UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 Form 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the FISCAL YEAR ENDED December 31, 1997 Commission File Number 0-22404 ALLIED Life Financial Corporation (Exact name of registrant as specified in its charter) Iowa (State or other jurisdiction of incorporation or organization) 42-1406716 (I.R.S. Employer Identification No.) 701 Fifth Avenue, Des Moines, Iowa (Address of principal executive offices) 50391-2003 (Zip Code) 515-280-4211 (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: None (Title of Class) Securities registered pursuant to Section 12(g) of the Act: Common Stock, no par value (Title of Class) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months 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. [ ] As of March 5, 1998 the number of Registrant's Common Stock, no par value, outstanding was 4,411,310. The aggregate market value of the Common Stock of the Registrant (based on the average bid and asked prices at closing) held by nonaffiliates at March 5, 1998 was $63,044,756. Documents Incorporated By Reference TheRegistrant's definitive proxy statement (1998 Proxy Statement), which will be filed with the Securities and Exchange Commission within 120 days after December 31, 1997, is incorporated by reference under Part III. The index to the exhibits is located on page 77. This document contains 97 pages. TABLE OF CONTENTS Part I Item 1. Business...........................................................1 Item 2. Properties........................................................17 Item 3. Legal Proceedings.................................................18 Item 4. Submission of Matters to a Vote of Security Holders...............18 Part II Item 5. Market for Registrant's Common Equity and Related Stockholders Matters..................................19 Item 6. Selected Financial Data.................... ......................20 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.................21 Item 8. Financial Statements and Supplementary Data.......................33 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.......................61 Part III Item 10. Directors and Executive Officers of the Registrant................61 Item 11. Executive Compensation............................................61 Item 12. Security Ownership of Certain Beneficial Owners and Management....61 Item 13. Certain Relationships and Related Transactions....................61 Part IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.......................................62 Index to Financial Statement Schedules.......................................62 Signatures ..................................................................76 Index to Exhibits............................................................77 PART I Item 1. Business ALLIED Life Financial Corporation (the Company) is a holding company that through its principal subsidiary ALLIED Life Insurance Company (ALLIED Life) underwrites, markets, and distributes a select portfolio of life insurance and annuity products to individuals who live primarily in rural and suburban areas of the United States. The Company was organized in 1993 by ALLIED Mutual Insurance Company (ALLIED Mutual). ALLIED Mutual has been engaged in the property-casualty business since 1929. The financial information included herein consists of the accounts of the Company and its wholly-owned subsidiaries: ALLIED Life, ALLIED Life Brokerage Agency (ALBA), and ALLIED Group Merchant Banking Corporation (AGMB). At December 31, 1997, ALLIED Mutual owned 56% of the outstanding voting stock of the Company and the ALLIED Life Employee Stock Ownership Trust owned 2%. The remainder was owned by public stockholders. The Company's long-term growth strategy is to: (1) provide its independent agents with well-designed products that are easy to understand, meet the needs of their customers and reward persistency over time, and (2) strengthen its distribution systems, which include marketing life insurance and annuity products through the independent property-casualty agencies (the ALLIED Agencies) representing ALLIED Mutual and the property-casualty insurance subsidiaries of ALLIED Group, Inc., and through the traditional distribution system, which includes independent marketing organizations, financial institutions, and independent life agencies. ALLIED Group, Inc. is an 18.2% owned subsidiary of ALLIED Mutual. There are approximately 2,300 independent ALLIED Agencies which provide the Company with access to numerous agency customers in addition to over 600,000 households having one or more ALLIED Property-casualty policies. Management believes that demand by these agencies for the Company's life insurance and annuity products is a result of several factors: (1) the Company's well-designed life products, coupled with a demonstrated commitment to service and support from a known insurance company, provide each agency with a competitive advantage in its local market; (2) sales of life insurance products enhance the agencies' relationships with their policyholders creating the potential for increased persistency of both life and property-casualty insurance policies; (3) life insurance sales, particularly given their high first-year commissions relative to property-casualty business, can provide substantial additional income to an agency; and (4) an annual ALLIED property-casualty/life sales incentive trip is available to qualifying agencies that achieve minimum property-casualty production targets as well as specified minimum life insurance and annuity production targets. The Company's products are designed to meet traditional needs, such as family income protection, supplemental retirement savings, mortgage protection, and college savings. The products are also designed to appeal to a wide array of consumers in the middle income and small business owner markets. The Company provides the independent ALLIED Agencies with many opportunities to cross-sell life insurance and deferred annuities to their existing property-casualty customers. Life insurance protection is sold as important elements of a total personal lines insurance package which may include auto insurance, homeowners insurance, personal liability, and inland marine coverage. The Company's annuities are marketed primarily as tax-deferred accumulation vehicles to individuals in anticipation of their retirement. See "Forward-looking Information" on page 21 for an outline of factors that may affect actual results. 1 Marketing and Distribution General ALLIED Life's products are sold through two distribution systems: the independent ALLIED Agencies and a traditional life insurance distribution system which includes financial institutions and a number of independent life insurance marketing organizations. In 1997, the Company sold 68% of its new life insurance face amount and 41% of its collected annuity premium through the ALLIED Agencies and the remainder of its products were sold through traditional distribution channels. Each distribution system is headed by a marketing vice president. Property-Casualty Distribution System The property-casualty distribution system encompasses approximately 2,300 independent ALLIED Agencies. The Company's relationship with the ALLIED Agencies is supported through a joint marketing arrangement between ALLIED Life and the ALLIED property-casualty affiliates (p-c affiliates) which provides for: (1) the promotion of ALLIED Life products through the p-c affiliates, in return for financial incentives related to successful new sales efforts; (2) shared data processing and client database resources; and (3) combined billing for all insurance products involving personal lines coverages, including life insurance, annuities, auto, homeowners, excess liability, and other types of insurance. The distribution system is led by a marketing vice president, who works with the following personnel. Regional Directors/Life Marketing Directors. The 12 ALLIED Life Regional Directors and 7 Life Marketing Directors are the Company's primary field marketing representatives to the ALLIED Agencies and are primarily responsible for the annual growth in life insurance and annuity sales in their respective geographic territories. Regional Directors, who are independent contractors and are not employees of the Company, implement the Company's sales strategies in the ALLIED Agencies, including packaging life insurance effectively with other personal lines coverages, promoting combined billing convenience, and expanding annuity sales and business life insurance planning for small commercial property-casualty accounts. Most of the Regional Directors are responsible for approximately 150 ALLIED Agencies. Regional Directors also recruit and train life insurance specialists (see Independent Property-Casualty Agencies on page 3) for certain ALLIED Agencies, as appropriate. Although substantially all of their life and annuity production is derived from sales by the ALLIED Agencies, Regional Directors also generate life and annuity production from non-property-casualty agencies. Regional Directors are compensated solely on an override and incentive basis. Regional Directors' incentive compensation is based upon the achievement of an annual production goal and the persistency of the book of business. Regional Directors who achieve certain levels of production may qualify for the annual ALLIED property-casualty/life incentive trip. (See ALLIED Property-Casualty/Life Incentive Trip on page 3). Life Marketing Directors have responsibilities similar to those of the Regional Directors. The Life Marketing Directors are employees of the Company and are compensated on a salary and production incentive basis. Property-Casualty Marketing Representatives. ALLIED property-casualty marketing representatives are employees of ALLIED Group, Inc. Their primary responsibility is to promote the sale of property-casualty products by the independent ALLIED Agencies. The field marketing representatives, however, are also responsible for promoting the relationship between the ALLIED Agencies and ALLIED Life in order to enhance the sale of life insurance products. The compensation of the marketing representatives includes bonuses based on the sale of ALLIED Life products by the ALLIED Agencies. In addition, their eligibility for the annual incentive trip could depend on the level of life insurance sales achieved by the ALLIED Agencies under their supervision. 2 Independent Property-Casualty Agencies. The ALLIED Agencies either sell life insurance and annuity products themselves, with the support of their Regional Director/Life Marketing Director and the systems capabilities of ALLIED Life, or they work in conjunction with life insurance specialists. Life insurance specialists are independent life insurance agents either employed by an ALLIED Agency or working with an ALLIED Agency on a joint basis. Their primary activity is to market life insurance and annuities to existing ALLIED Agency clients. Life insurance specialists may be recruited and introduced to an ALLIED Agency by its Regional Director/Life Marketing Director when the agency becomes large enough to justify a full-time life insurance agent or when an agency would prefer one specialist to handle all of its life insurance sales. The compensation of the life specialist is usually directly related to life and annuity production, in the form of split commissions, draws against agency commissions or salary and incentives from the agency. Life insurance specialists may sell the products of other life insurance companies. ALLIED Property-Casualty/Life Incentive Trip. The ALLIED p-c affiliates and ALLIED Life annually sponsor a joint incentive trip for both life and property-casualty agents who have met incentive sales objectives. The incentive trip is an important motivating factor in encouraging the ALLIED Agencies to sell ALLIED Life's products. ALLIED Agencies qualify for the trip based upon achieving their property-casualty objectives as well as certain life and annuity new business objectives. Failure to achieve the life qualification may preclude an agency from participation, even if it meets its property-casualty production goals. Those agencies with insufficient property-casualty growth and agencies selling through the traditional distribution system may still qualify for the incentive trip by producing a substantial volume of new life and annuity premium. 3 Traditional Life Insurance and Annuity Distribution System The Company has traditional agency relationships with a number of independent life agencies, independent marketing organizations and financial institutions. These agency relationships represent an important source of business for the Company and in 1997 produced approximately 32% of the total face amount of life insurance sold and 59% of the total annuity premium collected. A marketing vice president supervises the operation and performance of the Company's traditional distribution system and is responsible for its life insurance and annuity production. The Company has agency relationships with independent marketing organizations, most of which have more licensed agents covering a larger geographic area than a traditional independent life insurance agency. These organizations have their own insurance marketing systems and sell the Company's life insurance and annuity products. Contracted agents associated with marketing organizations generated over 48% of the Company's total annuity premium and over 17% of the total life insurance face amount sold in 1997. The Company hopes to form alliances with more marketing organizations. These alliances give the Company access to the organizations' licensed agents in a manner that is more efficient than if the Company tried to recruit these agents one at a time. Admission into 5 states during the year helped align the Company's territories more closely to these marketing organizations. This brings to 41 the number of states where the Company is admitted and pursuing business. In 1998, the Company will apply for admission in 4 more states. Additionally, the Company has agency relationships with traditional independent life agents which generally cover a smaller geographic area than the independent marketing organizations. The Company markets its annuity products through financial institutions (commercial and savings banks), and to a lesser degree, through annuity marketing agencies. Institutional annuity marketing is developed through agency relationships with third-party marketing agencies specializing in financial institutions as well as directly through several midwestern-based financial institutions. Annuity marketing agencies represent a small but growing volume of annuity business. The Company is developing sales of its universal life and term life insurance products through both types of annuity marketing systems. 4 Production by distribution system The following tables show production information by distribution system for ALLIED Life for the years indicated. 1997 1996 1995 (dollars in thousands) Life insurance face amount in force Directly produced by agents Property-casualty agencies Universal Life $ 2,867,625 $ 2,809,270 $ 2,627,447 Term life 3,530,113 3,200,793 2,506,890 Whole Life 35,501 34,521 34,402 6,433,239 6,044,584 5,168,739 Traditional agencies Universal life 1,708,199 1,531,331 1,588,116 Term life 1,081,686 997,711 908,647 Whole life 15,617 14,558 15,778 2,805,502 2,543,600 2,512,541 9,238,741 8,588,184 7,681,280 Other 390,899 371,130 433,236 Total $ 9,629,640 $ 8,959,314 $ 8,114,516 Life insurance face amount sold Directly produced by agents Property-casualty agencies Universal life $ 311,600 $ 282,388 $ 384,763 Term life 946,842 1,127,060 889,624 Whole life 4,888 3,115 2,775 1,263,330 1,412,563 1,277,162 Traditional agencies Universal life 263,320 128,247 224,937 Term life 338,528 348,917 333,920 Whole life 2,310 1,124 1,736 604,158 478,288 560,593 Other 1,867,488 1,890,851 1,837,755 Total 8,266 9,431 21,549 $ 1,875,754 $ 1,900,282 $ 1,859,304 Annuity Premiums Deferred annuities Property-casualty agencies $ 30,212 $ 30,816 $ 30,321 Traditional agencies 42,872 40,188 45,956 73,084 71,004 76,277 Immediate annuities 1,782 1,227 2,362 Total $ 74,866 $ 72,231 $ 78,639 5 The total face amount of life insurance in force grew at an average annual rate of 9.3% beginning at year end 1995 through year end 1997 and is up 7.5% at December 31, 1997 as compared to the prior year end. Annuity account balance grew at an average annual rate of 12.5% beginning at year end 1995 through year end 1997 and is up 10.1% at December 31, 1997 compared to the prior year end. The face amount of new term life insurance sold totaled $1.3 billion accounting for 69% of 1997 new insurance production. Term life insurance provides protection during a specified number of years that expires without policy cash value if an insured survives the stated period. The face amount of new term life insurance sold decreased 12.9% in 1997. The Company continues to sell mainly 10- and 20-year guaranteed rate term life insurance policies within this product line. For further information on this product line see Term Life Insurance on page 9. The face amount of new universal life insurance sold totaled $574.9 million representing 31% of 1997 new insurance production. Universal life insurance is flexible premium life insurance that allows policyholders to change the death benefit from time to time (with satisfactory evidence of insurability for increases) and vary the amount or timing of premium payments. Premiums minus policyholder assessments are credited to cash value or accumulative accounts to which interest is credited at rates that may change from time to time. The face amount of universal life insurance sold increased 40% in 1997. For further information on this product line see Universal Life Insurance on page 8. During 1997, first-year deferred annuity premiums increased 5.1% to $71.5 million. The Company offers two types of deferred annuities, fixed interest and equity indexed. Fixed interest annuities are tax-deferred cash accumulation contracts that pay a fixed interest rate established by the Company. Equity indexed annuities credit interest, which is also tax deferred, to the policyholders' account based on a percentage of the gain of the S&P 500 Index(R). The Company issues single and flexible premium annuities. Flexible premium annuities permit additional deposits by policyholders after initial premiums are paid. Sales of fixed interest annuities were slowed in the fourth quarter by a flat interest yield curve, which allowed banks and other financial institutions to offer short-term certificates of deposit at more competitive interest rates. Sales of equity indexed annuities reached expected levels during the latter part of the year fueled by more product offerings and expectations of gains in the equity markets. For further information on this product line, see Annuities on page 10. 6 Market Area The following table shows direct life insurance premiums and annuity considerations for ALLIED Life by state for the years indicated. 1997 1996 1995 Life Insurance Annuity Percentage Percentage Percentage Premiums Considerations Total (1) of Total of Total of Total (Dollars in thousands) Iowa $ 9,727 $ 14,025 $ 24,517 19.5 % 21.5% 26.1% California 11,534 5,408 17,040 13.5 10.8 10.0 Illinois 1,265 13,496 15,466 12.3 10.6 5.5 Wisconsin 2,162 12,126 14,334 11.4 11.3 7.0 Utah 1,469 8,591 10,062 8.0 8.3 5.8 Kansas 3,967 3,119 7,437 5.9 5.0 5.6 Nebraska 4,474 1,975 6,911 5.5 6.2 6.2 Missouri 2,107 1,918 4,214 3.3 3.4 6.6 Colorado 1,232 2,395 3,668 2.9 1.9 1.7 Minnesota 2,335 729 3,112 2.5 2.6 4.8 Idaho 1,264 1,622 2,927 2.3 4.5 1.3 Other (2) 6,037 9,462 16,285 12.9 13.9 19.4 $ 47,573 $ 74,866 $ 125,973 100.0% 100.0% 100.0% (1) Total includes accident and health and other miscellaneous premiums not separately shown in the table. (2) Includes all other jurisdictions, none of which accounted for more than 2% in 1997. For more information regarding the states where ALLIED Life is admitted for insurance business by distribution system, see the 1997 Annual Report, pages 6 and 8. Subsidiaries ALBA is a general agency which uses the ALLIED Life agency force to sell complementary insurance products not developed nor written by ALLIED Life, such as health insurance, major medical, and disability insurance. ALBA's revenues amounted to $1,000,000 in 1997, $681,000 in 1996, and $496,000 in 1995. AGMB is a registered broker-dealer which facilitates securities transactions for the insurance agents of the Company and its affiliates who are licensed to sell securities. AGMB's revenues for 1997, 1996, and 1995 were $579,000, $389,000, and $203,000. 7 Products Universal Life Insurance The Company's universal life policies provide permanent life insurance protection with a flexible premium structure that allows the customer to pre-fund future insurance costs and to accumulate savings on a tax-deferred basis. The policyholder may surrender the policy at any time and receive the accumulated account balance less a specified surrender charge based on the duration of the contract and the amount of the coverage. The following table reflects the account value, average face amount and average insured age at date of issue for the Company's universal life products (excludes riders): Average Average Number Average Account Face of Issue Value Amount Policies Age Policies sold in 1997: Policies with a minimum face amount in excess of $150,000 $ 6,758 $ 376,442 499 43 All other policies 1,559 69,564 3,290 39 Total policies in force as of December 31, 1997: Policies with a minimum face amount in excess of $150,000 $ 11,799 $ 328,320 5,247 40 All other policies 3,923 59,107 33,905 36 When the Company issues a universal life policy it receives an initial premium based on the face amount of insurance purchased and the premium is reflected as a deposit to the policyholder's account. Additional premiums may be deposited by the policyholder up to a specified maximum. The Company deducts an expense allowance from each premium within a contractually specified range and credits the remainder to the policyholder's account. Thereafter, the account balance is charged monthly for the cost of insurance, which reflects mortality and benefit charges and an administrative fee, and is credited interest monthly at current crediting rates. Certain of the Company's universal life policies are designed to encourage policyowner persistency and larger account balances by providing higher crediting rates for larger account balances as well as those maintained for longer periods. Policy liabilities for universal life contracts are comprised of policyholder account balances. The following table shows changes in account balances for each year in the five-year period ended December 31, 1997: Benefit Account Payments Account Deferred Average Balance, Plus Balance, Policy Interest Beginning of Premiums Interest Cost of Expense Surrender End of Acquisition Credited Year Year Received Credited Insurance Allowances Charges Year Costs Rate (dollars in thousands) 1993 125,650 32,468 9,293 (11,498) (3,931) (10,541) 141,441 40,890 7.0% 1994 141,441 29,640 9,229 (13,810) (3,591) (7,064) 155,845 46,653 6.2 1995 155,845 30,382 9,530 (15,563) (4,448) (7,092) 168,654 51,774 5.9 1996 168,654 32,644 9,490 (16,178) (4,549) (7,334) 182,727 56,333 5.4 1997 182,727 34,271 10,127 (17,322) (4,604) (8,490) 196,709 60,427 5.3 8 The Company's universal life products are designed to provide long-term returns to its policyowners. Most of the Company's products currently being sold are structured so that the Company's policy acquisition costs will be recovered upon the receipt of 5 to 10 years of annual premiums, depending on the product. The Company imposes surrender charges in order to recover its upfront acquisition costs upon an early lapse or surrender by the policyowner. Additionally, variable periodic mortality and benefit charges, percent-of-premium loads, and monthly policy fees cover the costs of insurance and other benefits, policy administration and taxes, and provide the Company with a profit margin. The products are structured so policyowners are rewarded for higher cash values and life insurance face amounts. Term Life Insurance A significant amount of the Company's current term life insurance sales are 10- and 20-year guaranteed rate policies. Under these policies, the customer purchases basic term insurance protection without the tax-deferred accumulation feature available under the Company's universal life insurance policies. Term life insurance provides only a death benefit for a specified period of time to the policyowner for a lower premium than would be required for a comparable face amount of universal life insurance. Cash value does not accumulate, rather, the premium charged is a function of mortality risk and policy expenses. The following table reflects the average face amount and average insured age at date of issue for the Company's term life products (excludes riders): Number Average Average of Face Issue Policies Amount Age Policies sold in 1997: Policies with a minimum face amount in excess of $150,000 2,188 $ 377,782 41 All other policies 4,026 91,648 40 Total policies in force as of December 31, 1997: Policies with a minimum face amount in excess of $150,000 7,988 $ 368,168 40 All other policies 16,823 89,925 39 The Company encourages the conversion of term life insurance to universal life insurance, and as an incentive it credits an amount equal to 50% of the current term life premium as an additional deposit into the universal life insurance account of a policyholder upon conversion. The credit is substantially offset by a reduction in the commission payable to the agent. The agent has incentive to encourage term conversion because the reduced commission payable upon conversion still exceeds the commission payable on the renewal of a term life insurance policy. This incentive to convert is promoted directly to the term policyowner at each of the first five policy renewals. Term conversions represented 5.4% of 1997 universal life face amount sold. Universal life insurance face amount sold resulting from conversions from ALLIED Life term products were $30.9 million in 1997, $35 million in 1996, and $30.5 million in 1995. Group Life and Other In Force Life Policies As of December 31, 1997, the Company had $297.9 million face amount of group term life insurance in force, on 2 employee groups, one of which is the ALLIED Group, Inc. employee group. 9 As of December 31, 1997, the Company had $51.1 million face amount of other life insurance products in force consisting of smaller, non-participating whole life policies. These are guaranteed premium and cash value contracts. Annuities The Company offers a variety of deferred annuity products, including single premium and flexible premium designs, to customers who wish to accumulate savings on a tax-deferred basis. Annuities currently enjoy an advantage over certain other savings vehicles because the annuity buyer receives a tax-deferred accrual of interest on his or her investment during the accumulation period. Annuities generally are marketed to individuals in anticipation of retirement. The following table reflects the average account value and average age of annuitant at date of issue for the Company's deferred annuity products : Number Average Average of Account Issue Policies Value Age Annuities sold in 1997: 3,384 $ 23,722 66 Total policies in force as of December 31, 1997: 24,027 21,330 65 Policy liabilities for annuity contracts without mortality risk are comprised of policyholder account balances. The following table shows changes in account balances for each year in the five-year period ended December 31, 1997: Benefit Account Payments Account Deferred Average Balance, Plus Balance, Policy Interest Beginning of Considerations Interest Surrender End of Acquisition Credited Year Year Received Credited Charges Year Costs Rate (dollars in thousands) 1993 221,568 56,427 16,682 (23,292) 271,385 15,114 6.7% 1994 271,385 86,899 17,723 (32,617) 343,390 21,393 5.8 1995 343,390 77,199 22,613 (30,986) 412,216 25,613 5.9 1996 412,216 71,770 24,566 (41,047) 467,505 25,623 5.6 1997 467,505 74,328 25,692 (52,617) 514,908 27,669 5.3 The Company's deferred annuities are sold as an alternative to bank certificates of deposit and other taxable savings vehicles. Annuity premiums are generally invested in intermediate term investment grade securities, the investment terms typically matching the underlying product surrender charge periods of three to nine years. For most fixed interest plans, the initial interest rate is guaranteed for one to three years with renewal crediting rates based on portfolio earnings and market conditions. Several of the Company's annuity plans provide 1% to 2% first-year interest bonuses and additional annual interest bonuses for long-term persistency. The present value of the interest rate bonuses are generally deducted from agents compensation, allowing the Company to maintain its targeted profit margin. Liquidity benefits are provided in the form of no-penalty partial withdrawal allowances, interest income payments, a nursing home waiver, a terminal illness waiver, and bonus annuitization options. 