMOKER SELECT SMOKER 1 O% 0% 2 - 10 40% 50% 11 + 60% 80% LIFE RE AGREEMENT #6550-1 AGREEMENT NUMBER 6550-1 The discounts granted for reinsurance amounts expressed as a percentage of the premium rate charged by the Company are shown below for each applicable benefit: BENEFIT FIRST YEAR RENEWAL YEARS LIFE INSURANCE - FLAT EXTRA PREMIUMS Aviation Hazards 10% 10% Temporary Extras (<= 5 years) 10% 10% Permanent Extras (> 5 years) 75% 10% WAIVER OF PREMIUM DISABILITY 75% 10% * On cessions in excess of $10,000,000, Life Re reserves the right to adjust the discounts/rates and expenses. LIFE RE AGREEMENT #6550-1 AGREEMENT NUMBER 6550-1 RETENTION LIMITS A. LIFE The Company will cede 100% of the excess over the retention shown below: AGES RETENTION 0 - 80 $25,000 B. WAIVER OF PREMIUM Same as Life LIFE RE'S SHARE Life Re's share of the ceded reinsurance amount will be 50%. AUTOMATIC BINDING LIMITS A. LIFE Seven times the retention up to a maximum of $350,000, of which Life Re's share is 50% or $162,500. B. WAIVER OF PREMIUM Same as Life PLANS COVERED The preceding schedules refer to insured lives whose surnames begin with the letters A through Z under the following plans: PLAN Secure Life (Form ULS197U) RIDERS Waiver of Premium Term Insurance Rider Spouse Term Rider LIFE RE AGREEMENT #6550-1 11/25/1997 EX-10.35 8 REINSURANCE AGREEMENT WITH BMA ARTICLE I BASIS OF REINSURANCE REINSURANCE UNDER THIS AGREEMENT MUST BE INDIVIDUAL INSURANCE. THE CEDING COMPANY SHALL AUTOMATICALLY REINSURE THE LIFE INSURANCE FOR THE PLAN(S) AS STATED IN SCHEDULE A. 1. REQUIREMENTS FOR AUTOMATIC REINSURANCE A. The individual risk must be a permanent resident of the United States. B. The individual risk must be underwritten by the CEDING COMPANY according to the standard underwriting practices and guidelines as shown in Exhibit IA. The CEDING COMPANY shall immediately notify BMA of any changes in underwriting practices or guidelines. Any risk falling into a category of special underwriting programs shall be excluded from this Agreement. C. Any risk offered on a facultative basis to BMA or any other reinsurer shall not qualify for automatic reinsurance. D. The maximum issue age on any risk shall be as stated in Schedule A. Applications with issue ages over the limit stated in Schedule A must be submitted facultatively. E. The mortality rating on any one risk shall not exceed the Table Rating stated in Schedule A, or its equivalent on a flat extra premium basis. Cases exceeding the Table Rating stated in Schedule A, or its equivalent must be submitted facultatively. F. The maximum amount of insurance issued and applied for in all companies on any one risk shall not exceed the Jumbo limits as stated in Schedule A. G. On any risk, the CEDING COMPANY must retain the amounts of insurance as stated in Exhibit I. H. The maximum amounts of insurance to be reinsured on any one life shall not exceed the automatic binding limits as stated in Schedule A. I. The minimum amount of insurance to be ceded shall be as stated in Schedule A. 2. REQUIREMENTS FOR FACULTATIVE REINSURANCE A. Plan of Insurance Listed in Schedule A: (1) If the Requirements for Automatic Reinsurance are met but the CEDING COMPANY prefers to apply for facultative reinsurance, or (2) If Requirements for Automatic Reinsurance are not met then the CEDING COMPANY must submit to BMA all the underwriting documentation relating to the insurability of the individual risk for facultative reinsurance. B. Plan of Insurance Not Listed in Schedule A: On a Yearly Renewable Term treaty the CEDING COMPANY may submit an application for facultative reinsurance on any plan(s). On a Coinsurance treaty the Ceding Company cannot submit an application for facultative reinsurance on plan(s) other than the plan(s) listed in Schedule A. C. An application for facultative reinsurance may include life insurance with or without either disability waiver of premium or accidental death or both. Supplemental benefits without life are not accepted on an individual cession basis. D. Copies of all underwriting papers relating to the insurability of the individual risk must be sent to BMA for facultative reinsurance. After BMA has examined the underwriting papers, BMA will promptly notify the CEDING COMPANY of the underwriting offer subject to additional requirements, the final underwriting offer or declination. Any final underwriting offer on the individual risk will automatically terminate upon the earliest of: (1) The date BMA receives notice of a withdrawal/cancellation by the CEDING COMPANY, (2) 120 days after the date on which the offer was made, or (3) The date specified in BMA's approval to extend the offer. E. The minimum amount of insurance to be ceded shall be as stated in Schedule A. 1 ARTICLE II LIABILITY 1. BMA's liability for automatic reinsurance shall begin simultaneously with the CEDING COMPANY's liability. 