Allied Life Financial: 10-Q for Quarter to 6/30/98 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 Form 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 1998 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) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes [ x ] No [ ] Indicate the number of outstanding shares of each of the issuer's classes of common stock, as of August 1, 1998: 4,450,269 shares of Common Stock. This document contains 18 pages. PART I Item 1. Financial Statements ALLIED Life Financial Corporation and Subsidiaries Consolidated Balance Sheets June 30, December 31, 1998 1997 (In thousands) Assets Investments Fixed maturities available for sale, at fair value $ 814,004 $ 766,028 Equity securities at fair value 4,667 3,201 Mortgage loans on real estate 825 984 Policy loans 11,407 11,164 Other invested assets 2,649 3,014 Short-term investments, at cost 1,968 3,594 Total investments 835,520 787,985 Accrued investment income 11,266 10,988 Accounts receivable 799 912 Reinsurance ceded receivables 6,805 7,168 Deferred policy acquisition costs 85,404 84,188 Other assets 16,476 13,216 Total assets $ 956,270 $ 904,457 See accompanying Notes to Interim Consolidated Financial Statements. 1 ALLIED Life Financial Corporation Subsidiaries Consolidated Balance Sheets June 30, December 31, 1998 1997 (In thousands) Liabilities Policy liabilities Policyholder account balances Annuity contracts $ 537,960 $ 514,908 Universal life contracts 202,690 196,709 Other 8,853 7,732 Future policy benefits 41,561 38,124 Policy and contract claims 5,461 4,102 Other policyholder funds 2,162 1,778 798,687 763,353 Checks drawn in excess of bank balances 1,490 2,066 Current income taxes payable ------ 23 Deferred income taxes 12,524 10,552 Indebtedness to affiliates (note 2) 2,170 3,638 Note payable (note 3) 17,570 6,360 Other liabilities (note 6) 5,845 4,308 Total liabilities 838,286 790,300 Stockholders' equity Preferred stock, no par value, issuable in series, authorized 7,500 shares 6.75% Series, authorized 2,440 shares, issued and outstanding of 2,370 in 1998 and 2,292 in 1997 25,716 24,869 ESOP Series, authorized 300 shares, issued and outstanding of 99 in 1998 and 101 in 1997 1,522 1,467 Common stock, no par value, $1 stated value, authorized 25,000 shares, issued and outstanding of 4,438 in 1998 and 4,398 in 1997 4,438 4,398 Additional paid-in capital 45,573 44,964 Retained earnings 30,353 29,404 Accumulated other comprehensive income 10,382 9,055 Total stockholders' equity 117,984 114,157 Total liabilities and stockholders' equity $ 956,270 $ 904,457 See accompanying Notes to Interim Consolidated Financial Statements. 2 ALLIED Life Financial Corporation and Subsidiaries Consolidated Statements of Income and Comprehensive Income Three Months Ended Six Months Ended June 30, June 30, 1998 1997 1998 1997 (In thousands, except per share data) Revenues Insurance revenues Policyholder assessments on universal life contracts $ 5,633 $ 5,430 $ 11,354 $ 10,813 Surrender charges 1,217 605 2,154 1,225 Life insurance premiums 3,869 3,652 8,191 6,898 Other insurance income 2,521 1,353 4,606 2,577 Reinsurance premiums ceded (3,538) (2,453) (6,770) (4,751) Total insurance revenues 9,702 8,587 19,535 16,762 Investment income 13,887 12,852 27,630 25,535 Realized investment gains (losses) 349 140 514 (253) Other income 380 339 797 662 24,318 21,918 48,476 42,706 Benefits and Expenses Policyholder benefits Interest credited to policyholder account balances Annuity contracts 7,342 6,437 14,624 12,621 Universal life contracts 2,662 2,488 5,281 5,181 Other 108 89 181 215 Death benefits 3,584 2,078 6,783 4,884 Other policyholder benefits 1,638 1,339 4,114 2,544 Reinsurance recoveries (494) (95) (2,043) (383) Total policyholder benefits 14,840 12,336 28,940 25,062 Amortization of deferred policy acquisition costs 2,881 2,557 5,353 4,713 Commissions 1,403 1,012 2,712 1,884 Affiliated operating expenses 148 158 315 301 Other operating expenses (notes 4 and 6) 2,897 1,838 6,973 3,538 22,169 17,901 44,293 35,498 Income before income taxes 2,149 4,017 4,183 7,208 Income Taxes Current (362) 1,918 459 2,242 Deferred 1,385 (580) 1,256 160 1,023 1,338 1,715 2,402 Net Income 1,126 2,679 2,468 4,806 Unrealized holding gain arising during the period, net of income tax 1,751 11,223 1,326 6,382 Comprehensive Income $ 2,877 $ 13,902 $ 3,794 $ 11,188 Net income