10 The Company's equity indexed annuity products guarantee the return of principal to the customer if held for the whole term and credit interest based on a percentage of the gain of the S&P 500 Index(R). A portion of the premium from each customer is invested in fixed income securities to cover the minimum guaranteed value due the customer at the end of the term. A portion of the premium is used by the Company to purchase S&P 500 call options to hedge the interest credited to the customer if there are increases in the S&P 500 Index(R). See Note 3 of Notes to Consolidated Financial Statements for additional information regarding call options. Surrender charges, which the Company imposes in the early years of a policy, reduce the amount payable to a policyholder upon surrender of a policy and generally permits the Company to recover its acquisition costs. These charges also generally reduce the statutory reserve applicable to the policy. Insurance Operations The Company's insurance and annuity operations achieve significant cost efficiencies through automation of policy issue and administration. Budgetary, quality service, and time service standards are established and closely monitored. Internal financial analysis and reporting are used to focus on the most profitable elements of the Company's operations and to identify cost saving and marketing opportunities. The Company is headquartered in Des Moines, Iowa, and physically located in the ALLIED property-casualty companies' home office. This close proximity facilitates marketing plan implementation between ALLIED Life and the ALLIED property-casualty affiliates. It also allows the Company to lease automation systems and support from ALLIED Group, Inc. on a more cost effective basis. See "Certain Transactions and Relationships" in the 1998 Proxy Statement for additional information. Life Insurance Underwriting The Company had adopted and follows detailed, uniform underwriting standards and procedures designed to properly assess and quantify life insurance risks before issuing policies to individuals. Underwriting administration is automated and management emphasizes the achievement of quality and time service objectives. The Company's underwriters review each applicant's written application, which is prepared under the supervision of the Company's agents or representative, and any required medical records. On larger cases the Company employs blood and urine testing to provide additional information on nicotine and drug usage. Based on the results of these tests, the Company adjusts the mortality charge or declines coverage completely. Any nicotine use by a life applicant within the preceding one year results in a substantially higher mortality charge. In accordance with industry practice, material misrepresentations on a policy application can result in the cancellation by the Company of the policy generally within the first 2 years upon the return of any premiums paid. The increasing incidence of Acquired Immune Deficiency Syndrome (AIDS) has not thus far adversely affected the Company's mortality experience. The Company considers AIDS information and testing results in its underwriting and pricing decisions. The Company's blood test includes a screening for human immunodeficiency virus (HIV). Reinsurance In keeping with industry practices, the Company reinsures portions of its life insurance and disability income exposure with unaffiliated insurance companies under traditional indemnity reinsurance agreements. New insurance sales are reinsured above prescribed limits and do not require the reinsurer's prior approval within certain guidelines. These treaties are automatically renewed and nonterminable for the first 10 years with regard to cessions already made and are terminable after 90 days with regard to future cessions. After 10 years, the Company has the right to terminate and can generally discontinue the reinsurance on a block of business. This is normally done to increase the Company's retention on older business to the same level as current cessions. 11 Generally, the Company enters into indemnity reinsurance arrangements to assist in diversifying its risk and to limit its maximum loss on risks that exceed the Company's policy retention limits, which are currently $150,000 or less per life ($250,000 or less per life for ages 59 and under). Indemnity reinsurance does not fully discharge the Company's obligation to pay policy claims on the reinsured business. The Company, as the ceding insurer, remains responsible for policy claims to the extent the reinsurer fails to pay such claims. No reinsurer of business ceded by the Company has failed to pay any material policy claims (either individually or in the aggregate) with respect to such ceded business. At December 31, 1997, the Company had ceded to reinsurers $2.4 billion of insurance in force, substantially all of which was reinsured with insurance companies rated A (excellent) or better by A.M. Best. There is currently no reinsurance with affiliated insurance companies and all reinsurance entered into is in the ordinary course of business. The Company continually monitors the financial strength of its reinsurers and the availability of replacement coverages in the reinsurance market. If for any reason such reinsurance coverages would need to be replaced, the Company believes that replacement coverages from financially responsible reinsurers would be available. Policy Liabilities The policy liabilities reflected in the consolidated financial statements are calculated in accordance with generally accepted accounting principles (GAAP). Liabilities for universal life and annuity policies consist of the premiums and considerations received plus accumulated credited interest, less accumulated policyholder assessments and benefits. For traditional products, liabilities for future policy benefits have been provided based on the net level premium method. These liabilities are based upon actuarial tables adjusted for ALLIED Life's actual mortality and persistency experience and investment income. GAAP policy liabilities differ from those established for statutory reporting purposes due to the use of different assumptions regarding mortality and interest rates and the introduction of lapse assumptions into the GAAP policy liability calculation. Actual mortality experience in a particular period may be greater than expected mortality experience and, consequently, may materially affect the Company's operating results for such period. See Note 1 of the 1997 Notes to Consolidated Financial Statements for additional information regarding policy liability assumptions under GAAP. Interest Crediting Policy On a monthly basis, or more frequently if required, the Company reviews and establishes current period interest rates based upon existing and anticipated investment opportunities. This applies to both new sales as well as in force universal life insurance and annuity products after any initial guaranteed period. The Company attempts to match the duration of the asset-liability characteristics of the various universal life insurance and annuity products with the underlying investment opportunities available. Interest rates are then established based on each product's required interest spread and market conditions at the time. Interest rates are reviewed and, if appropriate, adjusted for money received in the Company's home office on or after the effective date of the interest rate change. Investments The investment policy for ALLIED Life requires at least 95% of the portfolio consist of investment grade securities. At December 31, 1997, 84% of the Company's fixed maturity investments were rated "A" or higher, and less than 1% were rated less than investment grade. Effective May 13, 1997, the Company transferred its remaining securities classified as held to maturity ($196 million) to available for sale and recorded an increase to stockholders' equity of $1.2 million in accordance with Statement of Financial Accounting Standards (SFAS) 115. The Company now carries all of its securities at fair value and has more flexibility in managing its investment portfolio. The Company has no intent to classify future purchases of securities as held to maturity. 12 The table below shows the composition of the Company's investments: Estimated 1997 1996 Fair Carrying Percent Percent Investment Category Value Value Of Total Of Total (dollars in thousands) Fixed maturities: U.S. Treasury obligations (1) $ 26,462 $ 26,462 3.4 4.8% Foreign governments 5,408 5,408 0.7 1.5 Public utilities 106,924 106,924 13.6 12.5 Asset-backed securities (other than first lien mortgages) 49,990 49,990 6.3 3.1 Mortgage-backed securities: Pools 112,135 112,135 14.2 16.8 Collateralized mortgage obligations 55,426 55,426 7.0 12.8 Total mortgage-backed securities 167,561 167,561 21.2 29.6 Corporate debt securities: Investment grade (BBB - or greater) (2) 409,433 409,433 52.0 45.3 Non-investment grade (BB + or below) (2) 250 250 ----- ----- Total corporate debt securities 409,683 409,683 52.0 45.3 Total fixed maturities 766,028 766,028 97.2 96.8 Equity securities 3,201 3,201 0.4 0.9 Mortgage loans on real estate (3) 984 984 0.1 0.2 Policy loans 11,164 11,164 1.4 1.4 Other invested assets (4) 3,014 3,014 0.4 0.5 Short-term investments 3,594 3,594 0.5 0.2 Total investments $ 787,985 $ 787,985 100.0% 100.0% (1) All such securities are backed by the full faith and credit of the United States government. (2) Ratings are assigned primarily by Standard & Poor's or a recognized equivalent. (3) Consists of single family residential mortgages and farm mortgages. (4) Consists of instruments purchased for hedging purposes. 13 The following table sets forth the composition of the Company's portfolio of fixed maturity investments by rating at December 31, 1997: Estimated 1997 1996 Fair Carrying Percent Percent Rating (1) Value Value Of Total Of Total (dollars in thousands) AAA .......................................... $238,937 $238,937 31.2% 38.3% AA ........................................... 103,664 103,664 13.5 11.7 A ............................................ 302,368 302,368 39.5 39.0 BBB .......................................... 119,546 119,546 15.6 10.7 Total investment grade fixed maturities 764,515 764,515 99.8 99.7 Non investment grade 1,513 1,513 0.2 0.3 Total fixed maturities ................ $766,028 $766,028 100.0% 100.0% (1) Ratings are assigned primarily by Standard & Poor's or a recognized equivalent. The following table sets forth expected maturities in the Company's fixed maturity portfolio at December 31, 1997. Expected maturities at December 31, 1997 are shorter than contractual maturities because of mortgage backed and call-option securities in the portfolio. Borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Expected maturities are based on the same prepayment assumptions used in amortizing premiums and discounts on these securities. For additional information on contractual maturities, see Note 2 of the 1997 Notes to Consolidated Financial Statements. 1997 1996 Amortized Percent Percent Cost Of Total Of Total (dollars in thousands) One year or less $ 36,460 5.0% 5.6% Over 1 year through 5 years 192,151 26.2 24.8 Over 5 years through 10 years 334,636 45.6 49.7 Over 10 years through 20 years 111,493 15.2 14.9 Over 20 years 59,023 8.0 5.0 Total $ 733,763 100.0% 100.0% 14 Investment results of the Company for each year in the three years ended December 31, 1997 are shown on the following table. 1997 1996 1995 (dollars in thousands) Average invested assets, net (1) $ 719,053 $ 653,908 $ 584,223 Investment income (2) 52,197 48,182 45,411 Average annual yield on total investments 7.3% 7.4% 7.8% Realized investment gains (losses) $ 2,354 $ 122 $ (722) (1) Total invested assets, at cost, less balance outstanding on Federal Home Loan Bank note payable (see (2) below), on an average quarterly basis. (2) Investment income is net of interest and investment expenses and does not include realized investment gains or losses or provision for income taxes. Mortgage-backed securities (including collateralized mortgage obligations [CMOs]) comprise 21.9% of the Company's total fixed maturity portfolio at December 31, 1997. The mortgage-backed securities are backed primarily by first lien single family residential mortgages. The majority of the mortgage-backed securities are investment grade. The Company's investments in CMOs consist of pools of mortgages divided into sections or "tranches" which provide sequential retirement of bonds. As of December 31, 1997, ALLIED Life held CMO investments with a fair value of $55.4 million. As of December 31, 1997, 88.3% (86.8% in 1996) of the Company's CMO investments were in planned amortization classes (PACs) and sequential pay bonds. The Company invests primarily in PACs to provide call protection and more stable average lives. This provides more predictable cash flows within a range of prepayment speeds by shifting the prepayment risks to support tranches. All of the Company's CMO investments are rated "AAA", have an active secondary market, and accordingly are not expected to affect the Company's liquidity differently than other fixed maturity investments. The following table shows the December 31, 1997 estimated fair value and carrying value of the CMO portfolio by type: Estimated 1997 1996 Fair Carrying Percent Percent Type of CMO Value Value Of Total Of Total (dollars in thousands) Planned amortization class $ 37,147 $ 37,147 67.0% 60.2% Sequential pay 11,810 11,810 21.3 26.6 Other 6,469 6,469 11.7 13.2 Total investments in CMOs $ 55,426 $ 55,426 100.0% 100.0% 15 Hedging Activities In 1996, the Company began interest rate hedging programs whereby certain derivative financial instruments including cash settle put swaptions (swaptions) and interest rate floors (floors) were purchased. Swaptions are being purchased to reduce the negative effect of increased withdrawal activity related to the Company's annuity liabilities that may result from extreme increases in interest rates. They entitle the Company to receive payments from the instrument's counter parties on future reset dates if the interest rate (which is directly tied to the 5-year constant maturity swap curve) on any expiration date is above a specified fixed rate (8.8% to 10.5% for instruments entered into as of December 31, 1997). Floors are being purchased to reduce the negative effect that may result from extreme decreases in interest rates to a level below the guaranteed interest rates provided for in the universal life insurance contracts. They entitle the Company to receive payments from the instrument's counter parties on future reset dates if the interest rate (which is tied directly to the 10-year constant maturity treasury curve) on the expiration date is below a specified fixed rate (5.0% for instruments entered into as of December 31, 1997). The costs of the interest rate hedging programs have not had a material impact on the interest rate margin. For both swaptions and floors, the Company pays only the original premium and is not at risk of further payments regardless of market conditions. The Company is exposed to the risk of losses in the event of nonperformance of the counter parties of the above swaptions and floors. Losses recorded in the Company's financial statements in the event of non-performance will be limited to the unamortized premium paid to enter into the instruments. Economic losses will be measured by the net replacement cost of such instruments or by their fair value if the net fair value is in the Company's favor. The Company limits its exposure to such losses by diversification among reputable counter parties with appropriate credit ratings. For further information on swaptions and floors see Note 3 of Notes to Consolidated Financial Statements. Competition The Company operates in a highly competitive industry. In connection with the development and sale of its products, the Company encounters significant competition from other insurance companies, many of whom have financial resources substantially greater than those of the Company, as well as from other investment alternatives available to its customers. The operating results of companies in the insurance industry have historically been subject to significant fluctuations due to competition, economic conditions, interest rates, investment performance, maintenance of insurance ratings, and other factors. Management believes that the Company's ability to compete with other insurance companies is dependent upon, among other things, its ability to attract and retain agents to market its insurance products, its ability to develop competitive and profitable products, and its maintenance of high ratings from A.M. Best (currently "A" [excellent]) and Duff and Phelps Credit Rating Company (upgraded to "A+" during 1997). The Company competes on the basis of its distribution system, its innovative product development, its strong financial condition, and its high-quality agent services and marketing support. Growth in the Company's distribution channels is based on providing a competitive product portfolio combined with the value of its marketing, underwriting, and administrative support services to agents. Regulation The Company's insurance subsidiary is subject to varying degrees of regulation and supervision by the states in which it is admitted to transact business. State insurance laws establish regulatory agencies with broad administrative and supervisory powers related to granting and revoking licenses to transact business, establishing guaranty fund associations, licensing agents, approving policy forms, regulating premium rates for some lines of business, establishing reserve requirements, prescribing the form and content of required financial statements and reports, determining the reasonableness and adequacy of statutory capital and surplus, and regulating the type and amount of investments permitted. ALLIED Life must file guaranteed rates for the policies it underwrites with the insurance departments of certain states in which it operates; reinsurance generally is not subject to rate regulation. Insurance departments also examine the affairs of insurance companies, which includes periodic market conduct examinations by the regulatory authorities and review of annual and other reports prepared on a statutory accounting basis required to be filed on the financial condition of insurers or for other purposes. Further, state insurance statutes typically place limitations on the amount of dividends or other distributions payable by insurance companies in order to protect their solvency. The Iowa statute requires that insurance companies pay dividends only out of earned profits (unassigned surplus) and requires prior regulatory approval for the payment of any dividend which exceeds the greater of either (I) 10% of statutory policyholders surplus (total capital stock and surplus) as of December 31 of the preceding year or (ii) the statutory net gain from operations of the insurer for the 12-month period ending the December 31 of the preceding year. 16 The Company is also subject to statutes governing insurance holding company systems. Typically, such statutes require the Company to periodically file information with the state insurance regulatory authority, including information concerning its capital structure, ownership, financial condition, and general business operations. Under the terms of applicable state statutes, any person or entity desiring to acquire more than a specified percentage (commonly 10%) of the Company's outstanding voting securities is required first to obtain approval of the applicable state insurance regulators. Chapter 521A of the Iowa Code relating to holding companies, to which the Company is subject, requires disclosure of transactions between the Company and its insurance subsidiary or between an insurer and another subsidiary, that such transactions satisfy certain standards, including that they be fair, equitable and reasonable, and that the Insurance Commissioner be given an opportunity to disapprove certain material transactions. Further, prior approval by the Iowa Insurance Division is required for affiliated sales, purchases, exchanges, loans or extensions of credit, guarantees or investments which involve 5% or more of the insurer's admitted assets as of the preceding December 31st. Under insolvency or guaranty fund laws in states in which ALLIED Life operates, insurers can be assessed, up to prescribed limits, for losses incurred by policyholders as a result of the insolvency of other insurance companies. The amounts and timing of such assessments are beyond the control of the Company and generally have an adverse impact on the Company's earnings. A number of insurance companies are under supervision resulting in assessments to cover losses to policyholders of such companies. The Company cannot predict the amount of any future assessments. Recently, the insurance regulatory framework has been placed under increased scrutiny by various states, the federal government, and the National Association of Insurance Commissioners (NAIC). The NAIC has recommended to the states for adoption and implementation several regulatory initiatives, none of which are expected to have a material impact on ALLIED Life. Employees At December 31, 1997, ALLIED Life employed 126 persons. ALLIED Life employs all persons serving the Company and its subsidiaries. None of the employees are members of a collective bargaining unit. Management believes that relations with its employees are good. Item 2. Properties The Company does not own any real estate. The Company's principal operations are conducted from leased office space pursuant to a leasing arrangement with ALLIED Mutual. See "Certain Transactions and Relationships" in the 1998 Proxy Statement for additional information. Management considers the leased space to be adequate for its needs. 17 Item 3. Legal Proceedings For a description of certain lawsuits pending against the Company, see Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations" of this report which is incorporated herein by reference. Item 4. Submission of Matters to a Vote of Securities Holders No matters were submitted during the fourth quarter of 1997 to a vote of holders of ALLIED Life Financial Corporation stock. 18 PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters The Company's common stock trades on The Nasdaq Stock Market under the symbol ALFC. As of December 31, 1997, there were 122 stockholders of record. The following table shows the high and low market prices and dividends paid per share for each calendar quarter for the two most recent years. High Low Last Dividends 1997 First qtr. $ 19 $ 17 $ 17 $ .06 Second qtr. 20 15 3/4 19 3/4 .06 Third qtr. 23 3/4 18 3/4 23 3/4 .06 Fourth qtr. 24 19 3/4 21 .07 1996 First qtr. $ 18 1/4 $ 16 1/2 $ 17 $ .05 Second qtr. 21 1/2 15 20 .05 Third qtr. 20 15 1/4 15 3/4 .05 Fourth qtr. 18 3/4 15 3/4 17 1/2 .06 There are certain regulatory restrictions relating to the payment of dividends (see Note 10 of the 1997 Notes to Consolidated Financial Statements). It is the present intention of the Board of Directors to declare quarterly cash dividends. 19 Item 6. Selected Financial Data At or for the year ended December 31, 1997 1996 1995 1994 1993 Income Statement Data (Dollars in thousands, except per share data) Revenues Total insurance revenues $ 34,142 $ 31,350 $ 29,934 $ 25,393 $ 20,822 Investment income 52,197 48,182 45,411 38,136 33,243 Realized investment gains (losses) 2,354 122 (722) (724) 2,154 Other income 1,559 1,056 688 648 277 Total revenues 90,252 80,710 75,311 63,453 56,496 Benefits and expenses Policyholder benefits 51,392 47,988 46,063 37,359 32,870 Amortization of deferred policy acquisition costs (1) 11,097 10,595 5,941 5,136 5,347 Commissions 4,232 3,316 2,725 2,627 2,390 Operating expenses 7,832 6,801 6,313 5,715 4,966 Total benefits and expenses 74,553 68,700 61,042 50,837 45,573 Income before income taxes 15,699 12,010 14,269 12,616 10,923 Income taxes 5,226 3,937 4,557 4,059 3,739 Net income (1) $ 10,473 $ 8,073 $ 9,712 $ 8,557 $ 7,184 Net income applicable to common stock (1) $ 8,862 $ 6,567 $ 8,304 $ 7,239 $ 5,930 Diluted earnings per share (1) 1.94 1.39 1.75 1.57 1.67 Dividends paid per common share $ 0.25 $ 0.21 $ 0.17 $ 0.13 $ 0.03 Weighted average number of shares outstanding (in thousands) 4,572 4,712 4,732 4,612 3,546 Balance Sheet Data Investments at cost $ 755,615 $ 714,483 $ 637,245 $ 554,889 $ 451,982 Assets 904,457 835,600 759,947 643,340 532,588 Preferred stock 26,336 24,586 22,871 21,341 19,028 Stockholders' equity $ 114,157 $ 99,942 $ 101,682 $ 76,027 $ 74,368 Preferred shares outstanding (in thousands) 2,393 2,238 2,087 1,948 1,754 Common shares outstanding (in thousands) 4,398 4,497 4,633 4,586 4,572 Other Data Death benefits per share $ 0.91 $ 0.81 $ 0.81 $ 0.68 $ 0.72 Book value per share 17.84 16.16 15.01 13.42 11.98 Statutory capital and surplus 51,275 46,544 45,504 47,413 42,403 Life insurance in force 9,629,640 8,959,314 8,114,516 7,242,737 5,915,558 Annuity account balances $ 514,908 $ 467,505 $ 412,216 $ 343,390 $ 271,385 (1) The 1996 amounts include an additional $2.8 million ($1.9 million or $0.40 per share net of income taxes) charge relating to unlocking adjustments to deferred policy acquisitions costs. 20 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Forward-looking Information The Private Securities Litigation Reform Act of 1995 provides a safe harbor to encourage companies to provide prospective information so long as it is identified as forward-looking and is accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those discussed. Forward-looking statements relate to the plans and objectives of management for future operations, future economic performance, or projections of revenues, income, earnings per share, capital expenditures, dividends, capital structure, or other financial items. In the following discussion and elsewhere in this report, statements containing words such as expect, anticipate, believe, goal, objective, or similar words are intended to identify forward-looking statements. ALLIED Life Financial Corporation (ALFC or the Company) undertakes no obligation to update such forward-looking statements, and it wishes to identify important factors that could cause actual results to differ materially from those projected in the forward-looking statements contained in the following discussion and elsewhere in this report. The risks and uncertainties that may affect the operations, performance, development, and results of the Company's business include, but are not limited to, the following: (1) heightened competition, particularly intensified price competition, the entry of new competitors from the financial services sector, and the creation of new products by competitors; (2) adverse state and federal legislation and regulations, including federal tax laws affecting individuals, changes in the taxation of insurance companies, federal legislation allowing the entry of new competitors from the financial services sector, and the regulation of product design and the marketing of those products; (3) changes in interest rates causing a reduction of investment income; (4) general economic and business conditions that are less favorable than expected; (5) unanticipated changes in industry trends; (6) inaccuracies in assumptions regarding future morbidity, persistency, mortality, and interest rates; and (7) other risks detailed herein and from time to time in the Company's other reports. Overview The following analysis of the consolidated results of operations and financial condition of the Company should be read in conjunction with Selected Financial Data and Financial Statements and related footnotes included elsewhere herein. ALLIED Life Financial Corporation is an insurance holding company with 56% of its outstanding voting stock owned by ALLIED Mutual Insurance Company (ALLIED Mutual). The financial statements include the accounts of ALLIED Life Insurance Company (ALLIED Life), ALLIED Life Brokerage Agency, Inc. (ALBA), and ALLIED Group Merchant Banking Corporation (AGMB). ALLIED Life accounts for substantially all of the Company's operations and sells primarily life insurance and annuity products. ALLIED Life's universal life insurance products provide life insurance coverages with flexible premium payments determined by policyholders and accumulate cash value over the policy term. Premiums received less policy assessments for administration expenses and mortality costs are credited to policyholder account balances, to which tax-deferred interest is credited at rates adjusted periodically by ALLIED Life. Surrender charges may be deducted from the account balances if policies are surrendered within a specified period after their effective dates. Term life insurance policies provide life insurance protection over a specified number of years. Policyholders remit premiums for the insurance protection but accumulate no cash value. Annuity contracts are products that provide for fixed or variable periodic benefit payments that commence according to contract terms and permit interest income to accumulate on a tax-deferred basis. Considerations paid by policyholders are credited to their accounts and earn interest at rates determined by ALLIED Life. To encourage policy persistency, surrender charges are imposed against account balances for early termination of annuity contracts. 