2. Except for additional coverage pertaining to conditional receipt as described in Schedule C, BMA's liability for facultative reinsurance on individual risks shall not begin unless and until the CEDING COMPANY has accepted BMA's final and unconditional written offer on the application for facultative reinsurance. 3. BMA's liability for reinsurance on individual risks shall terminate when the CEDING COMPANY's liability terminates. 4. As long as the original policy remains in full force, all paid-up additions and accumulated dividends shall be the liability of the CEDING COMPANY. 5. In no event shall reinsurance under this Agreement be in force unless the insurance issued directly by the CEDING COMPANY is in force and is issued and delivered in a jurisdiction in which the CEDING COMPANY is properly licensed. 6. The payment of reinsurance premiums in accordance with this Agreement shall be a condition precedent to the liability of BMA under reinsurance covered by this Agreement ARTICLE III ADMINISTRATIVE REPORTING 1. Self-Administered Business Promptly after liability for insurance has begun on an individual risk, the CEDING COMPANY shall have the responsibility of maintaining adequate records for the administration of the reinsurance account and shall furnish BMA with monthly reports, in substantial conformity with the following: A. MONTHLY NEW BUSINESS REPORT (1) policy number (10) amount reinsured (2) full name of insured (11) automatic/facultative indicator (3) date of birth (12) state of residence (4) sex (13) table rating (5) issue age (14) flat extra (amount + number of years) (6) policy date (15) death benefit option (UL products) (7) underwriting classification (16) net amount at risk (8) plan of insurance (17) transaction code (9) amount issued (18) currency if other than U.S. 2 B. MONTHLY CONVERSION REPORT The CEDING COMPANY shall furnish BMA with a separate listing of reinsurance policies that are conversions or replacements to the plan(s) as stated in Schedule A. The listing should provide the following information: (1) 1 through 18 in 1.A above (4) attained age (2) original policy date (5) duration (3) original policy number (6) effective date if other than policy date C. MONTHLY PREMIUM REPORT At the end of each month the CEDING COMPANY shall send to BMA a listing of all reinsurance policies issued or renewing during the past month accompanied by the reinsurance premiums for such policies. The listing should be segregated into first year issues and renewals and should provide the following information: (1) 1 through 18 in 1.A above (2) current net amount at risk (3) On Yearly Renewable Term treaties the net reinsurance premium due for each reinsured policy with the premium for life and each supplemental benefit separated. (4) On Coinsurance treaties the gross reinsurance premium, commissions, net reinsurance premium and other amounts (e.g. dividends, cash surrender values) with premium separated for life and each supplemental benefit. All monthly lists shall be submitted to BMA no later than the 20th day of the following month. D. MONTHLY CHANGE REPORT The CEDING COMPANY shall report the details of all policy terminations and changes on the reinsured policies. In addition to the data indicated in 1.A, above, the report should provide information about the nature, the effective date, and the financial result of the change with respect to reinsurance. E. MONTHLY POLICY EXHIBIT REPORT The CEDING COMPANY shall provide a summary of new issues, terminations, recaptures, changes, death claims and reinstatements during the month and the inforce reinsurance at the end of the month. F. QUARTERLY REPORTING 1. Within ten (10) days following the end of the quarter, the CEDING COMPANY shall provide BMA with Premiums Due and Unpaid and Commissions Due and Unpaid. This report may be in summary form reporting totals by line of business with separate totals for first year and renewals. 2. Within ten (10) days following the end of the quarter, the CEDING COMPANY shall provide BMA with totals for the reserve liability including statutory reserves by valuation basis segregated by Yearly Renewable Term and Coinsurance. 