applicable to common stock (diluted basis) $ 700 $ 2,280 $ 1,621 $ 4,014 Earnings Per Share Basic earnings per share $ 0.15 $ 0.51 $ 0.36 $ 0.89 Diluted earnings per share $ 0.15 $ 0.50 $ 0.36 $ 0.87 See accompanying Notes to Interim Consolidated Financial Statements 3 ALLIED Life Financial Corporation and Subsidiaries Consolidated Statements of Cash Flows Six Months Ended June 30, 1998 1997 (Dollars in thousands) Cash Flow From Operating Activities Net income $ 2,468 $ 4,806 Adjustments to reconcile net income to net cash provided by operating activities Policyholder assessments on universal life contracts (11,354) (10,813) Surrender charges (2,154) (1,225) Interest credited to policyholder account balances 21,513 18,017 Realized investment (gains) losses (514) 252 Change in Accrued investment income (278) (314) Reinsurance ceded receivables 363 177 Deferred policy acquisition costs (3,183) (3,541) Liabilities for future policy benefits 3,437 1,967 Policy and contract claims and other policyholder funds 1,744 284 Current income taxes (1,182) (1,836) Deferred income taxes 1,256 159 Other, net (288) (1,335) Net cash provided by operating activities 11,828 6,598 Cash Flows from Investing Activities Purchase of fixed maturities held to maturity ------ (7,594) Maturities, calls, and principal reductions of fixed maturities held to maturity ------ 8,022 Purchase of fixed maturities available for sale (174,287) (99,272) Proceeds from sale of fixed maturities available for sale 93,282 71,304 Maturities, calls, and principal reductions of fixed maturities available for sale 37,776 11,035 Purchase of equity securities (1,840) (3,046) Proceeds from sale of equity securities 373 1,146 Proceeds from repayment of mortgage loans 159 335 Change in policy loans, net (243) (462) Purchase of property, plant, and equipment (1,152) (1,713) Net cash used in investing activities (45,932) (20,245) Cash Flows from Financing Activities Change in checks drawn in excess of bank balances (576) (682) Deposits to policyholder account balances 55,980 55,296 Withdrawals from policyholder account balances (32,914) (38,099) Change in note payable, net 11,210 (1,590) Change in note payable to affiliate (1,254) 2,228 Proceeds from issuance of stock, net 704 555 Repurchase of stock ---- (2,478) Dividends paid to stockholders (672) (587) Net cash provided by financing activities 32,478 14,643 Net (Decrease) Increase in Cash and Short-term Investments (1,626) 996 Cash and short-term investments at beginning of year 3,594 920 Cash and short-term investments at end of quarter $ 1,968 $ 1,916 See accompanying Notes to Interim Consolidated Financial Statements 4 ALLIED Life Financial Corporation and Subsidiaries Notes to Interim Consolidated Financial Statements (1) Summary of Significant Accounting Policies The accompanying consolidated financial statements include the accounts of ALLIED Life Financial Corporation (ALFC) and its subsidiaries on a consolidated basis (the Company). At June 30, 1998, ALLIED Mutual Insurance Company (ALLIED Mutual), an affiliated property-casualty insurance company, controlled 56% of the voting stock of ALLIED Life Financial Corporation and the ALLIED Life Financial Corporation Employee Stock Ownership Trust owned 1%. The remainder was owned by public stockholders. The accompanying interim consolidated financial statements should be read in conjunction with the following notes and with the Notes to Consolidated Financial Statements included in the ALLIED Life Financial Corporation's Annual Report on 10K for the year ended December 31, 1997. The interim consolidated financial statements have been prepared in conformity with generally accepted accounting principles (GAAP) and include all adjustments which are in the opinion of management necessary for a fair presentation of the results for the interim periods. In the opinion of management, all such adjustments are of a normal and recurring nature. All significant intercompany balances and transactions have been eliminated. (2) Transactions with Affiliates The Company and its affiliates pool their excess cash pursuant to the Intercompany Cash Concentration Fund Agreement. The fund, administered by AID Finance Services, Inc. (an affiliate of the Company), also issues short-term loans (30 days or less) to affiliated companies in accordance with the current intercompany borrowing policy. At June 30, 