21 In accordance with Generally Accepted Accounting Principles (GAAP), universal life insurance premiums received are shown as increases in liabilities for policyholder account balances and not as revenues. Revenues reported for universal life products consist of fee income from mortality charges, administration expenses, and surrender charges assessed against the account balances. Surrender benefits paid are reflected as decreases in liabilities for these account balances and not as expenses. Interest credited to account balances is reported as benefit expenses in the financial statements. Premium revenues reported for term life insurance products are recognized as revenues when due. Benefits relating to these products are associated with earned premiums. They are reported as benefit expenses by means of the change in the liabilities for future policy benefits so as to recognize profits over the premium-paying periods of the policies. Annuity considerations received and surrender benefits paid are shown as increases and decreases to liabilities for policyholder account balances and are not shown as revenues or expenses. Revenues reported for annuity products consist of surrender charges deducted from policyholder accounts. Expenses consist of interest credited to account balances. A significant source of revenue for ALLIED Life is investment income earned from the funds deposited to accounts by universal life and annuity policyholders, a portion of which is passed through to these policyholders in the form of interest credited. The costs related to acquiring new business (principally commissions), certain costs of issuing policies, and certain other variable selling expenses (defined as deferred policy acquisition costs) are capitalized and amortized into expense primarily in proportion to the present value of expected gross profits. This amortization is adjusted when ALLIED Life revises its current or estimated future gross profits. For example, deferred policy acquisition costs are amortized earlier than originally estimated when policy terminations are higher than expected and when investments are sold at a gain prior to their anticipated maturity. Estimated future profits and amortization of costs are reviewed annually for universal life insurance and annuity products and may be reviewed more frequently if circumstances dictate. GAAP requires that the estimated future profits and future amortization be recomputed based on actual experience and updated expectations of future experience (unlocking). This unlocking may result in adjustments related to prior amortization as well as changes to ongoing amortizations rates. Death and other policyholder benefits reflect ALLIED Life's exposure to mortality risk. They fluctuate from period to period according to the level of claims incurred under ALLIED Life's insurance retention limit. Profitability is primarily affected by investment spread (the excess of investment income earned over the amounts credited as interest to policyholder accounts), mortality experience (difference between actual and expected death and other policyholder benefits), and the ability to control policy acquisition costs and other operating expenses. Because of ALLIED Life's relatively small size, its operating results may be affected significantly by the level of death and other policyholder benefits incurred in any one reporting period. The following table reflects ALLIED Life's production information and pretax operating results excluding realized investment gains (losses) and related amortization of deferred policy acquisition costs for the years indicated. Life insurance operations included in the following analysis should be read with reference to the table on page 23. 22 Results of Operations 1997 Compared with 1996 Consolidated revenues for the year ended December 31, 1997 were $90.3 million, an 11.8% increase over the $80.7 million reported for 1996. Life insurance premiums and other insurance income net of reinsurance premiums ceded rose 12.6% to $9.5 million from $8.4 million. Investment income grew 8.3% to $52.2 million from $48.2 million. In 1997 the Company had realized gains on investments of $2.4 million as compared with realized gains of $122,000 in 1996. Life Insurance Operations Year Ended December 31, 1997 1996 1995 (Dollars in thousands) Production information Life insurance Life insurance face amount in force directly produced by agents Universal Life $ 4,575,824 $ 4,340,601 $ 4,215,564 Term life 4,611,799 4,198,504 3,415,536 Whole life 51,118 49,079 50,180 9,238,741 8,588,184 7,681,280 Other 390,899 371,130 433,236 $ 9,629,640 $ 8,959,314 $ 8,114,516 Face amount of new life insurance sold directly produced by agents Universal Life $ 574,920 $ 410,635 $ 609,700 Term life 1,285,370 1,475,977 1,223,544 Whole life 7,198 4,239 4,511 1,867,488 1,890,851 1,837,755 Other 8,266 9,431 21,549 $ 1,875,754 $ 1,900,282 $1,859,304 Life insurance termination rate Universal Life 7.1% 6.1% 6.7% Term life 19.7% 18.2% 18.9% Annuities Account balance $ 514,908 $ 467,505 $ 412,216 First-year annuity premiums $ 71,509 $ 68,063 $ 75,944 23 Life Insurance Operations (continued) Year Ended December 31, 1997 1996 1995 (Dollars in thousands) Profitability Investment income $ 52,131 $ 48,145 $ 45,215 Interest credited on Annuities 26,452 24,732 22,613 Universal life 10,126 9,490 9,530 Other 479 464 324 Total interest expense 37,057 34,686 32,467 Investment spread 15,074 13,459 12,748 Fee income Universal life charges 23,898 22,410 21,586 Annuity surrender charges 739 495 662 Total fee income 24,637 22,905 22,248 Other insurance income 9,505 8,445 7,686 Adjusted insurance revenues 49,216 44,809 42,682 Other expenses Amortization of deferred policy acquisition costs (1) 9,578 10,730 6,036 Renewal commissions 3,258 2,675 2,437 Other insurance operating expenses 4,875 4,505 3,973 Premium and other taxes 1,830 1,343 1,528 Administrative fees 520 508 309 Total acquisition and operating expenses 20,061 19,761 14,283 Death benefits, net 8,192 6,945 6,894 Other policyholder benefits, net 6,141 6,357 6,702 Total other expenses 34,394 33,063 27,879 Insurance operating income before income taxes and realized investment gains (losses) $ 14,822 $ 11,746 $ 14,803 (1) Amounts exclude amortization of deferred policy acquisition costs resulting from net realized investment gains (losses). In 1996, amortization includes an additional charge of $2.8 million relating to unlocking of deferred policy acquisition costs. Operating income before taxes (which excludes realized investment gains and losses net of related amortization of deferred policy acquisition costs) was $14.9 million for 1997 compared with $11.8 million in 1996. Operating earnings per share were $1.82 compared with $1.35. Net income totaled $10.5 million ($1.94 per share) compared with $8.1 million ($1.39 per share). Operating income before taxes for 1996 included an adjustment to deferred policy acquisition costs of $2.8 million reflecting changes in assumptions used to estimate future gross profits on certain blocks of annuity business. The effect of the adjustment was to decrease operating earnings per share by $0.40. 24 Life Insurance Operations Total life insurance in force grew 7.5% to $9.6 billion at December 31, 1997 from $9 billion at December 31, 1996. Growth was slowed by lower term life insurance sales. The face amount of new life insurance sold directly by agents in 1997 remained even at $1.9 billion. The face amount of new universal life insurance sold increased 40% to $574.9 million from $410.6 million. Universal life account balances increased 7.7% at year-end 1997 from year-end 1996. Fee income increased 7.6% in 1997 to $24.6 million from $22.9 million in 1996. The face amount of new term life insurance sold directly by agents decreased 12.9% to $1.3 billion from $1.5 billion. ALLIED Life continues to sell mainly 10- and 20-year guaranteed rate term life policies within this product line. First-year annuity premiums increased 5.1% to $71.5 million from $68.1 million in 1996. Sales of fixed interest annuities were slowed in the fourth quarter by a flat interest yield curve, which allowed banks and other financial institutions to offer short-term certificates of deposit at more competitive interest rates. The total annuity account balance increased 10.1% to $514.9 million at year-end 1997 from $467.5 million at year-end 1996. Adjusted insurance revenues increased 9.5% to $49.2 million in 1997 from $44.9 million in 1996. The increase was primarily attributable to increased investment spread, which grew 11% to $15.1 million from $13.6 million. Invested assets at cost increased 5.8% to $755.6 million at December 31, 1997 from $714.1 million at December 31, 1996; in 1997, investment income increased 8.3%. ALLIED Life's return on invested assets decreased to 7.3% in 1997 from 7.4% in 1996. Annual average interest-credited rates on universal life contracts decreased to 5.3% from 5.4% and on annuities decreased to 5.4% from 5.6%. The ratio of investment spread to investment income increased to 28.9% from 28.2% despite the volatile interest rate environment during 1997. This ratio is evidence of ALLIED Life's ability to adjust interest credited to policyholder accounts to reflect trends in investment earnings. Death benefits net of reinsurance increased 18% to $8.2 million from $6.9 million. Other policyholder benefits decreased 3.4% to $6.1 million from $6.4 million. Other insurance operating expenses increased 9% to $4.4 million from $4 million. Amortization of deferred policy acquisition costs (DPAC) decreased 10.7% in 1997 to $9.6 million from $10.7 million in 1996. Included in the 1996 amount was an adjustment of $2.8 million taken by the Company as the result of its annual DPAC study that suggested refinements in assumptions concerning future annuity policy persistency and interest rate spreads were necessary. While the Company continues to re-evaluate the DPAC assumptions, it does not anticipate making additional material adjustments to DPAC amortization schedules in the foreseeable future. Further adjustments would be necessary only if actual experience should differ significantly from the assumptions used in the DPAC study models. Primarily due to the DPAC adjustment taken in 1996, ALLIED Life's operating income in 1997 grew 26.2% to $14.8 million from $11.7 million. 25 Results of Operations 1996 Compared with 1995 Consolidated revenues for the year ended December 31, 1996 were $80.7 million, a 7.2% increase over the $75.3 million reported in 1995. The increase was attributable to life insurance premiums and other insurance income net of reinsurance premiums ceded that rose 9.9% due to increased sales of term life insurance. Investment income increased 6.1% to $48.2 million from $45.4 million. In 1996 the Company had realized investment gains of $122,000 compared with realized losses of $722,000 in 1995. Operating income before taxes (which excludes realized investment gains and losses net of related amortization of deferred policy acquisition costs) for the year included an adjustment to deferred policy acquisition costs of $2.8 million reflecting changes in assumptions used to estimate future gross profits on certain blocks of annuity business. Including the adjustment of $2.8 million, operating income before taxes was $11.8 million compared with $14.9 million reported in 1995. Operating earnings per share including the adjustment of $0.40 per share were $1.35 compared with $1.85. Net income totaled $8.1 million ($1.39 per share) in 1996 and was $9.7 million ($1.75 per share) in 1995. Life Insurance Operations Total life insurance in force grew 10.4% to $9 billion at December 31, 1996 from $8.1 billion at December 31, 1995. The increase was due to policy retention and new term life insurance sales. The face amount of new life insurance sold directly by agents in 1996 increased 2.9% to $1.9 billion from $1.8 billion in 1995. The face amount of new universal life insurance sold decreased 32.6% to $410.6 million from $609.7 million. Universal life account balances increased 8.3% at year-end 1996 from year-end 1995. Fee income increased 3% to $22.9 million from $22.2 million in 1995. The face amount of new term life insurance sold directly by agents increased 20.6% to $1.5 billion in 1996 from $1.2 billion in 1995. Sales of term insurance with 10- and 20-year guaranteed rates were strong during 1996. First-year annuity premiums decreased 10.4% to $68.1 million from $75.9 million in 1995. The lower sales were caused by a flat interest yield curve, which allowed banks and other financial institutions to offer short-term certificates of deposit at more competitive interest rates. The total annuity account balance increased 13.4% to $467.5 million at year-end 1996 from $412.2 million at year-end 1995. Adjusted insurance revenues increased 5.3% to $44.9 million in 1996 from $42.7 million in 1995. The increase was primarily attributable to increased investment spread and other insurance income (due to term life insurance sales). The growth in life insurance in force and policyholder account balances permitted invested assets at cost to increase 12.2% to $714.1 million at December 31, 1996 from $636.7 million at December 31, 1995. Investment income increased by 6.5%. ALLIED Life's return on invested assets decreased to 7.4% in 1996 from 7.8% in 1995. Investment spread grew to $13.6 million from $12.7 million. Annual average interest-credited rates on universal life contracts decreased to 5.4% from 5.9% and on annuities decreased to 5.6% from 5.9%. The ratio of investment spread to investment income remained even at 28.2%. 26 Death benefits net of reinsurance remained at $6.9 million. Other policyholder benefits decreased 5.1% to $6.4 million from $6.7 million as decreases in reserves for supplemental contracts and single premium immediate annuities with life contingencies more than offset the increase in reserves on new term life sales and policyholder bonus reserves on universal life products. Other insurance operating expenses increased 9.1% to $4 million from $3.7 million. Amortization of DPAC was $10.7 million in 1996. Included in that amount was an adjustment taken by the Company of $2.8 million as the result of its annual DPAC study. DPAC amortization was $6 million in 1995. Primarily due to the increase in DPAC amortization, operating income before taxes decreased to $11.7 million in 1996 from $14.8 million in 1995. Liquidity and Capital Resources ALLIED Life Financial Corporation As an insurance holding company, ALFC relies on dividends from ALLIED Life to make dividend payments to its preferred and common stockholders. Retained earnings of ALLIED Life available for distribution as dividends to ALLIED Life Financial Corporation are limited by law. Under the Iowa Insurance Code, dividends may be paid by ALLIED Life only from statutory earned surplus, which as of December 31, 1997 was $21.3 million. In addition, ALLIED Life may not pay an extraordinary dividend with-out prior notice to and approval of the Iowa Insurance Commissioner. An extraordinary dividend is defined as any dividend or distribution of cash or other property whose fair market value together with that of other dividends or distributions made within the preceding twelve months exceeds the greater of (i) 10% of statutory policyholders' surplus as of December 31 of the preceding year (ii)the statutory net gain from operations of the insurer for the twelve-month period ending December 31 of the preceding year. During 1998, the maximum amount available for distribution to the Company from ALLIED Life is approximately $9 million. During 1997, the Company paid cash dividends of $1.2 million to common and preferred stockholders. ALLIED Life paid to the Company dividends of $1.8 million primarily to fund the Company's dividend requirement and its note payments on indebtedness to affiliates. Annual dividends payable on the currently outstanding 6.75% Series preferred stock are approximately $1.6 million. In accordance with the terms of the 6.75% Series preferred stock, the Company may pay dividends thereon by issuing additional shares of such stock for any quarter ending on or prior to September 30, 1998. In 1997, the Company paid dividends in the form of 148,402 shares of 6.75% Series preferred stock. Effective May 13, 1997, the Board of Directors approved a stock repurchase program to acquire shares of Company common stock on the open market. The Company completed the program during the second quarter of 1997, repurchasing and cancelling 150,000 shares at an average cost of $16.52 per share. 27 Consolidated Life insurance companies generally produce a positive cash flow from operations. Its adequacy is measured by liquidity. There should be sufficient cash to meet benefit obligations to policyholders and normal operating expenses as they are incurred and sufficient excess to help meet future policy benefit payments and to write new business. ALLIED Life's liquidity position continued to be favorable in 1997, with cash inflows at levels sufficient to provide the funds necessary to meet obligations. The Company's cash inflows consist primarily of deposits to policyholder account balances; proceeds from sales, maturities and calls of investments; and repayments of investment principal. The Company's cash outflows primarily are related to policyholder account withdrawals, investment purchases, policy acquisition costs, policyholder benefits, and current operating expenses. These outflows are typically met from normal annual premium and net investment cash inflows. Company operations provided cash inflows of $9.4 million in 1997, $16.6 million in 1996, and $11.7 million in 1995. Cash inflows from financing activities amounted to $32.5 million, $62.4 million, and $73.3 million during 1997, 1996, and 1995, respectively. These funds and the excess operating inflows were used primarily to increase the Company's fixed maturity investment portfolio. Matching the investment portfolio maturities to the cash flow demands of the insurance coverages being provided is an important consideration. The Company continually monitors benefit and claims statistics to project future cash requirements. As part of this monitoring process, the Company performs cash-flow testing of its assets and liabilities under various scenarios to evaluate the adequacy of reserves. In developing its investment strategy, the Company establishes a level of cash and securities that when combined with expected net cash inflows from operations, maturities of fixed maturity investments, principal payments on amortizing securities, and its insurance products is believed to be adequate to meet anticipated short-term and long-term benefit and expense payment obligations. As of December 31, 1997, 97.2% of the Company's investments were in fixed maturities. The investment policy for the Company requires that the fixed maturity portfolio be invested primarily in debt obligations rated "BBB" or higher when they are acquired. Of the Company's fixed maturity investments held at year-end 1997, 84.2% were rated "A" or better; less than 1% were rated below investment grade (below "BBB"). The Company's fixed maturity portfolio includes collateralized mortgage obligations (CMOs). CMOs consist of pools of mortgages divided into tranches that provide sequential retirement of bonds. To provide call protection and more stable average lives, the Company invests primarily in planned amortization classes (PACs) and sequential-pay bonds that generally provide more predictable cash flows within a range of prepayment speeds by shifting some of the prepayment risks to support tranches. At year-end 1997, all of the Company's CMOs were investment-grade securities. They were carried at a fair value of $55.4 million; 88.3% of these investments were in PAC and sequential-pay bonds. All of the Company's CMO investments have an active secondary market; therefore, their effect on liquidity is not expected to differ from the effect of other fixed maturity investments. Effective May 13, 1997, the Company transferred its remaining securities classified as held to maturity ($196 million) to available for sale. In accordance with Statement of Financial Accounting Standards (SFAS) 115, the Company now carries all of its securities at fair value; as a result, a $1.2 million increase to stockholders' equity was recognized. The Company now has more flexibility in selling securities from its investment portfolio. The Company has no intent to classify future purchases of securities as held to maturity. 28 The Company has a line of credit agreement with the Federal Home Loan Bank that provides additional liquidity. The agreement makes $25 million available through March 13, 1998. At December 31, 1997, the Company had an outstanding borrowing of $6.4 million under the line of credit agreement. Interest is payable at the current rate upon issuance. From time to time, the Company has borrowed funds from its affiliates on an arm's-length basis. The Company has entered various note-payable agreements with ALLIED Mutual, an affiliate. The outstanding borrowing at December 31, 1997 was $3.6 million. Management anticipates that funds to meet the Company's short-term and long-term capital expenditures, cash dividends, and operating cash needs will come from existing capital and internally generated funds. As of December 31, 1997, the Company had no material commitments for capital expenditures. As additional capital needs arise, the Company will consider taking on additional debt or issuing equity. Specific methods for meeting such needs will depend upon financial market conditions at the time. Effects of Inflation and Interest Rate Changes Management does not believe inflation has had a material effect on consolidated results of operations. To reduce exposure to interest rate fluctuations, management attempts to invest new funds in securities with expected durations that match related policyholder obligations. As a rule, the fair value of the Company's fixed maturity portfolio increases or decreases in inverse relationship with fluctuations in interest rates while investment income moves in direct relationship with interest rate changes. For example, if interest rates decrease, the Company's fixed maturity investments generally will increase in value. Investment income, on the other hand, will decrease as fixed maturity investments mature or are sold and the proceeds are reinvested at the lower interest rates. Interest rate changes and the slope of the yield curve may have temporary effects on the sale and profitability of the universal life and annuity products offered by ALLIED Life. For example, if interest rates rise, competing investments may become more attractive to potential purchasers until the interest rates credited to policyholder account balances are increased. If interest rates fall, profitability will be affected negatively until credited rates are adjusted to compensate for the decline in investment income. ALLIED Life sells universal life and annuity contracts that generally permit flexible responses to interest rates, which are monitored frequently. Hedging Activities In June 1996, the Company began interest rate hedging programs whereby certain derivative financial instruments including cash settle put swaptions (swaptions) and interest rate floors (floors) were purchased. Swaptions are being purchased to reduce the negative effect of increased withdrawal activity related to the Company's annuity liabilities that may result from extreme increases in interest rates. They entitle the Company to receive payments from the instruments' counterparties on future reset dates if the interest rate (which is directly tied to the 5-year constant maturity swap curve) on any expiration date is above a specified fixed rate (8.8% to 10.5% for instruments entered into as of December 31, 1997). Floors are being purchased to reduce the negative effect that may result from extreme decreases in interest rates to a level below the guaranteed interest rates provided for in the universal life insurance contracts. They entitle the Company to receive payments from the instruments' counterparties on future reset dates if the interest rate (which is tied directly to the 10-year constant maturity treasury curve) on the expiration date is below a specified fixed rate (5.0% for instruments entered into as of December 31, 1997). 29 Premiums paid to purchase these instruments are capitalized and included in other invested assets. No swaptions or floors were purchased in 1997. For the year ended December 31, 1996, the Company paid $4.1 million in premiums. All such premiums are amortized into income over the term of the instruments on a straight-line basis. Gains and losses on these instruments and related assets are not recorded in income until realized. For more information on swaptions and floors see Note 3 of Notes to Consolidated Financial Statements. The Company's equity indexed annuity products guarantee customers the return of principal. Interest credited is based on a percentage of the gain of the S&P 500 Index(R). A portion of the premium is used to purchase S&P 500 call options (call options) to hedge the growth in interest credited to the customer if there are advances in the S&P 500 Index(R). Premiums paid to purchase call options are capitalized and included in other assets. For the years ended December 31, 1997 and 1996, the Company paid $6.4 million and $2.3 million, respectively, in premiums. Premiums are amortized as an expense over the term of the instruments on a straight-line basis. Gains and losses on these instruments and related liabilities are not recorded in income until realized. For more information on call options see Note 3 of Notes to Consolidated Financial Statements. The Company is exposed to the risk of extreme declines in the market value of its call options if there is a sharp and prolonged decrease in the stock market. The Company currently is purchasing puts to reduce the negative effect of such a decline. The put agreements allow the Company to receive payments on future exercise dates if the S&P 500 Index(R) is below specified levels. The costs of the interest rate hedging programs are not expected to have a material impact on the interest rate margin. The Company does not anticipate making any further purchases of interest rate hedges in the near future. For swaptions, floors, call, and puts the Company pays only the original premium and is not at risk of further payments regardless of market conditions. The Financial Accounting Standards Board (FASB) is evaluating the accounting and disclosure requirements for hedging activities and derivative financial instruments. It is likely the resulting accounting standards will require that these instruments be carried at fair value. The impact of such standards on the Company is not expected to be material to its financial position or results of operations. The Company is exposed to the risk of losses in the event of nonperformance of the counter-parties of the previously described swaptions, floors, and options. Losses recorded in the Company's financial statements in the event of nonperformance are limited to the unamortized premium paid to purchase the instruments. Economic losses will be measured by the net replacement cost of such instruments or by their fair value if the net fair value is in the Company's favor. The Company limits its exposure to such losses by diversification among reputable counterparties with appropriate credit ratings. Contingencies On January 20, 1998, a complaint was filed by Sharlotte G. Harbott, a policyholder of ALLIED Life, in Superior Court of the State of California for the County of Los Angeles, against the Company, ALLIED Life, ALLIED Mutual, and unnamed persons. The complaint, an alleged class action suit, asserts that ALLIED Life fraudulently increased the cost of insurance rates charged to policyholders in breach of the terms of its universal life policies, its fiduciary obligations, and its obligations of good faith and fair dealing toward its policyholders and without adequate notice. The plaintiff, an insured under a universal life policy issued by ALLIED Life, seeks actual, consequential, and punitive damages in unspecified amounts as well as interest, attorney's fees, an accounting for moneys allegedly improperly charged to policyholders, and injunctive relief on behalf of herself and all policyholders of ALLIED Life with similar universal life policies. 