3 G. ANNUAL INFORCE LISTING Within ten (10) days after the close of the year, the CEDING COMPANY shall furnish BMA a listing of reinsurance in force by policy, by year of issue, segregated by Yearly Renewable Term and Coinsurance and include statutory reserves for the same. H. CLAIMS Claims shall be reported as incurred on an individual basis. 2. Individual Cession Business Promptly after liability for reinsurance has begun on the individual risk the CEDING COMPANY shall send BMA a "Reinsurance Cession". Based on the information on the "Reinsurance Cession", BMA will prepare and send the CEDING COMPANY a "Client Individual Cession Record Report". When reinsurance is reduced or changed the CEDING COMPANY shall send BMA an "Amended Reinsurance Cession". ARTICLE IV PLANS OF REINSURANCE 1. Life reinsurance shall be ceded on the basis stated in Schedule A. 2. Copies of all life insurance policies, riders, rate manuals, benefit forms, commuted value tables and cash value tables shall be provided by the CEDING COMPANY to BMA, and BMA shall be promptly notified of any changes therein. ARTICLE V REINSURANCE PREMIUMS 1. Life Reinsurance Premiums A. Life Reinsurance Premiums Paid on a Coinsurance Basis The CEDING COMPANY shall pay the current premium as shown in Exhibit II based on the amount of life insurance reinsured, less the allowance stated in Exhibit III. In addition, the CEDING COMPANY shall pay any substandard table extra and flat extra premiums, but shall exclude the policy fee. In the event the current premium is changed, BMA shall be notified by the CEDING COMPANY immediately. 4 B. Life Reinsurance Premiums on a Yearly Renewable Term Basis The life reinsurance premium on the net amount at risk shall be based on rates shown in Exhibit II. For those premiums less than the valuation net premium based on the 1980 CSO Table at 3% interest, only the latter premiums shall be guaranteed. Should BMA increase the reinsurance premiums to the valuation net premium based on the 1980 CSO Table at 3% interest, then the CEDING COMPANY shall have the right to immediately recapture any business affected by that change. ARTICLE VI PREMIUM ACCOUNTING 1. Payment of Reinsurance Premium. A. The reinsurance premiums shall be paid to BMA using the rates shown in Exhibit II. B. On issues ceded by individual cessions BMA shall send the CEDING COMPANY each month two copies of a statement listing first year and renewal reinsurance premiums less refunds and allowances which are due during the current month. C. On self-administered business the CEDING COMPANY shall provide the statement to BMA using the format described in Article III Self- Administered Business. D. If a net reinsurance premium balance is payable to BMA the CEDING COMPANY shall pay this balance within forty-five (45) days after the close of that month. If the full balance is not received within the forty-five (45) day period, the reinsurance premiums for reinsurance risks listed on the statement, for which payment was not received, shall be delinquent and the liability of BMA shall cease as of the date reinsurance premium were due. E. If a net reinsurance premium balance is payable to the CEDING COMPANY, BMA shall pay this net balance within forty-five (45) days after the monthly statement was sent to the CEDING COMPANY. If the monthly statement has not been returned within forty-five (45) days, BMA shall assume the CEDING COMPANY has verified and is in agreement with the net balance and shall make payment to the CEDING COMPANY. 2. Currency. The reinsurance premiums and benefits payable under this Agreement shall be payable in the lawful money of the United States. 5 ARTICLE VII OVERSIGHTS If there is an unintentional oversight or clerical error in the administration of this Agreement by either the CEDING COMPANY or BMA, it can be corrected provided the correction takes place promptly after the time the oversight or clerical error is first discovered. In that event, the CEDING COMPANY and BMA will be restored to the position they would have occupied had such oversight or clerical error not occurred. ARTICLE VIII REDUCTIONS, TERMINATIONS AND CHANGES 1. A. If in accordance with policy provisions the original policy is converted to permanent life insurance, the life risk under the converted policy which exceeds the amount of risk originally retained by the CEDING COMPANY shall continue to be reinsured with BMA. B. If there is a replacement where full underwriting evidence is not required according to the CEDING COMPANY regular underwriting rules, the life risk which exceeds the amount of risk originally retained by the CEDING COMPANY shall continue to be reinsured with BMA. C. If there is a replacement where full underwriting evidence is required by the CEDING COMPANY, reinsurance may be ceded to BMA subject to a written agreement between BMA and the CEDING COMPANY. 