1998, the Company had a net investment balance in the intercompany fund of $1.8 million. Pursuant to the Agreement, AID Finance Services, Inc. receives a management fee of 5 basis points which the fund participants pay in the form of an additional 0.05% in the interest rate for borrowings and a 0.05% reduction in the interest rate on invested funds. ALLIED Life Financial Corporation has a note payable with ALLIED Mutual. At June 30, 1998 the outstanding balance of the note payable was $2.1 million. (3) Note Payable to Nonaffiliates ALLIED Life Insurance Company, a wholly owned subsidiary, has a line of credit agreement with the Federal Home Loan Bank (FHLB) to make available borrowings of $25 million. Interest is payable at either an adjustable interest rate with the interest rate set and charged daily on the outstanding advance amount or at a fixed rate with the interest rate set at issuance. As of June 30, 1998, borrowings on this line of credit agreement were $17.6 million at an interest rate of 6.37% per annum. All borrowings with the FHLB are secured by securities with a carrying value of $31.2 million. (4) Merger with Nationwide On June 3, 1998, ALFC announced that it had entered into an Agreement and Plan of Merger to be acquired by Nationwide Mutual Insurance Company (Nationwide) at a price of $30 per share cash for its common stock. The transaction is subject to regulatory approvals and, if required, approval by the ALFC shareholders. The transaction is structured as a tender offer for all of the outstanding shares of common stock of ALFC, to be followed by a second-stage merger of a subsidiary of Nationwide with and into ALFC. During the quarter, the Company incurred, net of tax, $921,000 ($0.20 per share) in merger related expenses ($955,000 pretax - included in Other operating expenses). 5 ALLIED Life Financial Corporation and Subsidiaries Notes to Interim Consolidated Financial Statements (continued) (5) New Accounting Standards In June of 1997, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (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. The Company adopted SFAS 130 on January 1, 1998. This statement requires 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. The Company adopted SFAS 131 on January 1, 1998. This statement requires revised and additional disclosures but has no effect on the results of operations or the financial position of the Company. The Company considers its combined life insurance and annuity operations to be its only material operating segment. In June of 1998, the FASB issued SFAS 133, "Accounting for Derivative Instruments and Hedging Activities," effective for fiscal quarters beginning after June 30, 1999. SFAS 133 establishes accounting and reporting standards for derivative instruments and hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure the instruments at fair value. Early application is encouraged, but is permitted only as of the beginning of any fiscal quarter that begins after issuance of this statement. SFAS 133 shall not be applied retroactively. Management has not determined the impact of SFAS 133 on the financial position, results of operations, or liquidity of the Company at this time. (6) Litigation Reserve The Company announced in January, 1998 that a complaint had been filed by a policyholder of ALLIED Life Financial Corporation's principal subsidiary, ALLIED Life Insurance Company ("ALLIED Life"), in Superior Court in the State of California for the County of Los Angeles. The Complaint was cast as a class action and alleged 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 obligation, 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. While the outcome of the litigation remains uncertain, the Company has estimated that a reasonable range of costs with respect to this litigation, including attorney fees, would be, on an after tax basis, $700,000 to $1.5 million. Accordingly, in the first quarter of 1998, the Company recorded an after tax reserve in the amount of $1.3 million ($2.0 million pretax - included in Other operating expenses) in connection with the lawsuit. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Forward-looking Information Management's estimates, beliefs and anticipations in the following discussion and in Note 6 of the Notes to Interim Financial Statements are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 (Reform Act). Investors are cautioned that there are important factors that could cause actual results to differ materially from those in these forward-looking statements. These factors include, but are not limited to (1) risks and uncertainties relating to the pending tender offer by Nationwide Mutual 6 Insurance Company for shares of the Company's common stock and the pending merger of a subsidiary of Nationwide Mutual Insurance Company into and with the Company, including the risks that the tender offer and merger are not consummated; (2) heightened competition, particularly intensified price competition, the entry of new competitors from the financial services sector, and the creation of new products by competitors; (3) 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; (4) changes in interest rates causing a reduction of investment income; (5) general economic and business conditions that are less favorable than expected; (6) unanticipated changes in industry trends; and (7) inaccuracies in assumptions regarding future morbidity, persistency, morality, and interest rates, and 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 the interim consolidated financial statements and related footnotes included elsewhere herein, and with the Company's Annual Report on Form 10-K for the year ended December 31, 1997. ALLIED Life Financial Corporation (ALFC) is an insurance holding company. 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 universal life insurance, term life insurance, and annuity products. 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 periods indicated. Life Insurance Operations Three Months Ended Six Months Ended June 30, June 30, 1998 1997 1998 1997 (Dollars in thousands) Production information Life insurance Face amount in force Directly produced by agents Universal Life $ 4,459,617 $ 4,485,388 Term life 4,789,323 4,468,907 Whole life 50,935 50,630 9,299,875 9,004,925 Other 411,605 378,839 $ 9,711,480 $ 9,383,764 Face amount of new life insurance sold Directly produced by agents Universal Life $ 80,981 $ 141,707 $ 170,516 $ 299,346 Term life 267,916 358,491 566,670 630,678 Whole life 1,282 2,723 3,582 4,479 350,179 502,921 740,768 934,503 Other 2,241 1,475 4,048 3,249 $ 352,420 $ 504,396 $ 744,816 $ 937,752 Termination rate Universal Life 13.6% 6.4% 12.4% 6.6% Term life 17.2% 16.5% 16.9% 16.9% Annuities Account balance $ 537,960 $ 484,569 First-year annuity premiums $ 12,945 $ 18,933 $ 32,638 $ 32,957 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued) Life Insurance Operations (Continued) Three Months Ended Six Months Ended June 30, June 30, 1998 1997 1998 1997 (Dollars in thousands) Profitability Investment income $ 13,876 $ 12,840 $ 27,600 $ 25,512 Interest credited on Annuities 7,342 6,437 14,624 12,858 Universal life 2,662 2,488 5,281 4,944 Other 108 89 181 215 Total interest expense 10,112 9,014 20,086 18,017 Investment spread 3,764 3,826 7,514 7,495 Fee income Universal life charges 6,613 5,831 13,111 11,669 Annuity surrender charges 237 204 396 369 Total fee income 6,850 6,035 13,507 12,038 Other insurance income 2,852 2,552 6,028 4,724 Adjusted insurance revenues 13,466 12,413 27,049 24,257 Other expenses Amortization of deferred policy acquisition costs (1) 2,689 2,486 5,075 4,922 Commissions 1,173 805 2,207 1,493 Other operating expenses 1,846 1,730 3,749 3,322 Administrative fees 196 127 379 247 Litigation reserve ---- ---- 2,000 ---- Total acquisition and operating expenses 5,904 5,148 13,410 9,984 Death benefits, net 3,342 1,968 5,324 4,294 Other policyholder benefits, net 1,386 1,353 3,530 2,751 Total other expenses 10,632 8,469 22,264 17,029 Income before income taxes and realized investment gains (losses) from insurance operations $ 2,834 $ 3,944 $ 4,785 $ 7,228 (1)Excludes amortization of deferred policy acquisition costs resulting from net realized investment gains(losses). PROPOSED MERGER WITH NATIONWIDE MUTUAL INSURANCE COMPANY On June 3, 1998, the Company announced it had entered into a Merger Agreement with Nationwide that provides for the acquisition of all of the outstanding common stock of the Company by Nationwide pursuant to a tender offer at a price of $30.00 per share cash for its common stock (the "Offer") to be followed by the merger of an acquisition subsidiary of Nationwide with and into the Company, in which the shareholder (other than Nationwide, its acquisition