30 The Company believes the allegations relate to a claim that ALLIED Life collected a federal tax, known as the deferred acquisition cost tax (DAC tax), as well as other increased costs of doing business from its policyholders. The Company believes the amount of DAC tax and other costs claimed to have been collected from each policyholder is minimal, but the plaintiff in the case has asked the California court to treat the case as a class action representing all ALLIED Life policyholders from whom the claimed costs were collected. Similar class actions have been filed against other life insurance companies since the federal DAC tax law was enacted in 1990. The Company believes the action will raise the issue of whether the DAC tax may be included in the cost of insurance charged to policyholders under the terms of the universal life contracts. Management believes the increased costs charged to policyholders never violated the contracts. The Company believes that the increased costs complained of relate to universal life policies issued during and prior to 1991 and that ALLIED Life charged the increased costs to universal life policyholders primarily during the 1992 through 1995 accounting periods. The Company, ALLIED Life, and ALLIED Mutual do not expect the lawsuit to materially affect their claims-paying ratings or daily business operations. The Company, ALLIED Life, and ALLIED Mutual disagree with the allegations, believe the claims presented in this case are without merit, and believe the resolution of this matter will not materially affect the Company's financial position. Year 2000 Issue The Company is aware of the problems associated with the programming code in existing computer systems as the millennium (year 2000) approaches. The year 2000 problem is pervasive and complex as virtually every computer operation will be affected in some way by the rollover of the two-digit year value to 00. Computer systems must properly recognize date-sensitive information when the year changes to 2000. Systems that do not properly recognize such information could generate erroneous data or cause a system to fail. The Company has assessed all computer systems as they relate to the year 2000 issue. The Company has formulated a plan to resolve the issue. Appropriate internal and external resources have been acquired and dedicated to implement the plan. The Company believes that testing of the systems will be finalized before the year 2000 and will not have a significant effect on the Company's ability to conduct business in a reasonable fashion. Anticipated expenditures for year 2000 compliance are not expected to be material to fiscal year 1998 and 1999 operations. Emerging Regulatory Issues The Company's insurance subsidiary is subject to regulation and supervision by the states in which it is admitted to transact business. State insurance laws generally establish supervisory agencies with broad administrative and supervisory powers related to granting and revoking licenses to transact business, establishing guaranty fund associations, licensing agents, approving policy forms, regulating premium rates for some lines of business, establishing reserve requirements, prescribing the form and content of required financial statements and reports, determining the reasonableness and adequacy of statutory capital and surplus, and regulating the type and amount of investments permitted. Recently, the insurance regulatory framework has received increased scrutiny from various states, the federal government, and the National Association of Insurance Commissioners (NAIC). The NAIC has recommended to the states for adoption and implementation several regulatory initiatives, none of which are expected to have a material impact on ALLIED Life. 31 New Accounting Standards In 1997, the Company adopted SFAS 128, "Earnings Per Share." SFAS 128 supersedes Opinion 15, "Earnings Per Share," and specifies the computation, presentation, and disclosure requirements for earnings per share (EPS). It replaces the presentation of primary EPS and fully diluted EPS with basic EPS and diluted EPS, respectively. Basic EPS includes the weighted average number of common shares outstanding and excludes all dilutive securities. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stocks were exercised or converted to common stock. Prior year amounts have been restated to conform to the new standard. In 1997, the Company adopted SFAS 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." This statement provides consistent standards for distinguishing transfers of financial assets that are sales from transfers that are secured borrowings. This adoption had no impact on the Company's financial position, results of operations, or liquidity. In June of 1997, the FASB issued SFAS 130, "Reporting Comprehensive Income." This statement establishes new rules for the reporting and display of comprehensive income and its components in a full set of general-purpose financial statements. The new rules require that all items that are recognized under accounting standards as components of comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. SFAS 130 is effective for fiscal years beginning after December 15, 1997. Earlier application of this statement is permitted. The Company will adopt SFAS 130 on January 1, 1998. This statement will require revised and additional disclosures but will have no effect on the results of operations or the financial position of the Company. In June of 1997, the FASB issued SFAS 131, "Disclosure about Segments of an Enterprise and Related Information." Under this statement, public companies will report financial and descriptive information about their operating segments. SFAS 131 is effective for fiscal years beginning after December 15, 1997. Earlier application of this statement is permitted. The Company will adopt SFAS 131 on January 1, 1998. This statement will require revised and additional disclosures but will have no effect on the results of operations or the financial position of the Company. In December of 1997, the American Institute of Certified Public Accountants (AICPA) issued Statement of Position (SOP) 97-3, "Accounting by Insurance and Other Enterprises for Insurance-Related Assessments." This statement provides guidance on when an insurance or other enterprise should recognize a liability for guaranty fund and other assessments and on how to measure such liability. SOP 97-3 is effective for fiscal years beginning after December 15, 1998. Earlier application of this statement is permitted. The Company will adopt SOP 97-3 on January 1, 1999. Management expects that such adoption will not have a material impact on the financial position or results of operations of the Company since the majority of guaranty fund assessments are expected to be recovered through future premium tax offsets. 32 Item 8. Financial Statements and Supplementary Data Report of Management The management of ALLIED Life Financial Corporation and its subsidiaries is responsible for the accompanying financial information appearing in this annual report. The consolidated financial statements have been prepared in conformity with generally accepted accounting principles and include amounts based on the best estimates and judgments of management. The Company maintains a system of internal accounting controls designed to provide reasonable assurance that assets are safeguarded and transactions are properly authorized and recorded. Management continually monitors these internal accounting controls, modifying and improving them as business conditions and operations change. An internal audit department also evaluates the adequacy and effectiveness of internal accounting controls and measures adherence to established policies and procedures. The management of ALLIED Life Financial Corporation believes that as of December 31, 1997 the Company's system of internal accounting controls was adequate to accomplish the objectives discussed herein. The Company's financial statements for the years ended December 31, 1997, 1996, and 1995 have been audited by KPMG Peat Marwick LLP, independent certified public accountants. The audits were conducted in accordance with generally accepted auditing standards and included a consideration of the system of internal accounting controls to the extent necessary to express an independent opinion on the financial statements. The audit committee of the Board of Directors, comprised solely of outside directors, meets regularly with the independent auditors, management, and internal auditors to review the scope and results of the audit work performed. The internal auditors and independent auditors have access to the audit committee to discuss the results of the audit, the adequacy of internal accounting controls, and the quality of financial reporting. /s/Samuel J. Wells Samuel J. Wells President /s/Wendell P.Crosser Wendell P. Crosser Treasurer /s/Donald J. Iverson Donald J. Iverson Chief Actuary 33 Independent Auditors' Report The Board of Directors and Stockholders ALLIED Life Financial Corporation We have audited the accompanying consolidated balance sheets of ALLIED Life Financial Corporation and subsidiaries as of December 31, 1997 and 1996 and the related consolidated statements of income, stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1995. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based upon our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of ALLIED Life Financial Corporation and subsidiaries as of December 31, 1997 and 1996 and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1997, in conformity with generally accepted accounting principles. /s/KPMG Peat Marwick LLP KPMG Peat Marwick LLP Des Moines, Iowa February 12, 1998 34 Consolidated Statements of Income Year ended December 31, 1997 1996 1995 (In thousands, except per share data) Revenues Insurance revenues Policyholder assessments on universal life contracts $ 21,926 $ 20,727 $ 20,011 Surrender charges 2,711 2,177 2,237 Life insurance premiums 14,201 13,005 12,568 Other insurance income 5,946 3,948 2,878 Reinsurance premiums ceded (10,641) (8,507) (7,760) Total insurance revenues 34,143 31,350 29,934 Investment income (notes 2 and 4) 52,197 48,182 45,411 Realized investment gains (losses) (note 2) 2,354 122 (722) Other income 1,558 1,056 688 90,252 80,710 75,311 Benefits and Expenses Policyholder benefits Interest credited to policyholder account balances Annuity contracts 26,452 24,732 22,613 Universal life contracts 10,127 9,490 9,530 Other 479 463 324 Death benefits 12,041 10,046 13,035 Other policyholder benefits 5,856 7,388 6,702 Reinsurance recoveries (3,563) (4,131) (6,141) Total policyholder benefits 51,392 47,988 46,063 Amortization of deferred policy acquisition costs 11,097 10,595 5,941 Commissions 4,232 3,316 2,725 Affiliated operating expenses (note 4) 640 839 1,411 Other insurance operating expenses 7,192 5,962 4,902 74,553 68,700 61,042 Income before income taxes 15,699 12,010 14,269 Income Taxes (note 13) Current 6,206 5,797 4,673 Deferred (980) (1,860) (116) 5,226 3,937 4,557 Net Income $ 10,473 $ 8,073 $ 9,712 Net income applicable to common stock (diluted basis) $ 8,862 $ 6,567 $ 8,304 Earnings per Share Basic earnings per share $ 1.98 $ 1.41 $ 1.78 Diluted earnings per share $ 1.94 $ 1.39 $ 1.75 See accompanying Notes to Consolidated Financial Statements 35 Consolidated Balance Sheets December 31, 1997 1996 (In thousands) Assets Investments Fixed maturities (notes 2 and 5) Held to maturity, at amortized cost $ ----- $ 199,209 Available for sale, at fair value 766,028 500,289 Equity securities, at fair value (notes 2 and 5) 3,201 6,407 Mortgage loans on real estate 984 1,457 Policy loans 11,164 10,307 Other invested assets (notes 3 and 5) 3,014 3,751 Short-term investments, at cost (notes 2, 4, and 5) 3,594 919 Total investments 787,985 722,339 Accrued investment income 10,988 9,738 Accounts receivable 912 608 Reinsurance ceded receivables 7,168 5,786 Deferred policy acquisition costs 84,188 92,418 Other assets (notes 3 and 5) 13,216 4,711 Total assets $ 904,457 $ 835,600 36 December 31, 1997 1996 (In thousands) Liabilities Policy liabilities Policyholder account balances Annuity contracts (note 5) $ 514,908 $ 467,505 Universal life contracts (note 5) 196,709 182,727 Other 7,732 8,846 Future policy benefits 38,124 33,474 Policy and contract claims 4,102 3,735 Other policyholder funds 1,778 1,576 763,353 697,863 Checks drawn in excess of bank balances 2,066 3,163 Current income taxes 23 941 Deferred income taxes (note 13) 10,552 8,009 Indebtedness to affiliates (note 4) 3,638 2,188 Note payable (notes 5 and 12) 6,360 20,470 Other liabilities 4,308 3,024 Total liabilities 790,300 735,658 Stockholders' Equity Preferred stock, no par value, issuable in series, authorized 7,500 shares (note 7) 6.75% Series, authorized 2,440 shares, issued and outstanding of 2,292 in 1997 and 2,144 in 1996 24,869 23,259 ESOP Series, authorized 300 shares, issued and outstanding of 101 in 1997 and 94 in 1996 1,467 1,327 Common stock, no par value, $1 stated value, authorized 25,000 shares, issued and outstanding of 4,398 in 1997 and 4,497 in 1996 (notes 8 and 9) 4,398 4,497 Additional paid-in capital 44,964 46,596 Retained earnings (note 10) 29,404 21,751 Unrealized appreciation of investments, net (notes 6 and 14) 9,055 2,512 Total stockholders' equity 114,157 99,942 Contingent liabilities (notes 6 and 14) Total liabilities and stockholders' equity $ 904,457 $ 835,600 See accompanying Notes to Consolidated Financial Statements. 37 Statements of Stockholders' Equity Year ended December 31, 1997 1996 1995 (In thousands) Preferred Stock at beginning of year $ 24,586 $ 22,871 $ 21,341 Issuance of shares of 6.75% Series for stock dividends (note 7) 1,610 1,506 1,408 Issuance of shares of ESOP Series, net of redemptions and issuance costs (note 7) 317 249 194 ESOP Series converted to common stock (note 7) (177) (40) (72) Preferred stock at end of year 26,336 24,586 22,871 Common Stock at beginning of year 4,497 4,633 4,586 Issuance of shares of common stock (notes 7, 8, and 9) 51 14 47 Repurchase of shares of common stock (note 8) (150) (150) ----- Common stock at end of year 4,398 4,497 4,633 Additional Paid-in Capital at beginning of year 46,596 48,774 48,159 Issuance of shares of common stock, net of issuance costs 696 214 615 Repurchase of shares of common stock (note 8) (2,328) (2,392) ----- Additional paid-in capital at end of year 44,964 46,596 48,774 Retained Earnings at beginning of year 21,751 16,238 8,804 Net income 10,473 8,073 9,712 Dividends paid on preferred stock (notes 7 and 10) (1,717) (1,601) (1,493) Dividends paid on common stock (notes 8 and 10) (1,103) (959) (785) Retained earnings at end of year 29,404 21,751 16,238 Unrealized Appreciation (Depreciation) of Investments at beginning of year 2,512 9,166 (6,864) Unrealized appreciation (depreciation), net (note 1) 6,543 (6,654) 16,030 Unrealized appreciation (depreciation) of investments at end of year 9,055 2,512 9,166 Total Stockholders' Equity $ 114,157 $ 99,942 $ 101,682 See accompanying Notes to Consolidated Financial Statements. 38 Conslidated Statements of Cash Flows Year ended December 31, 1997 1996 1995 (Dollars in thousands) Cash Flows from Operating Activities Net income $ 10,473 $ 8,073 $ 9,712 Adjustments to reconcile net income to net cash provided by operating activities Policyholder assessments on universal life contracts (21,926) (20,727) (20,011) Surrender charges (2,711) (2,177) (2,238) Interest credited to policyholder account balances 37,058 34,686 32,467 Realized investment (gains) losses (2,354) (122) 722 Change in Accrued investment income (1,250) (1,040) (1,070) Reinsurance ceded receivables (1,382) 1,840 (1,904) Deferred policy acquisition costs (6,216) (7,115) (11,298) Liabilities for future policy benefits 4,650 5,324 5,228 Policy and contract claims and other policyholder funds 568 (383) (87) Current income taxes (919) 1,810 509 Deferred income taxes (980) (1,860) (116) Other, net (5,646) (1,695) (194) Net cash provided by operating activities 9,365 16,614 11,720 Cash Flows from Investing Activities Purchase of fixed maturities held to maturity (7,594) (22,174) (15,582) Maturities, calls, and principal reductions of fixed maturities held to maturity 8,022 42,276 32,832 Purchase of fixed maturities available for sale (224,767) (140,828) (188,898) Proceeds from sale of fixed maturities available for sale 144,951 38,649 79,185 Maturities, calls, and principal reductions of fixed maturities available for sale 38,535 10,847 6,964 Purchase of equity securities (4,763) (1,908) (2,165) Proceeds from sale of equity securities 9,384 21 457 Proceeds from repayment and sale of mortgage loans 473 372 248 Purchase of other invested assets ----- (4,145) ----- Change in policy loans, net (857) (780) (616) Purchase of property, plant, and equipment (2,622) (1,156) (178) Net cash used in investing activities (39,238) (78,826) (87,753) Cash Flows from Financing Activities Change in checks drawn in excess of bank balances (1,097) 1,126 (67) Deposits to policyholder account balances 114,847 111,878 116,886 Withdrawals from policyholder account balances (66,236) (52,921) (44,048) Change in note payable, net (14,110) 3,865 605 Changes in notes payable to affiliate 1,946 1,617 ----- Proceeds from issuance of common stock, net 569 188 589 Proceeds from issuance of preferred stock, net 317 249 194 Repurchase of common stock (2,478) (2,541) ----- Dividends paid to stockholders (1,210) (1,052) (869) Net cash provided by financing activities 32,548 62,409 73,290 Net Increase (Decrease) in Cash and Short-term Investments 2,675 197 (2,743) Cash and short-term investments at beginning of year 919 722 3,465 Cash and short-term investments at end of year $ 3,594 $ 919 $ 722 See accompanying Notes to Consolidated Financial Statements. 39 Notes to Consolidated Financial Statements (1) Summary of Significant Accounting Policies Principles of Consolidation and Basis of Presentation The accompanying consolidated financial statements include the accounts of ALLIED Life Financial Corporation (the Company), an insurance holding company, and its wholly owned subsidiaries, which as of December 31, 1997 consisted of ALLIED Life Insurance Company (ALLIED Life), ALLIED Life Brokerage Agency, Inc. (ALBA), and ALLIED Group Merchant Banking Corporation (AGMB). At December 31, 1997, ALLIED Mutual Insurance Company (ALLIED Mutual) owned 56% of the outstanding voting stock of the Company and The ALLIED Life Employee Stock Ownership Trust (ESOP Trust) owned 2%. The remainder was owned by public stockholders. The consolidated financial statements have been prepared in conformity with generally accepted accounting principles (GAAP), which differ in some respects from those followed in reports to insurance regulatory authorities. All significant intercompany balances and transactions have been eliminated. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Nature of Operations The Company's operations consist primarily of those of ALLIED Life. ALLIED Life underwrites, markets, and distributes a portfolio of life insurance and annuity products to individuals who live primarily in rural and suburban areas of the United States. ALLIED Life's products are sold through two distribution systems: the independent agencies representing affiliated property-casualty insurance companies (ALLIED Agencies) and a traditional life insurance distribution system that includes financial institutions and a number of independent life insurance marketing organizations. In 1997 the ALLIED Agencies generated 68% of life insurance face amount sold and 41% of annuity premiums collected. Investments Investments in fixed maturities that may be sold prior to maturity and are not bought and held principally for the purpose of selling in the near term are segregated into an available for sale portfolio and are carried at fair value. Unrealized appreciation and depreciation of available for sale securities are excluded from income and reported as a separate component of stockholders' equity net of a provision for related deferred policy acquisition costs and deferred income taxes. Effective May 13, 1997, the Company transferred its remaining securities classified as held to maturity ($196 million) to available for sale and recorded an increase to stockholders' equity of $1.2 million in accordance with Statement of Financial Accounting Standards (SFAS) 115. The Company now carries all of its securities at fair value and has more flexibility in managing its investment portfolio. The Company has no intent to classify future purchases of securities as held to maturity. 40 Equity securities are carried at fair value with their unrealized appreciation or depreciation, net of taxes, reported in a separate component of stockholders' equity. Mortgage loans on real estate and policy loans are recorded at the unpaid principal balance of such loans, which approximated fair value as of December 31, 1997 and 1996. A majority of the Company's mortgage loans are on residential real estate located in Iowa. All short-term investments are recorded at cost, which approximates fair value. Cash settle put swaptions (swaptions), interest rate floors (floors), call options, and puts the Company uses for hedging purposes are carried at cost that is amortized over the term of the instruments on a straight-line basis (see note 3 for a discussion of hedging activities). Swaptions and floors are included in other invested assets; call options and puts are included in other assets. The amortization of the swaptions and floors is included as a reduction of investment income; the amortization of the call options and puts is included with annuity interest credited. Gains and losses on these instruments and related assets and liabilities will not be recorded as income until realized. The Financial Accounting Standards Board (FASB) is evaluating the accounting and disclosure requirements for these instruments, and, as a result, this accounting treatment will change in the future. It is likely the resulting accounting standards will require that these instruments be carried at fair value. The impact of such standards on the Company is not expected to be material to its financial position or results of operation. The carrying values of all the Company's investments are reviewed on an ongoing basis for credit deterioration; if this review indicates a decline in fair value below cost that is other than temporary, the Company's carrying value in the investment is reduced to its estimated realizable value and a specific write-down is taken. Such reductions in carrying value are recognized as realized losses and charged to income. Realized gains and losses on investments sold are recognized on a specific identification basis. Deferred Policy Acquisition Costs The costs of acquiring new business (principally commissions), certain costs of issuing policies (such as medical examinations and inspection reports), and certain other selling expenses, all of which vary with and are primarily related to the production of new business, have been deferred. These costs for universal life and annuity contracts are amortized in relation to the present value of expected gross profits using the assumed crediting rate. This amortization is adjusted retrospectively when the Company revises its estimates of current or future gross profits to be realized from a group of policies. These costs for term life insurance policies are amortized over the premium-paying periods in proportion to the ratio of annual premium revenues to total anticipated premium revenues. Anticipated premium revenues are estimated using the same assumptions employed for computing liabilities for future policy benefits. Deferred policy acquisition costs are reviewed at least annually to determine that the unamortized portion of such costs does not exceed recoverable amounts after anticipated investment income is taken into account. Expected gross profits used in determining the recoverability and amortization pattern of deferred policy acquisition costs are based on historical gross profits and management's estimates and assumptions regarding future investment spreads, maintenance expenses, and persistency of blocks of business. The accuracy of the estimates and assumptions is affected by several factors, including factors outside the control of management such as movements in interest rates and competition from other investment alternatives. It is reasonably possible that conditions affecting the estimates and assumptions will change and that such changes will result in future adjustments to deferred policy acquisition costs. 41 Costs deferred were $17.3 million, $17.7 million, and $17.2 million for the years ended December 31, 1997, 1996, and 1995, respectively. Amortization of deferred policy acquisition costs net of interest accretion included in the consolidated statements of income were $11.1 million, $10.6 million, and $5.9 million for the years ended December 31, 1997, 1996, and 1995, respectively. In 1996 the amortization included an adjustment of approximately $2.8 million the Company recorded as a result of its annual deferred policy acquisition costs study. The study suggested refinements in certain assumptions used to estimate future gross profits to be realized from blocks of annuity business. The Company will continue to re-evaluate all applicable assumptions but does not anticipate making further material adjustments in the foreseeable future. At December 31, 1997, unamortized deferred policy acquisition costs were decreased by approximately $18.4 million (by $4 million in 1996 and $9.6 million in 1995) to recognize the impact of unrealized appreciation of investments on such deferred costs. The decreases net of deferred income taxes were charged to stockholders' equity. Policy Liabilities Policyholder account balances for universal life and annuity contracts consist of deposits received plus accumulated credited interest less withdrawals and accumulated policy-holder assessments. Interest credited to policyholder account balances for universal life contracts averaged 5.3%, 5.4%, and 5.9% in 1997, 1996, and 1995, respectively. Interest credited to policyholder account balances for annuity contracts averaged 5.4%, 5.6%, and 5.9% in 1997, 1996, and 1995, respectively. Rates used to credit interest to policyholder account balances are subject to periodic adjustment. Certain universal life and annuity contracts offer persistency bonuses, which are accrued in the accompanying financial statements based on assumptions of investment yields, withdrawals, mortality, and other factors. For term life insurance policies, liabilities for future policy benefits are provided according to the net level premium method based on estimated investment yields, withdrawals, mortality, and other assumptions that were appropriate at the time the policies were issued. Recognition of Revenues, Benefits, and Expenses Revenues from universal life contracts include policy fees for administration expenses, mortality charges, and surrender charges assessed against policyholder account balances during the period; revenues from annuity contracts include only surrender charges. Benefits and expenses relating to these contracts include interest credited as well as benefits incurred in excess of policyholder account balances during the period. Premiums and considerations received and surrender benefits paid on these contracts are reported as deposits to and withdrawals from policyholder account balances. Term life insurance premium revenues are recognized over the premium-paying period. Benefits and expenses, which take into account the provisions for liabilities for future policy benefits and the amortization of deferred policy acquisition costs, are associated with earned premiums that result in the recognition of profits over the life of the policy contracts. The Company has no participating business. 