2. If the amount of insurance under a policy or rider reinsured under this Agreement increases and A. The increase is subject to new underwriting evidence, the provisions of Article I shall apply to the increase in reinsurance. B. The increase is not subject to new underwriting evidence, BMA shall accept automatically the increase in reinsurance but not to exceed the automatic binding limit as stated in Schedule A. 3. If the amount of insurance under a policy or rider reinsured under this Agreement is increased or reduced, any increase or reduction in reinsurance for the risk involved shall be effective on the effective date of the increase or reduction in the amount of insurance. 4. If any portion of the prior insurance retained by the CEDING COMPANY on an individual life reduces or terminates, any reinsurance under this Agreement based on the same life shall also be reduced or terminated. The CEDING COMPANY shall reduce its reinsurance by applying the retention limits which were in effect at the time the policy was issued. The "reinsurance adjustment due to lapse or reduction of previous insurance" shall be effective on the same date as the lapse or reduction of prior insurance. The reinsurance to be terminated or reduced shall be determined in chronological order by the date the risk was first reinsured. Two or more policies issued the same date shall be considered one policy. 6 5. If the insurance for a risk is shared by more than one reinsurer, BMA's percentage of the increased or reduced reinsurance shall be the same as BMA's percentage of initial reinsurance of the individual risk. 6. If a risk reinsured under this Agreement is terminated, the reinsurance for that risk shall be terminated as of the effective date of the termination. 7. For facultative reinsurance, if the CEDING COMPANY reduces the mortality rating, the reduction shall be subject to the facultative provisions of this Agreement as stated in Article I, Section 2. 8. BMA shall refund all unearned reinsurance premiums not including policy fees, less applicable allowances, arising from reductions, terminations and changes as described in this Article. ARTICLE IX INCREASE IN RETENTION AND RECAPTURES 1. If the CEDING COMPANY changes its retention limits, as listed in Exhibit I, prompt written notice of the change shall be provided to BMA. 2. The CEDING COMPANY shall have the option of recapturing the reinsurance under this Agreement in the event the CEDING COMPANY increases its retention limit and the policies have been in force the required length of time as stated in Schedule A. The CEDING COMPANY may exercise its option to recapture by giving written notice to BMA within ninety (90) days after the effective date of the increase in retention. If the recapture option is not exercised within ninety days (90) days after the effective date of the increase in retention the CEDING COMPANY may choose to recapture at a later date. In that case, the date of the written notification to BMA shall determine the effective date the recapture program shall begin. 3. If the CEDING COMPANY exercises its option to recapture, then: A. The CEDING COMPANY shall reduce the reinsurance on all individual risks on which it retained its maximum retention for the age and mortality rating that was in effect at the time the reinsurance was ceded. B. The CEDING COMPANY shall increase its total amount of retained insurance on the individual risk up to its new retention limit by reducing the amount of reinsurance. If an individual risk is shared by more than one reinsurer, BMA's percentage of the reduced reinsurance shall be the same as BMA's initial percentage of reinsurance on the individual risk. C. The reduction of reinsurance shall become effective on the later of the following dates: (1) The policy anniversary date immediately following the date the recapture program is to begin as determined by paragraph 2 of this Article; (2) The number of years stated in Schedule A starting with the "policy date." 7 D. In the event the CEDING COMPANY overlooks any reduction in the amount of a reinsurance policy because of an increase in the CEDING COMPANY's retention, the acceptance by BMA of reinsurance premiums under these circumstances shall not constitute a liability on the part of BMA for such reinsurance. BMA shall be liable only for a refund of premiums. 