subsidiary and shareholders validly exercising dissenters' rights of appraisal) 8 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued) would receive $30.00 in cash per share (the "Merger"). The Board of Directors ("Board") had unanimously approved the Offer and had determined that the terms of the Offer and the Merger are fair to and in the best interest of the Company's stockholders. The Board unanimously recommended that the Company's stockholders accept the Offer and tender their shares. Nationwide's obligations to consummate the Offer and the Merger and to purchase and pay for the shares are subject to a number of conditions, including, without limitation, the condition that all insurance regulatory approvals necessary for Nationwide's acquisition of control of the Company and its insurance subsidiaries are obtained on terms and conditions reasonably satisfactory to Nationwide. On June 10, 1998, Nationwide filed a Schedule 14D-1, a tender offer statement pursuant to Section 14 (D) (1) of the Securities Exchange Act of 1934, with the Securities and Exchange Commission ("SEC"). On June 10, 1998, the Company filed a Schedule 14D-9, Solicitation/Recommendation Statement, with the SEC. In conjunction with the tender offer by Nationwide, the Board of Directors of the Company, acting upon the recommendation of the Compensation Committee (Compensation Committee) of the Board, amended or approved of the adoption of several officer or employee related benefits. Upon a change in control, both the Company's Executive Stock Option Plan and Long-Term Management Incentive Plan will automatically vest all participants who hold unexercised stock options. The options will be settled in cash computing the amount to pay using the tender offer price of $30 less the strike price on each option. The Company will not incur the expense for the cash settlement of the options until the change in control occurs and estimates the amount to be approximately $2.4 million. The Compensation Committee approved of severance pay plans applicable to the Company's salaried and hourly employees as well as approved of the Company entering into separate severance agreements with executive officers and certain other employees of the Company. The severance pay plans will pay lump sum amounts and provide certain health benefits to employees and executive officers who are terminated, whose employment has been adversely affected, or who resign with the Company's approval following a change in control. The Company at this time can not estimate the amount of expense, if any, that will be incurred in relation to these severance plans. The Compensation Committee amended the Company's Employee Stock Ownership Plan (ESOP) to provide that employees in the ESOP will be fully vested in their accounts upon the occurrence of a change in control. Also, in the event of a change in control, the amendment provides that the Company will make an employer contribution to the ESOP in the form of cash equal to the value of certain minimum allocation requirements as defined by the plan for the plan year. The Company has determined that the additional expense to be incurred due to these amendments will be immaterial. In the second quarter, the Company incurred merger related expenses, pre-tax, of $955,000. Included in these expenses are two items that were the result of Board of Director action. They include the amending of the Short Term Management Incentive Plan to provide that in the event of a change in control that certain bonus amounts will be paid to participants regardless of actual level of growth or earnings per share. This was done to account for the fact that the Company has incurred large expenses in regards to the proposed merger and there would be a remote possibility of earnings per share goals being reached. Also, the Board of Directors approved of a retention bonus plan to which each employee of the Company (excluding any officer of the Company or ALLIED Life) who remains in the Company's employ through November 30, 1998, will receive a bonus in the amount equal to such employee's bi-weekly base salary to be paid as soon as practicable after November 30, 1998 but not later than December 15, 1998. Effective August 1, 1998, due to the pending merger, the Company suspended further purchases under its Employee Stock Purchase Plan, Outside Director Stock Purchase Plan and Dividend