42 Ceded Reinsurance The Company reports reinsurance activity on a gross basis. Amounts paid or deemed to have been paid that are recoverable under reinsurance contracts are recorded as reinsurance ceded receivables. The cost of reinsurance related to long-duration contracts is accounted for over the life of the underlying reinsured policies using assumptions consistent with those used to account for the underlying policies. Stock-based Compensation The Company accounts for its stock option plans in accordance with the provisions of Accounting Principles Board (APB) Opinion 25, "Accounting for Stock Issued to Employees," and related interpretations. Under these provisions, compensation expense is recorded on the date of grant only if the current market price of the underlying stock exceeds the exercise price. On January 1, 1996, the Company adopted SFAS 123, "Accounting for Stock-Based Compensation," which permits entities to recognize as expense over the vesting period the fair value of all stock-based awards on the date of grant. Alternatively, SFAS 123 allows entities to continue applying the provisions of APB Opinion 25 and to provide pro forma net income and pro forma earnings per share disclosures for employee stock option grants made in 1995 and future years as if the fair-value method defined in SFAS 123 had been applied. The Company elected to continue applying the provisions of APB Opinion 25 and to comply with the pro forma disclosure provisions of SFAS 123. Postretirement Benefits Other Than Pensions The Company participates in a medical plan (the Plan) sponsored by an affiliate, ALLIED Group, Inc., which presently provides postretirement medical benefits. The Plan is subject to termination or modification by ALLIED Group, Inc. The Plan is contributory, with retiree contributions adjusted annually, and contains other cost-sharing features such as deductibles and coinsurance. ALLIED Group, Inc. collects a fee from the Company that represents its share of the Plan's current net periodic postretirement benefit cost. The accumulated postretirement benefit obligation and plan assets for the Company are combined with those of the ALLIED Group, Inc. plan covering other affiliates' employees and are not readily determinable on a separate basis. Income Taxes The Company computes deferred income taxes under the asset and liability method, which requires deferred tax liabilities and assets at the end of each reporting period be determined using the tax rate expected to be in effect when taxes are actually paid or recovered. Accordingly, income tax expense provisions increase or decrease in the same period in which a change in tax rates is enacted. Deferred income taxes reflect the impact of temporary differences between the financial statement carrying amounts and the tax bases of assets and liabilities for tax reporting. Earnings per Common Share In 1997, the Company adopted SFAS 128, "Earnings Per Share." SFAS 128 supersedes APB Opinion 15, "Earnings Per Share," and specifies the computation, presentation, and disclosure requirements for earnings per common share (EPS). It replaces the presentation of primary EPS and fully diluted EPS with basic EPS and diluted EPS, respectively. Basic EPS includes the weighted average number of common shares outstanding and excludes all dilutive securities. Diluted EPS reflects the dilution that could occur if securities or other contracts to issue common stocks were exercised or converted into common stock. Diluted EPS is computed similarly to fully diluted EPS under APB 15. All prior periods have been restated to conform to the new standard. 43 The following table sets forth the computation of basic and diluted earnings per share: 1997 1996 1995 (In thousands, except per share data) Numerator Net income $ 10,473 $ 8,073 $ 9,712 Preferred stock dividends (1,717) (1,601) (1,493) Numerator for basic earnings per share-income available to common stockholders 8,756 6,472 8,219 Effect of diluted securities Convertible preferred stock dividends 107 95 85 Numerator for diluted earnings per share-income available to common stockholders after assumed conversions $ 8,863 $ 6,567 $ 8,304 Denominator Denominator for basic earnings per share-weighted average shares 4,430 4,580 4,613 Effect of dilutive securities Stock options 35 36 34 Convertible preferred stock 107 96 85 Dilutive potential common shares 142 132 119 Denominator for diluted earnings per share-adjusted weighted average shares and assumed conversions 4,572 4,712 4,732 Basic earnings per share $ 1.98 $ 1.41 $ 1.78 Diluted earnings per share $ 1.94 $ 1.39 $ 1.75 Cash Flows For purposes of reporting cash flows, all short-term investments are considered equivalent to cash since they have original maturities of three months or less. 44 (2) Investments The following is a schedule of amortized cost and estimated fair value of investments in fixed maturities and equity securities as of December 31, 1997 and 1996. The estimated fair value of fixed maturities and equity securities is based on quoted market prices where available or on values obtained from independent pricing services. Gross Gross Estimated Amortized unrealized unrealized fair cost gains losses value (In thousands) 1997 Fixed Maturities Available for Sale U.S. Treasury securities and obligations of U.S. government corporations and agencies $ 25,466 $ 1,018 $ (22) $ 26,462 Foreign governments 5,144 264 ----- 5,408 Corporate securities and public utilities 543,788 23,915 (1,105) 566,598 Mortgage-backed securities 159,365 8,254 (59) 167,560 $ 733,763 $ 33,451 $ (1,186) $ 766,028 Equity Securities $ 3,094 $ 107 $ ----- $ 3,201 1996 Fixed Maturities Held to Maturity U.S. Treasury securities and obligations of U.S. government corporations and agencies $ 1,007 $ 26 $ (64) $ 969 Foreign governments 4,482 230 ----- 4,712 Corporate securities and public utilities 128,885 5,220 (502) 133,603 Mortgage-backed securities 64,835 1,655 (426) 66,064 $ 199,209 $ 7,131 $ (992) $ 205,348 Available for Sale U.S. Treasury securities and obligations of U.S. government corporations and agencies $ 34,378 $ ----- $ (443) $ 33,935 Foreign governments 6,189 226 (8) 6,407 Corporate securities and public utilities 306,416 8,598 (4,030) 310,984 Mortgage-backed securities 145,703 3,706 (446) 148,963 $ 492,686 $ 12,530 $ (4,927) $ 500,289 Equity Securities $ 6,153 $ 254 $ ----- $ 6,407 45 The table below presents the amortized cost and estimated fair value of investments in fixed maturities at December 31, 1997 by contractual maturity. Expected maturities at December 31, 1997 will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Amortized Estimated Cost fair value (In thousands) Available for Sale Due in one year or less $ 13,149 $ 13,308 Due in one through five years 138,590 143,397 Due in five through ten years 287,026 298,451 Due after ten years 135,633 143,312 Mortgage-backed securities 159,365 167,560 Total fixed maturities $ 733,763 $ 766,028 As of December 31, 1997 and 1996, there were no investments that were non-income producing for the preceding twelve months. For the years ended December 31, 1997, 1996, and 1995, the Company realized gross gains of $1.7 million, $237,000, and $2.1 million and gross losses of $971,000, $454,000, and $2.8 million, respectively, from the call, prepayment, or sale of investments from the available for sale portfolio. There were no sales from the held to maturity portfolio in 1997, 1996, and 1995. 46 A summary of net realized investment gains (losses) and net changes in unrealized appreciation (depreciation) of invest-ments is as follows: Year ended December 31, 1997 1996 1995 (In thousands) Net realized investment gains (losses) Fixed maturities Held to maturity $ ----- $ 3 $ 24 Available for sale 792 (217) (746) Equity securities 1,562 334 ----- Other ----- 2 ----- 2,354 122 (722) Net changes in unrealized (depreciation) appreciation of investments Fixed maturities Held to maturity (6,139) (6,695) 29,973 Available for sale 24,662 (16,003) 31,430 Equity securities (146) 178 (31) 18,377 (22,520) 61,372 Net realized investment gains (losses) and changes in unrealized appreciation (depreciation) of investments $ 20,731 $ (22,398) $ 60,650 A summary of net investment income follows: Year ended December 31, 1997 1996 1995 (In thousands) Interest on fixed maturities $ 53,469 $ 48,899 $ 45,535 Interest on mortgage loans 110 160 88 Interest on policy loans 760 713 632 Dividends on equity securities 343 274 347 Interest on short-term investments 88 84 60 Other, net 27 17 31 Total investment income 54,797 50,147 46,693 Investment expenses 945 872 574 Interest expense 919 700 708 Amortization expense, hedges 736 393 ----- Net investment income $ 52,197 $ 48,182 $ 45,411 47 As required by law, fixed maturities and short-term investments were on deposit with or on behalf of various insurance regulatory authorities at December 31, 1997 and 1996, with carrying values of $754.5 million and $681.1 million, respectively. As of December 31, 1997 and 1996, bonds with a carrying value of $29.1 million and $30.2 million, respectively, were pledged as collateral for the Company's line of credit with the Federal Home Loan Bank. Investments in any one entity or its affiliates (other than U.S. Treasury securities and obligations of U.S. government corporations and agencies) exceeding 10% of the Company's consolidated stockholders' equity as of December 31, 1997 consisted of fixed maturity securities issued by Hydro Quebec at a carrying value of $11.5 million. (3) Hedging Activities In 1996, the Company began interest rate hedging programs whereby certain derivative financial instruments including swaptions and floors were purchased. The Company also began to purchase S&P 500 Index(R) call options and S&P 500 Index(R) puts as a result of the sale of equity indexed annuity products. Swaptions are being purchased to reduce the negative effect on the Company's fixed maturity investments and annuity liabilities of increased withdrawal activity that may result from extreme rises in interest rates. As of December 31, 1997, the Company was party to 44 agreements that expire quarterly from June 1999 through March 2006. The agreements entitle the Company to receive payments from the instruments' counterparties on future reset dates if the interest rate (which is tied directly to the 5-year constant maturity swap curve) on any expiration date is above a specified fixed rate (8.8% to 10.5% for instruments entered into as of December 31, 1997). As of December 31, 1997, the notional amounts range from $3 million to $9 million (total of $244 million) and the swaptions were carried at an amortized cost of $2.1 million. Amortized cost was $2.6 million at December 31, 1996. Floors are being purchased to reduce the negative effect that may result from extreme decreases in interest rates to a level below the guaranteed interest rates provided for in the Company's universal life insurance contracts. The 28 agreements for the floors outstanding as of December 31, 1997 expire quarterly from June 1999 through March 2006. The agreements entitle the Company to receive payments from the instruments' counterparties on future reset dates if the interest rate (which is tied directly to the 10-year constant maturity treasury curve) on the expiration date is below a specified fixed rate (5.0% for instruments entered into as of December 31, 1997). As of December 31, 1997, the notional amounts for each quarter ranged from $140 million to $270 million and the floors were carried at an amortized cost of $945,000. Amortized cost was $1.1 million at December 31, 1996. The Company offers equity indexed annuity products that guarantee the return of principal to the customer and credits interest based on a percentage of the gain in the S&P 500 Index(R). A portion of the premium from each customer is invested in investment grade fixed income securities to cover the minimum guaranteed value due the customer at the end of the term. A portion of the premium is used to purchase S&P 500 call options (call options) to hedge the growth in interest credited to the customer as a direct result of increases in the S&P 500 Index(R). The call options provide the Company the opportunity to participate in the increases of the S&P 500 Index(R) if the market advances. As of December 31, 1997, the Company had purchased 113 call options with notional amounts ranging from $70,000 to $1.1 million (total of $36.3 million) and the call options were carried at an amortized cost of $7.9 million. At December 31, 1996, the Company had 40 call options with notional amounts totaling $11.2 million and amortized cost of $2.2 million. 48 The Company is exposed to the risk of extreme declines in the market value of its call options if there is a sharp and prolonged decrease in the stock market. The Company currently is purchasing puts to reduce the negative effect of such a decline. The put agreements allow the Company to receive payments on future exercise dates if the S&P 500 Index(R) is below specified index levels. The costs of the interest rate hedging programs are not expected to have a material impact on the interest rate margin. For swaptions, floors, calls, and puts the Company pays only the original premium and is not at risk of further payments regardless of market conditions. The Company is exposed to the risk of losses in the event of nonperformance of the counterparties of the previously described swaptions, floors, and call options. Losses recorded in the Company's financial statements in the event of nonperformance are limited to the unamortized premium paid to purchase the instruments. Any economic loss will be measured by the net replacement cost of such instruments or by their fair value if net fair value is in the Company's favor. The Company limits its exposure to economic loss by diversifying purchases among reputable counterparties with appropriate credit ratings. (4) Affiliation and Transactions with Affiliates The Company and its subsidiaries are parties to the Intercompany Operating Agreement (the Agreement) with ALLIED Group, Inc., ALLIED Mutual, and each of their respective subsidiaries. ALLIED Mutual controls 18.2% of the voting stock of ALLIED Group, Inc. The Agreement provides for the continued availability of office space, marketing services, agency forces, and computer and other facilities. The Agreement extends through December 31, 2004, after which it may be terminated on two years' notice given after December 31, 2002 by any party. Expenses are charged to the Company based on specific identification, or, if undeterminable, the expenses are allocated on the basis of cost and time studies that are updated annually. Rental expense incurred for office space allocated to the Company by ALLIED Mutual amounted to approximately $226,000, $253,000, and $234,000 for the years ended December 31, 1997, 1996, and 1995, respectively. ALLIED Life receives certain services from the Human Resources Department of ALLIED Group, Inc. that include, but are not limited to, maintaining employment documents, administering payroll and employee benefits, keeping related records, placing employees, and providing termination counseling and processing. For such services, ALLIED Life pays a fee to ALLIED Group, Inc. based on a percentage of the Company's gross payroll. Also included in this fee is an amount that represents the Company's share of the current net periodic postretirement benefit cost for the ALLIED Group, Inc. medical plan. Amounts incurred were approximately $162,000, $156,000, and $132,000 for the years ended December 31, 1997, 1996, and 1995, respectively. The Company, ALLIED Life, and other affiliated companies are parties to the Management Information Services Agreement (the Services Agreement) with AMCO Insurance Company (AMCO), a subsidiary of ALLIED Group, Inc. Under the terms of the Services Agreement, AMCO provides certain computer services, printing, equipment leasing, and mail and communication services to ALLIED Life on a fee basis. The annual fee is subject to renegotiation throughout the term of the Services Agreement. The Services Agreement terminates on December 31, 2004 and has an extension provision similar to the Intercompany Operating Agreement's. Effective March 1, 1996, the Services Agreement was amended and certain personnel previously providing computer-related services to the Company and its subsidiaries were employed by ALLIED Life. As a result, fees paid for services provided by such employees prior to the amendment date are now paid directly by ALLIED Life. Expenses incurred under the Services Agreement were approximately $645,000, $863,000, and $1.4 million for the years ended December 31, 1997, 1996, and 1995, respectively. 49 ALLIED Life, ALLIED Mutual, and the property-casualty subsidiaries of ALLIED Group, Inc. are parties to the ALLIED Group Joint Marketing Agreement (JMA). The JMA requires ALLIED Mutual and the property-casualty affiliates to promote to their customers and agents the sale of the products of ALLIED Life. The JMA provides for payment by ALLIED Life of an annual access fee of $100,000 plus an annual new-production incentive fee. The JMA also provides for joint systems development, including joint databases of customers and agents, multiple-account billing systems, marketing plans and promotions. Development costs are to be allocated on a mutually agreeable basis reflecting projected and actual utilization of the systems. The JMA continues to the year 2008 and continues thereafter subject to termination on two years' notice given by any party. The JMA contains noncompete provisions applicable during its term and for a period of ten years thereafter. Fees and expenses incurred under this agreement for the years ended December 31, 1997, 1996, and 1995 were approximately $100,000, $165,000, and $121,000, respectively. ALLIED Life received premium income from ALLIED Group, Inc. for term life insurance on its employee group in the amounts of approximately $468,000, $452,000, and $418,000 for the years ended December 31, 1997, 1996, and 1995, respectively. The Company invests excess cash in a short-term investment fund with other affiliated companies. AID Finance Services, Inc., a wholly owned subsidiary of ALLIED Mutual, is the administrator of the fund. The fund was established to concentrate short-term cash in a single account to maximize yield. At December 31, 1997 and 1996, the Company had approximately $3.5 million and $795,000, respectively, invested in the fund, which is carried as a short-term investment. Interest earned from the fund during 1997, 1996, and 1995 was approximately $78,000, $74,000, and $77,000, respectively. The Company and its subsidiaries have from time to time borrowed funds from affiliates as needed on an arms length basis. The Company has various notes-payable agreements with ALLIED Mutual. As of December 31, 1997 and 1996 the outstanding borrowings were approximately $3.6 million and $1.6 million, respectively. The Company incurred interest expense to affiliates of approximately $241,000, $61,000, and $51,000 in 1997, 1996, and 1995, respectively. Management believes the costs incurred by its affiliates and allocated to the Company would not be materially different than if they had been incurred from an unrelated third party. The transactions discussed herein result in intercompany balances that are created during the normal course of business and are settled on a monthly basis unless otherwise indicated. 50 (5) Fair Value of Financial Instruments The following table presents the carrying value and estimated fair value of the Company's significant financial instruments at December 31, 1997, and 1996: 1997 1996 Estimated Estimated Carrying fair Carrying fair value value value value (In thousands) Fixed maturity investments $ 766,028 $ 766,028 $ 699,498 $ 705,637 Equity securities 3,201 3,201 6,407 6,407 Cash settle put swaptions 2,070 638 2,615 2,202 Interest rate floors 945 3,621 1,137 2,075 Short-term investments 3,594 3,594 919 919 Call options 7,924 11,641 2,175 2,814 Annuity contracts (514,908) (483,208) (467,505) (437,623) Universal life contracts (196,709) (143,866) (182,727) (132,977) Note payable (6,360) (6,360) (20,470) (20,470) The fair values of certain fixed maturity investments, equity securities, cash settle put swaptions, interest rate floors, and call options are based on quoted market prices for those or similar investments. For unquoted securities, the reported value is estimated by the Company on the basis of financial and other information. Fair values of short-term investments approximate their carrying values due to their short maturity. Fair values of the Company's liabilities for annuity and universal life policyholder account balances are estimated using the cash surrender value of the contracts. Due to the variable interest rate and short-term nature of the note payable, the carrying value of the note payable approximates fair value. Fair value approximates carrying value for other financial instruments primarily due to their short-term nature. (6)Reinsurance In the normal course of business, the Company seeks to limit its exposure to loss on any single insured and to recover a portion of benefits paid by ceding reinsurance to other insurance enterprises or reinsurers under excess coverage and coinsurance contracts. In 1997, the Company followed the policy of reinsuring that portion of the risk in excess of $150,000 on each life ($250,000 for insureds aged 59 and under). The Company's long-term care and medicare supplement insurance coverage is 100% ceded. Reinsurance contracts do not relieve the Company of its obligations to policyholders. The Company is contingently liable for these amounts and would become actually liable in the event such reinsurers were unable to pay their portion of the claims. 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 to minimize its exposure to significant losses from reinsurer insolvencies. 51 Assumed premiums and related benefits are not material to the Company's consolidated financial position and results of operations. (7) Preferred Stock The Company is authorized to issue 7.5 million shares of preferred stock without par value. The preferred stock may be issued from time to time by the Board of Directors in one or more series with such dividend rights, conversion rights, voting rights, redemption provisions, liquidation preferences, and other rights and restrictions as the Board of Directors may determine. 6.75% Series The 6.75% Series Preferred Stock (6.75% Series) issued to ALLIED Mutual is perpetual, nonconvertible, voting, and cumulative with respect to dividends. The annual dividend rate is 6.75% of the liquidation preference of $10.85 ($0.7324 per share) and is payable quarterly. At its option, the Company may pay the dividend in additional shares of 6.75% Series for any quarter ending on or prior to September 30, 1998. The 6.75% Series has no preemptive rights and is not registered or traded. Upon any transfer by ALLIED Mutual, the 6.75% Series becomes nonvoting and is callable under certain conditions. The Company paid dividends to ALLIED Mutual on its outstanding 6.75% Series through the issuance of 148,402, 138,793, and 129,808 shares of such stock in 1997, 1996, and 1995, respectively. ESOP Series During 1997, 1996, and 1995 the Company sold 19,143, 14,787, and 14,650 shares of Series A ESOP Convertible Preferred Stock (ESOP Series) to the ESOP Trust for $17.50, $18.13, and $15.00 per share, respectively. At December 31, 1997, a commercial bank, acting on behalf of the ESOP participants as the trustee for the ESOP, was the holder of 100,732 shares of the ESOP Series. The ESOP Trust purchased an additional 13,163 shares on January 2, 1998 for $21.88 per share funded by a $183,000 employer contribution from ALLIED Life and ESOP Series dividends. As holder of the outstanding ESOP Series, the ESOP Trust is entitled to vote the ESOP Series on all matters submitted to a vote of the holders of the common stock of the Company, voting together with the holders of common stock and 6.75% Series as one class. The ESOP generally provides that each ESOP participant is entitled to direct the trustee how to vote (or whether to tender or exchange) the shares of the ESOP Series allocated to the participant's account. Each share of the ESOP Series is convertible into one share of common stock and has one vote, subject to antidilution adjustments. During 1997, 1996, and 1995, respectively, 12,393, 2,834, and 5,263 shares of the ESOP Series were converted to common stock. 52 The ESOP Series ranks senior to the common stock as to the payment of dividends and has a cumulative annual dividend of $1.00 per share, payable each June 30 and December 31. In the event of a liquidation of the Company, the trustee as holder of the outstanding ESOP Series is entitled to receive $15 per share plus accrued dividends prior to any distribution to the holders of common stock. The ESOP Series can be redeemed at the option of the Company, in whole or part, at any time after three years from the date the shares are issued or, under certain circumstances, in the third year or before. For redemptions in the year 2004 and beyond, the redemption price is $15 per share plus accrued and unpaid dividends; in years prior to 2004, there is a premium above the $15 per share price as set forth in the Certificate of Designations for the ESOP Series. The Company, at its option, may make payment of the redemption price in cash, in shares of common stock, or a combination thereof. Upon receipt of a redemption notice from the Company, the trustee, acting in its fiduciary capacity, may elect to convert the ESOP Series to common stock prior to redemption. If necessary to provide for distributions to participants or for other special circumstances, the trustee may request the Company redeem shares at $15 per share. In accordance with the foregoing, the Company redeemed 438 shares of the ESOP Series at $15 per share in 1995. The ESOP Series has no preemptive rights and is not registered or traded. Upon any transfer by the trustee, the ESOP Series is automatically converted into shares of the Company's common stock. (8) Common Stock The Company and ALLIED Mutual have entered into a Stock Rights Agreement (Agreement) that expires in 2008. Under the Agreement, ALLIED Mutual is entitled to nominate and the Company is required to use its best efforts to cause the election or retention of a number of members of the Company's Board of Directors in proportion to ALLIED Mutual's percentage ownership of the total number of shares of the Company's voting stock outstanding at the time of nomination. In addition, the Company is required to elect to its Executive Committee at least one Company director who has been nominated by ALLIED Mutual. The Agreement restricts the ability of ALLIED Mutual to grant proxies to other than affiliated individuals and to solicit other shareholders of the Company. ALLIED Mutual also is prohibited from initiating or accepting a tender offer for shares of the common stock except under certain conditions. The Company has a right of first refusal with respect to any sale by ALLIED Mutual of the common stock, subject to certain exceptions. ALLIED Mutual has incidental registration rights and three-demand registration rights with respect to all stock of the Company owned by ALLIED Mutual. The Company has reserved 350,000 shares of common stock for issuance under the ALLIED Life Financial Corporation Employee Stock Purchase Plan (ESPP). The Company receives 85% of the fair market value of the shares issued under the ESPP. During 1997, 1,571 shares were issued at prices ranging from $13.82 to $20.40. During 1996 and 1995, 1,934 and 6,963 shares, respectively, were issued at prices ranging from $13.18 to $17.37 for 1996 and $12.33 to $19.13 for 1995. At December 31, 1997, 326,959 shares were available for issuance. The Company has reserved 350,000 shares of common stock for issuance under the ALLIED Life Financial Corporation Outside Director Stock Purchase Plan (DSPP). Under the DSPP, participants pay 85% of the fair value of the shares issued. The 15% discount is recognized as expense on the date of issue. During 1997, 2,958 shares were issued at prices ranging from $19.13 to $21.50. During 1996 and 1995, 2,677 and 4,737 shares were issued at prices ranging from $17.37 to $17.38 and $17.06 to $17.13, respectively. At December 31, 1997, 335,213 shares were available for issuance. During 1995 the Company reserved 350,000 shares of common stock for issuance under the ALLIED Life Financial Corporation Dividend Reinvestment and Stock Purchase Plan. Any stockholder of record may participate in the plan and have cash dividends reinvested in additional shares of Company common stock. The plan also allows for optional cash payments. Shares of common stock purchased under the plan may be either original issue shares or open market shares. The Company has determined the purchased shares will be original shares until it determines otherwise. The number of shares purchased by the plan participants is based upon fair market value on a predetermined date. During 1997, 535 shares were issued at prices ranging from $16 to $23.88. During 1996, 628 shares were issued at prices ranging from $15.88 to $21; during 1995, 312 shares were issued at prices ranging from $16.81 to $19.13. At December 31, 1997, 348,525 shares were available for issuance. 53 During 1997, pursuant to rule 10b-18 under the Securities Exchange Act of 1934, the Company repurchased and canceled 150,000 shares of Company common stock on the open market at an average cost of $16.52 per share. During 1996, the Company repurchased and canceled 150,000 shares of Company common stock on the open market at an average cost of $16.94 per share. The dividend per common share for 1997, 1996, and 1995 was $0.25, $0.21, and $0.17, respectively. (9) Stock Option Plans At December 31, 1997, the Company had four stock-based compensation plans, two described in note 8 (the ESPP and DSPP) and two described here: the ALLIED Life Financial Corporation Long-Term Management Incentive Plan (Incentive Plan) and the ALLIED Life Financial Corporation Executive Stock Option Plan (Option Plan). The Company applies APB Opinion 25 and related interpretations in accounting for its plans. Accordingly, no compensation cost has been recognized for the following stock option plans or for the ESPP. Had compensation cost for these items been determined consistent with SFAS 123, the Company's net income and earnings per share would have been reduced to the pro forma amounts indicated in the table: 1997 1996 1995 (In thousands, except per share data) Net income As reported $ 10,473 $ 8,073 $ 9,712 Pro forma $ 10,384 $ 8,018 $ 9,688 Diluted earnings per share As reported $ 1.94 $ 1.39 $ 1.75 Pro forma $ 1.92 $ 1.38 $ 1.75 Pro forma net income reflects only options granted since January 1, 1995. Therefore, the full impact of calculating compensation cost for stock options under SFAS 123 is not reflected in the pro forma net income amounts presented above because compensation cost is reflected over the options' vesting period and compensation cost for options granted prior to January 1, 1995 is not considered. 