4. No recapture shall be permitted for reinsurance on an individual risk if (a) the CEDING COMPANY retained less than its maximum retention for the age and mortality rating in effect at the time the reinsurance was ceded to BMA, or if (b) the CEDING COMPANY did not retain any of the individual risk. ARTICLE X REINSTATEMENT If a policy reinsured under this Agreement lapses for nonpayment of premium or is continued on the Reduced Paid-up or Extended Term Insurance basis, and is reinstated in accordance with the terms of the policy and the CEDING COMPANY's rules, the reinsurance on such policy shall automatically be reinstated by BMA upon written notice of such reinstatement. The CEDING COMPANY shall pay BMA all back reinsurance premiums. ARTICLE XI EXPENSE OF ORIGINAL POLICY The CEDING COMPANY shall bear the expense of all medical examinations, inspection fees, and other charges in connection with the issuance of the insurance. ARTICLE XII CLAIMS 1. The CEDING COMPANY shall give BMA prompt notice of any claim. Copies of the proofs obtained by the CEDING COMPANY together with a statement showing the amount due or paid on such claim by the CEDING COMPANY shall be furnished to BMA at the time payment is requested. 2. BMA shall accept the decision of the CEDING COMPANY in settling the claim and shall pay its portion to the CEDING COMPANY upon receipt of proof that the CEDING COMPANY has paid the claimant. It is agreed, however, that if a lesser amount at risk is retained by the CEDING COMPANY than the amount ceded to BMA, the CEDING COMPANY shall consult with BMA concerning its investigation and/or payment of the claim, although the final decision shall be that of the CEDING COMPANY. 8 3. The CEDING COMPANY shall notify BMA of its intention to contest, compromise, or litigate a claim involving reinsurance, and BMA shall pay its share of the payment and specific claim expenses therein involved, unless it declines to be a party to the contest, compromise, or litigation in which case it shall pay the full amount of the reinsurance to the CEDING COMPANY. "Claim expenses" shall be deemed to mean only the reasonable legal and investigative expenses connected with the litigation or settlement of claims. "Claim expenses" shall not include expenses incurred in connection with a dispute or contest arising out of conflicting claims of entitlement to policy proceeds which the CEDING COMPANY admits are payable or any routine claim administrative expenses, Home Office or otherwise. 4. In the event the amount of insurance provided by a policy or policies reinsured hereunder is increased or reduced because of a misstatement of age or sex established after the death of the insured, BMA shall share in the increase or reduction in the proportion that the net liability of BMA bore to the sum of the retained net liability of the CEDING COMPANY and the net liability of other reinsurers immediately prior to such increase or reduction. The reinsurance with BMA shall be written from commencement on the basis of the adjusted amounts using premiums and reserves at the correct ages and sex. The adjustment for the difference in premiums shall be made without interest. 5. It is understood and agreed that the payment of a death claim by BMA shall be made in one sum regardless of the mode of settlement under the policy of the CEDING COMPANY. 6. In no event shall BMA have any liability for any Extra Contractual Damages which are assessed against the CEDING COMPANY as a result of acts, omissions or course of conduct committed by the CEDING COMPANY or its agents, other than a good faith decision to deny claim liability, in connection with insurance reinsured under this Agreement. It is recognized that there may be special circumstances involved which indicate that BMA should participate in certain assessed damages. These circumstances are not amenable to advance specific definition, but could include those situations in which BMA was an active party in the act, omission or course of conduct which ultimately results in the assessment of such damages. The extent of such participation will be determined on a good faith assessment of culpability in each case, but all factors being equal, the division of any such assessment will generally be in the proportion of net liability borne by each party. 