Reinvestment, and Stock Purchase Plan. 9 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued) RESULTS OF OPERATIONS Consolidated revenues for the six months ended June 30, 1998 were $48.5 million, a 13.5% increase over the $42.7 million reported for the first six months of 1997. Investment income rose 8.2% to $27.6 million from $25.5 million. For the second quarter only, consolidated revenues grew 11% to $24.3 million in 1998 from $21.9 million in 1997. Investment income rose 8.1% to $13.9 million from $12.9 million. Operating income decreased 45.6% to $3.9 million from $7.3 million for the six months ended 1998 and 1997, respectively. Net income decreased 48.6% to $2.5 million ($0.36 per common share) from $4.8 million ($0.87 per common share) for the same time periods. These decreases were due to three factors. The Company incurred $955,000 in the second quarter for merger related expenses due to the Agreement and Plan of Merger with Nationwide Mutual Insurance Company. For further information on the merger see note 4 to Notes to Interim Consolidated Financial Statements. The Company also incurred higher than expected death benefits for the second quarter (see Life Insurance Operations below). Finally, during the first quarter of 1998, the Company established a $2.0 million reserve for potential litigation expenses (see note 6 to Notes to Interim Consolidated Financial Statements). Operating earnings per common share for the first six months of 1998 were $0.33 compared to $0.88 for the first six months of 1997. For the second quarter only, operating income decreased 49.5% to $2.0 million from $3.9 million. Net income decreased to $1.1 million ($0.15 per common share) from $2.7 million ($0.50 per common share) for the same time periods. Operating earnings per common share for the second quarter of 1998 were $0.13 compared to $0.50 for the second quarter of 1997. Life Insurance Operations The following analysis of life insurance operations should be read with reference to the preceding tables. Total life insurance in force grew 3.5% to $9.7 billion at June 30, 1998 from $9.4 billion at June 30, 1997. Growth was slowed by lower sales and a greater termination rate in relation to universal life insurance. The face amount of new life insurance sold directly by agents through June 30, 1998 decreased 20.7% to $740.8 million from $934.5 million through June 30, 1997. The primary factor was a 43% decrease in the face amount of new universal life insurance sold to $170.5 million from $299.3 million. For the second quarter only, the face amount of new universal life insurance sold decreased 42.9% to $81 million from $141.7 million. Universal life policyholder account balances were up 6.8% to $202.7 million from $189.8 million. The universal life termination rate will continue to run higher than historic levels for 1998 and 1999 as a result of higher expected lapses on the Champion Universal Life product which was sold in 1993 and 1994. About 50% of the Champion business was sold at a low term-like premium level, which increases to a more normal permanent life insurance premium level beginning after the fifth policy anniversary date. This block of business is expected to lapse at a higher rate as the customer is required to pay the higher premium levels. The minimum premium level Champion product was originally priced with a higher expected 6th year lapse ratio. The Company has an active conservation program to retain the minimum premium Champion business, which includes offering term life insurance products or a low minimum premium universal life policy. The face amount of new term life insurance sold directly by agents decreased 10.2% to $566.7 million through June 30, 1998 from $630.7 million through June 30, 1997. For the second quarter only, the face amount of new term life insurance sold decreased 25.3% to $267.9 million from $358.5 million. 