54 The fair value of each stock option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions used for grants: in 1997, 1996, and 1995, dividend yield of 1.25%, expected volatility of 45%, and expected life of 6 years and a risk- free interest rate of 6% for 1997 and 7% for 1996 and 1995. The Company reserved 186,800 shares of common stock for issuance to key employees of the Company and its affiliates under the Incentive Plan. Under the Incentive Plan, shares of common stock are available for grant until December 31, 2003 as incentive and nonqualified stock options (collectively, Options), stock appreciation rights (SARs), and restricted stock. The Options, SARs, and restricted stock were issued to vest beginning two or three years after the grant date at a rate of 25% or 33.3% per year and expire ten years after the date of grant. Options, SARs, and restricted stock prices are based on the fair market value as of the date of grant. As of December 31, 1997, the 64,467 outstanding Options and SARs had exercise prices ranging from $12.88 to $23.13 and had a weighted-average remaining contractual life of 8.6 years. At December 31, 1997, 108,282 shares were available for award under the Incentive Plan. The Company has reserved 213,000 shares of common stock for issuance to key employees of the Company and its affiliates under the Option Plan until September 1, 2003. The Option Plan is a nonqualified stock option plan. Options are granted subject to a vesting schedule whereby 33.3% vest three years from the date of grant, 66.7% vest four years from the date of grant, and 100% vest five years from the date of grant. The option price is equal to the fair market value of the common stock at the time the option is granted. Options granted under the Option Plan expire ten years from the date of grant. As of December 31, 1997, the 124,293 outstanding options had exercise prices ranging from $12.00 to $17.63 and had a weighted average remaining contractual life of 6.2 years. At December 31, 1997, 31,167 shares were available for award under the Option Plan. A summary of the status of the Company's stock options as of December 31, 1997, 1996 and 1995 and changes during the years ending on those dates is presented below: 1997 1996 1995 Weighted Weighted Weighted average average average Shares exercise price Shares exercise price Shares exercise price (In thousands, except price data) Outstanding at beginning of year 205 $ 12.99 183 $ 12.27 227 $ 12.06 Granted 38 19.35 27 17.63 14 15.30 Exercised (33) 12.36 (5) 12.13 (27) 12.00 Cancelled (25) 13.03 ----- ----- (31) 12.33 Outstanding at end of year 185 $ 14.40 205 $ 12.99 183 $ 12.27 Options exercisable at end of year 69 12.15 54 12.05 ----- ----- Weighted-average fair value of options granted during the year $ 9.54 $ 8.71 $ 7.08 55 The issuance of SARs and restricted stock under the Incentive Plan reduces the number of options available for future issuance. No restricted shares were awarded in 1997. During 1996 and 1995, 1,355 and 3,458 shares of restricted stock were awarded at $17.25 and $15.50 per share, re-spectively. At December 31, 1997, 3,167 restricted shares were outstanding. The following table shows SAR activity for the years ended December 31, 1997, 1996 and 1995: 1997 1996 1995 Weighted Weighted Weighted No. of average No. of average No. of average SARs exercise price SARs exercise price SARs exercise price Outstanding at beginning of year 5,182 $ 15.49 3,300 $ 14.10 2,000 $ 12.88 Granted ----- ----- 2,000 17.63 2,000 15.30 Exercised (962) 13.74 (118) 12.88 ----- ----- Cancelled (788) 15.78 ----- ----- (700) 14.06 Outstanding at end of year 3,432 $ 15.91 5,182 $ 15.49 3,300 $ 14.10 SARs exercisable at end of year 155 14.00 383 12.88 ----- ----- (10) Retained Earnings Retained earnings of ALLIED Life available for distribution as dividends to ALLIED Life Financial Corporation are limited by law. Under the Iowa Insurance Code, dividends may be paid by ALLIED Life only from statutory earned surplus, which as of December 31, 1997 was $21.3 million. In addition, ALLIED Life may not pay an extraordinary dividend without prior notice to and approval of the Iowa Insurance Commissioner. An extraordinary dividend is defined as any dividend or distribution of cash or other property whose fair market value together with that of other dividends or distributions made within the preceding twelve months exceeds the greater of (i) 10% of statutory policyholders' surplus (total capital stock plus surplus) as of December 31 of the preceding year or (ii) the statutory net gain from operations of the insurer for the twelve-month period ending December 31 of the preceding year. During 1997, 1996, and 1995, the Company paid cash dividends on common stock of $1.1 million, $959,000, and $785,000, respectively. During 1997, 1996, and 1995, the Company paid cash dividends of $107,000, $95,000, and $85,000, respectively, on preferred stock. ALLIED Life paid to the Company dividends of $1.8 million, $1.4 million, and $800,000 during 1997, 1996, and 1995, respectively, primarily to fund the Company's cash dividend requirements and its note payments on indebtedness to affiliates. During 1998, the maximum amount available for distribution to the Company from ALLIED Life without regulatory approval of the Iowa Insurance Commissioner is $9 million. Statutory capital and surplus for ALLIED Life was $51.3 million and $46.5 million at December 31 1997 and 1996, respectively. Statutory net income for ALLIED Life was $9.7 million, $5.3 million, and $6.7 million for the years ended December 31, 1997, 1996, and 1995, respectively. 56 (11) Employee Retirement Plans The ESOP established by the Company is a nonleveraged defined contribution plan. The ESOP covers all employees who meet eligibility requirements. Shares of the ESOP Series are allocated annually to each employee's account pursuant to a formula based on employee compensation and years of service and are held in trust until the employee's termination, retirement, or death. The Company recognized compensation expense for the amount contributed to the ESOP. The Company's ESOP expense was $183,000, $238,000, and $176,000 in 1997, 1996, and 1995, respectively. During 1997, 1996, and 1995, the ESOP Trust received $106,609, $95,163, and $84,826, respectively, from dividends on the ESOP Series, which were used to purchase stock for participants. (12) Line of Credit The Company has a line of credit agreement with the Federal Home Loan Bank to make available borrowings of up to $25 million. The line expires March 13, 1998. Interest is payable at either an adjustable interest rate with the interest rate set daily on the outstanding advance amount or at a fixed rate with the interest rate set at issuance. As of December 31, 1997 and 1996, borrowings on this line of credit agreement were $6.4 million and $20.5 million at an interest rate of 6.3% and 5.7% per annum, respectively. The Company incurred interest expense to nonaffiliates of $919,000, $690,000, and $656,000 in 1997, 1996, and 1995, respectively. (13) Federal Income Taxes Total income taxes for the years ended December 31, 1997, 1996, and 1995 were allocated as follows: 1997 1996 1995 (In thousands) Net income $ 5,226 $ 3,937 $ 4,557 Unrealized appreciation of investments, net 3,524 (3,584) 4,476 $ 8,750 $ 353 $ 9,033 57 The income tax effects of temporary differences that gave rise to significant portions of the deferred income tax assets and deferred income tax liabilities at December 31, 1997 and 1996 follow: December 31, 1997 1996 (In thousands) Deferred income tax assets Policy liabilities $ 27,673 $ 24,711 Deferred policy acquisition costs related to unrealized appreciation 6,454 1,398 Other 897 331 Total gross deferred income tax assets 35,024 26,440 Less valuation allowance ----- ----- Net deferred income tax assets 35,024 26,440 Deferred income tax liabilities Deferred policy acquisition costs (32,260) (30,363) Unrealized appreciation (11,330) (2,750) Market discount on bonds (1,230) (904) Other (756) (432) Total gross deferred income tax liabilities (45,576) (34,449) Net deferred income tax liability $ (10,552) $ (8,009) The valuation allowance for deferred income tax assets at the beginning of the years ended December 31, 1997 and December 31, 1996 was $0. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred income tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the period that those temporary differences become deductible. Management considers primarily the scheduled reversal of deferred income tax liabilities, projected future taxable income, and tax planning strategies in making this assessment and believes it is more likely than not the Company will realize the benefits of these deductible differences at December 31, 1997. For the years ended December 31, 1997, 1996, and 1995, the actual income tax expense differed from the expected income tax expense based on the statutory federal income tax rate of 35%, primarily as a result of a reduction of income taxes related to prior years. The Company paid federal and state income taxes of $7 million, $3.9 million, and $4.1 million in 1997, 1996, and 1995, respectively. Prior to 1984, life insurance companies were permitted to defer from taxation a portion of statutory income. At December 31, 1983, the Company had accumulated approximately $3.3 million of this deferred income in what is referred to as its policyholders' surplus account. This amount was frozen under the Deficit Reduction Act of 1984 and could become taxable in the future only under certain conditions that management considers remote. The accumulated amount of income subject to current taxation less certain adjustments is set aside in another special memorandum tax account called a shareholders' surplus account. Dividends paid by the Company in excess of the balance in the shareholders' surplus account cannot be paid without a portion of policyholders' surplus becoming taxable. The balance of the shareholders' surplus account was approximately $57.5 million as of December 31, 1997. 58 (14) Contingencies On January 20, 1998, a complaint was filed by a policyholder of ALLIED Life, in Superior Court of the State of California for the County of Los Angeles, against the Company, ALLIED Life, ALLIED Mutual, and unnamed persons. The complaint, an alleged class action suit, asserts that ALLIED Life fraudulently increased the cost of insurance rates charged to policyholders in breach of the terms of its universal life policies, its fiduciary obligations, and its obligations of good faith and fair dealing toward its policyholders and without adequate notice. The plaintiff, an insured under a universal life policy issued by ALLIED Life seeks actual, consequential, and punitive damages in unspecified amounts as well as interest, attorney's fees, an accounting for moneys allegedly improperly charged to policyholders, and injunctive relief, on behalf of herself and all policyholders of ALLIED Life with similar universal life policies. The Company believes the allegations relate to a claim that ALLIED Life collected a federal tax, known as the deferred acquisition cost tax (DAC tax), as well as other increased costs of doing business from its policyholders. The Company believes the amount of DAC tax and other costs claimed to have been collected from each policyholder is minimal, but the plaintiff in the case has asked the California court to treat the case as a class action representing all ALLIED Life policyholders from whom the claimed costs were collected. Similar class actions have been filed against other life insurance companies since the federal DAC tax law was enacted in 1990. The Company believes the action will raise the issue of whether the DAC tax may be included in the cost of insurance charged to policyholders under the terms of the universal life contracts. Management believes the increased costs charged to policyholders never violated the contracts. The Company believes that the increased costs complained of relate to universal life policies issued during and prior to 1991 and that ALLIED Life charged the increased costs to universal life policyholders primarily during the 1992 through 1995 accounting periods. The Company, ALLIED Life, and ALLIED Mutual do not expect the lawsuit to materially affect their claims-paying ratings or daily business operations. The Company, ALLIED Life, and ALLIED Mutual disagree with the allegations, believe the claims presented in this case are without merit, and believe the resolution of this matter will not materially affect the Company's financial position. The Company is a party to other lawsuits arising in the normal course of business. The Company believes the resolution of these lawsuits will not have a material adverse effect on its financial position. 59 (15) Unaudited Interim Financial Information Quarter ended March 31 June 30 September 30 December 31 1997 Operating Summary Insurance revenues $ 8,175 $ 8,587 $ 8,526 $ 8,854 Net investment income $ 12,683 $ 12,852 $ 13,223 $ 13,439 Realized investment (losses) gains $ (393) $ 140 $ 857 $ 1,749 Total revenues $ 20,788 $ 21,918 $ 23,086 $ 24,460 Total benefits and expenses $ 17,597 $ 17,901 $ 18,849 $ 20,206 Net income $ 2,127 $ 2,679 $ 2,826 $ 2,841 Earnings per common share $ .37 $ .50 $ .53 $ .54 Quarter ended March 31 June 30 September 30 December 31 1996 Operating Summary Insurance revenues $ 7,370 $ 7,550 $ 8,619 $ 7,811 Net investment income $ 11,750 $ 11,937 $ 11,827 $ 12,668 Realized investment (losses) gains $ (84) $ (60) $ (49) $ 315 Total revenues $ 19,324 $ 19,697 $ 20,644 $ 21 Total benefits and expenses $ 15,280 $ 16,056 $ 17,535 $ 19,830 Net income $ 2,697 $ 2,464 $ 2,105 $ 806 Earnings per common share $ .49 $ .44 $ .37 $ .09 60 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None. Part III Item 10. Directors and Executive Officers of the Registrant The information under the caption "Directors and Executive Officers" in the 1998 Proxy Statement is incorporated herein by reference. Item 11. Executive Compensation The information under the caption "Compensation of Executive Officers" in the 1998 Proxy Statement is incorporated herein by reference. Item 12. Security Ownership of Certain Beneficial Owners and Management The information under the caption "Security Ownership of Directors and Executive Officers" in the 1998 Proxy Statement is incorporated herein by reference. Item 13. Certain Relationships and Related Transactions The information under the caption "Certain Transactions and Relationships" in the 1998 Proxy Statement is incorporated herein by reference. 61 Part IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K Form 10-k (a) List of Financial Statements and Schedules. Page(s) 1. Financial Statements. Independent Auditors' Report. 34 Consolidated Statements of Income for the Years ended December 31, 1997, 1996, and 1995. 35 Consolidated Balance Sheets as of December 31, 1997 and 1996. 36-37 Statements of Stockholders' Equity for the Years ended December 31, 1997, 1996, and 1995. 38 Consolidated Statements of Cash Flows for the Years ended December 31, 1997, 1996, and 1995. 39 Notes to Consolidated Financial Statements. 40-60 2. Schedules. Independent Auditors' Report on Schedules. I. Summary of Investments-Other Than Investments in Related Parties. 69 II. Condensed Financial Information of Registrant. 70-73 III. Supplementary Insurance Information. 74 IV. Reinsurance. 75 All other schedules are omitted since the required information is not present or is not present in amounts sufficient to require submission of the schedule, or because the information required is included in the consolidated financial statements and notes thereto. 3. Executive Compensation Plans and Arrangements. Short Term Management Incentive Compensation Plan for 1994 (Incorporated by reference to Exhibit 10.4 to the Company's June 30, 1994 Form 10-Q on file with the Commission), Exhibit 10.4. ALLIED Life Financial Corporation Executive Stock Option Plan (Incorporated by reference to the Company's Registration Statement on Form S-8 filed with the Commission on November 19, 1993, Registration No. 33-71906), Exhibit 10.5. ALLIED Life Financial Corporation Outside Director Stock Purchase Plan (Incorporated by reference to the Company's Registration Statement on Form S-8 filed with the Commission on November 19, 1993, Registration No. 33-71962), Exhibit 10.6. ALLIED Life Financial Corporation Long-Term Management Incentive Plan (Incorporated by reference to Exhibit 10.18 to the Company's March 31, 1994 Form 10-Q on file with the Commission), Exhibit 10.18. 62 Short Term Management Incentive Compensation Plan for 1995 (Incorporated by reference to Exhibit 10.23 to the Company's December 31, 1994 Form 10-K on file with the Commission), Exhibit 10.23. Amendment dated July 21, 1995, the ALLIED Life Financial Corporation Executive Stock Option Plan (Incorporated by reference to Exhibit 10.28 to the Company's June 30, 1995 Form 10-Q on file with the Commission), Exhibit 10.28. Short Term Management Incentive Plan for 1996 (Incorporate by reference to Exhibit 10.32 to the Company's December 31, 1995 Form 10-K on file with the Commission), Exhibit 10.32. Short Term Management Incentive Plan for 1997 (Incorporate by reference to Exhibit 10.35 to the Company's December 31, 1996 Form 10-K on file with the Commission), Exhibit 10.35. Amendment dated December 16, 1996 to ALLIED Life Financial Corporation Long-Term Management Incentive Plan (Incorporate by reference to Exhibit 10.36 to the Company's December 31, 1996 Form 10-K on file with the Commission), Exhibit 10.36. Amendment dated June 12, 1997 to The ALLIED Life Financial Corporation Short Term Management Incentive Plan (Incorporate by reference to Exhibit 10.41 to the Company's June 30, 1997 Form 10-Q on file with the Commission), Exhibit 10.41. Short Term Management Incentive Plan for 1998, Exhbit 10.45. (b) Reports on Form 8-K. There were no reports filed on Form 8-K during the fourth quarter ended December 31, 1997. (c) Exhibits. NOTE: See "Index to Exhibits" on page number 77, which discloses the specific page numbers for the exhibits included in this Form 10-K. 3. Articles of incorporation and bylaws. 3.1 Articles of Incorporation of ALLIED Life Financial Corporation as of July 20, 1993 (Incorporated by reference to Exhibit 3.1 to the Company's Registration Statement on Form S-1 filed with the Commission on September 16, 1993, Registration No. 33-68928). 3.2 Bylaws of ALLIED Life Financial Corporation as of July 20, 1993 and Amendment to the Bylaws dated October 14, 1993, December 14, 1994, and December 18, 1997 (Incorporated by reference to Exhibit 3.2 to the Company's Form 8-K filed with the Commission on January 5, 1998). 3.3 Articles of Amendment for Certificate of Designations, defining the rights of holders of 6.75% Series Preferred Stock of ALLIED Life Financial Corporation (Incorporated by reference to Exhibit 3.3 to the Company's Registration Statement on Form S-1 filed with the Commission on September 16, 1993, Registration No. 33-68928). 3.4 Amendment to Articles of Amendment for Certificate of Designations, defining the rights of holders of 6.75% Series Preferred Stock of ALLIED Life Financial Corporation (Incorporated by reference to Exhibit 3.4 to the Company's Registration Statement on Form S-1 filed with the Commission on September 16, 1993, Registration No. 33-68928). 63 3.5 Certificate of Designations, defining the rights of holders of Series A ESOP Convertible Preferred Stock of ALLIED Life Financial Corporation. (Incorporated by reference to Exhibit 3.5 to the Company's June 30, 1994 Form 10-Q on file with the Commission). 10. Material contracts. 10.1 Long Term Management Incentive Compensation Plan for 1991 (Incorporated by reference to Exhibit 10.7 to the Company's Registration Statement on Form S-1 filed with the Commission on September 16, 1993, Registration No. 33-68928). 10.2 Short Term and Long Term Management Incentive Compensation Plans for 1992 (Incorporated by reference to Exhibit 10.8 to the Company's Registration Statement on Form S-1 filed with the Commission on September 16, 1993, Registration No. 33-68928). 10.3 Short Term and Long Term Management Incentive Compensation Plans for 1993, (Incorporated by reference to Exhibit 10.3 to the Company's December 31, 1993 Form 10-K on file with the Commission). 10.4 Short Term Management Incentive Compensation Plan for 1994, (Incorporated by reference to Exhibit 10.4 to the Company's June 30, 1994 Form 10-Q on file with the Commission). 10.5 ALLIED Life Financial Corporation Executive Stock Option Plan (Incorporated by reference to the Company's Registration Statement on Form S-8 filed with the Commission on November 19, 1993, Registration No. 33-71906). 10.6 ALLIED Life Financial Corporation Outside Director Stock Purchase Plan (Incorporated by reference to the Company's Registration Statement on Form S-8 filed with the Commission on November 19, 1993, Registration No. 33-71962). 10.8 Amended and Restated ALLIED Group Intercompany Operating Agreement between ALLIED Life Insurance Company and certain of its affiliated companies dated August 25, 1993 (Incorporated by reference to Exhibit 10.3 to the Company's Registration Statement on Form S-1 filed with the Commission on September 16, 1993, Registration No.33-68928). 10.9 The ALLIED Group Joint Marketing Agreement between ALLIED Life Insurance Company and affiliated property-casualty insurance companies dated August 30, 1993 (Incorporated by reference to Exhibit 10.4 to the Company's Registration Statement on Form S-1 filed with the Commission on September 16, 1993, Registration No. 33-68928). 10.12 Federal Home Loan Bank Open Line of Credit Application and Terms Agreement dated March 13, 1997 with ALLIED Life Insurance Company, (Incorporated by reference to Exhibit 10.12 to the Company's March 31, 1997 Form 10-Q on file with the Commission). 10.15 First Amendment to Amended and Restated ALLIED Group Intercompany Operating Agree-Agreement dated November 1, 1993 (Incorporated by reference to Exhibit 10.15 to the Company's Registration Statement on Form S-1 filed with the Commission on November 9, 1993, Registration No. 33-68928). 10.16 First Amendment to the ALLIED Group Joint Marketing Agreement dated November 1, 1993 (Incorporated by reference to Exhibit 10.16 to the Company's Registration Statement on Form S-1 filed with the Commission on November 9, 1993, Registration No. 33-68928). 64 10.17 Stock Rights Agreement between ALLIED Mutual Insurance Company and ALLIED Life Financial Corporation dated August 25, 1993 (Incorporated by reference to Exhibit 10.1 to the Company's Registration Statement on Form S-1 filed with the Commission on September 16, 1993, Registration No. 33-68928). 10.18 ALLIED Life Financial Corporation Long-Term Management Incentive Plan (Incorporated by reference to Exhibit 10.18 to the Company's March 31, 1994 Form 10-Q on file with the Commission). 10.19 Second Amendment to Amended and Restated ALLIED Group Intercompany Operating Agreement dated May 16, 1994, (Incorporated by reference to Exhibit 10.19 to the Company's June 30, 1994 Form 10-Q on file with the Commission). 10.21 The ALLIED Life Financial Corporation Employee Stock Ownership Trust, (Incorporated by reference to Exhibit 10.21 to the Company's June 30, 1994 Form 10-Q on file with the Commission). 10.22 Stock Purchase Agreement dated October 27, 1994, between ALLIED Life Financial Corporation and State Street Bank and Trust Company, (Incorporated by reference to Exhibit 10.22 to the Company's September 30, 1994 Form 10-Q on file with the Commission). 10.23 Short Term Management Incentive Compensation Plan for 1995 (Incorporated by reference to Exhibit 10.23 to the Company's December 31, 1994 Form 10-K on file with the Commission). 10.24 Third Amendment to Amended and Restated ALLIED Group Intercompany Operating Agreement dated December 15, 1994 (Incorporated by reference to Exhibit 10.24 to the Company's December 31, 1994 Form 10-K on file with the Commission). 10.25 Consulting Agreement between John E. Evans and ALLIED Group, Inc., ALLIED Mutual Insurance Company, and ALLIED Life Financial Corporation dated December 14, 1994 (Incorporated by reference to Exhibit 10.25 to the Company's December 31, 1994 Form 10-K on file with the Commission). 10.26 Stock Purchase Agreement dated January 3, 1995 between ALLIED Life Financial Corporation and State Street Bank and Trust Company (Incorporated by reference to Exhibit 10.26 to the Company's December 31, 1994 Form 10-K on file with the Commission). 10.28 First Amendment to the ALLIED Life Financial Corporation Employee Stock Ownership Plan (Incorporated by reference to Exhibit 10.28 to the Company's June 30, 1995 Form 10-Q on file with the Commission). 10.29 Amendment dated July 21, 1995 to the ALLIED Life Financial Corporation Executive Stock Option Plan (Incorporated by reference to Exhibit 10.29 to the Company's June 30, 1995 Form 10-Q on file with the Commission). 65 10.30 Intercompany Cash Concentration Fund Agreement (Incorporated by reference to Exhibit to the Company's June 30, 1995 Form 10-Q on file with the Commission). 10.31 Stock Purchase Agreement dated January 2, 1996 between ALLIED Life Financial Corporation and State Street Bank and Trust Company (Incorporated by reference to Exhibit 10.31 to the Company's December 31, 1995 10K on file with the Commission). 10.32 Short Term Management Incentive Plan for 1996 (Incorporated by reference to Exhibit to the Company's December 31, 1995 10K on file with the Commission). 10.33 Amended and Restated Management Information Services Agreement Effective January 1, 1995 (Incorporated by reference to Exhibit 10.33 to the Company's December 31, 1995 10K on file with the Commission). 10.34 Stock Purchase Agreement date January 2, 1997 between ALLIED Life Financial Corporation and State Street Bank and Trust Company (Incorporated by reference to Exhibit 10.34 to the Company's December 31, 1996 10K on file with the Commission). 10.35 Short Term Management Plan for 1997 (Incorporated by reference to Exhibit 10.35 to the Company's December 31, 1996 10K on file with the Commission). 10.36 Amendment dated December 16, 1996 to ALLIED Life Financial Corporation Long-Term Management Incentive Plan (Incorporated by reference to Exhibit 10.36 to the Company's December 31, 1996 10K on file with the Commission). 10.37 Amendment dated December 18, 1996 to Consulting Agreement between John E. Evans and ALLIED Group, Inc., ALLIED Mutual Insurance Company, and ALLIED Life Financial Corporation (Incorporated by reference to Exhibit 10.37 to the Company's December 31, 1996 10K on file with the Commission). 10.38 Tax Sharing Agreement, dated January 1, 1997, between ALLIED Life Financial Corporation, ALLIED Life Brokerage Agency, Inc., and ALLIED Group Merchant Banking Corporation (Incorporated by reference to Exhibit 10.38 to the Company's December 31, 1996 10K on file with the Commission). 10.39 Amended and Restated Management Information Services Agreement Effective March 1, 1996 (Incorporated by reference to Exhibit 10.39 to the Company's December 31, 1996 10K on file with the Commission). 10.40 First Amendment to Amended and Restated Management Information Services Agreement Effective March 1, 1996 (Incorporated by reference to Exhibit 10.40 to the Company's December 31, 1996 10K on file with the Commission). 10.41 Amendment dated June 12, 1997 to The ALLIED Life Financial Corporation Short Term Management Incentive Plan (Incorporate by reference to Exhibit 10.41 to the Company's June 30, 1997 Form 10-Q on file with the Commission). 10.42 Second Amendment dated May 13, 1997 to Consulting Agreement between John E. Evans and ALLIED Group, Inc., ALLIED Mutual Insurance Company, and ALLIED Life Financial Corporation (Incorporate by reference to Exhibit 10.42 to the Company's June 30, 1997 Form 10-Q on file with the Commission). 10.43 Promissory Note dated October 28, 1997 between ALLIED Mutual Insurance Company and ALLIED Life Financial Corporation (Incorporate by reference to Exhibit 10.43 to the Company's September 30, 1997 Form 10-Q on file with the Commission). 66 10.44 1997 Incentive Plan ALLIED Life Vice President Marketing (Incorporate by reference to Exhibit 10.44 to the Company's June 30, 1997 Form 10-Q on file with the Commission). 10.45 Short Term Management Incentive Plan for 1998 10.46 Stock Purchase Agreement dated January 2, 1998 between ALLIED Life Financial Corporation and State Street Bank and Trust Company. 11 Statement re Computation of Per Share Earnings. 21 Subsidiaries of the Registrant. 