7. If a claim is approved for disability waiver of premium insurance reinsured under this Agreement, the CEDING COMPANY shall continue to pay reinsurance premiums to BMA. BMA shall reimburse the CEDING COMPANY BMA's proportionate share of the premium waived by the CEDING COMPANY. ARTICLE XIII TAX CREDITS In jurisdictions which impose premium taxes on the CEDING COMPANY without deduction for reinsurance, BMA shall reimburse the CEDING COMPANY for taxes paid on the amount of the reinsurance premiums on the basis shown in Schedule A, unless BMA itself is required to pay a direct tax on such reinsurance premiums. ARTICLE XIV DEFERRED ACQUISITION COSTS TAX The CEDING COMPANY and BMA elect under Regulation 1.848-2(g) (8) to compute "specified policy acquisition expense", as defined in section 848(c) of the Internal Revenue Code, in the following manner: The party with net positive consideration as determined under Reg. 1.848-2(f) and Reg. 1.848-3 shall compute specified policy acquisition expenses without regard to the general deductions limitation of section 848(c)(1) for each taxable year. The parties will exchange information pertaining to the aggregate amount of net consideration as determined under Regs. 1.848-2(f) and 1.848-3, for all reinsurance agreements in force between them, to insure consistency for the purposes of computing specified policy acquisition expenses. BMA shall provide the CEDING COMPANY with the amount of such net consideration for each taxable year no later than May 1 following the end of such year. The CEDING COMPANY shall advise BMA if it disagrees with the amounts provided, and the parties agree to amicably resolve any difference. The amounts provided by BMA shall be presumed correct if it does not receive a response from the CEDING COMPANY by May 31. BMA represents and warrants that it is subject to U.S. taxation under Subchapter L of the Internal Revenue Code. ARTICLE XV INSPECTION OF RECORDS BMA shall have the right, at any reasonable time, to inspect at the office of the CEDING COMPANY, all books and documents which relate to reinsurance under this Agreement. ARTICLE XVI INSOLVENCY 1. In the event of insolvency of the CEDING COMPANY, all reinsurance shall be payable by BMA directly to the CEDING COMPANY or its liquidator, receiver, or statutory successor, on the basis of the liability of the CEDING COMPANY under the policy or policies reinsured, without diminution because of the insolvency of the CEDING COMPANY. 2. It is agreed that the liquidator, receiver, or statutory successor of the insolvent CEDING COMPANY shall give written notice to BMA of the pending of a claim against the insolvent CEDING COMPANY on any policy reinsured within a reasonable time after such claim is filed in the insolvency proceedings. During the pendency of any such claim BMA may investigate such claim and interpose, in the proceeding where such claim is to be adjudicated, any defense or defenses which BMA may deem available to the CEDING COMPANY or its liquidator, receiver, or statutory successor. The expense thus incurred by BMA shall be chargeable, subject to court approval, against the insolvent CEDING COMPANY as part of the expense of liquidation to the extent of a proportionate share of the benefit which may accrue to the CEDING COMPANY solely as a result of the defense undertaken by BMA. 3. Where two or more reinsurers are participating in the same claim and a majority in interest elect to interpose a defense to such claim, the expense shall be apportioned in accordance with the terms of the Agreement as though such expenses had been incurred by the CEDING COMPANY. 4. Any debts or credits, matured or unmatured, liquidated or unliquidated, in favor of or against either the CEDING COMPANY or BMA with respect to this agreement or with respect to any other claim of one party against the other are deemed mutual debts or credits, as the case may be, and shall be set off, and only the balance shall be allowed or paid. ARTICLE XVII ARBITRATION 1. It is the intention of the CEDING COMPANY and BMA that the customs and practices of the insurance and reinsurance industry shall be given full effect in the operation and interpretation of this Agreement. The parties agree to act in all things with the highest good faith. However, if BMA and the CEDING COMPANY cannot mutually resolve a dispute or claim which arises out of or relates to this agreement, the dispute or claim shall be settled through arbitration. 