10 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued) First-year annuity premiums decreased to $32.6 million through June 30, 1998 from $33 million through June 30, 1997. For the second quarter only, first year annuity premiums decreased 31.6% to $12.9 million from $18.9 million. The total annuity account balance increased 11% to $538 million at June 30, 1998 from $484.6 million at June 30, 1997. The decrease in sales of life insurance and annuity premiums are due to the fact that merger related events leading up to the proposed Plan of Merger caused uncertainties in the minds of the field producers which resulted in new production for the quarter at less than expected levels. A series of meetings with agents are being held to address their questions, and management currently expects, after the close of the contemplated transaction, future new business to return to more historic levels. Adjusted insurance revenues increased 11.5% to $27 million for the first six months of 1998 from $24.3 million for the first six months of 1997. The growth in annuity account balances permitted invested assets, on a cost basis, to increase by 9.0%. ALLIED Life's return on invested assets through June 30, 1998 decreased to 7.19% from 7.26% through June 30, 1997. Investment spread for the first six months of 1998 and 1997 remained at $7.5 million. For second quarter 1998 and 1997 only, the investment spread remained at $3.8 million. Annual average interest-credited rates on universal life contracts decreased to 5.28% from 5.30% and on annuities increased to 5.54% from 5.41%. Amortization of deferred policy acquisition costs for the first six months of 1998 and 1997 increased 3.1% to $5.2 million from $4.9 million. For the second quarter only, amortization of deferred policy acquisition costs increased 8.2% to $2.7 million from $2.5 million. Through the first six months other operating expenses increased 12.8% to $3.7 million from $3.3 million. For the second quarter only, operating expenses grew 6.7% to $1.8 million from $1.7 million. Death benefits net of reinsurance for the first six months of 1998 and 1997 increased 24% to $5.3 million ($0.57 per common share) from $4.3 million ($0.46 per common share). For the second quarter only, death benefits net of reinsurance increased 69.8% to $3.3 million ($0.36 per common share) from $2 million ($0.21 per common share). Other policyholder benefits net of reinsurance increased 28.3% to $3.5 million from $2.8 million. For the second quarter only, they remained at $1.4 million. In January, 1998 a lawsuit was filed by a policyholder of ALLIED Life related to a universal life insurance policy DAC tax (see note 5 to Notes to Interim Consolidated Financial Statements). The outcome of the litigation remains uncertain but the Company established a reserve in the first quarter of 1998 of $2.0 million ($1.3 million after tax) to cover potential expenses related to the lawsuit. ALLIED Life's operating income through June 30, 1998 and 1997 decreased 33.8% to $4.8 million from $7.2 million. For the second quarter only, operating income decreased 28.1% to $2.8 million from $3.9 million. For the year to date the Company has experienced higher death benefits which combined with the litigation reserve has caused operating income to be substantially lower. Higher death benefits and a lower investment spread are the main reasons operating income for the quarter is lower. 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. 11 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued) The Company has assessed its computer systems as they relate to the year 2000 issue. The Company has formulated a plan which management believes will resolve the issue. This plan is being updated and revised as additional information becomes available. The Company currently has both internal personnel and external consultants implementing the plan and believes resources dedicated to the problem are sufficient. The Company believes that testing of the systems will be finalized before the year 2000 and should not have a significant effect on the Company's ability to conduct business in a reasonable fashion. The Company estimates that total external related costs still to be incurred related to the year 2000 issue will range between $400,000 and $900,000. LIQUIDITY AND CAPITAL RESOURCES Consolidated Life insurance companies generally produce a positive cash flow from operations. Its adequacy is measured by the companies' 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 for the second quarter 1998 and cash inflows were at levels sufficient to meet its obligations. The Company's cash inflows consist primarily of deposits to policyholder account balances, income 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 typically are met from normal annual premium and net investment cash inflows. For the first six months of 1998 