23 Consent of KPMG Peat Marwick LLP. 27 Financial Data Schedule. (d) Financial statements required by Regulation S-X which are excluded from the Annual Report to Stockholders by Rule 14a-3(b)(1). None. 67 INDEPENDENT AUDITORS' REPORT ON SCHEDULES The Board of Directors and Stockholders ALLIED Life Financial Corporation Under date of February 12, 1998, we reported on the consolidated balance sheets of ALLIED Life Financial Corporation and subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1997, as contained in the 1997 Annual Report. In connection with our audits of the aforementioned consolidated financial statements, we also have audited the related consolidated financial statement schedules listed in Part IV, Item 14(a)2. These consolidated financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statement schedules based on our audits. In our opinion, such consolidated financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein. /s/KPMG Peat Marwick LLP KPMG Peat Marwick LLP Des Moines, Iowa February 12, 1998 68 ALLIED Life Financial Corporation and Subsidiaries SCHEDULE I-SUMMARY OF INVESTMENTS- OTHER THAN INVESTMENTS IN RELATED PARTIES December 31, 1997 Column A Column B Column C Column D Amount at which shown in Amortized Fair the balance Type of Investment Cost value sheet (In thousands) Fixed maturities available for sale: U.S. Treasury securities and obligations of U.S. government corporations and agencies $ 25,466 $ 26,462 $ 26,462 Foreign governments 5,144 5,408 5,408 Corporate securities and public utilities 543,788 566,598 566,598 Mortgage-backed securities 159,365 167,560 167,560 Total fixed maturities available for sale 733,763 $ 766,028 766,028 Equity Securities 3,094 $ 3,201 3,201 Mortgage loans on real estate 984 984 Policy loans 11,164 11,164 Other assets 3,014 3,014 Short-term investments 3,594 3,594 Total investments $ 755,613 $ 787,985 69 ALLIED Life Financial Corporation and Subsidiaries SCHEDULE II ALLIED Life Financial Corporation (Holding Company) CONDENSED BALANCE SHEET December 31, 1997 and 1996 1997 1996 (In thosuands) Assets Investments in subsidiaries, at equity $ 116,419 $ 101,327 Short-term investments, at cost 1,205 203 Accounts receivable 1 2 Current income taxes recoverable 135 43 Total assets $ 117,760 $ 101,575 Liabilities Note payable to affiliates (note 2) $ 3,564 $ 1,617 Other liabilities 39 16 3,603 1,633 Stockholders' Equity Preferred stock, no par value, issuable in series, authorized 7,500,000 shares 6.75% Series, authorized 2,440 shares, issued and outstanding of 2,292 in 1997 and 2,144 in 1996 24,869 23,259 ESOP Series, authorized 300 shares, issued and outstanding of 101 in 1997 and 94 in 1996 1,467 1,327 Common stock, no par value, $1 stated value, authorized 25,000 shares, issued and outstanding of 4,398 in 1997 and 4,497 in 1996 4,398 4,497 Additional paid-in capital 44,964 46,596 Retained earnings 29,404 21,751 Unrealized appreciation of investments, net 9,055 2,512 Total stockholders' equity 114,157 99,942 Total liabilities and stockholders' equity $ 117,760 $ 101,575 See accompanying Note to Condensed Financial Statements. 70 ALLIED Life Financial Corporation SubsidiariesSCHEDULE II ALLIED Life Financial Corporation (Holding Company) CONDENSED STATEMENT OF INCOME For the years ended December 31, 1997, 1996, and 1995 1997 1996 1995 (In thousands) Equity in undistributed earnings of subsidiaries $ 8,547 $ 6,698 $ 8,746 Dividends received from subsidiaries 2,100 1,475 925 Investment income 44 25 185 Realized investment gains ----- ----- 65 10,691 8,198 9,921 Operating expenses 157 154 180 Interest expense 181 44 ----- 338 198 180 Income before income taxes 10,353 8,000 9,741 Income tax (benefit) expense (120) (73) 29 Net income (note 1) $ 10,473 $ 8,073 $ 9,712 See accompanying Note to Condensed Financial Statements. 71 ALLIED Life Financial Corporation and Subsidiaries SCHEDULE II ALLIED Life Financial Corporation (Holding Company) CONDENSED STATEMENT OF CASH FLOWS For the years ended December 31, 1997, 1996 and 1995 1997 1996 1995 Cash Flows from Operating Activities Net income $ 10,473 $ 8,073 $ 9,712 Adjustments to reconcile net income to net cash provided by operating activities Equity in undistributed earnings (8,547) (6,698) (8,746) Realized investment gains ----- ----- (65) Accrued investment income ----- ----- 21 Income taxes (92) (42) (5) Other, net 24 13 (94) Net cash provided by operating activities 1,858 1,346 823 Cash Flows from Investing Activities Purchase of fixed maturities available for sale ----- ----- (1,635) Proceeds from sale of fixed maturities available for sale ----- ----- 4,432 Investments in subsidiaries ----- ----- (3,500) Net cash used in investing activities ----- ----- (703) Cash Flows from Financing Activities Proceeds from note payable to affiliate, net 1,946 1,617 ----- Proceeds from issuance of common stock, net 569 189 588 Proceed from issuance of preferred stock, net 317 249 194 Dividends paid to stockholders (1,210) (1,053) (870 ) Repurchase of common stock (2,478) (2,541) ----- Net cash provided by financing activities (856) (1,539) (88) Net Increase in Cash and Short-term investments 1,002 (193) 32 Cash and short-term investments at beginning of year (period) 203 396 364 Cash and short-term investments at end of year $ 1,205 $ 203 $ 396 See accompanying Note to Condensed Financial Statements. 72 ALLIED Life Financial Corporation and Subsidiaries SCHEDULE II ALLIED Life Financial Corporation (Holding Company) NOTE TO CONDENSED FINANCIAL STATEMENTS The accompanying condensed financial statements should be read in conjunction with the consolidated financial statements and notes thereto of ALLIED Life Financial Corporation and its subsidiaries. (1) Basis of presentation. The accompanying condensed financial statements of ALLIED Life Financial Corporation (ALFC) have been prepared in conformity with generally accepted accounting principles (GAAP). (2) Note payable to affiliate ALFC has entered into several note payable agreements with ALLIED Mutual. At December 31, 1997 and 1996, the outstanding balance of the note-payables were approximately $3.6 million and $1.6 million. In 1997 and 1996, ALFC incurred interest expense of approximately $181,000 and $44,000 relating to the note-payables. 73 ALLIED Life Financial Corporation and Subsidiaries SCHEDULE III - SUPPLEMENTARY INSURANCE INFORMATION For the years ended December 31, 1997, 1996 and 1995 Column A Column B Column C Column D Column E Column F Column G Column H Column I Column J Column K (In thousands) Future policy Other benefits, policy Benefits, Amortization Deferred losses, Claims Insurance claims, of deferred policy claims and Unearned and premiums and Net losses and policy Other acquisition loss revenue benefits other investment settlement acquisition operating Premiums Segment costs expenses reserve payable considerations income expenses costs expense written Year ended December 31, 1997: Life insurance $84,188 $757,473 $----- $5,879 $34,143 $52,132 $51,392 $11,097 $10,482 $ ----- Other ----- ----- ----- ----- ----- 65 ----- ----- 1,583 ----- Consolidated $84,188 $757,473 $----- $5,879 $34,143 $52,197 $51,392 $11,097 $12,065 $ ----- Year ended December 31, 1996: Life insurance $92,418 $692,551 $----- $5,312 $31,350 $48,145 $47,988 $10,595 $ 9,030 $ ----- Other ----- ----- ----- ----- ----- 37 ----- ----- 1,087 ----- Consolidated $92,418 $692,551 $----- $5,312 $31,350 $48,182 $47,988 $10,595 $10,117 $ ----- Year ended December 31, 1995: Life insurance $79,718 $616,654 $----- $5,695 $29,934 $45,215 $46,063 $ 5,941 $ 8,246 $ ----- Other ----- ----- ----- ----- ----- 196 ----- ----- 792 ----- Consolidated $79,718 $616,654 $----- $5,695 $29,934 $45,411 $46,063 $ 5,941 $ 9,038 $ ----- 74 ALLIED Life Financial Corporation and Subsidiaries SCHEDULE IV - REINSURANCE For the years ended December 31, 1997, 1996, and 1995 Column A Column B Column C Column D Column E Column F (In thousands) Percentage Assumed of amount Ceded to other from other assumed to Gross amount companies companies Net amount net Year ended December 31, 1997: Life insurance in force $ 9,536,681 $ (2,359,213) $ 92,959 $ 7,270,427 1.3% Premiums: Life insurance premiums: and charges (1) $ 35,912 $ (7,003) $ 215 $ 29,124 0.7% Accident and health insurance 3,514 (3,638) ----- (124) ----- Total premiums $ 39,426 $ (10,641) $ 215 $ 29,000 0.7% Year ended December 31, 1996: Life insurance in force $ 8,855,654 $ (2,633,078) $ 103,660 $ 6,326,236 1.6% Premiums: Life insurance premiums: and charges (1) $ 33,500 $ (6,275) $ 232 $ 27,457 0.8% Accident and health insurance 2,230 (2,232) ----- (2) ----- Total premiums $ 35,730 $ (8,507) $ 232 $ 27,455 0.8% Year ended December 31, 1995: Life insurance in force $ 7,995,050 $ (2,538,119) $ 119,466 $ 5,576,397 2.1% Premiums: Life insurance premiums: And charges (1) $ 32,350 $ (6,388) $ 228 $ 26,190 0.8% Accident and health insurance 1,376 (1,372) ----- 4 ----- Total premiums $ 33,726 $ (7,760) $ 228 $ 26,194 0.9% (1) Includes life insurance premiums and policyholder assessments on universal life contracts. 75 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. ALLIED Life Financial Corporation (Registrant) Date: March 3, 1998 By /s/ Wendell P. Crosser Wendell P. Crosser Vice President and Treasurer (Principal Financial Officer and Principal Accounting Officer) Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated. Signature Title Date /s/ SAMUEL J. WELLS President (Principal Executive March 3, 1998 Samuel J. Wells Officer) /s/ WENDELL P. CROSSER Vice President and Treasurer March 3, 1998 Wendell P. Crosser /s/ JOHN E. EVANS Chairman of the Board and Director March 3, 1998 John E. Evans /s/ JAMES W. CALLISON Director March 3, 1998 James W. Callison /s/ HAROLD S. EVANS Director March 3, 1998 Harold S. Evans /s/ DENNIS H. KELLY, JR. Director March 3, 1998 Dennis H. Kelly, Jr. /s/ GEORGE D. MILLIGAN Director March 3, 1998 George D. Milligan 76 ALLIED Life Financial Corporation and Subsidiaries INDEX TO EXHIBITS Exhibit Number Item Page 10.45 Short Term Management Incentive Plan for 1998 78 10.46 Stock Purchase Agreement dated January 2, 1998 between ALLIED Life Financial Corporation and State Street Bank and Trust Company 83 11 Statement re Computation of Per Share Earnings 94 21 Subsidiaries of the Registrant 95 23 Consent of KPMG Peat Marwick LLP 96 27 Financial Data Schedule 97 77 ALLIED LIFE FINANCIAL CORPORATION SHORT TERM MANAGEMENT INCENTIVE PLAN 1. PURPOSE This ALLIED Life Financial Corporation Short Term Management Incentive Plan (the "Plan") is effective January 1, 1998. The purpose of this Plan is to encourage outstanding performance by certain key employees of ALLIED Life Insurance Company in the attainment of annual financial and operating goals of ALLIED Life Financial Corporation, Inc. ("ALFC") and its subsidiaries (collectively "ALLIED Life"). 2. DEFINITIONS The capitalized terms used throughout the Plan have the following meaning: (a) "Base Award" is defined in Paragraph 5(c). (b) "Base Salary" is the annualized weekly base pay of the Participant in effect as of the last day in the position for which the bonus is being calculated, which in no event shall be later than December 31 of the Plan year. (c) "Committee" shall mean the Compensation Committee of the Board of Directors of ALFC. (d) "Discretionary Award" is defined in Paragraph 5(d). (e) "Discretionary Tier Award" is defined in Paragraph 5(i). (f) "Eligible Award Percentage" is defined in Paragraph 5(b). (g) "Eligible Individual Award" is defined in Paragraph 5(a). (h) "Eligible Tier Award" is defined in Paragraph 5(g). (i) "EPS" is defined in Paragraph 4. (j) "Goal" is the expected level of performance used to establish targeted awards as approved by the Committee. (k) "Growth" is defined in Paragraph 4. (l) "Maximum" is the level of performance at which the maximum eligible award could be made. (m) "Participant" is a key employee of ALLIED Life recommended by the President of ALFC and approved by the Committee to participate in this Plan. (n) "Threshold" is the minimum level of performance that will warrant an award. (o) "Total Award" is defined in Paragraph 5(e). 78 3. PARTICIPATION AND TIERS Participation in the Plan is tiered by responsibility level and the short-term impact of the management position. General Responsibility Levels Tier A President Tier B Primary Vice Presidents Tier C Other Vice Presidents Tier D Key Managers A participation list specifying the Participants in each tier shall be approved by the Committee prior to each fiscal year. The Committee may amend such list from time to time to add or delete Participants. Each tier level of participation will have varying award opportunity at the Threshold, Goal, and Maximum performance levels for each of the performance indicators. 4. PERFORMANCE INDICATORS Two performance indicators, EPS and Growth, will be used to measure the success of ALLIED Life and the level of bonus to be paid under this Plan. "EPS" is defined as the ALFC consolidated diluted operating earnings per share computed in accordance with generally accepted accounting principles ("GAAP"). EPS excludes realized investment gains and losses net of excess deferred policy acquisition costs ("DPAC") amortization and net of income taxes. "Growth" is defined as a performance indicator and is the increase in revenue from the prior year stated in terms of a percentage increase or dollar target. Revenue for ALFC is expressed as GAAP insurance revenues plus 2% first year annuity premiums less single premium income annuities. The Threshold for EPS must be attained before any award will be made based on Growth. 5. AWARDS Individual Calculations (a) A Participant may receive an Eligible Individual Award under the Plan. "Eligible Individual Award" is defined as the award potential for a Participant based on EPS and Growth results. Eligible Individual Award is the sum of (i) the Eligible Award Percentage for EPS multiplied by the Base Salary for the Participant and (ii) the Eligible Award Percentage for Growth multiplied by the Base Salary for the Participant. The Eligible Individual Award is the amount used to determine the Base Award and the Discretionary Award. (b) "Eligible Award Percentage" is defined as the percentage amount used to determine the potential Eligible Tier Awards and Eligible Individual Award. The amount of the Eligible Award Percentage is tied to tier and performance level attained (Threshold, Goal, or Maximum), as set forth in Exhibit B. 79 Example for Eligible Award Percentage for EPS for a Participant Step 1: Compare actual EPS results for the fiscal year to the goals specified in Exhibit A. If the actual EPS results for the fiscal year do not meet the Threshold, then the Eligible Award Percentage is 0, and no further calculations are necessary. Step 2: Determine the percent by which the EPS results exceeded the Threshold value (or the goal value as the case may be). There is no need for a calculation if the Maximum results were achieved or exceeded. Step 3: Identify the Eligible Award Percentage for EPS indicator in the tier at the Threshold level, as shown in Exhibit B. Multiply the Eligible Award Percentage by the percent calculated in Step 2. This will calculate the actual Eligible Award Percentage available based on the profit results attained. Repeat Steps 1 through 3 using Growth to compute the Eligible Award Percentage for Growth. (c) Upon meeting the Threshold for EPS, a Participant will receive a Base Award. "Base Award" is defined as the award to a Participant when a minimum performance level is met. The Base Award is 60% of the Eligible Individual Award. (d) Depending on the determination of the Committee, a Participant may or may not receive a Discretionary Award. "Discretionary Award" is defined as an amount separate from the Base Award which is awarded to a Participant based on the discretion of the Committee. The Discretionary Award is calculated as a percentage of the Eligible Tier Award. (e) A Participant's "Total Award" is defined as the sum of the Base Award and the Discretionary Award. The Discretionary Award combined with the Base Award cannot exceed 150% of the Participant's Eligible Individual Award. (f) In the event a Participant does not meet the Threshold for EPS, the Committee may, in unusual or extraordinary circumstances, award the Participant a special award under the Plan. This paragraph may only be invoked by the Committee in rare and extreme situations. Tier Calculations (g) "Eligible Tier Award" is defined as the award potential for a tier based on EPS and Growth results. Eligible Tier Award is the sum of the Eligible Individual Awards for all of the Participants in a particular tier. Total awards made to all of the Participants in a particular tier shall not exceed 100% of the Eligible Tier Award, but the total awards for a particular tier may be less than the Eligible Tier Award. (h) Notwithstanding the foregoing, if the Committee determines that a Participant has shown extraordinary performance in a calendar year, the Committee may exceed the Eligible Tier Award in order to increase the Discretionary Award for the Participant showing such extraordinary performance. (i) "Discretionary Tier Award" is defined as the portion of the tier award potential that is not guaranteed to payout but may be awarded based on contribution and performance. This portion may equal up to 40% of the Eligible Tier Award. A Participant may receive a portion, all, or none of the Discretionary Tier Award. 80 6. PRORATED AWARDS Employees who become eligible for participation in this Plan after the beginning of the Plan year may receive a prorated award based on the time the employee was a Participant and based on active time employed during the Plan year. Prorated awards will be calculated by determining the number of calendar days that a Participant has been eligible for a tier and dividing that number by the calendar days in that Plan year. 7. DEATH, DISABILITY, OR RETIREMENT In the event that a Participant dies, becomes disabled, or retires due to age in accordance with ALLIED Life policy, a prorated award will be made based on active time employed as a Participant during the Plan year. 8. PLAN YEAR The Plan year will be ALFC's fiscal year. 9. TRANSFERABILITY A Participant may not sell, pledge, donate, or otherwise assign any interest in this Plan. 10. EMPLOYMENT Nothing in this Plan confers upon a Participant any right to continued employment or interferes with or limits in any way ALLIED Life's right to terminate the employment of a Participant at any time. 11. TERMINATION OF EMPLOYMENT If a Participant terminates employment or is terminated by ALLIED Life for any reason other than death, disability, or retirement due to age in accordance with ALLIED Life's policy, and if such termination date is prior to the payment date of an award under this Plan, any right to an award under this Plan is forfeited. 12. PLAN AMENDMENT OR TERMINATION The Committee may amend or terminate the Plan at any time. Participants will be notified of such action as soon as it is practical to do so. In the event of any change in the corporate structure of ALFC affecting the goals set forth in Exhibit A or the eligible award percentages set forth in Exhibit B, and where such change in corporate structure would adversely affect a Participant, the Committee may adjust or amend the Plan so as not to disadvantage a Participant. In the event that a change in accounting rules or procedures would affect the goals set forth in Exhibit A or the eligible award percentages set forth in Exhibit B, and where such change in accounting rules or procedures would adversely affect or create a windfall for a Participant, the Committee may adjust or amend the Plan. 13. ADMINISTRATION All matters pertaining to the administration of this Plan will be the responsibility of the Committee, and any decisions of the Committee shall be conclusive and binding. This includes all matters of interpretation, areas not specified in the Plan, and any other issues that may affect the Plan. 14. GOVERNING LAW The Plan will be administered, enforced, construed, and interpreted in accordance with the laws of the State of Iowa. 81 EXHIBIT A GOALS Threshold Goal Maximum EPS $1.90 $2.00 $2.10 GROWTH 8% 10% 12% EXHIBIT B ELIGIBLE AWARD PERCENTAGES Threshold Goal Maximum Weight Tier A - President: EPS 19% 38% 56% 75% Growth 6% 12% 19% 25% Total 25% 50% 75% 100% Tier B - Primary Vice Presidents: EPS 15% 30% 45% 75% Growth 5% 10% 15% 25% Total 20% 40% 60% 100% Tier C - Other Vice Presidents EPS 12% 24% 36% 75% Growth 4% 8% 12% 25% Total 16% 32% 48% 100% Tier D - Key Managers EPS 3% 4.5% 6% 75% Growth 1% 1.5% 2% 25% Total 4% 6% 8% 100% 82 STOCK PURCHASE AGREEMENT STOCK PURCHASE AGREEMENT dated as of January 2, 1998, between ALLIED LIFE FINANCIAL CORPORATION, an Iowa corporation (the "Company"), and STATE STREET BANK AND TRUST COMPANY, a Massachusetts trust company, solely in its capacity as trustee under the Plan defined below and not individually (the "Trustee"). WITNESSETH; WHEREAS, the Company has established and maintains The ALLIED Life Financial Corporation Employee Stock Ownership Plan (the "Plan"), for the benefit of all employees eligible to participate therein; WHEREAS, the Plan qualifies as an "employee stock ownership plan" within the meaning of Section 4975(e)(7) of the Internal Revenue Code of 1986, as amended (the "Code"); WHEREAS, the Company has established and maintains The ALLIED Life Financial Corporation Employee Stock Ownership Trust (the "Trust") and the Company has appointed the Trustee to act as the trustee thereof pursuant to a trust agreement between the Company and the Trustee dated June 20, 1994 (the "Trust Agreement"); WHEREAS, the Trust Agreement provides that the assets of the trust created thereunder shall be invested in, among other things, shares of common stock of the Company ("Common Stock") or convertible preferred stock of the Company; WHEREAS, the Company has designated 300,000 shares as a series of convertible preferred stock, with no par value, called the Series A ESOP Convertible Preferred Stock, of which 122,717 shares were previously issued and of which it has offered 13,163 shares for sale to the Trustee (the "Series A Preferred Stock"); WHEREAS, as directed by the ESOP Committee (the "Committee") under the terms of the Trust Agreement, the Trustee is authorized to purchase shares of Series A Preferred Stock and the Company wishes to issue and sell such shares of Series A Preferred Stock to the Trustee, and no commission will be paid by the Trustee in connection with the purchase of such shares of Series A Preferred Stock; and WHEREAS, the Trustee is required under the Trust Agreement to independently determine (i.e., without direction from the Company) the purchase price that shall be paid for any stock of the Company, and the Trustee has received an opinion of Houlihan Lokey Howard & Zukin (the "Valuation Opinion") that the purchase of the shares of Series A Preferred Stock pursuant to the terms to this Agreement is fair and equitable to the participants in the Plan and the price to be paid for the Series A Preferred Stock is not in excess of adequate consideration. NOW THEREFORE, in consideration of these premises and the mutual promises contained herein, the parties hereto, intending to be legally bound, hereby agree as follows: 1. The Trustee hereby agrees to purchase (the "Purchase") with the funds directed by the Committee, and the Company hereby agrees to issue and sell for cash to the Trust 13,163 shares of Series A Preferred Stock (the "Series A Preferred Stock") for an aggregate purchase price (the "Purchase Price") of $287,936.00 (or $21.875 per share). The Company will pay all stamp and other transfer taxes, if any, which may be payable in respect of the issuance, sale and delivery of the Series A Preferred Stock and shall be entitled to any refund thereof. 2. The Purchase shall be consummated at or about 8:00 A.M. Central Standard Time on January 2, 1998 (such date of delivery being hereinafter called the "Delivery Date") at the offices of the Company, Des Moines, Iowa or as otherwise agreed by the parties hereto. On the Delivery Date, the Trustee shall deliver to the Company the Purchase Price in immediately available funds together with an opinion of Goodwin, Procter & Hoar, LLP, counsel to the Trustee, in the form attached as Annex A hereto and a copy of the Valuation Opinion, and the Company will deliver to the Trustee a certificate or certificates representing the Series A Preferred Stock which shall be registered in the name of the Trustee, as trustee under the Plan, or in the name of its nominee, together with an opinion of Katherine E. Schmidt, Associate Corporate Counsel of the Company, in the form attached as Annex B hereto. 83 3. The Company hereby represents, warrants and covenants to the Trustee as follows: a. the Company (i) is a corporation duly organized, validly existing and in good standing under the laws of the State of Iowa and (ii) has full corporate power and authority to execute and deliver this Agreement, to carry out the transactions contemplated hereby, to own, lease and operate its assets and properties, and to carry on its business as now being conducted; b. this Agreement has been duly authorized, executed and delivered by the Company and constitutes a valid and binding obligation of the Company, enforceable against the Company in accordance with its terms, subject to applicable bankruptcy, insolvency, fraudulent conveyance, reorganization, moratorium and similar laws affecting creditors' rights generally and to general principles of equity (regardless of whether considered in a proceeding at law or in equity); c. the execution, delivery and performance of this Agreement by the Company and the consummation of the transactions contemplated hereby will not violate (i) the Company's Articles of Incorporation or By-laws, each as amended to date or, (ii) any provision of any agreement, instrument, order, award, judgment or decree to which the Company is a party or by which it or any of its businesses or properties are bound, or (iii) any statute, rule or regulation of any federal, state or local government or governmental agency applicable to the Company except in the case of subparagraphs (ii) or (iii) of this Section 3(c) for any such violations which either individually or in the aggregate do not have a material adverse effect on the business or properties of the Company and its subsidiaries taken as a whole; d. except for any necessary applications with The NASDAQ Stock Market with respect to any newly issued shares of Common Stock which may be issued upon conversion of the Series A Preferred Stock, no approval, authorization or other action by, or filing (other than such filings of the Company as may be necessary in connection with any registration for sale of the common stock that may be issuable upon conversion of the Series A Preferred Stock) with, any government authority is required to be obtained or made by the Company in connection with the execution, delivery and performance by the Company of this Agreement and the consummation of the transactions contemplated hereby; e. the Certificate of Designations was filed with the Secretary of State effective June 21, 1994 prior to which the Series A Preferred Stock were duly and validly authorized and, when issued and delivered to and paid for by the Trustee pursuant to this Agreement, (i) will be validly issued, fully paid and nonassessable and not liable to any further call or assessment, (ii) the certificates representing the Series A Preferred Stock comply with the applicable requirements of Iowa law and (iii) the Trustee will acquire full right, title and interest in and to the Series A Preferred Stock free and clear of any and all liens, claims, charges and encumbrances (other than rights of participants in the Plan); f. the Company (i) has duly and validly authorized and reserved for issuance a sufficient number of shares of Common Stock, as may be issued, from time to time, upon conversion of the Series A Preferred Stock and (ii) such shares of Common Stock, when issued upon conversion of the Series A Preferred Stock in accordance with the Certificate of Designations, will be validly issued, fully paid and nonassessable and not liable to any further call or assessment and will not be subject to preemptive rights; g. the Plan has been duly authorized and established, and the Trust Agreement has been duly authorized, by all necessary corporate action on the part of the Company; the Plan constitutes in all material respects in form an employee stock ownership plan within the meaning of Section 4975(e)(7) of the Code, Code Regulation Section 54.4975-11 and Section 407(d)(6) of the Employee Retirement Income Security Act of 1974, as amended ("ERISA"); and the Series A Preferred Stock constitutes a qualifying employer security within the meaning of Section 4975(e)(8) of the Code; provided, however, that in making the representations contained in this Section 3(g) the Company has relied upon the correctness of the Trustee's representations contained in Section 4(g) of this Agreement; 84 h. the Company's annual report on 10-K for the year ended December 31, 1996 and quarterly reports on 10-Q for the quarterly periods ended March 31, June 30 and September 30, 1997, on the respective dates filed with the Securities and Exchange Commission ("SEC"), conformed in all material respects to the requirements of the Securities Exchange Act of 1934, as amended; i.no person or other entity is entitled to any fees or commissions due to the Company's actions in connection with the purchase and sale of the Series A Preferred Stock; j. the