2. The arbitrators shall be impartial regarding the dispute, and shall base their decision on the terms and conditions of this agreement plus, as necessary, on the customs and practices of the insurance and reinsurance industry. 3. There shall be three arbitrators who must be officers of life insurance companies other than the parties to this agreement or their subsidiaries. Each of the parties to this agreement shall appoint one of the arbitrators and these two arbitrators shall select the third. If a party to this agreement fails to appoint an arbitrator within thirty (30) days after the other party to this agreement has given notice of the arbitrator appointment, the American Arbitration Association shall appoint an arbitrator for the party to this Agreement that has failed to do so. Should the two arbitrators be unable to agree on the choice of the third, then the appointment of this arbitrator is left to the American Arbitration Association. 4. Except for the appointment of arbitrators in accordance with the provisions of Section 3 of this Article, arbitration shall be conducted in accordance with the Commercial Arbitration Rules of the American Arbitration Association which are in effect on the date of delivery of demand for arbitration. Arbitration shall be conducted in Kansas City, Missouri. 5. Each party to this agreement shall pay part of the arbitration expenses which are apportioned to it by the arbitrators. 6. The award agreed by the arbitrators shall be final, and judgment may be entered upon it in any court having jurisdiction. 9 ARTICLE XVIII PARTIES TO AGREEMENT This is an Agreement for indemnity reinsurance solely between the CEDING COMPANY and BMA. The acceptance of reinsurance under this Agreement shall not create any right or legal relation whatever between BMA and the insured, owner, or any other party to or under any policy reinsured under this Agreement. ARTICLE XIX ENTIRE CONTRACT 1. This agreement shall constitute the entire agreement between the parties with respect to business being reinsured hereunder and that there are no understandings between the parties other than those expressed in this agreement. 2. Any change or modification to this agreement shall be null and void unless made by addendum to this agreement signed by both parties. ARTICLE XX TERMINATION OF AGREEMENT 1. This Agreement may be terminated at any time by either party giving at least ninety (90) days written notice of termination. The day the notice is deposited in the mail addressed to the Home Office, or to an Officer of either company shall be the first day of the ninety-day (90) period. 2. The CEDING COMPANY shall continue to cede reinsurance and BMA shall continue to accept reinsurance, as provided for by the terms of this Agreement, until the date of termination. 3. All automatic reinsurance which became effective prior to the termination of this Agreement and all facultative reinsurance approved by BMA based upon applications received prior to termination of this Agreement shall remain in effect until its termination or expiration, unless the CEDING COMPANY and BMA mutually decide otherwise. 10 IN WITNESS WHEREOF, this agreement shall be effective with policies dated 12:01 A.M. September 1, 1997 and is hereby executed in duplicate between STANDARD LIFE INSURANCE COMPANY OF INDIANA Indianapolis, Indiana referred to as the CEDING COMPANY and BUSINESS MEN'S ASSURANCE COMPANY OF AMERICA Kansas City, Missouri referred to as BMA, and duly signed by both parties' respective officers as follows: THIS AGREEMENT CONTAINS A BINDING ARBITRATION PROVISION WHICH MAY BE ENFORCED BY THE PARTIES. CEDING COMPANY Edward T. Stahl Executive Vice President and Secretary signature title Gerald R. Hochgesang Senior Vice President signature title December 8, 1997 date BMA SENIOR VICE PRESIDENT/REINSURANCE signature title Vice President REINSURANCE ACTUARY signature title date BMA REINSURANCE TREATY #: 199709 - 002 - 0 AUTOMATIC TREATY TABLE OF CONTENTS ARTICLE PAGE I BASIS OF REINSURANCE 1 II LIABILITY 3 III ADMINISTRATIVE REPORTING 3 IV PLANS OF REINSURANCE 5 V REINSURANCE PREMIUMS 5 VI PREMIUM ACCOUNTING 6 VII OVERSIGHTS 7 VIII REDUCTIONS, TERMINATIONS AND CHANGES 7 IX INCREASE IN RETENTION AND RECAPTURES 8 X REINSTATEMENTS 9 XI EXPENSE OF ORIGINAL POLICY 9 XII CLAIMS 9 XIII TAX CREDITS 10 XIV DAC TAX 11 XV INSPECTION OF RECORDS 11 XVI INSOLVENCY 11 XVII ARBITRATION 12 XVIII PARTIES TO AGREEMENT 13 XIX ENTIRE CONTRACT.. 