the Company operations provided cash inflows of $11.8 million and financing activities provided cash inflows of $32.5 million. For the first six months of 1997 it was $6.6 million and $14.6 million, respectively. These 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 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 mortgage-backed securities, and its insurance products is believed by management to be adequate to meet anticipated short-term and long-term benefit and expense payment obligations. A source of cash flows for the holding company is dividend payments from ALLIED Life. Through the second quarter of 1998, the Company paid cash dividends on common stock of $619,000. ALLIED Life paid to the Company dividends of $1.1 million to fund the Company's dividend requirements and its note payment on the indebtedness to affiliates. The Company has a line of credit agreement that provides additional liquidity. The agreement makes $25 million available through March 13, 1999. Interest is payable at a current rate upon issuance. From time to time, the Company has also borrowed funds from its affiliates on an arms-length basis. At June 30, 1998, the Company had outstanding borrowings of $17.6 million under the line of credit agreements and $2.1 million from affiliates. 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 and believes the total is adequate to meet expected cash obligations. As of June 30, 1998, 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. 12 PART II Item 4. Submission of Matters to a Vote of Security Holders (a) The Annual Meeting of Stockholders was held on May 5, 1998. (b) James W. Callison and Dennis H. Kelly, Jr., were elected to serve as directors of the Company for a term of three years which expires in 2001. A current director whose term expires in 1999 is John E. Evans. Current directors whose terms expire in 2000 are Harold S. Evans and George D. Milligan. (c) With respect to the voting on the election of directors: For Withheld Broker Non Votes James W. Callison 6,459,943 710 0 Dennis H. Kelly Jr. 6,459,943 710 0 (d) None Item 6. Exhibits and Reports on Form 8-K (a) Exhibit 2.1 - Agreement and Plan of Merger, dated June 3, 1998, among Nationwide Mutual Insurance Company, Nationwide Life Acquisition Corporation, and the Company, incorporated by reference to Exhibit 2 to the Schedule 14D-9 of the Company, dated June 10, 1998. Exhibit 11 - Statement re Computation of Per Share Earnings. Exhibit 27 - Financial Data Schedule (b) The Company filed two reports on Form 8-K during the second quarter ended June 30, 1998. Items Financial Date Reported Statements Filed Item 5 -- Other None June 3, 1998 Item 5 -- Other None June 4, 1998 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. ALLIED Life Financial Corporation (Registrant) Date: August 13, 1998 By: /s/ Wendell P. Crosser ---------------------------------------------- Wendell P. Crosser, Vice President and Treasurer (Principal Financial Officer and Principal Accounting Officer) 13 Exhibit 11 ALLIED Life Financial Corporation and Subsidiaries COMPUTATION OF PER SHARE EARNINGS Three Months Ended Six Months Ended June 30, June 30, 1998 1997 1998 1997 (In thousands, except per share data) Numerator Net income $ 1,126 $ 2,679 $ 2,468 $ 4,806 Preferred stock dividends (453) (426) (900) (792) Numerator for basic earnings per share - income available to common stockholders 673 2,253 1,568 4,014 Effect of diluted securities Convertible preferred stock dividends 27 27 53 54 Numerator for diluted earnings per share - income available to common stockholders after assumed conversion $ 700 $ 2,280 $ 1,621 $ 4,068 Denominator Denominator for basic earnings per share - weighted average shares 4,422 4,446 4,413 4,474 Effect of dilutive securities Stock options 46 28 38 30 Convertible preferred stock 103 108 107 108 Dilutive potential common shares 149 136 145 138 Denominator for diluted earnings per share - adjusted weighted average shares and assumed conversions 4,571 4,582 4,558 4,612 Basic earnings per share $ 0.15 $ 0.51 $ 0.36 $ 0.89 Diluted earnings per share $ 0.15 $ 0.50 $ 0.36 $ 0.87 14 This Financial Data Statement has been filed with earnings per share restated for the applicable years in accordance with SFAS 128. This Financial Data Statement has been filed with earnings per share restated for the applicable years in accordance with SFAS 128. End