Company shall use its best efforts during the term of the Trust to cause the Plan to maintain its qualification as an employee stock ownership plan within the meaning of Section 4975 of the Code; and k. the Company has furnished and will continue to furnish to the Trustee from time to time copies of all reports and financial statements which the Company shall send or make available to its public stockholders generally, all other written communications from the Company to public shareholders generally and each regular or periodic report, proxy statement, registration statement or prospectus, if any, filed by the Company with the SEC; and 4. The Trustee represents and warrants to the Company as follows: a. the Trustee (i) is a duly organized and validly existing Massachusetts trust company in good standing as a trust company and with full power and authority to act as Trustee and exercise trust powers, including without limitation, the trust powers provided in and contemplated by the Trust Agreement, and (ii) has full corporate power and authority to execute and deliver this Agreement and to carry out the transactions contemplated hereby; b. this Agreement has been duly authorized, executed and delivered by the Trustee and constitutes a valid and binding obligation of the Trustee, enforceable against the Trustee in accordance with its terms, subject to applicable bankruptcy, insolvency, fraudulent conveyance, reorganization, moratorium and similar laws affecting creditors' rights generally and to general principles of equity (regardless of whether considered in a proceeding at law or in equity); c. the execution, delivery and performance of this Agreement by the Trustee and the consummation of the transactions contemplated hereby will not violate (i) the Trustee's Corporate Charter or By-laws, each as amended to date, or (ii) any provision of any agreement, instrument, order, award, judgment or decree to which the Trustee is a party or by which it or any of its businesses or properties are bound or (iii) any statute, rule or regulation of any federal, state or local government or governmental agency applicable to the Trustee except in the case of subparagraphs (ii) or (iii) of this Section 4(c) for any such violations which either individually or in the aggregate do not have a material adverse effect on the business or properties of the Trustee; provided, however, that in making the representations contained in clause (iii) of this Section 4(c), the Trustee has relied upon the correctness of (1) the Company's representations in Section 3(g), as limited by the proviso therein, and Section 3(i) of this Agreement and (2) the Committee's direction letter dated December 30, 1997; d. no approval, authorization or other action by, or filing with, any governmental authority is required to be obtained or made by the Trustee in connection with the execution, delivery and performance by the Trustee of this Agreement and the consummation of the transactions contemplated hereby; 85 e. the Trustee is acquiring the Series A Preferred Stock on behalf of the Plan solely for investment purposes and not with a view to, or for sale in connection with, any distribution thereof; provided, however, that the Series A Preferred Stock will be allocated to the accounts of the participants in the Plan pursuant to the terms of the Plan and distributions may be made to participants and beneficiaries of the Plan in shares of Common Stock issuable upon conversion of the Series A Preferred Stock or payable upon redemption of the Series A Preferred Stock, including upon exercise of the rights set forth in Section 7 of the Certificateof Designations, or in shares of Common Stock otherwise acquired by the Trustee pursuant to the terms of the Plan, it being understood that the Series A Preferred Stock are being sold to the Trustee pursuant to an exemption from the registration requirements of the Securities Act of 1933, as amended (the "Securities Act"), in reliance upon this representation and warranty; f. the purchase of the Series A Preferred Stock on the Delivery Date by the Trust for the Purchase Price is for not greater than "adequate consideration" as that phrase is defined in Section 3(18) of ERISA, and any proposed regulations thereunder, and will not constitute a prohibited transaction under Section 406 of ERISA or Section 4975(c) of the Code by reason of the exemptions set forth in Section 408(e) of ERISA and Section 4975(d) (13) of the Code; provided that in making the representations contained in this Section 4(f), the Trustee has relied upon the correctness of the Company's representations contained in Sections 3(g), as limited by the proviso therein, and 3(i) of this Agreement as well as the Valuation Opinion; g. the Series A Preferred Stock purchased by the Trust have a conversion price which is reasonable as of the date hereof; provided, however, that in making the representations contained in this Section 4(g), the Trustee has relied upon the correctness of the Valuation Opinion; and h. no person or other entity is entitled to any commissions due to the Trustee's actions in connection with the purchase and sale of the Series A Preferred Stock. 5. The Trustee hereby (i) acknowledges that the Series A Preferred Stock purchased on behalf of the Trust pursuant to this Agreement may, by their terms, be issued only to the Trustee or a successor trustee acting on behalf of the Trust, (ii) acknowledges that the Trust Agreement provides that none of the Series A Preferred Stock shall be transferred in any manner to participants under the Plan but in lieu thereof shares of Common Stock shall be distributed to participants or transferred to the participants' Section 401(k) accounts pursuant to the terms of the Plan, (iii) acknowledges that the Certificate of Designations provides that any Series A Preferred Stock that are transferred, sold or otherwise disposed of by the Trustee shall be automatically, and without any action on the part of the Company, converted into shares of Common Stock, and (iv) agrees not to transfer, sell or otherwise dispose of any of the Series A Preferred Stock or other shares of Series A Preferred Stock or to attempt to do so, except in compliance with the Trust Agreement. Nothing contained in this Section 5 shall be deemed to restrict the ability of the Trustee to convert shares of Series A Preferred Stock into shares of Common Stock or to require the Company to redeem shares of Series A Preferred Stock, in each case in accordance with the Certificate of Designations, or the ability of the Trustee to transfer, sell or otherwise dispose of shares of Common Stock of the Company issued upon conversion of shares of Series A Preferred Stock or upon a redemption of shares of Series A Preferred Stock. 6. The Trustee understands that the certificate(s) representing the Series A Preferred Stock will bear the following legend and that a notation restricting their transfer will be made on the stock transfer books of the Company: The shares of Series A preferred stock represented by this certificate have not been registered under the Securities Act of 1933, as amended. Such shares of stock may not be sold, assigned, pledged or otherwise transferred in the absence of an effective registration statement under said Securities Act covering such transfer or an opinion of counsel satisfactory to the issuer that registration under said Securities Act is not required. The shares of stock represented by this certificate are subject to restrictions on transfer set forth in the Certificate of Designations relating to the Corporation's Series A ESOP Convertible Preferred Stock and in a Stock Purchase Agreement dated as of January 2, 1998. The Corporation will furnish a copy of such agreement to the holder of this certificate without charge upon written request. 86 7. The Company has at its expense, prepared, filed, and obtained the effectiveness of, and will use its best efforts to cause to remain effective, a registration statement on an appropriate form, including a final prospectus (the "Registration Statement"), under and complying with the Securities Act and the rules and regulations thereunder, relating to the number of shares of the Company's Common Stock into which the Series A Preferred Stock are from time to time convertible or as are acquired upon a redemption or repurchase, including a redemption pursuant to the provisions of Section 7 of the Certificate of Designations, as shall be necessary, in the opinion of counsel to the Company, for the Trustee to carry out its responsibilities under the Plan and Trust Agreement. Whenever shares of Common Stock are so registered, the Company shall also use its best efforts to register or qualify such shares covered by the Registration Statement under the "blue sky" or securities laws of such jurisdictions within the United States as the Trustee may reasonably request; provided, however, that the Company shall not be required to consent to the general service of process for all purposes in any jurisdiction where it is not then qualified to do business. 8. The Company agrees that it will use its best efforts to maintain the qualification of the Plan as an employee stock ownership plan within the meaning of Section 4975(e)(7) of the Code. 9. The representations, warranties and agreements in this Agreement shall survive the date hereof and the Delivery Date. 10. This Agreement shall be governed by and construed in accordance with the laws of the State of Iowa applicable to contracts to be executed, delivered and performed in such state, to the extent not preempted by the laws of the United States of America. The parties hereby irrevocably and unconditionally consent to submit to the exclusive jurisdiction of the courts of the State of Iowa and the United States of America located in Polk County, Iowa for any actions, suits or proceedings arising out of or relating to this Agreement. This Agreement, the Plan and Trust Agreement (including documents referred to therein or delivered pursuant thereto) set forth the entire Agreement of the parties with respect to the subject matter contained herein and supersede all prior oral and written agreements, if any, between the parties with respect to such subject matter. This Agreement shall bind and inure to the benefit of all successors to, and assigns of, the parties hereto; provided, however, that the Trustee shall not assign or otherwise transfer its interest in, or obligations under, this Agreement without the written consent of the Company, except that the Trustee may assign, without the Company's written consent, all its rights hereunder to any institution exercising trust powers in connection with any such institution assuming the duties of a trustee under the Trust Agreement. In the event that any provision of this Agreement shall be declared unenforceable by a court of competent jurisdiction, such provision shall be stricken herefrom and the remainder of this Agreement shall remain binding on the parties hereto. In the event any such provision shall be so declared unenforceable due to its scope or breadth, then it shall be narrowed to the scope or breadth permitted by law. 87 11. This Agreement may be executed in two counterparts, each of which shall be deemed an original, but each of which taken together shall constitute one and the same instrument. 12. This Agreement may not be modified with respect to the obligations of a party hereto except by an instrument in writing signed by such party. 13. The terms and provisions of the Trust Agreement relating to the nature of the responsibilities of the Trustee and the indemnification by the Company of the Trustee are incorporated herein by reference and made applicable to this Agreement. 14. All notices, requests, or other communications required or permitted to be delivered hereunder shall be in writing, delivered to each party hereto at its address specified in the Trust Agreement and shall become effective as therein provided. Any party hereto may from time to time, by written notice given as aforesaid, designate any other address to which notices, requests or other communications addressed to it shall be sent. IN WITNESS WHEREOF, the parties hereto have duly executed and delivered this Agreement as of the date first above written. ALLIED LIFE FINANCIAL CORPORATION By /s/ Samuel J. Wells Name: Samuel J. Wells Title: President STATE STREET BANK AND TRUST COMPANY solely in its capacity as Trustee under the Plan and Trust Agreement referred to herein and not individually By /s/ John Scott Feely Name _________________________ Title ________________________ 88 Annex A January 2, 1998 ALLIED Life Financial Corporation 701 Fifth Avenue Des Moines, Iowa 50391 Re: The ALLIED Life Financial Corporation Employee Stock Ownership Trust Ladies and Gentlemen: We have acted as special counsel for State Street Bank and Trust Company ("State Street"), as trustee (the "Trustee") of The ALLIED Life Financial Corporation Employee Stock Ownership Trust (the "Trust"), which forms a part of The ALLIED Life Financial Corporation Employee Stock Ownership Plan (as amended and restated effective as of January 1, 1996, the "Plan"), and which is evidenced by the Trust Agreement dated June 20, 1994 (the "ESOP Trust Agreement") between the Trustee and ALLIED Life Financial Corporation (the "Company"), in connection with the purchase by the Trustee of _______ shares of Series A ESOP Convertible Preferred Stock of the Company, no par value (the "Preferred Stock") pursuant to the Stock Purchase Agreement dated as of January 2, 1998 between the Company and the Trustee (the "Stock Purchase Agreement"). Capitalized terms used herein that are not defined herein have the meanings set forth in the Stock Purchase Agreement. In connection therewith, we have reviewed executed copies of: (i) the ESOP Trust Agreement and the Stock Purchase Agreement; (ii) the Certificate of Designations of Series A ESOP Convertible Preferred Stock of ALLIED Life Financial Corporation; (iii) the corporate charter and by-laws of State Street, both as amended to date; (iv) other records, documents, and instruments relating to the powers and organization of State Street and to State Street's acceptance of fiduciary duties, obligations and trusts; and (v) such other certificates and documents as we have deemed relevant or necessary as a basis for the opinion expressed below. In our examination, we have assumed without any investigation (i) the legal capacity of each natural person, (ii) the full power and authority of each person other than State Street to execute, deliver and perform its obligations under each document heretofore executed and delivered or hereafter to be executed and delivered and to do each other act heretofore done or hereafter to be done by such person, (iii) the due authorization, execution and delivery by each person other than State Street of each document heretofore executed and delivered or hereafter to be executed and delivered by such person, (iv) the legality, validity, binding effect and enforceability as to each person other than State Street of each document heretofore executed and delivered or hereafter to be executed and delivered and of each other act heretofore done or hereafter to be done by such person, (v) the genuineness of each signature other than those of officers of State Street and the completeness and authenticity of each document submitted to us as an original, (vi) the conformity to the original of each document submitted to us as a copy, (vii) the authenticity of the original of each document submitted to us as a copy and (viii) no amendment or modification hereafter of any provision of any document. Insofar as our opinion relates to, or depends on, any matter of fact, we have relied on representations as set forth in the Stock Purchase Agreement, and upon written statements and certificates of officers of State Street and of public officials. We are members of the Bar of the Commonwealth of Massachusetts and, accordingly, we express no opinion herein concerning any law other than the laws of the Commonwealth of Massachusetts and the Federal laws of the United States of America, to the extent specifically referred to herein. As used in this opinion with respect to any matter, the qualifying phrase "to the best of our knowledge" means that, without independent review or verification, nothing has come to the attention of John J. Cleary or John O. Newell, the attorneys principally responsible for performing legal services for the Trustee with respect to said matter. We express no opinion as to matters governed by the Internal Revenue Code of 1986 (the "Code") or the Employee Retirement Income Security Act of 1974 ("ERISA"), both as amended, or federal or state securities laws. 89 Based on and subject to the foregoing, we are of the opinion that: 1. State Street, acting solely in its capacity as Trustee, has all requisite power and authority to execute, deliver and perform its obligations under the Stock Purchase Agreement. 2. The execution, delivery and performance of the Stock Purchase Agreement by State Street, as Trustee, will not violate the charter or the by-laws of State Street or, to the best of our knowledge, any order, judgment or decree binding on State Street (individually or as trustee). 3. The Stock Purchase Agreement has been duly executed and delivered by State Street, as Trustee. 4. No authorization, approval or consent of, and no filings or registrations with, any governmental or regulatory authority or agency are necessary for the execution, delivery or performance by State Street of the Stock Purchase Agreement or for the validity or enforceability thereof, except for filings with the Internal Revenue Service or the Department of Labor which may from time to time be required by ERISA or the Code. We express no opinion as to any matter other than as expressly set forth above, and no other opinion is intended to be implied nor may be inferred herefrom. The opinions expressed herein are given as of the date hereof and we undertake no obligation hereby and disclaim any obligation to advise you of any change after the date hereof pertaining to any matter referred to herein. Neither this opinion nor any part hereof may be delivered to, used or relied upon by any person or entity other than you without our prior written consent. Very truly yours, GOODWIN, PROCTER & HOAR, LLP 90 Annex B January 2, 1998 State Street Bank and Trust Company Legal Division, Q6N 200 Newport Avenue North Quincy, MA 02171 Ladies and Gentlemen: I have acted as legal counsel of ALLIED Life Financial Corporation, an Iowa corporation (the "Company"), and in such capacity I have advised the Company in connection with The ALLIED Life Financial Corporation Employee Stock Ownership Trust (the "ESOP Trust"), a trust established under that certain Trust Agreement dated June 20, 1994 (the "Trust Agreement"), between the Company and State Street Bank and Trust Company, as trustee (the "Trustee" or "State Street"), which implements and forms a part of the ALLIED Life Financial Corporation Employee Stock Ownership Plan (the "Plan"), and in connection with the purchase by the Trustee of ______ shares of Series A ESOP Convertible Preferred Stock of the Company, no par value (the "Preferred Stock" or "Preferred Shares"), pursuant to the Stock Purchase Agreement between the Company and the Trustee dated January 2, 1998 (the "Stock Purchase Agreement"). Capitalized terms used herein without definition shall have the meanings ascribed to them in the Stock Purchase Agreement. In connection therewith, I have reviewed executed copies of (i) the Stock Purchase Agreement, (ii) the Certificate of Designations in respect to the Series A Preferred Stock (the "Certificate of Designations"), and (iii) such other certificates and documents as I have deemed relevant or necessary as a basis for the opinion expressed below. In such connection, I have assumed the genuineness of all signatures, the authenticity of all documents submitted to me as originals, the conformity to original documents of all documents submitted to me as photostatic or certified copies, and the authenticity of the originals of such copies. I have relied, to the extent I deem such reliance proper, upon representations made in the documents and certificates or representations made in writing by duly authorized representatives of the Company. In rendering the opinions contained herein, I have assumed that (a) State Street, as Trustee, has all requisite power and authority to execute, deliver, and perform its obligations under the Stock Purchase Agreement; (b) that the execution, delivery, and performance of the Stock Purchase Agreement by State Street, as Trustee, will not violate the charter or bylaws of State Street; and (c) that the Stock Purchase Agreement has been executed and delivered by State Street as Trustee and constitutes the legal, valid, and binding obligation of the ESOP Trust, enforceable in accordance with its terms, except as enforcement may be limited by (i) bankruptcy, insolvency, reorganization, or similar laws affecting the enforcement of creditors' rights generally, or (ii) equitable principles of general applicability (regardless of whether such enforceability is considered in a proceeding in equity or law). I express no opinion with respect to the laws of any jurisdiction other than the State of Iowa and the United States of America. These opinions are expressed as of the date hereof and are therefore subject to subsequent interpretive, regulatory, legislative, and judicial developments. 91 Based on and subject to the foregoing, I am of the opinion that: 1. The Company is validly existing and in good standing under the laws of the State of Iowa and has all requisite corporate power to execute, deliver, and perform the Stock Purchase Agreement. The Company has taken all necessary corporate action to authorize the execution, delivery, and performance of the Stock Purchase Agreement. 2. The Stock Purchase Agreement has been duly executed and delivered by the Company and is the legal, valid, and binding agreement of the Company, enforceable against the Company in accordance with its respective terms, except as the enforceability thereof may be limited by (i) bankruptcy, insolvency, reorganization, moratorium, fraudulent conveyance, or similar laws affecting the enforcement of creditors' rights generally or (ii) equitable principles of general applicability (regardless of whether such enforceability is considered in a proceeding in equity or at law). 3. The Preferred Shares have the rights, preferences, and qualifications set forth in the Certificate of Designations, have been validly authorized, and upon payment therefor as provided in the Stock Purchase Agreement, will be validly issued and outstanding and will constitute fully-paid and nonassessable shares of Series A ESOP Convertible Preferred Stock of the Company. The shares of the Company's common stock, no par value ("Common Stock") initially reserved for issuance and to be issued upon conversion of the Preferred Shares in accordance with their terms have been duly and validly authorized and are sufficient in number for conversion of all the Preferred Shares, and such Common Stock, when so issued upon such conversion, will be duly and validly issued, fully-paid, and nonassessable. 4. Upon payment by the Trust as provided in the Stock Purchase Agreement, the Company will convey to the Trust good and valid title to the Preferred Shares free and clear of any liens, claims, security interests, and encumbrances, except for beneficial interests accruing to Plan participants and their beneficiaries. 5. As of the date hereof, the Plan and the ESOP Trust in form meet in all material respects (a) the applicable requirements of Section 401(a) of the Internal Revenue Code of 1986, as amended (the "Code"), (b) the requirements applicable to an employee stock ownership plan for purposes of Section 4975(e)(7) of the Code and the regulations promulgated thereunder, and (c) the requirements for exemption from tax under Section 501(a) of the Code. 6. The shares of Preferred Stock to be purchased by the ESOP Trust constitute "employer securities" within the meaning of Section 409(1) of the Code and "qualifying employer securities" within the meaning of Section 407(d)(5) of ERISA. 7. The shares of Preferred Stock to be purchased by the ESOP Trust have voting rights equivalent to the common stock into which such shares may be converted, and the Plan meets the voting rights requirements of Section 409(e)(2) of the Code with respect to such shares. 92 In rendering the foregoing opinions and any other opinions expressed in this letter, I have relied on the following assumptions: a. Except as to matters expressly opined on herein, the Plan and ESOP Trust have been, and will continue to be, administered and operated at all times strictly in accordance with their terms and with all requirements of applicable law including, but not limited to, all of the requirements applicable to a qualified plan under Section 401(a); the requirements applicable to an "employee stock ownership plan" (within the meaning of Section 4975(e)(7)) under Section 4975 and 409 of the Code; and the requirements applicable to a tax-exempt trust under Section 501(a); and with the provisions of ERISA and all regulations thereunder. b. The conversion price at which the shares of Preferred Stock may be converted to common stock of the Company is reasonable as of the date of acquisition of such Preferred Stock by the ESOP Trust. c. No fiduciary of the Plan has received any consideration of the type described in Section 4975(c)(1)(F) of the Code and Section 406(b)(3) of ERISA in connection with the transactions described herein. d. The fiduciaries of the Plan and the ESOP Trust have acted prudently and in good faith, and have given appropriate consideration to those facts and circumstances that are relevant to the transactions in accordance with the fiduciary requirements of part 4 of Title I of ERISA. In connection with the assumptions made in paragraph (b) above, I understand that the Trustee has received an opinion from Houlihan Lokey Howard & Zukin to the effect that (i) the price to be paid by the ESOP Trust per share of Preferred Stock is not in excess of fair market value or adequate consideration, as defined under Title I of the Employee Retirement Income Security Act of 1974, as amended, including the regulations thereunder ("ERISA"); and (ii) the terms and conditions of the proposed transaction, including the terms governing the right to convert the Preferred Stock into Common Stock of the Company, are fair and reasonable to the ESOP Trust from a financial point of view. These opinions are rendered solely to the Trustee in connection with the transactions of the Trustee contemplated by the Stock Purchase Agreement. No other person, firm, or corporation may rely upon these opinions for any purpose without my prior written consent. Yours very truly, Katherine E. Schmidt Associate Corporate Counsel 93 Exhibit 11 ALLIED Life Financial Corporation and Subsidiaries COMPUTATION OF PER SHARE EARNINGS For the years ended December 31, 1997, 1996, and 1995 1997 1996 1995 (In thousands, except per share data) Numerator Net income $ 10,473 $ 8,073 $ 9,712 Preferred stock dividends (1,717) (1,601) (1,493) Numerator for basic earnings per share - income available to common stockholders 8,756 6,472 8,219 Effect of diluted securities Convertible preferred stock dividends 107 95 85 Numerator for diluted earnings per share - income available to common stockholders after assumed conversion $ 8,863 $ 6,567 $ 8,304 Denominator Denominator for basic earnings per share - weighted average shares 4,430 4,580 4,613 Effect of dilutive securities Stock options 35 36 34 Convertible preferred stock 107 96 85 Dilutive potential common shares 142 132 119 Denominator for diluted earnings per share - adjusted weighted average shares and assumed conversions 4,572 4,712 4,732 Basic earnings per share $ 1.98 $ 1.41 $ 1.78 Diluted earnings per share $ 1.94 $ 1.39 $ 1.75 94 Exhibit 21 ALLIED Life Financial Corporation and Subsidiaries SUBSIDIARIES OF THE REGISTRANT As of March 1, 1998 ALLIED LIFE FINANCIAL CORPORATION 42-1406716 ALLIED Life ALLIED Life ALLIED Group Insurance Brokerage Merchant Banking Company Agency, Inc. Corporation 42-0921353 42-1285968 42-1341874 95 Exhibit 23 CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS The Board of Directors and Stockholders ALLIED Life Financial Corporation We consent to incorporation by reference in the Registration Statement Nos. 33-71906, 33-71960, 33-71962, 33-76874 and 33-83274 on Form S-8, and 33-92206 on Form S-3 of ALLIED Life Financial Corporation of our reports dated February 12, 1998 relating to the consolidated balance sheets of ALLIED Life Financial Corporation and subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of earnings, stockholders' equity and cash flows and related schedules for each of the years in the three-year period ended December 31, 1997, which appears in the December 31, 1997, annual report on Form 10-K of ALLIED Life Financial Corporation. /s/KPMG Peat Marwick LLP KPMG Peat Marwick LLP Des Moines, Iowa March 20, 1998 96 -----END PRIVACY-ENHANCE