13 XX TERMINATION OF AGREEMENT 13 SCHEDULES A SPECIFICATIONS B BENEFITS AND NAR CALCULATIONS C ADDITIONAL INFORMATION AND EXCEPTIONS EXHIBITS I RETENTION LIMITS IA UNDERWRITING GUIDELINES II REINSURANCE PREMIUMS IIA POLICY FEES, FLAT EXTRAS, SUBSTANDARD PREMIUMS III COMMISSIONS AND ALLOWANCES (COINSURANCE) EX-21 9 LIST OF SUBSIDIARIES EXHIBIT 21 SUBSIDIARIES OF STANDARD MANAGEMENT CORPORATION STATE PERCENTAGE OF OR COUNTRY IN NAME OF SUBSIDIARY OUTSTANDING WHICH ORGANIZED Standard Life Insurance Company of Indiana 100% Indiana Dixie National Life Insurance Company 99.4% Mississippi Standard Marketing Corporation 100% Indiana Standard Marketing International, Ltd. 100% Bermuda Standard Investor Services Corporation 100% Indiana Standard Administrative Services, Inc. 100% Indiana Standard Management International S.A. 100% Luxembourg Premier Life (Luxembourg) S.A. 100% Luxembourg Premier Life (Bermuda) Limited 100% Bermuda EX-23.1 10 CONSENT OF ERNST & YOUNG LLP EXHIBIT 23.1 CONSENT OF INDEPENDENT AUDITORS We consent to the incorporation by reference in the Registration Statement (Form S-8 No. 33-92906) pertaining to the Second Amended and Restated Stock Option Plan of Standard Management Corporation, the Registration Statement (Form S-8 No. 333-41119) pertaining to the Amended and Restated Stock Option Plan of Standard Management Corporation and the Registration Statement (Form S- 8 No. 333-41117) pertaining to the Standard Management Corporation Savings Plan of our report dated February 11, 1998, with respect to the consolidated financial statements and schedules of Standard Management Corporation and subsidiaries included in the Annual Report (Form 10-K) for the year ended December 31, 1997. Ernst & Young LLP Indianapolis, Indiana March 26, 1998 EX-23.2 11 CONSENT OF KPMG AUDIT EXHIBIT 23.2 CONSENT OF INDEPENDENT AUDITORS We consent to the incorporation by reference in the Registration Statement (Form S-8 No. 33-92906) pertaining to the Second Amended and Restated Stock Option Plan of Standard Management Corporation, the Registration Statement (Form S-8 No. 333-41119) pertaining to the Amended and Restated Stock Option Plan of Standard Management Corporation and the Registration Statement (Form S-8 No. 333-41117) pertaining to the Standard Management Corporation Savings Plan of our report dated February 11, 1998, with respect to the consolidated financial statements of Standard Management International S.A. and subsidiaries included in the Annual Report (Form 10-K) for the year ended December 31, 1997 of Standard Management Corporation. KPMG Audit Luxembourg March 26, 1998 EX-24 12 POWERS OF ATTORNEY EXHIBIT 24 POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS, that each of the undersigned persons whose signature appear immediately below, does hereby constitute and appoint Ronald D. Hunter and Stephen M. Coons, each with full power to act alone, his true and lawful attorney-in-fact and agent, with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to sign on behalf of the undersigned an Annual Report on Form 10-K ("Form 10-K") under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), granting unto said attorney-in-fact and agent full power and authority to do and perform each and every act and thing requisite and necessary to be done, as fully to all intents and purposes as the undersigned might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agent, or his substitute lawfully do or cause to be done by virtue hereof. IN WITNESS WHEREOF, I have hereunto set my hand this 26th day of March, 1998. /S/ RONALD D. HUNTER /S/ PAUL B. PHEFFER Ronald D. Hunter Paul B. Pheffer /S/ GERALD R. HOCHGESANG /S/ RAYMOND J. OHLSON Gerald R. Hochgesang Raymond J. Ohlson /S/ EDWARD T. STAHL /S/ STEPHEN M. COONS Edward T. Stahl Stephen M. Coons /S/ MARTIAL R. KNIESER /S/ RAMESH H. BHAT Martial R. Knieser Ramesh H. Bhat /S/ JAMES C. LANSHE /S/ ROBERT A. BORNS James C. Lanshe Robert A. Borns /S/ JERRY E. FRANCIS John J. Dillon Jerry E. Francis EX-27.1 13 1997 FINANCIAL DATA SCHEDULE
7 YEAR DEC-31-1997 JAN-01-1997 DEC-31-1997 372,576 0 0 52 375 2,163 398,782 4,165 61,596 21,435 668,992 439,390 0 0 0 26,000 0 0 40,646 2,667 668,992 7,100 29,516 396 9,857 9,098 3,248 12,599 3,262 617 0 0 0 0 2,645 .52 .47 0 0 0 0 0 0 0
EX-27.2 14 RESTATED FINANCIAL DATA SCHEDULE
7 YEAR DEC-31-1996 JAN-01-1996 DEC-31-1996 347,310 0 0 62 3,035 546 370,138 5,113 68,811 18,309 628,413 425,324 0 0 0 20,000 1,757 0 40,481 (562) 628,413 10,468 20,871 1,302 7,666 9,919 2,592 12,175 3,535 (730) 0 0 502 0 4,767 $.94 .87 0 0 0 0 0 0 0
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